PrefBlog

A mention in the Globe & Mail led me to an IMF publication (Chapter 3 of of the April, 2012, World Economic Outlook) titled Dealing with Household Debt:

Does household debt amplify downturns and weaken recoveries? Based on an analysis of advanced economies over the past three decades, we find that housing busts and recessions preceded by larger run-ups in household debt tend to be more severe and protracted. These patterns are
consistent with the predictions of recent theoretical models. Based on case studies, we find that government policies can help prevent prolonged contractions in economic activity by addressing the problem of excessive household debt. In particular, bold household debt restructuring programs such as those implemented in the United States in the 1930s and in Iceland today can significantly reduce debt repayment burdens and the number of household defaults and foreclosures. Such policies can therefore help avert self-reinforcing cycles of household defaults, further house price declines, and additional contractions in output.
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Macroeconomic policies are a crucial element of forestalling excessive contractions in economic activity during episodes of household deleveraging. For example, monetary easing in economies in which mortgages typically have variable interest rates, as in the Scandinavian countries,
can quickly reduce mortgage payments and avert household defaults. Similarly, fiscal transfers to households through social safety nets can boost households’ incomes and improve their ability to service debt, as in the Scandinavian countries.

Clearly, it is better to avoid such a situation in the first place, but there is only ineffective policy in place in Canada to do so at this time. Buying a larger house (or a small house or condominium instead of renting) is a means of capital formation, which is encouraged by low interest rates. That’s what lower interest rates are supposed to do, for heaven’s sake! However, housing is non-productive capital; so much so that it can almost be considered consumption.

So the question really is: in times of economic downturns, how should policy act to promote “good” capital formation as opposed to “bad” capital formation?

I suggest that both monetary and fiscal policy are very blunt tools – too blunt to address the issue. Instead, a regulatory response is required:

• Don’t be so damn eager to raise the limits on explicitly (Canada) or implicitly (US) government guarantees of mortgage debt. Set a limit, based on historical experience and rising with nominal GDP, of the amount of such guarantees. In 2006, CMHC insurance outstanding was $291-billion. In 2010 the plan was to have total outstanding of $533-billion. Why? Why do What-debt? and Spend-Every-Penny want to create a housing bubble? I can only assume that it is because this will give them more opportunity to micro-manage the economy, with credit-rationing and rule changes by government fiat, rather than the unexciting process of raising insurance prices when a reasonable limit is approached.
• Impose a capital surcharge the banks when their loan books get distorted. Mortgages are now 40% of the balance sheets; they used to be 30% not so very long ago. Such a sudden change indicates to me a strong possibility that this is simply regulatory arbitrage (why lend to Jimmy’s Barber Shop, with a risk-weighting of 100%, when you can lend to Jimmy himself as a mortgage, with a 35% risk-weight or maybe even a government guarantee with an even lower risk-weight?). So, in this case of distortion, and in every other case of material distortion, impose a surcharge. An extra 10% risk-weight (to 45% on mortgags) on loan book elements in material excess of their historical norms is my prescription.

Three cheers for offshore wind power!

Offshore wind costs about $232 a megawatt-hour of power generated, according to data from Bloomberg New Energy Finance. That compares with about $80 for onshore wind, $62 for gas-fired plants and $77 for coal. The government supports the industry with incentives for power produced by renewable energy sources.

It’s not clear if the price figures include provisions for back-up power and demand-timing differences (the wind tends to blow at night, when demand is relatively low, can sometimes die at highly inconvenient moments and electricity can’t be stored very well. This has a huge effect on honest cost assessment, and no effect on – shall we say – other assessments).

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums losing 4bp, FixedResets gaining 2bp and DeemedRetractibles down 2bp. Volatility was low. Volume was a little below average.

The US jobs number was disappointing:

Employers in the U.S. added fewer jobs than forecast in March, underscoring Federal Reserve Chairman Ben S. Bernanke’s concern that recent gains may not be sustained without a pickup in growth.

The 120,000 increase in payrolls, the fewest in five months, followed a revised 240,000 gain in February that was bigger than first estimated, Labor Department figures showed today in Washington. The March increase was less than the most pessimistic forecast in a Bloomberg News survey in which the median estimate called for a 205,000 rise. Unemployment fell to 8.2 percent, the lowest since January 2009, from 8.3 percent.

Stock lending can be profitable!

The other day on Bloomberg (the paid version), I came across several ETFs with incredibly rich dividends. One of them — Guggenheim’s Solar ETF (TAN/NYSE) — far outshined the others. TAN holds about 30 solar energy companies. Its dividend yield is 9.2%, reports Bloomberg and others. Indeed, its dividend of US$2.11, adjusted for a 1:10 reverse split, divided by its price of US$23.02 works out to 9.2%. But is that possible in what should be a high-growth sector?

Digging deeper, only seven of the companies in the ETF, representing about 28% of the total allocation, have ever paid a dividend. Two have postponed dividends for 2012 and another has cut its dividend by more than half. The weighted average yield on the seven companies is under 1%.

Since holdings can change every quarter, I also checked the holdings as of February 2011. The picture was the same: seven dividend payers with an average yield of below 1%.

Where then did most of TAN’s dividend come from? The answer, as revealed by the fund’s prospectus, is securities lending. Nearly 90% of TAN’s investment income for the 12 months ending last August came from lending about half its shares to short sellers.

Who needs retirement in Florida, when you can retire to sunny Spain?

Banks trying to offload billions of euros of property left on their hands by bankrupt developers are selling new apartments at rock-bottom prices with bargain-basement mortgage deals.

Santander, the eurozone’s largest bank, was responsible for the frenzy in Sesena. It offered two-bedroom apartments around a communal swimming pool for 65,000 euros (US$86,100), with 100% mortgages over 40 years, costing as little as 242 euros a month to service, about a sixth of the average Spaniard’s monthly income.

At the peak of the decade-long property boom that preceded the crash, similar apartments would have sold for at least twice that, and for properties it isn’t selling, a Santander mortgage would cover 80% of the property price over 25 years.

Those with an interest in YLO will be happy to learn there is a market for the assets:

AT&T Inc. (T) agreed to sell a majority stake in its Yellow Pages directory division to Cerberus Capital Management LP for about $950 million as part of an effort to dispose of units that are holding back revenue growth.

AT&T will receive $750 million in cash and a $200 million note, according to a statement from the Dallas-based phone carrier today. AT&T will keep a 47 percent stake in the business, which had about $3.3 billion in revenue in 2011.
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Sales at the Yellow Pages business declined 16 percent last year, compared with revenue growth of about 2 percent for AT&T as a whole.

So $950-million for 53% of a print company with $3.3-billion revenue …. YLO had revenue of $1.3-billion in 2011, but a buyer will have to assume the debt …

Boyd Erman opines in the Globe:

But giving Cerberus the benefit of the assumption that its people have some idea of what they’re doing, the purchase has set a bar for what Yellow Media bondholders, who are now mobilizing, will expect to receive in a restructuring. While the valuation is not enough to create any real recoveries for stockholders, or even preferred shareholders, it is enough to suggest there are gains in store for bondholders gutsy enough to buy Yellow Media paper at distressed levels.

Broadly speaking, Yellow Media has about $1.5-billion of debt that has been trading at about 50 cents on the dollar. If there’s $1-billion of value, that suggests the bonds should be closer to 67 cents on the dollar.

Some bondholders argue there’s more. Applying market multiples to the free cash flow generated from Yellow Media’s old-line and online operations, some bondholders argue you can get to a range of $1.4-billion to $2.2-billion.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 5bp, FixedResets down 1bp and DeemedRetractibles losing 15bp. Volatility was negligible. Volume was ridiculously low.

Julie Dickson’s speech was not very interesting – just a shopping list of aspirations for a board. Of passing interest was:

This leads me to explain why OSFI’s draft guideline (B-20) on Sound Residential Mortgage Underwriting Practices and Procedures, which we made public on March 19th, begins with the statement that boards must establish real estate underwriting policies. In fact, most boards have already established such policies. This makes sense; housing is the largest asset class exposure of banks – almost 42 per cent of total bank assets.

While these policies will have to be updated to reflect the new guidance, going forward senior management will have to provide a declaration to the board that the financial institution is in compliance with the OSFI guideline. This was added because we had noticed cases where board approved polices were not being followed.

Seems to me that if I was on a board that set a policy and that policy was not followed, I’d simply ensure that somebody senior got fired at every board meeting until it did get followed. But perhaps that’s just another reason why I’m not on a big-shot board.

Another, related, reason is my antiquated idea that boards are in place to set policies and hire staff to carry them out. The modern view is that boards exist to provide jobs to unqualified women – despite that fact that it does not work:

A recent study released by the German central bank found that risk taking within the banking industry increases with more women on an executive board. The same goes for younger executives. In contrast, men who are graying at the temples and executives with Ph.D. degrees reduce the level of risk.

Tomorrow’s US jobs number is expected to be encouraging:

Employers probably added more than 200,000 workers to payrolls in March for a fourth straight month as U.S. companies gained confidence sales will keep improving, economists said before a government report today.

Hiring increased by 205,000 after rising by 227,000 in February, according to the median projection of 80 economists surveyed by Bloomberg News. The last time employment advanced at a similar pace for as many months was late 1999 into 2000. The jobless rate probably held at a three-year low of 8.3 percent.

Cowboys will have 45 minutes to settle their bets:

While stock markets around the world are shut for Good Friday, the Labor Department will publish its monthly employment report at 8:30 a.m. New York time. Equity traders will have 45 minutes to react, as trading of futures linked to the Standard & Poor’s 500 Index and Dow Jones Industrial Average will continue until 9:15 a.m. on CME Group Inc. (CME)’s Chicago Mercantile Exchange.

The Canadian jobs number was good:

Canada’s labour market has finally perked up after half a year in the doldrums as a commodities boom and a firmer U.S. economy give employers the confidence to hire.

The economy churned out 82,300 jobs last month, the most since 2008, with many of the positions created in full-time work. The hiring spree sent the country’s jobless rate down two notches to 7.2 per cent in March, matching the lowest rate seen in the recovery.

First National, proud issuer of FN.PR.A, was confirmed at Pfd-3 by DBRS:

DBRS has today confirmed the Senior Secured – Guaranteed Debt and Class A Preference Shares ratings of First National Financial Corporation (FNFC) at BBB and Pfd-3, respectively, and the Issuer Rating of First National Financial LP (FNFLP) at BBB; all trends remain Stable.

The ratings and trends reflect FNFC’s status as Canada’s largest non-bank mortgage originator, with just under $60 billion in mortgages under administration (MUA) as of December 31, 2011; its strong asset quality profile, with all assets secured by real estate and a substantial portion insured; and its high-quality, low-cost servicing capabilities.

The rating on FNFC’s Senior Secured – Guaranteed Debt is based on a senior guarantee from FNFLP and an Intercreditor Agreement between Computershare Trust Company of Canada as the debenture trustee and the lenders under a credit facility. The Intercreditor Agreement ranks the indebtedness created under the debentures equally and ratably with the indebtedness created under FNFLP’s credit facility.

It was another mixed day for the Canadian preferred share market, with PerpetualPremiums winning 13bp, FixedResets off 2bp and DeemedRetractibles gaining 11bp. Only one issue made it to the Performance Highlights table. Volume was pathetic.

There are rumours about Rona, too:

In corporate news, Rona Inc. (TSX:RON) has denied that the company is up for sale after stock in the home renovation retailer jumped more than 12 per cent in heavy trading Tuesday on the Toronto Stock Exchange.

The Quebec-based retailer issued the denial in response to movement in its stock after Robert Hull, chief financial officer of Lowe’s Companies Inc., said his U.S.-based rival might be interested if Rona put itself up for sale. On Wednesday, Rona shares lost 42 cents, or four per cent, to $10.06.

The pain in Spain is starting to gain:

Prime Minister Mariano Rajoy said Spain’s situation is one of “extreme difficulty” and signaled that his budget cuts are less painful than a bailout would be, as demand for the nation’s debt slumped at an auction.
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Spain sold 2.59 billion euros ($3.4 billion) of bonds today, just above the minimum amount it planned for the auction and below the 3.5 billion-euro maximum target. The average yield on the bonds due in October 2016, which act as the five-year benchmark, rose to 4.319 percent from 3.376 percent at last month’s sale. Secondary-market yields rose to 4.48 percent.

Spain’s 10-year borrowing costs are approaching the levels seen in December, before the European Central Bank said it would make unlimited three-year loans to bank.

The BoC has published a paper by Bruno Feunou, Jean-Sébastien Fontaine, Abderrahim Taamouti and Roméo Tédongap titled Risk Premium, Variance Premium and the Maturity Structure of Uncertainty:

Expected returns vary when investors face time-varying investment opportunities. Longrun risk models (Bansal and Yaron 2004) and no-arbitrage affine models (Duffie, Pan, and Singleton 2000) emphasize sources of risk that are not observable to the econometrician. We show that, for both classes of models, the term structure of risk
implicit in option prices can reveal these risk factors ex-ante. Empirically, we construct the variance term structure implied in SP500 option prices. The variance term structure reveal two important drivers of the bond premium, the equity premium, and the variance premium, jointly. We also consider the term structure of higher-order risks as measured by skewness and kurtosis and still find that two factors are sufficient to summarize the information content from the term structure of risks. Overall, our results bode well for the ability of structural models to explain risk-returns trade-offs across different markets using only very few sources of risk.

Somebody complained to me today that they were getting spam from my company domain, himivest.com. So I found a good article about eMail spoofing:

When this simplistic method is used, you can tell where the mail originated (for example, that it did not come from thewhitehouse.com) by checking the actual mail headers. Many e-mail clients don’t show these by default. In Outlook, open the message and then click View | Options to see the headers, as shown in Figure 3.
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In this example, you can see that the message actually originated from a computer named XDREAM and was sent from the mail.augustmail.com SMTP server.

Unfortunately, even the headers don’t always tell you the truth about where the message came from. Spammers and other spoofers often use open relays to send their bogus or malicious messages. An open relay is an SMTP server that is not correctly configured and so allows third-parties to send e-mail through it that is not sent from nor to a local user. In that case, the “Received from” field in the header only points you to the SMTP server that was victimized.

BAM issued ten year CAD notes at 3.95% to pay off a maturing USD obligation.

Enbridge Gas Distribution, proud issuer of ENB.PR.A, ENB.PR.B, ENB.PR.D, ENB.PR.F and ENB.PR.H, was confirmed at Pfd-2(low) by DBRS:

DBRS has today confirmed the Unsecured Debentures & Medium-Term Notes, Commercial Paper, and Cumulative & Cumulative Redeemable Convertible Preferred Share ratings of Enbridge Gas Distribution Inc. (EGD or the Company) at “A”, R-1 (low) and Pfd-2 (low), respectively, all with Stable trends. The rating confirmation is based on EGD’s low business risk operations, stable regulatory environment in Ontario, strong franchise area and stable financial profile.
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EGD’s financial profile remained stable in 2011, with all credit metrics being commensurate with DBRS’s “A” rating guidelines. DBRS notes that the Company requires significant liquidity to finance working capital (mostly gas inventory for winter distributions). Given the low gas price environment, EGD’s liquidity remains adequate to meet its operational needs. Over the medium term, moderate cash flow deficits are expected, due to a large capex program. However, EGD’s current debt leverage is well below the regulatory capital structure of 36% equity, providing EGD with significant financial flexibility. DBRS expects the Company to remain prudent in funding its cash shortfalls and maintaining its credit metrics within the “A” rating category. In August 2011, the Company financed its $66 million acquisition of 15-megawatt (MW) solar power assets from its parent, Enbridge Inc., with equity, which was viewed as positive to the financial profile.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums flat, FixedResets gaining 9bp and DeemedRetractibles down 3bp. Volatility was low. Volume was slightly below average.

PerpetualDiscounts now yield 5.17%, equivalent to 6.72% interest at the current conversion factor of 1.3x. Long corporates now yield about 4.6%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 215bp, a dramatic drop from the 230bp reported March 30.

The David Berry saga continues to drag on:

A hearing was originally scheduled before a Hearing Panel of the Investment Industry Regulatory Organization of Canada (IIROC), in the matter of David Berry for April 10 to April 23, 2012. The hearing was adjourned to June 13, 2012.

The hearing concerns allegations that Mr. Berry solicited client orders during the distribution of new issues by Scotia Capital contrary to UMIR 7.7(5) (as it existed prior to May 2005), and conducted off-marketplace trades that were not printed on a marketplace or recognized exchange as required by UMIR 6.4.

Assiduous Readers will remember that David Berry was a superb trader of preferred shares, who was assigned significant capital by Scotia at a time when the market was starved for liquidity. He made ridiculous potfulls of money for the bank and in so doing, a pretty good pile for himself. The bank’s executives got upset that a mere peon was making so much and, when he wouldn’t accept a voluntary pay cut, unleashed an army of accountants and lawyers on his trading to uncover instances where a rule had been broken – I have also heard that clients were swept up in this witchhunt and required to cooperate voluntarily with the investigation as a condition of doing business with Scotia.

Naturally, they found a few picayune transgressions, pretended to be shocked and fired him. He’s suing for $100-million. IIROC is an eager participant in this charade.

Royal Bank is scooping up full control of RBC-Dexia:

Royal Bank of Canada (RY-T57.04-1.70-2.89%) is buying the 50-per-cent stake in RBC Dexia Investor Services that it doesn’t already own from its struggling European partner.

Canada’s largest bank said Tuesday morning it will purchase the 50 per cent stake of RBC Dexia partnership from Banque Internationale à Luxembourg SA for $1.1-billion in cash.

The deal will give RBC full control of the European business, which advises institutional investors and administers large pensions and investment funds. The assets went on the block last year when Banque Internationale à Luxembourg, formerly known as Dexia Banque Internationale, was hit hard by the European banking crisis and forced to jettison assets to stabilize its operations.

DBRS comments:

RBC will take an after-tax charge of approximately $200 million, with $170 million (after tax) of that owing primarily to a write-down of intangibles as a result of revaluing the 50% of RBC Dexia that is already owns. The other $30 million (after tax) represents RBC’s share of a loss related to an exchange of securities at RBC Dexia.

Courtesy of the US housing market, here’s another illustration of the law of unintended consequences:

As many as 1.25 million of America’s least cared for homes are headed for auction after a year-long probe into foreclosure practices kept them off the market.

Sales of repossessed properties probably will rise 25 percent this year from 1 million in 2011, according to Moody’s Analytics Inc. Prices for the homes could drop as much as 10 percent because they deteriorated as they were held in reserve during investigations by state officials resolved in February, according to RealtyTrac Inc. That month, 43 percent of foreclosures were delinquent for two or more years, from a 21 percent share in 2010, according to Lender Processing Services Inc. in Jacksonville, Florida.
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Homes stockpiled less than a year sell for about 35 percent below the value set by lenders, according to a March 15 report by the Federal Reserve Bank of Cleveland. At two years, the loss is close to 60 percent.

The Fed’s confidence in the US economy is increasing:

The Federal Reserve is holding off on increasing monetary accommodation unless the U.S. economic expansion falters or prices rise at a rate slower than its 2 percent target.

“A couple of members indicated that the initiation of additional stimulus could become necessary if the economy lost momentum or if inflation seemed likely to remain below” 2 percent, according to minutes of their March 13 meeting released today in Washington. That contrasts with the assessment at the FOMC’s January meeting in which some Fed officials saw current conditions warranting additional action “before long.”

There are many pairs of words that, when seen in the same sentence, alert the reader that some insane logic based on infantile assumptions is about to result in nonsensical verbiage. One such pair is “Privacy” and “Commissioner”. Another is “Internet” and “Regulators”:

Google Inc. (GOOG), owner of the world’s most-popular search engine, misled Australian consumers in 2007 by including paid advertisements from competitors in search results for businesses, an appeal court ruled.

The Federal Court of Appeal in Sydney today overturned a lower court decision and ordered the Mountain View, California- based company to set up a protocol to avoid repeating the practice.
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The ACCC appealed, citing four advertisements, including those that showed up in a search for the Australian company Harvey World Travel, that it said Google should have known would contravene the law.

A search for a business name would include results from competitors who paid to have their ads placed in a column beside the search results.
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A user who sought information about Harvey World Travel was instead given the web address of one of its competitors, the panel said.

“Google tells the user that the URL provided below is the contact information about Harvey World Travel,” the panel wrote. “The enquiry is made of Google and it is Google’s response which is misleading.”

So my question is: why does it matter whether Google’s respons is misleading, assuming that a rational person would consider it misleading, which is by no means obvious? The user isn’t paying Google anything for the service, zip, zero, zilch! How does Google owe some kind of duty to the user? As far as I’m concerned, Google can answer queries of any type with pictures of naked women without breaching any duty; if they aren’t pretty enough, I’ll use a different search engine.

If any user of the Internet can run crying boo-hoo-hoo to the courts to get something fixed – and, doubtless, to get some kind of pecuniary benefit out of the whimpering – I’ve got a long list of websites that I know contain demonstrably false statements about preferred shares …

It was another positive day for the Canadian preferred share market, with PerpetualPremiums up 10bp, and both FixedResets and DeemedRetractibles gaining 12bp. Volatility was good, but surprisingly skewed to the downside. Volume was low.