PrefBlog

Nothing happened today, although I was recently gratified to learn I’m not the only one in the world who is worried about central clearing houses:

IF THEY failed, there would be “mayhem”, says Paul Tucker of the Bank of England. Ben Bernanke, the chairman of the Federal Reserve, quotes a Mark Twain character, Pudd’nhead Wilson, to get the same point across: “If you put all your eggs in one basket, you better watch that basket.” Another regulator privately describes them as “too big to fail, on steroids”.

Central Clearing Houses are probably the single dumbest idea to come out of post-Credit Crunch reregulation. Who – other than a politician or a regulator – really thinks that a system susceptible to single-point failure is more stable than a network?

The Canadian preferred share market enjoyed a good uptick today, with PerpetualPremiums up 2bp, FixedResets gaining 14bp and DeemedRetractibles winning 21bp. Volatility was dominated by BAM, evenly split between winners and losers. Volume was light.

Spain’s in trouble again:

European Central Bank Executive Board member Benoit Coeure triggered speculation that the bank will revive its bond-purchase program to lower Spain’s borrowing costs as the region’s debt crisis threatens to boil over again.

Spanish “market conditions are not justified,” Coeure, who heads the ECB’s market operations division, said at an event in Paris today. “Will the ECB intervene? We have an instrument, the securities markets program, which hasn’t been used recently but it still exists.”
…
The yield on Spanish 10-year bonds, which climbed to a four-month high of 5.99 percent this morning, slid to 5.82 percent after Coeure spoke. The euro gained more than a quarter of a cent to $1.3134 at 2 p.m. in Frankfurt and European stocks rose, with the Stoxx Europe 600 Index (SXXP) up 1 percent.

Spain’s 10-year borrowing costs have jumped more than 1 percentage point since March 2, when Prime Minister Mariano Rajoy said the country will miss a 2012 deficit goal approved by the European Union. The euro area’s fourth largest economy is in recession and unemployment is nearing 24 percent.

It will be interesting to see how this plays out. ECB intervention may lower the probability of default, but its super-senior creditor status (seen in the Greek default) will increase the severity of default.

The Canadian preferred share market drifted slightly upward today, with PerpetualPremiums winning 5bp, FixedResets gaining 2bp and DeemedRetractibles up 4bp. Volatility was good, with Floaters notable amongst the losers. Volume was a little below average.

PerpetualDiscounts now yield 5.07%, equivalent to 6.59% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.45%, so the pre-tax interest-equivalent spread (in this context, the Seniority Spread) is now about 215bp, unchanged from the report of April 4.

A mention in the Globe & Mail led me to an IMF publication (Chapter 3 of of the April, 2012, World Economic Outlook) titled Dealing with Household Debt:

Does household debt amplify downturns and weaken recoveries? Based on an analysis of advanced economies over the past three decades, we find that housing busts and recessions preceded by larger run-ups in household debt tend to be more severe and protracted. These patterns are
consistent with the predictions of recent theoretical models. Based on case studies, we find that government policies can help prevent prolonged contractions in economic activity by addressing the problem of excessive household debt. In particular, bold household debt restructuring programs such as those implemented in the United States in the 1930s and in Iceland today can significantly reduce debt repayment burdens and the number of household defaults and foreclosures. Such policies can therefore help avert self-reinforcing cycles of household defaults, further house price declines, and additional contractions in output.
…
Macroeconomic policies are a crucial element of forestalling excessive contractions in economic activity during episodes of household deleveraging. For example, monetary easing in economies in which mortgages typically have variable interest rates, as in the Scandinavian countries,
can quickly reduce mortgage payments and avert household defaults. Similarly, fiscal transfers to households through social safety nets can boost households’ incomes and improve their ability to service debt, as in the Scandinavian countries.

Clearly, it is better to avoid such a situation in the first place, but there is only ineffective policy in place in Canada to do so at this time. Buying a larger house (or a small house or condominium instead of renting) is a means of capital formation, which is encouraged by low interest rates. That’s what lower interest rates are supposed to do, for heaven’s sake! However, housing is non-productive capital; so much so that it can almost be considered consumption.

So the question really is: in times of economic downturns, how should policy act to promote “good” capital formation as opposed to “bad” capital formation?

I suggest that both monetary and fiscal policy are very blunt tools – too blunt to address the issue. Instead, a regulatory response is required:

• Don’t be so damn eager to raise the limits on explicitly (Canada) or implicitly (US) government guarantees of mortgage debt. Set a limit, based on historical experience and rising with nominal GDP, of the amount of such guarantees. In 2006, CMHC insurance outstanding was $291-billion. In 2010 the plan was to have total outstanding of $533-billion. Why? Why do What-debt? and Spend-Every-Penny want to create a housing bubble? I can only assume that it is because this will give them more opportunity to micro-manage the economy, with credit-rationing and rule changes by government fiat, rather than the unexciting process of raising insurance prices when a reasonable limit is approached.
• Impose a capital surcharge the banks when their loan books get distorted. Mortgages are now 40% of the balance sheets; they used to be 30% not so very long ago. Such a sudden change indicates to me a strong possibility that this is simply regulatory arbitrage (why lend to Jimmy’s Barber Shop, with a risk-weighting of 100%, when you can lend to Jimmy himself as a mortgage, with a 35% risk-weight or maybe even a government guarantee with an even lower risk-weight?). So, in this case of distortion, and in every other case of material distortion, impose a surcharge. An extra 10% risk-weight (to 45% on mortgags) on loan book elements in material excess of their historical norms is my prescription.

Three cheers for offshore wind power!

Offshore wind costs about $232 a megawatt-hour of power generated, according to data from Bloomberg New Energy Finance. That compares with about $80 for onshore wind, $62 for gas-fired plants and $77 for coal. The government supports the industry with incentives for power produced by renewable energy sources.

It’s not clear if the price figures include provisions for back-up power and demand-timing differences (the wind tends to blow at night, when demand is relatively low, can sometimes die at highly inconvenient moments and electricity can’t be stored very well. This has a huge effect on honest cost assessment, and no effect on – shall we say – other assessments).

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums losing 4bp, FixedResets gaining 2bp and DeemedRetractibles down 2bp. Volatility was low. Volume was a little below average.

The US jobs number was disappointing:

Employers in the U.S. added fewer jobs than forecast in March, underscoring Federal Reserve Chairman Ben S. Bernanke’s concern that recent gains may not be sustained without a pickup in growth.

The 120,000 increase in payrolls, the fewest in five months, followed a revised 240,000 gain in February that was bigger than first estimated, Labor Department figures showed today in Washington. The March increase was less than the most pessimistic forecast in a Bloomberg News survey in which the median estimate called for a 205,000 rise. Unemployment fell to 8.2 percent, the lowest since January 2009, from 8.3 percent.

Stock lending can be profitable!

The other day on Bloomberg (the paid version), I came across several ETFs with incredibly rich dividends. One of them — Guggenheim’s Solar ETF (TAN/NYSE) — far outshined the others. TAN holds about 30 solar energy companies. Its dividend yield is 9.2%, reports Bloomberg and others. Indeed, its dividend of US$2.11, adjusted for a 1:10 reverse split, divided by its price of US$23.02 works out to 9.2%. But is that possible in what should be a high-growth sector?

Digging deeper, only seven of the companies in the ETF, representing about 28% of the total allocation, have ever paid a dividend. Two have postponed dividends for 2012 and another has cut its dividend by more than half. The weighted average yield on the seven companies is under 1%.

Since holdings can change every quarter, I also checked the holdings as of February 2011. The picture was the same: seven dividend payers with an average yield of below 1%.

Where then did most of TAN’s dividend come from? The answer, as revealed by the fund’s prospectus, is securities lending. Nearly 90% of TAN’s investment income for the 12 months ending last August came from lending about half its shares to short sellers.

Who needs retirement in Florida, when you can retire to sunny Spain?

Banks trying to offload billions of euros of property left on their hands by bankrupt developers are selling new apartments at rock-bottom prices with bargain-basement mortgage deals.

Santander, the eurozone’s largest bank, was responsible for the frenzy in Sesena. It offered two-bedroom apartments around a communal swimming pool for 65,000 euros (US$86,100), with 100% mortgages over 40 years, costing as little as 242 euros a month to service, about a sixth of the average Spaniard’s monthly income.

At the peak of the decade-long property boom that preceded the crash, similar apartments would have sold for at least twice that, and for properties it isn’t selling, a Santander mortgage would cover 80% of the property price over 25 years.

Those with an interest in YLO will be happy to learn there is a market for the assets:

AT&T Inc. (T) agreed to sell a majority stake in its Yellow Pages directory division to Cerberus Capital Management LP for about $950 million as part of an effort to dispose of units that are holding back revenue growth.

AT&T will receive $750 million in cash and a $200 million note, according to a statement from the Dallas-based phone carrier today. AT&T will keep a 47 percent stake in the business, which had about $3.3 billion in revenue in 2011.
…
Sales at the Yellow Pages business declined 16 percent last year, compared with revenue growth of about 2 percent for AT&T as a whole.

So $950-million for 53% of a print company with $3.3-billion revenue …. YLO had revenue of $1.3-billion in 2011, but a buyer will have to assume the debt …

Boyd Erman opines in the Globe:

But giving Cerberus the benefit of the assumption that its people have some idea of what they’re doing, the purchase has set a bar for what Yellow Media bondholders, who are now mobilizing, will expect to receive in a restructuring. While the valuation is not enough to create any real recoveries for stockholders, or even preferred shareholders, it is enough to suggest there are gains in store for bondholders gutsy enough to buy Yellow Media paper at distressed levels.

Broadly speaking, Yellow Media has about $1.5-billion of debt that has been trading at about 50 cents on the dollar. If there’s $1-billion of value, that suggests the bonds should be closer to 67 cents on the dollar.

Some bondholders argue there’s more. Applying market multiples to the free cash flow generated from Yellow Media’s old-line and online operations, some bondholders argue you can get to a range of $1.4-billion to $2.2-billion.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 5bp, FixedResets down 1bp and DeemedRetractibles losing 15bp. Volatility was negligible. Volume was ridiculously low.

Julie Dickson’s speech was not very interesting – just a shopping list of aspirations for a board. Of passing interest was:

This leads me to explain why OSFI’s draft guideline (B-20) on Sound Residential Mortgage Underwriting Practices and Procedures, which we made public on March 19th, begins with the statement that boards must establish real estate underwriting policies. In fact, most boards have already established such policies. This makes sense; housing is the largest asset class exposure of banks – almost 42 per cent of total bank assets.

While these policies will have to be updated to reflect the new guidance, going forward senior management will have to provide a declaration to the board that the financial institution is in compliance with the OSFI guideline. This was added because we had noticed cases where board approved polices were not being followed.

Seems to me that if I was on a board that set a policy and that policy was not followed, I’d simply ensure that somebody senior got fired at every board meeting until it did get followed. But perhaps that’s just another reason why I’m not on a big-shot board.

Another, related, reason is my antiquated idea that boards are in place to set policies and hire staff to carry them out. The modern view is that boards exist to provide jobs to unqualified women – despite that fact that it does not work:

A recent study released by the German central bank found that risk taking within the banking industry increases with more women on an executive board. The same goes for younger executives. In contrast, men who are graying at the temples and executives with Ph.D. degrees reduce the level of risk.

Tomorrow’s US jobs number is expected to be encouraging:

Employers probably added more than 200,000 workers to payrolls in March for a fourth straight month as U.S. companies gained confidence sales will keep improving, economists said before a government report today.

Hiring increased by 205,000 after rising by 227,000 in February, according to the median projection of 80 economists surveyed by Bloomberg News. The last time employment advanced at a similar pace for as many months was late 1999 into 2000. The jobless rate probably held at a three-year low of 8.3 percent.

Cowboys will have 45 minutes to settle their bets:

While stock markets around the world are shut for Good Friday, the Labor Department will publish its monthly employment report at 8:30 a.m. New York time. Equity traders will have 45 minutes to react, as trading of futures linked to the Standard & Poor’s 500 Index and Dow Jones Industrial Average will continue until 9:15 a.m. on CME Group Inc. (CME)’s Chicago Mercantile Exchange.

The Canadian jobs number was good:

Canada’s labour market has finally perked up after half a year in the doldrums as a commodities boom and a firmer U.S. economy give employers the confidence to hire.

The economy churned out 82,300 jobs last month, the most since 2008, with many of the positions created in full-time work. The hiring spree sent the country’s jobless rate down two notches to 7.2 per cent in March, matching the lowest rate seen in the recovery.

First National, proud issuer of FN.PR.A, was confirmed at Pfd-3 by DBRS:

DBRS has today confirmed the Senior Secured – Guaranteed Debt and Class A Preference Shares ratings of First National Financial Corporation (FNFC) at BBB and Pfd-3, respectively, and the Issuer Rating of First National Financial LP (FNFLP) at BBB; all trends remain Stable.

The ratings and trends reflect FNFC’s status as Canada’s largest non-bank mortgage originator, with just under $60 billion in mortgages under administration (MUA) as of December 31, 2011; its strong asset quality profile, with all assets secured by real estate and a substantial portion insured; and its high-quality, low-cost servicing capabilities.

The rating on FNFC’s Senior Secured – Guaranteed Debt is based on a senior guarantee from FNFLP and an Intercreditor Agreement between Computershare Trust Company of Canada as the debenture trustee and the lenders under a credit facility. The Intercreditor Agreement ranks the indebtedness created under the debentures equally and ratably with the indebtedness created under FNFLP’s credit facility.

It was another mixed day for the Canadian preferred share market, with PerpetualPremiums winning 13bp, FixedResets off 2bp and DeemedRetractibles gaining 11bp. Only one issue made it to the Performance Highlights table. Volume was pathetic.