PrefBlog

There were no surprises with Canadian inflation:

Statistics Canada reported Friday that the country’s inflation rate, as measured by the year-over-year change in the CPI, held steady at 1 per cent in October, as slumping energy costs continued to suppress an otherwise generally rising tide for consumer prices. The CPI edged up a thin 0.1 per cent in October over September, despite gains in most major categories, including a 0.4-per-cent rise in food prices and a 0.3-per-cent increase in shelter costs. But gasoline prices slid 2 per cent month over month, leaving them down 17 per cent compared with a year earlier.

Excluding the energy sector, CPI was up 0.2 per cent month over month, and 2.1 per cent year over year, the statistical agency said.
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But economists noted that the days of below-normal inflation rates are numbered – simply because the plunge in energy prices is about to drop out of the year-to-year price comparisons.

The BoC has published a working paper by Celso Brunetti, Bahattin Buyuksahin, Jeffrey H. Harris titled Speculators, Prices and Market Volatility:

We analyze data from 2005 through 2009 that uniquely identify categories of traders to assess how speculators such as hedge funds and swap dealers relate to volatility and price changes. Examining various subperiods where price trends are strong, we find little evidence that speculators destabilize financial markets. To the contrary, hedge funds facilitate price discovery by trading with contemporaneous returns while serving to reduce volatility. Swap dealer activity, however, is largely unrelated to both contemporaneous returns and volatility. Our evidence is consistent with the hypothesis that hedge funds provide valuable liquidity and largely serve to stabilize futures markets.
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We also examine whether the “financialization” of futures markets (as represented by the changing mix of participant positions) has affected the functioning of the futures markets. In every instance, we find that speculative position changes do not amplify volatility during the crisis and so do not impede the functioning of futures markets. Conversely, in each market we find that macroeconomic conditions are significantly related to futures market volatility, with the strongest link from 2006 through July 2008. In fact, during the heart of the financial crisis after July 2008, volatility is strongly related to macroeconomic uncertainty (rather than market conditions or financialization).

Although our tests do not examine positions, prices or volatility over short intervals (such as a few hours or days), we find no systematic, deleterious link between the trades of hedge funds or swap dealers and either returns or volatility. To the contrary, hedge fund trading, although positively correlated with price changes, is negatively related to volatility both contemporaneously and with a one-day lead. Hedge funds commonly provided liquidity in futures markets and improved price efficiency during the recent financial crisis. We conclude that speculators such as hedge funds and swap dealers should not be viewed as adversarial agents in financial markets, but rather as important liquidity providers to hedgers that enhance the proper functioning of financial markets.

It seems that all the downtown development that Toronto is seeing is not an isolated phenomenon:

Lena Edlund and Michaela Sviatchi of Columbia University and Cecilia Machado of the Getulio Vargas Foundation wondered why the relationship between housing prices and distance from the center of major U.S. cities has reversed since 1980. That year, prices were higher in the suburbs, and urban centers were going to seed. In the next 30 years, prices within three miles of the central business districts of the 27 biggest cities in the U.S. more than doubled. Within a radius of three to 10 miles, they increased by 60 percent. Further out, they only grew by 6 to 10 percent.

“The price profile flips,” the economists wrote in a recent paper. “In 1980, prices in the periphery are 50 percent higher than in the center. By 2010, prices in the center are 40 percent higher than in the periphery.”

The original paper also notes:

Between 1965 and 2005, leisure grew but not for the college educated. In the 1985-2005 period, the contraction in leisure among college men was substantial enough to result in an overall reduction for men (leisure grew among non-college men); for women, leisure contracted across the board but at the twice the rate for college women compared to non-college women [Aguiar and Hurst, 2009, table 2-2].

Aguiar and Hurst [2007, 2009] identified rising labor supply of the skilled to lie at the core of this development. Census data bear this out. The fraction college graduates who worked full time started to rise in the 1970s after three decades of barely moving, Figures 2 and 3. Unsurprisingly, the increase was more pronounced for women. Since 1990, there has also been a notable increase in the fraction (men and women) working 50+ hours per week (or “long hours” to use the terminology of Kuhn and Lozano [2006]).

I sneered at the Capital Power note exchange offer yesterday – the information circular has now been released on SEDAR although I am not permitted to link to it directly as this would make access to public documents too convenient for mere retail scum. The company states:

CPLP believes the Note Exchange Transaction may have the following benefits for the CPLP Noteholders, and that CPLP Noteholders should consider the following factors, among others, in making a decision whether to vote in favour of the Note Exchange Resolution:

• Same Terms. Upon completion of the Note Exchange Transaction, CPLP Noteholders will receive Capital Power Notes having terms (including with respect to coupon, maturity and redemption price) that are the same as those of the CPLP Notes for which they are being exchanged (except for conforming changes necessary to reflect Capital Power as the new issuer and to reflect the guarantee being provided by CPLP).
• Better Liquidity. Over time it is expected that debt of Capital Power will be more liquid than that of CPLP as Capital Power is expected to be the active debt issuer going forward and CPLP will not be.
• Structural Enhancement. Upon completion of the Note Exchange Transaction, CPLP Noteholders will receive Capital Power Notes that will rank pari passu with Capital Power’s other senior unsecured debt securities, will benefit from Capital Power’s diversified asset base (which includes CPLP’s asset base), will benefit from reporting consistent with Capital Power’s publicly traded equity, and will maintain the existing structural priority through a guarantee issued by CPLP. On November 19, 2015, each of DBRS Limited and Standard & Poor’s publicly announced that it expects to assign the same credit rating to the Capital Power Notes that it has assigned to the CPLP Notes.

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RBC Capital Markets has been retained on behalf of CPLP to act as solicitation agent and to solicit votes in favour of the Note Exchange Resolution.

The Solicitation Agent will be entitled to receive a fee for its services and be reimbursed for certain reasonable out-of-pocket expenses, including fees of legal counsel, and will be indemnified against certain liabilities and expenses in connection with the solicitation of votes in favour of the Note Exchange Resolution.

But I will note (from the Annual Report:

The Company, through its subsidiary CPLP, has the following externally imposed requirements on its capital as a result of its credit facilities and certain debt covenants, as defined in the respective agreements:

• Maintenance of modified consolidated net tangible assets to consolidated net tangible assets ratio, as defined in the debt agreements, of not less than 0.8 to 1.0;
• Maintenance of senior debt to consolidated capitalization ratio, as defined in the debt agreements, of not more than 0.65 to 1.0;
• Limitation on debt issued by subsidiaries; and
• In the event that CPLP is assigned a rating of less than BBB- by S&P and BBB (Low) by DBRS, CPLP would also be required to maintain a ratio of net income before interest, income taxes, depreciation and amortization to finance expense, as defined in the debt agreements, of not less than 2.5 to 1.0.

I will also note, from the Annual Report, that consolidated revenue was $1,228-million while CPLP revenue was $1,220-million. So: diversification , schmiversification. I’ll stick to my guns and say holders should vote against the plan, despite the fact that the agencies say the difference between the two entitities does not result in a notching of credit and despite the fact that one major dealer, at least, thinks everything’s peachy with voting in favour. Being closer to the money and being owed the money directly by a financing vehicle subject to covenants is worth something; and even if it’s only worth 5bp, I want that 5bp.

It was a poor day for the Canadian preferred share market, with PerpetualDiscounts down 33bp, FixedResets losing 69bp and DeemedRetractibles off 10bp. The Performance Highlights table is of moderate – by 2015 standards – length. Volume was well above average.

Interestingly, this time the market was down only moderately until about 3pm, when it commenced a significant downdraft – but this time, instead of a last minute collapse, there was a notable (albeit insufficient) rebound commencing at 3:54. Perhaps some players have set up to take advantage of late-session selling pressure!

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For as long as the FixedReset market is so violently unsettled, I’ll keep publishing updates of the more interesting and meaningful series of FixedResets’ Implied Volatilities. This doesn’t include Enbridge because although Enbridge has a large number of issues outstanding, all of which are quite liquid, the range of Issue Reset Spreads is too small for decent conclusions. The low is 212bp (ENB.PR.H; second-lowest is ENB.PR.D at 237bp) and the high is a mere 268 for ENB.PF.G.

Remember that all rich /cheap assessments are:
» based on Implied Volatility Theory only
» are relative only to other FixedResets from the same issuer
» assume constant GOC-5 yield
» assume constant Implied Volatility
» assume constant spread

Here’s TRP:

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TRP.PR.E, which resets 2019-10-30 at +235, is bid at 18.85 to be $0.77 rich, while TRP.PR.C, resetting 2016-1-30 at +154, is $0.47 cheap at its bid price of 13.25.

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Most expensive is MFC.PR.N, resetting at +230bp on 2020-3-19, bid at 20.90 to be 0.59 rich, while MFC.PR.K resetting at +222bp on 2018-9-19, is bid at 19.52 to be 0.42 cheap.

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The cheapest issue relative to its peers is BAM.PR.R, resetting at +230bp on 2016-6-30, bid at 16.59 to be $1.21 cheap. BAM.PF.E, resetting at +255bp on 2020-3-31 is bid at 19.90 and appears to be $0.78 rich.

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FTS.PR.K, with a spread of +205bp, and bid at 19.62, looks $0.90 expensive and resets 2019-3-1. FTS.PR.H, with a spread of +145bp and resetting 2020-6-1, is bid at 14.14 and is $0.81 cheap.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of -0.45%, with one outlier above 0.50%. There is one junk outlier below -1.50%.

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Shall we just say that this exhibits a high level of confidence in the continued rapacity of Canadian banks?

Today’s post is dedicated to the snivelling cowards who don’t want to take in Syrian refugees because ISIS might get mad at us. Wear one of these on your lapel on future Remembrance Days instead of a poppy:

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Today’s sick joke has to do with money laundering – Assiduous Readers will recall that here in North America we are spending untold billions of dollars on a regulatory regime that causes massive inconvenience to honest citizens and has, so far, caught the notorious master-criminals Hastert and Switzer, last discussed in detail on October 19. So how does ISIS make its money and move it around? They’ve got a lot of oil and wheat money:

These airstrikes were launched not because U.S. officials were prescient. They came after the Obama administration found and quietly fixed a colossal miscalculation. U.S. intelligence had grossly overestimated the damage they’d inflicted during airstrikes on the militants’ oil production apparatus last year, while underestimating Islamic State’s oil revenue by $400 million. According to U.S. Department of the Treasury officials and data they released in the wake of the Paris mayhem, the terrorist group is actually taking in $500 million from oil a year. What’s more, just a few hours before the first Islamic State suicide bomber blew himself up outside the Stade de France on Nov. 13, U.S. Army Colonel Steve Warren conceded at a press briefing that some American airstrikes disrupted IS oil operations for no more than a day or two.
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Arguably the least appreciated resource for Islamic State is its fertile farms. Before even starting the engine of a single tractor, the group is believed to have grabbed as much as $200 million in wheat from Iraqi silos alone. Beyond harvested grains, the acreage now controlled by militants across the Tigris and Euphrates river valleys has historically produced half of Syria’s annual wheat crop, about one-third of Iraq’s, and almost 40 percent of Iraqi barley, according to UN agricultural officials and a Syrian economist. Its fields could yield $200 million per year if those crops are sold, even at the cut rates paid on black markets. And how do you conduct airstrikes on farm fields?

But here’s the best part: when ISIS conquers territory in Iraq, the Iraqi government continues to pay the civil service in the area:

ISIS uses adjacent areas not only to access foreign funds, but also to cull money from Iraqi government officials still working in its territory. For example, Baghdad may be paying up to $130 million every month to government workers in Mosul alone.

The city’s formal banking system was shut down after ISIS took over, so “department emissaries are sent into Iraqi or Kurdish territory [to] collect salary money.” When these officials return to disburse the funds, ISIS naturally takes a cut off the top — according to the FATF report, the group “could potentially profit hundreds of millions of USD annually from taxing these salary payments.”
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The goal here should be strict regulation and transparency, not eliminating all money flows into these border areas.

The latter is neither realistic nor advisable, as a collapsed economy would only worsen the humanitarian crisis and hurt innocent civilians who are effectively ISIS hostages trying to survive one day at a time.

But without greater oversight and control over the flow of funds to areas in the Islamic State’s “near abroad,” the group will continue using backdoors to fund its brutality and terrorism in Syria, Iraq, and elsewhere.

So let’s not hear any more crap about how our Canadian banking regulations are an important element in the fight against terrorism. It’s a joke.

Oh, and while we’re on the topic of Canadian financial regulation, let’s see what Christine Duhaime has to say:

Two weeks from now, I appear before the United Nations law and policy group to discuss the regulation of bitcoin, the blockchain and digital finance, which are at the cutting edge of financial technology.

It’s appropriate that they asked a Canadian lawyer to speak, because we know about balanced financial regulation – 18 months ago, Canada moved to overregulate fintech with the world’s first law governing digital currencies, enacted amid concerns about terrorist financing.

Overnight, we drove away hundreds of millions of investment dollars in fintech from Canada, money that went to Britain instead.

Assiduous Reader JP sends me another interesting link today, bringing the score for the month to date to: JP 2 Youse Other Bums 0. This one is an essay on the corporate savings glut by Martin Wolf of the Financial Times:

In the six largest high-income economies – the US, Japan, Germany, France, the UK and Italy – corporations accounted for between half and just over two-thirds of gross investment in 2013 (the lowest share being in Italy, the highest in Japan).

Because corporations are responsible for such a large share of investment, they are also, in aggregate, the largest users of available savings, but their own retained earnings are also a huge source of savings.
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If the corporate sector runs a structural surplus of savings over investment, other sectors must run offsetting structural deficits. If the government is to be in financial balance, either households or foreigners must run these deficits.

In the euro zone, this logic has led to huge current account surpluses (a financial deficit for foreigners). For the UK and US, it is likely to mean renewed household deficits – a destabilising possibility.

Why is corporate investment structurally weak? The ageing of societies is one reason: by slowing potential growth, it lowers the level of investment needed.

Globalisation is another: it motivates relocation of investment from the high-income countries. Another reason is technological innovation. Much investment today is in IT, whose price is collapsing: constant nominal investment finances rising real investment. Again, much innovation seems to reduce the need for capital: consider the substitution of warehouses for retail stores. Another explanation could be that management is not rewarded for investing.

Together, all this might explain why, to take the US example, the ratio of corporate investment to profits has declined substantially since 2000.
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Moreover, if the corporate sector is unable to invest even its own savings, savings in the rest of the economy are bound to have a low marginal value. In such a world, both ultra-low real interest rates and high equity prices are not at all surprising. They are to be expected. So stop complaining.

The Bank of Canada has released the Bank of Canada Review, Autumn 2015, with articles:

• Is Slower Growth the New Normal in Advanced Economies?
• A Survey of Consumer Expectations for Canada
• Measuring Durable Goods and Housing Prices in the CPI: An Empirical Assessment
• The Effect of Regulatory Changes on Monetary Policy Implementation Frameworks
• Recent Enhancements to the Management of Canada’s Foreign Exchange Reserves

In the article A Survey of Consumer Expectations for Canada, the following table appears:

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There have been two new developments in the fascinating Sprott Silver battle. First, the fund is proposing to become an ETF:

The Board of Trustees of Silver Bullion Trust (“SBT”) (TSX:SBT.UN) (C$) (TSX:SBT.U) (US$) announced today that SBT has entered into a letter of intent with Purpose Investments Inc. (“Purpose”) regarding the proposed conversion of SBT into an exchange-traded silver bullion fund (“ETF”). The proposed conversion will involve certain amendments to SBT’s Declaration of Trust that will be subject to approval by SBT unitholders at a special unitholders’ meeting expected to be held by the end of January 2016. The proposal is also subject to the execution of definitive agreements, receipt of regulatory approvals and other customary conditions for transactions of this nature. Full details regarding the proposed conversion and its anticipated benefits will be outlined in a management information circular which will be mailed to unitholders in advance of the proposed special meeting.

Purpose is an independent, employee-owned Canadian investment management company established in January 2013 by Som Seif, founder and former CEO of Claymore Investments, a leading Canadian ETF provider, which was purchased by BlackRock, Inc. in 2012. Purpose, which has current assets under management of over $1.4 billion across 17 funds, is one of Canada’s most experienced ETF managers and has significant experience in managing bullion funds. Purpose and Silver Administrators Limited, SBT’s current administrator, will jointly administer SBT following approval of the conversion by SBT unitholders.

Second, the OSC has ordered enhanced disclosure from Sprott:

Silver Bullion Trust (“SBT”) (TSX:SBT.UN) (C$) (TSX:SBT.U) (US$) announced today that the Ontario Securities Commission (“OSC”) has issued an order requiring Sprott Asset Management Silver Bid LP and certain of its affiliates (collectively, “Sprott”) to issue a notice of change that provides enhanced disclosure to Unitholders regarding the amendments Sprott unilaterally made to the voting powers of attorney solicited by Sprott in connection with its unsolicited offer (the “Sprott Offer”) to acquire all of the units of SBT. The OSC also prohibited Sprott from exercising rights purportedly attaching to the voting powers of attorney before the expiry of 15 days after the notice of change is issued.

The November 4, 2015 Notice of Variation of the Sprott Offer unilaterally amended the intended use of the voting powers of attorney granted by those Unitholders who had tendered to the Sprott Offer. Sprott now intends to use the powers of attorney to replace the independent trustees of SBT, and to elect Sprott insiders as trustees, if more than 50.1% of the outstanding units of SBT are tendered to the Sprott Offer. These powers of attorney were originally intended to be used to replace the trustees if 66 2/3% of the units were tendered to the Sprott Offer to facilitate completion of the Sprott Offer. SBT applied to the OSC for an order, which among other things, would prevent Sprott from using the powers of attorney in this manner, in part because of the lack of proper disclosure about the change of intent. So long as the unsolicited Sprott Offer remains outstanding, Unitholders who have tendered their units will have conveyed their voting rights to Sprott and have forfeited their ability to consider the alternative transaction described below.

The OSC order has been published on the OSC site.

Capital Power is attempting to clean up its structure at the expense of bondholders:

Capital Power Corporation (“Capital Power”) (TSX: CPX) and Capital Power L.P. (“CPLP”) announced today that CPLP has called a meeting of the holders (“CPLP Noteholders”) of issued and outstanding 4.85% Medium Term Notes due February 21, 2019 (“Series 3”) and 5.276% Medium Term Notes due November 16, 2020 (“Series 1”) (collectively, the “CPLP Notes”) of CPLP. The principal amounts outstanding are $250 million for Series 3 and $300 million for Series 1.

The record date for determining CPLP Noteholders entitled to vote at the meeting is November 18, 2015 with the meeting to be held in Toronto on December 17, 2015 at the time set out in the Notice of Meeting. An information circular (“Circular) and related proxy materials will be mailed to CPLP Noteholders and also are available on SEDAR at www.sedar.com.

The meeting has been called to consider passing an extraordinary resolution to authorize CPLP to enter into a supplemental indenture amending the terms of the trust indenture dated April 14, 2010. In accordance with the steps described in the Circular, all issued and outstanding CPLP Notes would be exchanged for an equal principal amount of newly issued medium term notes of Capital Power having financial and other terms that are the same as those attached to the CPLP Notes and benefiting from a guarantee to be provided by CPLP (“Note Exchange Transaction”).

The Note Exchange Transaction and additional steps to reorganize CPLP’s capital structure are being undertaken to simplify the organizational structure and reduce reporting obligations. The cessation of CPLP as a reporting issuer and transition of long-term credit ratings to only Capital Power will result in efficiencies for CPLP while providing noteholders with better liquidity over time and structural enhancement. The timing of the Note Exchange Transaction follows the exchange of all remaining Exchangeable Common Limited Partnership Units of CPLP for shares of Capital Power by EPCOR Power Development Corporation on April 2, 2015.

RBC Capital Markets is the Solicitation Agent for the Note Exchange Transaction and Kingsdale Shareholder Services has been retained to act as Information Agent.

The Information Circular is not yet available, so I’m not sure how much is being paid to brokers for favourable votes from their clients. I have not seen any indication, so far, regarding the effect on the credit ratings of this structural subordination:

The Company’s power generation operations and assets are owned by Capital Power L.P. (CPLP), a subsidiary of the Company. As at December 31, 2014, the Company held 21.750 million general partnership units and 62.112 million common limited partnership units of CPLP which represented approximately 82% of CPLP’s total partnership units. EPCOR (in this MD&A, EPCOR refers to EPCOR Utilities Inc. collectively with its subsidiaries) held 18.841 million exchangeable common limited partnership units of CPLP which represented approximately 18% of CPLP. CPLP’s exchangeable common limited partnership units are exchangeable for common shares of Capital Power Corporation on a one-for-one basis.

Nonetheless, anybody who votes in favour of this arrangement without a sweetener is a fool. The position in the capital structure is worth … something and should not be given up without getting … something.

Big 8 Split Inc., proud issuer of BIG.PR.D (not tracked by HIMIPref™) was confirmed at Pfd-2(low) by DBRS:

DBRS Limited (DBRS) has today confirmed the rating of Class D Preferred Shares, Series 1 (the Preferred Shares) issued by Big 8 Split Inc. (the Company) at Pfd-2 (low).
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Dividends received from the Portfolio are used to pay fixed cumulative quarterly distributions to holders of the Preferred Shares, yielding 4.50% per annum on the initial issue price of $10.00. The Capital Shares are expected to receive all excess dividend income after the Preferred Share distributions and other Company expenses have been paid. Based on the current dividend yield on the Portfolio, the Preferred Share dividend coverage ratio is approximately 1.5 times, and as such there is no grind on the portfolio.
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Downside protection available to the Preferred Shares consists of the net asset value of the Capital Shares. As of November 11, 2015, the downside protection was approximately 55.6%.

5Banc Split Inc., proud issuer of FBS.PR.C (tracked by HIMIPref™ but relegated to the Scraps index on volume concerns) has been confirmed at Pfd-2 by DBRS:

DBRS Limited (DBRS) has today confirmed the rating of Class C Preferred Shares, Series 1 (the Preferred Shares) issued by 5Banc Split Inc. (the Company) at Pfd-2.
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Dividends received from the Portfolio are used to pay a quarterly fixed, cumulative, preferential distribution of $0.11875 per Preferred Share to yield 4.75% per annum. As of November 11, 2015, the downside protection was approximately 69%. Based on the dividend yields on the underlying Portfolio holdings as of November 11, 2015, the Preferred Share dividend coverage ratio is approximately 2.5 times.

Brookfield Renewable announced the exercise of the underwriters’ option for their new issue. I have updated the PrefBlog announcement post.

While today’s market swoon was nowhere near as dramatic as yesterday‘s, there was the same pattern of an exaggerated decline at the close, as the TXPL index moved from 708.63 at 3:56pm to 707.16 at the close:

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It was a mixed but poor day for the Canadian preferred share market, with PerpetualDiscounts off 19bp, FixedResets down 46bp and DeemedRetractibles gaining 2bp. The Performance Highlights table is ridiculously long. Volume was very high.

For as long as the FixedReset market is so violently unsettled, I’ll keep publishing updates of the more interesting and meaningful series of FixedResets’ Implied Volatilities. This doesn’t include Enbridge because although Enbridge has a large number of issues outstanding, all of which are quite liquid, the range of Issue Reset Spreads is too small for decent conclusions. The low is 212bp (ENB.PR.H; second-lowest is ENB.PR.D at 237bp) and the high is a mere 268 for ENB.PF.G.

Remember that all rich /cheap assessments are:
» based on Implied Volatility Theory only
» are relative only to other FixedResets from the same issuer
» assume constant GOC-5 yield
» assume constant Implied Volatility
» assume constant spread

Here’s TRP:

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TRP.PR.E, which resets 2019-10-30 at +235, is bid at 19.00 to be $0.82 rich, while TRP.PR.C, resetting 2016-1-30 at +154, is $0.59 cheap at its bid price of 13.25.

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Most expensive is MFC.PR.N, resetting at +230bp on 2020-3-19, bid at 21.20 to be 0.54 rich, while MFC.PR.K resetting at +222bp on 2018-9-19, is bid at 19.78 to be 0.49 cheap.

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The cheapest issue relative to its peers is BAM.PR.R, resetting at +230bp on 2016-6-30, bid at 16.79 to be $1.21 cheap. BAM.PF.G, resetting at +284bp on 2020-6-30 is bid at 21.50 and appears to be $0.73 rich.

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FTS.PR.K, with a spread of +205bp, and bid at 19.62, looks $0.85 expensive and resets 2019-3-1. FTS.PR.H, with a spread of +145bp and resetting 2020-6-1, is bid at 14.03 and is $0.96 cheap.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of -0.42%, with one outlier above 0.00%. There is one junk outlier above 0.00% and one below -2.00%.

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Shall we just say that this exhibits a high level of confidence in the continued rapacity of Canadian banks?

Assiduous Reader JP, who sends me more interesting links than all the rest of youse other bums combined, brings to my attention a popular press story on corporate bond liquidity:

Add one more name to the chorus of doom. Earlier this week, Andrew Tyrie, the Conservative MP and chairman of the Treasury Select Committee, wrote to Mark Carney, the Governor of the Bank of England, to express his concern about bond market liquidity – or, more precisely, the lack thereof.
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In May, Nouriel Roubini, the US economist made famous for predicting the US housing problems that led to the financial crisis, wrote about “the liquidity timebomb”.

In June, Stephen Schwarzman, the chief executive of private equity firm Blackstone, penned a comment piece for The Wall Street Journal on bond market liquidity entitled: “How the next financial crisis will happen”.

Why has what sounds like a pretty niche subject got so many knickers in such a twist?
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Regardless, there’s little appetite among regulators to row back on capital rules. So liquidity may need to come from somewhere else. One theory is that fund managers should try to trade directly with each other (although the fate of Bondcube, an online marketplace which tried to facilitate such transactions but went bust in July after only three months because investors couldn’t agree on prices without the involvement of a broker, doesn’t bode well).

Or perhaps the amount of liquidity available before the crisis was the aberration and we now need to reset our expectations. Should, for example, investors be allowed to withdraw money, at a moment’s notice, from funds that invest in rarely-traded securities?

Regulators have made a trade-off. Banks have been made less risky. But, as Bill Gross, the famous bond investor, said earlier this year, that risk hasn’t been eliminated – it’s just moved elsewhere in the system.

Nouriel Roubini’s piece makes the point:

As a result, when surprises occur – for example, the Fed signals an earlier-than-expected exit from zero interest rates, oil prices spike, or eurozone growth starts to pick up – the re-rating of stocks and especially bonds can be abrupt and dramatic: everyone caught in the same crowded trades needs to get out fast. Herding in the opposite direction occurs, but, because many investments are in illiquid funds and the traditional market makers who smoothed volatility are nowhere to be found, the sellers are forced into fire sales.

This combination of macro liquidity and market illiquidity is a time bomb. So far, it has led only to volatile flash crashes and sudden changes in bond yields and stock prices. But, over time, the longer central banks create liquidity to suppress short-run volatility, the more they will feed price bubbles in equity, bond, and other asset markets. As more investors pile into overvalued, increasingly illiquid assets – such as bonds – the risk of a long-term crash increases.

This is the paradoxical result of the policy response to the financial crisis. Macro liquidity is feeding booms and bubbles; but market illiquidity will eventually trigger a bust and collapse.

Blackrock’s report is titled US EQUITY MARKET STRUCTURE: LESSONS FROM AUGUST 24:

Contributors to disruptions on the morning of August 24:
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3.Excessive use of market and stop-loss orders that seek “liquidity at any price” inflamed the situation.

• When markets are volatile, liquidity can come at a cost.
• Market and stop-loss orders that demand “liquidity at any price” added to selling pressure and proved especially risky on the morning of August 24.

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Recommendations for enhancing US equity market resiliency:
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7.Educate investors on how to navigate the modern US equity market. Customer-facing broker-dealers should consider whether there is more to do to raise investor awareness regarding usage of market and stop-loss orders in volatile periods, especially at the open or close.
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Orders that seek liquidity at any price may expose investors to prices which reflect the cost of liquidity at a given point in time as opposed to the underlying fundamental value of a security. Taken together, we believe that it is important that investors are educated about how to navigate today’s complex equity market and volatility. In particular, investors should have an understanding of the implications and potential risks associated with the use of “liquidity at any price” order types, such as market and stop-loss orders. We are supportive of ongoing cost/benefit analyses to determine whether certain constraints on market and stop-loss orders would be appropriate. Further discussion is needed to determine whether other protections should be implemented; for example, additional disclosure to customers regarding the potential risks associated with the use of market and stop-loss orders. Customer-facing broker-dealers are best positioned to consider ongoing investor education efforts.

Blackrock’s emphasis on investor education is very sweet and leaves me wondering how much of this was written to curry favour with the regulators. Retail, taken as a whole, is stupid and enjoys being stupid. There are about a bazillion pages on the Web touting stop-loss orders as the sure-fire way to get free money, such as Stops – Minimizing Losses And Protecting Gains:

Next time someone tells you their stock portfolio is up by 50%, congratulate them, then ask “What have you done to protect your profit?”

If they look at you with a puzzled expression on their face, then you know their 50% paper gain could easily be lost within a matter of days or weeks. If they tell you they have an exit strategy with Stop Losses in place to protect a large percentage of their gain, then you know they are probably prepared.

Investor education, hah! I’ve got news for Blackrock: you can lead a horse to water, but you can’t make it drink.

On another note, the NYSE is banning stop-loss orders:

Stop orders — or instructions to immediately trade once a stock hits a certain price, even if the price is far worse than the one on the order — will no longer be available starting on Feb. 26, NYSE said this week.
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Brokerage firms can still program their systems to carry out orders that achieve the same results as a stop order for their clients, by entering a market order on the client’s behalf after a stock price reaches a specified threshold.

Nonetheless, Cunningham said, the exchange wants “to raise the profile of the risks associated with this order type.”

One possibility for mitigating the volatility due to stop-loss orders is to make them transparent: the Exchanges could make public a list of trigger prices and stop volume throughout the trading day. This would, I think, lead to market players putting in limit bids somewhere below each stop-trigger in hopes of getting a lucky fill. Currently, the TSX (for example) does not provide pre-trade transparency on stop orders:

No pre-trade transparency of: i) orders entered in the MOC facility; ii) “On-Stop Book” orders, until the limit price of the order is triggered, at which point they become part of the “Regular Book”; and iii) dark orders are fully hidden until execution.

On the other hand, it would probably also lead to a thinning of the market immediately above the major trigger points, so maybe that’s not such a great idea. Another possibility is a new order type that would interact only with stop-loss orders; that is to say, instead of stop-loss orders turning into limit or market orders, they would retain their stop-identity for the purpose of interacting with this new, bottom-feeder, order type.

And on the other other hand, who cares? Players using stop-losses aren’t trading on fundamentals, so screw ’em! Vapourizing the investments of non-fundamental investors is a Public Good so let’s just do it, ride out the volatility and move on.

But perhaps the most effective argument against eliminating stop-loss as an order type is practical: the fact is that in the first place, such orders will simply move to the brokers’ books and in the second place will be available to anybody via a simple algorithm. The latter point means that you must accept that certain simple order types will suddenly be restricted to big players, which won’t be very popular with self-proclaimed Investor Activists or with regulators who stop and think about what it is they’re doing … well, OK, with self-proclaimed Investor Activists, anyway.

Veresen Inc., proud issuer of VSN.PR.A, was confirmed at Pfd-3 by DBRS:

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Senior Unsecured Notes rating of Veresen Inc. (Veresen or the Company) at BBB as well as its Preferred Shares rating at Pfd-3. The trend on the ratings is Stable. Veresen’s ratings are supported by firm take-or-pay and fee-based cash flows from a diversified portfolio of energy infrastructure assets; however, some of the Company’s midstream gas gathering and processing operations are exposed to volume and commodity price risks.
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The Company’s non-consolidated financial profile remains reasonable for its current rating category. On a non-consolidated basis, the Company’s credit metrics improved in 2015 as debt relating to the Ruby acquisition in 2014 was fully repaid in 2015 with non-consolidated debt-to-capital at 24.1% and cash flow to debt at 32.5% as of Q3 2015. DBRS expects the Company to remain prudent in its future financing strategy to maintain its non-consolidated leverage at or near the 30.0% level.

The market made a funny noise this afternoon:

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No, I mean really, look at the TXPL chart:

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So sure, it wasn’t a great day from the beginning, with the TXPL index down about half a point by about 11am and drifting slowly lower thereafter. Then the fun started at about 2:45pm, with the index losing an additional 14bp by 3:25pm, losing another 14bp by 3:39pm, and then just getting crushed, losing another 50bp by the close (to an index level of 710.46), for a total of 154bp on the day. Looks like we’re back to all that fun we had in September and early October, with motivated sellers waiting until late in the trading day to dump their holdings.

I’m not sure how that works. It seems to me that if I had a big sell order to execute, come hell or high water, I would try to take the market down earlier in the day, in order to attract some buyers at the lower prices. It seems to me that one possible – and I do mean possible, don’t anybody assume that this is what is actually happening – mechanism for this is that Joe Trader gets an order to sell 50,000 shares throughout the day, slaps it into a cautious, liquid-equity style algorithm and then finds out at 3pm that he’s only got fills on 5,000 and has to get cracking. I don’t like speculating about such micro-mechanisms, but … it just seems so wasteful to take the market down 50bp in the last five minutes-odd of the day, when relatively few participants will have a chance to react.

It was a rotten day for the Canadian preferred share market, with PerpetualDiscounts off 13bp, FixedResets losing 93bp and DeemedRetractibles down 36bp. The Performance Highlights table is suitably long, with a heavy load of TRP issues among the worst losers. Volume was extremely high.

For as long as the FixedReset market is so violently unsettled, I’ll keep publishing updates of the more interesting and meaningful series of FixedResets’ Implied Volatilities. This doesn’t include Enbridge because although Enbridge has a large number of issues outstanding, all of which are quite liquid, the range of Issue Reset Spreads is too small for decent conclusions. The low is 212bp (ENB.PR.H; second-lowest is ENB.PR.D at 237bp) and the high is a mere 268 for ENB.PF.G.

Remember that all rich /cheap assessments are:
» based on Implied Volatility Theory only
» are relative only to other FixedResets from the same issuer
» assume constant GOC-5 yield
» assume constant Implied Volatility
» assume constant spread

Here’s TRP:

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TRP.PR.E, which resets 2019-10-30 at +235, is bid at 19.06 to be $0.79 rich, while TRP.PR.G, resetting 2020-11-30 at +154, is $0.36 cheap at its bid price of 20.80.

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Most expensive is MFC.PR.N, resetting at +230bp on 2020-3-19, bid at 21.13 to be 0.48 rich, while MFC.PR.K resetting at +222bp on 2018-9-19, is bid at 19.76 to be 0.52 cheap.

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The cheapest issue relative to its peers is BAM.PR.R, resetting at +230bp on 2016-6-30, bid at 16.79 to be $1.33 cheap. BAM.PF.G, resetting at +284bp on 2020-6-30 is bid at 21.70 and appears to be $0.83 rich.

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FTS.PR.K, with a spread of +205bp, and bid at 19.55, looks $0.78 expensive and resets 2019-3-1. FTS.PR.H, with a spread of +145bp and resetting 2020-6-1, is bid at 14.20 and is $0.82 cheap.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of -0.50%, with no outliers. There are two junk outliers above 0.00% and one below -2.00%.

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The BCE.PR.R / BCE.PF.Q pair is no longer being plotted as BCE.PF.Q will not be created, as pointed out by Assiduous Reader Peculiar_Investor.

Shall we just say that this exhibits a high level of confidence in the continued rapacity of Canadian banks?

Just the bare bones again today, I’m afraid!

It was a fine day for the Canadian preferred share market, with PerpetualDiscounts winning 48bp, FixedResets up 44bp and DeemedRetractibles gaining 42bp. The Performance Highlights table is dominated by winners, topped by low-spread insurance issues. Volume was slightly above average.

There’s are some interesting ventures assigning credit scores to marginal borrowers:

They have no bank account, no credit score, no financial identity. So a quarter of humanity hasn’t been able to borrow money. Until now.

Several dozen startups say they have developed ways to bring those 2 billion people into the international financial system, monitoring cell phone use and other personal habits to predict creditworthiness. For example, people who don’t let their phone batteries run low tend to do the same for their debt balance. Borrowers who get more calls than they make are better risks, and applicants who state their loan purpose in a few words are better borrowers than those who end up writing an essay.
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A key to creditworthiness is personal daily routine. People who charge the same amount of airtime on the same day every week are better credit risks than those who purchase a large amount, then let their accounts sit empty, according to Van Der Tuin of First Access. When phones stay in the same place every day, that is often a sign that the owner is at work.

Moreover, in emerging market countries mobile phones are increasingly serving as ledgers of money movement. So monitoring phone records becomes a simple substitute for examining a bank account. At the same time, traditional credit risk assessments, according to the startups, have ignored the added importance of social capital. Beyond serving as de facto bank statements, mobile and online footprints indicate how well borrowers are treated by their community.

It was a positive day for the Canadian preferred share market, with PerpetualDiscounts up 8bp, FixedResets winning 36bp and DeemedRetractibles gaining 4bp. The Performance Highlights table, while still much longer than was the norm a year ago, is unusually short when judged by 2015 standards. Volume was below average.

For as long as the FixedReset market is so violently unsettled, I’ll keep publishing updates of the more interesting and meaningful series of FixedResets’ Implied Volatilities. This doesn’t include Enbridge because although Enbridge has a large number of issues outstanding, all of which are quite liquid, the range of Issue Reset Spreads is too small for decent conclusions. The low is 212bp (ENB.PR.H; second-lowest is ENB.PR.D at 237bp) and the high is a mere 268 for ENB.PF.G.

Remember that all rich /cheap assessments are:
» based on Implied Volatility Theory only
» are relative only to other FixedResets from the same issuer
» assume constant GOC-5 yield
» assume constant Implied Volatility
» assume constant spread

Here’s TRP:

Click for Big

TRP.PR.E, which resets 2019-10-30 at +235, is bid at 19.31 to be $0.87 rich, while TRP.PR.G, resetting 2020-11-30 at +154, is $0.53 cheap at its bid price of 20.47.

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Most expensive is MFC.PR.N, resetting at +230bp on 2020-3-19, bid at 21.20 to be 0.64 rich, while MFC.PR.F resetting at +141bp on 2016-6-19, is bid at 14.50 to be 0.68 cheap.

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The cheapest issue relative to its peers is BAM.PR.R, resetting at +230bp on 2016-6-30, bid at 16.52 to be $1.59 cheap. BAM.PF.G, resetting at +284bp on 2020-6-30 is bid at 22.00 and appears to be $1.01 rich.

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FTS.PR.K, with a spread of +205bp, and bid at 19.55, looks $0.82 expensive and resets 2019-3-1. FTS.PR.H, with a spread of +145bp and resetting 2020-6-1, is bid at 13.96 and is $1.01 cheap.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of -0.61%, with no outliers. There are three junk outliers above 0.00% and one below -2.00%.

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The light blue point is an estimate for the potential BCE.PR.R / BCE.PF.Q pair, the latter of which is not trading. Its price has been set to the average defined by the other BCE Ratchet Rate preferreds.

Shall we just say that this exhibits a high level of confidence in the continued rapacity of Canadian banks?

Assiduous Reader IR brought to my attention recently a fascinating article titled Six Strange Things That Have Been Happening in Financial Markets:

Interesting things have certainly been happening in the underpinnings of global markets—things that either run counter to long-standing financial logic, or represent an unusual dislocation in the “normal” state of market affairs, or were once rare occurrences but have been happening with increasing frequency.
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1. Negative swap spreads
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2. Fractured repo rates
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3. Corporate bond inventories below zero

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Analysts at Goldman Sachs made waves this week when they highlighted the fact that inventories of some corporate bonds held by big dealer-banks had gone negative for the first time since the Federal Reserve began collecting such data. That means big banks are now net short corporate bonds with a maturity greater than 12 months equivalent to $1.4 billion, bucking the longer-term trend of net positive positions.

The record-breaking event revived a flurry of concerns about so-called liquidity, or ease of trading, in the $8.1 trillion corporate bond market. Similar to the repo market, a confluence of new rules is said to have made it more difficult for banks to hold corporate bonds on their balance sheets. At the same time, years of low interest rates have encouraged investors to herd into corporate bonds and hold onto them tightly.
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Synthetic credit is trading tighter than cash credit

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Above is the so-called basis between the CDX IG, an index that includes CDS tied to U.S. investment-grade companies, and the underlying cash bonds. The basis has been persistently wide and negative in recent years, as spreads on the CDX index trade at tighter levels than cash.

“In exchange for the substantial liquidity of derivative indices, investors are often giving up spread right now, as most indices trade at a negative basis versus the comparable cash market,” Barclays’ Bradley Rogoff wrote in research published today. “The negative basis right now is near the largest we have witnessed at a time when there was not a funding crisis.”

Investors may be ogling such synthetic tools not just because of their purported liquidity benefits but also because of funding benefits, a similar dynamic to the one currently pushing swap spreads into negative territory.
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Market moves that aren’t supposed to happen keep happening
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The number of assets registering large moves—four or more standard deviations away from their normal trading range—has been increasing. Such moves would normally be expected to happen once every 62 years.

While Martin blamed much of the confusion on unexpected decisions by central banks—such as the Swiss National Bank’s surprise decision to scrap its long-standing currency cap—there have been sharp market moves with seemingly little reasons behind them. Perhaps the best-known example is Oct. 15, 2014, when the yield on the 10-year U.S. Treasury briefly plunged 33 basis points—a seven standard-deviation move that should happen once every 1.6 billion years, based on a normal distribution of probabilities.
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Volatility is itself more volatile

Negative swap spreads were discussed on November 5.

The CDS Basis was discussed in the post BIS Releases March 2009 Quarterly Review, where the wide spread was considered to suggest “that arbitrage activities that would usually tend to compress the price differential continued to be constrained by elevated capital and financing costs for leveraged investors.” I consider this to have the potential for severely adverse effects on the economy due to “debt decoupling”, discussed in the post Credit Default Swaps: Links to Primers, notably a paper by Hu and Black titled Debt, Equity, and Hybrid Decoupling: Governance and Systemic Risk Implications:

There are also several sources of qualitative evidence. One is the recent tendency for credit default swap contracts to require the protection buyer, if it is also a creditor, to act in the interests of other creditors. This suggests concern that the protection buyer might not otherwise do so. How this obligation can be enforced, however, without disclosure of either votes or hedges, is anyone’s guess. We have also heard from bankruptcy judges that they sometimes see odd behavior in their courtrooms, which empty crediting might explain. For example, one judge described a case in which a junior creditor complained that the firm’s value was too high, even though a lower value would hurt the class of debt the creditor ostensibly held.

Also hinted at yesterday was the latest twist in the Silver Bullion Trust / Sprott battle:

Sprott has amended the Offer by attempting to unilaterally expand the scope of the powers of attorney granted to it by those Unitholders that tender to the Offer. The amendments purport to give Sprott the authority to replace the independent Trustees of SBT, insert their own conflicted Trustees and force completion of their inadequate Offer, despite their continued failure to attract sufficient Unitholder support for doing so by legitimate means.

SBT believes that Sprott’s attempt to unilaterally amend the powers of attorney is invalid and that any actions that Sprott would purport to take pursuant to them would be invalid. SBT also believes that Sprott’s actions are contrary to the take-over bid and proxy solicitation rules and the public interest. SBT has commenced an application before the Ontario Securities Commission to contest the amendments and other aspects of the Offer and has sought an order from the Ontario Securities Commission cease trading the Offer.

SBT is of the view that the use of the powers of attorney by Sprott to replace its independent Trustees when the conditions to the Offer have not been met is not a purpose for which the powers of attorney were solicited, and a clear violation of law. Sprott’s plan to change the terms of the powers of attorney granted by certain SBT Unitholders – without consulting Unitholders or complying with securities laws – is nothing more than an illegitimate tactic to ignore the will of Unitholders and replace SBT’s independent Trustees with insiders of Sprott, all of whom are clearly and obviously conflicted. Further, Sprott had previously represented to Unitholders and the Ontario Superior Court of Justice that it would use the powers of attorney granted in connection with the Offer for the purpose of carrying out the mechanics required to complete the Offer, only if they achieved the minimum acceptance of 66⅔% of SBT Units.

This is great entertainment – but I’m glad I’m not the one paying the lawyers!

It was a poor day for the Canadian preferred share market, with PerpetualDiscounts off 2bp, FixedResets losing 56bp and DeemedRetractibles down 5bp. BAM issues were notable in the bad part of the Performance Highlights table. Volume was average. What a week it has been – but at least we’re not alone.

For as long as the FixedReset market is so violently unsettled, I’ll keep publishing updates of the more interesting and meaningful series of FixedResets’ Implied Volatilities. This doesn’t include Enbridge because although Enbridge has a large number of issues outstanding, all of which are quite liquid, the range of Issue Reset Spreads is too small for decent conclusions. The low is 212bp (ENB.PR.H; second-lowest is ENB.PR.D at 237bp) and the high is a mere 268 for ENB.PF.G.

Remember that all rich /cheap assessments are:
» based on Implied Volatility Theory only
» are relative only to other FixedResets from the same issuer
» assume constant GOC-5 yield
» assume constant Implied Volatility
» assume constant spread

Here’s TRP:

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There is a major increase in implied volatility today. It’s almost as if the issues with the lowest spreads have a ‘floor price’ – which is not to say that they don’t go down, but they seem to outperform on lousy days.

TRP.PR.E, which resets 2019-10-30 at +235, is bid at 18.94 to be $0.68 rich, while TRP.PR.C, resetting 2016-1-30 at +154, is $0.24 cheap at its bid price of 13.90.

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Most expensive is MFC.PR.N, resetting at +230bp on 2020-3-19, bid at 20.98 to be 0.55 rich, while MFC.PR.F resetting at +141bp on 2016-6-19, is bid at 14.45 to be 0.69 cheap.

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The cheapest issue relative to its peers is BAM.PR.R, resetting at +230bp on 2016-6-30, bid at 16.41 to be $1.70 cheap. BAM.PF.G, resetting at +284bp on 2020-6-30 is bid at 22.11 and appears to be $1.12 rich.

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FTS.PR.K, with a spread of +205bp, and bid at 19.70, looks $0.78 expensive and resets 2019-3-1. FTS.PR.H, with a spread of +145bp and resetting 2020-6-1, is bid at 14.20 and is $0.93 cheap.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of -0.57%, with one outlier above 0.00%. There are two junk outliers above 0.00% and one below -2.00%.

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The light blue point is an estimate for the potential BCE.PR.R / BCE.PF.Q pair, the latter of which is not trading. Its price has been set to the average defined by the other BCE Ratchet Rate preferreds.

Shall we just say that this exhibits a high level of confidence in the continued rapacity of Canadian banks?