Interesting External Papers

Carney, Haldane, Swaps

Let’s say you sit on the Public Services Board of a seaside town; one of the things your board does is hire lifeguards for the beach.

One day, a vacationer drowns. You do what you can for the family and then haul the lifeguard on duty up in front of a committee to see why someone drowned on his watch.

“Not my fault!” the lifeguard tells you “He didn’t know how to swim very well and he went into treacherous waters.”

So what do you do? Chances are that you scream at the little twerp “Of course he went into treacherous waters without knowing how to swim well, you moron. That’s what vacationers do! That’s precisely why we hired you!”

Reasonable enough, eh? You’d fire the lifeguard if that was his best answer.

So why are we so indulgent with bank regulators? The banks were stupid. Of COURSE the damn banks were stupid. That’s what banks are best at, for Pete’s sake! We KNOW that. If they weren’t stupid, we wouldn’t need regulators, would we?

Which is all a way of saying how entertaining I find the bureaucratic scapegoating of banks in the aftermath of the crisis.

In my post reporting Carney’s last speech, I highlighted his reference to a speech by Haldane:

These exposures were compounded by the rapid expansion of banks into over-the-counter derivative products. In essence, banks wrote a series of large out-of-the-money options in markets such as those for credit default swaps. As credit standards deteriorated, the tail risks embedded in these strategies became fatter. With pricing and risk management lagging reality, there was a widespread misallocation of capital.

footnote: See A. Haldane, ―The Contribution of the Financial Sector—Miracle or Mirage?‖ Speech delivered at the Future of Finance Conference, London, 14 July 2010.

An interesting viewpoint, since writing a CDS is the same thing as buying a bond, but without the funding risk. I’ll have to check out that reference sometime.

I have now read Haldane’s speech, titled The contribution of the financial sector – miracle or mirage?, and it seems that what Haldane says is a bit of stretch … and the interpretation by Carney is a bit more of a stretch.

Haldane’s thesis is

Essentially, high returns to finance may have been driven by banks assuming higher risk. Banks’ profits, like their contribution to GDP, may have been flattered by the mis-measurement of risk.

The crisis has subsequently exposed the extent of this increased risk-taking by banks. In particular, three (often related) balance sheet strategies for boosting risks and returns to banking were dominant in the run-up to crisis:

  • increased leverage, on and off-balance sheet;
  • increased share of assets held at fair value; and
  • writing deep out-of-the-money options.

What each of these strategies had in common was that they generated a rise in balance sheet risk, as well as return. As importantly, this increase in risk was to some extent hidden by the opacity of accounting disclosures or the complexity of the products involved. This resulted in a divergence between reported and risk-adjusted returns. In other words, while reported ROEs rose, risk-adjusted ROEs did not (Haldane (2009)).

I don’t have any huge problems with his section on leverage. The second section makes the point:

Among the major global banks, the share of loans to customers in total assets fell from around 35% in 2000 to 29% by 2007 (Chart 29). Over the same period, trading book asset shares almost doubled from 20% to almost 40%. These large trading books were associated with high leverage among the world’s largest banks (Chart 30). What explains this shift in portfolio shares? Regulatory arbitrage appears to have been a significant factor. Trading book assets tended to attract risk weights appropriate for dealing with market but not credit risk. This meant it was capital-efficient for banks to bundle loans into tradable structured credit products for onward sale. Indeed, by securitising assets in this way, it was hypothetically possible for two banks to swap their underlying claims but for both firms to claim capital relief. The system as a whole would then be left holding less capital, even though its underlying exposures were identical. When the crisis came, tellingly losses on structured products were substantial (Chart 31).

… which is all entirely reasonable and is a failure of regulation, not that you’ll see anybody get fired for it.

The third section mentions Credit Default Swaps:

A third strategy, which boosted returns by silently assuming risk, arises from offering tail risk insurance. Banks can in a variety of ways assume tail risk on particular instruments – for example, by investing in high-default loan portfolios, the senior tranches of structured products or writing insurance through credit default swap (CDS) contracts. In each of these cases, the investor earns an above-normal yield or premium from assuming the risk. For as long as the risk does not materialise, returns can look riskless – a case of apparent “alpha”. Until, that is, tail risk manifests itself, at which point losses can be very large. There are many examples of banks pursuing essentially these strategies in the run-up to crisis. For example, investing in senior tranches of sub-prime loan securitisations is, in effect, equivalent to writing deep-out-of-the-money options, with high returns except in those tail states of the world when borrowers default en masse. It is unsurprising that issuance of asset-backed securities, including sub-prime RMBS (residential mortgage-backed securities), grew dramatically during the course of this century, easily outpacing Moore’s Law (the benchmark for the growth in computing power since the invention of the transistor) (Chart 32).

A similar risk-taking strategy was the writing of explicit insurance contracts against such tail risks, for example through CDS. These too grew very rapidly ahead of crisis (Chart 34). Again, the writers of these insurance contracts gathered a steady source of premium income during the good times – apparently “excess returns”. But this was typically more than offset by losses once bad states materialised. This, famously, was the strategy pursued by some of the monoline insurers and by AIG. For example, AIG’s capital market business, which included its ill-fated financial products division, reported total operating income of $2.3 billion in the run-up to crisis from 2003 to 2006, but reported operating losses of around $40 billion in 2008 alone.

I have a big problem with the concept of CDSs as options. Writing a Credit Default Swap is, essentially, the same thing as buying a corporate bond on margin. If the CDS is cash-covered, the risk profile is very similar to a corporate bond, differing only in some special cases that did not have a huge impact on the crisis.

You can, if you squint, call it an option, but only to the extent that any loan has an implicit option for the borrower not to repay the debt. If you misprice that option – more usually referred to as default risk – sure, you will eventually lose money.

But AIG’s big problem was not that it wrote CDSs, it was that it wrote far too many of them; it was effective leverage that was the big problem. And the potential for contagion if AIG fell was not so much the fault of the manner in which the deals were structured as it was the fault of the banks for not insisting on collateral, and the fault of the regulators for not addressing the problem with uncollateralized loans.

So Haldane’s thir point is more than just a little shaky, and Carney’s use of this to state that derivative use by banks was a contributing factor to the Panic of 2007 is shakier.

Market Action

September 15, 2010

OSFI has released its annual performance assessment:

A total of 49 one-on-one interviews were conducted among Chief Executive Officers (CEOs), Chief Financial Officers (CFOs), Chief Risk Officers (CROs), Chief Compliance Officers (CCOs), other senior executives, auditors and lawyers of deposit-taking institutions regulated by OSFI.

The regulated profess that the regulator is doing a great job!

Maple bonds issues are picking up:

Maple issuance may accelerate to C$6 billion ($5.8 billion) to C$8 billion next year, according to Greg McDonald, vice president and director of debt capital markets at Toronto- Dominion Bank’s TD Securities unit. The rest of this year may see an additional C$1 billion to C$1.5 billion in the Canadian dollar-denominated foreign debt, adding to the C$2.4 billion raised since January, he said.

Sales of Maple bonds, nicknamed after the leaf on the Canadian flag, surpassed the C$1.37 billion raised in all of 2009 in April, according to data compiled by Bloomberg. There haven’t been any Maple sales since July, when National Australia Bank Ltd. and Nederlandse Waterschapsbank NV raised C$600 million from two issues, as concern of a global economic slowdown drove investors to the refuge of government debt.

Would you like to diversify your fixed income portfolio with some Maples? Tough. The regulators say you’re too damn stupid for them to allow such a thing.

Subsidies to solar power lobbyists are continuing:

Prices for photovoltaic panels that convert sunlight into electricity may fall about 10 percent next year, less than analysts forecast, as European demand increases.

First-quarter prices will drop to an average of $1.65 a watt compared with $1.50 in the previous median estimate of five analysts surveyed by Bloomberg News. Analysts who contributed to the surveys included John Hardy at Gleacher & Co. in Connecticut and Sanjay Shrestha at Lazard Capital Markets. This year, contracts may average $1.80 to $1.85 a watt, they forecast.

Developers have rushed to complete solar-energy projects ahead of planned declines in government incentives in Germany and Spain. At the same time, smaller markets expanded in France, the Czech Republic and the U.S. Increased orders will extend to 2011, when the analysts forecast sales to increase 20 percent.

Demand growth in Europe and North America will outpace higher production in Asia, Hardy and Shrestha said.

Evidence of currently reduced supply can be found in inventories and in some order terms.

Julie Williams, Chief Counsel for the OCC testifed on covered bonds:

Another important component of a statutory covered bond program is the types of assets eligible to collateralize the covered bonds. Typically, in Europe, covered bonds are associated with high quality assets comprised of residential or commercial mortgage loans and public-sector debt. While some have advocated a broad statutory spectrum of U.S. asset types, including credit card, student, small business, and auto loans, more recent proposals have tended to narrow the eligible asset classes.

Various types of standards could be embodied in a covered bond regulatory framework. For example, all covered bonds, by asset class, should have minimum eligibility criteria setting asset quality standards to promote the inclusion of high quality assets in the cover pool. Most European jurisdictions prescribe asset quality criteria for the assets subject to the statutory covered bond program. Those standards in the U.S. could be set by statute or by the covered bond regulators through rulemaking. Given the likely detail involved, regulatory standards seem preferable.

Covered bond legislation could authorize the covered bond regulators to establish minimum overcollateralization requirements for covered bonds backed by different eligible asset classes. As a related standard, legislation also could set forth a framework requiring each cover pool to satisfy an asset coverage test that assesses whether the minimum overcollateralization requirements are met, and obligates the issuer and an independent “Asset Monitor” to confirm on a periodic basis whether the asset coverage test is satisfied.

Similar to the default situation approach, a statutory framework could create a
separate estate for the covered bond program similar to those in certain European jurisdictions. A recent legislative proposal creates a structure with the following general components when the FDIC is appointed as conservator or receiver for an insolvent issuer:

  • Creation of a separate estate and provision to the FDIC of an exclusive right for 180 days to transfer the issuer’s covered bond program to another eligible issuer.
  • A requirement that the FDIC as conservator or receiver, during the 180-day period, perform all monetary and nonmonetary obligations of the issuer until the FDIC completes the transfer of the covered bond program, the FDIC elects to repudiate its continuing obligations to perform, or the FDIC fails to cure a default (other than the issuer’s conservatorship or receivership).

US state pensions are in a bad way:

Less than half the 50 state retirement systems had assets to pay for 80 percent of promised benefits in their 2009 fiscal years, according to data compiled for the Cities and Debt Briefing hosted by Bloomberg Link in New York today. Two years earlier, only 19 missed the mark. Illinois covered just 50.6 percent of benefits last year, the lowest so-called funded ratio, which actuaries say shouldn’t be less than 80 percent.

Benefits paid by funds in at least 14 states equaled more than 10 percent of assets in the fiscal year, the figures show. In 2007, none exceeded the threshold. The growing burden prompted Colorado, Minnesota, Michigan and other states to trim benefits for millions of teachers and government workers. It also forced fund managers to keep money in short-term low-return investments to pay benefits, reducing chances pensions can earn their way back to financial health.

Expect to see more furious attacks on the reckless banks. Some misdirection is occurring already:

California sued Robert Rizzo, the ousted city manager of Bell who was paid almost $800,000 a year, and seven current and former officials, seeking the return of “excess salaries” and reductions in pension payouts.

“We are filing our lawsuit on behalf of the public to recover the excess salaries that Bell officials awarded themselves and to ensure their future pensions are reduced to a reasonable amount,” state Attorney General Jerry Brown said in a statement.

But this is funny:

Fannie Mae agreed to finance loans to homebuyers putting as little as $1,000 down without getting the approval of the U.S. agency in charge of minimizing the costs of the mortgage company’s bailout.

Fannie Mae is buying the Affordable Advantage loans from housing finance authorities in Massachusetts, Minnesota, Wisconsin and Idaho, Janis Smith, a spokeswoman, said today in a telephone interview. She declined to comment further.

The state housing authorities last year created the loan product aimed at first-time buyers, the New York Times reported Sept. 5. The mortgages come with 30-year fixed rates, require homeownership counseling, and are available to people with credit scores of at least 680 or 720, the paper said.

I love the bit about homeownership counselling. People only do naughty things because they don’t know better! That’s the only reason!

What makes this even funnier is some research from FRB-Richmond by Andra C. Ghent and Marianna Kudlyak, titled Recourse and Residential Mortgage Default: Theory and Evidence from U.S. States with the abstract:

We analyze the impact of lender recourse on mortgage defaults theoretically and empirically across U.S. states. We study the effect of state laws regarding deficiency judgments in a model where lenders can use the threat of a deficiency judgment to deter default or to shorten the default process. Empirically, we find that recourse decreases the probability of default when there is a substantial likelihood that a borrower has negative home equity. We also find that, in states that allow deficiency judgments, defaults are more likely to occur through a lender-friendly procedure, such as a deed in lieu of foreclosure.

They classify Minnesota and Wisconsin, two of the states mentioned with respect to the $1,000-down programme, as being non-recourse!

Another day of good returns and good volume on the Canadian preferred share market, with PerpetualDiscounts gaining 21bp and FixedResets up 10bp. MFC issues continued to be prominently displayed in the volume and performance tables.

PerpetualDiscounts now yield 5.67%, equivalent to 7.94% interest at the standard equivalency actor of 1.4x. Long Corporates now yield 5.4%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 255bp, a sharp tightening from the 270bp reported on September 8.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)
Median
YTW
Median
Average
Trading
Value
Median
Mod Dur
(YTW)
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 0.7245 % 2,097.2
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.7245 % 3,177.1
Floater 2.90 % 3.38 % 65,756 18.81 3 0.7245 % 2,264.5
OpRet 4.87 % -0.19 % 87,062 0.21 9 -0.0855 % 2,376.9
SplitShare 5.95 % -28.56 % 63,679 0.09 2 0.0821 % 2,366.6
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 -0.0855 % 2,173.4
Perpetual-Premium 5.70 % 5.36 % 128,075 5.36 14 0.3258 % 1,986.0
Perpetual-Discount 5.57 % 5.67 % 191,620 14.42 63 0.2078 % 1,952.8
FixedReset 5.24 % 3.04 % 277,968 3.31 47 0.1021 % 2,268.6
Performance Highlights
Issue Index Change Notes
MFC.PR.D FixedReset 1.03 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-19
Maturity Price : 25.00
Evaluated at bid price : 27.39
Bid-YTW : 3.92 %
POW.PR.D Perpetual-Discount 1.12 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-15
Maturity Price : 22.49
Evaluated at bid price : 22.67
Bid-YTW : 5.61 %
BMO.PR.L Perpetual-Premium 1.17 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-06-24
Maturity Price : 25.00
Evaluated at bid price : 26.05
Bid-YTW : 5.15 %
MFC.PR.C Perpetual-Discount 1.21 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-15
Maturity Price : 19.24
Evaluated at bid price : 19.24
Bid-YTW : 5.89 %
MFC.PR.B Perpetual-Discount 1.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-15
Maturity Price : 19.89
Evaluated at bid price : 19.89
Bid-YTW : 5.88 %
BAM.PR.B Floater 1.37 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-15
Maturity Price : 15.49
Evaluated at bid price : 15.49
Bid-YTW : 3.38 %
NA.PR.K Perpetual-Premium 1.38 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2011-06-14
Maturity Price : 25.25
Evaluated at bid price : 25.65
Bid-YTW : 4.34 %
BAM.PR.K Floater 1.38 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-15
Maturity Price : 15.38
Evaluated at bid price : 15.38
Bid-YTW : 3.41 %
Volume Highlights
Issue Index Shares
Traded
Notes
MFC.PR.C Perpetual-Discount 102,758 Nesbitt crossed 19,600 at 19.30; RBC crossed 45,000 at 19.31.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-15
Maturity Price : 19.24
Evaluated at bid price : 19.24
Bid-YTW : 5.89 %
TRP.PR.A FixedReset 81,248 Nesbitt bought two blocks of 10,000 each from RBC, both at 26.14. Nesbitt crosed 40,000 at 26.15.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-01-30
Maturity Price : 25.00
Evaluated at bid price : 26.13
Bid-YTW : 3.45 %
TD.PR.I FixedReset 74,405 TD sold 10,000 to anonymous at 28.10.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-08-30
Maturity Price : 25.00
Evaluated at bid price : 28.15
Bid-YTW : 3.08 %
MFC.PR.B Perpetual-Discount 74,092 Nesbitt crossed 53,000 at 20.00.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-15
Maturity Price : 19.89
Evaluated at bid price : 19.89
Bid-YTW : 5.88 %
TD.PR.R Perpetual-Premium 70,130 Nesbitt bought 15,000 from anonymous at 25.30 and crossed 25,000 at 25.31.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-05-30
Maturity Price : 25.00
Evaluated at bid price : 25.41
Bid-YTW : 5.47 %
TRP.PR.B FixedReset 66,165 Nesbitt crossed 60,000 at 25.23.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-15
Maturity Price : 25.15
Evaluated at bid price : 25.20
Bid-YTW : 3.53 %
There were 42 other index-included issues trading in excess of 10,000 shares.
Issue Comments

MFC USD Debt Issue: Pricing Clue for MFC Prefs?

Manulife Financial Corporation has announced

that it has priced a public offering in the United States of U.S.$1.1 billion aggregate principal amount of two series of its senior notes consisting of U.S.$600 million aggregate principal amount of 3.40% senior notes due 2015 (the “2015 Notes”) and U.S.$500 million aggregate principal amount of 4.90% senior notes due 2020 (the “2020 Notes”). The public offering price of the 2015 Notes is 99.854% and the public offering price of the 2020 Notes is 99.844%. The offering was made pursuant to an effective shelf registration statement.

The Company intends to use the net proceeds from the sale of the notes for general corporate purposes, including investments in its subsidiaries.

Morgan Stanley & Co. Incorporated, Citigroup Global Markets Inc., Banc of America Securities LLC and Goldman, Sachs & Co. are acting as joint book-running managers for the offering.

At 3.40%, the five-year notes yield 215bp over Treasuries; meanwhile, I see on CBID that the recent CAD 4.079% of 2015 are yielding 4.16%, about 205bp over Canadas.

These yields may be contrasted with the MFC sort-of-short-term preferreds:

MFC Sort-of-Short-Term Preferreds
Closing, 2010-9-14
Ticker Expected Maturity Extension Risk Quote Bid Yield to Presumed Call
MFC.PR.A 2015-12-18 Common < $2 25.10-15 4.02%
MFC.PR.D 2014-6-19 Market Reset Spread > 456bp 27.11-45 4.22%
MFC.PR.E 2014-9-19 Market Reset Spread > 323bp 26.30-60 4.20%

To the extent one is fearful that the extension risk will apply (or, to take a more extreme view, that they may actually go bankrupt in the next five years, which will presumably wipe out preferred shareholders while merely hurting the debtholders), there should be a premium on the preferreds; but given that the Bid Yield to Presumed Call will be received as the net amount of dividends and the expected capital loss on call, then those yields may be multiplied by the standard factor of 1.4x to give interest-equivalent yields in the range of 5.62%-6.08% … which seems like an awfully strong inducement.

The debt issue are interesting for another reason … there is some thought that MFC has maxed out on debt:

Manulife Financial Corp.’s US$1.1-billion debt raise (US$600-million in 5-year notes at 3.40% and US$500-million in 10-year notes at 4.90%) would bring its debt (plus preferreds and hybrids) to total capital ratio up to 30% from 27.7%.

That’s probably at the top end of Manulife’s range and above its long-term 25% target, according to BMO Capital Markets analyst Tom MacKinnon. As a result, he believes the company has little room for more debt or preferreds.

.

Note, however, that the smaller IAG was confirmed at Pfd-2(high) in February with higher gross leverage:

Capitalization has become more aggressive, in line with that of the industry, with a total debt ratio of 32% at the end of 2009, increasing to 33.2% pro forma a $200 million preferred and common share issue in mid-February. Within the last two years, Canadian life insurance companies have been increasing their financial leverage to better maximize return on equity, while also optimizing regulatory capital in a low interest rate environment. The Company’s adjusted debt ratio, which gives some equity treatment to preferred shares, was 22.6% at year-end, falling to 22% following the February issues, which is within DBRS’s tolerance for the current credit rating. However, the Company’s use of hybrid capital instruments such as preferred shares has increased over the past two years, significantly reducing its fixed-charge coverage ratio, which has fallen from double digits in the pre-2008 period to 6.0 times in 2009, notwithstanding the return to normal profitability.

Market Action

September 14, 2010

The Treasury Market Practices Group has updated its Best Practices Guidelines. The TMPG is a relatively recent creation:

The TMPG was formed in February 2007 in order to encourage dialogue on market issues and to offer recommendations for best practices in the Treasury cash, repo, and related markets. This private-sector group is currently composed of representatives from dealers, buy-side firms, custodians, and other market participants. In light of its aforementioned expansion, the TMPG’s membership composition will likely evolve over time to ensure robust support of the group’s efforts across the Treasury, agency debt, and agency MBS markets.

Sure, a private-sector group. When push comes to shove, which dealer in Treasuries is going to piss off the New York Fed?

One of the “best practices” is highly peculiar and likely to be counter-productive:

Market participants should be responsible in quoting prices and should promote overall price transparency in the interdealer brokers’ market.

  • Although legitimate price discovery activities are an integral part of the Treasury, agency debt, and agency MBS markets and should be encouraged, market participants should avoid pricing practices that do not have the objective of resulting in a transaction, or that otherwise result in market distortions.
  • Price discovery relies on efficient price reporting and transparent markets. Market participants should not conduct trades through interdealer voice brokers with electronic trading screens without having a record of the transaction published on the screen at the time of the transaction. In addition, market participants should avoid conduct that deliberately seeks to evade regulatory reporting requirements or impedes market transparency efforts.

Ludicrous. Remember, kiddies, bond trading is a cooperative game. It’s not about winning, it’s about being good citizens.

Not sure what to make of this:

International Business Machines Corp. Chief Executive Officer Sam Palmisano, who will turn 60 next year, said the practice of the company’s CEOs retiring from the position at that age isn’t “cast in stone.”

Ain’t nuthin’ cast in stone. You can carve things in stone and you can cast them in iron, but I’ve never heard of casting stone.

Another good day on good volume for the Canadian preferred share market, with PerpetualDiscounts up 24bp and FixedResets gaining 9bp. The yield on latter index is inching slowly towards 3%…

MFC.PR.A continues to trade heavily, at about even yield with the recent bond issue.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)
Median
YTW
Median
Average
Trading
Value
Median
Mod Dur
(YTW)
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 0.1492 % 2,082.2
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.1492 % 3,154.2
Floater 2.93 % 3.43 % 64,397 18.70 3 0.1492 % 2,248.2
OpRet 4.87 % 0.56 % 90,335 0.21 9 -0.0299 % 2,378.9
SplitShare 5.95 % -34.10 % 64,330 0.09 2 0.0000 % 2,364.6
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 -0.0299 % 2,175.3
Perpetual-Premium 5.72 % 5.43 % 127,499 5.36 14 -0.1122 % 1,979.5
Perpetual-Discount 5.58 % 5.67 % 191,243 14.38 63 0.2371 % 1,948.7
FixedReset 5.25 % 3.05 % 279,037 3.31 47 0.0874 % 2,266.3
Performance Highlights
Issue Index Change Notes
NA.PR.K Perpetual-Premium -1.56 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2012-06-14
Maturity Price : 25.00
Evaluated at bid price : 25.30
Bid-YTW : 5.45 %
GWO.PR.I Perpetual-Discount 1.00 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-14
Maturity Price : 20.14
Evaluated at bid price : 20.14
Bid-YTW : 5.61 %
GWO.PR.H Perpetual-Discount 1.18 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-14
Maturity Price : 21.40
Evaluated at bid price : 21.40
Bid-YTW : 5.69 %
IAG.PR.A Perpetual-Discount 1.19 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-14
Maturity Price : 20.45
Evaluated at bid price : 20.45
Bid-YTW : 5.65 %
ELF.PR.G Perpetual-Discount 1.24 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-14
Maturity Price : 20.40
Evaluated at bid price : 20.40
Bid-YTW : 5.93 %
SLF.PR.D Perpetual-Discount 1.28 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-14
Maturity Price : 19.71
Evaluated at bid price : 19.71
Bid-YTW : 5.67 %
Volume Highlights
Issue Index Shares
Traded
Notes
MFC.PR.A OpRet 103,656 RBC crossed 17.700 at 25.00. Nesbitt crossed blocks of 19,100 and 45,000, both at 25.01.
YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2015-12-18
Maturity Price : 25.00
Evaluated at bid price : 25.10
Bid-YTW : 4.02 %
POW.PR.B Perpetual-Discount 97,816 RBC crossed 91,200 at 23.37.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-14
Maturity Price : 23.09
Evaluated at bid price : 23.36
Bid-YTW : 5.82 %
TD.PR.G FixedReset 90,443 RBC crossed 25,000 at 28.15. Desjardins crossed 26,200 at 28.15 and 28,800 at 28.18.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-30
Maturity Price : 25.00
Evaluated at bid price : 28.14
Bid-YTW : 2.91 %
RY.PR.I FixedReset 79,773 TD crossed 15,000 at 26.67 and 59,900 at 26.70.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-03-26
Maturity Price : 25.00
Evaluated at bid price : 26.61
Bid-YTW : 3.10 %
RY.PR.D Perpetual-Discount 67,875 TD crossed 51,500 at 21.56.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-14
Maturity Price : 21.49
Evaluated at bid price : 21.49
Bid-YTW : 5.29 %
RY.PR.X FixedReset 56,978 TD crossed blocks of 15,000 and 20,000, both at 28.06.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-09-23
Maturity Price : 25.00
Evaluated at bid price : 28.05
Bid-YTW : 3.14 %
There were 48 other index-included issues trading in excess of 10,000 shares.
Issue Comments

INE.PR.A Closes at Premium on Good Volume

Innergex Renewable Energy Inc. has announced:

the closing of the previously announced offering of Cumulative Rate Reset Preferred Shares, Series A (the “Series A Preferred Shares”). The Corporation issued a total of 3,400,000 Series A Preferred Shares at $25 per share for aggregate gross proceeds of $85 million. The offering was made on a bought deal basis through a syndicate of underwriters led by BMO Capital Markets and TD Securities Inc.

The Series A Preferred Shares commence trading on the Toronto Stock Exchange today under the symbol INE.PR.A.

The Corporation intends to use the net proceeds of the offering to enhance its financial flexibility, to reduce indebtedness and for general corporate purposes.

Innergex Renewable Energy Inc. is a leading developer, owner and operator of run-of-river hydroelectric facilities and wind energy projects in North America. Innergex’s management team has been involved in the renewable power industry since 1990. Innergex owns a portfolio of projects which consists of: i) interests in 17 operating facilities with an aggregate net installed capacity of 326 MW; ii) interests in 7 projects under development with an aggregate net installed capacity of 203 MW for which power purchase agreements have been secured; and iii) prospective projects of more than 2,000 MW (net).

The issue traded 574,215 shares in a range of 24.96-18 before closing at 25.10-13.

Vital statistics are:

INE.PR.A FixedReset YTW SCENARIO
Maturity Type : Call
Maturity Date : 2016-02-14
Maturity Price : 25.00
Evaluated at bid price : 25.10
Bid-YTW : 4.94 %

INE.PR.A is tracked by HIMIPref™, but is relegated to the Scraps index on credit concerns.

Update, 2011-03-23: This is a 5.00%+279 FixedReset as previously announced.

Issue Comments

RY Put on Watch-Negative by Moody's

Moody’s Investor Services has announced:

placed all the long-term ratings of Royal Bank of Canada, including its Aaa rating for deposits, on review for possible downgrade. Royal Bank’s unsupported bank financial strength rating is rated B+, which maps to a Aa2. Royal Bank is rated Aaa for long-term deposits and senior debt, two notches higher than its unsupported ratings, because of Moody’s very high systemic support assumptions. The bank’s Prime-1 short-term ratings were affirmed.

During its review Moody’s will focus on Royal Bank’s commitment to capital markets and its growth plans for the business. Moody’s will also examine the bank’s controls on these businesses, including its limits on position concentrations and less-liquid assets.

On an industry basis, Moody’s believes wholesale banking activities poses heightened risks including those associated with concentrated positions, high levels of leverage, confidence sensitivity and opacity. Capital market activities expose bondholders to extreme events or “tail risks” if controls fail. Tail risk is difficult to measure and makes management of a global capital markets businesses especially challenging. Moreover, as market conditions improve and competitive pressures increase, managers at investment banks may relax their disciplines and venture into more complex products.

On a firm-wide basis, RBC management has expressed a strategic target to maintain a 25 to 30% earnings contribution on average from the capital markets segment, which Moody’s considers high for a B+ BFSR bank. Moody’s noted Royal Bank’s growth plans include select hiring of professionals and a growing contribution of revenues from outside Canada.

“Royal Bank and many other investment banks have recently de-risked, but shareholder demands will inevitably cause firms to increase risk and complexity over the next market cycle” said Peter Nerby, a Moody’s Senior Vice President.

This news about risk appetite will make Mr. Carney sad. Fortunately, the rest of us know this already.

On Review for Possible Downgrade:

  • Issuer: Royal Bank of Canada
    • Preferred Stock Preferred Stock, Placed on Review for Possible Downgrade, currently A2

Outlook actions:

  • Issuer: Royal Bank of Canada
    • Outlook, Changed To Rating Under Review From Negative(m)

RY has a host of preferred shares:
FixedResets

  • RY.PR.I
  • RY.PR.L
  • RY.PR.N
  • RY.PR.P
  • RY.PR.R
  • RY.PR.T
  • RY.PR.X
  • RY.PR.Y

PerpetualDiscount

  • RY.PR.A
  • RY.PR.B
  • RY.PR.C
  • RY.PR.D
  • RY.PR.E
  • RY.PR.F
  • RY.PR.G
  • RY.PR.W

The agencies are becoming increasingly concerned about banks’ exposure to dealing. Moody’s downgraded BMO an extra notch on these grounds in January.

Contingent Capital

Carney: Central Planning = Good

PrefBlog’s Department of Thesis Title Suggestions has another offering for aspiring MAs and MBAs: is the period of market ascendence over? I suggest that it is arguable that the fall of the Soviet Union in 1990 brought with it a period of free-market ascendency: behind every political and regulatory decision was the knowledge that central planning doesn’t work.

However, the Panic of 2007 has brought with it the knowledge that free markets don’t work either, and 1990 is ancient history, of no relevance to today’s perceptive and hard-nosed bureaucrats. So the pendulum is swinging and the pendulum never swings half way.

In his role as a leading proponent of central planning, Bank of Canada Governor Mark Carney gave a speech today titled The Economic Consequences of the Reforms:

Consider the jaded attitudes of the bank CEO who recounted: ―My daughter called me from school one day, and said, ‗Dad, what‘s a financial crisis?‘ And, without trying to be funny, I said, ‗This type of thing happens every five to seven years.‘‖

Footnote: J. Dimon, Chairman and CEO, JP Morgan Chase & Company, in testimony to the U.S. Financial Crisis Inquiry Commission, 13 January 2010

Possibly the most intelligent remark in the whole speech, but it was set up as straw man.

Should we be content with a dreary cycle of upheaval?

Such resignation would be costly. Even after heroic efforts to limit its impact on the real economy, the global financial crisis left a legacy of foregone output, lost jobs, and enormous fiscal deficits. As is typically the case, much of the cost has been borne by countries, businesses, and individuals who did not directly contribute to the fiasco.

This is true to a certain extent. Society is comprised of networks of relationships, some productive, others being a waste of time (do you believe that institutional bond salesmen are prized by employers because of their keen insight into the market and their uncanny ability to discern budding trends in the market? Ha-ha! They have a book of clients who will call them when the client wants to trade, that’s all). Humans form these networks with little more intelligence than an ant-hill; we only survive because recessions come along every now and then to sweep away at least a portion of the unproductive networks, leaving its participants to get new jobs, move, change their lifestyle and basically try again to form links to other networks that may, one hopes, be productive.

A financial crisis is larger than a normal recession, as Carmen M. Reinhart & Kenneth S. Rogoff have written. This has two effects – first, the number of inefficient networks that are swept away simultaneously is larger, and secondly a number of effiicient networks gets caught up in the frenzy and are swept away as well (they’re dependent upon the availability of credit. Trade finance took a beating during the crisis, for instance).

So yeah, financial crises are bad. But the most expensive North American bail-out has been GM (and is continuing to be GM, since they are being restored to health with the aid of electric car subsidies in addition to their usual welfare cheques) and GM was most certainly not an efficient network. The financial crisis was the trigger, not the cause.

Thus, we cannot blame all the pain on faceless bankers; much of it would have occurred anyway.

Carney claims:

By using securitization to diversify the funding sources and reduce credit risks, banks created new exposures. The severing of the relationship between originator and risk holder lowered underwriting and monitoring standards.

There is some doubt about this. The FRBB notes:

The evolving landscape of mortgage lending is also relevant to an ongoing debate in the literature about the direction of causality between reduced underwriting standards and higher house prices. Did lax lending standards shift out the demand curve for new homes and raise house prices, or did higher house prices reduce the chance of future loan losses, thereby encouraging lenders to relax their standards? Economists will debate this issue for some time.

It appears that this inconvenient debate will occur behind closed doors, as far as Carney is concerned.

Carney goes on to state:

In addition, the transfer of risk itself was frequently incomplete, with banks retaining large quantities of supposedly risk-free leveraged super senior tranches of structured products.

This is a clear failure of regulation, but we won’t won’t hear any discussion of this point, either.

These exposures were compounded by the rapid expansion of banks into over-the-counter derivative products. In essence, banks wrote a series of large out-of-the-money options in markets such as those for credit default swaps. As credit standards deteriorated, the tail risks embedded in these strategies became fatter. With pricing and risk management lagging reality, there was a widespread misallocation of capital.

footnote: See A. Haldane, ―The Contribution of the Financial Sector—Miracle or Mirage?‖ Speech delivered at the Future of Finance Conference, London, 14 July 2010.

An interesting viewpoint, since writing a CDS is the same thing as buying a bond, but without the funding risk. I’ll have to check out that reference sometime.

The shortcomings of regulation were similarly exposed. The shadow banking system was not supported, regulated, or monitored in the same fashion as the conventional banking system, despite the fact they were of equal size on the eve of the crisis.

There were also major flaws in the regulation and supervision of banks themselves. Basel II fed procyclicalities, underestimated risks, and permitted excess leverage. Gallingly, on the day before each went under, every bank that failed (or was saved by the state) reported capital that exceeded the Basel II standard by a wide margin.

So part of the problem was that not enough of the system was badly regulated?

In particular, keeping markets continuously open requires policies and infrastructure that reinforce the private generation of liquidity in normal times and facilitate central bank support in times of crisis. The cornerstone is clearing and settlement processes with risk-reducing elements, particularly central clearing counterparties or ―CCPs‖ for repos and OTC derivatives. Properly risk-proofed CCPs act as firewalls against the propagation of default shocks across major market participants. Through centralised clearing, authorities can also require the use of through-the-cycle margins, which would reduce liquidity spirals and their contribution to boom-bust cycles.(footnote)

The second G-20 imperative is to create a system that can withstand the failure of any single financial institution. From Bear Stearns to Hypo Real Estate to Lehman Brothers, markets failed that test.

Footnote: Market resiliency can also be improved through better and more-readily available information. This reduces information asymmetry, facilitates the valuation process and, hence, supports market efficiency and stability. In this regard, priorities are an expansion of the use of trade repositories for OTC derivatives markets and substantial enhancements to continuous disclosure standards for securitization.

This part is breathtaking. In the first paragraph, Carney extolls the virtues of setting up centralized single points of failure; in the second, he decries the system of having single points of failure. I have not seen this contradiction addressed in a scholarly and robust manner; the attitude seems to be that single points of failure are not important as long as they don’t fail; and they won’t fail because they’re new and will be supervised.

It is, however, the footnote that is egregious in either its ignorance or its intellectual dishonesty – one of the two. It has been shown time and time again that increased public information reduces dealer capital allocation, making the market more shallow and brittle (eg, see PrefBlog posts regarding TRACE. Additionally, see the work on what happened when the TSX started making level 2 quotes available back in 1993 or whenever it was. I feel quite certain that, somewhere, there is some investigation on what Bloomberg terminals did to the Eurobond market in the late eighties, but I’ve never seen any.)

Today, after a series of extraordinary, but necessary, measures to keep the system functioning, we are awash in moral hazard. If left unchecked, this will distort private behaviour and inflate public costs.

So, as part of the campaign to eliminate moral hazard, we’re going to have central clearinghouses? So it won’t matter if Bank of America does a $50-billion dollar deal with the Bank of Downtown Beanville, as long as it’s centrally cleared? And this will reduce moral hazard?

There’s another internal contradiction here, but I don’t think it will be discussed any time soon.

Another promising avenue is to embed contingent capital features into debt and preferred shares issued by financial institutions. Contingent capital is a security that converts to capital when a financial institution is in serious trouble, thereby replenishing capital without the use of taxpayer funds. Contingent conversions could be embedded in all future new issues of senior unsecured debt and subordinated securities to create a broader bail-in approach. Its presence would also discipline management, since common shareholders would be incented to act prudently to avoid having their stakes diluted by conversion. Overall, the Bank of Canada believes that contingent capital can reduce moral hazard and increase the efficiency of bank capital structures. We correspondingly welcome the Basel Committee‘s recent public consultation paper on this topic.

Carney’s proposed inclusion of senior debt as a form of contingent capital has been discussed in the post Carney: Ban the bond!. As has been often discussed on PrefBlog, this is simply a mechanism whereby bureaucrats can be given the power of bankruptcy courts, with none of those inconvenient creditors’ rights and committees to worry about. Just like the GM bail-out!

He then reprises the BoC paper on the effects of increased bank capitalization on mortgage rates, which has been discussed in the post BIS Assesses Effects of Increasing Bank Capitalization among others.

First, banks are assumed to fully pass on the costs of higher capital and liquidity requirements to borrowers rather than reducing their current returns on shareholders‘ equity or operating expenses, such as compensation, to adjust to the new rules.

Consider the alternative. If banks were to reduce personnel expenses by only 10 per cent (equal to a 5 per cent reduction in operating expenses), they could lower spreads by an amount that would completely offset the impact of a 2-percentage-point increase in capital requirements.

Second, higher capital and liquidity requirements are assumed to have a permanent effect on lending spreads, and hence on the level of economic output. No allowance is made for the possibility that households and firms may find cheaper alternative sources of financing.

The second point is critical. It seems quite definite that this will happen – if bank mortgages go up 25-50bp in the absence of other changes, then mortgage brokers will do a booming business. But he wants to regulate shadow-banks, too. And it will mean that shadow banks (or unregulated shadow-shadow-banks) will skim the cream off the market, leaving the banks with lower credit quality.

There has been nowhere near enough work done on the knock-on effect of these changes.

However, there are a variety of other potential benefits from higher capital and liquidity standards and the broader range of G-20 reforms.
First, the variability of economic cycles should be reduced by a host of macroprudential measures. Analysis by the Bank of Canada and the Basel group suggests a modest dampening in output volatility can be achieved from the Basel III proposals, as higher capital and liquidity allow banks to smooth the supply of credit over the cycle. For instance, a 2-percentage-point rise in capital ratios lowers the standard deviation of output by about 3 per cent.

So it would seem that we’re going to have another Great Moderation, except that this time irrational exuberance will not occur and we’ll live in the Land of Milk and Honey forever. Well, it’s a nice dream.

Greater competition commonly leads to more innovative and diverse strategies, which would further promote resiliency of the system. Greater competition and safer banks may also contribute to lower expected return on equity (ROE) for financial institutions. This, in turn, could help offset the costs and increase the net benefits discussed earlier.

These gains from competition could be considerable. The financial services sector earns a 50 per cent higher return on equity than the economy-wide average. If greater competition leads to a one-percentage-point decline in the ROE (through a decline in spreads), the estimated cost from a one-percentage point increase in capital would be completely offset.

Do all you bank equity investors hear this properly? What will the desired 1% decline in ROE do to your portfolio?

This was, quite frankly, a very scary speech.

Market Action

September 13, 2010

Deutsche Bank’s not letting the grass grow under their feet:

Deutsche Bank AG, Germany’s largest bank, plans to raise at least 9.8 billion euros ($12.5 billion) in its biggest-ever share sale to take over Deutsche Postbank AG and meet stricter capital rules.

Deutsche Bank fell 2.32 euros, or 4.6 percent, to 47.70 euros in Frankfurt trading on Sept. 10, giving the company a market value of 29.6 billion euros. Postbank jumped 1.23 euros, or 4.8 percent, to 27.04 euros, valuing the bank at 5.9 billion euros.

Ackermann, who previously said the bank would only raise capital for acquisitions, is trying to build up the bank’s so- called stable businesses of retail banking and asset management, and reduce reliance on investment banking, which accounted for 78 percent of pretax profit in the first half.

Postbank’s Tier 1 capital ratio, a measure of financial strength, fell to 6.6 percent under the most severe scenario of the European Union stress tests conducted in July, compared with the 6 percent minimum required to pass. Deutsche Bank’s ratio, by contrast, stood at 9.7 percent under the toughest test.

There is continued feeling that High Frequency Traders aren’t quite our type of person, dear:

The U.S. Securities and Exchange Commission has spent 15 years remaking the stock market into 11 competing exchanges and hundreds of computer-driven traders. In the process it has virtually eliminated the traditional market makers who bought and sold stocks when no one else would.

Now the SEC is concerned the revolution has gone too far, leaving markets vulnerable when selling starts to snowball.

Specialists at the NYSE maintained “fair and orderly” markets by stepping in themselves when buyers and sellers weren’t available. Similar to market makers on the Nasdaq, they took risks in return for the ability to see supply and demand for stocks and profit from the difference between the bid and offer prices. Both businesses suffered when exchanges started pricing stocks in penny increments in 2001, squeezing profit out of the bid-ask spread.

The SEC is in the “early stages of thinking about whether obligations on market makers akin to what used to exist might make sense,” Schapiro told reporters on Sept. 7. The issue is “whether the firms that effectively act as market makers during normal times should have any obligation to support the market in reasonable ways in tough times,” she said during a speech in New York the same day.

“The playing field has leveled dramatically,” said Joe Ratterman, chief executive officer of exchange operator Bats, which accounts for 11 percent of U.S. stock trading. “It used to be easy for a specialist to work off a 6- or 12-cent spread, but when he had to offer a penny spread it became hard to make a fat living. A new breed of firms stepped in and learned to be efficient. Those firms replaced the ones that were less efficient.”

The Brady Commission report on the October 1987 crash found NYSE specialists and Nasdaq market makers performed erratically and didn’t stem the downward slide of prices. Many Nasdaq market makers didn’t answer their phones, ignoring customers, while overwhelmed NYSE specialists who had bought as sell orders flooded in later gave up or halted trading, according to the January 1988 report by the Presidential Task Force on Market Mechanisms, led by former New Jersey Republican Senator Nicholas Brady.

The article highlighted Vanguard’s comment letter:

Vanguard and its investors have benefited fiom the competition that today’s market structure facilitates. Over the past fifteen years, the competition among trading venues and significant technologtcal advancements have greatly reduced transaction costs for all investors across our markets. Although Vanguard does not engage in “high frequency trading” and does not operate a “dark pool,” we believe much of the public concern over “high fiequency trading” is misplaced and believes such activity, appropriately examined, contributes to a more efficient market that benefits all investors.

Various groups have attempted to quantify the reduction in transaction costs over the last ten to fifteen years. The Commission will continue to receive this data throughout the comment period. While the data universally demonstrate a significant reduction in transaction costs over the last ten to fifteen years, the precise percentages vary (estimates have ranged from a reduction of 35% to more than 60%). Vanguard estimates are in this range, and we conservatively estimate that transaction costs have declined 50 bps, or 100 bps round trip. This reduction in transaction costs provides a substantial benefit to investors in the form of higher net returns. For example, if an average actively managed equity mutual fund with a 100% turnover ratio would currently provide an annual return of 9%, the same fund would have returned 8% per year without the reduction in transaction costs over the past decade.

Vanguard supports a trade-through rule that provides “depth-of-book protection because protecting quotations at multiple price levels encourages the display of limit orders, which, for the reasons set forth above, benefits all investor.

The recent IIROC report trumpeted Canadian-style depth-of-book protection.

Vanguard believes the Commission should consider the costs and benefits of a “trade-at” rule in which a trading center that was not displaying the NBBO price at the time a marketable order was received could either: “1) execute the order with significant price improvement (such as the minimum allowable quoting increment (generally one cent)); or 2) route lSOs to full displayed size of NBBO quotations and then execute the balance of the order at the NBBO price.”

Such a rule would clearly provide an incentive to display limit orders which, as discussed above, Vanguard believes is in the best interests of all investors.

Vanguard is missing the point. The purpose of public markets is to give the private school guys the opportunity to make a fat living with no brains and less work. What do customers have to do with it?

Another good move upwards on hefty volume in the Canadian preferred share market, with PerpetualDiscounts gaining 32bp and FixedResets up 4bp. MFC issues had a notable day, with three issues featured on the nice side of the performance table. MFC.PR.A had another day of high volume; I see on CBID that the recent MFC senior bond issue, 4.079% of 2015, are quoted to yield 4.12% … basically even-yield with the preferreds, so the 160-odd bp of tax effectiveness looks very nice for a five-year term.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)
Median
YTW
Median
Average
Trading
Value
Median
Mod Dur
(YTW)
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 0.8337 % 2,079.1
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.8337 % 3,149.5
Floater 2.92 % 3.43 % 62,908 18.69 3 0.8337 % 2,244.8
OpRet 4.87 % -0.18 % 91,379 0.21 9 0.3382 % 2,379.6
SplitShare 5.95 % -34.66 % 64,288 0.09 2 0.1439 % 2,364.6
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.3382 % 2,175.9
Perpetual-Premium 5.71 % 5.42 % 125,918 5.52 14 0.3378 % 1,981.8
Perpetual-Discount 5.60 % 5.68 % 191,586 14.36 63 0.3216 % 1,944.1
FixedReset 5.25 % 3.08 % 272,381 3.32 47 0.0419 % 2,264.3
Performance Highlights
Issue Index Change Notes
BAM.PR.R FixedReset -1.53 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2016-07-30
Maturity Price : 25.00
Evaluated at bid price : 26.23
Bid-YTW : 4.39 %
SLF.PR.A Perpetual-Discount 1.02 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-13
Maturity Price : 20.71
Evaluated at bid price : 20.71
Bid-YTW : 5.76 %
PWF.PR.E Perpetual-Discount 1.05 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-13
Maturity Price : 23.06
Evaluated at bid price : 24.00
Bid-YTW : 5.77 %
MFC.PR.D FixedReset 1.11 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-19
Maturity Price : 25.00
Evaluated at bid price : 27.30
Bid-YTW : 4.01 %
HSB.PR.C Perpetual-Discount 1.20 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-13
Maturity Price : 22.91
Evaluated at bid price : 23.13
Bid-YTW : 5.52 %
GWO.PR.L Perpetual-Discount 1.32 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-13
Maturity Price : 24.39
Evaluated at bid price : 24.60
Bid-YTW : 5.75 %
SLF.PR.E Perpetual-Discount 1.33 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-13
Maturity Price : 19.77
Evaluated at bid price : 19.77
Bid-YTW : 5.71 %
TRI.PR.B Floater 2.17 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-13
Maturity Price : 23.20
Evaluated at bid price : 23.50
Bid-YTW : 2.22 %
MFC.PR.B Perpetual-Discount 2.19 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-13
Maturity Price : 19.57
Evaluated at bid price : 19.57
Bid-YTW : 5.98 %
MFC.PR.C Perpetual-Discount 2.44 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-13
Maturity Price : 18.90
Evaluated at bid price : 18.90
Bid-YTW : 5.99 %
RY.PR.H Perpetual-Premium 2.92 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-06-23
Maturity Price : 25.00
Evaluated at bid price : 25.77
Bid-YTW : 5.20 %
Volume Highlights
Issue Index Shares
Traded
Notes
MFC.PR.A OpRet 196,414 Nesbitt crossed 100,000 at 25.00; RBC crossed three blocks of 25,000 each, all at the same price.
YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2015-12-18
Maturity Price : 25.00
Evaluated at bid price : 25.00
Bid-YTW : 4.11 %
BNS.PR.Y FixedReset 79,498 Scotia crossed 68,500 at 25.23.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-13
Maturity Price : 25.12
Evaluated at bid price : 25.17
Bid-YTW : 3.31 %
RY.PR.A Perpetual-Discount 47,835 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-13
Maturity Price : 21.35
Evaluated at bid price : 21.35
Bid-YTW : 5.26 %
CM.PR.D Perpetual-Premium 45,667 TD crossed 28,300 at 25.38.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2012-05-30
Maturity Price : 25.00
Evaluated at bid price : 25.32
Bid-YTW : 5.42 %
BMO.PR.P FixedReset 43,364 TD crossed 30,000 at 27.52.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-03-27
Maturity Price : 25.00
Evaluated at bid price : 27.50
Bid-YTW : 3.06 %
TRP.PR.C FixedReset 37,125 RBC crossed 25,000 at 25.98.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2021-03-01
Maturity Price : 25.00
Evaluated at bid price : 25.88
Bid-YTW : 3.78 %
There were 39 other index-included issues trading in excess of 10,000 shares.
Issue Comments

FIG.PR.A Meeting Does Not Get Quorum

Faircourt has announced:

The special meeting of unitholders of Faircourt Split Trust (“FCS”) was held today at which the unitholders approved various amendments to the FCS declaration of trust (the “FCS Proposals”), as described in the joint management information circular dated August 13, 2010 (the “Circular”). The FCS Proposals remain subject to approval by the preferred securityholders of FCS.

In addition the announced special meetings of unitholders and preferred securityholders of FIG and of preferred securityholders of FCS, were convened but adjourned because a quorum was not present. The special meetings for the Funds were adjourned to September 20, 2010 in the case of the meetings of preferred securityholders of FIG and FCS, and to September 27, 2010 in the case of the meeting of unitholders of FIG. Each special meeting will be at the offices of Stikeman Elliott LLP, 199 Bay Street, 53rd Floor, Toronto, Ontario, M5L 1B9 at 10:00 a.m. on the applicable date. As described in the Circular, the deadline for submitting proxies for the adjourned special meetings is Friday September 17, 2010 at 10:00 a.m., in the case of FIG and FCS preferred securityholders and Friday September 24, 2010 at 10:00 a.m., in the case of FIG unitholders.

The FCS Proposals were approved in contemplation of the proposed merger (the “Merger Proposal”) of Faircourt Income & Growth Split Trust (“FIG” and together with FCS, the “Funds”) into FCS to create a single trust, with FCS as the continuing trust (the “Continuing Trust”). The Merger Proposal, as described in the Circular, remains subject to approval by the unitholders and preferred securityholders of FIG.

The FCS Proposals are part of a response to expected changes in the taxation of income funds. As a result of these changes, there are now an insufficient number of “income funds” for FCS to continue to meet its investment restrictions. Consequently, if the FCS Proposals are approved by preferred securityholders, the investment mandate of the Continuing Trust will be expanded to remedy this situation and the Continuing Trust will be able to invest in a broader range of securities and adjust its portfolio in the future as and when required to respond to market movements.

Plans for he meeting have been reported on PrefBlog. There should be a prize for interested investors who can find the Management Information Circular on the Faircourt site – I wouldn’t win, I’ll tell you that much. It’s available on SEDAR, filing date 2010-8-18.

I recommend that FIG.PR.A holders vote in favour of the merger – it will be slightly accretive to Asset Coverage.

Regulation

Basel 3: Capital Conservation Buffer Will Improve Preferred Share Quality

I posted a brief note on Basel 3 when it was announced on the weekend … here are some more thoughts.

The press release states:

. In addition, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%.

The Group of Governors and Heads of Supervision also agreed that the capital conservation buffer above the regulatory minimum requirement be calibrated at 2.5% and be met with common equity, after the application of deductions. The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. While banks are allowed to draw on the buffer during such periods of stress, the closer their regulatory capital ratios approach the minimum requirement, the greater the constraints on earnings distributions. This framework will reinforce the objective of sound supervision and bank governance and address the collective action problem that has prevented some banks from curtailing distributions such as discretionary bonuses and high dividends, even in the face of deteriorating capital positions.

  • The capital conservation buffer will be phased in between 1 January 2016 and year end 2018 becoming fully effective on 1 January 2019. It will begin at 0.625% of RWAs on 1 January 2016 and increase each subsequent year by an additional 0.625 percentage points, to reach its final level of 2.5% of RWAs on 1 January 2019. Countries that experience excessive credit growth should consider accelerating the build up of the capital conservation buffer and the countercyclical buffer. National authorities have the discretion to impose shorter transition periods and should do so where appropriate.
  • Banks that already meet the minimum ratio requirement during the transition period but remain below the 7% common equity target (minimum plus conservation buffer) should maintain prudent earnings retention policies with a view to meeting the conservation buffer as soon as reasonably possible.

The American Enterprise Institute, quite rightly, considers this rather vague:

Third, the SFRC believes that both the capital conservation buffer and countercyclical buffer are insufficient to protect against sudden shocks. The proposal also suggests that enforcement of the capital conservation buffer may be unduly lenient. Rather than prohibiting distributions of earnings as the buffer is approached, the GGHS announcement indicates that there will only be some restriction on the size of such payouts. Permitting a payout of capital when a firm’s capital cushion is declining toward a critical threshold makes little economic sense.

I’ve seen a lot of lot of generalities about the constraints to be placed on banks when they are in the buffer zone, but no informed opinions, which makes me feel a little better about not having been able to find a schedule of restrictions on the BIS web-site.

However, it does appear – on the basis of what unfounded, uninformed and entirely speculative inferences I can make from the available documents – that banks will still be paying common dividends while in the buffer zone, although the amount of these dividends may be restricted. Who knows, there might be forced reductions but I think paying a penny will be OK. And if they pay common dividends, they have to pay the preferred dividends. So that’s a good thing, and from the perspective of safety the additional buffer will simply be that much more common equity between preferreds and a harsh environment.

The Globe story on the issue mentioned Eric Helleiner:

Nevertheless, the banker’s argument about the economic impact of new regulations got the authorities’ attention. Financial institutions won’t face higher capital standards until Jan. 1, 2013, a delay that seems “kind of long” and is probably “where some of the political compromises are coming in,” said Eric Helleiner, the Waterloo, Ont.-based Centre for International Governance and Innovation’s chair in political economy, who has written several articles about Basel III.

So I looked him up. Those interested in international bureaucracy may wish to review his publications.

There is euphoria over Basel 3:

Canadian banks said Monday they expect to be able to adopt new Basel III rules for maintaining reserve capital with little trouble, meaning dividend hikes and share buybacks could be on the way once Canada’s banking regulator gives the go-ahead.

“Based on our first read, we’re encouraged by the announcement and feel very comfortable in meeting these standards within the established timelines, given where our capital ratios stand today,” Janice Fukakusa, chief financial officer of Royal Bank of Canada, (RY-T54.601.102.06%) said at the Barclays Financial Services Conference in New York.

Her comments were echoed by other Canadian banks presenting at the conference.

Rod Giles, a spokesman for OSFI, told Reuters in an e-mail that the regulator will soon issue an advisory to the nation’s big banks providing more clarity on its expectations for future capital outlays.

Bank officials with the clout to hire ex-regulators will be in a far better position to judge the effect of the accord on Canadian regulation than any investor scum, so I won’t speculate too much about the final rules. I suspect, however, that OSFI’s ‘more capital is always better’ mind-set will result in a certain extra capital requirement over and above the global minimum. After all, if it tacks another 20bp on the price of Canadian mortgages, who cares?

Update: Within minutes of the “Publish” button being clicked, OSFI issued Interim Capital Expectations for Banks, Bank Holding Companies, Trust and Loan Companies (collectively, Deposit taking institutions or “DTIs”):

In light of the recent international developments providing greater certainty as to the reform of capital rules, until this Advisory is withdrawn or amended, OSFI expects sound capital management by DTIs, as set out in its guidance, but will no longer require the increased conservatism in capital management announced late in 2008.

As part of sound capital management, and in response to the continuing uncertainty caused by regulatory reform, DTIs must be able to demonstrate on request, both continually and prior to any transaction that may negatively impact their capital levels:

  • that they have prudent internal capital targets that incorporate:
    • the impact of the most recent regulatory reform information from the BCBS, GHOS and OSFI;
    • expected market requirements arising from such reforms; and
    • the impact of any such proposed transaction;
  • via an up-to-date capital plan, prepared in accordance with OSFI’s guidance on Internal Capital Adequacy Assessment Program (ICAAP)7, that they would have sufficient capital to meet their internal capital targets at all times while taking into account:
    • current regulatory requirements and the most recent regulatory reform information from the BCBS, GHOS and OSFI;
    • the full transition period required to implement such reforms;
    • due consideration of possible alternatives related to finalizing such reforms; and
    • due consideration of remote but plausible business scenarios that may adversely affect their ability to comply with current and reformed regulatory rules.

Please note that this Advisory repeals the October 2008 Advisory titled Normal Course Issuer Bids in the Current Environment.