PrefBlog

BAM is starting a Dubai property fund:

Brookfield Asset Management Inc. and a Dubai government investment arm will start a $1 billion fund to buy real estate assets in the emirate after prices dropped by more than half since 2008.

The eight-to-10-year fund will be started with $100 million each from Toronto-based Brookfield and the Investment Corporation of Dubai, the companies said today in a statement. It will target a “wide class of assets in both freehold and non-freehold areas.” Local, regional and international investors will also be invited to join the fund that will be capped at $1 billion.

The Europeans are now faced with Job #2: persuading people to invest:

Europe’s banks will need to raise 106 billion euros ($147 billion) in fresh capital under tougher rules being introduced in response to the euro area’s sovereign debt crisis, the region’s top banking authority said.

Seventy banks were tested, the European Banking Authority said late yesterday, with Spanish banks needing 26.2 billion euros and Italian banks 14.8 billion euros in core tier 1 capital. The lenders have until Dec. 25 to submit their plans for raising the money to national supervisors. The extra reserves are needed to meet a temporary requirement for lenders to hold 9 percent in core reserves, after sovereign debt writedowns.
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European leaders are meeting to hammer out an agreement on bolstering the region’s rescue fund, recapitalizing banks and relieving Greece to avoid contagion spreading to Italy and Spain. The summit is part of an attempt to solve the two-year- old sovereign-debt crisis that has pushed Greece closer to default, roiled global markets and dented confidence in the survival of the euro.

U.K. banks won’t be required to raise extra capital, according to the EBA figures, whereas German banks will have to find 5.2 billion euros.

The Americans aren’t learning anything from all this:

The congressional supercommittee seeking a long-term debt-reduction deal remains at an impasse with a deadline near, and the prospect of failure is prompting concern about further downgrades of the nation’s credit rating.

With the committee heading into what may be a make-or-break week for striking a deal over a package of at least $1.2 trillion in U.S. deficit cuts, members are deadlocked over Democrats’ insistence on tax increases, according to committee aides in Washington who spoke on condition of anonymity.

Senate Finance Committee Chairman Max Baucus proposed a deficit-reduction plan worth almost $3 trillion with about half comprised of tax increases, according to a congressional aide. The remainder would be spending cuts, including in Medicare and Medicaid, as well as fee increases, the aide said. Republicans rejected the plan, which Senate Democrats wanted to pair with extensions of a payroll tax break and jobless benefits scheduled to expire at the end of this year, the aide said.

But the Irish are paying close attention:

Greece’s difficulty paying its debts may turn out to be Ireland’s opportunity.

Greece’s failure to cut spending and boost revenue by enough to meet targets set by the European Union and International Monetary Fund prompted bondholders to accept a 50 percent loss on its debt. While Ireland won’t seek debt discounts, the government might pursue other relief given to Greece, including cheaper interest payments on aid and longer to repay it, according to a person familiar with the matter who declined to be identified as no final decision has been taken.

“There’s a political problem for the government,” said Gavin Blessing, a bond analyst at Collins Stewart Plc in Dublin. “The Greeks, who are seen to be behaving badly, get rewarded, whereas the Irish, the top boys in the class, get nothing.”

Ken Rogoff thinks the whole thing is just another band-aid:

European leaders’ agreement to expand a bailout fund to stem the region’s debt crisis only buys time as the problem worsens, Harvard University economist Kenneth Rogoff said.

“They don’t have any idea what the end game is here,” Rogoff said as a compensated speaker at the Bloomberg FX11 Summit in New York today. “It’s pretty darn clear the euro does not work.”

And there is some confusion regarding just what the plan might be:

A key component of the European program agreed in the wee hours in Brussels on Thursday is getting Greece’s debt down to a manageable 120 per cent of GDP. That effort involves Greek bondholders taking a 50 per cent loss on their investment, up from a previous agreement to take a haircut of 20 per cent.

This constitutes a default by any reasonable definition. But Europe’s leaders are trying very hard to frame these losses as voluntary, which would avoid triggering a broad Greek CDS redemption. The European plan says leaders will “invite” private investors to develop a “voluntary bond exchange with a nominal discount of 50 per cent on notional Greek debt held by private investors.”

So is it nudge-wink-voluntary or is it compulsory? If the former, there would appear to be some opportunity for non-European hedge funds to make a killing by buying Greek debt and refusing the invitation.

Here in Canada, we’re approaching a decision on the latest job creation scheme:

The Supreme Court of Canada appears close to releasing a much-awaited decision on whether the federal government has the authority to create a new national securities regulator.

The top court has asked parties involved in the case for permission to organize a media lock-up to release the ruling, according to information on the court’s web site. The electronic “docket” does not reveal a planned released date, but federal officials expect a decision by the middle of next month.

OSFI has released a NVCC roadshow. It is notable for the first defence I have seen from them for low-trigger contingent capital – indeed, the first acknowledgement from them that I know of that high-trigger contingent capital even exists:

The BCBS considered and rejected Co-Cos for the minimum capital requirements, buffers & Global systemically important bank (G-SIB) surcharge
– Key concern was the unreliability of early triggers
– Early trigger could exacerbate distress & hurt confidence
– Triggers can be subject to manipulation or arbitrage

It would be most interesting to see a full-fledged debate on this, but we won’t get one from the clowns at OSFI. The presentation is also notable for a bare-faced falsehood (emphasis added):

Existing instruments are akin to NVCC because:
– NVCC creates no new regulatory discretion.
– At non-viability, authorities are assessing how best to resolve the failed bank. NVCC is just a new resolution option in the toolkit:
– Liquidation, Assisted Purchase, Bridge Bank, Recapitalization (i.e. Bail-out), NVCC, and others.
– The NVCC triggers are very late and very remote. The decision point is the same as in existing securities, i.e. the PF, or PD, is the same or lower.
– NVCC instruments will likely behave similar to existing sub debt and preferred shares.
– Innovative Tier 1 instruments have similar regulatory triggers

They spout this bilge about “no new regulatory discretion” and then on the very next page they say Canadian authorities would only elect to trigger NVCC where there was a high level of confidence that the conversion plus additional measures would restore the viability of the failed FI. “Elect”. “confidence”. If that’s not discretion, I’d like to know what the hell is.

There’s one element of the presentation that is also a bit fishy (emphasis added):

Can OSFI pull the trigger too early?
– NVCC triggers narrowly defined by design to constrain authorities from acting prematurely
– Non-viability is an expectation of insolvency
– Backstop trigger designed to avoid Troubled Asset Relief Program (TARP) scenario – Viable FIs cannot be forced to accept a bail-out
– Triggers designed to permit authorities with flexibility to take certain actions (i.e. liquidity assistance) where an FI may require public sector support without triggering NVCC conversion
– Superintendent’s actions can be subject to legal challenge & judicial review
– Importantly, OSFI strongly believes the hierarchy must be respected – therefore, creditors should not be exposed to loss before non-viability

I’d like to see how they work that out: I read the advisory as granting the Superintendent full discretion … but perhaps the “can be subject” is just a weasel phrase. Gravity can be subject to challenge too, but you won’t get too far.

The Financial Stability Board has released a report titled Shadow Banking: Strengthening Oversight and Regulation. Lots of cool charts at the back.

The Globe published a long piece on YLO, How did Yellow Media’s stock go from $17 to 17 cents?. One part echoes my thoughts:

While his online competitors may be giants such as Google, Tellier claims he has a secret weapon: trust. Yellow Media’s bread and butter is still small business owners, many of whom are at a loss when it comes to arcane aspects of online advertising such as bidding on Google keywords. While many advertisers are realizing that Yellow’s books may no longer be the best place for their ads, that doesn’t mean they’ve soured on the company entirely. This is where its sales force comes in—a network of representatives that have established relationships with customers, something Google lacks. “Businesses would prefer to have a single point of contact to demystify this digital universe,” Tellier says. “We think the market dynamic is in our favour.”

There’s also a hopeful thought:

But after Yellow announced the new, more stringent credit agreement with the banks in late September, Tellier admitted the prospects for the company’s transition—whether digital businesses will be able to compensate for declining print revenues—are far from certain. The same might be said of his tenure as CEO.

I don’t have a lot of faith in the man’s competence. What the company needs is somebody with a little operational expertise.

YLO common has been active this week, going from $0.26 on October 21 to $0.495 yesterday to $0.39 today – total volume for the four days this week has been about 70-million shares. Seventy million! That’s more than 13% of the float! Even allowing for the fact that the day traders will have flipping like mad, it’s still impressive. Returns and volumes for the preferreds have been equally dramatic. YLO will report on 11Q3 on November 3.

Preferred shares from CZP, the latest ugly duckling, caught a bounce today – Assiduous Readers may insert the words “dead cat” if they wish, according to taste. All this comes from the DBRS warning of a possible 3-notch downgrade; S&P was less explicit, but just as gloomy. There will be more of this in future, as a few of those junky FixedReset chickens of the past few years come home to roost.

It was a mostly-up day for the Canadian preferred share market, with PerpetualDiscounts down 4bp, FixedResets up 10bp and DeemedRetractibles gaining 12bp. Plenty of skew in those results, with all entries on the Performance Highlights table being positive! Volume was well above average.

Discussions about Greece are at a familiar stage – nobody wants to take the loss:

European Union talks with banks on bondholder losses as part of a second Greek bailout were deadlocked, an EU official said, dimming the chances for a comprehensive crisis-fighting strategy at tonight’s summit.

German Chancellor Angela Merkel doused expectations of a breakthrough, saying on the way into the meeting at EU headquarters in Brussels that “work’s not been done yet, but everyone’s coming here today with the goal to progress quite a bit.”

Maybe the Chinese will take the loss!

French President Nicolas Sarkozy plans to call Chinese leader Hu Jintao tomorrow to discuss China contributing to a fund European leaders may set up to bolster its debt-crisis fight, said a person familiar with the matter.

The investment vehicle was one of the options being considered by European leaders at a summit tonight to expand the reach of its 440 billion-euro ($612 billion) European Financial Stability Facility.

Sarkozy’s plea to his Chinese counterpart would come the day before a planned visit to Beijing by Klaus Regling, chief executive officer of the EFSF, to court investors.

Italy’s beginning to get serious:

Prime Minister Silvio Berlusconi vowed to raise 5 billion euros ($8 billion) annually from asset sales, increase the retirement age and relax labor laws to convince European leaders Italy can reach its budget goals.

“We are aware of the need to present a comprehensive plan of reforms,” Berlusconi said in the letter that he presented to European Union leaders at a summit in Brussels. “We are aware that our debt is too high and our growth too limited.” The asset-sales plan will be completed by Nov. 30, he said.

The letter of intent fell short of the comprehensive plan European leaders had sought. Bickering within his Cabinet this week over pensions and other issues prevented the premier from complying with EU requests to deliver a blueprint to boost growth and tackle the euro-region’s second largest debt at the Brussels summit.

Just as this update goes to the server, there is some breaking news:

French President Nicolas Sarkozy estimates the euro region’s bailout fund will be worth $1.4 trillion after European governments agreed on steps to leverage existing guarantees by as much as five times. He spoke to reporters after a summit of European leaders in Brussels.

There are also rumours of a 50% write-down on Greek debt. And, at last minute before I wrap this up:

European leaders persuaded bondholders to take 50 percent losses on Greek debt and boosted the firepower of the rescue fund to 1 trillion euros ($1.4 trillion), responding to global pressure to step up the fight against the financial crisis.

Ten hours of brinkmanship at the second crisis summit in four days delivered measures that the euro area’s stewards said point the way out of the debt quagmire, even if key details are lacking. Last-ditch talks with bank representatives led to the debt-relief accord, in an effort to quarantine Greece and prevent speculation against Italy and France from ravaging the euro zone and wreaking global economic havoc.

SJR.PR.A was confirmed at Pfd-3 by DBRS:

DBRS has today confirmed its ratings on Shaw Communications Inc. (Shaw or the Company) at BBB and Pfd-3.
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In terms of Shaw’s financial risk profile, while the acquisition of a restructured Canwest in early F2011 weakened its credit metrics initially, they returned to reasonable levels by the end of F2011, with gross debt-to-EBITDA at 2.67 times, EBITDA interest coverage above 6.0 times and cash flow-to-debt at 0.25 times. This, along with growth in cash flow from operations (expected to cover higher capex and dividend levels in F2012 with free cash flow generation (including on a fully-taxed basis)), should give Shaw the flexibility to make small to medium-sized investments and/or to reduce its leverage to strengthen its financial risk profile within its current rating category.

DBRS believes that Shaw’s business risk profile remains manageable, even though the Company is now battling telcos that are able to compete service-for-service in fixed-line, in addition to offering wireless services. It would likely take a material deterioration in Shaw’s competitive position for DBRS to alter this view. Also, while Shaw retains a financial risk profile that is adequate for the ratings, the Company is currently weaker on this front than some of its peers. Any material changes in Shaw’s business or financial risk profile could result in pressure on the ratings.

LB.PR.D and LB.PR.E were confirmed by DBRS at Pfd-3(low):

DBRS has today confirmed all ratings of Laurentian Bank of Canada (Laurentian or the Bank), including the deposits and senior debt at BBB (high) and the short-term instruments at R-1 (low); all trends remain Stable.

The ratings are supported by Laurentian’s overall business risk profile, which is conservative relative to the larger banks in Canada, with a focus on retail lending funded by retail deposits and an absence of significant involvement in higher-risk wholesale or international strategies. Laurentian’s underlying asset quality profile has strengthened over the past several years as the loan mix shifted to a greater proportion of secured lending. Limitations on the ratings include a modest return on equity and high cost structure. Regional concentration in Québec, while still a potential rating challenge, was beneficial through the downturn as the economic performance of the province was resilient.

CZP issues got hammered again today, continuing their fall after DBRS warned of a possible 3-notch downgrade and S&P was less explicit, but just as gloomy.

It was a modestly good day for the Canadian preferred share market, with PerpetualDiscounts up 5bp, FixedResets gaining 2bp and DeemedRetractibles winning 8bp. Volatility was good and all to the upside. Volume was heavy – Nesbitt wrote a very nice ticket for CM.PR.D!

PerpetualDiscounts now yield 5.44%, equivalent to 7.07% interest at the standard equivalency factor of 1.3x. Long corporates are now at 5.0% (OK, maybe a little over), so the pre-tax interest-equivalent spread is now about 205bp, unchanged from the figure reported October 19.

The Europeans are still trying to square the circle, but at least they now seem to be downplaying the monetization idea:

Boosting the effectiveness of Europe’s bailout fund will require further talks with investors as German lawmakers prepare to vote on its new powers tomorrow, a European Union document showed.

While the European Financial Stability Facility can be bolstered under two models that may be combined and implemented “quickly,” the extent to which the fund is leveraged can only be ascertained after discussions with investors and rating companies, the document provided to German lawmakers said.

The draft underscores the gaps remaining in European Union efforts to address the debt crisis as Chancellor Angela Merkel and fellow leaders prepare to return to Brussels tomorrow for a second summit in four days. Leaders are still jousting with banks over the size of losses they take on Greek bonds while deliberating over leveraging the fund after ruling out tapping the European Central Bank’s balance sheet.

Rumours continue to swirl about the possible output from the summit:

European leaders increased pressure on Italian Prime Minister Silvio Berlusconi to specify how he will reach budget-reduction targets as German lawmakers prepared to vote on a revamped euro-area bailout package that officials raced to complete before a summit tomorrow.

Italy needs to back up commitments with “specific actions” and come up with “clear timing,” European Commission spokesman Amadeu Altafaj said in Brussels today after a crisis cabinet meeting in Italy late yesterday failed to announce steps to spur growth.
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While 27 EU leaders convene before the 17 chiefs of the 17 euro nations tomorrow, a meeting of the 27 EU finance ministers scheduled to precede them was cancelled with no explanation.

The elements of the revamped blueprint may include expanding the reach of the 440 billion-euro ($611 billion) European Financial Stability Facility by turning it into a bond insurer and setting up vehicles to raise outside funds, possibly alongside the International Monetary Fund, and a bank- recapitalization strategy.

At an Oct. 23 summit, the leaders excluded a forced restructuring of Greek debt, sticking with the tactic of enticing bondholders to accept losses to help restore the country’s finances, and ruled out tapping the balance sheet of the European Central Bank.

Euro-area leaders are counting on the ECB to continue buying troubled countries’ bonds, three people familiar with the deliberations said. They are debating how to obtain an ECB signal without appearing to give orders to the politically independent central bank, said the people. The central bank has bought 169.5 billion euros in bonds so far.

Super! Bond insurance! Loan guarantees! It worked out so well for Fannie Mae, Freddie Mac and all the monolines that it must be good! And doesn’t cost a cent!

I mentioned my fascination with longevity risk for pension plans on June 21. Swiss Re also considers it a fascinating topic:

A number of Canadian pension plans are not putting aside enough money to account for the risk that people will live longer than expected, says a new report to be released on Monday.
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Swiss Re, which is hoping to convince pension plans and insurers to buy protection against this risk, clearly has an agenda in publishing the report, which it characterizes as the first comprehensive look at longevity risk in Canada. But the numbers are startling nonetheless. And if the company succeeds in creating an active market for longevity risks in this country, it might ultimately package those risks up into bonds or securities that are sold to investors. The report estimates that between $10-billion and $20-billion of longevity risk will be transferred from Canadian pensions and annuities to reinsurers and investors in the next decade.

Canada’s longevity risk, at roughly five per cent of the total global amount, is relatively high because of the quantity of defined benefit pensions in this country, says George Graziani, a senior vice-president at Swiss Re in Canada.

Elizabeth A Duke, Member of the Board of Governors of the Federal Reserve System, gave a speech titled The Federal Reserve System and individual financial planning:

The Federal Reserve Bank of Dallas offers a popular financial planning publication, Building Wealth. In it, individuals and families seeking help to develop a plan for building personal wealth will find an overview of personal asset-building strategies that includes setting financial goals, budgeting, saving and investing, managing debt, and understanding credit reports and credit scores. The Dallas Fed makes Building Wealth available online in both English and Spanish, and has created an interactive version of the publication, making it usable as a personal finance education resource for schools, nonprofit community organizations, and financial services providers.

Another valuable online resource is the Federal Reserve Bank of San Francisco’s Guide to Financial Literacy. This free publication explains what level of financial education is appropriate for a variety of age groups, offers guidance for consumers making key financial decisions at different stages of life, and includes a compendium of financial education resources that address these needs.

Footnotes: Building Wealth can be found at www.dallasfed.org/ca/wealth/index.cfm.

The Guide to Financial Literacy Resource can be found at www.frbsf.org/community/webresources/bankersguide.pdf

The books mentioned in the Resource Guide at the end of the Dallas Fed publication are fascinating:

• Getting Rich in America: 8 Simple Rules for Building a Fortune and a Satisfying Life
  Dwight R. Lee and Richard B. McKenzie 1999, Harper Business

• It’s About the Money! The Fourth Movement of the Freedom Symphony: How to Build Wealth, Get Access to Capital, and Achieve Your Financial Dreams
  Reverend Jesse L. Jackson, Sr. and Jesse L. Jackson, Jr. with Mary Gotschall 1999, Times Business/Random
  House

• The Millionaire Next Door: The Surprising Secrets of America’s Wealthy Thomas J. Stanley and William D. Danko 1996, Longstreet

I’ve heard of “The Millionaire Next Door”, although I’ve never read it. Many things come to mind when I hear the name “Reverend Jesse L. Jackson, Sr.”, but I’ll admit that Financial Planning advice isn’t one of them! But it’s listed because of a single quote:

Accumulating wealth—as distinct from just making a big income—is the key to your financial independence. It gives you control over assets, power to help shape the corporate and political landscape, and the ability to ensure a prosperous future for your children and their heirs….

… which is reasonable enough!

OSFI has released the Autumn 2011 edition of the OSFI Pillar. The new Assistant Superintendent is Mark Zelmer, a career civil servant.

S&P affirmed Canada:

• We are affirming our ‘AAA/A-1+’ long- and short-term sovereign credit ratings on Canada.
• In our view, Canada has a superior political and economic profile and strong flexibility and performance profile.
• The outlook is stable. Given Canada’s strong starting position, a combination of increased political uncertainty and weaker fiscal or external outcomes would be necessary for downward pressure to build on the rating.

The BoC was full of cheery news:

The global economy has slowed markedly as several downside risks to the projection outlined in the Bank’s July Monetary Policy Report (MPR) have been realized. Financial market volatility has increased and there has been a generalized retrenchment from risk-taking across global markets
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The outlook for the Canadian economy has weakened since July, with the significantly less favourable external environment affecting Canada through financial, confidence and trade channels.
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Overall, the Bank expects that growth in Canada will be slow through mid-2012 before picking up as the global economic environment improves, uncertainty dissipates and confidence increases. The Bank projects that the economy will expand by 2.1 per cent in 2011, 1.9 per cent in 2012, and 2.9 per cent in 2013.

The weaker economic outlook implies greater and more persistent economic slack than previously anticipated, with the Canadian economy now expected to return to full capacity by the end of 2013. As a result, core inflation is expected to be slightly softer than previously expected, declining through 2012 before returning to 2 percent by the end of 2013. The projection for total CPI inflation has also been revised down, reflecting the recent reversal of earlier sharp increases in world energy prices as well as modestly weaker core inflation. Total CPI inflation is expected to trough around 1 per cent by the middle of 2012 before rising with core inflation to the two per cent target by the end of 2013, as excess supply in the economy is slowly absorbed.

Several significant upside and downside risks are present in the inflation outlook for Canada. Overall, the Bank judges that these risks are roughly balanced over the projection horizon.

Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at 1 per cent. With the target interest rate near historic lows and the financial system functioning well, there is considerable monetary policy stimulus in Canada. The Bank will continue to monitor carefully economic and financial developments in the Canadian and global economies, together with the evolution of risks, and set monetary policy consistent with achieving the 2 per cent inflation target over the medium term.

CZP issues have been hammered in the past two days, after DBRS warned of a possible 3-notch downgrade and S&P was less explicit, but just as gloomy.

It was a mixed day on the Canadian preferred share market, with PerpetualDiscounts gaining 11bp, FixedResets down 1bp and DeemedRetractibles winning 26bp. Volatility was quite good, with BAM issues prominent at both ends of the spectrum – FixedResets on the downside, probably reflecting the new issue. Volume was heavy; RBC scored a lock-out on the reported block trading.

Assiduous Reader BG sent me a link to a NYT article Bank’s Collapse in Europe Points to Global Risks:

Among Dexia’s biggest trading partners are several large United States institutions, including Morgan Stanley and Goldman Sachs, according to two people with direct knowledge of the matter. To limit damage from Dexia’s collapse, the bailout fashioned by the French and Belgian governments may make these banks and other creditors whole — that is, paid in full for potentially tens of billions of euros they are owed. This would enable Dexia’s creditors and trading partners to avoid losses they might otherwise suffer without the taxpayer rescue.

Whether this sets a precedent if Europe needs to bail out other banks will be closely watched.

This highlights my single largest complaint about the Basel I, II, and III rules: interbank loans are risk-weighted according to the credit rating of the sovereign; the only way this makes sense is if the regulators have taken an explicit view that inter-bank bail-outs will happen.

Note that the regulators’ moronic desire to see centralized clearing for derivatives will simply make matters worse.

Interbank loans should be risk-weighted according to the credit quality of the bank – or the collateral posted – not according to the sovereign. And, what’s more, the regulators should stop their pretense at surprise when this is what happens.

Dexia is also suffering losses on about 11 billion euros ($15.3 billion) in credit insurance it has written on mortgage-related securities, the same instruments that felled A.I.G., echoing that insurer’s troubles. In this business, too, Dexia’s problems have been worsened by aggressive demands by some trading partners for additional collateral. According to a person briefed on the transactions, Goldman Sachs, one of Dexia’s biggest trading partners, has asked for collateral equal to nearly twice the decline in market value of its deals. As was the case with A.I.G., Dexia must provide the collateral when the prices of the underlying securities fall, even if they have not defaulted.

Lucas van Praag, a spokesman for Goldman, said “we have no reason to believe that Dexia will not continue to meet its contractual obligations after it is restructured.”

As for the aggressive collateral calls by Goldman, Mr. van Praag said: “Our dealings with Dexia have been perfectly normal. In an environment of widening credit spreads and increased volatility, collateral calls are to be expected.” The suggestion that Goldman has been more aggressive than Dexia’s other trading partners is “quite odd,” he said, adding: “If collateral is owed, we ask for it.”

This looks like AIG: The Sequel for Lucas van Praag, World’s Greatest Corporate Spokesman. First, Goldman was vilified for needing a bail-out when AIG went bust. Then, when they proved to the Congressional Committe that they had no exposure to AIG because they (a) were collaterallized on most of the deals and (b) had purchased CDS protection on their uncollateralized exposure, they were vilified for creating a cash drain at AIG.

As far as I can tell, Goldman is the only financial institution in the world that behaves as if somebody, somewhere, is thinking about what they’re doing.

Assiduous Reader BG points out:

….problem is the contracts called for double in collateral for the amounts that the fixed interest rate borrow cost went offside when interest rates declined so much. So, while Dexia might have successfully hedged its net interest income spread over a 10-year term, the posting of collateral in the short term seems to have destroyed the bank.

Quite right, but it all seems somewhat peculiar. If Dexia is still solvent, but the overcollateralization has made it illiquid, then this is a classic study in central banking: the ECB should give them a loan at a punitive rate. But my question is: why double collateral? That’s a pretty fierce haircut! So my guess – and it’s only a guess, I haven’t been following the Dexia story closely – is that the collateral is no damn good; that the “double collateral” being talked about is computed according to the face value of the collateral, and that when the collateral is marked to market you arrive at a much more sensible figure. Any commentary from readers more familiar with the saga than I am would be appreciated!

Sadly, the Solvency Fairy did not arrive on the weekend:

Spanish and Italian government bonds fell as Europe’s leaders struggled to convince investors they can craft an effective response to the region’s debt crisis.
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“The main disappointment was that there was no agreement on increasing the size” of the European bailout fund, said Alessandro Giansanti, a senior interest-rates strategist at ING Groep NV in Amsterdam. “Spreads will continue to widen ahead of the upcoming supply from Italy.”

Italy’s 10-year yield increased six basis points, or 0.06 percentage point, to 5.95 percent as of 4:56 p.m. in London. The 4.75 percent security due September 2021 lost 0.380, or 3.80 euros per 1,000-euro ($1,387) face amount, to 91.75. Rates on similar-maturity Spanish securities increased seven basis points to 5.55 percent.

… and tempers are fraying:

David Cameron has begun a week of intense political infighting over Europe by becoming embroiled in a furious row with Nicolas Sarkozy over Britain’s role in talks to solve the crisis enveloping the euro.

The bust-up between Cameron and Sarkozy held up the conclusion of the EU-27 summit for almost two hours, with the French president expressing rage at the constant criticism and lectures from UK ministers.

Sarkozy bluntly told Cameron: “You have lost a good opportunity to shut up.” He added: “We are sick of you criticising us and telling us what to do. You say you hate the euro and now you want to interfere in our meetings.”

Being whined at by a petulant Frenchman isn’t going to do Cameron any harm:

Mr. Cameron is in the midst of a potentially destructive political meltdown within his Tory party, whose more right-wing backbenchers are adamantly opposed to Britain’s membership in the 27-member European Union.

On Monday, Mr. Cameron is facing a private members’ bill, proposed by one of his Tory backbenchers, that would ask the government to hold a referendum asking citizens if they want Britain to withdraw from Europe.

This, the Prime Minister knows, would be disastrous: A poll this week shows that almost half of Britons would vote positively in such a vote (the EU has never been popular in Britain).

Assiduous Reader BG also sends me a link to The Little State With a Big Mess:

After decades of drift, denial and inaction, Rhode Island’s $14.8 billion pension system is in crisis. Ten cents of every state tax dollar now goes to retired public workers. Before long, Ms. Raimondo has been cautioning in whistle-stops here and across the state, that figure will climb perilously toward 20 cents. But the scary thing is that no one really knows. The Providence Journal recently tried to count all the municipal pension plans outside the state system and stopped at 155, conceding that it might have missed some. Even the Securities and Exchange Commission is asking questions, including the big one: Are these numbers for real?
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Analysts also took a close look at the projected long-term investment return for the pension system: 8.25 percent. Everything rested on hitting that target, but the state’s actuary said there was less than a 30 percent chance that would happen over the next 20 years. The board voted to lower the assumption to 7.5 percent. (Given the recent run in the financial markets, even that figure may seem optimistic.)

As a result of that change, the state’s pension shortfall instantly rose to $9 billion from $7 billion. The unions said Ms. Raimondo had manufactured a crisis.
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Then, as if on cue, Central Falls declared bankruptcy. The city’s pension fund wasn’t just underfunded. It was completely out of money. A receiver for the city sought court permission to reduce by as much as half the base pensions of retired police officers and firefighters.

Suddenly the pension crisis wasn’t an abstraction any more. The unthinkable had happened, and the odds were that it would happen again unless the state acted quickly.

Feeling smug? Don’t. Here in Toronto, we like to pretend that a garbageman can lead a nice middle class existence ($22 / hour + pension + benefits, which is not much less than a Registered Nurse gets).

The US Treasury is contemplating floating-rate or reset bonds:

The U.S., seeking to attract investors who might otherwise avoid Treasuries amid a $1.3 trillion budget deficit, is considering the sale of floating- rate notes in what would be its first new security since it began offering inflation-linked debt 14 years ago.

The Treasury Department said this month it asked Wall Street’s biggest bond dealers for recommendations on structuring securities with coupons that rise or fall with benchmark rates. Officials are scheduled to gather with the 22 primary dealers, who include Goldman Sachs Group Inc. and JPMorgan Chase & Co., on Oct. 28 as it decides whether to go further during their regular meeting that precedes each quarterly refunding.

PWF was confirmed at Pfd-1(low) by DBRS:

DBRS has today confirmed the ratings on the Senior Debt and Preferred Shares of Power Financial Corporation (PWF or the Company) at AA (low) and Pfd-1 (low), respectively. The rating trends remain Stable.
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Given an uncertain economic environment that could limit organic growth, DBRS expects that PWF will take advantage of its strong financial position to pursue small tactical acquisitions in the financial services arena. Pressures on regulatory capital adequacy could conceivably encourage a number of financial institutions to sell certain business lines at opportunistic prices, which would complement and leverage those of the Company. Achieving additional scale in Putnam through the acquisition of incremental AUM with a shared distribution channel, for example, would bring its financial results closer in line with the Company’s original targets for Putnam, while supporting broader growth initiatives. That PWF retains the ability to consider such value-added acquisitions in the current environment is a testament to its conservative financial profile and its long-term perspective.
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With a 16.9% total unconsolidated debt ratio at the end of June 2011, the Company’s capitalization remains conservative, with only modest double leverage, exercised through the use of perpetual preferred shares. If such shares are treated as permanent equity, double leverage is close to non-existent. Debt service coverage ratios are strong at over 15 times on an earnings basis and just under 8.5 times on a cash flow basis. Liquidity is also not a source of concern, with close to $525 million in cash and short-term securities at the holding company pro forma the November 1, 2011, dividend payment of close to $250 million and additional stores of liquidity at both GWO and IGM. Such retention of liquid assets in the current uncertain economic environment reflects a unified and consistent approach to risk management across the organization. Financial flexibility is additionally enhanced by the proven access by the Company and its investee companies to capital-market funding should the Company require funding for an opportunistic acquisition.

If they want to make opportunistic acquisitions, they may find themselves bidding against the banks:

Phones are ringing steadily in the offices of Canada’s big banks as capital-starved European lenders seek buyers for assets.
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For companies like Royal Bank of Canada and Canadian Imperial Bank of Commerce, which want to get bigger in the asset management business, there are plenty of tasty morsels on offer.
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And there’s a belief in some of Bay Street’s bank towers that better deals will come to those who wait – that European banks have not cut their prices as much as they will be forced to do, by the time the euro zone mess is cleaned up.

Barrie McKenna has a good piece on milkfare in today’s Globe, All farmers are equal – but some are more equal than others.

It was a day of contrasts in the Canadian preferred share market, with PerpetualDiscounts losing 3bp, FixedResets gaining 11bp and DeemedRetractibles winning 27bp. Volatility was good and skewed to the upside. Volume was heavy.

The FRB-Boston has released Public Policy Discussion Paper that will be of interest to the “Occupy” mob – Quantifying the Role of Federal and State Taxes in Mitigating Income Inequality:

Income inequality has risen dramatically in the United States since at least 1980. This paper quantifies the role that the tax policies of the federal and state governments have played in mitigating this income inequality. The analysis, which isolates the contribution of federal taxes and state taxes separately, employs two approaches. First, cross-sectional estimates compare before-tax and after-tax inequality across the 50 states and the District of Columbia. Second, inequality estimates across time are calculated to assess the evolution of the effects of tax policies. The results from the first approach indicate that the tax code reduces income inequality substantially in all states, with most of the compression of the income distribution attributable to federal taxes. Nevertheless, there is substantial cross-state variation in the extent to which state tax policies compress the income distribution attributable to federal taxes. Cross-state differences in gasoline taxes have a surprisingly large impact on income compression, as do sales tax exemptions for food and clothing. The results of the second approach indicate that there has been little change since the early 1980s in the impact of tax policy on income inequality across almost all states.

Here’s a big surprise! Even bigger writedowns on Greek debt are being discussed:

European finance ministers grappled with an assessment that Greece’s economy is deteriorating as they began a six-day battle to stave off a default and shield banks from the fallout.

A review by European and International Monetary Fund experts showed Greek bond writedowns of 60 percent and more official aid would still leave the country with a debt load bigger than its annual economic output by 2020.
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Europe’s international image is “disastrous,” Luxembourg Prime Minister Jean-Claude Juncker told reporters before the Brussels meeting. “We’re not really giving a great example of a high standing of state governance.”

It will be remembered that Jean-Claude Juncker is a liar with lying staff.

Yellen is talking about QE3:

Federal Reserve Vice Chairman Janet Yellen said a third round of large-scale securities purchases might become warranted if necessary to boost a U.S. economy challenged by unemployment and financial turmoil.

The central bank should also give “careful consideration” to Chicago Fed President Charles Evans’s proposal to tie the near-zero interest-rate pledge to specific levels of unemployment and inflation, Yellen said today in a speech in Denver.

The remarks signal Fed officials may be prepared to delve further into unprecedented monetary territory and take criticism inside and outside the central bank for expanding the balance sheet. Fed policy makers are struggling to lower unemployment that’s been stuck near 9 percent or higher for 30 months without boosting inflation that’s already close to the central bank’s long-run goal.

See? The Republicans may be on to something

Interesting competition for retail deposits in Europe:

The rate paid on new bank deposits for up to a year has climbed in Portugal to 4 percent from 2.56 percent in December and in Italy to 2.41 percent from 1.40 percent, according to data from the European Central Bank. Banco Espirito Santo SA (BES), Portugal’s biggest publicly traded bank, is offering a 4.83 percent average annual return on three-year deposits of more than 1,000 euros.

In September, Intesa Sanpaolo SpA (ISP), Italy’s second-largest bank, sold two-year bonds yielding 4.5 percent to customers transferring cash from competitors.

In Spain, the government acted in May to penalize banks that offered what it deemed to be overly aggressive deposit rates by requiring them to make extra contributions to deposit guarantee funds. Average rates for new bank deposits have held steady this year in Spain at about 2.6 percent.

That hasn’t stopped banks from competing to lure savings with products such as the commercial paper that Bankia is selling to retail clients to raise 1 billion euros. Governments, both national and regional, are in on the act after states including Catalonia and Andalusia offered bonds for sale.
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Banco Espirito said in August that it trimmed lending by 3.1 percent from a year earlier and boosted customer funds by 23 percent to bring its loan-to-deposit ratio down to 155 percent from 198 percent a year earlier. A lower loan-to-deposit ratio is a sign the bank is less reliant on sources of funding such as bond sales to fund its business.

Santander expects lending at its Spanish branch network to shrink 3 percent a year through 2013 after it brought down the loan-to-deposit ratio at the unit to 134 percent from 159 percent in 2009.

Capital Power Corporation, proud issuer of CPX.PR.A has been confirmed at Pfd-3 by DBRS:

DBRS has historically assessed CPLP’s financial profile on a stand-alone basis and, as such, deconsolidated the results of its 29.2% ownership interest in Capital Power Income LP (CPILP; rated BBB (high), Under Review with Negative Implications). The strategic review process initiated by CPILP in the fall of 2010 resulted in an agreement (the Agreement) in which Atlantic Power Corporation (ATP) will acquire all the outstanding units of CPILP. Upon closing of the transaction in early November 2011, CPLP is expected to receive total consideration of approximately $320 million for its ownership interest in CPILP, in a mix of cash, ATP shares and assets. As part of the Agreement, CPILP will sell its Roxboro and Southport facilities, located in North Carolina, to CPLP for a purchase price of $121 million (forming a portion of combined consideration received).

The PPAs for CPILP’s North Carolina plants were finalized with Progress Energy Resources Corp. in June 2011 and DBRS expects their contribution to CPLP’s earnings to be modest, although they should also reduce uncertainty. Closing of the transaction is not expected to have any impact on the ratings of CPLP or CPC, given the modest cash contribution of CPILP to CPLP, and the consideration to be received.

It was a fairly uneventful day on the Canadian preferred share market, with PerpetualDiscounts down 3bp, FixedResets up 1bp and DeemedRetractibles gaining 4bp. There was a surprising amount of volatility for such a quiet day overall, with the majority of major changes in bid price being downwards. Volume was good.

The heroes of the SEC were able to extort $280-million from Citigroup:

The SEC alleges that Citigroup Global Markets structured and marketed a CDO called Class V Funding III and exercised significant influence over the selection of $500 million of the assets included in the CDO portfolio. Citigroup then took a proprietary short position against those mortgage-related assets from which it would profit if the assets declined in value. Citigroup did not disclose to investors its role in the asset selection process or that it took a short position against the assets it helped select.

The Basel Committee on Banking Supervision has released a Progress report on Basel III implementation. With respect to Basel III implementation, Canada reports:

Draft regulation expected in May 2012 and final guidance before the end of 2012 for implementation in Q1 2013. OSFI has issued a number of public communications concerning the implementation of Basel III.

Europe remains mired in wrangling:

German Chancellor Angela Merkel has canceled a planned speech to parliament in Berlin tomorrow because of a deadlock over proposals to leverage the European Financial Stability Facility to give it more firepower, three German lawmakers said.

“It’s a disappointing development but without any concrete proposal for increasing the efficiency of the fund the chancellor can’t present a complete set of proposals tomorrow,” Norbert Barthle the ranking member of Merkel’s Christian Democratic Union party on parliament’s budget committee, told reporters. Other lawmakers confirming cancelation of Merkel’s speech were opposition members Carsten Schneider and Priska Hinz.

“The French want more money from Germany than we are prepared to shoulder,” Otto Fricke, the budget spokesman for Merkel’s Free Democratic Party ally in parliament, told reporters today.

What’s on the table? Enormous credit lines:

Europe’s bailout fund may be authorized to provide credit lines of as much as 10 percent of a country’s economy, a draft document shows.

The enhanced fund, called the European Financial Stability Facility, may be able to offer loans to countries “before they face difficulties raising funds,” the draft guidelines obtained by Bloomberg News show. Credit lines for Spain and Italy, which required European Central Bank support, could reach 270 billion euros ($371 billion).

The guidelines prompted criticism from some German lawmakers who have opposed bailout aid as France and Germany wrangled over the role of the ECB in tackling Europe’s debt crisis. Finance ministers gather in Brussels tomorrow to set a common strategy, with leaders scheduled to meet Oct. 23.
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France favors creating a bank out of the EFSF, boosting its financial clout with backing from the ECB, a proposal that Germany rejects, Finance Minister Wolfgang Schaeuble told lawmakers in Berlin this week. French Prime Minister Francois Fillon said today that the euro region should agree to use leverage to make the region’s financial support fund “massive.”

Monetizing the debt through the ECB would certainly be the easiest solution. Too bad it would also be the worst.

There’s a little bit more detail regarding Kweku Adoboli / UBS, but not much:

Prosecutors amended two of the four charges against Adoboli to indicate that records he allegedly falsified were on ETF trades. A London magistrates court today transferred the case against the 31-year-old to a criminal court where he will be expected to enter a plea on the accusations at a Nov. 22 hearing.
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UBS questioned one of Adoboli’s trades in August this year, and he “provided a good and plausible explanation,” Williams said. The bank then asked him on Sept. 13 about further trades he’d made that could expose the bank to large losses, and whether he’d told the credit-risk department. He said he hadn’t.

The following day, UBS asked him to confirm “the exact identities of the counterparties” on the trades and he didn’t respond, Williams said at the hearing today. Adoboli left the office at lunchtime and went to his apartment in east London, where he e-mailed the bank about the positions.

“The bank was anxious to have him explain,” and he returned at 3:45 p.m. and cooperated with UBS managers, the prosecutor said. The bank called the police late that night and Adoboli was taken to Bishopsgate precinct, the closest one to UBS’s London headquarters. He was cautioned about his rights and interviewed and “made no admissions,” Williams said.
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In addition to the departure of Gruebel and the co-heads of global equities, Francois Gouws and Yassine Bouhara, the bank has suspended “a number of front office staff” pending further disciplinary action, Carsten Kengeter, head of the investment bank, said in a memo to staff.

Sounds like just another case of shitty management at an investment bank keeping sloppy records. Yawn.

I hadn’t realized this before but OMERS is in the mutual fund business. Many municipal employees – particularly the 75% (?) of the populace whose objective is to think about financial planning as little as possible – would be well advised to participate.

DBRS confirmed PFR.UN at STA-2:

The main constraints to the rating are the interest rate risk of the Portfolio and the potential for capital losses and reductions in income resulting from underlying securities being called for redemption by their respective issuers.

Seems to me to be a virtual certainty that one or the other of those risks will be realized.

DBRS confirmed NA at Pfd-2:

While strong market shares in the home province remain a key strength of the Bank, the rating reflects the Bank’s regional concentration in Québec, which accounted for 68% of its revenues in 2010, up from an average of 64% over the previous four years. National’s revenue is diversified by business line: the Bank generated 48% of earnings for the first three quarters of 2011 (excluding the Other segment) from the personal and commercial banking unit, 39% of earnings from the financial markets business and 13% from its wealth management operations.

Dan Hallett writes an entertaining piece in the Globe titled BMO income fund sets yield bar unreachably high:

In his recent article, Mr. Heinzl points out that the fund’s hefty monthly cash payout – now equal to more than 9.5 per cent annualized net of fees – has been well above the fund’s longer-term returns.
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Earlier this year, I tested the BMO Monthly Income’s distribution for sustainability. I found that since the managers would have to generate more than 17 per cent annually from its stock picks that the distribution would either need to be cut or risk further eating into the fund’s principal.
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BMO insists the payout is sustainable, an assertion they base on the fund’s net inflows.

I love that last paragraph quoted – Madoff was saying the same thing.

When I think of all the agonizing that has gone into my estimates of sustainable income for MAPF, this kind of stuff drives me wild … but BMO can afford to hire more ex-regulators than I can, so I suppose it’s OK.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts winning 14bp, FixedResets up 1bp and DeemedRetractibles losing 7bp. Volatility was average, as was volume.