PrefBlog

I have long taken the view that if sub-debt becomes contingent capital, then so will preferred shares; otherwise, issues’ seniority could leapfrog when an institution gets into trouble and that makes no sense. So I was gratified to hear this view echoed for the first time I’ve seen:

Canada is recommending that subordinated debt and preferred shares sold by banks be convertible to common shares to bolster capital in the event of a crisis. The conversion would be triggered if the banking regulator determines a troubled bank is about to fail, or if the government is forced to purchase shares in the bank.

It’s a shame that OSFI hasn’t actually published the proposal; or, indeed, done any work at all that I can see on the proposal.

An older paper on Contingent Capital is Rethinking Capital Regulation by Kashyap, Rajan & Stein, referenced but not previously linked in HM Treasury Discusses Contingent Capital.

Korea is imposing foreign exchange position limits:

Foreign banks will be required to cut currency derivatives holdings to 250 percent of equity capital and domestic banks to 50 percent, with three months to meet the new ceiling and two years to cover existing positions. The limit on derivatives to cover corporate settlements will be cut to 100 percent of the total, from 125 percent.

“We are not limiting portfolio investment,” said Kim Yi Tae, director at the finance ministry’s foreign exchange market division. “We’re not putting regulations on trade financing, only on bank lending in foreign currencies and on forwards.”
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The new rules are to reduce systemic risks, which should serve as a safety net to avert a crisis, the government and central bank said in yesterday’s statement.

The ‘systemic risk’ rationale sounds a little thin to me. If that was the problem, they could simply impose higher risk-weights on FX positions. But prescriptive rules are always more attractive to politicians and bureaucrats than market-based solutions.

Call risk is hitting the Asian junk market:

The biggest junk bond market rally in more than a decade is increasing the risk investors in Asian high-yield debt will be roiled by early redemptions, according to Morgan Stanley and Credit Agricole CIB.

Cheaper funding alternatives such as loans make companies more likely to buy back callable notes, unsettling investors who may be forced to reinvest at lower rates or in more volatile assets. Thirty-five percent of liquid Asian junk bonds are callable — most this year — and about 20 percent are trading above or close to their call price, according to Morgan Stanley research.

Junk? Greece is junk says Moody’s:

Greece’s credit rating was cut four steps to non-investment grade, or junk, by Moody’s Investors Service, which cited the country’s economic “risks.”

The rating was lowered to Ba1 from A3, Moody’s said in a statement today from London. The outlook is stable, it said. Greece is already rated junk by Standard & Poor’s.
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S&P cut Greece’s credit rating to non-investment grade on April 27, the first time a euro member lost its investment-grade since the euro’s 1999 debut. S&P warned that bondholders could recover as little as 30 percent of their initial investment if the country restructures its debt.

Fannie & Freddie continue to demonstrate that no matter what degree of incompetence at which we assess Wall Street, it will always be out-done by the politicians:

The cost of fixing Fannie Mae and Freddie Mac, the mortgage companies that last year bought or guaranteed three-quarters of all U.S. home loans, will be at least $160 billion and could grow to as much as $1 trillion after the biggest bailout in American history.

Quick! Trump up another charge against Goldman Sachs!

It was another very good day for Canadian preferred shares, with PerpetualDiscounts up 22bp and FixedResets gaining 29bp, on slightly elevated volume. There were no losers on the Performance Highlights table!

European banks are in serious trouble:

Investors have already pushed down financial stocks enough to imply the “erosion” in book value that may result from losses tied to a sovereign debt restructuring, said Dirk Hoffmann-Becking, an analyst at Sanford C. Bernstein in London. A Bloomberg index of European financial firms dropped as much as 22 percent since April 15 to the lowest level since July.
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Writedowns stemming from a Greek default would total almost $200 billion, estimates Jon Peace, an analyst at Nomura Holdings Inc. in London. Banks globally could lose as much as $900 billion in a worst-case scenario where Greece, Ireland, Italy, Portugal and Spain all have to restructure their debt, Nomura estimates.
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German financial companies including Deutsche Bank agreed in May to refinance maturing Greek debt and maintain existing credit lines to Greece and its lenders for the next three years. French banks made a similar pledge.

A majority of European banks haven’t tendered their Greek sovereign debt to the European Central Bank, according to an informal survey by Morgan Stanley analysts. One reason may be that some banks bought their Greek bonds when they were trading at 20 percent above par, meaning a sale to the ECB would prompt a loss, Morgan Stanley’s London-based analyst Huw van Steenis said in a note to clients on June 9.

Corporate eMail is not secret!

“Just between us,” it may be “stupid” to use certain words in e-mail to “discuss” the “big trouble” you might face if you’re ever investigated for financial wrongdoing or a subsequent cover-up.

Those are some of the terms that examiner Anton R. Valukas searched for in 34 million pages of Lehman Brothers Holdings Inc. e-mails and reports, to find out who knew what about the risks that drove the fourth-largest securities firm into bankruptcy, according to his 2,200-page study on the collapse.

I don’t understand why people don’t know this already. When I’m composing an eMail, I imagine an angry regulator looking over my shoulder – a regulator who feels no compunction about publishing irrelevancies for the mere joy of embarrassing me.

The Canadian preferred share market rally kept on rallying today, with PerpetualDiscounts gaining 21bp while FixedResets were up 8bp. Some might be interested in the fact that volume was rather light today, and that there is considerable volatility shown in the Performance highlights table. Of course, today was the exDate for a great many issues, so perhaps a little volatility was to have been expected anyway.

Different crimes for different times!

Sergio Natera and Anna McElaney are scheduled to be sentenced in Hartford’s federal court in August after pleading guilty to fraud. Their crime involved persuading lenders to approve the sale of homes for less than the balance owed –known as a short sale — without disclosing that there were better offers. They then flipped the houses for a profit.
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A prevalent scam involves a practice called “flopping,” [special inspector general for the Troubled Asset Relief Program Neil] Barofsky said. In that scheme, investors or home buyers hire brokers to assess a home for less than its market value and convince banks to accept a sale at that level. The buyer conceals from the lender that he has lined up a higher offer and then quickly resells the property for a profit, as in the Connecticut case.
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In the Connecticut case, Regions Bank in April 2008 agreed to a short sale of a Bridgeport house for $102,375, unaware that Natera and McElaney had a bidder willing to pay $132,500, according to the plea agreements. Eight weeks after the bank sold for a loss, the pair resold the house for a $30,125 gain.

The SEC wants to make competition illegal:

U.S. Securities and Exchange Commission Chairman Mary Schapiro said the agency may regulate the speed of stock orders in response to a surge in electronic trading and the May 6 plunge that wiped out $862 billion of market value in 20 minutes.

The SEC needs “to explore whether bids and orders should be regulated on speed so there is less incentive to engage in this microsecond arms race that might undermine long-term investors and the market’s capital-formation function,” she said at a conference in Montreal. “The markets have to serve that function for companies to raise money, create jobs and allow the economy to grow.”

The basic trouble is that old,school, comfortable, well connected, incompetent portfolio managers are having their lunch eaten by High Frequency Traders – which are often brokerage firms, hedge funds, and individuals with, say $10-million to play with. Since they can’t compete on results, they’ll compete on regulation.

The pace of the rally in the Canadian preferred share market continued at a slower pace today, with PerpetualDiscounts up 18bp and FixedResets up 12bp.

Merkel and Sarkozy have the perfect answer for those annoying brats who shout that the emperor has no clothes: jail ’em:

France and Germany called on the European Union to speed up curbs on financial speculation, saying some bets against stocks and government bonds should be banned as markets suffer a resurgence of “strong volatility.”

In a joint two-page letter, French President Nicolas Sarkozy and German Chancellor Angela Merkel sought proposals from European Commission President Jose Manuel Barroso on a ban on so-called naked short sales of “certain” stock and bonds, as well as on naked credit-default swaps on sovereign bonds. They call for proposals to be ready by the middle of next month rather than October as had been planned.

The clowns at Basis Yield Alpha Fund (last mentioned May 19) are squaring their rots for a good boohoohoo:

The lawyer, Eric Lewis, said Basis Yield Alpha Fund is suing Goldman to recoup the $56 million it lost on the now notorious Timberwolf collateralized debt obligation, which garnered a lot of attention during a recent congressional hearing.

The lawsuit, being filed on Wednesday in U.S. District Court for the Southern District of New York, also seeks $1 billion in punitive damages.
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David Lehman, who joined Goldman in 2004 and worked as a managing director in Goldman’s mortgage trading operation, met with representatives of Basis to convince them that the prices Goldman was selling the Timberwolf deal at were fair and legitimate.

The lawsuit alleges that Goldman’s sales and trading desks worked together to sell the deal, which Goldman was taking a shorting position on.

“This is not a bad case for dealing with the whole issue of how Goldman was conducting its business,” said Lewis. “They were selling bonds like they were used cars, in that you say what you need to get it done.”

Golly, you know, I can’t remember a single trade I’ve ever done (including buying tomatoes at the supermarket) in which the salesman didn’t try to convince me that the price was fair and reasonable. But I guess I should point out that my experience is limited to the planet Earth. If BYAF’s principals had spent a tenth as much on analysis as they are on lawyers, their investors would be a lot better off. The full document is hosted on Scribd, world’s second worst document storage system.

Amidst all this abuse of the legal system, there’s a bit of good news:

Distressed-debt investors shouldn’t have to disclose key details of their holdings when they participate in bankruptcy cases, a U.S. judiciary advisory group said.

Hedge funds and other investors that join together during bankruptcies as creditors need not reveal the prices paid for a company’s debt or the dates of purchase, according to a proposed change by the Advisory Committee on Bankruptcy Rules of the Administrative Office of the U.S. Courts.

The move is a victory for funds that invest in an ailing company’s debt and sometimes take control after the bankruptcy. They opposed an earlier proposal from the rules committee that would have required investor groups to reveal the date they acquired a company’s debt and, if ordered by a judge, the price.

It was another very good day for the Canadian preferred share market, as PerpetualDiscounts gained 44bp and FixedResets gained 26bp on moderate-to-elevated volume.

PerpetualDiscounts now yield 6.08%, equivalent to 8.51% interest at the standard equivalency factor of 1.4x. Long corporates now yield about 5.65%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) now stands at about 285bp, a dramatic tightening from the 305bp reported on June 2.

I suspect the propused US financial legislation will have severe and unintended knock-on consequences:

Lawmakers are set to negotiate a bill passed May 20 by the Senate that would require standardized derivative trades to be cleared through a third party and traded on an exchange or so- called swap-execution facility; place a fiduciary duty on dealers in transactions with municipalities; and subject the foreign exchange swaps market to regulation.
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The bill includes a provision that would require swaps dealers to report price information on a timely basis to the public — a provision designed to increase price transparency. Banks have opposed the language, arguing that it could reduce market liquidity. Gensler has backed the idea, which Stanford’s Duffie called one of “the most important additions” to the debate.

“Real time post-trade reporting of transactions is an essential element of a transparent marketplace,” Gensler said last week in his speech. “An effective conference committee report should include these provisions.”

Bond price reporting via TRACE has crippled the US public market in corporate bonds – see, for example, this post – but it doesn’t matter. The legislative climate is such that smooth functioning of the capital markets is not a concern; the concern is transparency, being nice to the little guy and bashing the banks.

The other big problem is fiduciary duty:

The fiduciary duty requirement was crafted in response to swaps deals between Wall Street and local governments designed to keep monthly interest payments low as lending rates change. Such deals often went sour during the economic crisis, pushing one municipality, Jefferson County, Alabama, to the brink of bankruptcy, Lincoln said.

“The bill’s ‘fiduciary duty’ provision would require swap dealers to put the financial interests of state and local governments, retirement plans, pensions and university endowments before its own, ensuring Wall Street doesn’t take advantage of Main Street and taxpayers,” Lincoln said in a June 4 statement provided by her office. “The stories of abuse in this area are alarming and need to be addressed.”

Asset-management firm BlackRock Inc. and some of the largest business trade groups in Washington have argued that imposing a fiduciary duty on deals with municipalities may shut down a market in which, for example, public retirement funds purchase derivatives in order to manage their portfolios.

‘No more buy-side, no more sell-side’ cry the legislators, ‘Capital markets should be a cooperative game, just like the ones we played in kindergarten!’

I suspect that what this will mean in practice is that institutional investors will no longer deal directly with the institutional desk. All orders will have to be routed through a stockbroker (who will probably be completely ignorant), garbled and transmitted. That broker will have to be paid, of course.

What I suspect might happen is that some of the larger asset management firms and hedge funds, not affected by the legislation, will take a more active approach to market-making via dark pools. Being headquartered in Dubai or Singapore will help, of course.

The Financial Crisis Investigation Committe Vice Chairman Bill Thomas demonstrated his integrity and deep committment to justice in the continuing scuffle over Goldman Sachs’ papers:

Blankfein, who has already testified in front of the FCIC along with other bank bosses back in January, is not expected to be asked to testify publicly again. A fired-up Thomas yesterday said the commission has no intention of giving Goldman a chance to make itself look cooperative.

“I’m not interested in providing [Blankfein] with a public forum to sound reasonable when in fact [Goldman’s] behavior has not been.”

Isn’t raking somebody over the coals publicly and under oath supposed to be a good corrective measure for wrongdoing or lack of cooperation? But I guess it’s more fun to vilify someone without giving him a chance to confront his accuser.

Banks’ holdings of each other’s paper – encouraged at the senior debt level by regulators – is attracting attention:

Small lenders, such as Riverside National Bank of Florida, were able to sell trust-preferred securities, known as TruPS, because investment bankers packaged them with those issued by dozens of other financial institutions.

Riverside, which started in a trailer in 1982, bought collateralized debt obligations made up of TruPS as it grew to 65 branches and $4.8 billion assets. When real estate soured and lenders racked up loan losses, Riverside and about 400 of its peers suspended interest payments on their TruPS, causing the CDOs to default or lose value and inflicting more harm on an industry suffering from the worst economy since the 1930s.
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Congress may end the use of TruPS as capital, forcing banks that issued them to replenish their coffers. Banks are lobbying to remove a provision barring their use that was introduced by Maine Republican Susan Collins and included in the financial reform bill passed by the Senate last month. The Senate version is being reconciled with one passed by the House of Representatives in December that doesn’t include a ban.

It’s a totally asinine reaction. The problem is not that they have issued the TruPS (which are Innovative Tier 1 Capital and, as the story notes, have had their distributions suspended in many cases, which is exactly what’s supposed to happen); the problem is simply that the risk-weighting on the assets is too low. The Fed could change that tomorrow if it felt like it.

If a bank bought $100 of Citigroup shares, it would have to hold $100 of capital against that asset. The purchase of $100 in Citigroup TruPS would require only $8 of capital. For $100 of AAA rated CDOs that pool bank TruPS, the amount of regulatory capital to be set aside declines to $1.60.

And before we start feeling smugly superior to the Americans, up here with our so-called better regulation, remember ING Canada’s 4Q08 balance sheet. However, the provision has been withdrawn:

Banks couldn’t use their TruPS as capital during the financial crisis because deferring the dividends would have been seen as weakness and could have led to bank runs.

“It contributes to a downward spiral,” said George French, the FDIC’s deputy director for policy in the division of supervision and consumer protection.

Trouble continues in Euroland:

Bank credit-default swaps surged near to a record on concern Spanish lenders will have to raise $60 billion to shore up capital as lawmakers struggle to finance a swollen budget deficit.

The Markit iTraxx Financial Index of swaps on 25 European banks and insurers climbed as much as 14 basis points to 208, approaching the all-time closing high of 210 basis points set in March 2009, JPMorgan Chase & Co. prices show. Banco Santander SA, Spain’s biggest bank, increased 23 basis points to a record 258, according to CMA DataVision.

Spanish lenders need as much as 50 billion euros ($60 billion) of capital, according to Banco Bilbao Vizcaya Argentaria SA, as they face mounting writedowns triggered by a housing market collapse and losses on government bond holdings. Civil servants went on strike today to protest at Prime Minister Jose Luis Rodriguez Zapatero’s efforts to tame the euro area’s third-largest deficit.

Another good day in the Canadian preferred share market, with PerpetualDiscounts up 65bp and FixedResets gaining 6bp, on moderate-to-elevated volume.

This is quite a recovery for PerpetualDiscounts! The total return index has returned to its level of March 19; Since March 19, their total return has been -0.35%, compared to -1.73% for FixedResets. Month to date returns have be +2.94% and +0.58%, respectively.