Market Action

November 20, 2009

Another nice day for Canadian Preferreds, with PerpetualDiscounts gaining 30bp while FixedResets were up 24bp, on moderate volume.

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 0.7250 % 1,513.0
FixedFloater 5.88 % 4.01 % 41,842 18.80 1 1.3699 % 2,650.4
Floater 2.58 % 3.01 % 93,780 19.65 3 0.7250 % 1,890.2
OpRet 4.80 % -6.65 % 120,645 0.09 14 0.0710 % 2,307.5
SplitShare 6.37 % -2.57 % 332,820 0.08 2 -0.0658 % 2,109.7
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0710 % 2,110.0
Perpetual-Premium 5.89 % 3.51 % 126,418 0.19 4 0.1987 % 1,867.4
Perpetual-Discount 5.84 % 5.92 % 182,633 14.03 70 0.2966 % 1,777.5
FixedReset 5.46 % 3.90 % 387,829 3.94 41 0.2397 % 2,140.3
Performance Highlights
Issue Index Change Notes
IAG.PR.E Perpetual-Discount -1.76 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-20
Maturity Price : 24.31
Evaluated at bid price : 24.51
Bid-YTW : 6.20 %
RY.PR.W Perpetual-Discount 1.04 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-20
Maturity Price : 22.20
Evaluated at bid price : 22.35
Bid-YTW : 5.51 %
IAG.PR.A Perpetual-Discount 1.15 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-20
Maturity Price : 19.36
Evaluated at bid price : 19.36
Bid-YTW : 6.05 %
BNS.PR.K Perpetual-Discount 1.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-20
Maturity Price : 21.56
Evaluated at bid price : 21.56
Bid-YTW : 5.63 %
TRI.PR.B Floater 1.29 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-20
Maturity Price : 19.65
Evaluated at bid price : 19.65
Bid-YTW : 2.01 %
BAM.PR.G FixedFloater 1.37 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-20
Maturity Price : 25.00
Evaluated at bid price : 18.50
Bid-YTW : 4.01 %
POW.PR.C Perpetual-Discount 1.43 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-20
Maturity Price : 23.80
Evaluated at bid price : 24.16
Bid-YTW : 6.07 %
RY.PR.D Perpetual-Discount 1.60 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-20
Maturity Price : 20.32
Evaluated at bid price : 20.32
Bid-YTW : 5.57 %
Volume Highlights
Issue Index Shares
Traded		 Notes
BNS.PR.T FixedReset 136,230 RBC crossed blocks of 76,000 and 52,800, both at 27.85.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-25
Maturity Price : 25.00
Evaluated at bid price : 27.80
Bid-YTW : 3.68 %
CM.PR.P Perpetual-Discount 103,910 RBC crossed 59,000 at 23.35; TD crossed 41,600 at the same price.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-20
Maturity Price : 22.61
Evaluated at bid price : 23.30
Bid-YTW : 5.93 %
BNS.PR.X FixedReset 80,680 RBC crossed 76,000 at 27.95.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-25
Maturity Price : 25.00
Evaluated at bid price : 27.75
Bid-YTW : 3.74 %
HSB.PR.E FixedReset 77,110 RBC bought 13,400 from HSBC at 27.85.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-30
Maturity Price : 25.00
Evaluated at bid price : 27.92
Bid-YTW : 4.13 %
TD.PR.G FixedReset 52,230 RBC crossed blocks of 19,500 and 20,000, both at 27.57.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-30
Maturity Price : 25.00
Evaluated at bid price : 27.60
Bid-YTW : 3.87 %
GWO.PR.E OpRet 40,449 Anonymous bought blocks of 10,700 and 13,500 from National and HSBC, respectively, both at 25.85.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2010-04-30
Maturity Price : 25.25
Evaluated at bid price : 25.71
Bid-YTW : 2.03 %
There were 36 other index-included issues trading in excess of 10,000 shares.

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Issue Comments

RPB.PR.A to Vote on Early Dissolution

ROC Pref III Corp. has announced:

ROC Pref III Corp. announces that its board of directors has approved a proposal to change the redemption date of the Preferred Shares from March 23, 2012 to December 22, 2009 (the “Proposal”). As a result of the Proposal, Shareholders will have their Preferred Shares redeemed by the Company on such date and will be paid the net asset value redemption price per Preferred Share as of December 18, 2009 plus a redemption premium of $1.00 per Preferred Share. The credit linked note portfolio to which the Company has exposure has suffered several defaults over the past year and if one or more occur in the time remaining to maturity. Shareholders risk losing all or a substantial portion of their investment. The Company’s Investment Advisor believes there are a number of reference companies in the credit linked note portfolio that are at a significant risk of default prior to the maturity of the credit linked note. Accordingly, the Company’s board of directors, Manager and Investment Advisor believe it is in the best interests of the Shareholders to crystalize and preserve the remaining value of the Preferred Shares for Shareholders. In this regard, following recently completed negotiations the issuer of the credit linked note has agreed to repurchase the note on December 18, 2009 to facilitate this outcome. The Proposal will involve the amendment of the Company’s articles of incorporation and will be subject to receipt of all necessary shareholder and regulatory approvals.

A special meeting of holders of Preferred Shares has been called and will be held on December 17, 2009 to consider and vote upon the Proposal. Details of the Proposal will be outlined in an information circular to be sent to shareholders in connection with the special meeting. Copies of the information circular will be available on www.sedar.com and www.cclcapitalmarkets.com.

The estimated NAV of the fund is 3.57 as of November 16.

They’re selling a structured note with high downside risk … I’ll bet they’re getting a good price!

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Issue Comments

RPQ.PR.A to Vote on Dissolution

Connor, Clark & Lunn ROC Pref Corp. has announced:

that its board of directors has approved a proposal to change the redemption date of the Preferred Shares from June 30, 2011 to December 22, 2009 (the “Proposal”). As a result of the Proposal, Shareholders will have their Preferred Shares redeemed by the Company on such date and will be paid the net asset value per Preferred Share as of December 18, 2009. The credit linked note portfolio to which the Company has exposure has suffered several defaults over the past year and if three or more occur in the time remaining to maturity Shareholders risk losing all or a substantial portion of their investment. The Company’s Investment Advisor believes there are a number of reference companies in the credit linked note portfolio that are at a significant risk of default prior to the maturity of the credit linked note. Accordingly, the Company’s board of directors, Manager and Investment Advisor believe it is in the best interests of the Shareholders to crystalize and preserve the remaining value of the Preferred Shares for Shareholders. In this regard, following recently completed negotiations the issuer of the credit linked note has agreed to repurchase the note on December 18, 2009 to facilitate this outcome. The Proposal will involve the amendment of the Company’s articles of incorporation and will be subject to receipt of all necessary shareholder and regulatory approvals.

A special meeting of holders of Preferred Shares has been called and will be held on December 17, 2009 to consider and vote upon the Proposal. Details of the Proposal will be outlined in an information circular to be sent to shareholders in connection with the special meeting. Copies of the information circular will be available on www.sedar.com and www.cclcapitalmarkets.com.

The estimated NAV of the fund is 9.20 as of November 16.

Let’s see … it’s backed by a structured note, downside risk is enormous, and there’s a motivated seller … I bet they’ll get a good price for the credit linked note!

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Interesting External Papers

Canadian Bond Liquidity Premia

The Autumn 2009 Bank of Canada Review contained an article by Alejandro Garcia and Jun Yang titled Understanding Corporate Bond Spreads Using Credit Default Swaps that, frankly, has me rather puzzled.

They state:

We use credit default swaps to decompose the spreads on Canadian corporate bonds because, as discussed in the next section, their lower susceptibility to liquidity effects makes them a much purer measure of default risk.
…
CDS contracts are commonly used to extract proxies for default risk for several reasons. As contracts, not securities, CDSs are far less sensitive to liquidity effects, since securities are in fi xed supply, while the supply of CDSs can be arbitrarily large. Because of this reduced sensitivity, CDSs provide a better measure of default risk. As well, it is less costly for investors to liquidate CDSs prior to maturity than to liquidate a corporate bond, since investors simply enter into a swap contract in the opposite direction. Further, CDSs are not likely to become “special” like treasury bills, or “squeezed” like corporate bonds. In principle, therefore, CDSs should contain mainly default information about the reference entity. However, they are not totally immune to liquidity effects, since search costs may be high for illiquid CDS contracts.
…
In this model, investors demand a return for holding corporate bonds that includes the risk-free rate, the default risk of the issuer, and the liquidity premium associated with the security. Similarly, investors demand compensation for selling the CDS that includes the risk-free rate and the default risk associated with the reference entity (bond issuer). Note that, in the model, we assume that the bond yield includes compensation for liquidity and default risk, whereas the CDS includes compensation only for default risk.

They derive the following decomposition. It should be noted that their phrase “average investment grade firm” is a little general, since they only had data for six companies, all BBB:

My problem is that I don’t understand their methodology. It ignores arbitrage – which means that you cannot capture the liquidity component by buying the bond and buying protection – and it would appear to blow up when confronted with the problem of positive basis trades, which (as observed by Choudhry) are are most common; negative basis trades became more common during the Crunch due to funding risk. For example:

BMO Capital Markets: Negative Basis Trades:

We recently executed a number of negative basis trades for clients involving auto companies when bond spreads were trading significantly wider than the CDS cost of protection. Investors were typically able to earn net spreads in excess of 25 bps after hedging both their interest rate risk and credit risk. This net spread offered a very attractive return for the risk resulting from this combination of transactions, i.e. a better than senior bank debt spread for assuming credit risk exposure that is meaningfully lower than direct bank exposure since the investor only looks to the bank CDS counterparty if the bond issuer fails.

Negative basis opportunities arise from time to time, but tend not to last for very long – investors who are able to act quickly are the big beneficiaries. We are active in the market, highlighting negative basis trade ideas for interested investors.

I have sent a query to the authors and will update this post if I get an answer.

Update: The methodology’s seminal paper by Longstaff (better link) examines CDS & bond yield spreads for Enron, which occasionally went negative, particularly towards the end. He notes:

It is important to acknowledge that our empirical approach of using a bracketing set of bonds does not eliminate all measurement error. This may partially explain why some of the percentages shown in Figure 3 for the size of the default component (particularly for the cases in which the Treasury and Refcorp curves are used) are in excess of 100.

It strikes me that dismissing negative basis as measurement error is cheating.

Doubt has been cast on the methodology by the results of Mahanti, Nashikkary & Subrahmanyam

Recent research has shown that default risk accounts for only a part of the total yield spread on risky corporate bonds relative to their risk-less benchmarks. One candidate for the unexplained portion of the spread is a premium for liquidity. We investigate this possibility by relating the liquidity of corporate bonds, as measured by their ease of market access, to the basis between the credit default swap (CDS) price of the issuer and the par-equivalent corporate bond yield spread. The ease of access of a bond is measured using a recently developed measure called latent liquidity, which is defined as the weighted average turnover of funds holding the bond, where the weights are their fractional holdings of the bond. We find that bonds with higher latent liquidity are more expensive relative to their CDS contracts, after controlling for other realized measures of liquidity. Additionally, we document the positive effects of liquidity in the CDS market on the CDS-bond basis. We also find that several firm-level variables related to credit risk negatively affect the basis, indicating that the CDS price does not fully capture the credit risk of the bond. In a similar vein, we document that bond-level variables related to features of the contract that may be related to credit risk, such as the presence of covenants, have a negative impact on the CDS-bond basis. These findings are consistent with the presence of frictions in the arbitrage mechanism between the CDS and bond markets, due to the costs of shorting” bonds.

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Market Action

November 19, 2009

James Mackintosh of the Financial Times was kind enough to link to a PrefBlog post in his discussion of Contingent Capital, CoCo farming shows the true value of government guarantees. He suggests that just about all of a banks capital market financing be contingent capital – which is, after all, what happens in bankruptcy:

Banks should be forced to turn a big chunk of existing bank debt into CoCos, with a conversion trigger based on a minimum level of capital – the worst case scenario – *or* on the bank failing. In effect, this would be a bank resolution regime which automatically converts debt to equity, avoiding the need for government rescues. Debt would cost a lot more, but bondholders would also have a far bigger incentive to keep an eye on bank management. Perhaps only 50 per cent of debt, or some other very large amount, rather than 100 per cent, would need to be convertible – but it would have to be far more than the normal belief of what might be needed in order to deal with the “black swan” events which lead to the need for government intervention.

Increased bank regulation and pay-approvals is leading to a talent drain to hedge funds:

Meredith Whitney, the analyst who cut her rating on Goldman Sachs Group Inc. last month, said the bank has lost some of its top-performing employees as executives left to start their own investment companies.

“Goldman’s lost a tremendous amount of talent going to set up their own hedge funds,” Whitney, founder of Meredith Whitney Advisory Group, said today in an interview on Bloomberg Radio. “It became a scary prospect of having the government determine what you make,” said Whitney, who also said today that bank stocks are “grossly overvalued.”

The stock plunge today was pretty tame, as plunges go, but Bloomberg says they plunged … with something even more interesting going on:

U.S. stocks extended a global drop as concern grew that the rally has outpaced the prospects for economic growth. The yen and the dollar strengthened, oil tumbled and yields on Treasury three-month bills turned negative for the first time since financial markets froze last year.

They now quote 3-month US Bills at 1bp – count ’em, one.

The preferred share market continued its recent run, with PerpetualDiscounts gaining 14bp on the day, while FixedResets were down a negligible amount. The big news was that volume fell.

PerpetualDiscounts now yield 5.92%, equivalent to 8.30% interest at the standard equivalency factor of 1.4x. Long Corporates are about 5.9%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is about 240bp. This is a shade wider than the 235bp reported on November 11, but the market seems to have found a new level … at least, until it doesn’t.

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 -0.7414 % 1,502.1
FixedFloater 5.96 % 4.08 % 43,496 18.70 1 0.2747 % 2,614.6
Floater 2.60 % 3.03 % 97,223 19.62 3 -0.7414 % 1,876.6
OpRet 4.81 % -4.85 % 121,164 0.09 14 -0.0818 % 2,305.9
SplitShare 6.36 % -7.34 % 336,155 0.08 2 -0.1096 % 2,111.1
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 -0.0818 % 2,108.5
Perpetual-Premium 5.90 % 5.53 % 124,939 2.41 4 0.1592 % 1,863.7
Perpetual-Discount 5.85 % 5.92 % 186,338 14.00 70 0.1380 % 1,772.2
FixedReset 5.47 % 3.97 % 392,496 3.94 41 -0.0045 % 2,135.2
Performance Highlights
Issue Index Change Notes
RY.PR.W Perpetual-Discount -1.47 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-19
Maturity Price : 21.99
Evaluated at bid price : 22.12
Bid-YTW : 5.56 %
BAM.PR.B Floater -1.43 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-19
Maturity Price : 13.12
Evaluated at bid price : 13.12
Bid-YTW : 3.03 %
MFC.PR.E FixedReset -1.26 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-10-19
Maturity Price : 25.00
Evaluated at bid price : 26.55
Bid-YTW : 4.13 %
BAM.PR.K Floater -1.14 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-19
Maturity Price : 13.00
Evaluated at bid price : 13.00
Bid-YTW : 3.05 %
SLF.PR.E Perpetual-Discount 1.16 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-19
Maturity Price : 19.21
Evaluated at bid price : 19.21
Bid-YTW : 5.96 %
SLF.PR.A Perpetual-Discount 1.29 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-19
Maturity Price : 20.38
Evaluated at bid price : 20.38
Bid-YTW : 5.93 %
SLF.PR.B Perpetual-Discount 1.44 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-19
Maturity Price : 20.49
Evaluated at bid price : 20.49
Bid-YTW : 5.96 %
Volume Highlights
Issue Index Shares
Traded		 Notes
RY.PR.A Perpetual-Discount 73,589 RBC crossed 19,400 at 19.70, then 20,000 at 19.80.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-19
Maturity Price : 19.84
Evaluated at bid price : 19.84
Bid-YTW : 5.64 %
BNS.PR.O Perpetual-Discount 62,200 RBC crossed three blocks of 20,000 shares each at 24.87.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-19
Maturity Price : 24.53
Evaluated at bid price : 24.75
Bid-YTW : 5.71 %
CM.PR.D Perpetual-Discount 42,350 RBC crossed 38,200 at 24.30.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-19
Maturity Price : 23.95
Evaluated at bid price : 24.28
Bid-YTW : 5.97 %
GWO.PR.L Perpetual-Discount 40,200 RBC crossed 34,300 at 23.75.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-19
Maturity Price : 23.51
Evaluated at bid price : 23.67
Bid-YTW : 6.06 %
TRP.PR.A FixedReset 37,125 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-01-30
Maturity Price : 25.00
Evaluated at bid price : 25.55
Bid-YTW : 4.28 %
RY.PR.B Perpetual-Discount 35,135 RBC crossed 25,000 at 20.83.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-19
Maturity Price : 20.79
Evaluated at bid price : 20.79
Bid-YTW : 5.69 %
There were 26 other index-included issues trading in excess of 10,000 shares.

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Issue Comments

KSP.UN: DBRS Downgrades to Pfd-4(low), Discontinues Coverage

DBRS has announced:

has today downgraded its rating on the LROC Preferred Units (the Units) issued by Kingsway Linked Return of Capital Trust (the Trust) to Pfd-4 (low) from Pfd-4. The Under Review with Negative Implications status, which was assigned to the Units on June 8, 2009, is being maintained.

The LROC Preferred Units are supported by an exposure to a note guaranteed by Kingsway Financial Services Inc. and Kingsway America Inc. (collectively, Kingsway) through a forward purchase agreement. The downgrade of the Units is a result of DBRS downgrading the long-term debt ratings of Kingsway earlier today to B (high) from BB (low).

Also, subsequent to today’s downgrade, DBRS immediately discontinued its ratings coverage of Kingsway. As a result, the rating of the Units has also been discontinued.

KSP.UN was last mentioned on PrefBlog when it was downgraded to Pfd-4 by DBRS. KSP.UN is not tracked by HIMIPref™.

Interesting External Papers

BoC Publishes Autumn 2009 Review

The Bank of Canada has announced that the Bank of Canada Review: Autumn 2009 is now available, with the following articles:

  • Bank of Canada Liquidity Actions in Response to the Financial Market Turmoil
  • Understanding Corporate Bond Spreads Using Credit Default Swaps
  • Agency Confl icts in the Process of Securitization

The second article is sufficiently important (by which I mean “important to me”) that it will be reviewed in its own post.

Interesting External Papers

Brown & Holden on Pegged Limit Orders

Pegged Orders were first discussed on PrefBlog in a review of Jeffrey MacIntosh’s essay in the Financial Post. A discussion paper published by IIROC, Dark Pools, Dark Orders, and other Developments in Market Structure in Canada requests commentary on potential regulation of this order type; and the order type was also discussed in the November 2009 edition of PrefLetter.

David P. Brown of the University of Wisconsin and Craig W. Holden of Indiana University wrote a paper in 2005 titled Pegged Limit Orders that is of great interest:

Limit orders face mispricing risk – the risk of executing at a stale limit price after an innovation in public valuation, because limit-order traders generally do not continuously monitor market conditions. We analyze the impact of pegged limit orders that automatically adjust the limit price in a hybrid market. We find the direct effect is to increase limit-order profits, reduce dealer profits, and increase market-order losses. However, the indirect effect is to increase the quantity of limit orders submitted. A numerical calibration finds that when dealers supply relatively little liquidity, there is a net benefit to market orders as well.

Well, relatively little liqudity supply from the dealers is a major attribute of the preferred share market, so let’s look at this a little more. They define two types of risk assumed when entering a limit order:

There are two kinds of risk facing limit orders. 1 One is execution risk – the limit order quantity executed is random. A second is mispricing risk – a limit order may execute after an innovation in public valuation (e.g. a public news item) at a mispriced limit price, because limit-order traders generally are off the exchange and do not monitor market conditions continuously. We analyze whether mispricing risk can be reduced by creating pegged limit orders that automatically adjust the limit price, even in the absence of direct intervention by the limit-order trader.

Mispricing risk is especially important during market crashes.

They design a model, play with it, and find:

Initially, we analyze the direct effect of a design change from Regular LOs to Market-PLOs, and then to Quote-PLOs (holding limit-order quantities fixed). We find:

  • • an increase in limit-order trader profits (Quote-PLOs > Market-PLOs > Regular LOs), because updating limit prices avoids states in which limit orders execute at a loss following a public value innovation,
  • • a reduction in dealer profits (Quote-PLOs < Market-PLOs < Regular LOs), because dealers suffer in two ways: (1) dealers cannot profit by picking off mispriced limit orders and (2) updated limit orders are more effective in competing with the dealers for the incoming flow of market orders,
  • • a reduction of market-order trader profits (or equivalently an increase in their losses) (Quote-PLOs < Market-PLOs < Regular LOs), because market orders lose the opportunity to pick off mispriced limit orders.

Which sounds very reasonable. A Market-PLO is linked to a market index, whereas a Quote-PLO is linked to the quote on a particular security.

Next, we analyze the indirect effect of a design change, allowing limit-order traders to choose the optimal quantities to submit. We find an increase in the quantity of limit orders submitted (Quote-PLOs > Market-PLOs > Regular LOs), because designs which avoid mispricing are more profitable. For marketorder traders, we find that the indirect effect is opposite the direct effect and increases market-order trader profits (Quote-PLOs > Market-PLOs > Regular LOs). This is because a greater quantity of limit orders reduces the probability of exhausting the total depth supplied by limit orders and dealers at the inside spread, and trading at prices outside the spread. Finally, we perform a numerical calibration exercise to analyze the combined impact of the direct and indirect effects on market-order trader profits. We find that under conditions when dealers endogenously choose to supply relatively little liquidity, then the indirect effect dominates and market-order traders benefit. Conversely, under conditions when dealers endogenously choose to supply a relatively large amount of liquidity, then the direct effect dominates and market-order traders lose. Empirically testable predictions of the model are that the introduction of pegged limit orders should cause a jump in limit order use, the cost of trading using market orders should decline in stocks where dealers supply relatively little liquidity, and overall volume should increase.

Miscellaneous News

Moody's May Massacre Hybrid Ratings

A Bloomberg story just appeared Moody’s May Downgrade Up to $450 Billion of Bank Debt:

Moody’s Investors Service is reviewing about $450 billion of bank hybrid and subordinated notes for possible downgrade after changing the assumptions underlying its ratings of the debt.

Some 775 securities issued by 170 “bank families” in 36 countries are affected, the New York-based risk assessor said in an e-mailed statement. Half the hybrids may have their ratings lowered by three to four grades, 40 percent may be cut by one or two grades and the remainder may be lowered by five steps or more, it said.
…
Moody’s reviews come after it stopped assuming holders of hybrids, which mingle characteristics of debt and equity, would benefit from government support for troubled lenders after the global financial crisis proved that wasn’t the case. The new system expects regulators to treat them more like equity, and takes into account the risk that banks might be forced to suspend coupon payments on their lower-ranked debt.

There does not appear to be a press release or notice on the Moody’s website yet … all I found was a July 28 press release saying that they expected to finalized the methodology in September, which was part of the same story reported on PrefBlog in June.

But then I had a look at their ratings list for Bank of Montreal and hey, looky-looky! All the prefs have “Possible Downgrade, 18 NOV 2009” under “Watch Status”. It the same thing for BNS, by the way, so the notation is not related to the extant Moody’s Watch on BMO.

Stay tuned.

Market Action

November 18, 2009

A very nice day for the Canadian preferred share market, with PerpetualDiscounts up 29bp and FixedResets gaining 4bp, on continued moderate volume. There were no losers in the Performance hightlights!

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 1.0355 % 1,513.3
FixedFloater 5.98 % 4.10 % 43,618 18.69 1 0.7194 % 2,607.4
Floater 2.58 % 2.98 % 93,344 19.73 3 1.0355 % 1,890.6
OpRet 4.80 % -4.39 % 121,636 0.09 14 0.1420 % 2,307.7
SplitShare 6.36 % -11.09 % 340,826 0.08 2 1.3449 % 2,113.4
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.1420 % 2,110.2
Perpetual-Premium 5.91 % 5.55 % 124,763 2.41 4 0.2294 % 1,860.7
Perpetual-Discount 5.86 % 5.94 % 182,839 13.99 70 0.2854 % 1,769.8
FixedReset 5.47 % 3.97 % 384,413 3.94 41 0.0370 % 2,135.3
Performance Highlights
Issue Index Change Notes
PWF.PR.L Perpetual-Discount 1.13 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-18
Maturity Price : 21.55
Evaluated at bid price : 21.55
Bid-YTW : 5.98 %
POW.PR.A Perpetual-Discount 1.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-18
Maturity Price : 23.06
Evaluated at bid price : 23.32
Bid-YTW : 6.07 %
HSB.PR.D Perpetual-Discount 1.34 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-18
Maturity Price : 21.53
Evaluated at bid price : 21.86
Bid-YTW : 5.79 %
MFC.PR.B Perpetual-Discount 1.40 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-18
Maturity Price : 19.61
Evaluated at bid price : 19.61
Bid-YTW : 5.94 %
BMO.PR.J Perpetual-Discount 1.46 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-18
Maturity Price : 20.20
Evaluated at bid price : 20.20
Bid-YTW : 5.60 %
RY.PR.C Perpetual-Discount 1.72 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-18
Maturity Price : 20.75
Evaluated at bid price : 20.75
Bid-YTW : 5.57 %
BNA.PR.D SplitShare 1.72 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2009-12-18
Maturity Price : 26.00
Evaluated at bid price : 26.30
Bid-YTW : -11.09 %
BAM.PR.B Floater 1.76 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-18
Maturity Price : 13.31
Evaluated at bid price : 13.31
Bid-YTW : 2.98 %
BAM.PR.K Floater 1.86 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-18
Maturity Price : 13.15
Evaluated at bid price : 13.15
Bid-YTW : 3.02 %
Volume Highlights
Issue Index Shares
Traded		 Notes
CM.PR.D Perpetual-Discount 89,700 RBC crossed blocks of 60,000 and 20,000 shares, both at 24.30.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-18
Maturity Price : 23.91
Evaluated at bid price : 24.24
Bid-YTW : 5.98 %
GWO.PR.X OpRet 79,529 Desjardins crossed 75,000 at 26.15.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2010-10-30
Maturity Price : 25.67
Evaluated at bid price : 26.13
Bid-YTW : 3.44 %
TRP.PR.A FixedReset 56,797 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-01-30
Maturity Price : 25.00
Evaluated at bid price : 25.71
Bid-YTW : 4.14 %
PWF.PR.J OpRet 50,858 Nesbitt crossed 50,000 at 26.10.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2009-12-18
Maturity Price : 25.75
Evaluated at bid price : 26.11
Bid-YTW : -9.40 %
BMO.PR.J Perpetual-Discount 43,500 CIBC bought 10,300 from TD at 20.24.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-18
Maturity Price : 20.20
Evaluated at bid price : 20.20
Bid-YTW : 5.60 %
BNS.PR.J Perpetual-Discount 33,600 RBC crossed 25,000 at 23.21.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-11-18
Maturity Price : 22.42
Evaluated at bid price : 23.15
Bid-YTW : 5.69 %
There were 33 other index-included issues trading in excess of 10,000 shares.