PrefBlog

Apple’s CFO is doubtless celebrating his $1.5-billion trading win:

Investors are nursing losses of up to 9 per cent on Apple’s record-breaking $17bn bond offering, less than six weeks after the securities landed in their portfolios.

The technology giant tapped the white-hot bond market for the largest debt fundraising to date on April 30, but a sharp turn in interest rates has caused a sell-off in corporate bonds and wiped hundreds of millions of dollars off the value of the offering.

Apple sold $3bn of bonds maturing in 2043, locking in a low interest rate of 3.9 per cent for the next 30 years, but the market price of these bonds had fallen to 90.36 per cent of face value in late trading on Monday, according to Trace data.Investors in the offering paid 99.418 per cent of face value for the new bonds, but institutional and retail demand was so high that they traded as high as 101.97 in the secondary market.

So I have a question for the Europeans: how much bonus is appropriate for this man?

You know, some people just ask to be cheated (emphasis added):

Traders at some of the world’s biggest banks manipulated benchmark foreign-exchange rates used to set the value of trillions of dollars of investments, according to five dealers with knowledge of the practice.

Employees have been front-running client orders and rigging WM/Reuters rates by pushing through trades before and during the 60-second windows when the benchmarks are set, said the current and former traders, who requested anonymity because the practice is controversial. Dealers colluded with counterparts to boost chances of moving the rates, said two of the people, who worked in the industry for a total of more than 20 years.
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Companies and asset managers typically ask banks to buy or sell currencies at a specified WM/Reuters fix later in the day, most commonly the 4 p.m. London close. That arrangement is open to abuse, as it gives traders a window in which they can adjust their own positions and try to move the benchmark to boost their profit, three of the dealers said.

What a pack of idiots. Anybody who complains under those circumstances should simply lose his license. It should be obvious that you can only front-run if you have a fiduciary relationship, which is not generally the case in such circumstances; if you don’t, you are at perfect liberty to take advantage of the counterparty’s stupidity. More gently, it can be called ‘positioning prior to a trade’, in precisely the same way as government bond primary dealers short bonds of tenor X before an auction of tenor X. However, the clients will typically not want a fiduciary relationship, because then they wouldn’t be able to boast about what hard-nosed BSDs they are.

There is continued chatter about a takeover of CIT Group:

CIT Group Inc. (CIT) Chief Executive Officer John Thain, whose commercial lending firm has drawn takeover speculation, said the logic of selling to a larger bank is “obvious.”

“The big banks are awash in deposits and they can’t generate attractive assets,” Thain said today in a Bloomberg Television interview with Erik Schatzker and Sara Eisen. “We, in all our businesses, are able to generate very high-yielding, attractive assets, so the logic of that is obvious.”

I confess, I still don’t fully understand why the logic of this wasn’t obvious in 2008.

Inflation? What inflation?

Some Federal Reserve policy makers are citing the lowest inflation rate in at least five decades as an alarm bell for the economy. Economists at UBS Securities LLC say the figure isn’t as troubling as it appears.

Consumer prices climbed 1.1 percent in the 12 months through April, according to a measure watched by the Fed that excludes food and fuel — matching the smallest increase since records began in 1960. That’s down from 1.9 percent in the year ended April 2012.
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Fed officials meeting June 18-19 in Washington will weigh how much changes in inflation and the labor market will influence the pace of their $85 billion in monthly asset purchases. James Bullard, president of the St. Louis Fed, this week said inflation below the central bank’s 2 percent target may warrant prolonging bond buying.

DBRS placed Spectra Energy under Review-Negative:

This rating action follows the announcement that Spectra Energy Corp (Spectra Energy, Spectra Capital’s 100% owner and guarantor of all series of notes outstanding under the Senior Indenture of Spectra Capital) intends to drop down all of its remaining U.S. Transmission and Storage Assets to Spectra Energy Partners (SEP, a master limited partnership controlled by Spectra Energy) by the end of this year, subject to market conditions. By completing this drop-down, Spectra Energy expects to provide its investors with higher dividend growth of approximately 12 cents per year compared with the current rate of eight cents per year. Management expects to provide more details concerning this transaction in its Q2 earnings call scheduled for August 6, 2013.

Spectra is an American company and does not directly issue Canadian preferred shares, but it is the parent of Westcoast Energy, which does (W.PR.H & W.PR.J). Westcoast has heavy capex that will keep cash flows negative for a while, but DBRS did not explicitly state a dependence upon parental support in their last review. Still, it’s worth mentioning.

GMP Capital, proud issuer of GMP.PR.B, was confirmed at Pfd-3(low), Trend Negative by DBRS:

The Company’s risk exposures are somewhat mitigated by low capital and liquidity requirements, its strong market position in its chosen niches, its integrated business model and a flexible expense base accompanied by a strong entrepreneurial culture. Nevertheless, the market tone continues to be very negative and is particularly unfriendly for broker-dealers. Additionally, the Company is more aggressively capitalized than it had been in earlier cycles following the $115 million issue of preferred shares in Q1 2011 and over $72 million in share buybacks during 2011, resulting in a total debt-to-capitalization ratio of over 30%, which is in the upper range of what is acceptable in this rating category. Without strong earnings, total debt-to-cash flow is increasing, and fixed charge coverage ratios have fallen to levels that are in the lower bounds of what is perceived as acceptable for this rating category. DBRS does recognize that the current environment represents a low point in the cycle and thus metrics are expected to be in the weaker end of the ranges; however, an extended period of weakness without the Company being able to generate more positive results remains a concern. DBRS notes favourably the Company’s decision to preserve capital in the current uncertain environment by cutting its common share dividend in half in 2012 and not utilizing its share buyback program in the past year. DBRS expects GMP to continue a prudent approach to retaining capital given the tough market environment.

It was another unfriendly day for the Canadian preferred share market … on the bright side, the losses are slowing down! PerpetualPremiums were down 23bp (a lot of these are now PendingPerpetualDiscounts!), FixedResets gained 7bp and DeemedRetractibles were off 7bp. There is another lengthy performance highlights table but (brace yourselves!) there were a significant number of gains on this list. Volume was quite high.

PerpetualDiscounts now yield 5.11%, equivalent to 6.64% interest at the standard equivalency factor of 1.3x. Long corporates now yield 4.30%, so the interest-equivalent pre-tax spread (in this context, the “Seniority Spread”) is now about 235bp, a significant widening from the 225bp reported June 5.

The BAM Straight Perpetual 4.90% new issue closes tomorrow with the symbol BAM.PF.D. It will not be pretty.

Interesting piece on Australian covered bonds:

Australia’s covered bond boom is waning less than two years after the market started as yield-hungry buyers more than double purchases of residential mortgage-backed securities.

Issuance of the debt, backed by the borrower and mortgages that stay on its balance sheet, fell 64 percent to $9.9 billion this year, data compiled by Bloomberg show. The decline in Australian offerings outpaced a 41 percent slump from banks worldwide, according to the data.

Renewed appetite for RMBS, as the market recovers after being decimated by the 2008 U.S. subprime collapse, has seen sales surge while banks reserve covered-bond allowances for when market conditions worsen. Commonwealth Bank of Australia (CBA)’s 2017 covered securities offered just 33 basis points more than swaps last month, compared with a 47 basis-point premium on shorter-dated unsecured notes sold by Westpac Banking Corp., Bloomberg-compiled data show. Global financial debt pays a 141 basis-point spread, Bank of America Merrill Lynch data show.

Does this sound familiar?

A one-bedroom, 55-square meter (592-square feet) apartment in Hoegalidsgatan, in the neighborhood where Larsson’s troubled heroine Lisbeth Salander grew up, sold last month for 3.75 million kronor ($569,000), 17 percent above the listing price, after a bidding war involving nine parties.

That level of demand is typical in the Swedish capital, where a shortage of construction, a population boom and mortgage rates below 3 percent have pushed prices in central Stockholm up 35 percent since early 2009. Borrowing for home purchases has in turn fueled record household debt across the country. That’s sparking concern among policymakers over potential damage to the economy and preventing the central bank from cutting rates, even as Sweden’s exporters say action must be taken to weaken the currency to protect thousands of jobs.

Another day, another slaughter for the Canadian preferred share market, with PerpetualPremiums down 48bp, FixedResets off 36bp and DeemedRetractibles losing 49bp. Naturally enough, the Performance Highlights table is again quite lengthy, comprised entirely of losers, dominated by Straight Perpetuals with a scattering of relatively low-reset FixedResets. BAM issues led the decline … their 4.90% Straight Perpetual new issue settles Friday … it won’t be pretty! Volume was extraordinarily high.

Last Friday we had good news regarding North American employment – now there is good news from the UK:

The pound had its biggest weekly gain versus the dollar in more than three years as U.K. manufacturing, services and home-price data beat economist forecasts, boosting confidence in the economy.

Sterling appreciated for the first week in six against the euro. It rallied to the strongest level in more than three months versus the greenback, as the U.S. currency dropped versus all but two of its 16 major counterparts. U.K. government bonds fell for a third week after Bank of England policy makers kept stimulus measures unchanged at Governor Mervyn King’s final meeting.

It will be interesting to see what happens to Treasury yields this week:

For the first time since 2009, U.S. bond yields are rising at the same time inflation is slowing, providing a cushion for investors in Treasuries whether or not the Federal Reserve slows the pace of its debt purchases.

While 10-year (USGG10YR) yields reached 2.23 percent May 29, the highest since April 2012, the personal consumption expenditure deflator, the Fed’s preferred gauge of inflation, rose 0.7 percent in April from a year earlier, the smallest increase since 2009. The yield gap between Treasury Inflation-Protected Securities, or TIPS, and non-indexed bonds show investors have cut their expectations for consumer price increases to the lowest level since July.

Ever get the feeling that you were in the wrong business?

To get at the heart of a hearing aid’s cost, we can turn to data data unearthed by a German regulator (PDF) studying the major manufacturers. Based on this information, it costs about $250 to make a device that will get sold to an audiologist retailer for $1,000. Hearing aid makers spend $75 per device on research and development and $250 on marketing and then chalk up $425 in profit. The retailers then mark up the price $2,000 to cover overheard and make a profit, resulting in a $3,000 price tag.

And, with respect to financial repression:

New collateral rules for hedge funds, insurers and others in the $633 trillion over-the-counter derivatives market are poised to boost demand for U.S. Treasuries, potentially slowing rising yields as the Federal Reserve considers scaling back unprecedented stimulus.

Swaps traders will need to come up with $800 billion to $4.6 trillion to meet Dodd-Frank Act regulations requiring that the derivatives be backed by clearinghouses that collect upfront collateral such as cash or Treasuries, according to estimates from the Treasury Borrowing Advisory Committee. The regulations take effect today for the second group of firms designated by the Commodity Futures Trading Commission in the market for interest-rate and credit-default swaps.

DBRS confirmed LCS.PR.A at Pfd-5(high):

On October 25, 2012, DBRS downgraded the ratings of the Preferred Shares to Pfd-5 (high) from Pfd-4 (low), due to the volatility in the NAV of the Company and the insufficient levels of downside protection in the months leading up to the rating action. Since then, the NAV of the Company has recovered, with downside protection available to holders of the Preferred Shares reaching 32.2% as of May 30, 2013. However, the Preferred Share dividend coverage ratio is rather low at 0.6 times and there is less than one year remaining until the Preferred Shares mature. While Canadian life insurance companies have recovered, the industry as a whole continues to experience stress as interest rates remain at all-time lows. As a result, the rating of the Preferred Shares has been confirmed at Pfd-5 (high).

E-L Financial has sold The Dominion to a US insurer:

One of Canada’s oldest insurance companies is being sold for $1.125-billion to a major U.S. insurer, in a deal that will see the business fall into foreign hands for the first time since it was founded by Sir John A. Macdonald in 1887.

Dominion of Canada General Insurance Co. is to be acquired by The Travelers Companies Inc.
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E-L Financial hasn’t yet decided what it will do with the cash left on its books after the sale closes in the last quarter of the year, pending regulatory approvals and other conditions.

There was carnage for the Canadian preferred share market today, with PerpetualPremiums down 55bp, FixedResets off 41bp and DeemedRetractibles losing 73bp. As might be expected, the Performance Highlights table is very lengthy, with only a single winner – ELF.PR.F, which merely recovered some of Friday’s extraordinary loss. Volume was quite high, though not – yet! – sufficient to indicate widespread panic.

There is more indication that, if Carney was Spend-Every-Penny’s lapdog, Poluz will be his parakeet:

The two previous Bank of Canada governors, Mr. Carney and David Dodge, were unafraid to engage on subjects that didn’t necessarily pertain to the Bank of Canada’s core mandate of keeping inflation at an annual rate of 2 per cent. This tendency brought both men attention that they might not have had otherwise, and could cause them to eclipse their political masters.

Mr. Poloz came across as inclined to mind his own business. He called the central bank a “team player” and “part of the family of the public service.” He told New Democratic finance critic Peggy Nash that he had no problem with a legislation that would give cabinet a veto over hiring decisions at Crown corporations, including the central bank. “I see quite a clean separation between, if you like, administrative independence versus monetary policy independence,” he said.

How can you run an enterprise if you don’t have total control over staff? Answer: you can’t.

There was a decent jobs number in the US:

American employers took on more workers than forecast in May as the world’s largest economy weathered the impact of higher taxes and federal spending cuts.

Payrolls rose 175,000 after a revised 149,000 increase in April that was smaller than first estimated, Labor Department figures showed today in Washington. The median forecast in a Bloomberg survey called for a gain of 163,000. The unemployment rate climbed to 7.6 percent from 7.5 percent as a surge in the number of people entering the labor force swamped the number of positions available.

The Canadian number was very good:

The Canadian economy churned out 95,000 jobs last month, the second-biggest monthly gain on record, mostly in full-time positions in the private sector.

The jump in job creation is the largest since August, 2002, and sent the country’s jobless rate down a notch to 7.1 per cent in May, Statistics Canada said Friday. The increase was eight times what economists had expected.
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Private companies led the way. The private sector added 94,600 positions while the public sector created 6,600 jobs. Self employment fell by 6,200. The construction sector added 42,700 jobs, the biggest gain on record.

Wage gains, though still modest, are running above the rate of inflation, with average hourly wages growing 2.3 per cent in May from last year.

Bloomberg has an interesting piece about high frequency trading:

For the first time since its inception, high-frequency trading, the bogey machine of the markets, is in retreat. According to estimates from Rosenblatt Securities, as much as two-thirds of all stock trades in the U.S. from 2008 to 2011 were executed by high-frequency firms; today it’s about half. In 2009, high-frequency traders moved about 3.25 billion shares a day. In 2012, it was 1.6 billion a day. Speed traders aren’t just trading fewer shares, they’re making less money on each trade. Average profits have fallen from about a tenth of a penny per share to a twentieth of a penny.
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By the end of Aug. 2, Knight had spent $440 million unwinding its trades, or about 40 percent of the company’s value before the glitch.

Knight is being acquired by Chicago-based Getco, one of the leading high-frequency market-making firms, and for years considered among the fastest. The match, however, is one of two ailing titans. On April 15, Getco revealed that its profits had plunged 90 percent last year. With 409 employees, it made just $16 million in 2012, compared with $163 million in 2011 and $430 million in 2008. Getco and Knight declined to comment for this story.

Getco’s woes say a lot about another wound to high-frequency trading: Speed doesn’t pay like it used to. Firms have spent millions to maintain millisecond advantages by constantly updating their computers and paying steep fees to have their servers placed next to those of the exchanges in big data centers. Once exchanges saw how valuable those thousandths of a second were, they raised fees to locate next to them. They’ve also hiked the prices of their data feeds. As firms spend millions trying to shave milliseconds off execution times, the market has sped up but the racers have stayed even. The result: smaller profits. “Speed has been commoditized,” says Bernie Dan, CEO of Chicago-based Sun Trading, one of the largest high-frequency market-making trading firms.

It was a grim day for the Canadian preferred share market – for half of it, anyway! – with PerpetualPremiums losing 48bp, FixedResets gaining 4bp and DeemedRetractibles down 28bp. The lengthy Performance Highlights table is comprised almost entirely of losers, largely PerpetualPremiums. Volume was average.

NextEra’s legal tactics and understanding of the word “terror” terrify me.

The losing streak on the Canadian preferred share market continued today, with PerpetualPremiums losing 17bp, FixedResets down 14bp and DeemedRetractibles off 11bp. The performance highlights table is comprised entirely of losers, mostly Straight Perpetuals – but it’s only a little above average in length! Volume was high.

The SEC is continuing to tiptoe around Money Market Mutual Fund reforms in an effort to please their future employers at the fundcos:

The SEC’s proposal includes two principal alternative reforms that could be adopted alone or in combination. One alternative would require a floating net asset value (NAV) for prime institutional money market funds. The other alternative would allow the use of liquidity fees and redemption gates in times of stress. The proposal also includes additional diversification and disclosure measures that would apply under either alternative.
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The public comment period for the proposal will last for 90 days after its publication in the Federal Register.

Gating will accelerate runs, as investors rush to redeem before they are imposed. Similarly for liquidity fees, in which case it’s devil take hindmost.

What is gating? The 698-page full proposal (which I confess I have not read in its entirety) explains:

The second alternative proposal would require money market funds to impose a liquidity fee (unless the fund’s board determines that it is not in the best interest of the fund) if a fund’s liquidity levels fell below a specified threshold and would permit the funds to suspend redemptions temporarily, i.e., to “gate” the fund under the same circumstances.

It will be recalled, by those who retain the brains they were born with, that MMFs can only break the buck if there is a default and the only way to protect against such an occurrence is capital. However:

In the sections that follow, we discuss our evaluation of a NAV buffer requirement and an MBR requirement for money market funds. We also discuss comments FSOC received on these recommendations. For the reasons discussed below, the Commission is not pursuing these alternatives because we presently believe that the imposition of either a NAV buffer combined with a minimum balance at risk or a stand-alone NAV buffer, while advancing some of our goals for money market fund reform, might prove costly for money market fund shareholders and could result in a contraction in the money market fund industry that could harm the short-term financing markets and capital formation to a greater degree than the proposals under consideration.

One of the ‘reasons against’ is completely devoid of logic:

In addition, a NAV buffer does not protect shareholders completely from the possibility of heightened rapid redemption activity during periods of market stress, particularly in periods where the buffer is at risk of depletion. As the buffer becomes impaired (or if shareholders believe the fund may suffer a loss that exceeds the size of its NAV buffer), shareholders have an incentive to redeem shares quickly because, once the buffer fails, the fund will no longer be able to maintain a stable value and shareholders will suddenly lose money on their investment.504 Such rapid severe redemptions could impair the fund’s business model and viability.

Naturally, the buffer size most susceptible to these ill-effects is the buffer size of …. zero! So the SEC wants to maximize the incentive for shareholders to redeem shares quickly.

Equally moronic is:

The most significant direct cost of a NAV buffer is the opportunity cost associated with maintaining a NAV buffer. Those contributing to the buffer essentially deploy valuable scarce resources to maintain a NAV buffer rather than being able to use the funds elsewhere. The cost of diverting funds for this purpose represents a significant incremental cost of doing business for those providing the buffer funding. We cannot provide estimates of these opportunity costs because the relevant data is not currently available to the Commission.

The purpose of a market is to find a clearing price. The amount of buffer capital available will be determined by the excess yield it receives. The excess yield paid to buffer capital will determine the yield reduction to the normal unitholders. The yield reduction to the normal unitholders will determine the size of the fund. The size of the fund will determine the amount of buffer capital required.

It all works out, as long as you’re not afraid of free markets.

And then they get to the nub:

Taken together, the demand by investors for some yield and the incentives for fund managers to reduce portfolio risk may impact competition and capital formation in two ways. First, investors seeking higher yield may move their funds to other alternative investment vehicles resulting in a contraction in the money market fund industry.

Naturally, a contraction in the MMF industry would impair employment prospects for regulators.

In his opening statement Commissioner Troy A. Paredes demonstrated that it is possible to have lived through the Credit Crunch and not learnt a damned thing:

It has been suggested that some investors might redeem preemptively before a fee is imposed or a gate comes down. I think that this concern is overstated. Boards have discretion over whether a fee or gate will be instituted. Because fund investors do not know what the board will decide, they may find it difficult to redeem preemptively with any confidence that their timing is correct. In any event, to reduce the potential skittishness of investors, fund managers have an incentive to operate money market funds even more conservatively than Rule 2a-7’s risk-limiting conditions require. On the remote chance that preemptive redemptions are heavy enough to stress a fund, then the liquidity fee would be triggered and the board could decide to gate, the corrective effects of which I just described.

In the midst of a panic with several possible outcomes investors will (i) assign higher than realistic probabilities to their worst-case scenario and (ii) double it.

The basic theme is that MMFs should be allowed to endanger financial stability because a more conservative stance might harm their business.

It was another mixed day for the Canadian preferred share market, with PerpetualPremiums losing 21bp, FixedResets gaining 3bp and DeemedRetractibles down 20bp. The relatively lengthy performance highlights table is comprised entirely of losers, mostly straight perpetuals with a couple of low-coupon DeemedRetractibles thrown in. Volume was high.

PerpetualDiscounts now yield 4.98%, equivalent to 6.47% interest at the standard conversion factor of 1.3x. Long corporates now yield 4.21%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 225bp, unchanged from the figure reported May 29.