PrefBlog

This is getting monotonous:

Greece’s sovereign credit rating was cut three steps by Moody’s Investors Service, which said the European Union’s financing package for the debt-laden nation implies “substantial economic losses” for private creditors.

Greece’s long-term foreign currency debt was downgraded to Ca from Caa1, the ratings company said in a statement in London today. Moody’s assigned a developing outlook to the ratings and said it will re-assess the credit risk profile of any outstanding or new securities issued by the Greek government after Greece’s debt exchange has been completed.

It occurs to me … one way that the Greek government hid debt was to enter into currency swaps with a present value far different from zero at trade-time. This was not just allowable under the rules at that time, but even encouraged and everybody knew they were doing it; this made it a little harder for the politicians to say it was all the brokers’ (Goldman Sachs’) fault, but somehow they managed.

I haven’t seen anything about these things for a while. Could it be possible that lenders through a swap facility will get off scot-free?

Who wants to take responsibility for this bond market effect?

A cut in the U.S. government’s AAA grade could force investors to sell asset-backed securities tied to student loans, causing spreads to widen “significantly,” according to Citigroup Inc.

“A ratings downgrade would be a significant blow” to the $250 billion government-guaranteed sector, Citigroup analysts led by Mary Kane said in a July 22 report. “The likelihood of forced selling is elevated.”

Citigroup sees a 50 percent chance of a ratings cut this year as the U.S. struggles to reduce its long-term debt. Many investors buy student-loan securities specifically because they’re so highly rated and a U.S. government credit risk, according to analysts at the New York-based lender. Money managers with rating-based guidelines would be forced to sell into a sinking market, affecting the sector more than other asset-backed debt tied to consumers, commercial mortgages and corporate loans, they wrote.

The situation worries me. I don’t think there’s any imminent danger, and I’ve written about this before … but remember the last days of the Roman Republic. You had two parties: the “good men” and the “populists”, nominally representing basically the old traditional oligarchy and the new guys looking in, respectively. Their main political purpose was to ensure that the other party couldn’t do anything – so little got done and everybody got frustrated and angry. Then along came Julius Caesar: smart, ambitious and ruthless, who staged a coup. All the US needs is another two decades or so of log-jam, and I’ll start taking bets.

S&P revised its outlook on BAM:

• We are revising our outlook on Brookfield Asset Management to stable from negative.
• At the same time, we are affirming our ratings on the company, including our ‘A-‘ corporate credit and ‘A-2’ short-term ratings.
• We base the outlook revision on the improved operating performance and outlook in Brookfield’s operating subsidiaries. It also reflects the
  company’s continued ability to execute its asset management strategy by attracting external investment capital, while maintaining company-level cash flow coverage measures in line with our expectation for the ratings.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts winning 19bp, FixedResets up 1bp and DeemedRetractibles gaining 17bp. Volatility was minimal; volume was low.

Trader Corporations debt deal closed:

Trader Corp. late yesterday completed an offering of secured notes via sole bookrunner RBC Capital Markets, sources said. Terms were inked at the middle of talk, with a $15 million upsizing, to $290 million, after a 103 prepay option was removed from the deal, sources note. Beyond that, terms include a first call at par plus 75% of the coupon to balance the shorter-than-typical call protection on a seven-year tenor. Issuance comes under Rule 144A for life. Proceeds support the buyout of the classified-ads-magazine publisher by Apax Partners from Montreal-based Yellow Media. The assets being acquired comprise AutoTrader.ca and a roughly 30% interest in Dealer Dot Com. Yellow Media’s real-estate, employment and LesPAC.com businesses are excluded from the proposed asset sale.

Settlement is July 28, so we should soon see definitive timing of the YLO deal.

Speaking of junk, Fitch has declared default on Greece:

Fitch ratings agency declared Greece would be in temporary default as the result of a second bailout, which Athens said had bought it breathing space.

But the agency pledged to give Greece a higher, “low speculative grade” rating after its bonds had been exchanged and said Athens now had some hope of tackling its debt mountain, which most economists still expect to force a deeper restructuring in the future.
…
Ratings agencies Standard & Poor’s and Moody’s are likely to follow Fitch’s lead since banks and insurers are expected to write down the value of Greek bonds by around 20 percent, with more losses maybe to follow.

“We have long thought that the most likely outcome for Greek bondholders would be that they would take a small haircut first followed by a larger one at a later date. To give Greece a fighting chance they probably need a write down close to 65 per cent,” said Gary Jenkins, head of fixed income research at Evolution.

The default will cost a big pile of money:

Europe’s biggest banks stand to lose 20.6 billion euros ($29.7 billion) on their Greek government bonds after lenders in the region pledged to contribute to a new rescue package for Greece.

Banks will voluntarily agree to write down the value of their Greek securities by 21 percent as part of the bond exchange and debt buyback program, the Institute of International Finance said in a statement today. Europe’s 90 biggest banks hold about 98 billion euros of Greek debt, according to the European Banking Authority.

Which just goes to show: private enterprise can sometimes screw up big-time, but nobody, nobody, can screw up like government.

The Financial Post has a bit today on the TMX / Maple talks:

“If TMX and Maple got together, if they were to agree on something, whatever they agree on would probably have a better chance of passing competition reviews in Canada,” said Ed Ditmire, an analyst with Macquarie Capital in New York.

The Competition Bureau is reviewing Maple’s offer, which includes plans to integrate the Toronto Stock Exchange with the Alpha Group alternative trading system (ATS), the TSX’s largest domestic competitor.

The move would result in the combined entity controlling more than 80% of Canadian stock trading and has raised concerns it would give TMX-Alpha too much power over listing prices.

Earlier this week, the bureau requested more information to complete its review of the proposed deal.

“It is inconceivable it should be an issue for the competition bureau, given other (ATS) players such as Chi-X and PureTrading could fill any void,” said independent analyst Chris Damas.

I don’t quite understand that. How often are the banks going to have a void when they make a decisions as to where to place a limit order? I looked at the website for Chris Damas’ firm, BCMI Research, but was unable to find any performance data, so I skipped down to later in the FP article:

“It’s not as simple an issue as people let out to be,” said Thomas Caldwell, chairman of Caldwell Securities, who conceded that Maple’s competition hurdles were not insurmountable.

“It’s about some major institutions basically trying to gain control of the pricing mechanisms. So from that perspective, let’s call a spade a shovel here. It’s actually a remutualization (of the TMX) with a little bit of window dressing.”

Caldwell, who has not been shy about his opposition to the Maple offer and the nationalist rhetoric surrounding the deal, said he was “open” to Maple should the two sides find a middle ground that addressed concerns over access, pricing, and a promise by Maple’s key members to eventually reduce their ownership over time.

OK, that part I understand, except for the part about how the competition hurdles are surmountable.

Interesting bit on fiduciary responsibilities of doctors:

When you go to a walk-in clinic, instead of a hospital emergency department, your doctor gets financially dinged for it.

If that clinic billed Ontario for an intermediate assessment done on your son, for example, your doctor would lose $33.10 from his so-called access bonus because he’s in a family health network; or in a family health organization or on a blended salary model. That, however, does not give him the right to threaten to fire you from his medical practice and it is highly inappropriate for him to suggest as much.

I called Ontario’s Health Minister Deb Matthews about your question and she’s heard other stories of doctors suggesting to patients they go to an emergency instead of a walk-in clinic, though not necessarily threatening to fire them.

“That is disappointing,” Ms. Matthews says in a telephone interview, “the doctor would put their compensation ahead of the best possible care for their patient.”

Not disappointing. Expected. This is a dumb dinging system: it is the patient who should have been dinged for the $33.10. Why is it that bureaucrats always assume that everybody in the world is a Good Scout?

I recently had occasion to send some registered mail; today, when I checked to see whether it had been delivered, I was startled to see a note on the Canada Post tracking website that I should call customer service. ‘Uh-oh’, I thought, or words to that effect, ‘this can’t be good’. So I call and it turns out everything was fine – the delivery has been made, albeit one day later than I thought would be the case. So why did I have to call customer service? It seems that tracking numbers can be duplicated and when they are the computerization doesn’t work properly.

Leave it to Canada Post to carefully build a system involving eleven digit tracking numbers, and then duplicate them! Good old Canada Post, always good for a laugh!

It was a good day for the Canadian preferred share market, with PerpetualDiscounts up 6bp, FixedResets gaining 7bp and DeemedRetractibles winning 15bp. Not much volatility. Volume was low.

Here’s an interesting snippet on the Yellow / Apax / Traders’ deal:

Apax-owned Trader Media, which publishes Auto Trader, will take on £150m of additional debt to fund a dividend for the private equity firm. The new loan is the first covenant-lite package to be issued in Europe for four years, according to law firm Eversheds.
…
In order to secure lender support for its dividend, Apax has also offered to defer £50m of its dividend strip until Trader Media’s gearing –or net debt to earnings before interest, taxes, depreciation and amortisation ratio- falls below about five times, according to Mark Spinner, a partner at Eversheds.

He added that leveraged buyouts currently have an average gearing multiple in the region of three and a half to four times.

Another Apax Partners portfolio company, Dutch directories publisher Truvo, which the firm acquired alongside Cinven in 2004, issued one of the first covenant-lite debt structures in Europe in 2007. Truvo filed for bankruptcy protection last year, following two years of declining sales. The firm posted a net loss of €260.8m in 2009.

Spinner said Trader Media was not as risky an investment for banks. “Trader Media is clearly a very good company and as such is almost certainly seen as a good credit risk for the banks prepared to inject an additional £150m..

Yesterday’s rant on water prices was timely, since Willem Buiter thinks water will be bigger than oil:

I expect to see a globally integrated market for fresh water within 25 to 30 years. Once the spot markets for water are integrated, futures markets and other derivative water-based financial instruments — puts, calls, swaps — both exchange-traded and OTC will follow. There will be different grades and types of fresh water, just the way we have light sweet and heavy sour crude oil today. Water as an asset class will, in my view, become eventually the single most important physical-commodity based asset class, dwarfing oil, copper, agricultural commodities and precious metals.

Possible, but it’s equally likely that Mohammed must go to the mountain. If I were a Big Noise at one of the huge asset management shops – with so many hundreds of billions under management that it becomes possible to put serious money into tail event scenarios while retaining a prudent portfolio – I’d be looking seriously at Cleveland. Buy lots of land and water rights in Cleveland, hope to stay cash flow neutral through rentals to farmers, and wait. Detroit, too, is a place where vast quantities of Great Lakes real-estate are available at depressed prices.

Rumour are swirling that the Europeans may face reality:

Euro-area leaders may accept a temporary Greek default and widen the scope of their rescue fund as officials intensify efforts to resolve the region’s 21-month sovereign debt crisis.

With Greece being charged about 35 percent to borrow for two years, government chiefs meeting in Brussels are devising a second aid package that could tip it into default for a few days. They may also cut interest rates on loans to Greece, Portugal and Ireland to about 3.5 percent and could double the repayment time to at least 15 years.

Europe’s main rescue fund, boosted just last month to 440 billion euros ($632 billion), may be allowed to buy bonds directly from investors, help recapitalize banks and offer International Monetary Fund-style precautionary credit-lines to repel speculative attacks.

What, no subsidized daycare or aid for farmers? What kind of European rescue fund is that?

Further details are slowly coming out:

The Greek financing package will consist of 109 billion euros from the euro region and the IMF. Financial institutions will contribute 50 billion euros after agreeing to a series of bond exchanges and buybacks that will also cut Greece’s debt load, the leaders’ communiqué said.

The European Commission plans to brief reporters on the package’s technical details at 1 p.m. in Brussels.

The leaders sought to regain the initiative after market turmoil intensified amid a spat between ECB President Jean- Claude Trichet and German Chancellor Angela Merkel over how to manage the crisis. The outlook was worsened by signs that Greece was backsliding on axing its budget deficit as it struggles to cut a debt of 143 percent of gross domestic product. A Bank of America Merrill Lynch poll this week showed investors trimming their European stock holdings to the lowest in more than a year.
…
Banks will reduce Greece’s debt by 13.5 billion euros by exchanging bonds and “potentially much more” through a buyback program still to be outlined by governments, said the Institute of International Finance, a Washington-based group representing banks.

Investors will have the option to exchange existing Greek debt into four instruments. Three will be fully collateralized by AAA-rated zero-coupon securities and have a 30-year maturity, and the fourth will be for 15 years and partially collateralized by funds held in an escrow account.

Crisis managers are aiming for a 90 percent participation rate from Greek bondholders.

One wonders what the participation rate will be in bond funds sponsored by the banks!
And:

Participating investors would see on average a 21 percent reduction in the net present value of their existing Greek bonds, the IIF estimates. [ Institute of International Finance Managing Director Charles] Dallara said the effects on bank profits, balance sheets and capital structure will be handled on an institution-by-institution basis.

S&P confirmed Brookfield Renewable Power the operator and 34% owner of Brookfield Renewable Power Fund, which is the sole owner of Brookfield Renewable Power Preferred Equity Inc., which is the issuer of BRF.PR.A:

• We are affirming our ‘BBB’ long-term rating on Brookfield Renewable Power
  Inc. (BRPI).

• At the same time, we are revising our short-term rating on BRPI to ‘A-2’ from ‘A-3’, based on the ‘BBB’ long-term rating and the company’s adequate liquidity.
• The rating action follows our assessment that the company’s cash flows remain in line with our expectations despite challenging hydrology in
  2010.

• The stable outlook reflects our view that BRPI’s improved business risk profile and strong financial flexibility support the ratings despite our concerns about its high debt and resulting weak coverage measures for the ratings.

Although financial measures (both consolidated and at the company level) are weak for the ratings, we believe strong financial flexibility and its strategic relationship with its corporate
parent, Brookfield Asset Management Inc. (Brookfield; A-/Negative/A-2), mitigate this. The weak financial measures reflect BRPI’s practice of using substantial project-level debt in its operating companies or investments. Although these debts are nonrecourse to the company, they increase the variability of cash flows distributable to BRPI, as they are available only after operating needs and debt servicing requirements at the operating company level are satisfied. Exposure to hydrological risk and wholesale power price volatility, albeit reducing, also constrain the ratings.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts winning 29bp, FixedResets gaining 5bp and DeemedRetractibles up 7bp. Volume was very light.

European banks will need lots of capital:

Banks in the European Union could face fines of up to 10 percent of turnover if they fail to comply with tougher capital and liquidity rules, the bloc’s financial services chief said on Wednesday.

Michel Barnier, the EU’s internal market commissioner, unveiled draft laws in Brussels to implement the new global Basel III accord, which will force 8,200 banks in the EU to hold more and better quality capital over six years from 2013 in a bid to shield taxpayers in a future financial crisis.

Banks will have to raise 460 billion euros of extra capital to fully comply by the start of 2019, which Barnier said would hit economic growth by 0.1 percent for every 1 percent increase in capital and cut the risk of a big banking crisis by 70 percent.

One of the most amazing things about arithmetic is that ownership of a company will always total 100%:

For the second time in less than a month, a fund manager has crossed the 10 per cent ownership threshold in Sino-Forest Corp. (TRE-T4.900.6214.49%)

The latest buyer is Singapore-based Richard Chandler Corp. On Wednesday the fund manager announced that it purchased another 2.5 million shares, bringing its total ownership to 26.7 million shares, or 10.9 per cent of the company (hence the new disclosure).

This is something new: Google’s in the malware detection game:

Google Inc. has detected a “large number” of Windows-based computers infected with a specific type of malicious software, and the company behind the world’s largest search engine is warning Web users they might be affected.

“This is important,” Matt Cutts, the software engineer who leads the company’s Webspam team, wrote in a post on Tuesday night.

“If you go to Google and do a search (any word will do) right now, check to see whether you get a “Your computer appears to be infected” warning at the top of the search results,” he said in comments last edited at 8:22 p.m. ET.
…
Google security engineer Damian Menscher explained in a post to the Google blog this particular type of malware causes infected computers to reroute traffic sent to the Google homepage through a small group of intermediary or “proxy” servers.

The widespread infection was recently discovered during a routine maintenance check and confirmed by security engineers at several companies, he said.

A great source of cheap entertainment during the current drought is to wander around looking at all the neatly trimmed brown lawns – nobody wants to water their lawns any more since the city is gouging on the water rates. A neighbor tells me that a friend of hers has put down astroturf – which sounds bizarre to me, but she tells me it’s getting more popular – which stands out now, looking more like a Saharan oasis than a front lawn. So anyway, I found a reasonable-looking source for North American water rates:

The Circle of Blue survey includes data on water rates and water usage from the 20 largest U.S. cities, according to the 2000 Census, and ten regionally representative cities to gain a broad view of urban water pricing. The survey comes as municipal water departments and their customers across the country contend with the ironic and unintended consequence of the economic recession and water conservation. In most major cities water use is declining while rates charged to residential customers are rising.

The effect of the crossing trends is less severe in Chicago, Detroit and Milwaukee, where municipal water is supplied by the lakes and prices range from $24.12 to $28.36.

“The reason why rates are so low in the Great Lakes region is proximity to abundant water,” said Nick Schroeck, executive director of the Great Lakes Environmental Law Center in Detroit. “Moving water takes an extraordinary amount of energy. Energy costs are higher in arid regions where water has to be brought from far away. For us, you look at the larger cities, and they are right on one of the lakes. It’s easy to get water to the population centers.”

The city tells me that I use about 100 gallons per day (which I think is a gross exaggeration. Half a ton per day? I don’t see it.) and recently charged me about $30/month, of which about 40% is for water. So call it $12/month for 100 gallons per day of water; or, if I was four people using water at the same per capita rate, call it roughly $50 month.

Now look at the comparative figures:Chicago, $24. New York, $42; Detroit, $28. Looks like we’re getting gouged all right! Typically, the Water Department’s budget document compares Toronto’s water rates to little rinky dink neighbors that are not right on the lake, and provides no comparable figures for cities that are actually comparable (Chicago, Detroit, Cleveland …).

It was a mixed day on the Canadian preferred shares market, with PerpetualDiscounts losing 13bp, FixedResets gaining 7bp and DeemedRetractibles up 6bp. Volatility was quiet. Volume was very high.

PerpetualDiscounts now yield 5.51%, equivalent to 7.16% at the standard equivalency factor of 1.3x. Long corporates now yield about 5.2% (a little under, maybe?) so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 200bp, a widening from the 190bp reported on July 13, as yields have increased on PerpetualDiscounts and stayed put for corporates.

The BoC remains on hold:

Overall, the Bank projects the economy will expand by 2.8 per cent in 2011, 2.6 per cent in 2012, and 2.1 per cent in 2013, returning to capacity in the middle of 2012.

Total CPI inflation is expected to remain above 3 per cent in the near term, largely reflecting temporary factors such as significantly higher food and energy prices. Core inflation is slightly firmer than anticipated, owing to temporary factors and to more persistent strength in the prices of some services. Core inflation is now expected to remain around 2 per cent over the projection horizon. Total CPI inflation is expected to return to the 2 per cent target by the middle of 2012 as temporary factors unwind, excess supply in the economy is gradually absorbed, labour compensation growth stays modest, productivity recovers, and inflation expectations remain well-anchored.

The Bank’s projection assumes that authorities are able to contain the ongoing European sovereign debt crisis, although there are clear risks around this outcome.

Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at 1 per cent. To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be withdrawn, consistent with achieving the 2 per cent inflation target. Such reduction would need to be carefully considered.

Ooooh! It will have to be carefully considered! I hadn’t realized that! Thank goodness Mr. Carney is governor!

Frankly, I think the BoC is getting a little behind the curve.

The fight over BMO’s annuity continues:

A handful of the top life insurers have banded together and written a letter to the Office of the Superintendent of Financial Institutions, demanding that the regulator immediately stop Bank of Montreal from selling a product that it recently rolled out called BMO Lifetime Cash Flow.

The product provides buyers 55 and older with guaranteed payments for life. But banks are not allowed to sell most types of insurance in their branches, and the life insurance sector thinks this product is suspiciously similar to an annuity – which is one of the insurance products that are forbidden in bank branches.
…
The largest players have pooled their legal resources and crafted a detailed letter for OSFI outlining why they believe BMO’s product violates the federal Bank Act. And, they complain, the result is that banks have obtained an advantage over insurers.

That’s because BMO does not have to abide by the same capital and reserve requirements as an insurer who issues annuities, says the letter, a copy of which was obtained by the Globe.

Sure sounds like an annuity to me, although I haven’t heard BMO’s side of it. The answer, however, is not prohibition – the answer is an encouragement of specialization by the capital rules. Similarly to my belief that financial institutions should make a choice between banking and trading – and pay a surcharge on the capital charges required for activities that are outside their specialty – banks and insurers should make a choice between banking and insurance. BMO should be allowed to sell all the annuities it wants – but it should be putting up at least 25% extra capital on these products because insurance is not its specialty.

Moody’s downgraded TRE:

Moody’s Investors Service Inc. downgraded the debt of Sino-Forest Corp. Tuesday morning.

The rating agency cut the corporate family and senior unsecured debt ratings of the troubled forestry company to B1, or “speculative,” from Ba2 and said it continues to review the company for a further possible action.

The move, which affects US$1.9-billion of debt, does not come as a surprise after Moody’s indicated in early June it put Sino-Forest under review for possible downgrade and Standard & Poor’s cut its credit rating for the company on Jun. 30.

Ken Chan, a Moody’s vice-president and senior analyst, said the action reflects the ratings agency’s feeling that Sino-Forest’s operations have been negatively affected by the company’s current investigations commissioned following the research report from Muddy Waters LLC.

“Its financial performances are expected to weaken and therefore be more appropriately positioned in the single-B level,” Mr. Chan said, adding, “The company’s ability to access external funding from the bank and capital markets is also significantly and adversely affected in the interim.”

Moody’s also put five states on Review-Negative:

Five of the 15 states with top bond ratings from Moody’s Investors Service may be downgraded because their dependence on federal revenue makes them vulnerable to a U.S. credit cut should talks to raise the debt limit fail.

Maryland, New Mexico, South Carolina, Tennessee and Virginia are under review, New York-based Moody’s said in a statement today. The action affects $24 billion of general- obligation and related debt, Moody’s said. The states are rated Aaa, Moody’s top municipal grade.

Tara Perkins of the Globe reports that no Canadian banks are G-SIFIs:

No Canadian banks are currently considered “systemically important,” this country’s financial regulator says.
…
No Canadian banks are on the current list of 28 banks that made the cut (an honour that institutions do not want, since it means tougher requirements), says a spokesman for the Office of the Superintendent of Financial Institutions.

Most observers didn’t expect any of the Canadian banks to be on the list, although there has been some debate about Royal Bank of Canada, the country’s largest.

But OSFI notes that the process of determining which banks are on the list is dynamic, because inputs such as size are constantly changing for all banks.

Every day, a little freedom is eroded:

Sorry, parents, but no little Lucifers will be entering this world. Not in New Zealand, anyways.

The country’s Registrar of Births, Deaths and Marriages is cracking down on parents who want to give their little bundle of joy names that are too creative.

It effectively banned the name Lucifer after getting the request from not one, not two but three parents.

Funny, I thought it was the Registrar’s job to record things, not to judge whether or not the parents were looney-tunes. But I guess I’m old fashioned.

It was a positive day for the Canadian preferred share market, with PerpetualDiscounts up 4bp, FixedResets winning 10bp and DeemedRetractibles gaining 6bp. Volatility was low. Volume was average.

Bloomberg editorialized on the European stress test:

What most undermines the credibility of this latest attempt to calm Europe’s financial fears — the third in three years — is that a sovereign-debt default wasn’t among the worst-case scenarios under consideration, even though credit-default swaps already indicate an 87 percent chance that Greece won’t be able to repay its debts. Instead, European authorities looked at the ability of banks to endure an economic contraction of 0.5 percent — in other words, a mild recession — as well as a 15 percent stock-market decline, rising unemployment, a drop in housing prices and trading losses on government debt.

Even so, the unprecedented publication of bank data is laudable. It represents a much-needed step toward improving transparency in an otherwise opaque financial system that has yet to recover from the 2008 collapse of Lehman Brothers Holdings Inc. As analysts pore over the data in the days ahead, investors will finally be able to get a sense of how much of a capital buffer each bank has, and what profitability estimates look like for each in 2011 and 2012. The size and maturities of sovereign-debt holdings by all 90 banks, spread over 21 countries, have also been laid bare, allowing analysts and investors to run their own tests and identify the laggards.

And similar criticism is piling up:

European banks may have to raise as much as 80 billion euros ($113 billion) of additional capital as the stress tests failed to allay investor concern about a Greek default and governments’ ability to bail out their lenders.

The eight out of the 90 banks that failed the July 15 tests had only a combined capital shortfall of 2.5 billion euros, the European Banking Authority said July 15. As many as 20 banks need to bolster capital, JPMorgan Cazenove analysts led by Kian Abouhossein wrote in a report after the results were published.

Regulators didn’t include a Greek default in the tests even though credit default swaps indicate investors see an almost 90 percent chance of one. The EBA included a 25 percent writedown on 10-year Greek government bonds held in banks’ trading books even as the securities trade at about 51 cents on the euro. The exams won’t succeed in reassuring investors until governments put in place a mechanism to stop failing banks weighing on public funds, said Gary Greenwood, an analyst at Shore Capital.

Governments adore the idea of voluntary cooperation:

Germany is insisting private investors be involved in the second bailout, and Merkel indicated on Sunday that if they did not voluntarily agree to a major contribution now, they might eventually be forced into a more costly solution to the crisis.

“The more we can involve private creditors now on a voluntary basis, the less likely it is that we will have to take next steps,” Merkel told public broadcaster ARD without elaborating on what those steps might be.

There is now incentive to get married:

Canadian women in growing numbers are making more money than their husbands, after three decades of gains in post- secondary education and professional jobs. About 31 percent of wives made more than their husbands in 2009, up from 12 percent in 1976, according to the most recent data from Statistics Canada.

Dealbreaker has an entertaining post on the efforts to eliminated credit ratings:

These rules are a consequence of some half-baked thinking that went into Dodd-Frank. Yes, investors relied too much on ratings and didn’t do enough of their own credit work in evaluating bonds and the balance sheets of banks that held them. But that’s hard to fix by just regulating that everyone should do better credit work. The SEC’s proposed rules are a clever compromise, paying pages of lip service to the idea that everyone should think deeply about the creditworthiness of all of their assets while in practice giving brokers a fair amount of leeway to rely on easy-to-read external indicators like ratings and spreads. Particularly with the addition of SIFMA’s friendly amendment, the SEC may be able to follow Congress’s instructions without doing much to change how brokers calculate capital. Which, y’know, will be great until the next crisis in highly rated debt instruments.

It’s easy to criticize credit ratings and the agencies. It’s not so easy to do a better job.

The capital surcharge on globally important banks moved closer to reality:

Global regulators have backed Basel plans that would force banks judged too big to fail to hold as much as 2.5 percentage points in additional capital, as part of efforts to prevent them from collapsing and causing another financial crisis.

The Financial Stability Board said that the extra requirements are necessary because of the threat such lenders would pose to the global economy if they failed. Regulators also endorsed measures including bondholder writedowns to shield taxpayers from bank bailouts.

Systemically important banks will face “capital surcharges of between one and 2.5 percent,” Mario Draghi, the board’s chairman, told reporters after the meeting in Paris today.

I don’t like it – too many edge effects, too much scope for lobbying and corruption. A standard, progressive surcharge on banks based on their Risk Weighted Assets and the size of the national banking sector relative to GDP would be much better.

Speaking of bank capital…:

Bank of America Corp. (BAC) may have to build its capital cushion by $50 billion and renege again on Chief Executive Officer Brian T. Moynihan’s pledge to raise the firm’s dividend as mortgage losses drain funds.

Expenses tied to soured home loans may total $20.4 billion in the second quarter, pulling the bank further from capital ratios demanded under new international standards, the Charlotte, North Carolina-based company said June 29. The gap may equal 2.75 percent of risk-weighted assets starting in 2013 — at about $18 billion for each percentage point — crimping Moynihan’s ability to raise dividends and repurchase shares.

DBRS confirmed IAG:

Strategically, the Company is challenged to achieve growth as a mid-sized competitor in a relatively concentrated market where competitive scale is critical. The three largest Canadian life insurance companies control between 60% and 70% of the market in most product lines, forcing IAG to distinguish itself in very specific market niches, where it can exercise a competitive advantage while also pursuing the goal of growth and diversification. The Company has been focused on broadening its product exposure in the Canadian financial services market to include a larger proportion of wealth management products and enhancing its geographic diversification to include the United States and the non-Québec Canadian market. A conscious decision to pursue a multichannel distribution strategy has facilitated this diversification strategy, with a career sales force serving Québec and independent brokers and managing general agents (MGAs) serving the balance of the Company’s markets. Nevertheless, the Company remains disproportionately exposed to the Canadian market and to universal life insurance specifically, which represented 54% of its individual life insurance sales in 2010. Universal life is in turn more highly exposed to interest rate and equity market risks.
…
The Company balances its market vulnerability with a more conservative risk tolerance. For example, IAG’s product design and actuarial assumptions with respect to mortality, reinvestment rates and equity market returns are sufficiently conservative that there is a large cushion available to protect Company earnings in the event of adverse market experience, as seen in the 2008–2009 financial crisis, when the Company came through better than most of its competitors. To mitigate its exposure to low interest rates, the Company has increased the portion of equities backing its liabilities, albeit assuming a higher capital charge as a result. The Company retains a higher proportion of mortality risk than its peers rather than reinsuring it since it is confident that the long-term improvement in mortality will ultimately accrue to the Company’s benefit given the Company’s relative exposure to individual life insurance liabilities. Investment policies are similarly conservative in order to minimize the Company’s capital charge and market exposures.

DBRS confirmed TD:

At the end of Q2 2011, the Bank’s tangible common equity-to-risk-weighted assets ratio, as determined by DBRS, was 8.9%, while the Basel II Tier 1 capital ratio was 12.7%. Although these ratios are at the lower end relative to its Canadian bank peers, it compares favourably with historical levels. As the Canadian banking regulator moves toward the application of Basel III capital rules, TD is in a good position given its capital levels. DBRS’s expectation is for ongoing strength in capital during the period prior to the implementation of Basel III.
…
TD has five segments: four operating lines of business and the Corporate segment. The operating businesses are Canadian Personal and Commercial Banking (Canadian P&CB), U.S. Personal and Commercial Banking (U.S. P&CB), Wealth Management and Wholesale Banking, representing 55%, 20%, 12% and 13%, respectively, of adjusted net income (excluding intangible amortization and the Corporate segment) in H1 2011. Retail businesses (i.e., Canadian P&CB, U.S. P&CB and Wealth Management) generated approximately 87% of earnings in H1 2011. This percentage has been at this level since 2008, which is consistent with TD’s objective to minimize earnings volatility through its strategy of achieving a higher proportion of earnings through retail operations.

DBRS commented on MFC’s asset sale:

DBRS notes that Manulife Financial Corporation (Manulife or the Company) has today announced that it has entered into an agreement to sell its Life Retrocession business to Pacific Life Insurance Company (Pacific Life). There are no rating implications at this time.

DBRS notes that the Life Retrocession sale is expected to result in an after-tax gain of approximately $275 million for Manulife. The sale is expected to increase the Minimum Continuing Capital and Surplus Requirements (MCCSR) ratio of Manulife’s operating subsidiary, The Manufacturers Life Insurance Company, by approximately six percentage points. This MCCSR ratio was 243% as of March 31, 2011. Given Manulife’s higher relative market exposure to the equity markets and the current uncertain economic environment, DBRS regards the Company’s maintaining higher regulatory capital ratios as prudent until its risk-reduction targets are more fully achieved.

The Life Retrocession business was a non-core business for Manulife that did not have a lot of growth potential, in part because of the fact that competitors in other jurisdictions have an advantage as a result of less restrictive capital requirements. The proposed sale is consistent with the Company’s strategy to achieve a better balance of risk exposures while focusing on more profitable and capital-efficient products, with a stronger component of fee-based revenues. The transaction is subject to standard closing conditions, including receipt of regulatory approvals, and is expected to close during the third quarter of 2011.

It was a positive day for the Canadian preferred share market, with PerpetualDiscounts up 2bp, FixedResets up 2bp and DeemedRetractibles winning 15bp. Volatility was good. Volume was average.

Eight European banks failed their stress test:

Eight banks failed the European Union stress tests after regulators said they had a combined capital shortfall of 2.5 billion euros ($3.5 billion).

The banks were found to have insufficient reserves to maintain a core tier 1 capital ratio of 5 percent in the event of an economic slowdown, the European Banking Authority said.

The assessments are the first by the European Banking Authority since it was set up earlier this year. Last year’s tests by its predecessor were criticized for not being tough enough because banks were shown to need only 3.5 billion euros more capital, a 10th of the lowest analyst estimate. Banks that fail the stress test must present a plan to raise more capital within three months.
…
Rating company Standard & Poor’s own stress test, published in March, found European banks would need as much as 250 billion euros in fresh capital if faced with a “sharp” increase in yields and a “severe” economic downturn. In contrast, a survey of 113 investors by Goldman Sachs Group Inc. (GS) last month showed they expect banks to raise 29 billion euros after the tests.

It is not clear just how stressful the tests were – the last batch involved a rise in government yields, but no defaults – which was a rosy projection even at the time.

This test included what are referred to as write-downs on EU government bonds:

European Union regulators’ stress tests on the region’s banks include a 25 percent writedown on Greek government bonds. The market has already driven down the price of 10-year Greek debt to 52 cents on the euro.

Regulators didn’t include the possibility of a sovereign default in the tests even though credit-default swaps indicate about an 87 percent chance that Greece won’t be able to repay its debts. The tests included a 22.3 percent writedown on Portuguese 10-year securities, while they currently trade at 54 cents per euro.

“Current market expectations regarding sovereign risk are not incorporated in the tests,” Hank Calenti, a bank strategist at Societe Generale (GLE) SA in London, wrote in a note to clients today.

… but it is not clear to me whether these were actually write-downs, or merely market value adjustments (which affect the trading book but not the banking book). Last time ’round, the test included only a temporary decline in the market value of government debt, not a permanent impairment.

There is more discussion from the Peterson Institute:

Second, and perhaps more importantly given the importance of “tail-end events” for bank stress tests, it remains unclear what the “sovereign risk shock” will entail in terms of assumed haircuts for sovereign bonds. Here it is clear that the stress test focus on “a shock on [government bond] interest rates” in its sovereign component is a clever way to avoid explicitly stating the politically explosive number for just how large a haircut on sovereign bonds banks should be expected in the EU “adverse scenario.” On the other hand, as anyone can calculate the “implied bond haircut” from the assumed increase in the interest rate, the avoidance of any explicit reference to a default is clearly a political exercise.
…
Several “press leaks” suggest that differentiated haircuts are being assumed in the EU stress tests, with some reports stating that Greek bonds will suffer a 17 percent haircut and Spanish bonds 3 percent. Other reports suggest that the implied Greek haircut could be 20 percent, 8 percent for Spanish bonds and 5 percent for Portugal.

C-EBS states merely:

The exercise also envisages adverse conditions in financial markets and a shock on interest rates to capture an increase in risk premia linked to a deterioration in the EU government bond markets.

… which is not the same thing as a default. This is more than just a little disingenuous. There is more than one dimension of risk in bonds, and recent prices are clearly a reflection of credit, not interest-rates.

So the Europeans will do what they do best:

Eurozone leaders will meet in Brussels on July 21 to discuss a second bailout package for Greece and the financial stability of the euro area, European Council President Herman Van Rompuy said on Friday.

The summit, which will start at 1000 GMT, could prove a critical moment in determining what role private sector creditors play in further aid to Greece, and how EU leaders will stem the threat of debt contagion to Italy and Spain.

“Our agenda will be the financial stability of the euro area as a whole and the future financing of the Greek program,” Van Rompuy said in a statement posted on Twitter.

“I have asked the preparatory work to be brought forward inter alia by the finance ministries,” he said, indicating that senior finance officials would meet ahead of time, probably on Wednesday July 21, to agree the agenda.

There’s an ownership change for Betapro:

Jovian Capital Corp. announced Friday it will sell its stake in exchange traded funds business BetaPro Management Inc. to a South Korean firm, confirming plans hinted at last week.

Seoul-based Mirae Asset Global Investments Co. will acquire Jovian’s approximately 58% interest in the ETF business, among other things, based on an enterprise value of about $150-million. Jovian’s portion of the purchase price is expected to be about $90-million.
…
The Mirae deal includes: Jovian’s interest in BetaPro; AlphaPro Management Inc. (a subsidiary of BetaPro); BetaPro’s 40% interest in BetaShares Holdings Pty. Ltd. (the parent company of an Australian ETF company); Jovian’s wholly owned subsidiary Horizons Exchange Traded Funds Inc.; and Jovian’s wholly owned subsidiary JovInvestment Management Inc.

Jovian’s interest in ETF manager Hahn Investment Stewards & Co. Inc. is not part of the deal.

The amazing thing about this business is that you only have to make one good, well-publicized market forecast to be set up for life (if they’re not well publicized, you just talk about it all the time; then it will be well-publicized to your clients). The latest example is Meredith Whitney:

Time is running out on the credibility of Meredith Whitney, who has yet to acknowledge that her eight-month-old prediction of widespread defaults this year in the market for state and local government debt is proving unfounded.

Defaults fell 60 percent in the first half of 2011 compared with the same period last year, including a $12.5 million Austin, Texas, apartment project that made a late payment in June, according to Distressed Debt Securities Newsletter.

Whitney, the analyst who rose to prominence by predicting Citigroup Inc.’s 2008 dividend cut, predicted “hundreds of billions of dollars” of municipal defaults within 12 months in a Dec. 19 “60 Minutes” broadcast, fueling a wave of selling in the $2.9 trillion market. Instead, the number has fallen as cities slashed spending to balance budgets and state lawmakers stepped in to guard against insolvency and local bankruptcies.
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Whitney, 41, who started New York-based Meredith Whitney Advisory Group LLC in 2009 after leaving Oppenheimer & Co., predicted 50 to 100 “sizable” municipal defaults as states slashed spending, in the interview with CBS Corp.’s “60 Minutes.” As for timing, she said it would be “something to worry about within the next 12 months.”

“There’s absolutely nothing about our thesis that has changed,” she said on July 12 in an interview with Tom Keene on Bloomberg Radio’s “Bloomberg Surveillance” show in New York. “There are not enough revenues to go around and service all of the debt obligations or debt commitments outstanding.”

Whitney also sought to amend her prediction in the radio interview, saying that she said in December “you’d start to see defaults within 12 months.” She didn’t respond to telephone calls and e-mails seeking additional comment.

DBRS confirmed RBC:

The Bank’s ratings are underpinned by its highly diversified business model. This is reflected in its resilient performance, generating average annual ROE of 17.6% since 1994 and a minimum annual ROE over this same period of 11.9% (2009). RBC’s diversified model consists of a superior domestic franchise, growing international businesses (wealth management and capital markets) plus solid credit and financial risk profiles.
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The Bank’s operations are divided into six segments: Canadian Banking, Wealth Management, Insurance, International Banking, Capital Markets and Corporate Support, which represented 51%, 13%, 6%, minus 2%, 32% and minus 1% of pre-tax earnings in H1 2011, respectively.

CIBC has bought a 41% interest in American Century Investments:

CIBC (TSX: CM) (NYSE: CM) announced today that it will acquire a 41% equity interest in American Century Investments, a major U.S. asset management company with US$112 billion under management and a track record of solid earnings and strong investment performance. Total consideration is US$848 million. The 100% cash transaction will be immediately accretive and CIBC’s share of American Century earnings is expected to contribute approximately 15 cents per share of earnings in 2012 on a cash basis.

CIBC is purchasing the minority interest held by JP Morgan Chase & Co. pursuant to a shareholder agreement using a pre-determined valuation methodology conducted by an independent third party.

According to the investor presentation, American Century is:

• Ranked 3rd among its peer group by Morningstar with 65% of assets holding four- or five-star ratings
• 84% of rated funds in first or second quartile rankings by Lipper
• Named “Best Large Mutual Fund Company” by Lipper in 2009

The emphasis on “assets” in the first point is interesting, since the similar statistic for CIBC Asset Management is presented by number of funds. Figures don’t lie, but liars can figure! I note that five out of nine 5-star funds are from the “LIvestrong” class, which are target date funds and another is the Zero-Coupon 2015 Fund.

According to Bloomberg:

Kansas City-based American Century, founded in 1958, has $112 billion in assets under management and was named the “Best Large Mutual Fund Company” at the 2009 Lipper Fund Awards. American Century’s majority shareholder is the Stowers Institute for Medical Research.

American Century is known for its focus on growth stocks, or shares in companies whose profit is expected to grow faster than the broader market, fund industry consultant Geoff Bobroff said in a telephone interview.

The growth-oriented American Century Ultra Fund (TWCUX) was once considered the company’s flagship product, Bobroff said. Its assets have fallen from $23.8 billion in 2004 to $6.5 billion as of June 30. Ultra has returned 5.3 percent annually in the past five years, beating 64 percent of competing funds, Bloomberg data show.

“One has to puzzle over why CIBC would want a minority stake, unless it saw the opportunity to either buy more or use American Century as a platform for the entry of its own products into the U.S.,” Bobroff said.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts up 8bp, FixedResets losing 14bp and DeemedRetractibles winning 23bp. Volatility was fair, volume was average-to-sub-par.

Fitch had better prepare for a crowd of sans culottes shouting ‘a la lanterne’:

Greece’s credit rating was cut three levels to Fitch Ratings’ lowest grade for any country in the world as the company followed rivals and said that a default is a “real possibility.”

The move to CCC from B+ “reflects the absence of a new, fully funded and credible” program by the International Monetary Fund and the European Union, the ratings company said yesterday in a statement in London. It also reflects “heightened uncertainty surrounding the role of private creditors in any future funding, as well as Greece’s weakening macroeconomic outlook.”

BIS continues its drive to make finance a cooperative game with its release of a Report on asset securitisation incentives:

The Report recognises regulators can play a role in establishing a framework for securitisation that ensures that it is conducted in a prudent manner, continues to be an alternative funding source for institutions, and contributes to the availability of credit to support the real economy. They can do this by building a regulatory and supervisory framework which addresses the misaligned incentives and conflicts of interest and which supports enhanced disclosure and transparency for investors. The Report encourages policy makers, regulators and supervisors to strive for internationally and cross-sectorally consistent supervisory frameworks, and to develop and implement regulations in a timely manner. The Report further sets out three recommendations (some of which build on earlier work of Parent Committees). These recommendations specify that:

• Authorities should employ a broad suite of tools to address misaligned incentives, which may include measures to improve loan origination standards, and to align compensation arrangements with long-term performance and asset quality.
• Authorities should encourage markets to improve transparency to ensure that investors, other market participants, and supervisors have access to relevant and reliable information.
• Authorities should encourage greater document standardisation and less product complexity, which should assist in reducing information asymmetries and stimulating liquidity in secondary securitisation markets.

OSFI is requiring quarterly disclosures of new information:

Enhancements to the Basel II Framework strengthen disclosure requirements under Pillar 3 in several key areas, including: securitisation exposures in the trading book; sponsorship of off-balance sheet vehicles; resecuritisation exposures; and, pipeline and warehousing risks with regard to securitisation exposures. Revisions to the Basel II Market Risk Framework incorporate additional disclosure requirements under Pillar 3 including disclosures on the incremental risk capital charge, the comprehensive risk capital charge and the stressed value-at-risk (VaR) requirement
…
Further, while the Basel II text5 indicates that qualitative disclosures that provide a general summary of a bank’s risk management objectives and policies, reporting systems and definitions may be published on an annual basis, it is OSFI’s view that the qualitative disclosures enable investors and other users of financial statements to have a better understanding of the quantitative disclosures that are required in quarterly reports. As such, OSFI expects that the first quarter of fiscal 2012 disclosures should include full qualitative disclosures in Pillar 3 enhancements and revisions to complement the required quantitative disclosures.

These enhancements are described in the BCBS document Revisions to the Basel II market risk framework. It is noteworthy that the BCBS has entirely missed the whole point of the credit crisis: the aging of trading inventory. If a bank has a significant position in its trading book that it hasn’t turned over in three months, I want to know that. And if they’ve got stuff in their trading book that they haven’t turned over in a year … well then, that’s not really trading inventory, is it? That’s banking, not trading.

Tim Kiladze of the Globe noted that, in contrast to the European ETFs discussed on July 11, Canadian ETFs are less risky, and less profitable:

Because most Canadian ETFs are more vanilla, the fees earned are lower. Generally, for low cost products, ETF providers here will earn 5 to 7 basis points, while higher cost products bring in 20 to 30 basis points. Leveraged ETFs can earn more because they typically charge higher management fees that typically range from 1 to 1.25 per cent.

Those numbers differ drastically from Deutsche Bank’s report, which estimated profits around 60 basis points for traditional ETFs. Mr. Seif said that the big difference between North America and Europe is that the securities held in ETFs here don’t earn much money by the way of securities lending. The Deutsche Bank report’s authors estimated 26 basis points on securities lending.

Why such a big difference? In Europe, investment banks are the big providers of ETFs, with everyone from UBS to Deutsche Bank to Credit Suisse selling their own suite of products. Here in North America, the big ETF providers are largely independent fund management firms such as Claymore, Horizons BetaPro, Vanguard and State Street.

The NYSE / Deutsche Bourse deal is basically done, with a minimum of cry-babyism. Speaking of crybabies, the milkfare bums are whining about competition.

DBRS confirmed BNS:

Other acquisitions, albeit more modest, include an advisor to ultra-high net worth clients and their families and a few global wealth management divisions. BNS has also been expanding its insurance offering by introducing new products and building additional retail insurance centres. DBRS expects Scotiabank will continue to expand its wealth management businesses in order to maintain proportional growth among its other segments such that the risk profile of the Bank does not materially change in the medium term. Global Wealth Management accounted for 15% of pre-tax earnings (excluding the gain related to the write-up of the original investment in DundeeWealth Inc. and the Other segment) in H1 2011.
…
Scotiabank has a significant cost advantage relative to its Canadian banking peers. Although this differential has been narrowing over the last few years, it nevertheless is a key success factor and a contributor to earnings growth. Since 2000, except for one year, Scotiabank has had the lowest expense ratio of the largest five Canadian banks.

It was a quiet day for the Canadian preferred share market, with PerpetualDiscounts up 1bp, FixedResets down 1bp and DeemedRetractibles gaining 10bp. Volatility was low. Volume was slow.