PrefBlog

Those contemplating reverse mortgages would do well to incorporate the new OSFI advisory into their planning … the rules for qualification for optimal capital treatment will indubitably influence the packages offered by banks, notably:

• initial loan-to-value of less than 40%
• Ongoing loan-to-value of less than 60%

I regret that it is not possible for me to prepare the market report. There is a difficulty recovering prices from the TSX.

Update, 2009-5-16: Well, it took a little while, but eventually the TSX’s little computer that could spit out the data: Volume was down sharply in pre-holiday trading (which is always something of a mystery to me) but PerpetualDiscounts had a good up-day while FixedResets were flattish.

The Bank for International Settlements has announced standardized guidelines for debt market statistics:

The Handbook is the first publication of its kind dealing exclusively with the conceptual framework for the compilation and presentation of securities statistics. As such, it directly addresses a recommendation of one of the Group of Twenty (G20) working groups concerning the need to fill data gaps and strengthen data collection. The aim of the Handbook is to assist national and international agencies in the production of relevant, coherent, and internationally comparable securities statistics for use in financial stability analysis and monetary policy formulation.

The Handbook is available from the IMF. It is not clear whether Canada will be producing and publishing statistics in accordance with the guidelines; both the Bank of Canada and Statistics Canada participated in the development of the guidelines.

Judicial Watch has released documents regarding the inauguration of TARP. Paulson made the first injection of TARP money an offer they couldn’t refuse:

This is a combined program (bank liability guarantee and capital purchase). Your firms need to agree to both.

• We don’t believe it is tenable to opt out because doing so would leave you vulnerable and exposed.
• If a capital infusion is not appealing, you should be aware that your regulator will require it in any circumstances

…
And, we want each of you to contact your Boards of Directors and confirm your participation this evening

Further to the Exchange Traded CDS idea the SEC is musing about a TRACE-like system:

U.S. regulators may impose the same price reporting and transparency requirements on over-the- counter derivatives that reduced bank profits by almost half in the corporate bond market when the Trace system was adopted seven years ago.

“I think it’s something we’ll look at very closely as a potential model,” Securities and Exchange Chairwoman Mary Schapiro said yesterday at a news conference in Washington, in which regulators laid out potential structural changes to improve policing of the $684 trillion OTC derivatives market.

Trace, the bond-price reporting system of the Financial Industry Regulatory Authority, gives anyone with an Internet connection access to trading data for corporate bonds. The system, in full operation since February 2005, reduced the difference in prices that banks charge to buy and sell bonds by almost half.

The BoC has published a working paper by Fuchun Li titled Testing for Financial Contagion with Applications to the Canadian Banking System:

The author’s new test is applied to investigate contagion from a variety of recent financial crises to the Canadian banking system. Three empirical results are obtained. First, compared to recent financial crises, including the 1987 U.S. stock market crash, 1994 Mexican peso crisis, and 1997 East Asian crisis, the ongoing 2007 subprime crisis has been having more persistent and stronger contagion impacts on the Canadian banking system. Second, the October 1997 East Asian crisis induced contagion in Asian countries, and it quickly spread to Latin American and G-7 countries. The contagion from the East Asian crisis to the Canadian banking system was not as strong or as persistent as that of the ongoing subprime crisis. However, it had a stronger impact on emerging markets. Third, there is no evidence of contagion from the 1994 Mexican peso crisis to the Canadian banking system. Contagion from that crisis occurred in Argentina, Brazil, and Chile, but the contagion effects of that crisis were limited to the Latin American region.
…
The stock returns of Canadian banks are used to measure the banks’s vulnerability to a financial crisis.

As in Forbes (2001), and Hartmann, Straetmans, and de Vries (2005), a stock return is chosen as an indicator to investigate whether there exists contagion for several reasons. First, since stock returns are measured at a much high frequency, they can more accurately pinpoint the effects of a specific crisis and are available for a large sample of countries. Second, since stock returns incorporate the immediate impact of a crisis as well as its expected longer-term effects, stock returns should capture the total impact of a crisis on a particular country. Third, the choice of bank stock prices for measuring banking system risk is also motivated by Merton’s (1974) option theoretic framework toward default. This approach has played an important role in risk analysis.

I question the utility of stock market prices in demonstrating anything other than stock price contagion. Evidence of contagion of effects impacting the real economy would be much more useful – not that I disagree that such is the case now, mind you, but stock market hiccups are not, in and of themselves, really all that important.

Financial Webring brings to my attention an essay by Keith Ambachtsheer & Rob Bower, Losing Ground (published in the Spring, 2007, Canadian Investment Review), that makes the claim:

The measured Canadian mutual fund average return
shortfall (before sales charges) of 3.8% per annum relative to similar mandates executed by Canadian pension funds suggests the average Canadian mutual fund has not been producing fair value for its customers.

Well, all I can say is … substituting “the benchmark” for “similar mandates executed by Canadian pension funds”, that’s not the experience of my fund, MAPF, which, somewhat to my chagrin, is still accepting new clients. Why do Canadians typically get lousy performance on their managed investment? Because that’s what they want.

A regulatory initiative that would help would be the regulatorially mandated disclosure of performance for all funds under management vs. appropriate benchmarks, for all time (i.e., a composite compliant with CFA Institute Standards) for all advisors. I should be able to click on “Joe Broker” and determine whether or not his claims of stock market acuity are backed up by actual dollar-and-cents returns. And that goes double for somebody with discretionary power over client assets.

I have previously written of the soon-to-be Exchange-Traded CDS market and debt decoupling (the idea that bankruptcy rules are based on actual creditors having a vote and using it in the best interests of holders of the debt; an assumption that is not necessarily true if they are hedged or – particularly – over-hedged). There are some new twists on this process with respect to Elliott Management and Clear Channel:

Elliott Management Corp., the hedge fund that almost pushed the government of Peru into default in 2000, is now seeking to profit from the failure of distressed companies.

About 11 percent of Elliott’s $13 billion of assets were in so-called basis trades at the end of the first quarter, meaning it bought bonds and credit-default swaps that protect against losses on the debt, according to a report dated April 29 sent to investors and obtained by Bloomberg News.
…
“Investors will hold out if they would benefit more if there’s a default than a successful distressed debt exchange,” said Kingman Penniman, president of high-yield research firm KDP Investment Advisors in Montpelier, Vermont. “It’s an easy decision to say ‘No’ and put the company into bankruptcy.”
…
CreditSights Inc. and Barclays Capital analysts have cited the rise in basis trades for restructuring attempts that floundered. Residential Capital LLC faced bondholder resistance to its debt-exchange proposal in December partly because the investors also held derivatives, Bradley Rogoff, an analyst at Barclays in New York, said in a report that month. Minneapolis- based mortgage lender ResCap was later bailed out by taxpayers.
…
In some cases, the wide basis has helped companies refinance because it boosts demand from investors who can buy the new debt while also purchasing relatively cheap insurance against default, Barclays’ Rogoff said in an interview in March.
…
In mid-November, investors could buy both Clear Channel’s 5.5 percent bonds due in 2014 and protection against a default for five years for about 80 cents on the dollar, according to CMA DataVision and Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

As default concerns increased, the combined cost jumped to 94 cents on the dollar. Investors can sell the bonds and unwind the credit-swap trade to cash in on that profit. Or, if they think a default remains likely, they could hold out for par.

Volume continued to be elevated today and the market continued its previously schedule ascent. PerpetualDiscounts now yield 6.51%, equivalent to 9.11% interest at the standard equivalency factor of 1.4x. Long corporates, however, are on fire, now yielding 7.0% (with a 4.13% Month-to-Date return), so the Pre-Tax Interest-Equivalent spread is now about 211bp.

Former SEC Chairman Arthur Levitt, who has been sharply criticized on PrefBlog, has said something sensible:

Arthur Levitt warned the Obama administration and U.S. regulators against attempting to change the way executives at financial firms are compensated.

“Government can jawbone but for government to regulate I think is overkill and very mistaken because you don’t know where it’s going to end,” Levitt said in an interview with Bloomberg Television today. Efforts by the Obama administration to change Wall Street pay practices are “totally wrongheaded,” he said.
…
Government attempting to regulate executive pay “has never worked and it cannot work,” Levitt said. “You just can’t micromanage in that way.”

Undismayed by fears of micromanagement, Geithner is pushing for OTC Derivative transparency:

The U.S. Treasury will tell banks to increase transparency in the over-the-counter derivatives market by making prices available on centralized computer platforms, according to people familiar with the plan.

Treasury Secretary Timothy Geithner may announce the decision as soon as today, said the people, who declined to be identified because they weren’t authorized to speak publicly.
…
Electronic execution of trades including interest-rate and credit-default swaps would allow users of the financial instruments to get greater price transparency and make processing trades easier. Transactions in the $684 trillion over-the-counter derivatives market are now typically conducted over the phone between banks and customers.

“Anything that will bring transparency to this market will help the market, but the dealers who broker the deals would make less money,” said Paul Zubulake, a senior analyst with Boston- based Aite Group. “More transparency for the buy-side is less profit for the sell-side.”

Zubulake said any mandated changes “are not good for business in general.”

There’s an interesting piece on VoxEU today by Adrian R. Bell, Chris Brooks & Tony Moore: The credit crunch of 1294: Causes, consequences and the aftermath. Plus ca change, plus ca meme chose! The direct parallels to the current crunch drawn by the authors seem to me to be a little contrived, but nevertheless all knowledge is good knowledge.

Volume eased off a bit today, but remains above average levels. Price action was flattish, but with a fair amount of dispersion.

Julia Dickson of OSFI gave a good speech at the Asian Banker Summit, with the central point:

As pointed out by Counterparty Risk Management Policy Group (CPRMG) III “financial excesses fundamentally grow out of human behaviour…which on the upside of the cycle, fosters risk taking and on the downside fosters risk aversion”. The CPRMGIII report goes on to make a number of very basic recommendations: know the risk you are taking, determine a risk appetite and monitor it, have good corporate governance, and ensure that control functions have authority and independence from the business units, communicate well within the firm, among others. What were we doing before this crisis if we did not know the value of these recommendations? We keep learning that we should not assume risks that we do not understand, that we should be diversified, and more… and we keep relearning!

Unfortunately, she continued with the regulators’ obsession with the fact that some people make more money than they do and are sexier:

Why is it that people do not learn these lessons; is it because they have short memories? Memory does fade with time, but I would also suggest it is because powerful incentives are at play. Perhaps we should be looking at how these incentives can blind us to some basic common sense principles.

Looking at incentives requires us to look at a lot more than just bankers’ compensation packages. It requires us to go down some paths that might be quite sensitive; many of them involve the depth to which the financial sector has pervaded our culture.

If I thought all this musing would end with a de facto separation of investment banking and commercial banking, I wouldn’t be so worried. However, the trend seems to be towards further increases in staffing investment banks – and the associated asset management firms – with unmotivated 18-year-old bank tellers. Ultimately, this will cost us a lot of money; and we won’t, ultimately, get fewer instances of rampant idiocy, we’ll just get different ones. Chrysler & GM, propped up for years by the political allure of good jobs, are going to cost taxpayers a lot more money than any of the banks.

Ms. Dickson spoke approvingly of an essay by Claudio Borio of BIS, The macroprudential approach to regulation and supervision, who notes:

Just as an asset manager, who cares about the loss on her portfolio as a whole, focuses on the co-movement of the portfolio’s securities, so a macroprudential regulator would focus on the joint failure of institutions, which determines the loss for the financial system as a whole. The main policy question is how to design the prudential framework to limit the risk of losses on a significant portion of the overall financial system and hence its “tail risk”.

Some might wonder how a desirable object such as heterogeneity of banks might possibly be accomplished with homogeneous banking rules; but it seems to be the regulators’ position that “Regulatory Arbitrage” is a bad thing.

The WSJ has published some criticism of the European response to the Credit Crunch; in return, C-EBS has published a statement on stress-testing:

The Committee of European Banking Supervisors (CEBS) today publishes its statement on stress testing exercise.

– Supervisory authorities in the EU are, in the context of their regular risk assessment of the financial sector, carrying out an EU-wide forward looking stress testing exercise on the aggregate banking system.

– This is not a stress test to identify individual banks that may need recapitalization, as the assessment of specific institutions’ needs for recapitalization remains a responsibility of national authorities.

– This test builds on common scenarios and guidelines developed by the Committee of European Banking Supervisors (CEBS).

– The objective is an EU-wide exercise with common guidelines and scenarios, so as to increase the level of aggregate information among policy makers in assessing the European financial system’s potential resilience to shocks and to contribute to the convergence of best practices in the EU.

– CEBS’ next regular risk assessment will be ready by September 2009. The outcomes are confidential.

DBRS downgraded a big batch of sub-prime RMBS today:

DBRS has today downgraded 1,441 classes from 195 residential mortgage-backed securities (RMBS) transactions. Of the 195 affected transactions, 125 are backed by first-lien subprime collateral, 53 are backed by Alt-A collateral, 12 are backed by prime collateral and five are backed by second-lien subprime collateral.

The classes have been downgraded as a result of the continued rapid increase in serious delinquencies and cumulative losses relative to the available credit enhancement. Additionally, the persistent negative outlooks of the housing market and unemployment rates, coupled with low prepayment speeds, have contributed significantly to the increased default and loss expectations.

As a result, current credit support is not expected to sufficiently cover the anticipated losses. In many cases, subordinate classes have already been impaired, further weakening the available credit support for the remaining senior and mezzanine classes.

They also downgraded Toyota from AAA.

Morningstar reports:

Mutual fund rating agency Morningstar has ranked Canada mid-pack among 16 major countries as a good place for fund investors – but with a failing grade for fees and expenses.

Canada rates high for investor protection and investment transparency, and its overall grade was B-minus, based on criteria which also included taxation and investment choices.
…
Canada, by contrast, got the only F grade for fees among the 16 countries studied.

The typical Canadian fund investor pays a management expense ratio of 1.25 to 1.49 per cent for a bond fund, and between two and 2.5 per cent for an equity fund.

Canadians also typically face a front-end load of between four and five per cent, “primarily because investors are unaware that this fee is negotiable,” the Morningstar study adds.

And it notes that Canadian MERs contain trailer fees – “which are fees fairly specific to the Canadian market” – that are paid by fund companies on an ongoing basis to the advisers that sold the funds.

“Canadian investors are comfortable with the fees because they don’t know how low these fees should actually be,” the Morningstar study asserts.

“Assets tend to flow into average-or higher-fee funds because Canadian investors use financial advisers to help them make decisions,” it adds.

“Advisers direct client assets to funds that pay better trailers. And since the trailer is included in the MER, the result is that assets flow into higher-fee funds.”

I note that MAPF now has another competitor, AIC Preferred Income Fund, which pays a trailer of up to 1% out of a management fee of 2.00% plus expenses.

Price changes were mixed today in the preferred share market, netting out to about flat; volume was very good.

About a year ago, there were wild claims being made (e.g., Naked Capitalism) that grading US municipalities on a global scale would bring about Nirvana and the end of useless and expensive municipal bond insurance. It turns out – surprise, surprise – that despite the changes, there are still credit differences between municipalities and the weaker credits still need insurance to flog their bonds:

An early contender to replace them, Warren Buffett’s Berkshire Hathaway Assurance Corp., was downgraded to Aa1 by Moody’s Investors Service in April. The billionaire investor in February called tax-exempt bond guarantees “a dangerous business.” His firm insured $3.3 billion in issues last year, ranking third in the industry.

Buffett’s warning isn’t stopping Macquarie Group Ltd., Australia’s biggest securities firm, from backing a new guarantor: Municipal and Infrastructure Assurance Corp. plans to sell its first policy by July, said Richard E. Kolman, the New York-based startup’s executive vice chairman.

“It is surprising to find that municipal bond insurance is anything but moribund in the early going in 2009,” wrote Philip J. Fischer, a Merrill Lynch & Co. municipal strategist in New York, in an April 6 report.

The overall market price changes were minimal today, although volume continued strong. It was most interesting to see that FixedResets were shut out of the volume-leaders table … that hasn’t happened in a while!