Regulation

The Life Insurance Industry and the Long Game

Julie Dickson of OSFI gave a speech titled The Life Insurance Industry and the Long Game, which gave some gentle hints to the industry, but was short on details regarding the potential for regulatory change:

Should rates continue at the current low level – below 3% on government bonds for a 30-year term – it will be a real game changer for the life insurance sector.

Since life insurers often lock in their assumptions for the expected rate of return when the product is priced, there is an implicit assumption that the life insurer will continue to earn the same average interest rate over the lifetime of the product. When interest rates fall life insurers must reinvest the renewal premiums on new investments at lower rates than originally priced, leading to a compression in the product margin.
…
As regulators, we want life insurers to maintain healthy solvency ratios and still deliver on their promises to policyholders. If insurers are moving risk from their balance sheets onto policyholders, policyholders need to understand the risks they are assuming – we would not want to see a repeat of the vanishing premium events of the early 1990s.
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The low interest rate environment also puts pressure on life insurers to recognize that they must discount their liabilities at the prevailing rate of interest. Currently in Canada, actuarial practice allows life insurers to grade in the effects of a decreasing interest rate environment over 10 years. This is a prudent approach. But we are concerned that a few life insurers may not be moving quickly enough to recognize that a change in strategy is also required. Life insurers need to start making changes to their product portfolios today to mitigate the grading of these low interest rates into the ultimate reinvestment rate (URR) to value long term insurance liabilities.
…
Through fora like the G-20, the Basel Committee on Banking Supervision, and the Financial Stability Board, international agreements are moving from discussion to implementation. The banking industry has been the focus of the majority of the reforms to date, but the life insurance industry is never far from the discussions.
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For example, we see the role of the Chief Risk Officer (CRO) as being of primary importance to both banks and insurers. The first line of defence is the business itself and it must own the risk in its operations. We see the CRO as being another line of defence for the board, shareholders, creditors, policyholders and other significant stakeholders (including regulators and supervisors) to ensure the effective management of risk within a financial institution – sort of like wearing a belt and suspenders, or a check on the front office. We expect the CRO to be independent, to work with the board to ensure there are independent processes and controls throughout the organization, and to serve the interests and concerns of significant stakeholders. Strengthening the role of the CRO is a significant change for some life insurers, but a necessary one.
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On the process of stress testing, we know that the recent “simulated crisis” stress test that OSFI asked specific Canadian life insurers to undertake did cause some concerns for those companies, in particular the degree of detail we requested. At the same time, however, we were struck by some of the weaknesses in the operating capacity of companies to provide the material in a timely manner. We have had discussions with industry representatives to review these concerns and are in the process of making changes to the reporting requirements of the 2012 stress test.

An issue that is receiving considerable attention globally is capital. The right amount of regulatory capital needs to be carried for the right risk. As the regulatory capital regime in Canada evolves, the objective will be to ensure this happens. We also encourage insurers to continue to develop their capabilities: economic capital models need to be more than a multiple (or a fraction) of regulatory capital – they need to allocate the right economic capital to the right risk.

Interesting External Papers

Countercyclical Credit Buffers

The Bank for International Settlements has released a working paper by Mathias Drehmann, Claudio Borio and Kostas Tsatsaronis titled Anchoring countercyclical capital buffers: the role of credit aggregates:

We investigate the performance of different variables as anchors for setting the level of the countercyclical regulatory capital buffer requirements for banks. The gap between the ratio of credit-to-GDP and its long-term backward-looking trend performs best as an indicator for the accumulation of capital as this variable captures the build-up of system-wide vulnerabilities that typically lead to banking crises. Other indicators, such as credit spreads, are better in indicating the release phase as they are contemporaneous signals of banking sector distress that can precede a credit crunch.

They explain:

We find that the variable that performs best as an indicator for the build-up phase is the gap between the ratio of credit-to-GDP and its long-term trend (the credit-to-GDP gap). Across countries and crisis episodes, the variable exhibits very good signalling properties, as rapid credit growth lifts the gap as early as three or four years prior to the crisis, allowing banks to build up capital with sufficient lead time. In addition, the gap typically generates very low “noise”, by not producing many false warning signals that crises are imminent.

The credit-to-GDP gap, however, is not a reliable coincident indicator of systemic stress in the banking sector. In general, a prompt and sizeable release of the buffer is desirable. Banks would then be free to use the capital to absorb writedowns. A gradual release would reduce the buffer’s effectiveness. Aggregate credit often grows even as strains materialise in the banking system. This reflects in part borrowers’ ability to draw on existing credit lines and banks’ reluctance to call loans as they tighten standards on new ones. A fall in GDP can also push the ratio higher. Aggregate credit spreads do a better job in signalling stress. However, their signal is very noisy: all too often they would have called for a release of capital at the wrong time. Moreover, as spread data do not exist for a number of countries their applicability would be highly constrained internationally.

We conclude that it would be difficult for a policy tool to rely on a single indicator as a guide across all cyclical phases. It could be possible to construct rules based on a range of conditioning variables rather than just one, something not analysed in this paper. However, it is hard to envisage how this could be done in a simple, robust and transparent way. More generally, our analysis shows that all indicators provide false signals. Thus, no fully rule-based mechanism is perfect. Some degree of judgement, both for the build-up and particularly for the release phase, would be inevitable when setting countercyclical capital buffers in practice. That said, the analysis of the political economy of how judgement can be incorporated in a way that preserves transparency and accountability of the policymakers in charge goes beyond the scope of this paper.

It’s a lucky thing that judgement is required for the process to work – otherwise there might be layoffs in the regulatory ranks! It’s also a lucky thing that details regarding the incorporation of judgement are beyond the scope of the paper, as otherwise one might have to examine the track record of the regulatory establishment in predicting crises.

I suggest that incorporating the judgement of the regulators into the process will have numerous effects:

  • Increasing politicization of the regulatory bureaucracy
  • Fewer crises (since the regulators will tend to err on the side of caution)
  • More severe crises (since the range of judgments existing in the private sector will be replaced by a one-size-fits-all judgment imposed according to the fad of the day)
  • increased uncertainty during a crisis, as both the sellers and the buyers of new bank capital will be unsure as to whether or not the buffers will be released.

I suggest that eventually we will regret the role of regulatory judgement to the extent that it is incorporated into the process.

I believe that the release of countercyclical buffers should be linked to the amount by which a bank’s write-offs have exceeded the norm for the past one (maybe two?) years. This would encourage (or at least mitigate the discouragement) of recognition of losses and provide a time limit for raising replacement capital (since the release will be effective for only one (maybe two) years.

The authors considered using bank losses as the anchor (building-up) indicator:

Aggregate gross losses: This indicator of performance focuses on the cost side (non-performing loans, provisions etc). The financial cycle is frequently signalled by the fall and rise of realised losses.

Although the use of this signal is not supported by the raw data, I suggest that:

  • It provides the most logical link to the condition that one is trying to alleviate, and
  • the knock-on effect of such a change (i.e., the way in which behaviour will be adjusted to account for the adjustement in rules) is in this case highly desirable – losses will be recognized faster.

As the authors’ graph shows, there’s no magic formula for predicting a bank crisis:


Click for Big

Although the credit-to-GDP gap is the best-performing indicator for the build-up phase, Graph 2 indicates that it declines only slowly once crises materialise. This is also borne out by the statistical tests shown in Tables 5 to 7. As before, bold values for “Predicted” highlight thresholds for which a release signal is issued correctly for at least 66% of the crises. The bold noise-to-signal ratio indicates the lowest noise-to-signal ratio for all threshold values that satisfy this condition.

None of the macro variables and of the indicators of banking sector conditions satisfy the required degree of predictive power to make them robust anchor variables for the release phase, ie none of these variables signals more than 66% of the crises. The best indicator is a drop of credit growth below 8%. This happens at the onset of more than 40% of crises and such a signal provides very few false alarms (the noise-to-signal ratio is around 10%).

A backtest of the Credit Gap as an anchor variable is encouraging:


Click for Big

Part of the authors’ conclusion is:

The analysis shows that the best variables to signal the pace and size of the build-up of the buffers differ from those that provide the best signals for their release. Credit, measured by the deviation of the credit-to-GDP ratio from its trend, emerges as the best variable for the build-up phase, as it has the strongest leading indicator properties for financial system distress. A side-benefit of using this variable as the anchor is that it could help to restrain the credit boom and hence risk taking to some extent.
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A final word of caution is in order. Are our empirical results subject to the usual Lucas or Goodhart critiques? In other words, if the scheme proved successful, would the leading indicator properties of the credit-to-GDP variable disappear? The answer is “yes”, by definition, if the criterion of success was avoiding major distress among banks. As credit exceeds the critical threshold, banks would build-up buffers to withstand the bust. If, in addition, the scheme acted as a brake on risk-taking during the boom, the bust would be less likely in the first place. However, the answer is less clear if the criterion was the more ambitious one of avoiding disruptive financial busts: busts could occur even if banks remained reasonably resilient. In either situation, however, the loss of predictive content per se would be no reason to abandon the scheme.

One thing I will note is that it may be helpful to disaggregate the accumulation signal. As has previously been reported on PrefBlog, residential real-estate now makes up more than 40% of Canadian banks’ credit portfolios, vs. the more normal 30%. I suggest that it would be useful to examine the components of the credit gap, in the hopes that one or more of them will prove a better signal than the complete set.

It may also be the case that changes in the proportion of various components of aggregate credit are just as important as the aggregate amount itself – these changes could be indicative of dislocations in the economy that will have grievous effects if, as and when they return to normal.

MAPF

MAPF Performance: October, 2011

The fund had a good month in October, making up some of the ground lost in September.

The fund’s Net Asset Value per Unit as of the close October 31 was $10.4924.

Returns to October 31, 2011
Period MAPF Index CPD
according to
Claymore
One Month +2.16% +0.60% +0.82%
Three Months -3.80% -0.39% -0.65%
One Year +2.37% +6.44% +3.72%
Two Years (annualized) +11.41% +10.28% N/A
Three Years (annualized) +27.68% +12.72% +9.95%
Four Years (annualized) +18.37% +5.90%  
Five Years (annualized) +13.74% +3.64%  
Six Years (annualized) +12.47% +3.88%  
Seven Years (annualized) +11.58% +3.90%  
Eight Years (annualized) +12.06% +4.11%  
Nine Years (annualized) +13.57% +4.46%  
Ten Years (annualized) +12.01% +4.37%  
The Index is the BMO-CM “50”
MAPF returns assume reinvestment of distributions, and are shown after expenses but before fees.
CPD Returns are for the NAV and are after all fees and expenses.
* CPD does not directly report its two-year returns.
Figures for Omega Preferred Equity (which are after all fees and expenses) for 1-, 3- and 12-months are +0.85%, -0.52% and +4.67%, respectively, according to Morningstar after all fees & expenses. Three year performance is +10.86%.
Figures for Jov Leon Frazer Preferred Equity Fund Class I Units (which are after all fees and expenses) for 1-, 3- and 12-months are +0.54%, -0.26% and +1.79% respectively, according to Morningstar
Figures for Manulife Preferred Income Fund (formerly AIC Preferred Income Fund) (which are after all fees and expenses) for 1-, 3- and 12-months are +0.40%, -0.30% & +3.36%, respectively
Figures for Horizons AlphaPro Preferred Share ETF are not yet available (inception date 2010-11-23)

MAPF returns assume reinvestment of dividends, and are shown after expenses but before fees. Past performance is not a guarantee of future performance. You can lose money investing in Malachite Aggressive Preferred Fund or any other fund. For more information, see the fund’s main page. The fund is available either directly from Hymas Investment Management or through a brokerage account at Odlum Brown Limited.

The fund’s returns in October were aided by a small bounce in the value of the YLO preferreds:


Click for big

However, there was a drag on performance due to a holding in CZP.PR.A. The bulk of this position was purchased in February and March of this year, when this PerpetualDiscount issue was rated three notches higher than BBD.PR.C, but yielded about the same:

The spread widened in June, 2011, following S&P’s announcemnet that CZP was on review-negative, but gradually returned to more usual levels … until the details of the take-over by Atlantic Power (ATP) were announced! DBRS warned of a three-notch downgrade (which would make the credit ratings of BBD and CZP equal) and … there was a lot of selling in late October.

The problem with the ATP take-over is that it is being structured, effectively, as a complete acquisition, rather than keeping Capital Power as a wholly-owned subsidiary. While the structure retains the wholly-owned subsidiary legal structure, the subsidiary is guaranteeing the senior debt of the holding company (the same way in which the attempted Teachers / BCE deal was structured), so CZP has lost its credit advantage of being “closer to the money” than the holding company.

The position in CZP.PR.A as of October 31 amounted to about 2.6% of fund value. It is my current intention to maintain the position until such time as the yield is again comparable with BBD.PR.C – as it now “should” be, given that a three-notch downgrade will make the credit ratings identical.

Sometimes everything works … sometimes the trading works, but sectoral shifts overwhelm the increment … sometimes nothing works. The fund seeks to earn incremental return by selling liquidity (that is, taking the other side of trades that other market participants are strongly motivated to execute), which can also be referred to as ‘trading noise’. There were a lot of strongly motivated market participants during the Panic of 2007, generating a lot of noise! Unfortunately, the conditions of the Panic may never be repeated in my lifetime … but the fund will simply attempt to make trades when swaps seem profitable, without worrying about the level of monthly turnover.

There’s plenty of room for new money left in the fund. I have shown in recent issues of PrefLetter that market pricing for FixedResets is demonstrably stupid and I have lots of confidence – backed up by my bond portfolio management experience in the markets for Canadas and Treasuries, and equity trading on the NYSE & TSX – that there is enough demand for liquidity in any market to make the effort of providing it worthwhile (although the definition of “worthwhile” in terms of basis points of outperformance changes considerably from market to market!) I will continue to exert utmost efforts to outperform but it should be borne in mind that there will almost inevitably be periods of underperformance in the future.

The yields available on high quality preferred shares remain elevated, which is reflected in the current estimate of sustainable income.

Calculation of MAPF Sustainable Income Per Unit
Month NAVPU Portfolio
Average
YTW		 Leverage
Divisor		 Securities
Average
YTW		 Capital
Gains
Multiplier		 Sustainable
Income
per
current
Unit
June, 2007 9.3114 5.16% 1.03 5.01% 1.2857 0.3628
September 9.1489 5.35% 0.98 5.46% 1.2857 0.3885
December, 2007 9.0070 5.53% 0.942 5.87% 1.2857 0.4112
March, 2008 8.8512 6.17% 1.047 5.89% 1.2857 0.4672
June 8.3419 6.034% 0.952 6.338% 1.2857 $0.4112
September 8.1886 7.108% 0.969 7.335% 1.2857 $0.4672
December, 2008 8.0464 9.24% 1.008 9.166% 1.2857 $0.5737
March 2009 $8.8317 8.60% 0.995 8.802% 1.2857 $0.6046
June 10.9846 7.05% 0.999 7.057% 1.2857 $0.6029
September 12.3462 6.03% 0.998 6.042% 1.2857 $0.5802
December 2009 10.5662 5.74% 0.981 5.851% 1.0819 $0.5714
March 2010 10.2497 6.03% 0.992 6.079% 1.0819 $0.5759
June 10.5770 5.96% 0.996 5.984% 1.0819 $0.5850
September 11.3901 5.43% 0.980 5.540% 1.0819 $0.5832
December 2010 10.7659 5.37% 0.993 5.408% 1.0000 $0.5822
March, 2011 11.0560 6.00% 0.994 5.964% 1.0000 $0.6594
June 11.1194 5.87% 1.018 5.976% 1.0000 $0.6645
September 10.2709 6.10%
Note		 1.001 6.106% 1.0000 $0.6271
October, 2011 10.4924 6.01%
Note		 1.001 6.016% 1.0000 $0.6312
NAVPU is shown after quarterly distributions of dividend income and annual distribution of capital gains.
Portfolio YTW includes cash (or margin borrowing), with an assumed interest rate of 0.00%
The Leverage Divisor indicates the level of cash in the account: if the portfolio is 1% in cash, the Leverage Divisor will be 0.99
Securities YTW divides “Portfolio YTW” by the “Leverage Divisor” to show the average YTW on the securities held; this assumes that the cash is invested in (or raised from) all securities held, in proportion to their holdings.
The Capital Gains Multiplier adjusts for the effects of Capital Gains Dividends. On 2009-12-31, there was a capital gains distribution of $1.989262 which is assumed for this purpose to have been reinvested at the final price of $10.5662. Thus, a holder of one unit pre-distribution would have held 1.1883 units post-distribution; the CG Multiplier reflects this to make the time-series comparable. Note that Dividend Distributions are not assumed to be reinvested.
Sustainable Income is the resultant estimate of the fund’s dividend income per current unit, before fees and expenses. Note that a “current unit” includes reinvestment of prior capital gains; a unitholder would have had the calculated sustainable income with only, say, 0.9 units in the past which, with reinvestment of capital gains, would become 1.0 current units.
DeemedRetractibles are comprised of all Straight Perpetuals (both PerpetualDiscount and PerpetualPremium) issued by BMO, BNS, CM, ELF, GWO, HSB, IAG, MFC, NA, RY, SLF and TD, which are not exchangable into common at the option of the company (definition refined in May). These issues are analyzed as if their prospectuses included a requirement to redeem at par on or prior to 2022-1-31, in addition to the call schedule explicitly defined. See OSFI Does Not Grandfather Extant Tier 1 Capital, CM.PR.D, CM.PR.E, CM.PR.G: Seeking NVCC Status and the January, February, March and June, 2011, editions of PrefLetter for the rationale behind this analysis.
Yields for September, 2011, to October, 2011, were calculated by imposing a cap of 10% on the yields of YLO issues held, in order to avoid their extremely high calculated yields distorting the calculation and to reflect the uncertainty in the marketplace that these yields will be realized.

Significant positions were held in DeemedRetractible and FixedReset issues on August 31; all of the former and most of the latter currently have their yields calculated with the presumption that they will be called by the issuers at par prior to 2022-1-31. This presents another complication in the calculation of sustainable yield. The fund also holds a position in a SplitShare (BNA.PR.C) and an OperatingRetractible Scrap (YLO.PR.B) which also have their yields calculated with the expectation of a maturity at par, a somewhat dubious assumption in the latter case.

However, if the entire portfolio except for the PerpetualDiscounts were to be sold and reinvested in these issues, the yield of the portfolio would be the 5.98% shown in the MAPF Portfolio Composition: October 2011 analysis (which is greater than the 5.37% index yield on October). Given such reinvestment, the sustainable yield would be $10.4924 * 0.0598 = $0.6274, an increase from the $10.2709 * 0.0584 = $0.5998 reported in September.

Different assumptions lead to different results from the calculation, but the overall positive trend is apparent. I’m very pleased with the results! It will be noted that if there was no trading in the portfolio, one would expect the sustainable yield to be constant (before fees and expenses). The success of the fund’s trading is showing up in

  • the very good performance against the index
  • the long term increases in sustainable income per unit

As has been noted, the fund has maintained a credit quality equal to or better than the index; outperformance is due to constant exploitation of trading anomalies.

Again, there are no predictions for the future! The fund will continue to trade between issues in an attempt to exploit market gaps in liquidity, in an effort to outperform the index and keep the sustainable income per unit – however calculated! – growing.

MAPF

MAPF Portfolio Composition: October, 2011

Turnover remained low in October, at about 3%.

Sectoral distribution of the MAPF portfolio on October 31 was as follows:

MAPF Sectoral Analysis 2011-10-31
HIMI Indices Sector Weighting YTW ModDur
Ratchet 0% N/A N/A
FixFloat 0% N/A N/A
Floater 0% N/A N/A
OpRet 0% N/A N/A
SplitShare 9.8% (-0.4) 7.01% 5.96
Interest Rearing 0% N/A N/A
PerpetualPremium 0.0% (0) N/A N/A
PerpetualDiscount 10.6% (+0.6) 5.98% 13.94
Fixed-Reset 10.4% (+1.1) 3.15% 2.96
Deemed-Retractible 59.7% (-2.5) 6.07% 7.92
Scraps (Various) 9.4% (+1.1) 7.99% (see note) 8.66 (see note)
Cash +0.1% (0.0) 0.00% 0.00
Total 100% 6.01% 7.90
Yields for the YLO preferreds have been set at 10% for calculation purposes, and their durations at 5.00. The extraordinarily low price of these issues has resulted in extremely high calculated yields; I feel that substitution of these values results in a more prudent total indication.
Totals and changes will not add precisely due to rounding. Bracketted figures represent change from September month-end. Cash is included in totals with duration and yield both equal to zero.
DeemedRetractibles are comprised of all Straight Perpetuals (both PerpetualDiscount and PerpetualPremium) issued by BMO, BNS, CM, ELF, GWO, HSB, IAG, MFC, NA, RY, SLF and TD, which are not exchangable into common at the option of the company. These issues are analyzed as if their prospectuses included a requirement to redeem at par on or prior to 2022-1-31, in addition to the call schedule explicitly defined. See OSFI Does Not Grandfather Extant Tier 1 Capital, CM.PR.D, CM.PR.E, CM.PR.G: Seeking NVCC Status and the January, February, March and June, 2011, editions of PrefLetter for the rationale behind this analysis.

The “total” reflects the un-leveraged total portfolio (i.e., cash is included in the portfolio calculations and is deemed to have a duration and yield of 0.00.). MAPF will often have relatively large cash balances, both credit and debit, to facilitate trading. Figures presented in the table have been rounded to the indicated precision.

Credit distribution is:

MAPF Credit Analysis 2011-10-31
DBRS Rating Weighting
Pfd-1 0 (0)
Pfd-1(low) 47.6% (-2.5)
Pfd-2(high) 21.4% (0.0)
Pfd-2 0 (0)
Pfd-2(low) 21.5% (+1.4)
Pfd-3(high) 3.0% (+0.1)
Pfd-3 3.7% (-0.4)
Pfd-4(low) 2.7% (+1.4)
Cash +0.1% (0.0)
Totals will not add precisely due to rounding. Bracketted figures represent change from September month-end.
A position held in ELF preferreds has been assigned to Pfd-2(low)
A position held in CSE preferreds has been assigned to Pfd-3

Liquidity Distribution is:

MAPF Liquidity Analysis 2011-10-31
Average Daily Trading Weighting
<$50,000 5.3% (-7.5)
$50,000 – $100,000 20.7% (+4.7)
$100,000 – $200,000 23.6% (+3.2)
$200,000 – $300,000 30.9% (-11.4)
>$300,000 19.4% (+11)
Cash +0.1% (0.0)
Totals will not add precisely due to rounding. Bracketted figures represent change from September month-end.

MAPF is, of course, Malachite Aggressive Preferred Fund, a “unit trust” managed by Hymas Investment Management Inc. Further information and links to performance, audited financials and subscription information are available the fund’s web page. The fund may be purchased either directly from Hymas Investment Management or through a brokerage account at Odlum Brown Limited. A “unit trust” is like a regular mutual fund, but is sold by offering memorandum rather than prospectus. This is cheaper, but means subscription is restricted to “accredited investors” (as defined by the Ontario Securities Commission) or those who subscribe for $150,000+. Fund past performances are not a guarantee of future performance. You can lose money investing in MAPF or any other fund.

A similar portfolio composition analysis has been performed on the Claymore Preferred Share ETF (symbol CPD) as of August 31, 2011, and published in the October, 2011, PrefLetter. While direct comparisons are difficult due to the introduction of the DeemedRetractible class of preferred share (see above) it is fair to say:

  • MAPF credit quality is better
  • MAPF liquidity is a higher
  • MAPF Yield is higher
  • Weightings in
    • MAPF is much more exposed to DeemedRetractibles
    • MAPF is much less exposed to Operating Retractibles
    • MAPF is slightly more exposed to SplitShares
    • MAPF is less exposed to FixFloat / Floater / Ratchet
    • MAPF weighting in FixedResets is much lower
Market Action

November 4, 2011

It would seem that nobody can make a decision about Greece:

World leaders failed to agree on increasing the resources of the International Monetary Fund, dashing the hopes of European governments keen to tap more foreign aid to buttress their crisis-fighting efforts.

Governments are awaiting further details of Europe’s week- old rescue package before they commit cash, German Chancellor Angela Merkel said today on the final day of a Group of 20 summit in Cannes, France.

The reluctance of the leaders of the world’s biggest economies to immediately channel funds to the euro area reflects frustration with Europe’s failure to end a crisis that sparked again this week, with Greece’s government lurching towards collapse and Italy facing intensifying pressure to restore fiscal order.

To be frank, I don’t know what is happening in Greece:

Prime Minister George Papandreou won a confidence vote after offering to form a government of national unity that may lead to him stepping down as he sought to reach an accord on European aid needed to avert default.

The premier said he’ll meet with President Karolos Papoulias to discuss his proposal to create a unity government. Main opposition leader Antonis Samaras rejected the offer and called for elections.

Lapdog Carney got his reward:

Mark Carney, governor of the Bank of Canada, has been confirmed as new chairman of the Financial Stability Board, the G20’s global banking watchdog.

Mr. Carney serves as an inspiration to yes-men and sycophants everywhere.

Interesting paper by Rui Zhu, Utpal M. Dholaki, Xinlei Chen and René Algesheimer: Does Online Community Participation Foster Risky Financial Behavior?:

Although consumers increasingly use online communities for various activities, little is known regarding how participation in them affects individuals’ decision making strategies. Through a series of field and laboratory studies, we demonstrate that participation in an online community increases risk seeking tendency of individuals in financial decisions and behaviors. Our results reveal that participation in an online community leads consumers to perceive support from other members, that is they believe they will be helped by other community members should difficulties arise. Such a perception leads online community members to make riskier financial decisions than non-participants. We also discover a boundary condition to the effect: online community members are more risk seeking only when they have relatively strong ties with other members; when ties are weak, they exhibit similar risk preferences as non-members.

As I have suspected all along, it appears that the ‘MF Global Missing Funds’ hysteria was ramped up by the regulators and trustee to serve their own purposes:

Customer funds missing from bankrupt brokerage MF Global Inc. have been located in a custodial account at JPMorgan Chase & Co. (JPM), according to two people with knowledge of the matter.

An MF Global custodial account at JPMorgan contained about $658.8 million of client funds as of Oct. 31, according to one of the people, who declined to be identified because they weren’t authorized to speak publicly.

MF Global’s customer funds had a shortfall of $633 million, or more than 11 percent, out of a segregated fund requirement of about $5.4 billion, regulators said yesterday.

Does anybody think this hasn’t been known all along? But this way, we can praise the extraordinary detective work of the trustee and regulatory authorities, whose hard work, dedication, and extraordinary forensic auditing ability led them to ask the question: “Where’s the $600-million?” and pierce through all the layers of evasions and ambiguity to uncover the truth behind the answer “At JPMorgan. Why?”.

On November 2 I mentioned some projections that some banks would meet their new capital requirements by backing away from non-core lending. Commerzbank steps up to illustrate:

Germany’s second-largest lender Commerzbank AG will refuse loans which don’t help Germany or Poland, as the euro zone crisis makes European banks more protectionist in choosing between writing new business and meeting stringent capital requirements.

“We are not doing business which is not to the benefit of Germany or Poland,” chief financial officer Eric Strutz told analysts on a conference call discussing third-quarter earnings on Friday. “We have to focus on supporting the German economy as other banks pull out.”
…
Commerzbank, which is 25 per cent owned by the state, is accelerating the pullback from euro zone nations and cutting risky assets to avoid another state bailout after a €798-million ($1.10-billion U.S.) impairment on Greek assets pushed it to a third-quarter operating loss.

Having cut exposure to indebted euro zone countries by more than 20 per cent to €13-billion, including a 52 per cent haircut on Greek debt, the Frankfurt-based lender said it would continue reducing its public sector debt in Portugal, Italy, Spain, Ireland and Greece, mirroring a similar move made by French rival BNP Paribas SA.
…
Commerzbank said it had a core Tier One ratio of 9.4 per cent at the end of September and needs to raise €2.9-billion to meet tougher capital requirements set out by the European bank regulators.

“We can meet the required capital ratio by, for example, reducing risk assets in non-core areas, selling non-strategic assets or by means of retained earnings and we do not intend to tap new state funds,” Commerzbank said.

Commerzbank will keep its Eastern European BRE Bank unit and its online arm comdirect but may sell other units as it seeks to cut risky assets by a further €30-billion. Its property financing unit Eurohypo will also stop taking new business, the bank said.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts winning 10bp, FixedResets down 5bp and DeemedRetractibles losing 8bp. Lots of volatility, with SLF issues notable amonst the losers. Volume was on the light side of average.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices
Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)		 Median
YTW		 Median
Average
Trading
Value		 Median
Mod Dur
(YTW)		 Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 -0.0644 % 2,125.6
FixedFloater 4.88 % 4.60 % 24,383 17.18 1 -0.5115 % 3,155.1
Floater 3.38 % 3.41 % 72,188 18.71 2 -0.0644 % 2,295.1
OpRet 4.93 % 0.95 % 50,640 1.51 7 0.2465 % 2,484.3
SplitShare 5.73 % 6.24 % 59,903 5.16 3 0.2235 % 2,523.8
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.2465 % 2,271.6
Perpetual-Premium 5.57 % 0.75 % 106,680 0.10 13 -0.0240 % 2,149.7
Perpetual-Discount 5.34 % 5.43 % 108,686 14.74 17 0.1021 % 2,282.7
FixedReset 5.12 % 3.03 % 210,542 2.44 62 -0.0486 % 2,345.4
Deemed-Retractible 5.04 % 4.40 % 214,101 3.91 46 -0.0836 % 2,215.3
Performance Highlights
Issue Index Change Notes
CM.PR.K FixedReset -1.83 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-31
Maturity Price : 25.00
Evaluated at bid price : 26.25
Bid-YTW : 3.47 %
SLF.PR.E Deemed-Retractible -1.74 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 21.40
Bid-YTW : 6.55 %
SLF.PR.C Deemed-Retractible -1.71 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 21.21
Bid-YTW : 6.60 %
SLF.PR.F FixedReset -1.66 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-06-30
Maturity Price : 25.00
Evaluated at bid price : 26.64
Bid-YTW : 3.65 %
SLF.PR.D Deemed-Retractible -1.53 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 21.20
Bid-YTW : 6.61 %
SLF.PR.G FixedReset -1.44 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.65
Bid-YTW : 3.78 %
MFC.PR.C Deemed-Retractible -1.21 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 21.16
Bid-YTW : 6.71 %
BAM.PR.J OpRet 1.02 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-03-31
Maturity Price : 26.00
Evaluated at bid price : 26.80
Bid-YTW : 4.09 %
BAM.PR.X FixedReset 1.12 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-04
Maturity Price : 22.89
Evaluated at bid price : 24.35
Bid-YTW : 3.79 %
BAM.PR.H OpRet 1.46 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2011-12-04
Maturity Price : 25.00
Evaluated at bid price : 25.77
Bid-YTW : -23.09 %
Volume Highlights
Issue Index Shares
Traded		 Notes
CM.PR.E Perpetual-Discount 652,815 Nesbitt crossed blocks of 250,000 shares, 45,600 shares, 20,000 and 100,000, all at 25.00. TD crossed 100,000 at the same price. Nesbitt sold 24,500 to anonymous at 25.01.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-04
Maturity Price : 24.69
Evaluated at bid price : 24.99
Bid-YTW : 5.63 %
TD.PR.K FixedReset 92,643 TD crossed blocks of 54,400 and 32,000, both at 27.35.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-31
Maturity Price : 25.00
Evaluated at bid price : 27.36
Bid-YTW : 2.70 %
BAM.PR.Z FixedReset 89,395 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-04
Maturity Price : 23.11
Evaluated at bid price : 25.03
Bid-YTW : 4.56 %
ENB.PR.B FixedReset 68,480 RBC crossed 20,000 at 25.75.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-06-01
Maturity Price : 25.00
Evaluated at bid price : 25.70
Bid-YTW : 3.54 %
SLF.PR.H FixedReset 55,370 Anonymous crossed (?) 10,100 at 24.30.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.35
Bid-YTW : 4.30 %
BMO.PR.J Deemed-Retractible 47,497 TD crossed 37,700 at 25.40.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2016-02-25
Maturity Price : 25.00
Evaluated at bid price : 25.36
Bid-YTW : 4.09 %
There were 29 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
BAM.PR.H OpRet Quote: 25.77 – 27.47
Spot Rate : 1.7000
Average : 1.0127

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2011-12-04
Maturity Price : 25.00
Evaluated at bid price : 25.77
Bid-YTW : -23.09 %
CM.PR.K FixedReset Quote: 26.25 – 26.76
Spot Rate : 0.5100
Average : 0.3292

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-31
Maturity Price : 25.00
Evaluated at bid price : 26.25
Bid-YTW : 3.47 %
CM.PR.M FixedReset Quote: 27.48 – 27.84
Spot Rate : 0.3600
Average : 0.2471

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-31
Maturity Price : 25.00
Evaluated at bid price : 27.48
Bid-YTW : 2.76 %
MFC.PR.C Deemed-Retractible Quote: 21.16 – 21.50
Spot Rate : 0.3400
Average : 0.2524

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 21.16
Bid-YTW : 6.71 %
TRP.PR.C FixedReset Quote: 25.60 – 25.84
Spot Rate : 0.2400
Average : 0.1555

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-04
Maturity Price : 23.41
Evaluated at bid price : 25.60
Bid-YTW : 3.18 %
TD.PR.Y FixedReset Quote: 26.15 – 26.37
Spot Rate : 0.2200
Average : 0.1389

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-10-31
Maturity Price : 25.00
Evaluated at bid price : 26.15
Bid-YTW : 2.75 %
Issue Comments

RON.PR.A: Ripe for Credit Downgrade?

DBRS has commented:

RONA inc. (RONA or the Company) today announced that it has offered to purchase for cash, by way of two successive offers, up to $200 million of the aggregate principal amount of its 5.40% unsecured debentures due October 20, 2016.
…
On May 11, 2011, DBRS revised RONA’s trend to Negative from Stable. That rating action reflected DBRS’s concern that weak operating performance and a challenging consumer environment may result in RONA’s credit risk profile deteriorating to a level that is no longer consistent with the current rating categories. DBRS’s concern was highlighted by continued weakness in same-store sales growth and the negative impact this was having on operating margins and income. At that time (end of Q1 2011), lease-adjusted debt-to-EBITDAR had increased to 2.82 times (x) from 2.55x a year earlier. DBRS stated that if RONA was successful in implementing a sustainable recovery, including improved operating performance (during the critical summer season, in particular) and prudent capital management that results in a lease-adjusted debt-to-EBITDAR ratio closer to the 2.5x level by the end of the year, it may consider changing the trend to Stable. On the other hand, a lack of improvement in sales, operating income and key credit metrics could result in a downgrade to the ratings before the end of the year.

Since then, RONA released its Q2 2011 results, which delivered same-store sales growth of -9.6%, overall revenue decline of -2.4% and EBITDA of $90 million (versus $133 million year-over-year) as the Company continued to engage in heavy promotional activity to spur growth. This performance resulted in the last 12 months lease-adjusted gross debt-to-EBITDAR of 3.1x.
…
DBRS maintains its view that stabilization will require significant improvement in sales, operating income and significant capital conserving measures – including prudence with regards to capex, working capital management, dividend payouts, share repurchases and debt-financed acquisitions – for an extended period. Lack of improvement in sales, operating income, and key credit metrics in the near term could result in a ratings downgrade.

Contingent Capital

BCBS Discusses Contingent Capital

The Basel Committee on Banking Supervision has released the Global systemically important banks: assessment methodology and the additional loss absorbency requirement, which contains a series of points regarding Contingent Capital.

The idea of using the low-trigger contingent capital so beloved by OSFI (see the discussion of the NVCC Roadshow on October 27) was shot down in short order:

B. Bail-in debt and capital instruments that absorb losses at the point of nonviability (low-trigger contingent capital)

81. Given the going-concern objective of the additional loss absorbency requirement, the Basel Committee is of the view that it is not appropriate for G-SIBs to be able to meet this requirement with instruments that only absorb losses at the point of non-viability (ie the point at which the bank is unable to support itself in the private market).

Quite right. An ounce of prevention is worth a pound of cure!

To understand my remarks on their view of High-Trigger CoCos, readers might wish to read the posts BoE’s Haldane Supports McDonald CoCos. Hedging a McDonald CoCo, A Structural Model of Contingent Bank Capital and the seminal Contingent Capital with a Dual Price Trigger.

High-Trigger Contingent Capital is introduced with:

C. Going-concern contingent capital (high-trigger contingent capital)

82. Going-concern contingent capital is used here to refer to instruments that are designed to convert into common equity whilst the bank remains a going concern (ie in advance of the point of non-viability). Given their going-concern design, such instruments merit more detailed consideration in the context of the additional loss absorbency requirement.

83. An analysis of the pros and cons of high-trigger contingent capital is made difficult by the fact that it is a largely untested instrument that could potentially come in many different forms. The pros and cons set out in this section relate to contingent capital that meets the set of minimum requirements in Annex 3.

However, the discussion is marred by the regulators’ insistence on using accounting measures as a trigger. Annex 3 includes the criteria:

Straw man criteria for contingent capital used to consider pros and cons

1. Fully convert to Common Equity Tier 1 through a permanent write-off or conversion to common shares when the Common Equity Tier 1 of the banking group subject to the additional loss absorbency requirement falls below at least 7% of risk-weighted assets;

Naturally, once you define the trigger using risk-weighted assets or other accounting measures, you fail. Have the regulators learned nothing from the crisis? Every bank that failed – or nearly failed – was doing just fine in their reporting immediately before they got wiped out.

Risk-Weighted Assets are a fine thing in normal times and give a good indication of how much capital will be required once things turn bad – but as soon as there’s a paradigm shift, they stop working. Not to mention the idea that regulators like to manipulate Risk-Weights just as much as bank managers do – by, for instance, risk weighting bank paper according to its sovereign and by considering Greek paper as good as German.

The only trigger mechanism I consider acceptable is the common equity price (your bank doesn’t have publicly traded common equity? That’s fine. But you cannot issue Contingent Capital). For all the problems this comes with, it comes with a sterling recommendation: it will work. If a bank is in trouble, but the conversion has not been triggered – well then, by definition the bank’s common will be priced high enough that they can issue some.

But anyway, we have a flaw in the BCBC definition that renders the rest of the discussion largely meaningless. But what else do we have?

84. High-trigger going-concern contingent capital has a number of similarities to
common equity:

(a) Loss absorbency – Both instruments are intended to provide additional loss absorbency on a going-concern basis before the point of non-viability.

(b) Pre-positioned – The issuance of either instrument in good times allows the bank to absorb losses during a downturn, conditional on the conversion mechanism working as expected. This allows the bank to avoid entering capital markets during a downturn and mitigates the debt overhang problem and signalling issues.

(c) Pre-funded – Both instruments increase liquidity upon issuance as the bank sells the securities to private investors. Contingent capital does not increase the bank’s liquidity position at the trigger point because upon conversion there is simply the exchange of capital instruments (the host instrument) for a different one (common equity).

Fair enough.

85. Pros of going-concern contingent capital relative to common equity:

(a) Agency problems – The debt nature of contingent capital may provide the benefits of debt discipline under most conditions and help to avoid the agency problems associated with equity finance.

(b) Shareholder discipline – The threat of the conversion of contingent capital when the bank’s common equity ratio falls below the trigger and the associated dilution of existing common shareholders could potentially provide an incentive for shareholders and bank management to avoid taking excessive risks. This could occur through a number of channels including the bank maintaining a cushion of common equity above the trigger level, a pre-emptive issuance of new equity to avoid conversion, or more prudent management of “tail-risks”. Critically, this advantage over common equity depends on the conversion rate being such that a sufficiently high number of new shares are created upon conversion to make the common shareholders suffer a loss from dilution.

I have no problem with this. However, the last sentence makes it possible to speculate that the UK authorities have recognized the lunatic nature of their decision to accept the Lloyds ECN deal.

(c) Contingent capital holder discipline – Contingent capital holders may have an extra incentive to monitor the risks taken by the issuing bank due to the potential loss of principal associated with the conversion. This advantage over common equity also depends on the conversion rate. However, in this case the conversion rate would need to be such that a sufficiently low number of shares are created upon conversion to make the contingent capital holders suffer a loss from conversion. The conversion rate therefore determines whether the benefits of increased market discipline could be expected to be provided through the shareholders or the contingent capital holders.

I don’t think this makes a lot of sense. Contingent capital holders are going to hold this instrument because they want some degree of first loss protection. On conversion, they’re going to lose the first loss protection at a time when, by definition, the bank is in trouble. Isn’t that enough?

However, I am prepared to listen to arguments that if the conversion trigger common price is X, then the conversion price should be X+Y. In my preferred methodology, Y=0, but like I said, I’ll listen to proposals that Y > 0 is better … if anybody ever makes such an argument.

(d) Market information – Contingent capital may provide information to supervisors about the market’s perception of the health of the firm if the conversion rate is such that contingent capital holders suffer a loss from conversion (ie receive a low number of shares). There may be incremental information here if the instruments are free from any too-big-to-fail (TBTF) perception bias in other market prices. This could allow supervisors to allocate better their scarce resources and respond earlier to make particular institutions more resilient. However, such information may already exist in other market prices like subordinated debt.

Don’t you just love the advertisement for more funding implicit in the phrase “scarce resources”? However, it has been found that sub-debt prices don’t reflect risk. However, I will point out that hedging the potential conversion will affect the price of a McDonald CoCo; it is only regulators who believe that a stop-loss order constitutes a perfect hedge.

(e) Cost effectiveness – Contingent capital may achieve an equivalent prudential outcome to common equity but at a lower cost to the bank. This lower cost could enable banks to issue a higher quantity of capital as contingent capital than as common equity and thus generate more loss absorbing capacity. Furthermore, if banks are able to earn higher returns, all else equal, there is an ability to retain those earnings and generate capital internally. This, of course, depends on other bank and supervisory behaviours relating to capital distribution policies and balance sheet growth. A lower cost requirement could also reduce the incentive for banks to arbitrage regulation either by increasing risk transfer to the shadow banking system or by taking risks that are not visible to regulators.

Lower Financing Costs = Good. I’m fine with this.

86. Cons of going-concern contingent capital relative to common equity:

(a) Trigger failure – The benefits of contingent capital are only obtained if theinstruments trigger as intended (ie prior to the point of non-viability). Given that these are new instruments, there is uncertainty around their operation and whether they would be triggered as designed.

I can’t see that there’s any uncertainty if you use a reasonably high common equity trigger price (I have previously suggested half of the issue-time common price). That’s the whole point. It’s only when you have nonsensical triggers based on accounting measures that you have to worry about this stuff.

(b) Cost effectiveness – While the potential lower cost of contingent capital may offer some advantages, if the lower cost is not explained by tax-deductibility or a broader investor base, it may be evidence that contingent capital is less loss absorbing than common equity.26 That is, the very features that make it debt-like in most states of the world and provide tax-deductibility, eg a maturity date and mandatory coupon payments prior to conversion, may undermine the ability of an instrument to absorb losses as a going concern. For example, contingent capital with a maturity date creates rollover risk, which means that it can only be relied on to absorb losses in the period prior to maturity. Related to this, if the criteria for contingent capital are not sufficiently robust, it may encourage financial engineering as banks seek to issue the most cost effective instruments by adding features that reduce their true loss-absorbing capacity. Furthermore, if the lower cost is entirely due to tax deductibility, it is questionable whether this is appropriate from a broader economic and public policy perspective.

This paragraph illustrates more than anything else the regulators’ total lack of comprehension of markets. CoCo’s will be cheaper than common equity because it has first loss protection, and first loss protection is worth a lot of money – ask any investor! When CIBC lost a billion bucks during the crisis, who took the loss? The common shareholders, right? Did investors in other instruments take any of that loss? No, of course, not. They had first loss protection, and were willing to ‘pay’ for that with the expectation of lower returns.

(c) Complexity – Contingent capital with regulatory triggers are new instruments and there is considerable uncertainty about how price dynamics will evolve or how investors will behave, particularly in the run-up to a stress event. There could be a wide range of potential contingent capital instruments that meet the criteria set out in Annex 3 with various combinations of characteristics that could have different implications for supervisory objectives and market outcomes. Depending on national supervisors’ own policies, therefore, contingent capital could increase the complexity of the capital framework and may make it harder for market participants, supervisors and bank management to understand the capital structure of G-SIBs.

It is this complexity that makes the specifications in Annex 3 so useless. A McDonald CoCo can be hedged with options and we know how options work.

(d) Death spiral – Relative to common equity, contingent capital could introduce downward pressure on equity prices as a firm approaches the conversion point, reflecting the potential for dilution. This dynamic depends on the conversion rate, eg an instrument with a conversion price that is set contemporaneously with the conversion event may provide incentives for speculators to push down the price of the equity and maximise dilution. However, these concerns could potentially be mitigated by specific design features, eg if the conversion price is pre-determined, there is less uncertainty about ultimate creation and allocation of shares, so less incentive to manipulate prices.

Well, sure. How many times can I say: “This objection is met by a McDonald CoCo structure, rather than an idiotic Annex 3 structure,” before my readers’ eyes glaze over?

(e) Adverse signalling – Banks are likely to want to avoid triggering conversion of contingent capital. Such an outcome could increase the risk that there will be an adverse investor reaction if the trigger is hit, which in turn may create financing problems and undermine the markets’ confidence in the bank and other similar banks in times of stress, thus embedding a type of new “event risk” in the market. The potential for this event risk at a trigger level of 7% Common Equity Tier 1 could also undermine the ability of banks to draw down on their capital conservation buffers during periods of stress.

Well, sure, which is just another reason why the 7% Common Equity trigger level of Annex 3 is stupid. I should also point out that as BoE Governor Tucker pointed out, a steady incidence of conversion is a Good Thing:

Moreover, high-trigger CoCos would presumably get converted not infrequently which, in terms of reducing myopia in capital markets, would have the merit of reminding holders and issuers about risks in banking.

(f) Negative shareholder incentives – The prospect of punitive dilution may have some potentially negative effects on shareholder incentives and management behaviour. For example, as the bank approaches the trigger point there may be pressure on management to sharply scale back risk-weighted assets via lending reductions or assets sales, with potential negative effects on financial markets and the real economy. Alternatively, shareholders might be tempted to ‘gamble for resurrection’ in the knowledge that losses incurred after the trigger point would be shared with investors in converted contingent instruments, who will not share in the gains from risk-taking if the trigger point is avoided.

Well, the first case, reducing risk, is precisely the kind of behaviour I thought the regulators wanted. The second sounds a little far-fetched, particularly if (one last time) the trigger event is a decline in the common price.

Anyway, having set up their straw-man argument against High-Trigger CoCos, the regulators made the decision that I am sure their political masters told them to reach:

D. Conclusion on the use of going-concern contingent capital

87. Based on the balance of pros and cons described above, the Basel Committee concluded that G-SIBs be required to meet their additional loss absorbency requirement with Common Equity Tier 1 only.

88. The Group of Governors and Heads of Supervision and the Basel Committee will continue to review contingent capital, and support the use of contingent capital to meet higher national loss absorbency requirements than the global requirement, as high-trigger contingent capital could help absorb losses on a going concern basis.

Market Action

November 3, 2011

There was possible insider trading in MF Global bonds:

The U.S. Securities and Exchange Commission is reviewing trades in MF Global Holdings Ltd. (MF) convertible bonds to determine whether some investors sold the debt based on confidential information before the firm’s demise, according to two people with direct knowledge of the matter.

Investigators are in part focusing on trades that were made ahead of announcements that the firm’s credit rating had been downgraded, the people said, speaking on condition of anonymity because the matter isn’t public.

It’s not clear whether or not a Greek referendum is planned:

Just hours after saying Greeks need to decide on whether their future is in the euro, Papandreou said the country belongs in the currency bloc. He welcomed support shown by the main opposition New Democracy party for last week’s rescue pact agreed with European Union leaders in Brussels. Finance Minister Evangelos Venizelos said Greece won’t hold a referendum.

“We had a dilemma: either real consensus or referendum,” Papandreou told ministers, according to an e-mailed transcript of his statements. “As I said yesterday, coming out of the meeting, if there were consensus we wouldn’t need a referendum. I said if the opposition comes to the table to agree on the loan, there’s no need for a referendum.”

Some say no:

Greek Finance Minister Evangelos Venizelos, speaking to party lawmakers in Parliament in Athens today, said the nation won’t hold a referendum. Just hours after saying Greeks need to decide on whether their future is in the euro, Papandreou said the country belongs in the currency bloc.

“Papandreou absolutely blinked in this game of chicken,” Michael Holland, chairman and founder of New York-based Holland & Co., said in a telephone interview. His firm oversees more than $4 billion. “The interesting thing is that it took him so long to blink. The world’s markets told him he was wrong and he still persisted for an extended period of time. It was insane.”

It’s not clear to me whether the world’s markets get any say in the matter. The question is: can he simultaneously meet the EU requirements and reduce the incidence of riots and national strikes to a dull roar? I suggest he’s between a rock and a hard place; and if the Greek government pledges to meet the demands, the Greek population will make it impossible. Remember, we’re not talking about some professional snivellers snivelling about shooting the hippo – we’re talking about a dramatic and broadly based reduction in living standards.

Speaking of snivelling, we may be in for a new round of the HFT debate:

Estimates vary, but some traders say that as much as 35 per cent of volume on Canadian stock markets is now generated by high frequency trading firms that are jumping in and out of markets with buy and sell orders in hopes of profiting from tiny inefficiencies. In the U.S., some estimates place the amount of volume generated by HFTs at 60 per cent of all trading.
…
Canadian regulators are grappling with what to do about dark pools. Who should be allowed to trade on them, and on what terms? While dark pools do allow money managers to avoid high frequency traders, they can also sap volume from stock markets, eroding their value as a place for others to trade. Too many dark pools is most definitely not a good thing. In the U.S., so much trading takes place away from stock markets that what’s left on the public markets like NYSE and Nasdaq is “the exhaust,” as [LiquidNet CEO] Mr. [Seth] Merrin puts it.
…
The implication is that dark pools shouldn’t allow small orders, and shouldn’t be just ways for brokerages to avoid fees on their order flow. They should be reserved truly for orders that can’t be efficiently traded in light markets.

That’s right – make sure that retail doesn’t get any cut of the efficiencies! That’s what pays regulators’ salaries!

S&P confirmed MFC:

  • Manulife Financial Corp. reported third-quarter net losses driven by equity-market and interest rate declines and net charges from its annual review of actuarial methods and assumptions.
  • We are affirming our ‘A-‘ long-term counterparty credit rating on Manulife and our ratings on its subsidiaries.The company’s Canadian fair-value accounting framework is considerably more volatile, for comparable risks, than the relatively
    book-value-focused U.S. accounting framework.

  • We expect Manulife to sustain its extensive global competitive advantages and its favorable capitalization.

TMX DataLinx seems to have resolved their networking problems – the quotes listed today are official.

It was a day of uneven strength for the Canadian preferred share market, with PerpetualDiscounts winning 40bp, FixedResets up 6bp and DeemedRetractibles gaining 18bp. There was a long list of Performance Highlights, heavily skewed towards winners. Volume was quite good.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices
Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)		 Median
YTW		 Median
Average
Trading
Value		 Median
Mod Dur
(YTW)		 Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 1.5707 % 2,126.9
FixedFloater 4.86 % 4.57 % 24,128 17.22 1 0.5141 % 3,171.3
Floater 3.38 % 3.40 % 162,561 18.73 2 1.5707 % 2,296.5
OpRet 4.94 % 0.66 % 50,622 1.52 7 0.4236 % 2,478.1
SplitShare 5.75 % 6.24 % 60,720 5.16 3 0.4350 % 2,518.2
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.4236 % 2,266.0
Perpetual-Premium 5.56 % -0.21 % 106,268 0.10 13 0.2778 % 2,150.2
Perpetual-Discount 5.34 % 5.43 % 108,907 14.73 17 0.4003 % 2,280.3
FixedReset 5.12 % 2.95 % 209,051 2.45 62 0.0591 % 2,346.6
Deemed-Retractible 5.04 % 4.40 % 216,707 3.91 46 0.1763 % 2,217.2
Performance Highlights
Issue Index Change Notes
SLF.PR.H FixedReset -2.03 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.17
Bid-YTW : 4.39 %
CU.PR.C FixedReset -1.01 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-06-01
Maturity Price : 25.00
Evaluated at bid price : 25.45
Bid-YTW : 3.75 %
ELF.PR.F Perpetual-Discount 1.03 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-03
Maturity Price : 22.30
Evaluated at bid price : 22.58
Bid-YTW : 5.91 %
BAM.PR.B Floater 1.04 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-03
Maturity Price : 15.54
Evaluated at bid price : 15.54
Bid-YTW : 3.40 %
CM.PR.P Deemed-Retractible 1.09 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2012-10-29
Maturity Price : 25.00
Evaluated at bid price : 25.88
Bid-YTW : 1.93 %
BAM.PR.M Perpetual-Discount 1.11 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-03
Maturity Price : 22.46
Evaluated at bid price : 22.81
Bid-YTW : 5.25 %
GWO.PR.L Deemed-Retractible 1.19 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 25.50
Bid-YTW : 5.50 %
GWO.PR.F Deemed-Retractible 1.19 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2011-12-03
Maturity Price : 25.25
Evaluated at bid price : 25.46
Bid-YTW : 2.33 %
GWO.PR.G Deemed-Retractible 1.21 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 25.00
Bid-YTW : 5.30 %
PWF.PR.F Perpetual-Discount 1.71 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-03
Maturity Price : 24.65
Evaluated at bid price : 24.91
Bid-YTW : 5.29 %
FTS.PR.E OpRet 1.77 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-06-01
Maturity Price : 25.75
Evaluated at bid price : 27.62
Bid-YTW : 0.66 %
BAM.PR.K Floater 2.11 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-03
Maturity Price : 15.50
Evaluated at bid price : 15.50
Bid-YTW : 3.41 %
Volume Highlights
Issue Index Shares
Traded		 Notes
BAM.PR.Z FixedReset 221,540 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-03
Maturity Price : 23.09
Evaluated at bid price : 24.95
Bid-YTW : 4.58 %
IAG.PR.C FixedReset 120,532 Nesbit sold blocks of 24,000 and 15,000 to RBC, both at 26.50. Desjardins crossed 20,000 at the same price. RBC crossed blocks of 10,000 and 25,000 at the same price again.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-12-31
Maturity Price : 25.00
Evaluated at bid price : 26.50
Bid-YTW : 3.59 %
CM.PR.E Perpetual-Discount 107,455 Desjardins crossed 62,600 at 25.00.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-03
Maturity Price : 24.69
Evaluated at bid price : 25.00
Bid-YTW : 5.63 %
MFC.PR.F FixedReset 107,300 RBC crossed 80,300 at 24.50.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.36
Bid-YTW : 4.00 %
BMO.PR.Q FixedReset 92,435 Nesbitt crossed 75,000 at 25.60.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 25.52
Bid-YTW : 3.09 %
ENB.PR.B FixedReset 62,250 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-06-01
Maturity Price : 25.00
Evaluated at bid price : 25.65
Bid-YTW : 3.57 %
There were 39 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
HSB.PR.D Deemed-Retractible Quote: 25.07 – 25.49
Spot Rate : 0.4200
Average : 0.2497

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 25.07
Bid-YTW : 5.05 %
BAM.PR.H OpRet Quote: 25.40 – 25.82
Spot Rate : 0.4200
Average : 0.2592

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2011-12-03
Maturity Price : 25.00
Evaluated at bid price : 25.40
Bid-YTW : -7.00 %
MFC.PR.F FixedReset Quote: 24.36 – 24.74
Spot Rate : 0.3800
Average : 0.2466

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.36
Bid-YTW : 4.00 %
SLF.PR.H FixedReset Quote: 24.17 – 24.45
Spot Rate : 0.2800
Average : 0.1702

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.17
Bid-YTW : 4.39 %
TD.PR.O Deemed-Retractible Quote: 25.51 – 25.75
Spot Rate : 0.2400
Average : 0.1650

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-10-31
Maturity Price : 25.25
Evaluated at bid price : 25.51
Bid-YTW : 4.30 %
MFC.PR.D FixedReset Quote: 26.87 – 27.10
Spot Rate : 0.2300
Average : 0.1624

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-06-19
Maturity Price : 25.00
Evaluated at bid price : 26.87
Bid-YTW : 3.94 %
New Issues

New Issue: SLF FixedReset 4.25%+273

Sun Life Financial has announced:

a Canadian public offering of $250 million of Class A Non-Cumulative Rate Reset Preferred Shares Series 12R (the “Series 12R Shares”). The Series 12R Shares will be issued to the public at a price of $25.00 per share and holders will be entitled to receive non-cumulative preferential fixed quarterly dividends for the initial period ending December 31, 2016, as and when declared by the Company’s board of directors, payable in the amount of $0.26563 per Preferred Share, to yield 4.25 per cent annually.

On December 31, 2016, and every five years thereafter, the dividend rate will reset at a rate equal to the 5-Year Government of Canada bond yield plus 2.73 per cent. Subject to certain conditions, holders may elect to convert any or all of their Series 12R Shares into an equal number of Class A Non-Cumulative Floating Rate Preferred Shares Series 13QR (the “Series 13QR Shares”) on December 31, 2016 and on the 31st of December every fifth year thereafter. Holders of the Series 13QR Shares will be entitled to receive non-cumulative preferential floating rate quarterly dividends, as and when declared by the Company’s board of directors, equal to the then 3-month Government of Canada Treasury Bill yield plus 2.73 per cent.

The net proceeds of the offering will be used for general corporate purposes. The offering will be underwritten by a syndicate led by Scotia Capital Inc., CIBC and TD Securities Inc. on a bought deal basis, and is expected to close on November 10, 2011. The proceeds from this domestic public offering are expected to qualify as Tier 1 capital of Sun Life Financial Inc. under current capital adequacy guidelines established by the Office of the Superintendent of Financial Institutions (OSFI).

The underwriters have been granted an option to purchase up to an additional $50 million of the Series 12R Shares exercisable at any time up to two business days before closing. The maximum gross proceeds raised under the offering will be $300 million if this option is exercised in full.

Subject to regulatory approval, Sun Life Financial Inc. may redeem the Series 12R Shares in whole or in part on December 31, 2016 and on the 31st of December every five years thereafter.

An application is being made to list the Series 12R Shares as of the closing date on the Toronto Stock Exchange.

Sun Life also announced the redemption of some SLEECS:

Sun Life Capital Trust, a subsidiary of Sun Life Financial Inc. (TSX: SLF) (NYSE: SLF), today announced its intention to redeem at par on December 31, 2011, all of its outstanding $950 million principal amount of Sun Life ExchangEable Capital Securities-Series A (the “SLEECS-Series A”). The SLEECS-Series A are redeemable at the Trust’s option on December 31, 2011, at a redemption price per SLEECS-Series A equal to $1,000 plus unpaid “indicated yield” to that date. Notice will be delivered to holders of SLEECS-Series A in accordance with the terms outlined in the prospectus for the SLEECS-Series A.

After the SLEECS-Series A are redeemed, holders of SLEECS-Series A will cease to be entitled to distributions of “indicated yield” and will not be entitled to exercise any rights as holders other than to receive the redemption price.

Market Action

November 2, 2011

The FOMC statement was pretty gloomy:

To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies 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. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013

Of perhaps more interest was the voting:

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was Charles L. Evans, who supported additional policy accommodation at this time.

I reported on October 13 that Kocherlakota was decrying Opertation Twist, and extracted a big piece of Fisher’s dissent on September 27. This time, however, the dissenter wants looser policy. Uh-oh.

Speaking of Central Banks, Lapdog Carney’s opening statement to the House of Commons Standing Committee on Finance discussed the inflation target:

At the time of the last renewal, the Bank committed to continue its research into potential improvements that might build on the success of the current framework. A concerted and ambitious research agenda focused on evaluating whether two specific changes – targeting a lower rate of inflation or a path for the level of prices – could provide significant net benefits to the Canadian economy and Canadian households. Subsequently, the experience of the global financial and economic crisis prompted the Bank to add a third item to its research agenda – asking to what extent monetary policy should take account of financial stability considerations.

Allow me to highlight just some of the initiatives and work undertaken by the Bank over the past five years. Since 2008, we have had three major conferences for our staff and other researchers to present work on inflation targeting and the monetary policy framework. The most important of these research papers have been published in three special issues of the Bank of Canada Review – Winter 2007–08, Spring 2009 and Summer 2010. As well, Governing Council members have spoken regularly and publicly about the issues.

The research he mentions is basically with respect to Price Level Targetting, which has been discussed on PrefBlog and which I favour. What makes this interesting, however, is that there was no mention of the rumoured move to a dual mandate:

In an all-party vote on Thursday, members of the House of Commons finance committee decided they will hold at least one hearing on whether the bank’s mandate should be changed to include targets beyond inflation, such as full employment or nominal gross domestic product.

However such large-scale changes appear to be off the table.

“The Governor and I have discussed this [inflation targeting mandate renewal] at some length and I think we are understanding each other. We are … in line with each other on this,” Mr. Flaherty said. “So we’re not talking about a new policy or a new mandate for the Bank of Canada. What we are talking about is being more explicit about what the mandate of the Bank of Canada is.”

Mr. Flaherty’s comments are in line with a report by The Globe and Mail on Monday that the 2-per-cent target is expected to be renewed with a more forceful assertion of what the bank calls “flexible inflation targeting,” or the governor’s right to take longer than usual to bring inflation to the 2-per-cent target.

BIS has released a Consultative Document: Capitalisation of bank exposures to central counterparties:

CCPs can improve the safety and soundness of OTC derivatives markets through the multilateral netting of exposures, the enforcement of robust risk management standards, including mandatory posting of initial margin, and the mutualisation of losses should a clearing member fail.

Gee, mutualisation of losses is really working out well with respect to Greek debt in Europe, isn’t it? The banks have decided they’re in the business of making a profit:

The European Union’s plan for recapitalizing banks has “serious problems” that will hurt economic growth and make it harder for some nations to borrow, the Institute of International Finance said.

There is a “clear need” to restore confidence in Europe’s banks, IIF Managing Director Charles Dallara said today in a letter to the Group of 20 nations on the eve of a summit in Cannes, France. Yet the extra capital requirements at the center of the EU’s strategy will come with “considerable cost” because of a flawed scope and approach, he said.
…
Banks are likely to decide that the costs of raising capital are “prohibitive,” Dallara said in his letter to the G-20. Rather than accept forced injections, banks are more likely to sell risky assets and cut back on lending, which will make it harder for countries on Europe’s periphery to access capital markets.

“The market value of the debt of the countries most under scrutiny is likely to decline further as banks unload sovereign bonds,” Dallara said. “This is contrary to the goal of stabilizing and underpinning the outlook for sovereign debt in Europe.”

If banks acted to meet the new requirements relying only on retained earnings and a reduction in credit supply, “overall credit exposure to the euro-area private sector would need to decline by at least 5 percent,” he said. “It is essential that the higher European capital requirements are a temporary measure as intended, not sustained over time and not seen as a new standard to be imposed more widely.”

The Europeans are furious with Papandreou:

Crisis talks were under way in the French resort of Cannes on the eve of a Group of 20 summit after Papandreou was summoned by European counterparts to explain his call for a referendum that risks delaying aid the country needs to avert default. In Athens, Greek lawmakers debated a confidence motion that could bring down his government.

The stewards of the euro “won’t accept” a break from last week’s agreement, Luxembourg Prime Minister Jean-Claude Juncker told reporters in Cannes. German Chancellor Angela Merkel said “we have to get to the point where we know exactly what comes next.”
…
European Commission President Jose Barroso said the referendum may hold up Greece receiving 8 billion euros ($11 billion) of already delayed support. “In the European Union, we have agreed on far-reaching measures to support Greece,” he said in a statement. “But for those measures to be implemented it is critically important to have stability in the country.”

Europe’s woes are returning G-20 leaders to the crisis footing they adopted three years ago after the collapse of Lehman Brothers Holdings Inc. Australian Prime Minister Julia Gillard said in Cannes that Europe faces questions that “need to be answered and answered quickly,” while Chinese President Hu Jintao told Lagarde the crisis must be “prevented from spreading further.”

The European royalty is talking tough:

The euro declined, trading 0.7 percent from a three-week low against the dollar, as European leaders said Greece will hold a referendum next month to determine whether it will stay in the 17-nation currency.

The euro dropped against most of its 16 major counterparts as French President Nicolas Sarkozy said Greece won’t receive a “single cent” in aid without holding to its bailout agreement’s terms.
…
Crisis talks ended in the French resort of Cannes with German Chancellor Angela Merkel and Sarkozy withholding 8 billion euros ($11 billion) of assistance to Greece and warning it will surrender all European aid if the nation votes against a bailout package agreed last week.

The hardball tactics open the door for the first time for a country to leave the 12-year-old currency bloc that its founders declared was “irrevocable.”

Remember all that leverage that was going to save the world?:

Market turmoil has got the best of Europe’s big bailout fund, forcing it to pull its latest bond issue.

On Wednesday the European Financial Stability Facility confirmed that its €3-billion ($4.12-billion U.S.) bond offering, intended to finance the next bailout loan to Ireland, has been postponed because of “market conditions,” according to the group’s spokesperson.

The earliest the deal could come back is next week, and the new timeline could cause trouble. Ireland has €4.4-billion worth of debt coming due on Nov. 11, according to FT Alphaville.

OSFI has released a letter regarding the Financial Stability Board Principles on Mortgage Lending. They note that they expect to see a LOT MORE paperwork and cover-your-ass bullshit in the future. My idea, that OSFI should surcharge risk-weightings for mortgage exposure – or any other kind of exposure, for that matter – when this exposure greatly exceeds historical norms (as it does, er, now) has not yet been mentioned. The FSB document is titled Consultation Paper: FSB Principles for Sound Residential Mortgage Underwriting Practices:

As the global crisis demonstrated, the consequences of weak residential mortgage underwriting practices in one country can be transferred globally through securitisation of mortgages underwritten to weak standards. As such, it is important to have sound underwriting practices at the point at which a mortgage loan is originally made.

In other words, caveat vendor. Gee, what a wonderful world it will be when we finally have enough rules, eh?

Regardless of whether or not there actually is money missing from segregated accounts at MF Global, their sloppy bookkeeping cost them a deal:

Corzine, 64, steered MF Global into bankruptcy proceedings on Oct. 31 after increasing risk-taking at the firm, including investments in European sovereign debt that roiled markets. Discrepancies over the missing funds that were used to back futures trades sent Interactive Brokers Group Inc. (IBKR) fleeing from a potential acquisition that may have averted the filing, according to a board member at the Greenwich, Connecticut, firm.

“The board certainly considered that purchase and stepped away from it at a point where it became clear there were lots of uncertainties about the accounts and segregated funds,” Hans Stoll, an Interactive Brokers director and a professor of finance at Vanderbilt University in Nashville, Tennessee, said yesterday in a telephone interview.

When your contemplating doing a big deal on 48 hours notice, the last thing you want is uncertainty over the bookkeeping! However, everything is highly unclear at the moment, at least to the public:

.MF Global Holdings Ltd. (MF) customers may have to wait years to get their money back if the futures broker is sued, according to Frederick Grede, the liquidation trustee overseeing the bankruptcy of Sentinel Management Group Inc.

“People should expect that the money on deposit with MF Global will be tied up for some time,” Grede said in a telephone interview today. Grede, a former chief executive officer of the Hong Kong Futures Exchange, has sought to recover about $600 million of customer money from Sentinel, the futures broker that filed for bankruptcy in 2007. “If litigation is involved it well could be years” for MF Global customers, he said.

The day it filed the eighth-largest U.S. bankruptcy on Oct. 31, New York-based MF Global disclosed a shortfall in customer accounts that people with knowledge of the matter said may be about $700 million. CME Group Inc., which has the authority to audit those accounts, said yesterday it didn’t know how much client money was missing.

Grede said it was likely that the client funds won’t be released until the bankruptcy court approves the decision. “To move the money out of MF Global, they have to get the trustee to agree, and I believe the trustee will want the court to agree as well,” he said.

Experience suggests to me that the actual players know very well what the answer to the segregated account mystery is, but are posturing for political purposes. However, the accusations are getting more specific:

MF Global Holdings Ltd. (MF) may have transferred customer money last week following an audit by CME Group Inc. (CME), which has regulatory authority over the futures broker.

The transfer “may have been designed to avoid detection in so far as MF Global did not disclose or report such transfers” to the Commodity Futures Trading Commission or CME Group, the Chicago-based exchange owner said today an e-mailed statement.
…
All MF Global customer positions held at CME Group, and not third-party custodians such as banks, are accounted for, the company said in the statement. “MF Global’s customer positions on CME Group exchanges were and continue to be substantially over-collateralized,” CME Group said. The “apparent shortfall” was in accounts held by MF Global, CME Group said.

In other words, if you had an account with MF Global with $100,000 cash, and your contracts actually required $75,000 of exchange collateral, that part would have been posted OK, but – it is alleged – they were naughty with the remaining $25,000. Even more specific is the claim:

MF Global Inc.’s commodity customer funds have a shortfall of $633 million, or about 11.6 percent, out of a segregated fund requirement of about $5.4 billion, the Commodity Futures Trading Commission said.

At a hearing today in U.S. Bankruptcy Court in Manhattan, lawyers for the CFTC said the trustee for the bankrupt broker- dealer may recover the shortfall.
…
“It now appears that the firm made subsequent transfers of customer segregated funds in a manner that may have been designed to avoid detection,” as the transactions weren’t reported to regulators until Oct. 31, it said.

However, it’s still unclear to me just what has happened, or is claimed to have happened. The truth will out, but, as is always the case, the nature of that truth will only be reported after a few years have passed. The company is represented in court by the trustee – not by lawyers appointed by former management – and the trustee has an interest in painting as black a picture as possible in order to maximize his fee income.

I have noticed not just one, but two interesting juxtapositions in the press recently. The first is some weeping and wailing over smoking in hospitals, reflecting the usual arrogant mindset of the medical profession:

As an emerging standard for Canadian hospitals, smoke-free property is intended to reduce exposure to second-hand smoke, communicate denormalization messages about smoking and enhance tobacco cessation.

However, noncompliance and inadequate treatment for tobacco dependence appear to be the norm. Enhancing appropriate health care for patients who use tobacco to include consistent and effective treatment for the symptoms of withdrawal may improve this problem. Reframing tobacco use as an addiction may be an important root strategy to shift practise norms. People who smoke will have symptoms of withdrawal during a stay in a hospital with a smoke-free policy. With the advent of these policies, abstinence support with effective management of withdrawal symptoms for patients in hospital is imperative.

Harm reduction, as defended by the Supreme Court, is given short shrift in the study – mentioned, but very briefly and not in so many words.

The other juxtapositon involved great alarm over string attached to Chinese funding of US universities:

The Confucius Institute at North Carolina State University made its feelings known after the Dalai Lama accepted an invitation to speak in 2009 on the Raleigh campus. China’s military took over Tibet in 1959, exiling the spiritual leader considered a traitor in China for advocating Tibetan self-rule.

Confucius Institute director Bailian Li told North Carolina State provost Warwick Arden that a visit by the Lama could disrupt “some of the strong relationships we were developing with China,” Arden said. Besides the institute, joint programs include student exchanges, summer research and faculty collaboration.

And this was published on the same day as a piece about US de-funding of UNESCO:

A day after the Palestinians won full membership in the UN group with 107 votes in favor and 14 against, the U.S. cut off its funding, almost a quarter of the agency’s budget. Moreover, swing votes the Palestinians need to bolster their support on the Security Council for full UN membership have evaporated.

Today’s numbers are all provisional (although probably pretty good) as TMX DataLinx continues to experience networking problems.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts up 10bp, FixedResets winning 15bp and DeemedRetractibles gaining 14bp. There were only three issues in the Performance Highlights table, but all three were positive. Volume was a little light.

PerpetualDiscounts now yield 5.44%, equivalent to 7.07% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.95%, so the pre-tax interest equivalency spread (also called the Seniority Spread) is now about 210bp, a slight widening from the 205bp reported on October 26.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices
Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)		 Median
YTW		 Median
Average
Trading
Value		 Median
Mod Dur
(YTW)		 Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 0.8581 % 2,094.1
FixedFloater 4.88 % 4.60 % 23,864 17.18 1 1.0390 % 3,155.1
Floater 3.44 % 3.44 % 155,094 18.65 2 0.8581 % 2,261.0
OpRet 4.97 % 1.81 % 50,783 1.51 7 0.2703 % 2,467.7
SplitShare 5.77 % 6.40 % 61,386 5.16 3 0.2391 % 2,507.3
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.2703 % 2,256.5
Perpetual-Premium 5.58 % 2.42 % 106,332 0.10 13 0.2394 % 2,144.2
Perpetual-Discount 5.36 % 5.44 % 110,078 14.76 17 0.0953 % 2,271.2
FixedReset 5.12 % 3.08 % 210,336 2.45 62 0.1540 % 2,345.2
Deemed-Retractible 5.05 % 4.45 % 219,543 3.92 46 0.1364 % 2,213.3
Performance Highlights
Issue Index Change Notes
GWO.PR.N FixedReset 1.02 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.80
Bid-YTW : 3.41 %
BAM.PR.G FixedFloater 1.04 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-02
Maturity Price : 25.00
Evaluated at bid price : 19.45
Bid-YTW : 4.60 %
BAM.PR.M Perpetual-Discount 1.17 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-02
Maturity Price : 22.20
Evaluated at bid price : 22.56
Bid-YTW : 5.31 %
Volume Highlights
Issue Index Shares
Traded		 Notes
BAM.PR.Z FixedReset 506,476 New issue settled today.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-02
Maturity Price : 23.10
Evaluated at bid price : 25.00
Bid-YTW : 4.57 %
HSE.PR.A FixedReset 93,687 Anonymous sold 16,700 to TD and blocks of 10,000 and 15,100 to RBC, all at 25.40. RBC crossed 35,000 at the same price.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-02
Maturity Price : 23.34
Evaluated at bid price : 25.43
Bid-YTW : 3.42 %
IFC.PR.A FixedReset 58,435 Nesbitt crossed 44,000 at 25.15.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 25.12
Bid-YTW : 3.92 %
CM.PR.E Perpetual-Discount 55,532 Desjardins crossed 25,000 at 25.00.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-02
Maturity Price : 24.69
Evaluated at bid price : 25.00
Bid-YTW : 5.62 %
BNS.PR.Z FixedReset 38,483 Recent secondary offering.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.95
Bid-YTW : 3.34 %
MFC.PR.E FixedReset 37,341 Scotia crossed 16,000 at 26.20.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-09-19
Maturity Price : 25.00
Evaluated at bid price : 26.06
Bid-YTW : 4.30 %
There were 27 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
BNA.PR.E SplitShare Quote: 23.30 – 23.80
Spot Rate : 0.5000
Average : 0.4035

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2017-12-10
Maturity Price : 25.00
Evaluated at bid price : 23.30
Bid-YTW : 6.40 %
GWO.PR.L Deemed-Retractible Quote: 25.20 – 25.59
Spot Rate : 0.3900
Average : 0.2983

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 25.20
Bid-YTW : 5.65 %
TD.PR.I FixedReset Quote: 27.33 – 27.56
Spot Rate : 0.2300
Average : 0.1497

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-31
Maturity Price : 25.00
Evaluated at bid price : 27.33
Bid-YTW : 2.74 %
ELF.PR.F Perpetual-Discount Quote: 22.35 – 22.73
Spot Rate : 0.3800
Average : 0.3006

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-11-02
Maturity Price : 22.06
Evaluated at bid price : 22.35
Bid-YTW : 5.97 %
MFC.PR.B Deemed-Retractible Quote: 21.95 – 22.29
Spot Rate : 0.3400
Average : 0.2616

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 21.95
Bid-YTW : 6.40 %
MFC.PR.E FixedReset Quote: 26.06 – 26.29
Spot Rate : 0.2300
Average : 0.1554

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-09-19
Maturity Price : 25.00
Evaluated at bid price : 26.06
Bid-YTW : 4.30 %