PrefBlog

OSFI has released a letter to IASB about Insurance Contracts. Their first objection is serious – very serious indeed:

We are concerned that, if the ED is finalized as proposed, OSFI would likely need to make significant adjustments to the financial statements for regulatory capital purposes.

Oh golly! They might have to change their regulatory capital calculations!

Funny, I would have thought that the sole legitimate consideration was: do the proposed changes provide a materially better reflection of reality than the prior accounting paradigm? But I suppose I am only parading my naivety.

Their second objection is equally oblivious to the issues:

Moreover, the adjustments in question may have the effect of relaxing rather than constraining the assumptions that lie behind the requirements of the standard.

Well, that’s fine – as long as the new standards reflect reality better than the old ones, who cares whether they’re relaxing or constraining?

The meat of their letter highlights some motherhood issues, but doesn’t provide any suggestions:

In our 2010 comment letter, OSFI noted the potential for significant, inappropriate volatility if short term fluctuating market rates were used to discount very long-duration liabilities. The IASB has confirmed that either a bottom-up or top-down approach could be used to determine the discount rate. However, due to the high-level nature of a principles based standard, we understand there are a wide range of views of how the top-down approach could be interpreted for the long duration discount rates as currently drafted in the ED. We are pleased that the exposure draft allows more weight to be put on long term estimates than on short-term fluctuations when forecasting unobservable discount rates for long-duration liabilities. We believe current period fluctuations should not exaggerate the volatility of very long-dated liabilities. As such, long-duration liabilities beyond the observable period where deep and liquid markets exist should grade to a slow-moving long-term rate.

When discussing Asset Liability Management, they’re a little shy about stating their concern directly:

We believe the use of OCI for insurance contract liability measurement should be optional, rather than mandatory as currently proposed in the ED.

Asset Liability Management (ALM) practices are designed to ensure that there are sufficient assets to support insurance liabilities. This is achieved by investing in various types of assets with different attributes (e.g. yield, cash flow, risk and duration) that best fulfill various insurance liabilities obligations. Accounting standards should capture economic mismatches between assets and the insurance contract liabilities they support, but standards should not create accounting mismatches on their own. We believe the mandatory use of OCI may have an unintended consequence by reflecting both economic and accounting mismatches in the financial statements, making it difficult for users to distinguish between true economic mismatches and those created by accounting standards.

In order to fulfill various types of insurance liabilities obligations, investing in assets like mortgages, equities and derivatives instead of plain vanilla bonds could be appropriate for a portfolio that is well managed and diversified. We believe the interaction between IFRS 4 and IFRS 9 needs further consideration to take into account ALM practices of life insurers and to reduce accounting mismatches.

A very bureaucratic letter! All the substance will take place behind closed doors, to ensure opacity and non-accountability.

The latest housing bubble worry emanates from Australia:

Australia, where housing accounts for about 60 percent of average household wealth compared with a global average of 45 percent, joins countries from Canada to Sweden to China seeing rapid price gains amid low borrowing costs that are sparking fears of a housing bubble. For now, constrained housing supply and demand from investors are driving prices higher, overpowering the downdraft from slower economic growth and a rising jobless rate.
…
In Sydney, the nation’s most populous city, the average home price surged 13 percent in the 10 months to Oct. 31 to a record A$718,122 according to the RP Data-Rismark home value index. That compares with $806,000 in New York as of Sept. 30, according to the Real Estate Board of New York, and 331,338 pounds ($536,237) in London, according to the Nationwide Building Society.

A report to the U.S. Treasury’s Borrowing Advisory committee titled Assessing fixed income market liquidity makes some cogent points:

• ● Market turnover has if anything increased since the financial crisis
• ● But liquidity is about much more than turnover
  • – Tendency to disappear abruptly when really needed
• ● Primary liquidity not really a problem; major issues all in secondary
• ● Neither turnover nor the street have been able to keep pace with the massive expansion in markets
• ● Regulations have created multiple constraints likely to curtail liquidity when it is really needed:
  • – Most have pushed liquidity towards Treasuries, reducing it in risky assets:
  • • Basel risk-weightings, swaps clearing, LCR requirements
    • – Now, supplementary leverage ratios risk curtailing it even in Treasuries: dealers likely to meet requirements by reducing assets rather than raising capital
  • ● Effects of regulations to date have been offset by Fed policy pushing investors in the opposite direction:
    • – Significant demand for fixed income assets in general, and risky assets in particular
  • ● Technology and shifts in market structure have added to the appearance of liquidity, but done little to add depth
  • ● Potential for significant dislocation when investor flows reverse

  …
  Secondary trading requires risk warehouses
  …
  Capital cost under Basel 3 … 3-5x increase in charges for corporate bonds
  …
  Dealers can no longer afford to act as credit warehouses

There are a lot of great charts in those slides and I thoroughly recommend a full reading of the presentation. It strikes me that at some point, some large hedge fund – perhaps one that already acts as an intermediary for retail equity trades, standing between the brokerage house and the exchanges – will find it worth their while to make markets from their long positions. I think that – subject to regulatory bullshit, which is probably extremely bullshitty – the big Canadian funds should be doing that now. Why not?

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts up 5bp, FixedResets gaining 2bp and DeemedRetractibles off 8bp. Volatility was dominated by FixedResets. Volume was well above average.

So what happens to US banks if skyrocketting interest rates cause another housing collapse? The Fed wants to know:

The Federal Reserve said it will examine how the biggest banks might react to a jump in long-term interest rates and another housing crash as it released the next round of stress-test scenarios designed to monitor the ability of the U.S. financial system to withstand economic shocks.

The central bank mentioned that as part of two adverse scenarios it will gauge bank resilience against declines in the prices of high-risk, high-yield loans and debt and some high-priced real estate markets around the country, according to a statement released in Washington today. The central bank also inserted a test for large trading and clearing banks on counterparty default.

There’s an interesting piece on Bloomberg about local government in the rural US:

Monroe is hemorrhaging residents, like rural jurisdictions across the U.S. Yet these communities operate with the same layers of government as when horse-and-buggy travel helped determine the boundaries of the nation’s more than 3,000 counties. As population drops and infrastructure decays, officials and residents concerned about the loss of jobs and identity resist shrinking their government.

“People like that eye-to-eye contact,” said Monroe County Judge Larry Taylor, the top elected official in the county of 7,800. It has lost 44 percent of its population since 1980 as its main budget grew 9 percent, even when adjusted for inflation.
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In North Dakota, public costs would have fallen 2.5 percent annually by combining general government, road maintenance, public safety, and health and welfare, according to a 1996 North Dakota State University analysis of a failed proposal to merge 53 counties into 15.

Rob Carrick of the Globe writes an interesting piece on BMO’s generic advisor, titled Investing advice: How adviceDirect stakes out middle ground:

In the investing business, there’s no surer validation of a new initiative than having your competitors copy you. AdviceDirect has struck out on that count. After a full year in operation, no one else has introduced a service where clients invest online while receiving a combination of Web-based and person-to-person advice.

But adviceDirect is on to something in targeting people who gravitate to DIY investing, but need help. “The discipline adviceDirect gives a do-it-yourself investor can be very attractive for people who don’t have the time, the experience or the confidence,” says Viki Lazaris, president and CEO of BMO InvestorLine.
…
BMO won’t say how many people have signed up for adviceDirect, but you get an idea of how busy things are in the fact that the advice team there comprises just eight people right now. If adviceDirect manages to build its franchise, it will be a result of the work done by these investment specialists (that’s BMO’s title for them).

I’ll suggest that a good business case for adviceDirect can be made solely on the basis of insurance … insuring BMO against the risk that mutual fund trailers will be banned (see various posts and comments commencing on December 17, 2012). In such a case, they’ll be up and running with a working model of access to small investors and that head start could be quite an advantage.

Incidentally, there was a bit of an update on that situation in June:

Indeed, according to the OSC’s transcript of the event, Greg Pollock, president and CEO of Advocis, cautioned that “financial advice would become unaffordable, and therefore
inaccessible, to the average Canadian.”

There also are fears that any move away from embedded commissions could ultimately drive many advisors out of the business. Indeed, defenders of the current system point to the U.K., which introduced new rules outlawing embedded commissions, among other reforms, on Jan. 1. It was suggested at the OSC meeting that the U.K. has lost 25% of its advisory sales force due to its ban on commissions, with several large financial services institutions dropping out of the retail investment advice business altogether.
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According to data from London-based Matrix Solutions Inc., since the RDR took effect on Jan. 1, the number of authorized investment intermediary firms is down by about 6% as of May; the total number of registered individuals in this sector is off by 9.5%; and the ranks of so-called “customer-facing staff” is down by 12.3%.

Those figures are much lower than was suggested at the OSC’s January meeting, and it appears that the immediate effects now are being reversed a bit. In fact, the data show that the number of registered reps rose in May month-over-month, and the number of customer-facing reps rose for the second straight month.

Ontario has a message for business – Spend, spend, spend!

In a speech at Toronto’s Empire Club Monday, Finance Minister Charles Sousa took aim at so-called “dead money” – capital that corporations have been holding onto since the global recession. The federal government has already pressed companies to invest that money in the economy, and Mr. Sousa said his government would use the tax system to encourage them to do it.

These would include a tax credit for research and development spending, and an incentive for companies that buy new equipment or technology, or spend money to train employees.

Mr. Sousa said he understands why companies have been hoarding cash, but warned that doing so is holding back Canada’s economy.

Me, I’d say that what is holding back Canada’s economy is government distortion of the free markets, but I’m not the treasurer of Ontario.

Robert Shiller is warning of another housing bubble – but this one’s in Brazil:

The government increased the price limit of houses people can buy using the unemployment insurance fund on Sept. 30 after public lending for homes increased more than four times as much as private banks in the two years through June, to 202 billion reais ($90 billion), according to central bank data.

Rousseff’s homebuilding program has propelled demand as she seeks to stimulate the economy before next year’s presidential election. Robert Shiller, six weeks before winning the Nobel Prize for economics, cautioned that such demand may be fueling a bubble as home prices grow twice as fast as rent. Mortgage debt as a percentage of disposable household income has climbed to a record 15 percent, almost double the level at the start of Rousseff’s term.

It was a strong day for the Canadian preferred share market, with PerpetualDiscounts winning 27bp, FixedResets up 26bp and DeemedRetractibles gaining 16bp. FixedResets with a low Issue Reset Spread dominated the winning side of the Performance Highlights table. Volume was average.

There was a little pop in bond yields today:

Treasury 10-year note yields (USGG10YR) rose to the highest levels in two weeks after a gauge of U.S. manufacturing expanded at a faster pace than forecast, weakening the case for the Federal Reserve to maintain stimulus.

The benchmark securities extended the first five-day drop in three weeks as Fed Bank of St. Louis President James Bullard said labor market gains in the past year could warrant a cut in the bond buying. Fed policy makers said Oct. 30 that the economy showed signs of “underlying strength” even as they maintained their $85 billion of monthly asset purchases.

Want a raise? Go west, young man!

Data released yesterday by Statistics Canada showed the difference in average hourly wages in Alberta and the rest of the country, but for Saskatchewan, widened again in August.

“Note that hourly wages are now nearly $6 less in Atlantic Canada than in Alberta, the widest gap on record, a factor that has contributed to pushing more than 11,000 migrants out of the region in the past year – a major headache for housing markets, government finances, etc.,” said senior economist Robert Kavcic of BMO Nesbitt Burns.

“Even B.C. is seeing the wage gap approach $4/hour versus Alberta, and not coincidentally is also seeing a decade-high net outflow of workers.”

The StatsCan report indicates that a decent economy is still comfortably far away:

Click for Big

… with an implication that those who decided to earn a living filing paperwork for construction companies are getting vindicated …

Click for Big

DBRS confirmed Enbridge at Pfd-2(low):

DBRS has today confirmed the Issuer Rating of Enbridge Inc. (ENB or the Company) at A (low) and ratings on ENB’s Medium-Term Notes & Unsecured Debentures, Commercial Paper and Cumulative Redeemable Preferred Shares ratings at A (low), R-1 (low) and Pfd-2 (low), respectively, all with Stable trends. The ratings reflect (1) a relatively strong business risk profile, (2) pressure on ENB’s near-to-medium-term credit metrics and (3) results under the ten-year Competitive Tolling Settlement (CTS), effective July 1, 2011.

Enbridge is the proud issuer of ENB.PR.A, ENB.PR.B, ENB.PR.D, ENB.PR.F, ENB.PR.H, ENB.PR.N, ENB.PR.P, ENB.PR.T and ENB.PR.Y, as well as some US-Pay stuff that I don’t track.

It was a negative day for the Canadian preferred share market, with PerpetualDiscounts down 11bp, FixedResets off 3bp and DeemedRetractibles losing 18bp. The Performance Highlights table is longer than one might expect given the modest overall moves, with a preponderance of Straight losers. Volume was on the low side of average.

Nothing happened today.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts up 37bp, FixedResets gaining 11bp and DeemedRetractibles off 3bp. The Performance Highlights table is notable on the downside for domination by BAM Floating Rate issues, while the upside has a surprisingly large population of FixedResets. Volume was high.

PerpetualDiscounts now yield 5.49%, equivalent to 7.14% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.7%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 245bp, unchanged from October 23.

And that’s it for another month!

Today’s FOMC release was ‘Steady as she goes’:

Taking into account the extent of federal fiscal retrenchment over the past year, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.

Joshua Zumbrun & Jeff Kearns of Bloomberg comment:

The consumer price index increased 0.2 percent after rising 0.1 percent the prior month, a Labor Department report showed today. The Fed’s preferred gauge of inflation, the personal consumption expenditures index, rose 1.2 percent in August and hasn’t breached 2 percent since March 2012.

The Fed removed a sentence from the previous statement that had said tighter financial conditions could slow the improvement in the economy.

Kansas City Fed President Esther George dissented for the seventh meeting in a row, citing the risk the Fed’s stimulus could create financial imbalances and cause long-term inflation expectations to rise.

Richard Vedder of Bloomberg rages against the cost of US universities’ hubris:

I have written before on how the expansion of federal student-loan programs has encouraged colleges to simply raise their costs. Students are left to pile up more debt while colleges indulge in their Edifice Complex — building luxury dorms and gyms and stadiums (all “sustainable,” of course) at the expense of poorer students. There is another, related government subsidy that also has perverse effects and needs reform: the tax-exempt debt binge by universities.

Schools are exuberantly borrowing, in some cases issuing 100-year (century) bonds. Some bond offerings are justified, even wise, as schools are taking advantage of low interest rates to reduce future debt-service obligations. But a lot of this activity is financing construction of high-end student housing, faddish “centers” and stadiums.

These perquisites appeal to the most affluent. For many students, however, the costs of college are rising relative to the perceived benefits, pushing them to consider lower-cost substitutes (online education, nondegree certificate programs).

Many bonds are tax-exempt. The more money borrowed, the more generous the exemption, creating in effect a taxpayer subsidy for rich universities. Should there be no cap on the tax exemptions private colleges can claim on their bond debt, and is it appropriate for the government to subsidize all types of projects at these schools?

And the argument regarding the cost of Too-Big-to-Fail rages on as well:

McCloskey’s confusion about the nature of the too-big-to-fail subsidy leads directly to another misconception: that regulatory compliance costs could somehow offset the subsidy. Compliance may or may not put a greater burden on larger banks (I suspect executives at small banks would disagree). In any case, the costs do nothing to reduce the taxpayer subsidy or the incentive to preserve it by becoming as big and systemically threatening as possible.

In other words, U.S. taxpayers are paying big banks to put the economy in danger, which is crazy. The best solution is to make banks less likely to fail by requiring that they finance themselves with more equity capital, which absorbs losses in bad times.

Regulators have taken a small step in that direction by proposing that bank holding companies have at least $5 in capital for every $100 in assets — a 5 percent leverage ratio that is a bit more than the global minimum of 3 percent. The proposal, to which banks are adamantly opposed, falls far short of the 20 percent that economists have argued would be best for the economy, but at least it’s a start. Let’s hope they stick to it.

Matt Levine writes a more sensible than usual piece about the so-call FX manipulation scandal, which I never-the-less disagree with:

There are two problems with this. One, while the bank is guaranteeing the client the WM/Reuters fix price, nobody’s guaranteeing the bank anything. The bank has to actually go trade and try to hit that price. The way the fix works is that it’s set by sampling trades over a 60-second window, so you have to have a certain amount of skill and luck to trade at (or better than) the official price. It’s risky.

Two — and this is important, too — banks are in the business of making money, and the trade they want is not “buy at WM/Reuters fix and sell at WM/Reuters fix” but rather “buy at less than WM/Reuters fix and sell at WM/Reuters fix.”
If your client tells you at 3:30 that they want to buy francs at the 4 p.m. price, there are fairly straightforward ways to try to ensure a profit. Like: If they’re buying a lot of francs, then you’d expect that to push the market for francs up. So what you could do is start buying francs at 3:30 when they’re trading at $1.1150 or whatever,**** and keep buying steadily until 4 p.m. when they’re trading at $1.1200, for an average price of like $1.1175, and then sell to the client at the 4 p.m. fix of $1.1200. You buy francs for $1.1175, you sell them for $1.1200, you make $0.0025 per franc, you do it a lot, boom, good business.
…
Also some things are right out:

In June, Bloomberg News reported that dealers pooled information about their positions through instant messages, executed their own trades before client orders and sought to manipulate the benchmark WM/Reuters rates by pushing through trades around the 60-second windows when the benchmarks are set.

The sharing client data among dealers seems self-evidently bad. The “executed their own trades before client orders and sought to manipulate the benchmark” is either bad, or just legit hedging that looks bad, or something in between, or some combination thereof, it is hard to know.

This shows a fundamental misconception of the order.

The bank has not agreed to act as agent, with fiduciary responsibility, for the client. What the bank has done is sold a very short-term (intra-day) forward contract to the client. When the dealers talk to each other, they’re not sharing information about client orders, they’re sharing information about their own orders, which they will be placing as principal in order to cover their position.

The big problem with the market is that there are too many fools and charlatans in charge of too much client money. Dealers are not your friends. Dealers are counterparties, just like Loblaws is my counterparty when I buy groceries. Loblaws and I get on well and have a mutually beneficial relationship – but they’re always trying to make it a little more beneficial for them and I’m always trying to make it a little more beneficial for me. Sadly, this fundamental truth escapes the Boo-hoo-hoo brigade.

The industry is staffed with MBAs, which stands for Minimal Brain Activity. There is nothing the dealers do that a large client – large enough to matter, large enough to be asked their intentions – cannot do himself. Trades can be sampled over a given period, whether it’s the period of the fix, or the run-up to it, or the aftermath … but, unfortunately, that involves actual work, which MBAs are fundamentally incapable of doing, or even understanding. Why, one might have to write, or commission, an algorithmic programme to buy your USD 100-million in million dollar chunks! Computer programmes? Those are for geeks! Daddy didn’t pay for a good school so I could write computer programmes! It might take more than one ‘phone call to execute the trade! More than one call? How are you going to discuss the analysis of Warren Buffet’s pronouncement on Yellen’s approach to the Fed if you have to make more than one call. Can’t be done. Call a dealer, just like Daddy calls his stockbroker.

It may be ugly and awful, but US sequestration might be working anyway:

Senator Jeff Sessions of Alabama, the top Republican on the Budget Committee, said today in an interview such an accord could be a way to replace for a year or two the automatic spending cuts, known as sequestration, that both parties decry.

“A great number of entitlement programs, mandatory programs, are not Social Security and Medicare,” Sessions said. “There are a whole bunch of programs that are mandatory in nature and have never been looked at” and weren’t in the law setting up the automatic cuts, he said, citing farm subsidies and food stamps.

Asked if such a deal is a fallback to a broader deal, he said. “I would hope so.”

BAM closed a big deal:

If you have a railroad or a port for sale, there’s a big new buyer as Brookfield Asset Management just closed a massive $7-billion (U.S.) infrastructure fund that will invest in such things as transportation and energy assets. The new money has the potential to bump up Brookfield’s fee income markedly.

Brookfield blew right through the $5-billion target. There are more than 60 investors, including sovereign wealth funds, insurers, and public and private pension plans. Brookfield is putting in $2.8-billion of its own money (through its Brookfield Infrastructure Partners and Brookfield Renewable Energy Partners LP subsidiaries), meaning $4.2-billion is coming from outside investors. Brookfield said half the investors are rookies at putting money into Brookfield funds.

The new fund will surely significantly boost Brookfield’s fee income.

At a 1.5 per cent management fee, which is in the ballpark for funds of that size, the new outside assets would represent about $63-million a year in additional income for Brookfield. That would be before any performance fees.

It’s very encouraging to see business trying to take back control of the Republican party:

The U.S. Chamber of Commerce fired an opening salvo yesterday in the battle for control of the Republican Party, endorsing a self-described “pro-business” candidate in a special U.S. House race whose opponent is backed by Tea Party groups and is vowing to “be like Ted Cruz.”

The endorsement in the Alabama contest is the chamber’s first political move since the 16-day partial U.S. government shutdown and debt-ceiling battle, which exposed a rift between the Republican establishment wing and the smaller-government movement. Cruz, a Republican senator from Texas, was the chief proponent of the ill-fated plan to link defunding Obamacare to lifting the debt ceiling and passing a government spending bill.

In reaction to the shutdown, which Standard & Poor’s estimated cost the U.S. economy $24 billion, the chamber and other business groups said they will engage in elections — including Republican primaries — to help candidates aligned with their economic goals.

It would be nice to see that in Canada, too.

It was a strong day for the Canadian preferred share market, with PerpetualDiscounts up 34bp, FixedResets gaining 10bp and DeemedRetractibles winning 59bp. The Floating Rate sector got whacked, perhaps in response to the FOMC release and those issues figured prominently on the wrong side of the Performance Highlights table. BAM issues were notable on the winning side. Volume was very high.