PrefBlog

There’s some criticism of the European stress tests:

Regulators have told lenders the tests may assume a loss of about 17 percent on Greek government debt, 3 percent on Spanish bonds and none on German debt, said two people briefed on the talks who declined to be identified because the details are private.

“This isn’t a stress test,” said Jaap Meijer, a London- based analyst at Evolution Securities Ltd. It’s “merely the current valuation of government bonds.”

Credit markets are pricing in losses of about 60 percent on Greek bonds should the government default, more than three times the level said to be assumed by CEBS. Derivatives known as recovery swaps are trading at rates that imply investors would get back about 40 percent in a Greek default or restructuring.

“I wonder how much these stress tests are reverse- engineered to inspire confidence in the market” and banks, said Bruce Packard, an analyst at Seymour Pierce Ltd. in London.

Reverse engineering? Surely not! That’s done by evil bonus-seeking bankers underwriting sub-prime, not by Holy Regulators!

American banks are hoping to generate investor opposition to fair value accounting:

The American Bankers Association opposes the Financial Accounting Standards Board’s plan to apply fair-value rules to all financial instruments, including loans, rather than just to securities. The group says the rule could make strong banks appear undercapitalized.

The association’s website, noting that FASB’s stated mission is to serve investors, provides a sample letter for people writing to the board and suggests they focus on why the proposal isn’t “useful for investors.”

The ABA has devoted a whole page to the campaign.

State Street reached for yield – and suffered:

State Street Corp., the third-largest U.S. custody bank, reported second-quarter earnings that missed analysts’ estimates because of a $251 million after-tax charge related to its securities lending business.
…
State Street recorded the charge, which reduced earnings by 50 cents a share, to replenish funds that managed money on behalf of securities lenders. The funds invest cash deposited as collateral by securities borrowers. The injection allows State Street to lift redemption restrictions placed on clients in the fall of 2008 after the funds suffered losses.

Pensions & Investments has some interesting background:

It could be argued that the U.S. pension fund sector had historically engaged proportionately more in leveraged finance — by lending securities to raise cash collateral that can be reinvested for returns — than securities lending over recent years and that pension funds only very recently adopted a profile more in line with the U.S. mutual fund sector. That profile has maturity and liquidity more in line with the underlying loan transaction, that is, short term.

The mean return of the total return to lendable securities in a portfolio generated by the U.S. pension fund sector is almost double than that of the U.S. mutual fund sector over the three-year period under consideration. What should really worry the pension fund sector now is that the difference is at its historic low. The pension fund sector has reined in reinvestment guidelines and reduced its return expectations to reduce risk.

AIG writ small!

It was a good day in the Canadian preferred share market, with PerpetualDiscounts up 16bp and FixedResets gaining 3bp. Volume was moderate.

There’s some doubt about the EU stress tests:

Investors say they don’t know if some banks are hiding bad loans, whether they have enough capital to withstand a debt default by a European state and whether governments can afford to rescue them. The European Union still hasn’t disclosed the tests’ criteria, including if they contain a sovereign default.
…
Protecting the senior bonds of 11 U.S. banks from default using credit default swaps costs an average of about 144 basis points, according to data compiled by CMA DataVision. In Europe, the average cost has climbed to about 224 basis points this year, the data show.
…
Europe’s largest banks are trading at a discount to their book value while their U.S. counterparts trade at a premium. Europe’s 20 largest lenders are trading at about 10 percent less than the net value of their assets. The 20 biggest U.S. banks trade at a 10 percent premium, Bloomberg data show.
…
Some European lenders used accounting-rule changes made in October 2008, about a month after Lehman Brothers Holdings Inc.’s collapse, to allow them to avoid writedowns on assets based on plunging market values, unless a default was deemed likely. Under pressure from EU leaders, the International Accounting Standards Board approved changes letting financial institutions in more than 100 countries that use International Financial Reporting Standards to reclassify some investments so they no longer had to book paper gains and losses as credit markets fluctuated.

Deutsche Bank, for example, used the change to shift about 38 billion euros of assets, including commercial real estate and leveraged finance, into its loan book from the third quarter of 2008 to the first quarter of 2009, saving it a net 3.2 billion euros in markdowns based on valuation gains and losses through the first quarter of 2010. ING Groep NV, the biggest Dutch financial-services company, reclassified 24.4 billion euros and Societe Generale SA shifted 25.3 billion euros in assets, escaping about 2.8 billion euros in losses.

Perhaps in response (yes, OSFI, sometimes regulators respond to investor outcry! How ’bout dat?), C-EBS has released some details:

The macro-economic scenarios include a set of key macro-economic variables (e.g. the evolution of GDP, of unemployment and of the consumer price index), differentiated for EU Member States, the rest of the EEA countries and the US. 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.

On aggregate, the adverse scenario assumes a 3 percentage point deviation of GDP for the EU compared to the European Commission’s forecasts over the two-year time horizon. The sovereign risk shock in the EU represents a deterioration of market conditions as compared to the situation observed in early May 2010.

Mr Joseph S Tracy, Executive Vice President of the Federal Reserve Bank of New York, spoke at the Westchester County Bankers Association, Tarrytown, New York, 25 June 2010, drawing parallels between the Credit Crunch and the Panic of 1907.

There’s an interesting trend in bond underwriting:

Borrowers are obtaining credit from banks competing for a pool of bond deals that dropped to $1.18 trillion in the first half from $1.92 trillion a year earlier as Europe’s sovereign debt crisis pared sales, according to data compiled by Bloomberg. The number of banks on each high-yield deal has almost tripled since 2000, cutting fees by an average of 57 percent per firm.

“We’ve been very clear with our banking business partners that we’ll take care of those who are good to us,” said Martin of London-based Virgin, which enlisted a record 14 banks to sell debt in January. “If you want to be in the bond, we need you to give us your balance sheet as well.”

Martin included Credit Suisse, Citigroup, Barclays Capital and HSBC Holdings Plc in Virgin Media’s bond offering, along with 10 other managers, after they agreed to join a 1.925 billion-pound ($2.9 billion) credit facility. The four banks, whose spokesmen declined to comment, ultimately weren’t needed on the loan.

There’s a big TIPS sale tomorrow and speculation there will be a big concession:

Barclays Plc’s Michael Pond, the top-rated analyst of Treasury Inflation Protected Securities, said the U.S. may struggle to sell a record-tying $12 billon of the securities tomorrow with the government likely to bolster the size of future auctions and inflation expectations low.

“We are concerned that the market will have difficulty absorbing this much supply given other headwinds and believe a significant concession is needed for the auction to go well,” Pond said in a note to clients dated July 2. “The level of real yields combined with the size presents a high hurdle for a good auction.”
…
The $12 billion of 10-year TIPS will match the record amount sold in January 2004. The U.S. will sell $30 billion of the security during the second half of 2010, based on the size of tomorrow’s auction and the Treasury’s plans to reopen the issue twice, Pond wrote. That amount is up from $15 billion worth of sales during the second half of last year and the historical high of $21 billion during the first half of 2004, he wrote.

Real yields, which take into account inflation or deflation, have fallen to 1.218 percent on 10-year Treasuries, from 1.685 percent April 2, according to Bloomberg Data. Current real yield levels, only 30 basis points away from the 91 basis point yield experienced in March of 2008 during the deflation scare, leaves the security with “limited upside,” Pond wrote. “At current levels, this would be the lowest yield at a 10-year TIPS auction.

I was briefly quoted in the Globe, deprecating GICs:

So why would anyone choose a government bond?

“The main thing is liquidity,” says James Hymas, president of Hymas Investment Management in Toronto.

With most GICs (cashable GICs being the major exception), you agree to lock in your money for a certain period. In exchange, you earn a higher return. Bonds can be sold at any time, but you earn a lower return.

“I don’t really recommend GICs at the best of times because of the liquidity issue,” he says.

The semi-annual TXPR index rebalancing should be announced soon – last year’s announcement was on Friday, July 10.

PerpetualDiscounts were flat on the day, while FixedResets rose by 15bp on average volume.

PerpetualDiscounts now show a median-weighted-average yield of 5.99%, equivalent to 8.39% interest at the standard equivalency factor of 1.4x. Long corporates now yield about 5.50%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 290bp, unchanged from June 30.

There’s some interesting speculation about credit spreads:

Executives who run big companies and big funds expect to be dealing with sovereign debt problems for years to come.

That’s one of the big conclusions from a survey of executives commissioned by Royal Bank of Canada’s capital markets unit.

Some of the most striking findings were a high degree of concern that a Group of Twenty country would default in the coming three years (Italy was voted most likely), skepticism that the euro-zone would survive that period intact, and a belief that high quality corporate bonds might be safer than some government bonds.

A full 40 per cent of respondents said that they expected yields on the highest level of corporate debt to drop below yields on sovereign debt of the countries where they are based, according to the poll of about 440 executives around the world.

Geez … you mean we have to re-write the textbooks again? We haven’t even finished rewriting the sections on monetary policy!

A good day in the Canadian preferred share market, with PerpetualDiscounts up 32bp and FixedResets gaining 7bp, with good volume.

Lobbying against end-user margin requirements for OTC derivatives (mentioned on June 30) appears to have had some effect, according to Jim Hamilton’s World of Securities Regulation in a discussion of a letter from senators Dodd & Lincoln:

The Dodd-Frank Wall Street Reform and Consumer Protection Act does not authorize regulators to impose margin on end users that use derivatives to hedge or mitigate commercial risk, said Senator Chris Dodd and Senator Blanche Lincoln, who have instructed the SEC and CFTC not to make hedging so costly that it becomes prohibitively expensive for end users to manage their risks. In a letter to the Chairs of the House Financial Services and Agriculture Committees, the senators emphasized that Congress does not intend to regulate end users as major swap participants or swap dealers just because they use swaps to hedge or manage the commercial risks associated with their business. Just as Congress has heard the end user community, they said, regulators must carefully consider the impact of regulation and capital and margin on end users.

We’ll see how this works out, but the camel’s got his nose in the tent!

There’s an entertaining scuffle between Themis Trading:

A gift received by a sixth rate player. Now, we didn’t expect to be showered with gifts from the LSE but a simple “thank you” would have been nice. After all, a paper written by “two or three guys” managed to accomplish something that an organization headed by commercial director, Natan Tiefenbrun, couldn’t do by themselves.

So this brings us to the rubbish which was written by that previously mentioned commercial director. If you care to read his piece, here it is: http://tradeturquoise.blogspot.com/

It seems like Natan is tired because he read a piece written by Kate Welling about Themis Trading ([link]). If reading 16 pages gets him tired, maybe he should get some Red Bull. Much of Natan’s rant against Themis Trading sounds like a defense of HFT. Maybe that’s because he also has a very conflicted ownership structure with brokers owning almost half of his MTF.

Natan’s piece is titled Luddites Unite:

One again these self-proclaimed defenders of “fair markets” make dozens of claims about how exchanges, brokers and high-frequency traders are conniving to screw both retail and institutional investors. Here are some of my favourite excerpts:…

By me, the fundamental difference is one of philosophy, explained by Themis principal Sal Arnuk early on in the article that started the spat (which is copy protected, so no quotes for you!). He’s worried about what happened in the Flash Crash to those who panicked and those who had stop-loss orders in place. I suggest that the fact that these people lost money is a good thing. The less stupid money there is in the market, the better.

Much of the hand-wringing regarding securitization revolves around adverse selection – the idea that originators will securitize their worst loans. Credit Sights is alleging an interesting twist on that story:

Spanish savings banks may be hiding losses on home loans by taking non-performing mortgages out of securitized transactions, according to CreditSights Inc.

By carrying the bad loans on their own books the so-called cajas sidestep downgrades to their mortgage-backed securities, the independent bond research firm said in a report.
…
CreditSights follows a sample of 143 Spanish residential mortgage-backed securities collateralized by 136 billion euros ($170 billion) of loans, with about 45 percent originated by cajas. While the savings banks give little information about the state of their loan books, investor reports on the performance of the securitized debt suggest asset quality is weaker than at commercial lenders, CreditSights said.

“Caja-originated mortgages are performing much worse than those extended by Spain’s commercial banks,” analysts David Watts, John Raymond and Hana Galetova wrote. By buying mortgages out of the pools “they could have been artificially reducing the level of bad loans in RMBS while simultaneously undermining the quality of the cajas’ own assets,” they wrote.

Over a million people attended the Pride Parade in a stunning rebuke to nasty backstairs whisperers and grandstanding politicians (presumably under the influence of foreign governments). Left to itself, the City of Toronto can’t run a souvlaki cart; I suggest that in future it recognizes its total incompetence and stops interfering with the internal decisions of groups who actually bring money into the city.

Yet another power outage today … and the clowndorks are discussing who should march in somebody else’s parade.

It was a strong day in the Canadian preferred share market, with PerpetualDiscounts gaining 25bp and FixedResets up 23bp, on light volume.

The US jobs number was poor:

Employment at companies rose 83,000, less than the 110,000 gain forecast by economists in a Bloomberg News survey. Including government, payrolls fell for the first time this year because of a drop in federal census workers. The jobless rate dropped to 9.5 percent from 9.7 percent as the labor force shrank, the Labor Department reported today in Washington.

OSFI has published a presentation by Michel Montambeault, Director, to the Canada Institute of Actuaries (CIA) Annual Meeting, on the topic of “Canadian Mortality Experience”, 29 June 2010, Vancouver, British Columbia. In related news, a cluster of longevity genes has been identified:

U.S. scientists say they have discovered the genetic signature of an exceptionally long life, and with nothing more than a DNA sample they can predict – with 77 per cent accuracy – those biologically built to live beyond a century.

They also predict that such a test, based on a set of 150 genetic markers, will be available to the curious by summer’s end.

“It’s really quite revolutionary,” said Thomas Perls, associate professor of medicine at Boston University and senior author of a research paper published online Thursday by the journal Science. “With the accuracy we’ve demonstrated, companies are going to pick this up. We’ll see it on the market in a month.”

Adverse selection just became a bigger risk for the insurance companies!

I sent an eMail to the Toronto Stock Exchange:

On June 30, MFC.PR.B traded 5,792 shares on the TSX in a range of 19.63-80 and closed at 19.01-66, 10×12. The last trade was at 3:58pm, 300 shares at 19.66.

I have a number of questions:
i) Who is the market maker for this issue?
ii) Which firm employs the market maker?
iii) What committments were made regarding spreads by the market maker?
iv) How have these committments been kept over the past year?
v) How have other committments made by this market maker been kept over the past year?
vi) How have other committments made by the market maker’s firm been kept over the past year?

We’ll see what happens with that! (Fearless prediction: Nothing).

On an extremely quiet day in the Canadian preferred share market, PerpetualDiscounts lost 4bp while FixedResets gained 14bp.