PrefBlog

There’s renewed grumbling about currency manipulation:

The new idea in trade negotiations is an old idea: punish currency manipulation.

Avery Shenfeld, chief economist at CIBC World Markets, said Thursday in a new commentary that currency policy should be included in any new free-trade agreements.

“Free trade, but free currencies as well,” Mr. Shenfeld wrote. “Trade may be liberalized, but are the exchange rates that set relative prices and costs also going to have their shackles removed? If not, the free market will be anything but free.”
…
Mr. Shenfeld says that since 2007, international investors have purchased Canadian-dollar bonds worth $280-billion, compared with $65-billion over the previous five years.

That demand is partly explained by a healthy appetite for AAA-rated securities. But international investors also are buying Canada because they are being pushed out of other markets by interventionist central banks. Canada’s dollar is among the most overvalued in the world, Mr. Shenfeld said, citing calculations by the International Monetary Fund.

I can’t agree that great excitement is required over currency manipulation. Just as security price manipulation gives rise to exploitable opportunities for fundamental investors, so does currency manipulation allow consumers and cross-border purchasers to make a killing. If the Chinese want to sell me $1.00 worth of goods for $0.50, I say ‘Fine! Back up the truck!’

On a related note, Spend-Every-Penny has realized it’s good to lock in low yields for longer terms:

The Honourable Jim Flaherty, Minister of Finance, today highlighted adjustments to the debt strategy plan for 2012–13. These adjustments include the temporary reallocation of short-term bond issuance towards long-term bonds.

Since the release of the 2012–13 Debt Management Strategy, published as part of Budget 2012, long-term interest rates have continued to fall and remain near historically low levels.

“Given this environment, it is both advantageous and prudent for our Government to lock in additional long-term funding,” said the Minister. “These adjustments help us meet our goal of raising stable and low-cost funding to meet the financial needs of our Government to best serve taxpayers.”

Further details are provided in the Notice accompanying the Quarterly Bond Schedule on the Bank of Canada website.

The Bank of Canada highlights:

As an extension of the plan outlined in the Debt Management Strategy for 2012-13 to lock in funding at attractive rates, the Government plans to reallocate short-term bond issuance toward long-term bonds. Consequently, for the remainder of 2012-13, the following changes are planned:

Bond Auctions
•10-year bonds – one additional auction will be held in the last quarter of 2012-13;
•30-year nominal bonds – one additional auction will be held, resulting in a total of four auctions in 2012-13; and
•The size of 10-year and 30-year nominal bond auctions may be increased, subject to market conditions.

Regular Bond Buyback Program
•30-year bond buyback operations on a cash basis – operations will be halted for the remainder of 2012-13; and
•30-year bond buyback operations on a switch basis – one additional operation will be conducted in the last quarter of 2012-13.

In all other respects, the implementation of the medium-term debt strategy, announced in Budget 2011, will continue. The adjustments to the debt strategy outlined above will be monitored and, if necessary, modified to ensure that the market for Government of Canada securities continues to function well.

The problem with the Bank of Canada’s debt management process is that the planning horizon is only ten years. This reduces the advantage of issuing long bonds relative to a more rational thirty-year planning horizon.

It looks like there’s a little bit of profit-taking in the junk bond market:

Speculative-grade bonds in the U.S. are poised for their biggest weekly loss since May as buyers withdraw money from domestic funds that buy the debt for the first time in more than three months.

The securities lost 0.6 percent this week through yesterday after gains in the five previous periods, Bank of America Merrill Lynch index data show. Funds that buy the notes reported $5 million of outflows, with investors pulling $65 million from exchange-traded funds, according to a Sept. 27 Bank of America Corp. (BAC) report.

Yields on speculative-grade bonds closed at 7.125 percent yesterday, up from a record low 6.948 percent reached on Sept. 19 as an unexpected drop in demand for U.S. durable goods other than transportation signaled a slowdown in business investment and exports. Investors sold the debt as concern mounted that the European Central Bank’s current bailout funds would be insufficient to prevent a sovereign default.

“There was legitimate selling for the first time,” said Timothy Gramatovich, chief investment officer at Peritus Asset Management LLC. “This is the first week in recent memory that we actually saw bonds offered out there.”

Investors yanked 3.9 million shares, worth about $157 million, from State Street Corp.’s ETF that buys junk bonds on Sept. 27, the biggest outflow since May 21, according to data compiled by Bloomberg. U.S. high-yield bond funds reported net withdrawals of $310 million, the first decline after 13 consecutive weeks of inflows, according to Lipper.

The regulatory pretense of concern over LIBOR has had its intended effect:

Oversight of Libor will be handed to the U.K.’s financial regulator, and dozens of the currencies and maturities that make up the benchmark axed, under proposals designed to revive confidence in a rate tarnished by scandal.

The British Bankers’ Association should be stripped of the responsibility for managing the rate and other organizations invited to replace it, Financial Services Authority Managing Director Martin Wheatley said in London today. More than 100 Libor rates tied to currencies and maturities where there isn’t enough trading data to set them properly should be scrapped, and a code of conduct introduced for how lenders contribute to the benchmark backed by criminal penalties, he added

“Governance of Libor has completely failed,” Wheatley said as he unveiled a report on the future of Libor. “This problem has been exacerbated by a lack of regulation and a comprehensive mechanism to punish those who manipulate the system.”
…
The FSA should receive greater powers to vet bankers who contribute to the rate, according to Wheatley, who will become the chief executive officer of the Financial Conduct Authority, when the FSA splits into two agencies next year.
…
The “first priority” of Libor’s new administrator will be to create a code of conduct for rate submitters with specific guidelines that the submissions be corroborated by trade data, he said.

“Transactions will need to be recorded and there needs to be a requirement for regular external audit of submitting firms,” Wheatley said.

The Bank of Canada has released a completely unconvincing discussion paper by David Xiao Chen, H. Evren Damar, Hani Soubra and Yaz Terajima titled Canadian Bank Balance-Sheet Management: Breakdown by Types of Canadian Financial Institutions. My hackles rose as early as the third paragraph:

Our main findings regarding the first objective are summarized as follows. First, risk indicators have decreased during the past three decades for most non‐Big Six financial institutions, and have remained relatively unchanged for the Big Six banks. As a result, a divergence between non‐Big Six and the Big Six banks is observed, especially in leverage and capital ratios. Second, heterogeneity among non‐Big Six financial institutions has increased, especially in capital and funding ratios. The observed overall decline and increased heterogeneity in the risk indicators follow certain regulatory changes, such as the introduction of liquidity guidelines on funding in 1995 and the implementation of bank‐specific leverage requirements in 2000. This suggests that regulatory changes have had significant and heterogeneous effects on the management of balance sheets by financial institutions and, given that these regulations required more balance‐sheet risk management, they contributed to the increased resilience of the banking sector.

Excuse me? Isn’t that last line a bit of circular reasoning? Regulating funding and leverage certainly had an effect on funding and leverage. Whether this has any connection with “resilience” is another matter entirely, one that is not addressed in the paper.

The mystery is resolved in the concluding statements:

The resilience of the Canadian financial system could be attributed to the conservatism and prudent approach of its regulatory bodies. Over the past couple of decades, Canadian banks were resilient to several financial stresses that, for the most part, originated outside Canada’s borders. More
recently, at the onset of the 2007 financial crisis, while many international foreign banks faced difficulties and required public capital injections and debt guarantees, the Canadian financial system did not require any public assistance or experience any bank failures. It has been argued that this was due in large part to the tighter regulatory ratios set by the Office of the Superintendent of Financial Institutions (OSFI), which exceeded international minimums. Potentially more important is OSFI’s regulatory approach based on individual financial institutions. A part of the observed heterogeneity in balance‐sheet ratios among Canadian banks is likely attributable to this.

OK, so the purpose of the paper was to evangelize OSFI-worship. Next!

The Canadian preferred share market closed the month and quarter with a good day: Perpetual premiums won 18bp, FixedResets gained 7bp and DeemedRetractibles were up 2bp. Volatility was average. Volume was average.

U.S. Securities and Exchange Commission member Daniel Gallagher is favourably disposed towards a floating NAV for money-market funds:

Requiring money funds to have a fluctuating share price “is an attractive option that I am likely to support,” Gallagher, a Republican, said in an interview.
…
Gallagher said he couldn’t vote for Schapiro’s plan because its centerpiece was to make the funds hold extra capital. The cushion was too small to protect investors, Gallagher said, leading him to believe the money would be used as collateral in case the funds needed to borrow from the Federal Reserve.
…
Schapiro has argued that the funds’ $1 share price encourages investors to flee at the first sign of trouble. That’s because those who react quickly can sell their shares at $1 each even if the net asset value has dropped below that level.

The industry has maintained that a floating share price would make money funds unworkable for many investors by saddling them with new accounting and tax obligations. In addition, insurers, municipalities and other large users of money funds are often legally bound to invest assets they account for as cash in funds with a stable share price.

Schapiro gave up on her plan on Aug. 22 after three of the five commissioners — Republicans Gallagher and Troy Paredes, joined by Democrat Luis Aguilar — told her they wouldn’t vote to issue it for public comment. Her proposal spelled out two options, the capital cushion coupled with some restrictions on redemptions, or the floating share price.
…
On Aug. 28, Gallagher and Paredes said they supported an alternative that would allow firms running money funds to prohibit withdrawals to stop investor flight in the event of a run. They backed Aguilar’s call for further study on whether new rules could cause investors to move money from money-market funds to other unregulated investments.

In the interview, Gallagher said his support of a floating share price was contingent on the SEC “fully understanding and addressing” the tax and accounting issues that could arise with the change. Gallagher said a fluctuating share price may need to be coupled with other protections, such as the freezing redemptions option that he and Paredes had suggested.

If anybody knows what the ‘capital used as collateral’ idea is all about, please let me know, because I haven’t the faintest notion regarding what is being implied. I think the redemption freeze idea is just plain stupid.

I am advised of a government checklist for choosing investment advisors:

Does your financial professional try to “time” the market?
•Financial professionals cannot forecast market changes successfully on a consistent basis. For most people, changing strategies or buying and selling investments frequently will just result in higher costs and more losses. The right financial strategy should do well without frequent changes, in good markets and bad.

Now, I’m not much of a fan of market timing, but nevertheless this seems a bit overreaching to me. We have a government agency pronouncing officially on the relative merits of investment strategies? It’s actually a little scary!

Good fiscal news federally, not so much provincially:

Ottawa’s cost-cutting measures have put it on a sound fiscal track for the future, but the provinces are left holding the bag, says Canada’s budget watchdog.
…
Mr. Page also judges the Canada Pension Plan and Quebec Pension Plan fiscally sound.

But the report, released Thursday, shows provinces and municipalities adding so much debt over the next 70 years or so they would resemble Greece and Italy if something is not done.

The report calculates that provinces and their municipalities have a fiscal gap of about 2 per cent of gross domestic product now – or $36-billion – and by 2086 will have debt worth 350 per cent of GDP. Meanwhile, Ottawa will be in a structural surplus.
…
While he has been critical of the Harper government in the past for failing to acknowledge it was in a structural deficit several years ago – for which he took personal blow-back – Mr. Page said Ottawa has acted to rectify the situation.

In the past two years, Finance Minister Jim Flaherty put a limit to growth on health transfers to provinces, essentially froze program spending for five years, and raised the age of eligibility for benefits under Old Age Security to 67 from 65.

The change in health transfers alone is responsible for about three-quarters of the provincial fiscal gap, Mr. Page says, or about $25-billion in fiscal room.

It was a good day for the Canadian preferred share market, with PerpetualPremiums gaining 4bp, FixedResets winning 19bp and DeemedRetractibles up 12bp. Volatility was muted. Volume was average.

I’m all in favour of a cap on leverage at banks … but a leverage cap of 12.5:1 seems quite extreme:

Banks should be required to reduce by half the amount they can borrow against equity to make the financial system safer, according to former Federal Deposit Insurance Corp. Chairman Sheila Bair.

Bair called for a “hard-and-fast” leverage ratio of 8 percent in “Bulls by the Horns,” her memoir of the financial crisis published this month. That’s double the 4 percent ratio U.S. banks must adhere to currently and more than twice the 3 percent called for by new global rules on bank capital.

Lenders could borrow about 13 times their equity, based on Bair’s suggestion, compared with 25 times under existing U.S. rules. Bair, 58, who stepped down from the FDIC last year, was a proponent of the Basel Committee on Banking Supervision introducing a simple leverage ratio, which ignores the riskiness of different loans in setting minimum capital requirements. While the Basel committee agreed on including such a ratio, European countries have balked at implementation.
…
The Basel committee narrowed the definition of what counts as capital. It also devised a method of tallying assets for calculating leverage ratio that puts aside the different accounting standards used in the U.S. and Europe. The new method would increase the balance sheets of U.S. banks because of differences in how derivatives are treated.

Using Basel’s narrower capital definition, the two largest U.S. banks would have to raise about $100 billion of capital to comply with Bair’s leverage recommendation. JPMorgan Chase & Co. (JPM) would have a leverage ratio of 5.8 percent under the new capital definition, and No. 2 Bank of America Corp.’s would be 5.9 percent. Neither bank has yet reported what their ratios would be under the new Basel method of calculating assets.

At some point, we’re going to be so safe that nothing happens. An unchanging world of tick-boxes … the regulators’ dream.

The CDHowe Institute has issued a plea for more RRBs – More RRBs, Please! Why Ottawa Should Issue More Inflation-Indexed Bonds:

This Commentary explores the potential impact of a larger RRB issue over the next five years than Ottawa currently plans. Rather than the $2.4 billion annually now planned, we suggest $7.2 billion annually. We further recommend that two-thirds of the larger RRB issue have 10-year maturities rather than the 30-year maturities exclusively issued to date. A plausible estimate of the net interest savings on federal debt comes to $200 million in 2016/17 and $500 million over the period until then. We canvass a number of ways the federal government can ensure that this higher RRB issue does not hurt the depth and liquidity of the market for its nominal debt.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums up 18bp, FixedResets down 5bp and DeemedRetractibles gaining 1bp. Volatility was average. Volume was low.

PerpetualDiscounts (all three of them!) now yield 4.91%, equivalent to 6.38% interest. Long corporates now yield about 4.25% so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 215bp, a sharp increase from the 200bp reported September 19.

Charles Plosser of the Philiadelphia Fed outlined his opposition to QE3, including one very good point:

Continued expansion of the Fed’s balance sheet has other costs as well. By greatly expanding the size of the Fed’s balance sheet, the new asset-purchase program will exacerbate the challenges that the Fed will face when it comes time to exit this period of extraordinary accommodation, risking higher inflation and harm to the Fed’s reputation and credibility. I have been a student of monetary theory and policy for over 30 years. One constant is that central banks tend to find it easier to lower interest rates than to raise them. Moreover, identifying turning points is difficult even in the best of times, so timing the change in the direction of policy is always a challenge. But this time, exit will be even more complicated and risky. With such a large balance sheet, our transition from very accommodative policies to less accommodative policies will involve using tools we have not used before, such as the interest rate on reserves, term deposits, and asset sales. Once the recovery takes off, long rates will begin to rise and banks will begin lending the large volume of excess reserves sitting in their accounts at the Fed. This loan growth can be quite rapid, as was true after the banking crisis in the 1930s, and there is some risk that the Fed will need to withdraw accommodation very aggressively in order to contain inflation. At this point, it is impossible to know whether such asset sales will be disruptive to the market. A rapid tightening of monetary policy may also entail political risks for the Fed. We would likely be selling the longer maturity assets in our portfolio at a loss, meaning that we may be unable to make any remittances to the U.S. Treasury for some years. Yet, if we don’t tighten quickly enough, we could find ourselves far behind the curve in restraining inflation.

The SEC has hardened its stance that investing has nothing to do with fundamentals:

A New York-based brokerage allowed overseas clients to run a scheme aimed at distorting stock prices by rapidly canceling orders, according to the U.S. Securities and Exchange Commission.

Clients of Hold Brothers On-Line Investment Services were “repeatedly manipulating publicly traded stocks” by placing and erasing orders in an illegal strategy designed to trick others into buying or selling, the SEC said today in a release. Hold Brothers, its owners, and the foreign firms Trade Alpha Corporate Ltd. and Demonstrate LLC agreed to settle allegations that the New York broker failed to supervise customers and pay $4 million in total SEC fines.

The SEC complaint targeted practices that abused high-speed computer trading on American equity venues. As high-frequency activity has grown in recent years, the agency’s efforts to stop fraudulent practices such as “layering” or “spoofing” have extended to the automated trading tactics.
…
“The fairness principle that underlies the foundation of our markets demands that prices of securities accurately reflect a genuine supply of and demand for those securities,” Daniel M. Hawke, the chief of the SEC’s enforcement division’s market abuse unit, said in the statement. “The SEC will not tolerate any abusive practice that is designed to distort these natural forces.”

Bluffing is part of the trading game. A fundamental investor can often take advantage of the little boys’ games. But logic has no relevance to regulation.

The Kansas City Fed has a good review of deposit insurance:

The effect on the financial system of this emergency assistance and related risk-taking incentives is difficult to assess and measure. However, a unique circumstance in the 1930s provides an insight into how a piece of the federal safety net—federal deposit insurance—has altered the financial landscape. The vast majority of U.S. banks quickly became insured after the Federal Deposit Insurance Corporation (FDIC) began offering deposit insurance in 1934. Many state-chartered banks in Kansas, however, chose to remain uninsured. Why
did these Kansas banks think they could operate successfully without deposit insurance following the worst banking crisis in U.S. history?
Also, how did these banks differ from the banks that quickly adopted deposit insurance, and what might these differences tell us about
deposit insurance?

Another forthcoming article asks have cheques met their match?:

During the last decade, both demand-side and supply-side factors have contributed to a surge in new methods of making person-to-person (P2P) payments. On the demand side, the driving factors have been the emergence of new forums for commerce such as online auctions and the increasing desire by consumers to monitor and control payments. On the supply side, the main factors have been technological advancements such as faster Internet speeds, increased computing power and smartphones. Despite the surge in new P2P payment methods, studies show that consumers in the United States still prefer to make payments to other people with checks and cash. In fact, P2P payments by check are the only type of check payment that is still increasing. If consumers could be induced to use a digital alternative to P2P payments by cash and check, the efficiency and safety of the U.S. payments system might be enhanced.

It was a moderately good day for the Canadian preferred share market, with PerpetualPremiums winning 13bp, FixedResets gaining 4bp and DeemedRetractibles up 6bp. Volatility was minimal. Volume returned to low levels.

US regulators are in disarray regarding the MetLife / GE Capital deal. It’s too complex to summarize, so you’ll have to read the whole article.

Financial Repression is alive and well … there may be many forced buyers of sovereigns:

Under Dodd-Frank, as well as under Europe’s new Market Infrastructure Regulation (EMIR), asset management firms must abide but the same central clearing rules as the banks. For that reason, they will need a hefty amount of both cash and AAA-rated sovereign bonds to pledge as collateral. The problem, though, is that many of them aren’t ready for the new rules to be implemented in just a few months.

As the FT noted, a recent report from Moody’s projected that the collateral shortfall could fall between $700-billion (U.S.) and $1.2-trillion. Those figures are based on projections from places like the Chicago Mercantile Exchange, which is heavily engaged in swap clearing and estimates that its margins for interest rate swaps will be about 3 to 4 per cent for 10-year U.S. interest rate swaps and 9 to 10 per cent for a 30-year swap, according to Moody’s.

The fear is that once asset managers realize how big their collateral shortfall is, they’ll race out to buy things like Treasury bonds, which will push their yields even lower. Moody’s also worries that asset managers may put these bonds into segregated custodian accounts that prevent them from being re-used, effectively removing them from the market.

The Financial Times article is here; the Moody’s report is for subscribers only:

New over-the-counter (OTC) derivatives regulations will likely cause a surge in demand for liquid, high-quality government securities that are eligible as collateral to meet these requirements, says Moody’s Investors Service in a new Special Comment published today.

Increased collateral requirements for derivatives transactions will result in a sounder credit environment for the market as a whole; however, Moody’s says that lower yields on government securities resulting from their increased demand from regulatory requirements may lead to a shift in bond and money market fund allocations into riskier, lower credit-quality investments to seek higher yields.

The new report, entitled “Managed Funds: New OTC Regulations Will Boost Demand for Eligible Collateral” is now available on www.moodys.com. Moody’s subscribers can access this report via the link provided at the end of this press release.

Moody’s says that the regulations require central clearing for standardised derivatives and global standards on margins for uncleared trades. As the new regulations come into effect by the end of 2012, the demand for government securities will increase and exert downwards pressure on yields, which will lower returns for the funds that are mandated to invest in these securities.

Moody believes that the new regulations will exacerbate conditions that are already exerting pressure on yields, such as (i) government benchmark yields have fallen, some to negative territory, with a flight to quality; (ii) the supply of higher-rated investment-grade corporate, supranational and agency bonds remains limited; and (iii) the use of higher credit-quality corporate and agency bonds as eligible collateral is beginning to be seen in the market, although the level of usage remains low.

Canaccord, proud issuer of CF.PR.A and CF.PR.C is experiencing some difficulty:

Canaccord, one of Canada’s biggest independent securities dealers, is closing 16 branches and keeping 16. Canaccord is also cutting loose 35 advisory teams in the offices that remain. Toronto-based Canaccord lost about $6.5-million in the most recent quarter handling accounts for individuals, but will now “operate in a near break-even basis in current market conditions,” the firm said.

Canaccord was put on Trend-Negative by DBRS last December:

Benefiting from revenue and expense synergies associated with larger and more diversified operating platforms, the Company is well-positioned to grow its revenues and earnings substantially when the global capital markets stabilize. In the meantime, the more stable wealth management and advisory revenues of Collins Stewart add favourable diversification to the Company’s overall business risk profile, which otherwise remains concentrated in the small and mid-cap Canadian equity markets. While the Pfd-3 (low) rating with a Stable trend assigned to the Canaccord preferred shares in June 2011 took into account anticipated volatility associated with broker-dealers, this material acquisition in the current uncertain economic and market environment introduces an additional degree of risk that cannot be ignored. The ambiguity regarding longer-term take-out financing was also a consideration in assigning a Negative trend at this time.

AltaGas, proud issuer of ALA.PR.A, was confirmed at Pfd-3 by DBRS:

DBRS has today confirmed the rating on the Medium-Term Notes (MTNs) and the Issuer Rating of AltaGas Ltd. (AltaGas or the Company) at BBB and on the Preferred Shares – Cumulative at Pfd-3, all with Stable trends. The confirmation reflects: (1) continuing progress on the Company’s goal to grow and diversify earnings and cash flow while reducing its business risk; (2) mitigation of cost overrun risks on its major growth projects and (3) a reasonable financing plan for the 2011 to 2014 growth phase, supported by strong liquidity.

On August 30, 2012, AltaGas acquired SEMCO Holding Corporation (SEMCO), the sole shareholder of SEMCO Energy, Inc., a regulated public utility company with natural gas distribution and storage operations in Michigan and Alaska (see DBRS press release dated February 1, 2012, for details). DBRS expects the overall impact of the acquisition on AltaGas’s credit profile to be modestly positive, with improvement in AltaGas’s business risk profile through the addition of relatively low-risk, regulated natural gas distribution and storage assets in Michigan and Alaska being partly offset by a negative impact on key credit metrics.

DBRS estimates that, with the SEMCO acquisition and related financing, combined with the $144 million common share offering completed on November 15, 2011, and the December 20, 2011, Pacific Northern Gas Ltd. (PNG) acquisition, total debt-to-capital ratio would rise from 47% as at September 30, 2011, to 55% on a pro forma basis as at June 30, 2012, and its cash flow-to-debt ratio would drop from 20% to 12%.

As noted previously, DBRS expects some deterioration in the Company’s key credit metrics during its growth phase from 2011 to 2014, with recovery expected toward the end of the period as cash shortfalls are to be primarily funded by debt. DBRS expects AltaGas to manage the construction period risks (e.g., cost overruns, completion delays, large financing requirements and potential deterioration of credit metrics) for all of its projects, and the PNG and SEMCO acquisitions, within the context of its current BBB rating and total debt-to-capital ratio in the low-to-mid-50% range, with cash flow-to-debt in the high-teens to low-20% range, as calculated by DBRS. If the Company’s ratios do not move closer to the above-noted ranges (from the pro forma levels) over the near to medium term, its credit ratings could come under negative pressure.

It was a mildly positive date for the Canadian preferred share market, with PerpetualPremiums up 5bp, FixedResets winning 6bp and DeemedRetractibles gaining 3bp. Volatility was negligible. Volume was high! Yes, high! It’s been a long time since it was last possible to say that!