PrefBlog

Fitch Ratings (my favourite CRA) didn’t win an account recently – so they decided to win some political brownie points instead:

The recently closed CSMC Trust Mortgage Corp 2012-CIM3 (‘CIM3’) transaction has insufficient credit enhancement to achieve a ‘AAA’ rating, according to Fitch Ratings.
While asked to provide feedback, Fitch was ultimately not selected to rate the transaction, the ninth new issue prime RMBS transaction completed in 2012. Fitch believes it has a more conservative credit stance regarding this transaction. In fact, at 5.85%, the credit enhancement available to the ‘AAA’ rated A-2 class is more than 15% lower than any Fitch rated prime RMBS transaction issued since 2008. Fitch’s estimated credit enhancement (‘CE’) for the senior class A-1 and A-2 notes was 8%.

The collateral attributes of the CIM3 pool are consistent with those Fitch would consider representative of a high credit quality prime portfolio. That said, the 5.85% CE available to the A-2 class is not sufficient in Fitch’s view to fully address the risks associated with the pool, including concentrations in geographies whose property prices remain well above what Fitch believes are sustainable values.

A key component of Fitch’s analysis is to reduce home prices to their sustainable value prior to applying its market value decline (MVD) stresses. Six of the top ten MSA’s represented in the transaction were applied base MVD’s over 20% including Washington-Arlington-Alexandria that accounts for 17.3% of the pool.

They didn’t say who won the deal but Bloomberg did:

The AAA ratings assigned by Standard & Poor’s in a mortgage-bond deal by Credit Suisse Group AG (CSGN) are too high, Fitch Ratings said for the second time this year.
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Rating companies have stepped up their public criticism of competitors’ grades on securitized debt after investors and lawmakers accused them of lowering standards to win business as issuers practiced so-called ratings shopping during the credit boom. A report by a Senate panel last year described the industry as engaging in “a race to the bottom,” before the bubble began to burst in 2007 and sparked a global financial crisis.

I am perplexed to learn that the SEC is studying decimalization:

The Securities and Exchange Commission today announced that its staff will host a roundtable early next year to discuss the impact of decimal-based stock trading on small and mid-sized companies, market professionals, investors, and U.S. securities markets.

The roundtable will be held on Feb. 5 at the SEC’s Washington, D.C., headquarters, and will be open to the public and webcast live on the SEC’s website. Information on the agenda and participants will be issued shortly.

This has been given some focus by the SEC Report to Congress on Decimalization:

One of the IPO Task Force’s conclusions is that changes in the market structure of U.S. capital markets toward a low-cost, frictionless environment characterized by electronic trading has favored highly liquid, very large capitalization stocks at the expense of smaller capitalization stocks. According to the IPO Task Force Report, the impact of decimalization has been twofold. First, market structure changes associated with decimalization favor short-term trading strategies over long-term fundamental strategies. For smaller public company stocks with lower liquidity, the lack of fundamental strategies results in trading volume that is too low “to make money for the investment bank’s trading desk.” The IPO Task Force Report argues that this lack of profitability undermines the incentive for underwriters to take smaller companies public.

Second, the IPO Task Force Report states that “decimalization . . . put the economic sustainability of sell-side research departments under stress by reducing the spreads and trading commissions that formerly helped to fund research analyst coverage.” The IPO Task Force Report also argues that analyst coverage has significantly shifted away from smaller capitalization stocks towards highly liquid, larger capitalization stocks, reflecting the change in financial institution focus.9 In particular, the IPO Task Force Report suggests that analyst coverage of smaller public companies has become unprofitable both because of the Global Analyst Research Settlement in 2003, which prohibited the direct compensation of research analysts through investment banking revenue, and the advent of decimalization, which reduced spreads that formerly helped fund analyst coverage. Thus, the IPO Task Force Report concludes, less analyst coverage of smaller capitalization companies means that less information on these stocks is generated, which, in turn, reduces market interest in these stocks.

In many ways this echoes my criticism of the concept of exchange trading for bonds: transparency sounds wonderful, but it leads to a shallower and more brittle market than OTC. However, my perception is that the big problem for smaller companies is the immense cost of prospectus preparation and compliance with regulation for public companies; I think the SEC would be better advised to fix that first, prior to fiddling with market mechanics.

The Nobel Foundation is reaching for yield:

The Nobel Foundation, which this year lopped 20 percent off its cash prizes, is planning to invest more money through hedge funds to boost its returns and restore the award to its previous size.

“When we look at the analysis we see that we can get more return with less risks by doing that,” Executive Director Lars Heikensten said in an interview at the Nobel Foundation’s Stockholm headquarters yesterday. “If we can choose hedge funds that we trust, then we can get better returns for given risks.” The fund “probably shouldn’t” be fully invested in debt securities, he said.

Audit fees and expenses are going up:

Accounting firm Ernst & Young LLP has been accused by regulators of failing to properly scrutinize the books of failed forestry company Sino-Forest Corp., marking a rare case of auditors facing allegations of wrongdoing by the Ontario Securities Commission.

The case was announced Monday just as lawyers for Sino-Forest’s shareholders were also revealing they had reached a record $117-million settlement with E&Y late last week. The settlement is the largest class-action lawsuit payment by an audit firm in Canadian history.

Both developments are expected to have a broad impact on the work of auditors, especially those working for companies like Sino-Forest who trade on Canadian stock exchanges but have all their operations based in another country.

The Canadian preferred share market drifted very slightly upward today, with PerpetualPremiums and DeemedRetractibles up 2bp while FixedResets gained 4bp. There was a surprising amount of volatility, heavily skewed to the upside. Volume was below average.

I have long been amused that monetary loosening intended to provoke investment in productivity enhancing endeavors has instead had the result of inflating housing bubbles; and now Citibank says there’s another problem:

Worldwide quantitative easing may be making investors richer rather than encouraging business investment, according to Citigroup Inc. (C)

Fulfilling the goals of central bankers such as Federal Reserve Chairman Ben S. Bernanke, ultra-low interest rates and bond purchases are encouraging investors to buy stocks. Policy makers’ intent was that asset prices and wealth would rise, encouraging consumers and businesses to spend more.

The sticking point is the particular equities investors are favoring, Robert Buckland, Citigroup’s London-based chief global equity strategist, said in a Nov. 21 report. His research suggests they tend to choose companies that issue dividends and buy back shares rather than those that invest in the economy.

It was a modest day in the Canadian preferred share market, with PerpetualPremiums up 4bp while FixedResets and DeemedRetractibles both gained 2bp. Volatility was low but entirely comprised of losers. Volume was high.

And that’s it for another month!

Nothing happened today.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 7bp, FixedResets off 2bp and DeemedRetractibles gaining 6bp. Volatility was minimal. Volume was above average.

Evan Soltas writes an interesting piece on Bloomberg titled Misconceptions 101: Why College Costs [in the US] Aren’t Soaring:

What has happened is a shift toward price discrimination — offering multiple prices for the same product. Universities have offset the increase in sticker price for most families through an expansion of grant-based financial aid and scholarships. That has caused the BLS measure to rise without increasing the net cost.

Wealthier families now pay more than ever to send their children to college. But for much of the middle class, the real net cost of college has not changed significantly; for much of the poor, the expansion of aid has increased the accessibility and affordability of a college education.

Data from the College Board show effectively no change in real net tuition and fees for dependent students at four-year public or private universities whose families are in the lower-two income quartiles. There also have been some increases in the real cost of room and board, but for families with below-average income, the rise has been on the order of 20 percent over 20 years.

At four-year public universities, the average sticker price for tuition and fees has risen 127 percent in real terms, from $3,810 in 1992 to $8,660 in this academic year. But only $990 of this $4,850 increase in sticker price, or 20 percent, is due to increases in net cost. The remaining 80 percent is price discrimination.

At four-year private universities, the story is the same. From 1992 to 2012, their average sticker price rose $12,020, or 70 percent, after inflation. Only 28 percent of this increase, or $3,370, has come from net cost; 72 percent of the increase is in the sticker price only.

In other words, the universities are now part of the tax system. Is this supposed to be good? I’m all in favour of merit-based scholarships and grants – but that’s not what is being defended. I also note that the increase in real net cost is about 25% over the past twenty years; it is not clear how this increase is justified.

Co-operators General Insurance Company was confirmed by DBRS at Pfd-3(high):

The Company is the cornerstone of The Co-operators Group Limited, a co-operative financial services organization with complementary interests in life insurance and investment management. As part of a larger financial services group, the Company enjoys a strong franchise in the co-operative space, which ranks it among the top five providers of general insurance products in Canada. The Company is positioned to benefit from recent management initiatives to reduce costs, contain underwriting risk and cultivate deeper customer relationships. The Company is demonstrating the discipline to pull back from unprofitable business even at the cost of lost revenue. More customer segmentation and differential pricing create a more favourable platform for improved future profitability.
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In line with the improvement in underwriting profitability, return on equity has recovered to low double digits, which is in line with the Company’s targets. Investment income remains pressured by lower interest rates, although realized gains in market values of securities have supported investment results in recent periods. Financial leverage remains modest, with the preferred shares representing just 17.4% of capitalization. The corresponding fixed-charge coverage ratio has averaged between seven and eight times, which is strong for the rating category. The Company’s consolidated regulatory minimum (MCT) capital ratio is 269%, which is well in excess of the Company’s minimum target of 180% ($437 million of excess capital). Strong regulatory capital ratios at its major operating subsidiaries permit the regular flow of dividends up to the Company which, in addition to its own operating earnings, are available to meet its preferred share obligations. Liquidity is generally not a concern in the general insurance industry as premiums are written and invested in relatively liquid assets.

There’s an interesting article on Bloomberg about accountability of anti-piracy troops.

It was a day of very little movement for the Canadian preferred share market, with PerpetualPremiums and DeemedRetractibles both gaining 1bp and FixedResets up 2bp. Volatility was low. Volume was a little above average.

PerpetualDiscounts now yield 4.89%, equivalent to 6.36% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 4.2%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 215bp, a small (and perhaps spurious) increase from the 210bp reported November 21.

There is some chatter about London’s decline as a financial centre:

Investment bankers and traders at European banks should expect at least a 15 percent cut in pay this year, while U.S. lenders may leave compensation unchanged, three consultants surveyed by Bloomberg said. That’s because bonus pools at European banks may be reduced by as much as half, while those at U.S. firms, which can cushion the impact of falling fees in the region with earnings from home, may fall 20 percent, they said.

“The real split is coming, and we will see the quantum divide this year,” said Tom Gosling, a partner at PricewaterhouseCoopers LLP in London, referring to the difference in pay between the two financial centers. “U.S. regulators don’t have the same obsession with pay structures that European regulators have.”

While lower pay for all bankers reflects what may be a temporary drop in business, cuts at European lenders probably will be structural rather than cyclical, cementing a two-tier system, said John Purcell, chief executive officer of Purcell & Co., a London search firm. They also could spur some employees to relocate, according to recruitment company Astbury Marsden.

It’s not clear yet, but the latest Greek bail-out might work:

European finance ministers eased the terms on emergency aid for Greece, declaring after three years of false starts that Europe has found the formula for nursing the debt-stricken country back to health.

In the latest bid to keep the 17-nation euro intact, the ministers cut the rates on bailout loans, suspended interest payments for a decade, gave Greece more time to repay and engineered a Greek bond buyback. The country was also cleared to receive a 34.4 billion-euro ($44.7 billion) loan installment in December. Greek bonds rose.

“This has been a very difficult deal,” Luxembourg Prime Minister Jean-Claude Juncker told reporters in Brussels after chairing a 13-hour meeting that ended early today. “All initiatives decided upon today will bring Greece’s public debt clearly back on a sustainable path.”

After 240 billion euros in loan pledges and the biggest writedown of privately held debt failed to turn Greece around, the creditor governments led by Germany proclaimed the latest fix just as they grappled with swelling financing needs in Cyprus and a potential aid request by Spain, the fourth-largest euro economy.

To compensate for this little bit of progress, the Europeans have gone completely nuts on Credit Rating Agencies:

Credit ratings companies face curbs on when they can assess government debt and restrictions on their ownership under draft plans agreed on by European Union officials and legislators.

Lawmakers from the European Parliament and Cyprus, which holds the rotating presidency of the EU, also agreed today to allow investors to sue ratings companies if they lose money because of malpractice or gross negligence.
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[ EU financial services chief Michel] Barnier proposed the tougher ratings rules after warnings from nations including France and Germany that downgrades of sovereign debt had deepened the bloc’s fiscal crisis. Barnier said last year that ratings companies were guilty of “serious mistakes” and shouldn’t be allowed to “increase market volatility” through ill-timed or unjustified downgrades.
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On sovereign debt ratings, lawmakers and officials agreed that each credit rating firm must pick three days a year when they would be allowed to give so-called unsolicited assessments of governments’ creditworthiness, according to Jean-Paul Gauzes, a lawmaker involved in the talks. Ratings firms may get a chance to issue unsolicited ratings outside those dates if they could justify it to regulators.
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The EU also plans to block any investor from owning stakes of more than 5 percent in more than one rating company, Gauzes said in an interview after the meeting.
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The commission said that it will weigh further steps to regulate the credit ratings market, including the creation of a “European credit rating agency.” Officials will report on the possible step by 2016, it said.

All this sounds like a really good reason for CRAs to set up shop well outside the EU.

I wonder if they will declare the OECD to be illegal?

The OECD slashed its global growth forecasts on Tuesday, warning that the debt crisis in the recession-hit euro zone is the greatest threat to the world economy.

In light of the dire economic outlook, the Organization for Economic Cooperation and Development urged central banks to prepare for more exceptional monetary easing if politicians fail to come up with credible answers to the debt crisis.
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Cutting its estimates, the OECD forecast that the euro zone economy would contract 0.4 per cent this year and another 0.1 per cent next year, only returning to growth in 2014 with a rate of 1.3 per cent.

Maybe that’s related to the bad press for long sovereigns:

Given the overheated market, it’s understandable why Michael Sabia, chief executive of the Caisse, told the Financial Times on Tuesday that he is planning to lower his institution’s $58.8-billion allocation to fixed-income investments by at least $7-billion next year. And why [Boston-based fund manager] GMO, a highly regarded money manager, told the FT it has “given up” on long-dated sovereign debt.

But if big institutions are starting to pull out of fixed income investments, ordinary Canadians are continuing to pile in. As of the end of October, retail investors had poured a net $16.3-billion into bond funds so far in 2012 – almost three times as much as in the same period in 2011 – while redeeming a net $11.5-billion from equity funds, according to the Investment Funds Institute of Canada.

The Caisse hasn’t always been the best proxy for smart money, but GMO has. Headed by the famed investor Jeremy Grantham, it shifted its portfolios to a high cash position in late 2007, just before the credit crisis mushroomed, and also managed to avoid being sucked in by the Internet bubble in the late 1990s.

Now, GMO is holding 40 per cent of its assets in cash, according to the FT. Canadians thinking it’s high time they added more bonds to their portfolios should think twice; there may be safer places to keep that money.

Why is it so expensive to go to school in the US?:

At universities nationwide, employment of administrators jumped 60 percent from 1993 to 2009, 10 times the growth rate for tenured faculty. “Administrative bloat is clearly contributing to the overall cost of higher education,” says Jay Greene, an education professor at the University of Arkansas. In a 2010 study, Greene found that from 1993 to 2007, spending on administration rose almost twice as fast as funding for research and teaching at 198 leading U.S. universities.

It was a negative day for the Canadian preferred share market, with PerpetualPremiums down 5bp, FixedResets losing 18bp and DeemedRetractibles off 3bp. Volatility was average, but all negative. Volume was well above average.