PrefBlog

The big news of the day was the FOMC statement:

Information received since the Federal Open Market Committee met in April suggests that economic activity has been expanding moderately after having changed little during the first quarter. The pace of job gains picked up while the unemployment rate remained steady. On balance, a range of labor market indicators suggests that underutilization of labor resources diminished somewhat. Growth in household spending has been moderate and the housing sector has shown some improvement; however, business fixed investment and net exports stayed soft. Inflation continued to run below the Committee’s longer-run objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports; energy prices appear to have stabilized. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations have remained stable.
…
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.

There were no dissents. Other information released indicates that the committee is dovish:

For Federal Reserve officials, the U.S. economy is a glass house where aggressive moves could break something.

While the median forecast of policy makers still calls for two interest-rate increases by year-end, more officials say just one would be enough in 2015. Still more advocate a go-slow approach to further tightening in 2016.

Projections from the Federal Open Market Committee published Wednesday showed that five officials foresee one increase in the federal funds rate this year, up from just a single policy maker who said so in March. And while policy makers said the economy has picked up after a first-quarter slump, Fed Chair Janet Yellen said she still wants to see more “decisive” evidence of a lasting turnaround.
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At her press conference following the FOMC meeting, Yellen cited signs of “cyclical weakness” in the labor market, and noted wage growth remains “subdued.”

“Although progress clearly has been achieved, room for further improvement remains,” Yellen said. “Economic conditions are currently anticipated to evolve in a manner that will warrant only gradual increases in the target federal funds rate.”

As a result:

Treasuries climbed and the dollar weakened against the euro after the Federal Reserve revised down its outlook for interest rates amid fragile economic conditions.
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Yields on 10-year U.S. notes fell four basis points to 2.28 percent by 11:05 a.m. in Tokyo, with rates on Japanese and Australian debt also down. The greenback weakened to $1.1362 per euro and slipped 0.2 percent versus the yen.

Back in April, Natixis Global Asset Management (parent of NexGen Financial) released the results of a poll of Canadian investors:

The majority of those surveyed (54%) say they fear future oil price drops, 61 percent admit they are not willing to take more investment risk compared to a year ago and 59 percent said they feel vulnerable when it comes to protecting their portfolios from market shocks.
…
Besides oil prices, investors’ other concerns include a worldwide economic slowdown (cited by 54%), slower global growth (39%) and higher interest rates (37%).

Despite the economic challenges, 88 percent of Canadian investors believe their current approach will enable them to have a steady income when they retire. To get there, investors say their portfolio needs to gain an average of 9.3 percent annually, over and above inflation, the survey found. Eighty percent of investors think their target is realistic.
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Retirement remains the top financial priority, and most investors (57%) say the responsibility of funding retirement is falling increasingly to individuals and away from government- and employer-sponsored schemes.

They anticipate 50 percent of their retirement income will come from their own efforts – saving, investing, selling their home or business or picking up a job after retiring. Of the rest of their retirement income, 26 percent would come from an employer pension, 18 percent from government support and 6 percent from other sources (including support from children).
…
Natixis surveyed 250 individual investors across Canada with a minimum of C$256,460 (US$205,230) in investable assets. The online survey was conducted in February 2015 and is part of a larger global study of 7,000 investors in 17 countries from Europe, the Americas and the Middle East. The findings are published in a new whitepaper, “Close enough isn’t good enough.” For more information, visit durableportfolios.com.

9.3% annual returns, over and above inflation? Good luck with that!

The global summary has an amusing section on retirement expectations:

When asked at what age they would like to retire, younger investors are clearly focused on early retirement: Millennials say age 58, while Generation X say 62. When asked when they think they will actually retire, their aspirations moderate only slightly at age 60 and age 63 respectively.

Asked the same questions, Baby Boomers say age 68 on both counts. Pre-Boomers respond with 73 on both counts. In reality, for members of those generations who are already retired, the day came much earlier at age 59 and 63 respectively.

… but respondents have a Plan B:

Should they fall short on their retirement savings, investors have clear plans on how they will make up the difference. The largest number (45%) say employment will be the answer, followed by support from their spouse or significant other (36%), government programs (35%), and family (23%).

And finally, there’s a little section on the value of advice:

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Now, this study is hardly up to academic standards – it’s in Natixis’ best interests to convince everybody (particularly those with over $200,000 in investible assets) that they need an advisor and they need alternative investments. But I suspect that meticulously unbiased research would give similar results.

And it is, perhaps, these unrealistic expectations and the expectation of government support that is driving the trend towards enhanced public pension plans, both in Ontario (as discussed May 1, 2014; also see the official ORPP website) and in the States:

The U.S. retirement system is a failure, in at least one respect: Half of private-sector workers have no access to a 401(k) or a pension plan on the job, so millions of Americans have scant retirement savings or none at all. To retire, they’ll need to rely on programs such as Social Security and Medicaid.

The federal government has done little to get more Americans saving for retirement. In December the White House launched a pilot program called myRA (My Retirement Account), an individual retirement account (or IRA) set up through an employer’s payroll system and aimed at low-income workers. But participation is voluntary, and Congress has gotten nowhere with bills proposed to encourage workplace retirement plans.

So the states are stepping up. This month, an Illinois law went into effect that would give a state-run IRA to all employees of companies with at least 25 people on staff who don’t have their own retirement plan. Workers would automatically be signed up to contribute 3 percent of their salary to the IRA and could opt out or adjust their contribution. The system is scheduled to be up and running by June 2017.

California is working on a similar plan, and on Tuesday the Oregon State Senate sent the governor a bill requiring automatic IRAs at private employers by July 2017. By early next year, Connecticut officials must finish a study, mandated by the state legislature, of how feasible a state-run retirement plan would be there. There are advocates for similar plans in at least a dozen other state legislatures.

Separately, we are told that employees are idiots:

Canadians are missing out on billions of dollars of potential retirement savings every year by not taking full advantage of matching contributions by their employers in group RRSP and defined contribution retirement plans.

Tom Reid of Sun Life Financial estimates more than $3-billion a year of potential company contributions go unmade because employees don’t make the required matching contributions to obtain them.
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A survey by Great-West Life found significant numbers of respondents weren’t taking advantage of voluntary plans. It found a 79 per cent participation rate for voluntary DC plans and just 51 per cent for voluntary group RRSPs in 2014.

Meanwhile there is a call to eliminate Canada Savings Bonds:

The private sector already offers various savings products, backed by deposit insurance, according to a report prepared by KPMG LLP for the Canadian Finance Department. Canadian households appear to like those options better, as the stock of retail debt outstanding in the Canada Savings Bond program plummeted to just under 8 billion Canadian dollars ($6.5 billion) in 2013 from a 1987 level of C$55 billion. That’s an average decline of C$1.8 billion a year.
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“There is currently no valid economic rationale for the retail debt program,” KPMG said. “Outstanding stock is expected to reach a level where, despite all the recent accomplishments in cost reduction, it will be difficult to justify the existence of the program either on economic grounds, on participation levels, or as a share of retail debt outstanding to market debt.”

A spokeswoman for Canada’s Finance Department said the Canada Savings Bonds Program would be maintained in its current format, while officials would look at potential ways to reduce the scheme’s costs. The spokeswoman said more than a million Canadians still purchase securities from the program, “demonstrating their continuing interest” in the program.

The U.S. and Germany have essentially terminated their retail debt programs, which like the Canadian one were created to provide citizens with a guaranteed savings instrument in an era when the retail banking sector was underdeveloped, and there was no such mechanism as deposit insurance. In Germany’s case, it concluded it could no longer issue a cost-effective rate that would attract retail investor interest.

I love the official response. It must be nice to be in government and never have to show any intellectual integrity at all!

The actual report includes a fascinating graph:

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In terms of spread:

We notice that the CPB rate is tracking closely the 3-year benchmark Government of Canada bond since 2008 with a spread ranging between minus 20 to plus 60 basis points (bps) leaving little or no margin to offset unit administration and option costs (see Chart 6). Likewise, the CSB rate, even with spreads ranging from 10 to 70 bps compared to the 1 year treasury bill rate since 2009 does not leave enough margin to cover unit administration and option costs.

In terms of cost:

Today, the operating costs of the Retail Debt Program at $58 million are equivalent to the yearly interest costs (approx. $58 million) on the outstanding stock of retail debt (see Chart 7). Of course this relation may change in the future, based on the evolution of interest rates and changes in the cost structure. It is nevertheless an interesting snapshot putting the overall costs of the Retail Debt Program in perspective.

The largest component of the operating costs for the Retail Debt Program is the HP back-office operations which stand at $36 million or 62% of the expenses.

Given all the recent fuss, one wonders whether some aspects of the programme will be changed …

Introduced in 1997 by Canada Investment and Savings Agency (CI&S), trailer fees were discontinued in the fall of 2010 and replaced by an up-front 35 bps commission. This proved a significant cost reduction measure. Beforehand, financial institutions benefitted from annual trailer fees of 23 bps until maturity. In 2009 trailer fees accounted for 93% of total commissions to financial institutions.

Based on the pre-2000 issues still outstanding and on the estimated pace of redemptions, trailer fees are expected to end in 2019-2020. We estimate that in 2012-2013 they still represent approximately 92% of the commission expense as this would be consistent with $3.5 billion of outstanding debt still being subject to the 23 bps trailer fee (see Table 4).

KPMG makes one recommendation I really like … but it comes with a warning label!

Consider making the Retail Debt Program totally internet-based, with no intermediaries: This is the current US model, and the phase-in would likely be very expensive. With respect to the US example, it should be noted that the infrastructure they built behind their Treasury Direct website is mostly used for individuals purchasing retail sizes of wholesale US Treasury securities.

It’s surprisingly difficult to find information on the size of the Treasury Direct retail programme; if anybody knows where I can get this information, let me know!

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts down 21bp, FixedResets off 8bp and DeemedRetractibles gaining 6bp. FixedResets continue to dominate the Performance Highlights table at both ends. Volume was 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:

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TRP.PR.E, which resets 2019-10-30 at +235, is bid at 23.00 to be $0.87 rich, while TRP.PR.B, which will reset June 30 at 2.152% (+128), is $0.63 cheap at its bid price of 14.58

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Another excellent fit, but the numbers are perplexing. Implied Volatility for MFC continues to be a conundrum. It is still too high if we consider that NVCC rules will never apply to these issues; it is still too low if we consider them to be NVCC non-compliant issues (and therefore with Deemed Maturities in the call schedule).

Most expensive is MFC.PR.J, resetting at +261bp on 2018-3-19, bid at 24.60 to be $0.44 rich, while MFC.PR.H, resetting at +313bp on 2017-3-19, is bid at 25.50 to be $0.41 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 19.41 to be $0.94 cheap. BAM.PR.X, resetting at +180bp 2017-6-30 is bid at 17.82 and appears to be $0.61 rich.

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FTS.PR.H, with a spread of +145bp, and bid at 16.52, looks $0.43 cheap and resets 2020-6-1. FTS.PR.G, with a spread of +213bp and resetting 2018-9-1, is bid at 21.95 and is $0.16 rich.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of about 0.40%, including the outlier TRP.PR.A / TRP.PR.F at -0.37%. On the junk side, three of the six currently extant pairs are outside the range of the graph: DC.PR.B / DC.PR.D at -0.22%; AZP.PR.B / AZP.PR.C at +1.01%; and FFH.PR.E / FFH.PR.F at -0.86%.

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

After a very brief review of the recently released OSC-commissioned report Mutual Fund Fee Research, I have seen the future and it is Spanish:

First, credit institutions heavily dominate the Spanish mutual fund industry: banks and savings banks6. In fact, 91% of mutual funds are distributed through banks (63%) and savings banks (28%), and 91% of mutual fund assets are managed by companies belonging to banks (66%) and savings banks (25%). The reason for this predominance is perhaps the traditional universal banking model, which has provided credit institutions with a vast base of clients for their mutual funds. In fact, the business of mutual fund management accounts for a non-negligible part of Spanish banks’ revenues. If we take only the three most important management companies (belonging to credit institutions) that manage 52% of all assets (as of December 2001), we find that their sales revenues contribute to 1.71% (the largest company), 2.15% (the second largest), and 3.22% (the smallest) of their respective group’s total ordinary revenues. Clearly, this situation gives rise to a number of potential conflicts of interest. For instance, bank customers are more vulnerable to marketing or advice from their bank and therefore more likely to invest in bank-managed mutual funds than to shop for better quality or cheaper funds. Also, fund managers could be biased towards investing in financial assets issued by companies belonging to their own financial group. Finally, the fact that only credit institutions can become custodial institutions of the assets held by the mutual funds gives banks and savings banks an advantage over independent management companies. The extent to which such potential conflicts of interest translate into agency costs in delegated portfolio management remains an open empirical question.

As far as total returns go (according to the OSC’s report):

Where regulation has been changed to ban or limit commission,there is evidence that this change impacted investor outcomes.

• In the absence of embedded compensation, advisors recommend lower cost products. These typically have better returns because of lower expenses.
• While removing commission lowers product cost, advisory fees may rise as a means of paying for the cost of service. There may also be new or increased administrative fees, higher costs on margin accounts and lower payments on cash balances.
• It is not yet clear whether moving from commission-based to asset-based compensation will result in a net improvement in the overall return to the investor.

…
Based on the research cited, we can formulate some high level conclusions that are backed by substantial evidence. In addition to compensation, we identify some related issues that affect investor outcomes.

• …
• In jurisdictions that have moved to fee-based compensation, people with less wealth and less income find it harder to get advisory service than others. We do not know whether it is more difficult with fee-based compensation than it was before the change in compensation regime. Alternative advisor methods (e.g., robo-advisors) are developing to fill the advisory gap.

So we all know how this movie is going to turn out, assuming the regulators get their way. Regulators were created for the purpose of insulating politicians from public opprobrium following scandals. The fewer scandals, the better they’ve done their job and the sooner they can start working in the compliance department of a bank. So the ideal is a plain vanilla portfolio for everybody, preferably provided by one of the regulators’ future employers. If a hundred people get put into ridiculously risky portfolios by a some commission driven salesmen … that’s a scandal. If a hundred thousand people retire with significantly less money than they should have, due to a long-term emphasis on short-term (bank issued) fixed income (including GICs) … that’s a statistic.

As I have come to expect, there is nothing in the OSC report that covers new issue commission and proxy solicitation fees; the former form of compensation has been alleged to have played a role in some preferred share complaints I have seen. Admittedly, these forms of compensation were not in the report’s mandate; golly, I wonder why. According to the IIAC, the “Firms that are national in scope and have extensive retail and institutional operations; includes dealers of the six major chartered banks” had investment banking revenue that exceeded their mutual fund commission revenue.

Central GoldTrust is fighting an exchange offer from Sprott Asset Management Gold Bid LP to exchange units of Central GoldTrust for units of Sprott Physical Gold Trust, and its Trustee’s Circular contains an entertaining attack on Sprott’s competence:

A large number of Sprott Inc. actively managed funds also suffer from chronic underperformance, while Sprott Inc. continues to generate very significant management fees from these funds. The table below shows that over the past three years the selected group of poorly performing Sprott funds underperformed by approximately 13% on average against their respective Sprott-selected benchmark indices, while Sprott Inc. and SAM have collected over approximately $110 million in management fees from these funds over the same three year period.
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When looking at the broader group of Sprott funds where information is publicly available, similarly poor returns were observed relative to their respective benchmarks. As shown below, these funds over the past three years have underperformed, on average, 11% below their respective benchmarks.

I don’t see a response from Sprott Physical Bullion; Sprott’s response did not address the charges.

I keep reading a lot about how entrepreneurial millennials are:

Call it entitlement, call it independence: Millennials want to be a generation of entrepreneurs.

Roughly two in every three Gen Y-ers have aspirations of going into business for themselves. About 18% of them are actually doing it, according to a new report from Babson College that found entrepreneurship across all ages is on the incline. (Meanwhile, just 13% of millennials are interested in climbing the corporate ladder.)

Millennials fit into the role of a self-starter easily for a number of reasons; we’re digital natives, with heady career dreams and a job market that has taught us to think outside the box — because we might not be hired within it very quickly.

… which always makes me wonder why there aren’t more plumbers, electricians and computer repair shops. And I wonder how many entrepreneurs get driven to work by their moms. And I wonder how many of them are entrepreneurial and how many just dream of being a big-shot. I wonder why virtually every stranger who knocks on my door is begging for a hand-out (for charity, or to participate in sports tournament, or whatever) and why so few of them are trying to sell me a product or service (and why those that do try to sell me something are always so careful to emphasize that it’s ‘for school’). I wonder a lot of things, and wasn’t too surprised at this rebuttal:

When she started her research, “I thought that I was doing a next-generation-of-leadership focus; I thought that the criteria was age specific,” [author of The Creator’s Code: The Six Essential Skills of Extraordinary Entrepreneurs, Amy] Wilkinson said. But her research led her to a different place—it turns out that fewer millennials are starting businesses than the generations preceding them. “The most interesting and problematic thing I learned is that millennials aren’t starting companies the way previous generations did—all the research confirms this,” she said, pointing to research by the Kansas City-based Kauffman Foundation and the Brookings Institute, among others. And research that just came out this week from Kauffman only helps confirm this: for example, new entrepreneurs ages 20 to 34 fell to 24.7% last year, compared to the 34.3% of people who were in the same age demographic in 1996 when they started businesses.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts off 24bp, FixedResets gaining 1bp and DeemedRetractibles up 2bp. FixedResets dominated both sides of the Performance Highlights table, with a notable preponderance of winners. 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:

Click for Big

TRP.PR.A, which resets 2019-12-31 at +192, is bid at 20.26 to be $0.71 rich, while TRP.PR.B, which will reset June 30 at 2.152% (+128), is $0.51 cheap at its bid price of 14.67

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Another excellent fit, but the numbers are perplexing. Implied Volatility for MFC continues to be a conundrum. It is still too high if we consider that NVCC rules will never apply to these issues; it is still too low if we consider them to be NVCC non-compliant issues (and therefore with Deemed Maturities in the call schedule).

Most expensive is MFC.PR.J, resetting at +261bp on 2018-3-19, bid at 24.60 to be $0.45 rich, while MFC.PR.H, resetting at +313bp on 2017-3-19, is bid at 25.50 to be $0.30 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 19.63 to be $0.81 cheap. BAM.PF.G, resetting at +284bp 2020-6-30 is bid at 24.16 and appears to be $0.41 rich.

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FTS.PR.H, with a spread of +145bp, and bid at 16.40, looks $0.36 cheap and resets 2020-6-1. FTS.PR.M, with a spread of +248bp and resetting 2019-12-1, is bid at 24.18 and is $0.17 rich.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of about 0.40%, including the outliers TRP.PR.A / TRP.PR.F at -0.33% and FTS.PR.H / FTS.PR.I at +1.00%. On the junk side, only one of the six currently extant pairs is within the range of the graph.

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

There is grave concern that some young adults are paying off their student loans:

In a growing refinancing boom, a new generation of private lenders — backed by hedge-fund billionaires and Silicon Valley royalty — is targeting successful graduates with professional degrees and student loans. For the borrowers, “it’s an uncashed lottery ticket,” said Brendan Coughlin, head of education finance for Citizens Financial Group Inc.

There’s a catch. Their good fortune could cost taxpayers billions and damage the credit quality of the government’s $1.2 trillion student-loan portfolio, the biggest pool of U.S. debt, except for mortgages. That’s because professional-school graduates and other borrowers with successful careers subsidize the less fortunate, who are more likely to default.

“Cream-skimming by private lenders will remove these profitable loans and leave mainly — or only — the more risky loans,” said James McAndrews, executive vice president and director of research at the Federal Reserve Bank of New York.

Precisely, Mr. McAndrews, and that’s just the way it should be. If the government decides that it is good policy to write loans to borderline students taking degrees in – shall we say – relatively impractical subjects because they’re easy … fine. That’s a political decision, made for (in theory) the greater good of society and elected representatives will (in theory) be accountable for the decision. But since it’s for the greater good of society, society as a whole should pay for it … it should not be paid by excessive, disproportionate taxation on young, smart STEM graduates.

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Fixed income volatility is causing some scratching of heads:

The gyrations gripping the world’s fixed-income market are so great that it’s almost impossible to make sense of them on a historical basis. In Germany, for example, yields on 10-year securities have surged from almost nothing in late April to about 1 percent last week — a move so swift that some strategists are likening it to a once-in-a-generation event.
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Across Europe, investors are ripping up their old models to analyze the $100 trillion global bond market that dictates how much consumers and companies pay to borrow. Volatility is soaring as central-bank policies diverge, whiffs of inflation emerge and new regulations cause big banks to back away from their traditional role facilitating buying and selling.
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BlackRock is testing how risky its holdings are by running them through new worst-case scenarios that assume more volatility and varying correlation among asset classes. And strategists at JPMorgan Chase & Co., the world’s biggest debt underwriter, now see the need to calculate a “liquidity premium” for top-rated, longer-maturity government bonds in Europe, a new wrinkle for benchmark securities that are considered the safest assets available because of their deep markets.
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Yield volatility on 10-year bunds has climbed to nine-times its average during the past 15 years, giving traders a taste of the turbulence European Central Bank President Mario Draghi said June 3 they should get used to as the byproduct of record monetary stimulus.

A measure of 30-day volatility on bunds surged to 300 percent in May. It hadn’t gone above 100 before this year, in data compiled by Bloomberg going back to the middle of 2005. The market’s gyrations are being magnified by record-low yields: In the week of Draghi’s remarks, yields soared 0.36 percentage point, the biggest jump since 1998. The yield was at 0.82 percent on Monday at 6:19 a.m. in New York, up from a record of 0.049 percent on April 17.

Hank Greenberg won on principle, but lost on cash:

Hank Greenberg won his fight to hold the U.S. responsible for the bitter pill it forced down the throat of American International Group Inc. shareholders. But that’s about it.

The judge who called the terms of the $85 billion bailout illegally onerous also ruled that without it investors would have gotten nothing. As a result, he awarded Greenberg no money.

The split-decision sets up the possibility that both sides will appeal, and that a battle over a key element of the government response to the 2008 financial crisis will continue for months or years to come.

“In the end, the Achilles’ heel of Starr’s case is that, if not for the government’s intervention, AIG would have filed for bankruptcy,” U.S. Court of Claims Judge Thomas Wheeler said. “AIG’s shareholders would most likely have lost 100 percent of their stock value.”

In response, the Fed issued a press release:

The Federal Reserve strongly believes that its actions in the AIG rescue during the height of the financial crisis in 2008 were legal, proper and effective. The court’s decision today in Starr International Company, Inc. v. the United States recognizes that AIG’s shareholders are not entitled to compensation for that decision, and that the Federal Reserve’s extension of credit to AIG prevented losses to millions of policyholders, small businesses, and American workers who would have been harmed by AIG’s collapse during the financial crisis. The terms of the credit were appropriately tough to protect taxpayers from the risks the rescue loan presented when it was made.

I take issue with that. In the first place, it is not the business of a central bank to make risky loans. Central banks must restrict themselves to loans made to solvent institutions, where the loans are secured by sound collateral, and the interest rate is punitive. Otherwise you wind up with the danger of a politicized institution determining who goes into selective bankruptcy. This is classical central banking that dates back to Bagehot.

If the “authorities” feel that bankruptcy will lead to horrible knock-on effects and the path of least evil is a bail-out … fine. But that’s a political decision; if AIG was to have been bailed out, it should have been by the Treasury Department.

In the second place, it is not entirely clear to me why the bankruptcy of the holding company should have led to such horrid knock-on effects. The company with the biggest exposure to AIG – which was Goldman Sachs – proved itself to be the only institution on Wall Street that had the brains it was born with when it showed that all the exposure to bankruptcy had been laid off to third parties. All the bail-out money left the country; some of it helped out CIBC.

Jamie Dimon had some good things to say about proxy advisors:

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon chided shareholders as “lazy” for casting votes at annual meetings based on the advice of proxy advisers.

“God knows how any of you can place your vote based on ISS or Glass Lewis,” Dimon, 59, said Wednesday at an investor conference in New York. “If you do that, you are just irresponsible, I’m sorry. And you probably aren’t a very good investor, either.”

JPMorgan’s board is reviewing how it pays top executives including Dimon after a record low percentage of shareholders voted this month to approve their latest packages. Investors are seeking that a greater portion of executives’ incentive pay be based on performance, Lee Raymond, the board’s lead director and chairman of the compensation committee, said at the firm’s annual meeting May 19.

Proxy advisers Institutional Shareholder Services and Glass Lewis & Co. had recommended investors reject the pay resolution, saying the bank lacks preset goals to determine compensation and didn’t give a good reason for giving Dimon his first cash bonus in three years.

It may have been inspired by a fit of pique over his pay, but he’s right anyway … well, mostly. It does not reflect well on the industry – but Portfolio Managers just don’t have time to examine a routine proxy vote carefully. Quick – how many issues are there in the S&P 500? Did you say 500? Award yourself a kewpie doll! Now do some quick arithmetic … that’s two companies per day. And how big a team is going to make the decisions? I mean, really? Four, tops, maybe? At most shops, one? Being generous? And this is after having to plough through such trivia as, you know, investment qualities? Give me a break. Proxy votes will only be examined carefully when they are meaningful; routine director elections will be rubber-stamped … except that rubber-stamping is illegal nowadays. OK, fine, hire an advisory company and pay them whatever it takes to keep the business legal. Stick the charge onto the MER. No problem. Granny’s got lots of money.

Who remembers Cracked magazine? It was the a defining symbol of twelve year old hipsters in the 1970s who found it more authentic than Mad magazine. Anyway, it’s been through several incarnations and is now a website attempting to appeal to young men; it’s a men’s magazine without the boobs, which means that their stock in trade is they look at actual issues or experiences from a first person perspective and report it in the ever-popular list format with a large dollop of (often rather predictable) sardonic humour. Much of it is quite good; they recently published 5 Nightmare Realities When Your Money Is Suddenly Worthless, giving a personal perspective of what it was like in Zimbabwe during their period of hyperinflation.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts gaining 4bp, FixedResets off 31bp and DeemedRetractibles up 16bp. Floaters got hammered; BAM FixedResets were prominent losers on the Performance Highlights table. Volume was well above 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:

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TRP.PR.A, which resets 2019-12-31 at +192, is bid at 19.90 to be $0.53 rich, while TRP.PR.B, which will reset June 30 at 2.152% (+128), is $0.44 cheap at its bid price of 14.65

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Another excellent fit, but the numbers are perplexing. Implied Volatility for MFC continues to be a conundrum. It is still too high if we consider that NVCC rules will never apply to these issues; it is still too low if we consider them to be NVCC non-compliant issues (and therefore with Deemed Maturities in the call schedule).

Most expensive is MFC.PR.M, resetting at +236bp on 2019-12-19, bid at 23.63 to be $0.44 rich, while MFC.PR.H, resetting at +313bp on 2017-3-19, is bid at 25.36 to be $0.47 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 19.80 to be $0.62 cheap. BAM.PF.G, resetting at +284bp 2020-6-30 is bid at 24.15 and appears to be $0.53 rich.

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FTS.PR.H, with a spread of +145bp, and bid at 16.41, looks $0.47 cheap and resets 2020-6-1. FTS.PR.M, with a spread of +248bp and resetting 2019-12-1, is bid at 24.45 and is $0.36 rich.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of about 0.45%, with no ridiculous outliers. On the junk side, three out of the six pairs are outside the range of the graph: FFH.PR.E / FFH.PR.F at -1.23%; AIM.PR.A / AIM.PR.B at -0.37%; and DC.PR.B / DC.PR.D at -1.32%.

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

The June 2015 Financial System Review released by the Bank of Canada had a few interesting nuggets.

For instance, a chart showing where the negative yields are in Europe:

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And there has been some concern expressed regarding the potential for negative yields on FixedResets, should five-year Canadas be greatly negative at the time of reset. This type of thing is being addressed in Europe:

Nevertheless, crossing the boundary marked by a zero interest rate creates distinct challenges, given the institutional, regulatory and accounting features of markets and contracts. For example, issuing bonds with a negative yield appears inconsistent with setting the issuing price at par value—a common convention—because these bonds would have to offer negative coupons. Collecting coupon payments from investors is probably too costly to be implemented and is unlikely to be accepted by investors. Instead, bonds can be issued at negative market yields if their price is above par. For example, current 1- and 2-year German bunds bear no coupons, but they are sold at a premium above par, implying negative yields to maturity. Similar adjustments may be needed in other markets, including modifications to pricing models for interest rate derivatives and to floating rate notes. For example, European investors are now seeking contractual guarantees that they are not liable to borrowers when floating rates become negative.

There are three things we have to worry about:

Key Vulnerabilities in the Canadian Financial System
The Bank continues to highlight three key areas of vulnerability:

• the elevated level of household indebtedness,
• imbalances in the housing market, and
• illiquidity and investor risk taking in financial markets.

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Indebted Alberta households have relatively low levels of liquid financial assets, carry more debt and have a higher debt-service ratio than indebted households in other areas of the country (Table 2). Moreover, the proportion of highly indebted households in Alberta—those with a ratio of debt to gross income above 250 per cent—is among the highest in the country. In addition, unlike other provinces in Canada, a sizable proportion of mortgages in Alberta (and Saskatchewan) permit no recourse against individual borrowers in the event of default.[Footnote]

Footnote reads: Creditors holding non-recourse mortgage loans are prevented from seizing other assets or incomes from borrowers in the event of a default if the proceeds from the sale of the house are not sufficient to pay off the loan and associated legal costs. Generally, mortgages to individuals that have a low loan-to-value ratio in Alberta and all mortgages in Saskatchewan are non-recourse loans while, in the rest of Canada, all mortgages are full-recourse loans. In Alberta, for example, about 35 per cent of mortgage loans held by federally regulated lenders are uninsured and non-recourse.

I hadn’t know that! Well, who knows … maybe the American custom of “jingle-mail” will make it to the Prairies!

Meanwhile fears of increasing policy yields have Canadians shortening term on their borrowing. Look, I know this makes no sense. Don’t blame me.

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And finally we get to my favourite topic:

Liquidity in fixed-income markets has become less reliable

Market liquidity has become less consistent in Canadian fixed-income markets, in both the government and corporate sectors, and could deteriorate rapidly during a financial stress event. While volatility may be gradually returning to more normal levels as a result of fundamental factors, a deterioration in market liquidity could amplify volatility if a large number of investors tried to unwind their positions in the same manner at the same time. This could lead to large investor losses and reduce investor confidence.

Certain trends observed in Canadian fixed-income markets are likely reducing market liquidity. First, the investor base in these markets has shifted. In particular, investment funds such as exchange-traded funds and mutual funds are now more important participants in the Canadian corporate bond market.[Footnote 17] In normal times, these funds hold sufficient cash buffers to cover investor redemptions. However, large redemptions may force funds to sell their assets, and the lack of market liquidity could intensify price movements. Bank of Canada analysis suggests that Canadian open-end mutual funds hold adequate amounts of cash buffers, which, coupled with low leverage, pose a limited risk of large sell-offs.[Footnote 18]

Similarly, foreign investors now hold a larger share of the Canadian federal government bond market. As such, a domestic shock could be the catalyst for a rapid sell-off of these bonds. If a sell-off were accompanied by a decline in market liquidity, it could cause discontinuous price movements.

However, many of the investors are foreign central banks and sovereign wealth funds, which tend to be patient, buy-and-hold investors aiming to diversify their portfolios. Their holdings therefore tend to be more stable. Second, market-making activity is evolving, owing to regulations and other changes in market structure, such as the growth in electronic trading in bond markets. Internationally and in Canada, the Basel III requirements compel institutions to hold more high-quality liquid assets. While these requirements should make banks more resilient to liquidity stress, they have reduced the willingness of banks to commit capital to make markets in fixed-income instruments.

[Footnote 17]: For example, mutual fund holdings of non-government bonds have increased from 7 per cent of outstanding bonds at the end of 2004 to 11 per cent at the end of 2014.

[Footnote 18]: For more details, see S. Ramirez, J. Sierra Jimenez and J. Witmer, “Canadian Open-End Mutual Funds: An Assessment of Potential Vulnerabilities,” in this report.

The report referenced in Footnote 18 is summarized as:

• ƒƒMutual funds provide retail investors with access to a broad range of investment opportunities. Globally, mutual funds have grown considerably in recent years and have become important players in many securities markets, prompting regulatory interest in vulnerabilities that could emanate from the sector.
• This report finds that vulnerabilities arising from Canadian mutual funds are currently limited:
  • (i) Funds hold an adequate amount of cash, given the underlying liquidity of their investments, and have a stable investor base, limiting risks from liquidity and maturity transformation.
  • (ii) Since the degree of leverage held by a fund is restricted by securities regulation, funds have low leverage ratios and limited derivatives exposures.
  • (iii) Even the largest funds are not dominant players in the securities markets in which they invest.

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I think fund investors should be upset about the high proportion of cash in fixed income funds. Ten percent cash holdings is a bloody expensive liquidity buffer!

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The average fixed-income fund keeps enough cash and equivalents to cover unusually large redemptions.[Footnote 10] In addition, Canadian mutual funds have a predominantly retail investor base that is focused mostly on long-term investing.[Footnote 11] Although it is theoretically possible, for example, for all investors in Canadian fixed income funds to redeem their shares en masse, Canadian fixed-income flows have been stable during past periods of stress (Chart 4).[Footnote 12]

[Footnote 10]: In 2013, the average fixed-income fund held about 10 per cent of its assets in cash equivalents, while only 5 per cent of fixed-income funds experienced monthly outflows greater than 6 per cent of their assets, on average, during this period.

[Footnote 11: During the financial crisis, institutional U.S. money market funds experienced more outflows than retail funds did during the run on the Reserve Primary Fund in September 2008 (McCabe 2010; Schmidt, Timmermann and Wermers 2014).

[Footnote 12: Chart 4 shows measures at the 5th and 95th percentiles of net flows across fixed-income funds for each month, together with industry total flows. For example, in December 2012 the 5th percentile of net flows was -4.2 per cent, indicating that 5 per cent of fixed-income funds had net flows less than -4.2 per cent (i.e., net outflows greater than 4.2 per cent) in that month.

Part of their conclusion reads:

Since fixed-income mutual funds represent a non-negligible proportion of Canadian corporate and government fixed-income markets, a sell-off triggered by outflows could, at least in principle, cause significant price volatility in these markets. Nevertheless, redemption behaviour during past periods of stress was contained, suggesting that this potential vulnerability is limited. Finally, although many Canadian fund management firms are affiliated with a major bank, these banks are unlikely to suffer losses from stress in any of the management firm’s funds, since funds and their management firms are separate legal entities and there is no implicit expectation that a long-term mutual fund’s price would be supported to maintain a certain value.

While that conclusion is mostly true, I suggest a reference to the disgusting precedent set by the regulatory response to the Asset-Backed Commercial Paper blow-up in the summer of 2007 would have been in order.

Meanwhile, a lot of US homeowners are still underwater:

It’s the one chart that keeps Stan Humphries up at night.

A decade after U.S. home sales peaked, 15.4 percent of owners in the first quarter owed more on their mortgages than their properties were worth, according to a report Friday by Zillow Inc. While that’s down from a high of 31.4 percent in 2012, it’s still alarmingly above the 1 or 2 percent that marks a healthy market, said Humphries, the chief economist at the Seattle-based real-estate data provider. Worse yet: The pace of healing is losing steam.

The blotch stains the economy by restraining the housing recovery and by preventing the job market from becoming even more vigorous. It also will probably exacerbate wealth inequality for years to come as homes valued in the bottom third of the market are more likely to be underwater.

Some more figures would be interesting; if I was underwater on my home, I’d consider any money spent paying down the mortgage to be so much money wasted; I’d want to know how my minimum required mortgage payment compared to rent.

A highly technical Fed research note by Andrew Figura and David Ratner titled The Labor Share of Income and Equilibrium Unemployment makes a very interesting point:

We argue that the recent secular decline in the labor share (shown in Figure 3) has been driven by structural factors that also tend to raise the vacancy-unemployment (V-U) ratio, and that this has, in turn, served to reduce the equilibrium unemployment rate. As shown in Figure 3, the labor share of income has moved noticeably below levels that prevailed until the early 2000s (see Elsby, Hobijn, and Şahin (2013) and Karabarbounis and Nieman (2014) for recent work on the labor share).2 Smoothing through some of the volatility in the data, the labor share has declined by roughly 6.5 percentage points since the early 2000s and now hovers around 63 percent. Through the lens of a standard labor market model, we argue that if the decline in the labor share has been driven by a reduction in worker bargaining power, the incentive for firms to post vacancies has increased and equilibrium unemployment will be lower as a result.
…
Going back to Figure 4, our results suggest that as the labor share has declined, the JC has rotated counterclockwise. Mapping this estimate into an effect on the unemployment rate, however, requires an estimate of the slope of the Beveridge curve. To derive an estimate, we regress log vacancies on log unemployment, allowing for a break in the intercept beginning in 2009. Our estimated coefficient suggests that a one percent increase in the V-U ratio along a BC will lead to about a one-half percent decrease in the unemployment rate. Thus, when combined with the 30% increase in the V-U ratio estimated above, we find the lower labor share would reduce the equilibrium unemployment rate by 15%, or by around two-thirds of a percentage point from an initial equilibrium unemployment rate of 5%.

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Their argument is not just out of my field but, as I said, highly technical … so I’ll leave commentary on the matter up to the economists out there! Journalists Craig Torres and Jordan Yadoo of Bloomberg comment:

Next week, Federal Reserve officials publish new quarterly forecasts, and all eyes are going to be on where they set the job market’s Goldilocks rate.

That’s the estimated unemployment level officials figure is neither too high nor so low that it starts to drive wages and prices higher. To quote Goldilocks, it’s “just right.”

Fed officials in March estimated this “natural rate” of unemployment at 5 percent to 5.2 percent. Unemployment stood at 5.5 percent in May. A new paper by Fed board staff shakes up this view by suggesting the number could be as low as 4.3 percent.

That has implications for next week’s Fed policy meeting. If Fed Board economists Andrew Figura and David Ratner are right, the labor market has room to run. So there may be no need to raise interest rates soon, or fast.
…
Even if Fed officials do raise the benchmark lending rate in September, as about half the economists in a Bloomberg News survey this month expect, the research suggests the pace of tightening will be slow.

“It could mean that one percentage point of tightening per year is too steep in a world where” the rate of full employment is 4.25 percent, [chief U.S. economist at Barclays in New York Michael] Gapen said.

On the other hand consumers have lots of sentiment:

Bigger paychecks are giving American consumers reason to believe again.

The University of Michigan’s preliminary consumer sentiment index for June rose to 94.6, topping all estimates in a Bloomberg survey of economists, from a reading of 90.7 last month, figures showed Friday. Households were the most upbeat about their wage prospects in seven years.

As the ranks of the unemployed shrink, the competition for skilled workers is heating up and forcing employers to boost wages to attract and retain staff. Firming confidence makes it likely the recent pickup in consumer spending, which accounts for almost 70 percent of the economy, will be sustained.

Meanwhile, the Dimon – Warren pissing match continues:

U.S. Senator Elizabeth Warren shot back at criticism from JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon, saying bankers don’t dislike her because she knows too little but because she knows too much.

“The problem for these guys is that I fully understand the system and I understand how they make their money, and that’s what they don’t like about me,” Warren told the Huffington Post in a podcast interview released Friday.

I reported on Round 1 of the battle on June 10.

I mentioned whispers of a decline in junk bond credit quality yesterday. Here’s another tidbit for the legions of doom:

U.S. junk-bond defaults rose to the highest level since October 2009 as depressed prices plague energy, metal and mining issuers that represent the largest contingent of debt from the riskiest companies.

There were nine defaults in May, including iron processor Magnetation LLC and Patriot Coal Corp., according to Fitch Ratings, with energy and metals and mining companies accounting for all of them. The two industries comprised 93 percent of defaults in the second quarter.

The Bloomberg Commodity Index of 22 raw materials has lost 25 percent in the past year, with the price of a barrel of oil plummeting by nearly half and iron falling by as much as a third.

Calgary housing is looking interesting, if not chaotic. On the one hand the high-end is tumbling:

Nationally, home prices rose 0.9 per cent from April, and 4.6 per cent from a year earlier.

Notable in that annual measure were a 7.6-per cent surge in Toronto, a 6.2-per-cent jump in Vancouver, and a similar rise in Hamilton.

“The 0.9-per-cent rise was slightly below the May average of 1.1 per cent over the last 14 years,” senior economist Marc Pinsonneault said in releasing the numbers.

“This was because Calgary prices fell 3.3 per cent from April, the largest monthly drop recorded for that region, subtracting 0.3 percentage points from the gain of the composite index,” he added.

On the other hand, condominiums are getting built:

As the population of Calgary continues its steep incline, the city’s downtown core is bracing itself for an influx of high-rise condominium developments to house its ever-increasing number of professionals.

In the city’s Beltline neighbourhood, the population has risen consistently by about 4 per cent a year between 2010 and 2014 according to the official city of Calgary census.
…
With a population increase of over 130,000 in five years, the Beltline and other downtown residential districts are prime candidates for large-scale condominiums, and the city’s continual growth, as well as its economic and socio-economic atmosphere, have attracted the eye of many Toronto-based developers.

In the past few years, firms such as Tribute Communities, Lamb Development Corp., and Great Gulf have been exploring the Calgary market for investment and development opportunities.

A Globe story on community mailboxes has brought to the fore my puzzlement over the issue:

Once Canada Post phases out door-to-door service across the country in favour of a new generation of CMBs, every neighbourhood, no matter how dense, will face the same problem: How many of these boxes will be needed – and where will they be installed?

Toronto residents will get their first look at that process next week, when city council’s planning and transportation committee considers an initial report on mailbox-location guidelines.
…
But when those estimates are extrapolated to the scale of the city as a whole, the numbers become formidable, indeed. The estimates to date vary widely. Canada Post estimates that it will have to deploy 2,500 to 11,000 CMBs across Toronto, as the Crown corporation ends door-to-door delivery by 2019. But according to the city’s staff report, Canada Post between 2017 and 2019 expects 565,784 “points of call” (i.e. individual delivery addresses) to be converted to community mailboxes – a figure that would require more than 35,000 new boxes. Residents who live in basement apartments, duplexes or laneway homes will also have their own slots in the boxes. Just over 22,000 downtown residential addresses will continue to get door-to-door delivery.

I don’t understand the issue, frankly. Look, if a postman cannot physically deliver enough mail to make it worth paying him, something has to change – I get it! Let’s say an individual postie has to deliver X pieces of mail every hour to make it worthwhile; for the sake of an argument, let’s say X = 1000.

So fine, out in the suburbs where he has to walk at least fifty feet between houses, he can only deliver 400 pieces per hour on the average day. To me, the obvious solution is to cut back to twice-weekly delivery. Then, on the two days delivery, he’ll hit the 1,000 piece threshold and we’re all happy. What comes in the mail, anyway? Bills and magazines. Nothing that can’t wait a day or two.

Eventually, once you’ve cut back to once a week delivery and you’re still below the 1,000 piece/hour threshold, that’s when you bring in a community box. But the way it stands, we’re all losing all service, regardless of whether we’re on a rural route or in the older sections of town where lot sizes are 20-feet frontage and there’s lots of businesses getting lots of mail. It makes no sense to me.

And, by the way, when Canada Post surveys you asking which of a few locations you think are good for your box, I have it on good authority that you should pick the spot furthest away. Apparently the area turns into a zoo when people come home from work at the same time and stop at the box on their way home. Lots of traffic, lots of mess, lots of aggravation.

It was, as usual, another poor day for the Canadian preferred share market, with PerpetualDiscounts down 37bp, FixedResets off 21bp and DeemedRetractibles flat. This is getting depressing. The Performance Highlights table is notable for its complement of FixedReset losers. Volume was very low; I assume everybody’s waiting for PrefLetter.

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 22.52 after horrible, worst-on-the-board performance today, to be $0.52 rich, while TRP.PR.B, which will reset June 30 at 2.152% (+128), is $0.49 cheap at its bid price of 14.61

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Another excellent fit, but the numbers are perplexing. Implied Volatility for MFC continues to be a conundrum. It is still too high if we consider that NVCC rules will never apply to these issues; it is still too low if we consider them to be NVCC non-compliant issues (and therefore with Deemed Maturities in the call schedule).

Most expensive is MFC.PR.M, resetting at +236bp on 2019-12-19, bid at 23.63 to be $0.40 rich, while MFC.PR.H, resetting at +313bp on 2017-3-19, is bid at 25.36 to be $0.49 cheap.

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The cheapest issue relative to its peers is BAM.PF.B, resetting at +263bp on 2019-3-31, bid at 22.00 to be $0.66 cheap. BAM.PF.G, resetting at +284bp 2020-6-30 is bid at 24.40 and appears to be $0.53 rich.

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FTS.PR.H, with a spread of +145bp, and bid at 16.25, looks $0.72 cheap and resets 2020-6-1. FTS.PR.M, with a spread of +248bp and resetting 2019-12-1, is bid at 24.40 and is $0.30 rich.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of about 0.50%, with no ridiculous outliers. On the junk side, three out of the six pairs are outside the range of the graph: FFH.PR.E / FFH.PR.F at -1.16%; AIM.PR.A / AIM.PR.B at -0.38%; and DC.PR.B / DC.PR.D at -1.14%.

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

A lot of people get enraged over mutual fund fees, and the extreme awfulness of an advisor who recommends a relatively higher MER. But as I’ve often noted, performance doesn’t mean as much in this business as one might think; for retail advisors, simple hand-holding is a very real service:

In the study for financial advisers, Putting a Value on Your Value, released Tuesday by Vanguard Investments Canada Inc., research indicates that “the value proposition of advice is changing. Advisers will have to add value, or alpha, through relationship-oriented services such as providing cogent wealth management via financial planning, discipline, and guidance, rather than by trying to outperform the market.”
…
Vanguard’s new study suggests that advisers who provide clients with more than the basic investment management, and follow a certain set of best practices, has the potential to add approximately 3 per cent in net returns to their clients’ portfolios.

Best practices would include: offering low costs funds, re-balancing portfolios, not engaging in market timing, asset allocation and “behavioural coaching” – in other words, helping investors stay the course, says Francis Kinniry, a principal of Vanguard’s investment strategy group.

Vanguard research found the discipline and guidance that an adviser might provide an investor through behavioural coaching could be the largest value-add available – adding 1 per cent to 2 per cent in net return.

We now know why UK Chancellor of the Exchequer got his Lapdog to provide a distraction with the war on banks yesterday:

Britain will start selling its £32-billion stake in Royal Bank of Scotland in the coming months, finance minister George Osborne said on Wednesday, giving up on his previous intention to only sell the shares for a profit.
…
[Investment bank] Rothschild said taxpayers were on course to lose more than 7 billion pounds on the RBS rescue although they would make a profit from the full bailout plan which included other banks.

RBS, Britain’s fourth-biggest bank by market value, was saved from collapse by former prime minister Gordon Brown’s Labor government during the 2007-09 financial crisis at a cost of 45.8 billion pounds to taxpayers, leaving the government holding an 80 per cent stake.

The sabre-rattling phase of the Greek debt negotiations has ended and the table-pounding phase has begun:

European Union President Donald Tusk told Greece’s Alexis Tsipras to stop maneuvering and decide whether to accept the conditions on financial aid as the International Monetary Fund’s negotiators left Brussels empty-handed.

The IMF said that its team flew out after failing to make progress on a debt deal that would help Greece avoid default and cement its position within the euro. Tusk accused Greece of playing games with its future and pressed Tsipras to make concessions to escape economic ruin.

There are whispers that the credit quality of junk debt is declining:

While American companies seem to be in good shape based on a historically low default rate, they look a lot less good if you peek under the hood of their balance sheets.

One problematic sign: the least-creditworthy companies have seen pretty much no growth in a basic measure of their earnings, even after stripping out the embattled energy companies, Bank of America Corp. analysts found. Yet these junk-rated corporations are selling debt at a rapid clip to lock in ultra-low borrowing costs, meaning their levels of debt relative to their income are steadily rising.

Another problematic sign: creditors of companies that are going bankrupt are getting less of their money back than you’d expect given the macro landscape of low defaults, a generally growing economy and such low borrowing costs.

“We find this very worrying,” wrote Bank of America analysts Michael Contopoulos, Neha Khoda and Rachna Ramachandran in a June 11 report. “We believe we are seeing the slow unraveling of fixed-income markets,” and debt of speculative-grade companies won’t be able to hide from such fundamental problems, they wrote.

While shouldering the White Man’s Burden of fighting corruption in foreign countries, a US court has discovered how business gets done:

In an attempt to underscore [chief prosecution witness Gregory] Weisman’s ethical sketchiness and desire to shift culpability to his former boss, [defense attorney William] Price questioned the disbarred lawyer about his practice of demanding that PetroTiger’s outside U.S. law firm, Philadelphia-based Duane Morris, provide him with free tickets to expensive professional sports events. Weisman acknowledged that he made these requests during exchanges with Duane Morris over PetroTiger’s past-due bills.

“I was getting tickets to sporting events and things like that, which is typical in the industry at big law firms,” Weisman testified. The defense lawyer, Price, asked about an October 2008 e-mail from Duane Morris partner Sandra Stoneman in which she promised Weisman tickets to the baseball World Series, but only if PetroTiger got current on its bills: “No promises till you get me one million in business[,] big guy. Oh yeah, and pay,” Stoneman said.

Price then read Weisman’s response: ” ‘You’ll get your million after I get my tix,’ et cetera.”

A Bloomberg filler article about millennials had an interesting chart relating mobility to age. It’s not too surprising in broad outline, but it’s nice to see some numbers. The chart is taken from the original paper, Young Adult Migration: 2007–2009 to 2010–2012; note that “migration” appears to be any change of address; a section at the end focusses on “inmovers”, who have changed cities.

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It was a poor day overall for the Canadian preferred share market, with PerpetualDiscounts off 28bp, FixedResets down 29bp and DeemedRetractibles gaining 4bp. A very lengthy Performance Highlights table is dominated by losing FixedResets. 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 23.40 to be $1.14 rich, while TRP.PR.B, which will reset June 30 at 2.152% (+128), is $0.76 cheap at its bid price of 14.55

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Another excellent fit, but the numbers are perplexing. Implied Volatility for MFC continues to be a conundrum. It is still too high if we consider that NVCC rules will never apply to these issues; it is still too low if we consider them to be NVCC non-compliant issues (and therefore with Deemed Maturities in the call schedule). It is clear that the lowest spread issue, MFC.PR.F, is off the relationship defined by the other issues, but this doesn’t resolve the conundrum – it just makes it more conundrous.

Most expensive is MFC.PR.L, resetting at +216bp on 2019-6-19, bid at 23.03 to be $0.52 rich, while MFC.PR.H, resetting at +313bp on 2017-3-19, is bid at 25.46 to be $0.49 cheap.

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The cheapest issue relative to its peers is BAM.PF.B, resetting at +263bp on 2019-3-31, bid at 22.06 to be $0.62 cheap. BAM.PF.G, resetting at +284bp 2020-6-30 is bid at 24.37 and appears to be $0.54 rich.

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FTS.PR.H, with a spread of +145bp, and bid at 16.30, looks $0.69 cheap and resets 2020-6-1. FTS.PR.G, with a spread of +213bp and resetting 2018-9-1, is bid at 22.00 and is $0.31 rich.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of about 0.50%, with no ridiculous outliers. On the junk side, four out of the six pairs are outside the range of the graph: FFH.PR.E / FFH.PR.F at -1.23%; AIM.PR.A / AIM.PR.B at -0.09%; BRF.PR.A / BRF.PR.B at -0.48%; and DC.PR.B / DC.PR.D at -1.37%.

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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 whining over liquidity focusses on investor homogeneity and the victory of deep pockets:

The size of the U.S. corporate-bond market has ballooned by $3.7 trillion during the past decade, yet almost all of that growth is concentrated in the hands of three types of buyers: mutual funds, foreign investors and insurance companies, according to Citigroup. That combination could lead to more selling than the market can absorb when the Federal Reserve raises interest rates for the first time since 2006, [Citigroup Inc. strategist Stephen] Antczak said.

“All the money is going to the same place, and when something adversely impacts one, chances are the same factor adversely impacts everyone else, and there’s nobody there to take the other side,” Antczak said in a telephone interview. “We used to have 23 types of investors in the market. Now we have three. In my mind, that’s the key driver.”

The three investor groups hold almost two-thirds of total corporate debt, Citigroup data show. Mutual funds, which are forced to sell when investors redeem cash, grew the fastest, more than doubling their share to 22 percent in 10 years. Overseas investors now hold almost a quarter of the market. Wells Fargo & Co. analysts warned last month that those buyers may be prompted to exit if the dollar weakened at the same time bond yields rose.

Hedge funds, government pension funds and securities brokers are among 20 other groups that hold 37 percent.
…
“A couple of investors have been acting like brokers, thinking about being a source of liquidity to the Street,” Antczak said. “They are big and able to hold less-liquid positions because they don’t have to mark it against the market and can hold until maturity.”

That’s what New York Life Insurance Co.’s investment arm, which oversees $215 billion of policyholder money, did during the so-called taper tantrum of 2013. The Fed’s move to end its unprecedented stimulus measures that year triggered a selloff that wiped out 5 percent from U.S. speculative-grade corporate bonds in less than two months.

The declines were “exaggerated because the need for liquidity was in excess of what the dealer community could provide,” Tom Girard, head of fixed-income investments at NYL Investors, said in a telephone interview. The firm stepped in to buy both investment-grade and speculative-grade securities, he said.

“New York Life acquired significant amounts of bonds at very attractive spreads and yield levels because we were able to provide liquidity,” he said. “If we get another situation similar to that taper tantrum, then from my perspective it starts to shift from a challenge to an opportunity.”

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And there is chatter that junk bond investors are getting nervous:

After providing a haven from the global bond-market selloff, speculative-grade securities have now joined the rout, tumbling almost 1 percent since the end of May. Investors are starting to flee, yanking $1.5 billion from the two biggest high-yield bond exchange-traded funds over the past week, according to data compiled by Bloomberg.
…
High-yield debt markets have “shown a degree of resiliency here to the shift in the inflation outlook,” Jeffrey Rosenberg, a managing director at BlackRock Inc.’s, said in a Bloomberg radio interview Tuesday. “That resilience could be challenged if we follow up this bout of higher rates with a shift in” expectations for when the Federal Reserve will lift rates.

Case in point: BlackRock’s $14.3 billion high-yield bond ETF plunged 1.6 percent in the six days through Monday as $940.5 million exited the fund, Bloomberg data show. State Street Corp.’s $10.7 billion junk-debt ETF dropped 1.7 percent, with $571.7 million of withdrawals.

Leveraged-loan investors aren’t too happy either:

Leveraged loans dropped to their lowest level in four months amid a pullback by buyers stung by borrowers such as Dollar Tree Inc. and Goodyear Tire & Rubber Co., who have taken advantage of a paucity of new deals by seeking to lower payments on existing debt. Barclays Plc last week cut its 2015 forecast for U.S. leveraged-loan issuance to as little as $250 billion as regulatory scrutiny slows the pace of buyout financings.

Investors who buy leveraged loans are caught in a bind. A push by regulators to curb risky underwriting practices has left them with fewer deals to chase, while the interest they earn on the loans they hold falls. Sentiment has also been weighed down by a global bond rout that has sent Treasury yields to levels not seen since October.

“Buyers are pulling back from paying a premium due to the fear they will be hurt by a refinancing in very short order,” said Jason Rosiak, head of portfolio management at Newport Beach, California-based Pacific Asset Management. “That weighs on the overall market.”

Loans prices dropped to 95.9 cents on the dollar on Wednesday, after falling each of the past three weeks in the longest such stretch since the fourth quarter, according to the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index. The debt lost 0.36 percent this month, after gaining just 0.05 percent in May, the smallest monthly return of the year.

But at least there’s less debt with negative yield:

Everyone knew it defied logic to pay for the privilege of lending trillions of dollars to European governments.

But two months ago, that didn’t stop investors from doing exactly that, causing the pool of European bonds with negative yields to soar to almost 3 trillion euros ($3.4 trillion) as of mid-April, Bank of America Corp. data show.

That trade is now dying quickly. The amount of such securities in the market has shrunk nearly in half, to 1.6 trillion euros as of June 9.

The Lapdog’s boss has told him to step up the war on banks:

Bank of England Governor Mark Carney ordered the finance industry to observe new rules on market conduct and threatened an even tougher regime if traders and bankers fail to comply.

His comments came as the BOE published the Fair and Effective Markets Review in London Wednesday, which recommends a new code of practice and longer jail terms for infractions. He said individuals must be “held to account” and firms must also take greater responsibility.

“This is a major opportunity for the industry to establish common standards of market practice,” Carney said. “If firms and their staff fail to take this opportunity, more restrictive regulation is inevitable.”
…
The markets review was announced by Chancellor of the Exchequer George Osborne at the same event a year ago. In his comments, Carney said revelations of misconduct have appeared with a “depressing frequency.” Bankers’ “ethical drift” has led to higher borrowing costs and falling confidence, while the $150 billion in fines levied on global banks has reduced their lending capacity by $3 trillion.

I love the bit where the banks are being blamed for the effects of their payment of $150-billion in fines. Very Jesuitical.

Naturally, Osborne has a valuable ally in his campaign for eternal re-election:

The Justice Department has begun an examination of trading in the U.S. Treasury market, following the outlines of its successful cases against Wall Street’s illegal practices in foreign currencies and other businesses, said three people familiar with the inquiry.

The government is also continuing to look into possible collusion in gold and silver markets and in trading around certain oil benchmarks, the people said.

Though the latest inquiry into Treasury trading is in its earliest stages, investigators are said to be probing whether information is being shared improperly by financial institutions. Some of the world’s biggest banks and their subsidiaries pleaded guilty after traders were shown to be using chat rooms, which functioned as cartels, to coordinate positions on foreign-exchange markets. These practices violated federal antitrust laws. Some of the same banks were among those that settled fraud and antitrust investigations into manipulating key interest rates.
…
It remains unclear where in the Treasury markets prosecutors aim to find wrongdoing, or if any specific allegations against Wall Street banks prompted the inquiries.

The best part of that story is that individual traders will be blamed for liquidity problems:

The Treasury Market Practices Group, an advisory committee backed by the New York Fed, finalized additions to its best practices guidelines Wednesday. For example, on a list of trading practices to avoid, it now includes “those that give a false impression of market price, depth or liquidity.”

It also added an updated recommendation “that market participants who employ trading strategies that involve high-trading volume or quoting activity should be mindful of whether a sudden change in these strategies could adversely affect market liquidity and should seek to avoid changes likely to cause such disruption,” the TMPG wrote in a statement.

And the regulators are very concerned about ‘banging the close’:

It was a simple process, according to the CFTC: Barclays traders told their brokers to buy or sell as many interest-rate swaps as needed just before 11 a.m. New York time to push the benchmark in the desired direction.
…
Here’s how a broker described the process to a trader in 2007, according to the CFTC: “If you want to affect it at 11, you tell me which way you want to affect it we’ll, we’ll attempt to affect it that way.”

Another time that year, a Barclays trader told his broker to buy as much as $400 million worth of swaps to move the benchmark, according to the complaint.
…
For example, on June 25, 2007, the Barclays options desk in New York had a $635 million swaption contract that was coming due, according to the CFTC. “Barclays traders on multiple desks coordinated to employ three methods of manipulation in an attempt to maximize the amount paid to Barclays in the swaption cash settlement,” the CFTC said in the complaint.

At 10:50 a.m. that day, the trader told his broker, “Don’t let ’em go down. For the eleven o’clock fix I need to lift 5s up,” he said, referring to the five-year swap spread trade. This is the trader who told the broker he could buy as much as $400 million in notional value of the swaps to move the benchmark.
…
That’s also known as banging the close — or, as a Barclays trader put it on March 7, 2007: “What happens at 11 is the bloody thing moves like half a basis point up and down because everybody’s trying to bang the screen.”

The obvious solution to the problem – if there is indeed a problem, which is by no means clear – is to lengthen the period of time over which the fix is calculated … if indeed a fix is really required at all. Another excellent option is to ensure that expiring contracts can be exchanged for physicals, rather than automatic cash settlement. But this isn’t about logic; this is all about asshole regulators and politicians making names for themselves.

You don’t believe me? Then I must assume you also don’t believe in proportionality:

Jamie Forese, head of the Citigroup Inc. unit that houses trading and investment banking, said fines the firm paid for rigging foreign-exchange markets dwarfed the amount generated by the illegal conduct.

Revenue from the trades amounted to about $1 million, while Citigroup paid out $2.5 billion in fines and penalties, Forese estimated Wednesday at an investor conference in New York.

However, one guy has been brave enough to bite back:

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon took aim at U.S. Senator Elizabeth Warren, a critic of large banks, as he expressed broad concerns about leadership in Washington.

“I don’t know if she fully understands the global banking system,” Dimon, speaking Wednesday at an event in Chicago, said of the Massachusetts Democrat. Still, he said he agrees with some of her concerns about risks.

It looks like Lagarde isn’t the only one who wants to be a Fed governor:

The World Bank joined the IMF in urging the Federal Reserve to hold off raising rates until next year, citing an uneven U.S. recovery and the risks to emerging markets of tightening policy any sooner.

“My concern is that the signals coming out of the U.S. economy have been mixed,” World Bank Chief Economist Kaushik Basu told reporters Wednesday in Washington on a conference call to discuss the bank’s semiannual global economic forecasts.

A premature move by the Fed could cause the dollar to strengthen, which may slow the U.S. economy and sideswipe emerging and developing countries, he said.

The Washington-based development bank lowered its forecast for U.S. growth this year to 2.7 percent, from 3.2 percent in January. The bank also expects the U.S. to expand at a 2.8 percent pace next year, down from 3 percent in January.

And many sets of entrails are being examined:

Economists surveyed June 5-9 put the probability of a September increase in the benchmark federal funds rate at 50 percent, according to the median estimate. The odds were nine percent for October, 20 percent for December and 10 percent for some time in 2016.

Some investors making bets on interest-rate futures have a more hawkish view. The market-implied probability of liftoff by September is somewhere between 93 percent and 100 percent, according to Stan Jonas, who has been trading fed funds futures since he helped create them in 1988.

The Federal Open Market Committee gathers on June 16-17, and Chair Janet Yellen will hold a press conference after the meeting. Fed officials will also publish updated quarterly economic and interest-rate forecasts.

And, as some comic relief, Bloomberg presents a good story on medical billing:

Dealing with medical bills, like waiting for the cable guy or buying a used car, has become a cliché of consumer exasperation. Everything from electricity and phone bills to tax returns and parking tickets migrated to electronic payments years ago, but America’s $2.9 trillion health-care economy remains stubbornly stuck in the 1990s. The number of medical bills paid by paper check through the U.S. mail has even increased while payments for all other services have decreased dramatically. Medical payments are the only category to register an increase in paperwork since the start of the 21st century: [Chart]

It’s not just consumers who are paying by mail. Just 15 percent of commercial insurers make payments to medical providers electronically, according to a report last month from PricewaterhouseCoopers Health Research Institute. The largest insurers are usually the best at going digital, but Cigna, with 14.5 million customers, sends only 39 percent of payments electronically. That’s because many doctors aren’t signed up to receive electronic transfers, according to spokesman Joe Mondy. Aetna and UnitedHealth Group, in contrast, both say around 80 percent of payments are paperless.

Hospitals, medical offices, and insurance companies need an army of workers to push all that paper1increase click area, which is also frequently shuffled through middlemen like billing agencies2increase click area and clearinghouses3increase click area. One claims clearinghouse, Emdeon, which handles paper billing for many of its health plan clients, spent $87 million4increase click area on postage alone in the first three months of 2015—nearly a quarter of its total revenue—according to financial filings. All this bureaucracy pushed the cost of administering private insurance to $173 billion5increase click area in 2013, according to federal data.

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It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts gaining 1bp, FixedResets off 15bp and DeemedRetractibles up 6bp. The Performance Highlights table is of average length – given recent standards – and features ENB FixedReset losers and BAM FixedReset winners. Volume was on the high side of average.

PerpetualDiscounts now yield 5.09%, equivalent to 6.62% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.1%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 250bp, a slight (and perhaps spurious) narrowing from the 255bp reported June 3.

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 23.52 to be $1.19 rich, while TRP.PR.B, which will reset June 30 at 2.152% (+128), is $0.85 cheap at its bid price of 14.60

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Another excellent fit, but the numbers are perplexing. Implied Volatility for MFC continues to be a conundrum. It is still too high if we consider that NVCC rules will never apply to these issues; it is still too low if we consider them to be NVCC non-compliant issues (and therefore with Deemed Maturities in the call schedule). It is clear that the lowest spread issue, MFC.PR.F, is well off the relationship defined by the other issues, but this doesn’t resolve the conundrum – it just makes it more conundrous.

Most expensive is MFC.PR.L, resetting at +216bp on 2019-6-19, bid at 23.27 to be $0.63 rich, while MFC.PR.H, resetting at +313bp on 2017-3-19, is bid at 25.46 to be $0.54 cheap.

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The cheapest issue relative to its peers is BAM.PF.B, resetting at +263bp on 2019-3-31, bid at 22.73 to be $0.42 cheap. BAM.PF.G, resetting at +284bp 2020-6-30 is bid at 24.88 and appears to be $0.70 rich.

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FTS.PR.H, with a spread of +145bp, and bid at 16.20, looks $0.89 cheap and resets 2020-6-1. FTS.PR.M, with a spread of +248bp and resetting 2019-12-1, is bid at 24.40 and is $0.35 rich.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of about 0.45%, with no ridiculous outliers. On the junk side, four out of the six pairs are outside the range of the graph: FFH.PR.E / FFH.PR.F at -1.22%; AIM.PR.A / AIM.PR.B at -0.09%; BRF.PR.A / BRF.PR.B at -0.48%; and DC.PR.B / DC.PR.D at -1.37%.

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

There’s an interesting trend in US bank accounting:

Big U.S. banks have been shifting huge chunks of their securities portfolios from AFS to HTM as they seek to offset the coming impact of a rate rise. Bloomberg News reported last year that the share of securities that the five biggest banks keep in the HTM bucket jumped to 8.4 percent, the highest in almost two decades. The trend appears to have accelerated in the ensuing months, with almost a third of the MBS on bank balance sheets now classified as HTM, according to new research from JPMorgan.
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As JPMorgan analysts note: “… [B]anks have shifted nearly a third of their MBS into HTM accounts, thanks to concern about capital volatility driven by recent regulatory changes. This means that banks should ultimately be less sensitive to rate moves, since fewer securities are being marked to market.” The shift makes some sense in the face of declining bank profit margins and the need to hold more lower-yielding assets that are considered super-liquid under other new banking rules.

Buying longer duration MBS and then stuffing them in HTM portfolios can help banks offset some of the lower returns on offer from investing in things such as shorter-term U.S. Treasuries.

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It is interesting that the freeze on trading implied by Hold-to-Maturity status for these liquidity buffers will make MBS less liquid as a group; this is just another one of the inherent contradictions of capitalism.

Matt Levine explains:

If you own that bond for investment purposes, and you don’t have any “intent of selling it within hours or days,” you have an investment loss on paper, but you get to treat it a bit more gently. (This is called “available for sale,” or AFS.) The loss doesn’t flow through your net income; instead it flows through a different place called “other comprehensive income,” and everyone agrees to treat that as somewhat less important than net income.3 Everyone except Basel III bank capital regulation: Last year, regulators ungallantly decided to require you to treat those unrealized investment losses as reducing your capital.

If you have the “positive intent and ability” to hold the bond until it matures, then you can just ignore the economic loss until maturity. (This is called “held to maturity,” or HTM.) You just keep the bond on your books at the price you paid for it,[4] and at maturity you get back par and your loss vanishes.5 You ignore the loss in net income, other comprehensive income, your balance sheet, your capital, whatever.

Footnote 4: Amortized cost, but let’s not split hairs

Footnote 5: Which makes a sort of sense: If you never sell the bond in the market, you never realize the loss in the form of getting fewer dollars for your bond than you paid for it. Your loss becomes just an opportunity cost: Instead of getting 5 percent interest and your money back, you got 4 percent interest and your money back. But you got your money back. Everything is fine.

So it would seem that banks are now doing with long-term MBS what retail loves to do with GICs – carry the position at historical cost and blithely ignore market marks.

So, as Mr. Levine points out, one immediate problem is:

First, one reaction to a rising interest rate environment might be to reduce one’s holdings of long-dated fixed-income securities. One might say “hmm, I should maybe sell my trillions of dollars of very liquid Fannie Mae bonds that I expect to lose value in the next few years.” Or not, I mean, I’m not advising anyone to predict the timing of interest rate rises. The point is though that banks seem to be reacting to their expectations of rising interest rates with the opposite of the economically rational strategy: Not “sell bonds to avoid losses later,” but rather “reclassify bonds as hold-forever to avoid recognizing losses later.” The accounting provides opposite incentives from the economics.

Another obvious problem is that, in a scenario of higher interest rates, there will be a good chunk of unrealized and unrecognized losses on the books. Therefore, in a crisis when bank investors change their valuation paradigm from ‘going-concern’ to ‘break-up value’ we might just see some problems!

As we’ve learned in Ontario with respect to gender quotas on boards of public companies, protecting the interests of investors is BORING. So US regulatory agencies have now become soldiers in the great battle of social change:

The OCC, Board, FDIC, NCUA, CFPB, and SEC are issuing a final interagency policy statement establishing joint standards for assessing the diversity policies and practices of the entities they regulate, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

My favourite part is:

In addition, entities’ prime contractors often use subcontractors to fulfill the obligations of various contracts. The use of minority-owned and women-owned businesses as subcontractors provides valuable opportunities for both the minority-owned and women-owned businesses and the prime contractor. Entities may encourage the use of minority-owned and women-owned subcontractors by incorporating this objective in their business contracts.

Just like South Africa, that paragon of economic development!

SEC Commissioner Luis A. Aguilar doesn’t like it:

For example, the Final Policy Statement fails to address the following concerns raised by commenters:

• • First, that allowing the voluntary disclosure of information by regulated entities is prohibited under Section 342 of the Dodd-Frank Act because it renders the statute ineffective and fails to achieve the Congressional intent of advancing diversity in the financial services industry.
• • Second, that voluntary self-assessments are ineffective because, without specific obligations and requirements, few regulated entities will conduct assessments or share assessment information.
• • Third, that failing to include standard criteria and uniform metrics for assessing the diversity and inclusion practices at regulated entities will make it very difficult, if not impossible, to assess diversity at different firms.
• • Fourth, that a purely voluntary requirement, and one without a reporting timeline, lacks transparency and accountability. Firms can therefore decide not to conduct any assessment and treat any OMWI oversight as optional or irrelevant.
• • Fifth, that OMWI would fail to satisfy its Congressional mandate under Section 342 by simply monitoring voluntary reports that may or may not be filed by regulated entities.
• • Finally, that a definition of “diversity” that is too narrow would fail to accomplish the goals of Section 342. In fact, the Final Policy Statement’s definition of “diversity” excludes people with disabilities and excludes the entire LGBT community.

It was a mostly negative day for the Canadian preferred share market, with PerpetualDiscounts gaining 2bp, FixedResets down 27bp and DeemedRetractibles off 26bp. The Performance Highlights table is fairly lengthy, with a mixed bag of entries, mostly losers. Volume was average.

But, I mean, Holy Smokes! Here’s a picture of CPD total returns for the past month. Don’t these damn things ever go up?

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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 23.50 to be $1.21 rich, while TRP.PR.B, which will reset June 30 at 2.152% (+128), is $0.71 cheap at its bid price of 14.73

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Another excellent fit, but the numbers are perplexing. Implied Volatility for MFC continues to be a conundrum. It is still too high if we consider that NVCC rules will never apply to these issues; it is still too low if we consider them to be NVCC non-compliant issues (and therefore with Deemed Maturities in the call schedule). It is clear that the lowest spread issue, MFC.PR.F, is well off the relationship defined by the other issues, but this doesn’t resolve the conundrum – it just makes it more conundrous.

Most expensive is MFC.PR.M, resetting at +236bp on 2019-12-19, bid at 24.10 to be $0.49 rich, while MFC.PR.F, resetting at +141bp on 2016-6-19, is bid at 25.00 to be $0.50 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 21.00 to be $0.20 cheap. BAM.PR.T, resetting at +231bp 2017-3-31 is bid at 21.50 and appears to be $0.24 rich.

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FTS.PR.H, with a spread of +145bp, and bid at 16.15, looks $0.99 cheap and resets 2020-6-1. FTS.PR.K, with a spread of +205bp and resetting 2019-3-1, is bid at 21.65 and is $0.41 rich.

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Investment-grade pairs predict an average three-month bill yield over the next five-odd years of about 0.45%, with no ridiculous outliers now that the awful performance of FTS.PR.I today has brought the FTS.PR.H / FTS.PR.I pair into the fold. On the junk side, five out of the six pairs are outside the range of the graph: FFH.PR.E / FFH.PR.F at -1.23%; AIM.PR.A / AIM.PR.B at -0.41%; BRF.PR.A / BRF.PR.B at -0.36%; DC.PR.B / DC.PR.D at -0.47%; and FFH.PR.C / FFH.PR.D at +1.14%.

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