What is the YTW of RY.PR.N? Win a PrefLetter!

December 22nd, 2008

I will admit that sometimes I look at the analysis generated by HIMIPref™ and blink. The assumptions and procedures and approximations used in the course of the analysis can sometimes work together in unexpected ways … so the results need to be reviewed in order to determine whether

  • the programme is really doing what I wanted it to do, and
  • whether I still want the programme to do what I previously wanted it to do

Such are the joys of quantitative analysis, when you can spend a month trying to figure out the analysis of one instrument on a date from ten years back!

This time, however, it’s today’s analysis of RY.PR.N: it closed today at 26.00-10, 28×1, after trading 29,390 shares in a range of 26.00-10.

And yet despite the $26.00 price, HIMIPref™ shows the pre-tax bid-YTW scenario as being the limitMaturity – that is, the dummy maturity thirty-years hence which is used as a substite for “forever”.

First, some facts: the issue closed on December 9 and is a fixed reset with the terms 6.25%+350. The analysis assumes that 5-year Canadas will now and forever yield 1.83%, so the rate is presumed to be reset to 5.33% at the first (and all subsequent) reset dates.

HIMIPref™ calculates the yield to first call of 5.4130% and yield-to-limit of 5.2913%. I have uploaded the cash-flow reports for the five year and 30-year maturities. The YTW is the worst yield, 5.2913%, and the YTW scenario is the 30-year maturity.

There cannot be much argument about the yield calculation for the five year maturity; everything is known, so it’s all perfectly standard. However, the thirty year maturity is simply an analytical placeholder for “forever” and the maturity value is not known. As you can see from the reports, HIMIPref™ estimates a price of $23.44 for the 30-year case.

Why $23.44? For that we have to look at the HIMIPref™ calculation of costYield … I have uploaded the relevant cash flow analysis. Readers will note the cash flow entry dated 2014-3-26, for -1.73 (future value) discounted to -1.34 (present value). This is the estimate of what the issuer’s call option is costing the holder; the implication is that if this option didn’t exist, we’d be willing to pay $1.34 (present value) more for the security.

The value of the option is calculated using a time-influenced distribution of possible prices centred on the current price. As shown by the Option Cash Flow Effect Analysis, it is currently assumed that there is a 53% chance of the option being exercised. Slicing the price distribution into two parts on that date, it is calculated that the average unconstrained price in exercise scenarios is 28.24; the average unconstrained price in non-exercise scenarios is 23.44. Voila! An estimated maturity price of $23.44.

I’ve also uploaded an Excel spreadsheet where I did a little fooling around with the reports. Raw data is in cells a1:e128. I’ve converted the semi-annual yield back into annual in cells c129:c130. The cash-flows with some decimals put back in are in cells g1:g122. My check on the arithmetic is in cells i1:j122 and sum to a present value of $26.03805; I’m assuming that the extra 3.805 cents is due to rounding differences of dates and days-in-year approximations. I used cells l1:n124 to play around with the yield-effect of different maturity values, and summarized my playing in cells l127:n130, which I will reproduce here:

RY.PR.N
Effect of Maturity Value
on Calculated Yield
Maturity Value Semi-Annual Yield
25.00 5.38%
26.00 5.44%
23.44 5.290%

It’s not all that sensitive, but the rate with a 26.00 end-value is slightly in excess of the 5-year rate, implying that if we rely on a 26.00 end-value then the 5-year yield is the YTW … as would be expected.

But I claim that you cannot count on a 26.00 end-value. I claim that if the unconstrained market price is 26.00 on a call date, then the issuer will call the issue at 25.00 instead. All you can count on at the end of eternity (which is 30-years off) is that fraction of the price distribution that escaped the calls … and that has an average value of 23.44.

And hence, the YTW scenario for a 26.00 issue callable at 25.00 in five years is … the limit maturity. This doesn’t happen for normal “straight” perpetuals: if the issue had an expected cash flow stream of 6.25% for the entire 30-year period, rather than 6.25% for five years and 5.33% thereafter, the five-year call would have a lower yield and hence be the YTW scenario.

And, just for fun, let’s have a contest! Presuming an end-value of 23.44, what post-reset 5-Year Canada yield (and hence, what dividend rate on RY.PR.N) do we need to bump the yield up to the point where the 5-year call becomes the Yield-To-Worst scenario? First correct answer wins a copy of the January edition of PrefLetter.

Posted in Issue Comments, PrefLetter | No Comments »

RPA.PR.A Downgraded to P-3 / Watch Negative by S&P

December 22nd, 2008

ROC Pref II Corp has announced:

that Standard & Poor’s (“S&P”) lowered its ratings on ROC II’s Preferred Shares from P-2 to P-3 and the Preferred Shares remain on CreditWatch with negative implications. S&P expects to resolve the CreditWatch placement within a period of 90 days and update its opinion. As announced in a press release dated December 8, the move comes as a result of the Tribune Company credit event as well as several downgrades of companies held in the Reference Portfolio.

ROC Pref II Corp.’s Preferred Shares pay a fixed quarterly coupon of 4.65% on their $25.00 principal value and will mature on or about December 31, 2009. The Standard & Poor’s rating addresses the likelihood of full payment of distributions and payment of $25.00 principal value per Preferred Share on the maturity date. The Preferred Shares are listed for trading on the Toronto Stock Exchange under the symbol RPA.PR.A.

The effect of the Tribune credit event was reported on PrefBlog.

RPA.PR.A is not tracked by HIMIPref™.

Posted in Issue Comments | 1 Comment »

PRF.PR.A Downgraded to P-2(high) / Watch Negative by S&P

December 22nd, 2008

ROC Pref Corp has announced:

that Standard & Poor’s (“S&P”) lowered its ratings on the Company’s Preferred Shares from P-1 to P-2 (high) and the Preferred Shares remain on CreditWatch with negative implications. S&P expects to resolve the CreditWatch placement within a period of 90 days and update its opinion. As announced in a press release dated December 8, the move comes as a result of the Tribune Company credit event as well as several downgrades of companies held in the Reference Portfolio.

ROC Pref Corp.’s Preferred Shares pay a fixed quarterly coupon of 4.30% on their $25.00 principal value and will mature on or about September 30, 2009. The Standard & Poor’s rating addresses the likelihood of full payment of distributions and payment of $25.00 principal value per Preferred Share on the maturity date. The Preferred Shares are listed for trading on the Toronto Stock Exchange under the symbol PRF.PR.A.

The effect of the Tribune credit event was reported on PrefBlog.

PRF.PR.A is not tracked by HIMIPref™.

Posted in Issue Comments | 2 Comments »

OSFI Clarifies Position on Bank Capital

December 22nd, 2008

In a speech given on November 18, OSFI Superintendant Julia Dickson said:

With the new found appreciation for capital, everyone is asking what capital level is enough, particularly in the banking sector, which has been in the eye of the storm. While it is difficult to do a comparison of capital ratios across global life companies (due to differences in nomenclature and approach), it is easier to do in the banking sector, and that has been the focus of much attention.

What we see in a comparison of international banks against Canadian banks is that our big five banks went into the turmoil with high capital levels (and we would say the same about life companies). Bank Tier 1 ratios at Q3 2008 ranged from 9.47 per cent to 9.81 per cent. This compared to Tier 1 ratios at other global banks that often started with the digits 6, 7 and 8 (versus 9 in Canada).

If you look at what is contained in Tier 1 — as they say, never judge a book by its cover — you will find that Canadian banks have platinum quality Tier 1 when compared to banks in other countries. The percentage of common shares is skyhigh, something not replicated in other places around the world.

Capital injections from governments into other global banks have tended to be in preferred shares (and sometimes preferred shares with step-ups or incentives to redeem that detract from their permanence, and permanence is a critical element for OSFI to consider something as Tier 1 capital). Canadian bank Tier 1 common ratios at Q3 2008 tended to be in the high 7s or low 8s. Elsewhere in the world the ratios were typically 5, 6, and low 7s.

To summarize, quality, and level of capital, are equally important and the market needs to focus on that. Going forward, there is going to be an incredible amount of attention paid by regulators internationally on the level and quality of capital. I believe Canada is well placed to enter those discussions. I also think that decisions will likely only be taken once world economies strengthen, and financial institutions will be given plenty of advance notice regarding new requirements.

The increase in the Tier 1 preferred limit has been discussed on PrefBlog. It does seem rather odd to me that OSFI is exalting the high quality of bank capital while at the same time permitting its debasement. There’s not necessarily a contradiction here, but there is definitely a need for a wee bit of discussion on the point.

Now, in the face of media frenzy, OSFI has released a note of calm:

Recent media reports regarding the Office of the Superintendent of Financial Institutions’ (OSFI) position on capital ratio levels may have led to some confusion. On Friday, December 19, 2008, OSFI provided the following information to the media:
OSFI’s views on capital were outlined in a speech given by Superintendent Julie Dickson on November 13, 2008, and those views have not changed.

In that speech, the Superintendent made a number of points, among them, that Canadian banks remain well capitalized. It noted that common equity ratios of the large banks are particularly high, and that markets ought to consider this in their views about capital adequacy. This point was made because markets were demanding that Canadian banks increase capital, possibly based on a simple comparison of Tier 1 levels across global banks, even though many global banks have had capital injections from governments.

Further, it was noted that banks should not engage in share buy-backs without first clearing it with OSFI, as capital needed to be managed conservatively. Managing capital conservatively does not mean increasing capital.

OSFI has discussed global market developments both with banks and international regulators, as a similar phenomenon of markets taking a view on capital and driving up capital levels, is being observed globally. At the same time, to the extent banks have met market expectations regarding capital, this makes Canadian banks well-positioned to continue to lend.

As well, OSFI has increased flexibility within its rules by increasing the preferred share limit to 40 per cent from 30 per cent, which reduces the cost of capital for financial institutions, and may further support lending.

In short, OSFI has not pushed for higher capital ratios across the board, and OSFI agrees that capital is a cushion that should be available to be drawn down when faced with unexpected losses.

Posted in Regulation | No Comments »

Term Premia on Real-Return Bonds in the UK

December 22nd, 2008

The Bank of England has released Working Paper #358, “Understanding the real rate conundrum: an application of no-arbitrage finance models to the UK real yield curve”, by Michael Joyce, Iryna Kaminska and Peter Lildholdt, with the abstract:

Long-horizon interest rates in the major international bond markets fell sharply during 2004 and 2005, at the same time as US policy rates were rising; a phenomenon famously described as a ‘conundrum’ by Alan Greenspan the Federal Reserve Chairman. But it was arguably the decline in international long real rates over this period which was more unusual and, by the end of 2007, long real rates in the United Kingdom remained at recent historical lows. In this paper, we try to shed light on the recent behaviour of long real rates, by estimating several empirical models of the term structure of real interest rates, derived from UK index-linked bonds. We adopt a standard ‘finance’ approach to modelling the real term structure, using an essentially affine framework. While being empirically tractable, these models impose the important theoretical restriction of no arbitrage, which enables us to decompose forward real rates into expectations of future short (ie risk-free) real rates and forward real term premia. One general finding that emerges across all the models estimated is that time-varying term premia appear to be extremely important in explaining movements in long real forward rates. Although there is some evidence that long-horizon expected short real rates declined over the conundrum period, our results suggest lower term premia played the dominant role in accounting for the fall in long real rates. This evidence could be consistent with the so-called ‘search for yield’ and excess liquidity explanations for the conundrum, but it might also partly reflect strong demand for index-linked bonds by institutional investors and foreign central banks.

From the discussion:

One clear finding of our results across all the models we estimate is the importance of movements in estimated real term premia in explaining movements in real rates. This is contrary to what appears to be the conventional wisdom that real term premia are small and negligible. Indeed, many papers simply ignore the presence of real term premia altogether (for a recent example, see Ang, Bekaert and Wei (2007)).
…
Negative term premia are of course quite consistent with finance theory and may indicate that for some investors long-maturity index-linked bonds are seen as providing a form of ‘insurance’. However, the emergence of negative term premia in the late 1990s seems likely to have reflected the impact of various accounting and regulatory changes that have caused pension funds to match their assets more closely to their liabilities by switching into long-maturity conventional and index-linked bonds (see McGrath and Windle (2006)). Indeed, the timing of the move to negative term premia suggested by the model decompositions seems to broadly match the introduction of the MFR in 1997, which market commentary suggests had a significant impact on UK pension fund asset allocation.

Footnote: More recently, the Pensions Act 2004, which became effective in December 2005, introduced a new Pensions Regulator with powers to require pension fund trustees and sponsors to address issues of underfunding. Another factor that may also have influenced pension fund behaviour has been the ‘FRS 17’ accounting standard, which became effective from the start of 2005, and has meant that pension scheme deficits/surpluses need to be measured at market value and included on company balance sheets. Both these factors are thought to have increased pension fund demand for longer-duration nominal and real gilts, as assets which provide a better match for their liabilities. See discussion in the ‘Markets and Operations’ article of the Bank of England Quarterly Bulletin, Spring 2006.

With conclusions:

Another important finding, common to all the estimated model specifications, is that our term premia estimates appear to have been negative over much of the sample period since the late 1990s. We have argued that this is likely to reflect the impact of various accounting and regulatory changes in the United Kingdom that have encouraged pension funds to match their assets more closely to their liabilities, by switching into long-maturity conventional and index-linked bonds. The importance of this Category 3 explanation for the behaviour of term premia after the 1990s needs to be borne in mind when interpreting more recent downward moves in term premia.
…
In terms of understanding the fall in long rates over the conundrum period during 2004 and 2005, all the estimated models suggest that falls in UK long real rates have to a significant degree reflected reductions in real term premia, though the extent to which this is true varies with the precise model specification used. The importance of the reduction in term premia might indicate the influence of changing institutional investor behaviour, but the fact that the decline in long rates was a global phenomenon suggests to us that this is unlikely to have been the primary cause. This leads us to the conclusion that excess liquidity and search for yield were more important in explaining the compression of real term premia. But since our models also suggest that there is some evidence that perceptions of the neutral rate of interest may have fallen, we cannot rule out the possibility that changes in the balance of investment and saving may also have had an impact. In terms of the recent conjuncture, all our model specifications would suggest that there is a risk real rates may rise in the future, since in all of the models forward premia or expected future short rates are below their long-run expected levels.

Chart 6: Decomposition of the ten-year real forward rate from the survey model:

Posted in Interesting External Papers | 2 Comments »

Financing the Fed's Balance Sheet

December 22nd, 2008

James Hamilton of Econbrowser writes another marvellous review of the Fed’s Balance sheet, updating his prior commentary which was also reviewed on PrefBlog.

One thing I had been unclear about was the precise nature of the “Supplementary Financing Program Account” of Treasury at the Fed, which is financing all the special programmes. While the assertion has been made that the Fed’s intervention is sterilized (meaning that it is causing no increase in monetary aggregates) … I wasn’t sure. However, the Monthly Treasury Statement referenced by Dr. Hamilton shows clearly (Table 6 on page 20) that Treasury has issued about $630-odd billion in Treasury Securities in fiscal 2009 to date, of which $588-billion has been from the public. This more than covers the $134-billion increase in the Supplementary Account, while still leaving $402-billion to finance the deficit … which is the total deficit for F2009 reported in Table 5 on page 18.

OK, so that’s cleared up!

Dr. Hamilton concludes:

For the record, let me reiterate my personal position on all this.

(1) I am doubtful of the Fed’s ability to alter interest rate spreads through the kinds of compositional changes in its balance sheet implemented over the last two years. Whatever your prior ideas were about this, surely it’s time to revise those in light of incoming data– if the first trillion dollars didn’t do the job, how much do you think it would take to accomplish the task?

(2) I think the Fed’s goal should be a 3% inflation rate. Paying interest on reserves and encouraging banks to hoard them is inconsistent with that objective, as would be a new trillion dollars in money creation.

I would therefore urge the Fed to eliminate the payment of interest on reserves and begin the process of replacing the exotic colors in the first graph above with holdings such as inflation-indexed Treasury securities and the short-term government debt of our major trading partners.

I’m not sure that point 1 is phrased in a useful manner. As I see it, the objective is not so much to maintain spreads as it is to ensure that the market exists at all. It has been observed that securitization has declined, which has had essentially forced banks to intermediate between borrowers and lenders, as opposed to simply engaging in the disintermediation inherent in packaging their loans and taking the spreads and servicing fees.

John Kiff, Paul Mills & Carolyne Spackman wrote a piece for VoxEU, European securitisation and the possible revival of financial innovation:

Collapsing global securitisation volumes in the wake of the subprime crisis have raised fundamental questions over the viability of the originate-to-distribute business model.1 Issuance has dropped precipitously in both Europe and the US, with banks keeping more loans on their balance sheets and tightening lending standards as a result (Figure 1). The decline has been particularly sharp for mortgage-backed securities and mortgage-backed-securities-backed collateralised debt obligations. The originate-to-distribute model was thought to have made the financial system more resilient by dispersing credit risk to a broad range of investors. Ironically, however, it became the source of financial instability.
…
The risk transfer and capital saving benefits of securitisation, combined with underlying investor demand for securities, should eventually revive issuance. But the products are likely to be simpler, more transparent, and trade at significantly wider spreads.

All that lost securitization issuance is staying on banks’ balance sheets and there are only a few possibilities:

  • let the market collapse: in this case, banks will simply cease to make new loans; their balance sheets won’t take the strain and they can’t really issue new equity while the markets are so awfully depressed without really sticking it to their existing shareholders, or
  • let the markets adjust.

An adjustment in the market can take place in several different ways:

  • banks can re-intermediate: this will require balance sheet expansion, which can’t happen until they can sell equity at reasonable prices, or
  • securitization markets can get restarted

I suggest that it is a Public Good for securitization markets to restart and agree with Kiff et al. that this will likely be accompanied by greater transparency and wider spreads. Trouble is, nobody knows what those spreads will be like.

What should the spread of mortgages over governments be? Agency spreads in the US were minimal prior to the current crisis and it seems clear to me that they should be wider. I’ve tried to find an easy graph for mortgage spreads in Canada – where securitization is nowhere near as important – but the best I’ve been able to come up with is a chart from 1999:

Mortgages are not, perhaps, the best example to choose because as I have repeatedly noted, there is a lot more that’s wrong with the American mortgage market than mere sub-prime:

Americans should also be taking a hard look at the ultimate consumer friendliness of their financial expectations. They take as a matter of course mortgages that are:

  • 30 years in term
  • refinancable at little or no charge (usually; this may apply only to GSE mortgages; I don’t know all the rules)
  • non-recourse to borrower (there may be exceptions in some states)

  • guaranteed by institutions that simply could not operate as a private enterprise without considerably more financing
  • Added 2008-3-8: How could I forget? Tax Deductible

Clearly, in the particular case of US mortgages, the underlying pools must not just trade at wider spread, but they must be more investor friendly.

However, I do recognize Dr. Hamilton’s desire to put a limit on the amount of reintermediation that is being done by the Fed, but must disagree with the prescription of keeping the balance sheet grossed up with government bonds of any description.

I suggest that a schedule be put into place whereby, for instance, the Commercial Paper Funding Facility have its spreads gradually widened. Rates are now 2.19% for unsecured commercial paper and is scheduled to cease purchasing new paper on April 30, 2009. The current rate paid on excess & required reserve balances is now 0.25%. Thus, it is apparent that in the current environment, a spread of 194bp is not enough to get the banks to move into commercial paper in a big way. The same applies to the general public.

I suggest that this is a distress-level spread, being paid for CP of perfectly good quality; indicating a flight to safety. Eventually the climate of blind fear will dissapate, but until that happens the Fed should continue to apply the implicit Bagehot prescription of making credit freely available at punitive rates. And, perhaps, announce that the programme will be extended past April, but at spreads on CP of 110+110 (for the duration of the extension), rather than the current 100+100. Eventually, one of several things will happen:

  • Greed will overcome fear, and banks (et al.) will cease lending to the Fed at 0.25% and start lending to solid companies at 2.25%, or
  • Companies will refinance with longer term paper, or
  • Companies will go bust.

Posted in Banking Crisis 2008 | 5 Comments »

Bronte Capital Added to Blogroll

December 20th, 2008

I haven’t read much of Bronte Capital, but I like what I see! The blog has been favourably reviewed by Felix Salmon.

The identification is not robust, but I believe that the author, John Hempton, was a Senior Analyst with Australia’s Platinum Asset Management. There is a Canadian connection with unsupported allegations that Mr. Hempton was involved – somehow – with the shorts’ attack on Fairfax. There is a John Hempton named in a class action lawsuit against SAC regarding Fairfax, but whether the lawsuit’s John Hempton is the same as the other John Hemptons named here is not clear. There is a similar reference in Fairfax’s lawsuit.

Posted in Administration | No Comments »

December 19, 2008

December 20th, 2008

S&P cut a whack of bank ratings today, on the following grounds:

  • overall assessment of industry risk has been increased
  • sensitivity of ratings model to reliance on short term funding has increased
  • levels of stress are expected to be higher than typical cycles
  • model emphasizing risk-adjusted capital; developing framework that is more risk-sensitive than Basel I and more conservative than Basel II, particularly with respect to market risk and private equity risk.
  • “Systemically important” banks will have potential government support recognized

Rating changes were:

  • Bank of America, AA- from AA
  • Barclays, AA- from AA
  • Citibank, A+ from AA
  • Credit Suisse, A+ from AA-
  • Deutsche Bank, A+ from AA-
  • Goldman Sachs, A from AA-
  • HSBC, AA (negative outlook) from AA (stable)
  • JPMorgan, AA- from AA
  • Morgan Stanley, A from A+
  • Royal Bank of Scotland, A+ from AA-
  • UBS, A+ from AA-
  • Wells Fargo, AA+ (negative outlook) from AAA (Watch negative)

Some pretend-managers, very upset by Deutsche Bank’s refusal to execute an out-of-the-money call are very upset:

Deutsche Bank AG’s decision to pass up an opportunity to redeem 1 billion euros ($1.39 billion) of bonds is a setback for financial market stability, according to U.K. and German investment management and insurance groups.

The bank’s choice “will weigh on the markets for months,” said Andreas Fink, a Frankfurt-based spokesman for the BVI German Investment and Asset Management Association, whose 92 members oversee about 1.4 trillion euros of assets.
…
“This is a setback for the stabilization of banking markets and is likely to increase funding costs for banks generally,” Jonathan French, the London-based spokesman for the Association of British Insurers, said in an e-mailed statement to Bloomberg News.

S&P’s note on their bank downgrades stated:

We believe that the difficult operating environment will increase payment deferral risk of most regulated financial institutions’ hybrid capital securities in the U.S. and Europe, including the large systemically important banks covered in this review. This is because the difficult environment is expected to pressure financial performance.

Both Sarkozy and our very own Spend-Every-Penny are grandstanding about what a great banking system there would be if only they ran it. However, not all Canadian politicians have their ideas forgotten! California’s civil servants will get Rae days!

Accrued Interest brings an update on the new Term Auction Loan Facility; it looks like the Fed is desperate to get the securitization market started again.

Via Dealbreaker comes a link to a NYT article, Even Winners May Lose with Madoff:

One client said he invested more than $1 million with Mr. Madoff over a decade ago. As his portfolio rose in value, he took out several million dollars. While his statements showed several million dollars in his Madoff account when the fund collapsed last week, the client still ended up ahead.
…
But previous court rulings regarding financial frauds suggest the winners could be forced to give up some of their gains to losers.
…
Yet even Mr. Madoff’s most fortunate clients may wind up having to give back some of their gains, as investors might have to do in another recent financial fraud, the collapse of the hedge fund Bayou Group in 2005.

In the Bayou case, in which investors lost $400 million, a bankruptcy judge ruled that investors who withdrew money even before Bayou collapsed might have to return their profits, and possibly some of the initial investments, to the bankruptcy trustee overseeing the unwinding of Bayou.

The returned money is to be distributed among all investors, who are expected to receive only about 20 to 40 percent of their original investments.

Mr. Madoff’s winning clients are likely to face similar legal challenges. In fact, the Madoff client who profited from his investment spoke on the condition that he not be identified, out of concern that he might be sought out to repay some of his gains to the receiver or bankruptcy trustee for Mr. Madoff.

This is the worst thing that can happen in a fraud like this. The highlighted investor, it would seem, did everything right (except due-diligence, and nobody does that; it’s too expensive and if you do do it, you’ve got to listen to some whiny little geek who can’t even sell investment strategies tell you that you can’t put your [client’s] money into a sure thing with a great story): he regarded his hedge fund investment as high-risk and rebalanced regularly, taking his money off the table. He has adjusted his investment portfolio – and quite possibly his entire lifestyle – as a result of his ethereal winnings and now has to give them back.

I was once part (a very small, clerical level part) of an investigation of a stockbroker who had been naughty. Little Joe & Jane Lunchbucket had gone out and bought houses – retired, even, if memory serves – on the basis that their accounts were worth lots of money and would support them. The firm made good on actual losses, but not on fictitious winnings. It was a really, really bad situation.

There’s a marvellous post regarding the Madoff scandal on Bronte Capital and a thoroughly fascinating letter to the SEC via the WSJ.

What-Debt? is musing about a $30-billion deficit. I don’t have any problems with a deficit of that size, and I support Econbrowser‘s James Hamilton’s call for the stimulus to take the form of unrestricted grants to lower levels of government. I would go farther than that: there are hospitals and charities (a friend specifically mentioned Habitat for Humanity) who can get shovels in the ground next week if they can get some funding. There should be controls, of course, to ensure that the capital projects are actually useful (unlike Japan’s Ibaraki Airport discussed on December 4); but speed in spending the money is important.

No, my problem with a $30-billion deficit is that we don’t have the money already. Planned debt reduction of $3 billion per year for 2010–11 to 2012–13 based on rosy forecasts of continued good times won’t pay for a lot of recessions. But What-Debt? and Spend-Every-Penny have crippled Canada’s ability to maintain a surplus through a normal business cycle, importing the simplistic US Republican thesis that tax cuts are always good, particularly if the cuts are completely bone-headed, like the GST cut. Throw the rascals out!

Another day of very heavy volume and … the sixth straight decline in PerpetualDiscounts, which now yield 8.31%; edging closer to their recent high of 8.63%. The former, current, figure is equivalent to 11.63% interest at the standard conversion factor of 1.4x; given that long corporates yield about 7.50%, the pre-tax interest-equivalent spread is an astonishing 413bp.

PerpetualDiscounts are currently down 1.48% total return on the month; Split-shares have had a better time of it and are now up 13.11% on the month; probably due to the market’s discovery of monthly retraction possibilities.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30.
The Fixed-Reset index was added effective 2008-9-5 at that day’s closing value of 1,119.4 for the Fixed-Floater index.
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet N/A N/A N/A N/A 0 N/A N/A
Fixed-Floater 8.57% 8.73% 134,564 11.91 7 -0.0141% 615.9
Floater 9.49% 9.56% 87,210 9.98 2 +4.7913% 342.5
Op. Retract 5.57% 6.98% 163,527 4.12 14 +0.3043% 976.6
Split-Share 6.68% 12.27% 96,353 3.94 15 +1.4955% 924.0
Interest Bearing 9.88% 19.63% 57,409 2.66 3 +1.6042% 750.4
Perpetual-Premium N/A N/A N/A N/A N/A N/A N/A
Perpetual-Discount 8.17% 8.31% 239,331 11.12 71 -0.4405% 680.0
Fixed-Reset 6.03% 5.38% 1,164,322 13.83 18 +0.0489% 1,002.3
Major Price Changes
Issue Index Change Notes
BCE.PR.Z FixFloat -5.8824%  
HSB.PR.C PerpetualDiscount -5.6250% Now with a pre-tax bid-YTW of 8.51% based on a bid of 15.10 and a limitMaturity. Closing quote 15.15-25, 20×20. Day’s range of 15.10-00.
POW.PR.C PerpetualDiscount -4.4251% Now with a pre-tax bid-YTW of 8.31% based on a bid of 17.51 and a limitMaturity. Closing quote 17.73-91, 1×1. Day’s range of 17.50-18.89.
CU.PR.B PerpetualDiscount -3.9543% Now with a pre-tax bid-YTW of 7.54% based on a bid of 20.16 and a limitMaturity. Closing quote 20.15-29, 8×5. Day’s range of 20.15-81.
BMO.PR.H PerpetualDiscount -3.7589% Now with a pre-tax bid-YTW of 8.35% based on a bid of 16.13 and a limitMaturity. Closing quote 16.18-39, 6×1. Day’s range of 16.05-60.
CM.PR.P PerpetualDiscount -3.0890% Now with a pre-tax bid-YTW of 8.80% based on a bid of 16.00 and a limitMaturity. Closing quote 16.21-45. Day’s range of 15.70-16.51.
SLF.PR.C PerpetualDiscount -2.8754% Now with a pre-tax bid-YTW of 9.23% based on a bid of 12.16 and a limitMaturity. Closing quote 12.26-49, 3×12. Day’s range of 12.15-10.
CM.PR.G PerpetualDiscount -2.7778% Now with a pre-tax bid-YTW of 8.78% based on a bid of 15.75 and a limitMaturity. Closing quote 15.91-00, 8×5. Day’s range of 15.75-50.
NA.PR.M PerpetualDiscount -2.5600% Now with a pre-tax bid-YTW of 8.36% based on a bid of 18.27 and a limitMaturity. Closing quote 17.31-60, 5×1. Day’s range of 17.31-60.
BNS.PR.N PerpetualDiscount -2.5507% Now with a pre-tax bid-YTW of 7.98% based on a bid of 16.81 and a limitMaturity. Closing quote 16.80-09, 9×18. Day’s range of 16.80-60.
CM.PR.K FixedReset -2.5352%  
BCE.PR.C FixFloat -2.5271%  
BAM.PR.N PerpetualDiscount -2.4390% Now with a pre-tax bid-YTW of 14.33% based on a bid of 8.40 and a limitMaturity. Closing quote 8.35-58, 1×1. Day’s range of 8.35-93.
SBN.PR.A SplitShare -2.3502% Asset coverage of 1.6+:1 as of December 11, according to Mulvihill. Now with a pre-tax bid-YTW of 9.04% based on a bid of 8.31 and a hardMaturity 2014-12-1 at 10.00. Closing quote of 8.30-82, 200×3. Yes, that’s a bid for 20,000 shares. The retraction is highly profitable.
MFC.PR.B PerpetualDiscount -2.2566% Now with a pre-tax bid-YTW of 7.74% based on a bid of 15.16 and a limitMaturity. Closing quote 14.51-92, 2×11. Day’s range of 14.75-64.
BAM.PR.M PerpetualDiscount -2.2196% Now with a pre-tax bid-YTW of 14.38% based on a bid of 8.37 and a limitMaturity. Closing quote 8.36-49, 10×1. Day’s range of 8.34-70.
BNS.PR.K PerpetualDiscount -2.1223% Now with a pre-tax bid-YTW of 7.81% based on a bid of 15.68 and a limitMaturity. Closing quote 15.54-14, 15×15. Day’s range of 15.53-20.
PWF.PR.K PerpetualDiscount -2.0408% Now with a pre-tax bid-YTW of 8.79% based on a bid of 14.40 and a limitMaturity. Closing quote 14.46-63, 5×1. Day’s range of 14.30-99.
POW.PR.A PerpetualDiscount +2.3270% Now with a pre-tax bid-YTW of 8.37% based on a bid of 16.80 and a limitMaturity. Closing quote 16.37-51, 10×2. Day’s range of 16.51-00.
RY.PR.W PerpetualDiscount +2.3399% Now with a pre-tax bid-YTW of 7.48% based on a bid of 16.62 and a limitMaturity. Closing quote 16.96-40, 2×10. Day’s range of 16.00-17.50.
BNA.PR.B SplitShare +2.6154% Asset coverage of 1.8+:1 based on BAM.A at 19.27 and 2.4 BAM.A per unit. Now with a pre-tax bid-YTW of 8.82% based on a bid of 20.01 and a hardMaturity 2016-3-25 at 25.00. This is now very clearly trading off the estimated retraction price of 21.69. Closing quote of 20.00-99, 4×1. Day’s range of 19.50-01.
FIG.PR.A InterestBearing +2.7132% Asset coverage of 1.0:1 as of December 18, according to Faircourt. Now with a pre-tax bid-YTW of 20.16% based on a bid of 5.30 and a (dubious) hardMaturity 2014-12-31 at 10.00. Closing quote of 5.30-49, 2×7. Day’s range of 5.17-33.
BAM.PR.H OpRet +2.8571% Now with a pre-tax bid-YTW of 13.89% based on a bid of 19.80 and a softMaturity 2012-3-30 at 25.00. Closing quote of 20.00-50, 10×5. Day’s range of 19.25-20.50.
LBS.PR.A SplitShare +2.9216% Recently discussed on PrefBlog. Now with a pre-tax bid-YTW of 11.70% based on a bid of 7.75 and a hardMaturity 2013-11-29 at 10.00. Closing quote of 7.86-35, 250×1. That’s right, a bid for 25,000 shares; estimated retraction price is 9.41; need I say more? Day’s range of 7.36-99.
SBC.PR.A SplitShare +3.0263% Asset coverage of 1.3+:1 as of December 18 according to Brompton. Now with a pre-tax bid-YTW of 12.81% based on a bid of 7.83 and a hardMaturity 2012-11-30 at 10.00. Closing quote of 7.85-98, 30×1. Day’s range of 7.60-00.
CL.PR.B PerpetualDiscount +3.0769% Now with a pre-tax bid-YTW of 7.83% based on a bid of 20.10 and a limitMaturity. Closing quote 19.51-07, 2×4. Day’s range of 19.25-20.74.
WFS.PR.A SplitShare +4.3478% Asset coverage of 1.2-:1 as of December 11 according to Mulvihill. Now with a pre-tax bid-YTW of 12.88% based on a bid of 8.40 and a hardMaturity 2011-6-30 at 10.00. Closing quote of 8.50-59, 115×8 (estimated retraction price is 9.60). Day’s range of 8.02-50.
FTN.PR.A SplitShare +4.5455% Asset coverage of 1.4-:1 as of December 15 according to the company. Now with a pre-tax bid-YTW of 9.78% based on a bid of 7.82 and a hardMaturity 2015-12-1 at 10.00. Closing quote of 8.01-15, 55×5. Day’s range of 7.50-01.
BNA.PR.A SplitShare +5.1795% See BNA.PR.B, above. Now with a pre-tax bid-YTW of 18.89% based on a bid of 20.51 and a hardMaturity 2010-9-30 at 25.00. Closing quote of 20.50-29, 2×1. Day’s range of 19.70-22.49 (!).
BCE.PR.F FixFloat +6.4701%  
BAM.PR.K FixFloat +9.5313%  
Volume Highlights
Issue Index Volume Notes
PWF.PR.J OpRet 154,000 Nesbitt crossed 150,000 at 24.60. Anonymous crossed (?) 10,000 at 24.59. Now with a pre-tax bid-YTW of 5.28% based on a bid of 24.60 and a softMaturity 2015-12-18 at 25.00.
MFC.PR.A OpRet 119,475 Desjardins crossed 100,000 at 24.25. Now with a pre-tax bid-YTW of 4.62% based on a bid of 24.26 and a softMaturity 2015-12-18 at 25.00.
BNS.PR.L PerpetualDiscount 105,980 Scotia bought 10,300 from TD at 14.35; Nesbitt crossed 35,400 at the same price. Now with a pre-tax bid-YTW of 7.90% based on a bid of 14.55 and a limitMaturity.
BNS.PR.M PerpetualDiscount 100,658 Nesbitt crossed 14,200 at 14.55. Now with a pre-tax bid-YTW of 7.90% based on a bid of 14.55 and a limitMaturity.
RY.PR.N FixedReset 96,515 RBC was buying! 20,600 from anonymous at 26.00; 25,000 from Nesbitt at 26.00; 19,800 from anonymous at 26.00; and 10,000 from TD at 25.99. Perhaps notable for being the first FixedReset issue for which the Real Genuine 100% YTW Scenario is the five year call.

There were ninety-four other index-included $25-pv-equivalent issues trading over 10,000 shares today.

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LBS.PR.A : Dividends on Capital Units Suspended

December 20th, 2008

Brompton Group has announced:

In accordance with its prospectus and the Class A Share Provisions, the regular, non-cumulative, monthly distribution for the month of December will not be paid on the class A shares of Life & Banc Split Corp. Under the prospectus, no cash distribution may be paid on the class A shares, if after payment of the distribution by the Fund, the net asset value per unit (consisting of one class A share and one preferred share) would be less than $15.00. The net asset value per unit as at December 11, 2008 was $12.86. The Fund will re-evaluate the payment of class A share distributions in each subsequent month with the expectation that normal monthly distributions will resume and a press release will be issued if the net asset value per unit is in excess of $15.00 prior to declaration.

LBS.PR.A has been placed on Review-Negative by DBRS … and Assiduous Reader lystgl asked the question:

LBS.PR.A is on the list of “about to be or may be” downgraded. I was just wanting, in terms I can understand, to know why.

My response is:

LBS.PR.A is backed by a portfolio of the Big 6 Banks and Big 4 Insurers. This is better than being backed by a single financial issuer, but is worse than the backing of a fully diversified portfolio.

Equity market declines have eroded the asset coverage of the portfolio to a mere 1.279:1 as of December 18. In DBRS terminology, thats “Downside Protection” of about 22% … in other words, if the portfolio declines by another 22%, then the Capital Units will have no intrinsic value (they will have option value) and the Preferred Shares will be fully exposed to further declines in portfolio value. Worse … when the NAV per Unit is $10, they have full downside exposure but no upside, as increases in the portfolio above that point will belong to the Capital Units.

The DBRS guideline (which is influenced by other factors, such as the nature of the underlying portfolio and income coverage) for a Pfd-2/Pfd-2(low) rating is downside protection of 40-50%. Since LBS.PR.A is currently below that figure, they’re reviewing it … and if there are no extenuating factors, they’ll cut the rating.

When we look at their most recent financial statements, we find that all the declared income looks sustainable – it’s nearly all dividends, with minor contributions from securities lending and interest income. There’s no one-off stuff in there, and no games-playing with “option income” or other crap. So we can estimate sustainable income going forward as $4.838-million per six-month period … dependent, of course, on none of their underlying holdings cutting the dividend.

Expenses were $1.189-million, which looks sustainable. Distributions on preferred shares were $2.980-million.

Thus, income coverage is 4.838/(1.189 + 2.980) = 1.16:1. This is a good number. They can cover their expenses and preferred share distribution with sustainable income (assuming no cuts in dividend receipts), which is a Good Thing and not the case for all split-shares (see Split Shares and the Credit Crunch).

There is a major drag on NAV of the Capital Unit distribution, which amounted to $6.818-million in the financial statements. Given that there were 11.363-million units outstanding, this amounts to a drag on NAV of $0.60 per unit per half, or $1.20 per year – which ties in admirably with the “8.0% targeted yield based on $15.00 issue price, paid monthly”. However, this drag has been eliminated due to:

No distributions will be paid on Class A shares if (i) distributions payable on the Preferred shares are in arrears or (ii) after the payment of the distributions by the Fund, the Published NAV per unit is less than $15.

Hurray!

So income and asset coverage both look reasonable especially when compared to the market price rather than to the obligation of $10. But to me, it doesn’t look good enough to warrant a Pfd-2/Pfd-2(low) rating and I expect a cut to maybe Pfd-3 / Pfd-3(high).

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Yet ANOTHER DBRS Mass Review of Splits

December 19th, 2008

DBRS has announced that it:

has today placed the rating of certain structured preferred shares (Split Shares) Under Review with Negative Implications. Each of these split share companies has invested in a portfolio of securities (the Portfolio) funded by issuing two classes of shares – dividend-yielding preferred shares or securities (the Preferred Shares) and capital shares or units (the Capital Shares). The Preferred Shares benefit from a stable dividend yield and downside principal protection via the net asset value (NAV) of the Capital Shares against the percentage loss in the Portfolio’s NAV. Preferred Shares have experienced significant declines in downside protection during the past number of months due to volatility in the global equity markets. As a result, DBRS has placed the Preferred Shares listed below Under Review with Negative Implications. DBRS will take final rating action on these Preferred Shares once a longer-term trend has been established for the NAVs of the affected split share companies.

They note that analysis will be performed according to the methodology of 2007

They do not explicitly list the affected splits in the main text, but they do have a list of related issues. On the assumption that there is a one-to-one relationship, the following table may be prepared.

DBRS Review Announced 2008-12-19
Ticker Rating Asset
Coverage		 Last
PrefBlog
Post		 HIMIPref™
Index
ABK.PR.B Pfd-2(low) 1.3+:1
12/18		 Issue Closes None
TDS.PR.B Pfd-2(low) 1.5-:1
12/18		 Microscopic Redemption Scraps
FTN.PR.A Pfd-2 1.4-:1
12/15		 No Fear! SplitShare
BMT.PR.A Pfd-2(low) 1.1+:1
12/18		 Partial Call Scraps
MST.PR.A Pfd-2(low) 1.3+:1
12/18		 Capital Unit Dividend Suspended Scraps
FFN.PR.A Pfd-2(low) 1.1+:1
12/15		 Capital Unit Dividend Suspended SplitShare
EN.PR.A Pfd-2(low) 1.4+:1
12/18		 Partial Redemption Scraps
BXN.PR.B Pfd-2(low) 1.6-:1
12/18		 Partial Redemption None
PPL.PR.A Pfd-2 1.4-:1
12/15		 Added to HIMIPref™ SplitShare
LSC.PR.C Pfd-2 1.4-:1
12/18		 Partial Redemption None
BSC.PR.A Pfd-2(low) 1.4+:1
12/18		 Partial Redemption None
SBC.PR.A Pfd-2 1.3+:1
12/18		 Added to HIMIPref™ SplitShare
PDV.PR.A Pfd-2 1.3+:1
12/15		 None None
SOT.PR.A Pfd-2(low) 1.4+:1
12/18		 None None
BBO.PR.A Pfd-2 1.6+:1
12/11		 Rights Offering None
LBS.PR.A Pfd-2 1.3-:1
12/18		 Analysis SplitShare
RBS.PR.A Pfd-2(low) 1.2-:1
12/18		 Tiny Redemption None
LCS.PR.A Pfd-2 1.2+:1
12/18		 Analysis None

The previous DBRS Review of Splits has not yet been completed. All these are new.

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