PrefBlog

Australia’s debt market is not what it used to be:

Australia sold A$3.25 billion ($3.3 billion) of notes due in 16 1/2 years, the longest-maturity bonds on record in government data going back to 1982, matching its largest ever offering.

The 3.25 percent April 2029 security was placed via syndication and yielded 3.595 percent, according to an e-mailed statement from the Australian Office of Financial Management. Notes due April 2027 were previously the nation’s longest-dated debt.

Foreign investors seeking the world’s highest-yielding AAA rated sovereign debt hold a near-record 77.5 percent of Australian government bonds, government data show. The U.K. gilt due July 2052 offers the highest top-graded rates outside of Australian securities, at 3.24 percent. Prime Minister Julia Gillard’s plan to end four years of budget deficits has also driven demand for federal debt. The benchmark 10-year note touched an all-time low of 2.698 percent in June.

The 10-year rate was at 3.08 percent as of 3:45 p.m. in Sydney, while the 15-year yield was 3.39 percent. The Australian dollar bought $1.0220.

Larry Fink appears to favour bank capital buffers over hard minima:

Speaking at a seminar during the International Monetary Fund’s annual meeting in Tokyo, Mr. Fink got vocal about the need for even tougher and more stringent recap rules
…
“Regulators spend too much time focusing on the potential failure of an institution,” he said in his remarks, which were noted by Euromoney. “We need to spend more time on resolution when there is even [just] a small deterioration of capital.”

Mr. Fink’s proposal: If a bank that meets the 9 per cent tangible common equity ratio suddenly falls to 8.5 per cent, they should have a strict time period to restore their capital levels, or face penalties. The time period he suggests is 90 days.

Regulators devote too much time to hashing out plans for dealing with failed banks, he said, rather than making sure that those who are starting to suffer stay afloat.

Mr. Fink also argued in favour of even higher capital requirements, something you rarely hear from someone who works for a financial institution.
…
As Euromoney points out, there is speculation that Mr. Fink could be named Treasury Secretary should President Obama win a second term.

The IMF GFSR – October 2012 has some interesting things in it:

Click for Big

Most measures show that liquidity in the U.S. corporate bond market has declined since the start of the global financial crisis and has not returned to precrisis levels (Table 2.6.1). For instance, the ratio of trading volume ($17 billion) to the value of outstanding corporate bonds ($5 trillion) is just 0.33 percent, one of the lowest ratios among key U.S. assets, and lower than it was before the crisis. Other liquidity measures have also deteriorated relative to precrisis levels: Market turnover ratios have declined and bid-ask spreads are generally wider, especially on larger-size trades and off-the-run issues. The distribution of liquidity has also grown more top-heavy, with trading activity more concentrated in a smaller number of issuers.

The decline in liquidity in the secondary corporate bond market is due to a combination of cyclical and secular forces. Three are most notable:
1. Changes in dealer-banks’ business models and greater global uncertainty…
2. Trading has shifted to exchange-traded funds (ETFs), corporate derivatives, and other alternatives to trading corporate bonds directly (the cash market)…
3. Changes in the investor base are also affecting trading conditions…

One issue that is examined is “Did Some Banking Systems Withstand International Contagion Because They Are Less
Globally Integrated?”

The recent episode of global financial turmoil highlights the risk of international contagion and the potential resiliency of less integrated banking systems. This box explore the banking system “openness” and regulatory frameworks of four jurisdictions generally regarded as less globally integrated, all of which fared relatively well in the financial crisis. It concludes that the funding structure of banks could be more important than a lack of foreign bank ownership for financial stability.
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Regulatory policies in Australia and Canada share some features that might have resulted in less globally integrated banking systems. One important policy they have in common is the de facto prohibition of mergers among the major domestic banks. While its primary objective is to retain competition, the prohibition has prevented an increase in the size of these banks and the creation of national “champions” that could compete with major global financial institutions. This may have been a factor limiting their banks’ international activities. The two economies also impose restrictions on shareholder ownership, which limits acquisition of domestic banks by either other domestic banks or foreign ones, although establishment of subsidiaries and branches of foreign banks are not restricted, except on prudential grounds.
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The data suggest, however, that prudential regulatory requirements placed on entry of foreign banks may be less important for financial stability than the funding structure of domestic banks. Analysis shows that banking systems less reliant on foreign funding — economies whose bank assets were relatively less funded with international liabilities in 2007 — had higher credit growth in the five years since the crisis (Figure 3.5.4).5 All four economies reviewed here follow the pattern of other peer groups on average, especially Australia and Malaysia. Other evidence suggests that having a strong domestic deposit base is important for supporting local lending by foreign banks (Claessens and Van Horen, 2012). Hence, the positive experience of these four economies could be attributable not only to their regulatory approaches but also to the funding structure of the banks.

This is consistent with earlier studies. Not much in there about OSFI’s wisdom!

More consideration of risks in moving OTC derivatives contracts to central counterparties (CCPs). Current efforts to reduce counterparty exposures through such moves come with some danger that the CCPs themselves will become too important to fail and that the “location” requirements enforced in multiple jurisdictions may create too many CCPs. These institutions could have diverse requirements and levels of oversight that would hinder the benefits of netting, increase the demands for collateral, and unnecessarily increase costs. In general, the international effort to harmonize approaches to reforms in OTC derivatives markets should be reenergized.

The PDF claims that there is a chapter titled “The Financial Impact of Longevity Risk”, as there was in April, but the HTML announcement. Most peculiar.

LNG may not be a panacea for the North American gas industry:

China is importing more natural gas by pipeline than sea for the first time, highlighting the risk to planned LNG projects costing at least $100 billion as buyers seek cheaper supplies.

The country, which accounted for almost a quarter of Asia’s gas use last year, increased shipments from Turkmenistan, the provider of almost all its piped supplies, by 55 percent to 9.85 million metric tons in the first eight months of the year, customs data show. Liquefied natural gas purchases from nations including Australia and Qatar advanced 23 percent to 9.08 million tons and cost about 3 percent more than pipeline imports, even before the cost of regasification.
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China’s spending on LNG has surged as prices and volumes have climbed. The bill in 2008 was $942 million and the average price paid was $282 a ton. This year’s price is equivalent to $10.81 per million British thermal units, or about three times as much as benchmark U.S. gas futures, which were at $3.459 today, according to data compiled by Bloomberg. Cargoes from Qatar, China’s biggest and most expensive supplier, cost $19.33 per million Btu.

I stumbled across a good paper by Rohan Churm and Nikolaos Panigirtzoglou titled Decomposing Credit Spreads:

This paper investigates the information contained in the yields of corporate debt securities using a structural credit risk model. As previous studies have found, credit risk is not the only factor that affects corporate yield spreads. The aim is to decompose credit spreads, using a structural model of credit risk, into credit and non-credit risk components. The contribution relative to the existing literature is the use of contemporaneous forward-looking information on equity risk premia and equity value uncertainty in a structural model. In particular, implied equity risk premia from a three-stage dividend discount model that incorporates analysts’ long-term earnings forecasts are used, together with implied measures of equity value uncertainty from option prices. The paper examines the evolution of the different components of spreads across time as well as the effect of particular events. It also analyses the relationship between the derived components and other financial variables, such as swap spreads and the equity risk premium.
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The non-credit risk component, attributed to liquidity, regulatory or tax effects, increases as the credit risk component increases, consistent with the empirical evidence of higher bid-ask spreads for lower quality credits. This component is closely related to swap spreads for investment-grade companies, in line with the existing literature that finds that a small proportion of swap spreads is due to credit risk. Moreover, it provides justification for the use of the swap curve as a fixed income benchmark for corporate debt. For high-yield companies, the non-credit risk component is much higher than swap spreads, suggesting a greater importance of liquidity for these lower quality corporates. In the second half of 2002, we observe small movements in the UK investment-grade credit spreads compared to the United States. Our decomposition implies that this is due to the combination of a reduction in compensation for non-credit risk factors in the United Kingdom and greater credit risk in the United States.

Another result of our decomposition is that the credit risk premium component of the credit spread as a proportion of the assumed equity risk premium, increased by a factor of two for investment-grade. We can explain this increase qualitatively, using a standard CAPM framework, by the correlation between equity market (a proxy for the market portfolio) returns and credit returns.

The 2012 Nobel Prize in Chemistry has been announced:

Your body is a fine-tuned system of interactions between billions of cells. Each cell has tiny receptors that enable it to sense its environment, so it can adapt to new situtations. Robert Lefkowitz and Brian Kobilka are awarded the 2012 Nobel Prize in Chemistry for groundbreaking discoveries that reveal the inner workings of an important family of such receptors: G-protein–coupled receptors.

For a long time, it remained a mystery how cells could sense their environment. Scientists knew that hormones such as adrenalin had powerful effects: increasing blood pressure and making the heart beat faster. They suspected that cell surfaces contained some kind of recipient for hormones. But what these receptors actually consisted of and how they worked remained obscured for most of the 20th Century.

Lefkowitz started to use radioactivity in 1968 in order to trace cells’ receptors. He attached an iodine isotope to various hormones, and thanks to the radiation, he managed to unveil several receptors, among those a receptor for adrenalin: β-adrenergic receptor. His team of researchers extracted the receptor from its hiding place in the cell wall and gained an initial understanding of how it works.

The team achieved its next big step during the 1980s. The newly recruited Kobilka accepted the challenge to isolate the gene that codes for the β-adrenergic receptor from the gigantic human genome. His creative approach allowed him to attain his goal. When the researchers analyzed the gene, they discovered that the receptor was similar to one in the eye that captures light. They realized that there is a whole family of receptors that look alike and function in the same manner.

Today this family is referred to as G-protein–coupled receptors. About a thousand genes code for such receptors, for example, for light, flavour, odour, adrenalin, histamine, dopamine and serotonin. About half of all medications achieve their effect through G-protein–coupled receptors.

The studies by Lefkowitz and Kobilka are crucial for understanding how G-protein–coupled receptors function. Furthermore, in 2011, Kobilka achieved another break-through; he and his research team captured an image of the β-adrenergic receptor at the exact moment that it is activated by a hormone and sends a signal into the cell. This image is a molecular masterpiece – the result of decades of research.

And there’s a video!

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 5bp, FixedResets up 6bp and DeemedRetractibles off 3bp. Volatility was very low. Volume was average.

PerpetualDiscounts now yield 5.01%, equivalent to 6.51% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 4.25%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 225bp, widening from the 215bp reported October 3.

Great news! At long last, high-earning Britons will pay their fair share:

U.K. Prime Minister David Cameron said his government will announce additional measures to increase taxes on the rich, while ruling out a so-called mansion tax wanted by his Liberal Democrat coalition partners.

“We are going to take further action to make sure that the richest people in our country pay their fair share towards deficit reduction,” Cameron told the BBC’s “Andrew Marr Show” today as his Conservative Party began its annual conference in Birmingham, central England. He said he didn’t believe that people who saved and bought large houses should be hit “every year with a massive great tax. That’s not going to happen.”
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The leader of the opposition Labour Party, Ed Miliband, last week used his own keynote conference speech to accuse Cameron of “writing a check to each and every millionaire in Britain for 40,000 pounds” and pledged to keep the income-tax rate at 50 percent if Labour takes power in 2015. He said Labour is now the party best able to represent people of all backgrounds and incomes.

Two polls published today showed Labour extending its lead following its conference. A YouGov Plc (YOU) poll in the Sunday Times found 45 percent of respondents saying they would vote for Labour, 31 percent favoring the Conservatives and 8 percent backing the Liberal Democrats.

Detroit – a new IT hub?

General Motors Co. says it will hire as many as 1,500 workers to staff a new computer technology centre in the Detroit suburb of Warren, Mich.

GM is shifting computer work into the company from outside firms and plans to open four new technology centers in the U.S. Last month the company announced it would hire 500 people for a center in Austin, Tex.

S&P’s (and Egon Jones’) downgrade of the US is looking more justifiable all the time:

A polarised Washington that cannot find a way around the looming “fiscal cliff” is compounding economic uncertainty, freezing business investment and threatening growth, the IMF’s No. 2 official and its top-ranking American said on Monday.

In an interview with Reuters in Tokyo, IMF First Deputy Managing Director David Lipton said the United States needs to do more to show it is trying to address the expiring tax cuts and automatic spending reductions that will hit early next year unless Congress acts.
…
If nothing is done, U.S. tax increases and spending cuts worth $600-billion (U.S.), equivalent to 4 per cent of U.S. GDP, will take effect in fiscal 2013, Fitch Ratings has estimated.

Taxes would rise in 2013 by an average of $3,500 per household for 90 per cent of Americans, the U.S. Tax Policy Center has said.

The IMF also warns of a potentially massive sale of bank assets:

The International Monetary Fund said European banks may need to sell as much as $4.5 trillion in assets through 2013 if policy makers fall short of pledges to stem the fiscal crisis, up 18 percent from its April estimate.

Failure to implement fiscal tightening or set up a single supervisory system in the timing agreed could force 58 European Union banks from UniCredit SpA (UCG) to Deutsche Bank AG (DBK) to shrink assets, the IMF said. That would hurt credit and crimp growth by 4 percentage points next year in Greece, Cyprus, Ireland, Italy, Portugal and Spain, Europe’s periphery.

They’re mulling over inflation linked debt in Singapore:

Singapore is considering issuing bonds that protect against inflation after price gains sent the cost of a public-housing apartment to a record S$1 million ($813,000) last month and made cars as expensive as U.S. homes.

Singapore’s consumer price index rose 3.9 percent in August from the year before, more than double the 1.7 percent rate in the U.S., the world’s biggest economy. Inflation in the island state averaged 5 percent for the past year. With the nation home to world’s highest proportion of millionaire households, the central bank is studying the feasibility of securities to help savers protect their funds from rising costs.

There’s a new wrinkle on crowding-out:

U.S. debt has shrunk to a six-year low relative to the size of the economy as homeowners, cities and companies cut borrowing, undermining rating companies’ downgrading of the nation’s credit rating.

Total indebtedness including that of federal and state governments and consumers has fallen to 3.29 times gross domestic product, the least since 2006, from a peak of 3.59 four years ago, according to data compiled by Bloomberg. Private- sector borrowing is down by $4 trillion to $40.2 trillion.
…
Consumer debt declined to $11.4 trillion at the end of the second quarter, from a peak of $12.7 trillion in 2008. The market for commercial paper, a form of short-term corporate IOUs, has shrunk to $975 billion from a record $2.22 trillion in July 2007, central bank data show.

Net U.S. taxable debt issuance, which includes corporate, mortgage and Treasury securities, is forecast to fall to $821 billion in 2012, the least since 2000 and less than half the record $2.28 trillion in 2007, according to Ira Jersey, an interest-rate strategist at Credit Suisse Group AG in New York.

Canada’s outlook according to the IMF worsened:

The International Monetary Fund is taking a dimmer view of Canada, cutting its economic forecasts and warning of the threats from the housing market and swollen consumer debt levels.

“In Canada, the key priority is to ensure that risks from the housing sector and increases in household debt remain well contained and do not create financial sector vulnerabilities,” the IMF said today in updated global projections that, over all, paint a bleak picture of the world in the post-crisis era.
…
The IMF trimmed its forecasts for economic growth in Canada – to 1.9 per cent this year and 2 per cent next, down in each case by 0.2 from earlier projections – and warned unemployment will remain stubbornly at 7.3 per cent.

LIBOR is becoming very narrowly based:

After being rigged by some of the world’s biggest financial institutions, the London interbank offered rate, the benchmark for more than $300 trillion of securities and loans, is now increasingly being set by a smaller group of banks.

Bank of America Corp., Citigroup Inc. (C), Bank of Tokyo Mitsubishi UFJ Ltd., Royal Bank of Canada, Sumitomo Mitsui Financial Group Inc. and Lloyds Banking Group Plc (LLOY)’s submissions have been used in setting the rate on an almost daily basis in the past four months, data compiled by Bloomberg show. Two years ago, none of the 18 designated lenders made it into every fixing of the measure, which excludes outliers by stripping out the four highest and lowest contributions.
…
Unsecured lending between banks — the activity Libor is designed to reflect — has dried up as institutions increasingly demand collateral before money changes hands or go to central banks for funds. As a result, banks’ reported borrowing costs have diverged, meaning the same group of lenders is dominating the middle ground where the benchmark is set.

The gap between the highest and lowest submissions has widened from before the scandal, reaching an average 0.32 percentage point in the past four months, compared with 0.1 percentage point in the same period of 2011, data compiled by Bloomberg show.

I don’t understand why any banks participate. What’s in it for them, other than liability?

On a sort-of related note, I would imagine CHF and DKK LIBORs are getting pretty boring:

Royal Bank of Canada is imposing negative interest rates on some customers who hold Danish kroner and Swiss francs, joining U.S. rivals in charging depositors who seek refuge from the crisis-stricken euro.

Royal Bank, Canada’s largest lender, cited recent market conditions for the policy, which reverses the traditional practice of paying customers who deposit funds at a bank. State Street Corp. (STT) and Bank of New York Mellon Corp., two of the world’s biggest custody banks, have already disclosed plans to offer negative interest rates on those currencies.

Denmark and Switzerland have cut interest rates close to or below zero to keep the krone and franc from rising as investors flee the euro for safer havens, reflecting concern that the currency may break up.

Amidst all this, the Kansas City Fed suggests financial stress is receding:

The Kansas City Financial Stress Index (KCFSI) measured -0.50 in September, down from -0.40 in August. The KCFSI has now decreased over four consecutive months. This series of declines places the index at its lowest level since May of 2011.

The second table on the following page describes the contribution of each of the eleven variables comprising the KCFSI. Yield spreads suggest subdued financial stress as all seven of the spread variables contributed negatively to the index. Together, declines in yield spreads deducted 0.11 point from the index. The behavior of asset prices had a minimal effect on the KCFSI. Each of the asset price variables added or subtracted 0.01 point or less. Collectively, however, these variables increased the index by 0.01 point.

The 2012 Nobel Prize in Physics has been announced:

Serge Haroche and David J. Wineland have independently invented and developed methods for measuring and manipulating individual particles while preserving their quantum-mechanical nature, in ways that were previously thought unattainable.

The Nobel Laureates have opened the door to a new era of experimentation with quantum physics by demonstrating the direct observation of individual quantum particles without destroying them. For single particles of light or matter the laws of classical physics cease to apply and quantum physics takes over. But single particles are not easily isolated from their surrounding environment and they lose their mysterious quantum properties as soon as they interact with the outside world. Thus many seemingly bizarre phenomena predicted by quantum physics could not be directly observed, and researchers could only carry out thought experiments that might in principle manifest these bizarre phenomena.

Through their ingenious laboratory methods Haroche and Wineland together with their research groups have managed to measure and control very fragile quantum states, which were previously thought inaccessible for direct observation. The new methods allow them to examine, control and count the particles.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums down 9bp, FixedResets off 4bp and DeemedRetractibles gaining 7bp. There was very little volatility. Volume was below average.

The US jobs number was OK:

The unemployment rate in the U.S. unexpectedly fell to 7.8 percent in September, the lowest since President Barack Obama took office in January 2009, as employers took on more part-time workers.

The economy added 114,000 workers last month after a revised 142,000 gain in August that was more than initially estimated, Labor Department figures showed today in Washington. The jobless rate dropped from 8.1 percent, and hourly earnings climbed more than forecast.

Unfortunately, it’s being politicized:

Jack Welch, writing on his Twitter account, said the Obama administration manipulated U.S. employment data for political gain by showing a drop in the jobless rate.

“Unbelievable jobs numbers..these Chicago guys will do anything..can’t debate so change numbers,” the former General Electric Co. (GE) chief executive officer said in a message posted immediately after the U.S. Labor Department reported that the unemployment rate fell to 7.8 percent last month, the lowest since President Barack Obama took office in January 2009.

It might be worth having a congressional inquiry into the integrity of the numbers although I suggest that somebody of stature should simply declare ‘show me the evidence or shut up’. The US jobs number much more important than silly old LIBOR. Welch has been challenged, but hasn’t put up:

During a television interview last night, when CNBC host Larry Kudlow said it was unrealistic to allege the White House tampered with the data, Welch tempered his words.

“Let’s hope that’s totally correct, Larry,” Welch said. Still, he said, “This election is too important for one number that might be corrected next month to determine the election. I want to see a real debate about this number.”

David Berman of the Globe points out that inflation numbers are also a favourite bugbear of conspiracy theorists.

Roger Lowenstein, an outside director of the Sequoia Fund, writes an op-ed diatribe against High Frequency Trading in the New York Times titled A Speed Limit for the Stock Market (hat tip: Financial Webring Forum). He starts off by revealing his prejudice:

Some 50 percent to 70 percent of all trading is done by “traders” who live in server parks, are nourished by direct current and speak only in binary pulses.

This can be taken as a slam against computer geeks who didn’t go to the right school and aren’t seen at the charity dinners; or it can just be taken as an implication that nobody thought about the process, nobody wrote the algorithms, nobody’s putting up any capital: HFT was air-dropped on the world by Martian invaders.

He lauds the highly suspect SEC report and links to another article titled In Calls for Market Reform, Multiple Voices which provides just a tiny hint of what really happened in the Flash Crash:

Maureen O’Hara, a professor at Cornell University, said at a conference Wednesday that technological advances had made it cheaper for ordinary investors to buy and sell stocks. But she noted that this progress created problems that industry participants had only started to recognize, like the increased the instability of the market.

Assiduous Readers with good memories will remember Maureen O’Hara: she wants to sell her technical analysis for big bucks, a process that will be facilitated by embedding the concept in regulation.

It seems clear to me that the concepts of “cheaper for ordinary investors to buy and sell stocks” and “instability of the market” have a very large causation component. It was the highly touted retail “Stop-Loss Order”, which continues to be vigorously promoted by the brokerage houses, that turned a sharp decline into a rout in the Flash Crash.

Anyway, back to Lowenstein:

The reason that market squares like me harp on the long term isn’t because we’re technologically illiterate. It’s because, again, society relies on the market to allocate capital. If market signals are based on algorithms that become outmoded in a nanosecond, we end up with empty factories and useless investment.

How much effort do high-speed traders devote to analyzing the future prospects of Apple? Precisely none. Their aim is only to exploit tiny price discrepancies that disappear in milliseconds.

This conjunction of paragraphs is totally devoid in logic. On the one hand, he says that HFT exists to “exploit tiny price discrepencies that disappear in milliseconds” and on the other hand he wants to blame them for misallocation of capital. Make up your mind, Mr. Lowenstein! Are the effects major or minor? How is the success of a new issue related to the HFT activity?

In fact, HFT serves to promote capital formation by speeding the rate at which supply and demand reach equilibrium. Market signals become more accurate, not less so.

Lowenstein concludes with:

But the better way to discourage this excessive, short-term market myopia is to take a page from anti-tobacco efforts: let high taxes discourage the antisocial behavior.

We already encourage long-term investing by taxing capital gains on investments held for more than a year at a rate of just 15 percent — in contrast to short-term capital gains, which are assessed at much higher rates. We could simply fine-tune that incentive even more. Intraday trades should be taxed at 50 percent. And “investments” that mature in 60 seconds should be regarded as, in effect, electronic errors — with any profit going to the government. This will greatly reduce high-speed trading and divert its remaining gains to the public.

If one wished to destroy market liquidity, one would do precisely that. I presume there would be an exemption for highly regulated market makers employed by large brokerages, who would then be free to jack up their spreads, unhindered by computer geeks intent on eating their lunch.

I see that BMO-InvestorLine is now offering Recognia’s Value Analyzer™:

Provided by Recognia, an industry leader in actionable investment research, Value Analyzer is designed to help BMO InvestorLine clients with:
• Becoming more proficient in value investing;
• Validating ideas using value analysis that classifies the value of the stock based on key value investing metrics;
• Gaining access to a list of pre-screened value investment ideas which are updated daily and organized by industry sector; and
• Utilizing value-based investing industry research to monitor favourite stocks and identify undervalued stocks.

This is somewhat different from what their product brief states:

For the on-line broker, Value Analyzer provides daily investment ideas to drive trading volumes. Furthermore, Value Analyzer empowers investors with the confidence to take control of their investments. This in turn enables them to make more trades and enhances their loyalty to the broker and their services.

As is usual, neither company provides any information regarding performance.

I confess to puzzlement regarding DBRS’ upgrade of DPS.UN to STA-2(low):

On August 26, 2010, DBRS assigned a stability rating of STA-3 (high) to the Units issued by the Trust in accordance with the new methodology for rating structured income funds, published in May 2010. The rating was mainly based on the strong credit quality of the Trust’s preferred share portfolio and the limited flexibility of the Administrator to invest in riskier assets. The shortfall in portfolio income relative to the distribution paid out to the Trust’s unitholders is the main constraint to the rating. Other constraints to the rating include the interest rate risk of the Portfolio and the capital losses that may result from underlying securities being called for redemption by their respective issuers.

The current weighted-average yield of the Portfolio is approximately 4.93%. The Trust had previously been making quarterly distributions to the Unitholders equal to $0.30 per unit, yielding 4.80% per annum on the unit issue price of $25, but the Trust announced a change in the distribution rate from $0.30 per unit to $0.25 per share (yielding 4.00% per annum on the Unit issue price of $25) on September 26, 2011, effective with the distribution paid on January 13, 2012. The amount of the distribution and the net asset value (NAV) of the Portfolio may vary in accordance with the credit profile of each of the Portfolio’s underlying securities, prevailing interest rates and rate change expectations, and any losses or gains on rebalancing the Portfolio. As a result of the decreased distribution rate, the Trust’s net income can now cover approximately 93% of the distributions paid out to the unitholders (compared to 78% based on the original distribution rate). The rating of the Units is being upgraded to STA-2 (low) primarily due to the increased distribution coverage ratio, as well as the continued strength in the credit quality and diversification of the Trust’s Portfolio.

According to the DBRS Methodology:

A stability rating provides an opinion on both the stability and sustainability of a structured income fund’s cash distributions per unit. In other words, the rating reflects the fund’s ability to generate sufficient cash to pay out a stable level of distributions on a per unit basis over the longer term.
…
STA-2 Very good stability and sustainability of distributions per unit
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Closed-end funds typically offer unitholders a stated distribution on the unit issue price, which is a crucial component in the marketing of the prospective offering. The stated distribution can typically be changed by the fund manager during the life of the fund for any reason without the approval of unitholders. As a result, analysis of the stability of the stated distribution is a key consideration for potential investors who want to know the likelihood of the manager being able to maintain the distribution over the long term. DBRS provides an independent opinion on the long-term stability of the distribution.

Open-end funds and ETFs normally do not have a stated distribution; net income is paid to investors each payment period. In such cases, a DBRS rating evaluates the general stability of the income paid out by the fund. Regardless of whether a distribution is stated, the same concept of stability is applicable. At any point in time, investors in the fund will want to know the likelihood that the fund’s assets will continue to generate income at historical or greater levels over the long term.
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Preferred shares carry a number of features (aside from the credit quality of the company) that affect the stability of the distribution, including retraction ability and the ability of the company to call the shares for redemption, among others. These factors are considered by DBRS in its rating analysis. For example, the ability of a company to redeem a higher-yielding preferred share before the termination date of the fund will be a risk in a low interest rate environment. If a significant portion of the portfolio is exposed to similar risk, it may have a negative impact on the DBRS stability rating assigned to the fund.

DPS.UN reports:

Current monthly distribution of $0.2500 per unit

but a quick check of the recent distributions reveals that it’s actually $0.25 quarterly, or $1.00 p.a. on a NAV of 21.075, or 4.74%. MAPF only manages 4.624% and that’s with a decidedly non-index-like portfolio. DBRS notes that [DPS.UN] Trust’s net income can now cover approximately 93% of the distributions paid out to the unitholders so one may assume that the yield, defined as the Trust’s net income, is 4.41%.

Given a very brief review of the June 30 portfolio highlights, I find it very hard to believe that the yield, defined as the weighted-average YTW of the portfolio, is anywhere close to 4.41%. This suggests a review in PrefLetter …

DBRS also updated its report on Innergex, proud issuer of INE.PR.A:

DBRS has today updated the report for Innergex Renewable Energy Inc. (Innergex or the Company), in relation to the rating action on August 9, 2012, when the trends on Innergex’s ratings were changed to Negative from Stable. Going forward, this is an unsolicited rating based on public information.

The trend change reflected a continuing decline in Innergex’s financial risk profile, driven by three main factors: (1) continued growth has put pressure on the balance sheet, due to increasing amounts of capital expenditure; (2) high dividend payouts are expected to continue decreasing Innergex’s equity base, limiting its ability to assume higher debt levels at the holding company level to support its growth strategy; and (3) growth has gradually caused increases in the usage and size of the corporate revolving credit facility, increasing leverage at the holding company level.

Considering Innergex’s business risk profile and the structural protections of non-recourse, project-financing strategy, DBRS views deconsolidated leverage (i.e., debt at the holding company level) of approximately 30% and consolidated leverage of 60% appropriate for maintaining an investment-grade rating. The Company needs to manage its debt-to-capital ratio on both a consolidated and deconsolidated basis in a way that provides the financial flexibility required for growth and consistent execution of project-level borrowing. A lack of material improvement in leverage (both on a consolidated and non-consolidated basis) could warrant a downgrade to the ratings in the near future.

It was a modestly good day for the Canadian preferred share market, with PerpetualPremiums winning 10bp, FixedResets up 6bp and DeemedRetractibles gaining 2bp. Volatility was negligible. Volume was low.

Looks like it will be the Americans getting all the Asian LNG business:

A massive new proposal to export natural gas from Alaska brings a major competitor into the race to carry North American gas to Asia, and adds pressure on Canadian export projects to build quickly or risk losing out.

The Alaska Southcentral LNG project would include construction of a 1,300-kilometre pipeline from Alaskan North Slope gas fields to southern waters, near Valdez or Anchorage, where a new terminal would load liquefied natural gas on to tankers.

Canadian productivity, Canadian schmoductivity. We’ll sell our gas to the US at a discount so they can sell theirs at a premium. Just like oil.

Another flattish day for the Canadian preferred share market, with PerpetualPremiums off 1bp, FixedResets gaining 2bp and DeemedRetractibles up 1bp. Volatility was muted. Volume was low.

These are great times for American mortgage borrowers, as long as they have jobs and aren’t underwater:

Mortgage prepayment rates have soared to the highest in seven years as homeowners take advantage of the lowest borrowing costs on record to refinance.

Home loans were repaid in August at a pace that would erase 25 percent of the debt in a year, according to Lender Processing Services Inc. (LPS), a Jacksonville, Florida-based data provider that tracks 40 million mortgages.

The cost of 30-year loans dropped to 3.4 percent last week, helping push refinancing applications to a three-year high, after the Federal Reserve said it will buy $40 billion of mortgage securities per month to stimulate the economy. That followed government efforts to increase refinancing with new rules designed to expand eligibility and reduce costs.

If the feds insist on coddling an expensive flag-carrier, Canadians know what to do:

The Conference Board of Canada report says about five million Canadians now cross the U.S. border by land every year to fly out of American airports.

It says higher airfares and fees and taxes in Canada, as well as differences in wages, aircraft prices and industry productivity makes it 30 per cent cheaper to fly out of the U.S.

We want unilateral open-skies, now!

It was a dull day for the Canadian preferred share market, with PerpetualPremiums up 2bp, FixedResets gaining 1bp and DeemedRetractibles down 4bp. Volatility was average. Volume was average.

PerpetualDiscounts (all four of them! from both issuers!) now yield 4.87%, equivalent to 6.33% interest at the standard conversion factor of 1.3x. Long Corporates now yield 4.2% (!) so the pre-tax interest equivalent spread is now about 215bp, unchanged from the September 26 report.

Just when you thought smart-phone malware had reached a limit…:

As smartphones become more pervasive, they are increasingly targeted by malware. At the same time, each new generation of smartphone features increasingly powerful onboard sensor suites. A new strain of `sensor malware’ has been developing that leverages these sensors to steal information from the physical environment | e.g., researchers have recently demonstrated how malware can `listen’ for spoken credit card numbers through the microphone, or `feel’ keystroke vibrations using the accelerometer. Yet the possibilities of what malware can `see’ through a camera have been understudied.

This paper introduces a novel `visual malware’ called PlaceRaider, which allows remote attackers to engage in remote reconnaissance and what we call virtual theft.” Through completely opportunistic use of the phone’s camera and other sensors, PlaceRaider constructs rich, three dimensional models of indoor environments. Remote burglars can thus `download’ the physical space, study the environment carefully, and steal virtual objects from the environment (such as financial documents, information on computer monitors, and personally identifiable information). Through two human subject studies we demonstrate the effectiveness of using mobile devices as powerful surveillance and virtual theft platforms, and we suggest several possible defenses against visual malware.

This is the source of all concern about high frequency trading:

Wall Street banks’ equities-trading units aren’t getting much relief from the strongest stock rally since 2009, as sinking volume and already thin margins threaten to make their annual performance the worst in six years.

Third-quarter equities-trading revenue probably fell 14 percent from the same period in 2011, the fifth straight drop of more than 8 percent, according to estimates by Kian Abouhossein, a JPMorgan Chase & Co. (JPM) analyst. Full-year revenue at the five largest U.S. investment banks may be the lowest since 2006, UBS (UBSN) AG’s Brennan Hawken wrote in a Sept. 19 note to clients.

Equities trading, which generated $40 billion for the nine largest global investment banks last year, has been an attractive business because capital requirements aren’t as strict as those threatening fixed-income returns. Lower volumes have damped that optimism as investors remain skeptical about the global economy, which may lead to job cuts.
…
Banks’ revenue also is reduced by the continued move to electronic trading, which accounts for as much as 70 percent of transactions on the Nasdaq Stock Market and generates lower margins than voice orders. Institutions pay an average of 2.05 cents per share for orders that require handling compared with 1.08 cents for those entered through algorithms, according to Tabb Group LLC.

It sounds like an oxymoron, but there’s excitment in the indexing world:

MSCI Inc. (MSCI) fell the most on record after being dropped as benchmark provider for 22 index funds by Vanguard Group Inc., the largest U.S. mutual-fund company.

MSCI declined 27 percent to close at $26.21 in New York, the most since it went public in November of 2007, after Vanguard said funds with about $537 billion in assets will replace New York-based MSCI to cut costs for fund shareholders.

Vanguard will adopt benchmarks from FTSE Group for six international stock index funds, and benchmarks developed by the University of Chicago’s Center for Research in Security Prices for 16 U.S. equity and balanced funds. The defection puts pressure on MSCI to lower the licensing fees it charges to BlackRock’s IShares unit, the biggest ETF provider, according to David Nadig, director of research at San Francisco-based ETF research firm IndexUniverse LLC.
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Separately, MSCI disclosed in a regulatory filing today that it received a so-called “Wells Notice” from the U.S. Securities and Exchange Commission, informing the company it will recommend public administrative proceedings for violations of the Investment Advisers Act. A Wells Notice typically gives recipients a chance to dissuade investigators from recommending the agency authorize enforcement action.

The company said in March that an employee had provided information about clients’ proxy voting to a proxy solicitor in violation of its policies, according to the filing.
…
BlackRock uses MSCI indexes to guide 197 ETFs with $162 billion in assets, Melissa Garville, a spokeswoman, said in an e-mail.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 3bp, FixedResets down 8bp and DeemedRetractibles up 2bp. Volatility was muted. Volume was low.

Here’s a good example of why government agencies should not regulate Credit Rating Agencies:

Now, incredibly, Egan-Jones is the sole rater that the SEC has decided to attack. The trouble for the firm started on July 16, 2011, when Egan-Jones downgraded the U.S.’s sovereign debt by one notch, to AA+ from AAA. Egan-Jones cited “the relatively high level of debt and the difficulty in significantly cutting spending.” Two days later, the SEC’s Office of Compliance Inspections and Examinations contacted the firm seeking information about its rating decision. (The next month, S&P also downgraded the U.S.’s sovereign debt, but neither Moody’s nor Fitch did.)

Then, on Oct. 12, Egan-Jones received a call from the SEC notifying the firm of a Wells Notice, an indication that it was being investigated. On April 5 of this year, Egan-Jones again downgraded the U.S. sovereign debt, to AA from AA+. On April 19, leaks started emanating from the SEC that it had voted to start an “administrative law proceeding” against the firm. And on April 24, the SEC filed its complaint.

Just what does the SEC object to so vehemently about Egan- Jones? The commission claims that on its 2008 supplemental application to be a “nationally recognized” ratings firm, Egan- Jones “falsely stated” that it had already rated the credit of 150 asset-backed securities and of 50 sovereign-debt issues. The SEC claims Egan-Jones “willfully made these misstatements and omissions to conceal the fact that it had no experience issuing ratings on ABS or government issuers.” The SEC intends to fine Egan-Jones and to possibly censure Sean Egan — neither move would be good for business.
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His lawyer, Alan S. Futerfas, told the Wall Street Journal that the SEC knows that Egan did rate the securities in question but it is “saying he didn’t disseminate it publicly.” Futerfas continued: “It’s a very technical argument the SEC is using; it’s not substantive. There’s nothing in this complaint that suggests or alleges that any rating was without integrity or was not accurate or was not predictive.”

If he is right, that raises a question: Is the SEC retaliating against Egan and his firm for downgrading the U.S. sovereign debt?

Regulation of CRAs inevitably leads to a very tiresome discussion of conspiracy theories. There are certainly problems with “Issuer pays”; “Issuer regulates” is worse.

Is QE3 inflationary? Who cares?

Investors initially increased their inflation expectations on the Fed’s plan. The gap between yields on 10-year notes and same-maturity Treasury Inflation-Protected Securities, or TIPS, widened to 2.73 percentage points on Sept. 17, the highest level since May 2006. The so-called break-even rate, which measures how much traders anticipate consumer prices will rise over the life of the debt, narrowed last week to 2.42 percentage points.

In a startling new development, the SEC has hired somebody with a clue:

The U.S. Securities and Exchange Commission, stung by criticism that it lacks the knowledge to analyze the computerized trading that has come to dominate American stock markets, is planning to catch up.

Initiatives to increase the breadth of data received from exchanges and to record orders from origination to execution are at the center of the effort. Gregg Berman, who holds a doctorate in physics from Princeton University, will head the commission’s planned office of analytics and research.
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Berman, who studied experimental and nuclear physics, developed trading strategies in commodities and stocks at a hedge fund and became a founding member of RiskMetrics Group Inc. in 1998 when JPMorgan Chase & Co. spun off the company. He writes programming code and did some of the flash-crash modeling when the SEC examined how trade requests were withdrawn from exchange order books that day.

The analytics and research office plans to hire traders from banks and hedge funds as well as financial engineers and individuals with quantitative and analytical skills. It’s looking for programmers in the C++ computer language and “UNIX gurus who really know how to get under the hood and in former lives may have written trading programs and now are going to write analytical programs,” Berman said.

Traditionalists will be relieved to learn that the new Office of Analytics and Research comes under the Division of Trading and Markets, which is headed by a lawyer.

He also served as counsel to Chairman Schapiro on issues involving the Division of Trading and Markets, including the agency’s analysis and response to the Flash Crash on May 6, 2010, and numerous other market structure and Dodd-Frank related rulemakings, studies, and programs.

Readers will remember that the agency’s response to the Flash Crash was a highly politicized put-up job.

Moody’s believes that the Spanish stress test was insufficiently conservative:

Spain’s banks face a capital shortfall that could climb to 105 billion euros ($135 billion), almost double the estimate the government provided last week, according to Moody’s Investors Service.

The nation’s lenders may need infusions of 70 billion euros to 105 billion euros to absorb losses and still keep capital ratios above thresholds outlined in legislation last year, Moody’s analysts wrote yesterday in a report. That compares with the 53.7 billion euro shortfall found last week after officials commissioned a stress test designed to lift doubts about the financial industry’s ability to withstand losses.

“The recapitalization amounts published by Spain are below what we estimate are needed for Spanish banks to maintain stability in our adverse and highly adverse scenarios,” the analysts, Maria Jose Mori and Alberto Postigo, said in the report. “If market participants are skeptical about the stress test, negative sentiment could undercut the government’s efforts to fully restore confidence in the solvency of Spanish banks.”
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While many assumptions in the stress test were conservative, some may be questioned, Moody’s said. The test used a 6 percent core capital ratio under a stressed scenario, while the ratings firm assumed capital ratios of 8 percent to 10 percent, according to the report. The rate used by Ireland for its test, including a buffer, was 9 percent.

What makes this interesting is that it continues to reflect one of the big problems of the Credit Crunch: bank capital is supposed to ensure that unexpected losses will bankrupt the company only once in 1,000 years (insert jokes about recent experience here).

The confidence level is fixed at 99.9%, i.e. an institution is expected to suffer losses that exceed its level of tier 1 and tier 2 capital on average once in a thousand years. This confidence level might seem rather high. However, Tier 2 does not have the loss absorbing capacity of Tier 1. The high confidence level was also chosen to protect against estimation errors, that might inevitably occur from banks’ internal PD, LGD and EAD estimation, as well as other model uncertainties.

But! In demanding that the banks maintain capital above the regulatory minimum even after experiencing these 1,000-year losses, we are demanding that they remain solvent even after experiencing 1,000 year losses in successive years (which is probably not a million-year two-year-loss; it will depend on the correlation between successive years). I don’t think anybody knows how to deal with this. The concept of a buffer is helpful, but it remains to be seen what will happen to a bank in times of great stress when it has used up its buffer.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums down 4bp, FixedResets gaining 2bp and DeemedRetractibles up 11bp. There weren’t many volatile issues, but they made up in energy what they lacked in numbers. Volume was low.