PrefBlog

Some Assiduous Readers may feel that I have a knee jerk reaction to increased rule-making … but it isn’t always the case! The proposed rules on US Municipal bond new issues isn’t all that bad:

Some institutional investors claimed that underwriters and their related accounts “buy bonds in the primary offering for their own account even though other orders remain unfilled,” the Municipal Securities Rulemaking Board said in a statement today. The board is an industry self-regulatory group dominated by securities dealers.

The board proposal would require underwriters to “give priority to customer orders over orders for its own account” or from affiliates. It wouldn’t prohibit sales to related accounts, though underwriters “shall have the burden of justifying that such allocation was in the best interests of the syndicate” and in accord with principles of “fair dealing,” the board said in a draft interpretive notice.
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The board’s announcement doesn’t mention complaints by issuers, who incur extra costs if bonds are sold at lower prices and higher interest rates than needed.

“The proposed changes help make the case for competitive rather than negotiated bond sales,” said Robert Doty, president of American Government Financial Services, a Sacramento, California-based adviser to issuers.

In competitive sales, issuers take the best price offered by bankers, whereas in negotiated sales, they rely on the advice of their underwriter and sometimes a financial adviser. Local governments’ and not-for-profits’ negotiated deals accounted for 86 percent of the $391.3 billion of new municipal bonds sold last year, according to Thomson Reuters data.

“Bond pricing in 2009 is the least efficient in years,” bankers at Ziegler Cos. said in a July 27 letter sent to clients who issue bonds. After underwriters set prices low enough to attract more orders than there are bonds, “investors rush to buy the cheap securities, and many flip them the next day for a quick profit,” the Chicago-based firm said.

Conflict of interest is an often overrated fault, but acting as both advisor and counterparty to an issuer … well, I call that a step over the line. By me, advising on price is an advisory matter and the brokerage is an agent; they are more than welcome to backup their advice with money and say something like …. ‘well, we can try and sell it at 5.50%, but if you go to 5.60% we’ll guarantee it’, and provide a backstop for the success of the underwriting. The key part of the word “backstop”, however, is “back” and third party orders should take priority. Once they start giving preferential – or even pro-rata – fills to related accounts, however, they are no longer agents but principals; they should make it very clear from the beginning just how they are acting.

Frankly, I’m a little surprised this issue hasn’t surfaced before, or that clients have allowed it! The source document states:

The Municipal Securities Rulemaking Board (the “MSRB”) is requesting comment on draft amendments to Rule G-11, on new issue syndicate practices, Rule G-8, on books and records, and Rule G-9, on preservation of records. The draft amendments to Rule G-11 would expand the rule to cover all primary market offerings, not just those for which syndicates are formed. They would also provide that, in general, unless otherwise agreed to by the issuer, the syndicate manager or the sole underwriter (as the case may be) shall give priority to customer orders over orders for its own account, orders from an affiliate for its account, or orders for their respective related accounts.

The UK FSA has published its rules on bonuses. Many of the principles insist on giving the employer a great deal of discretion:

Non-financial performance metrics should form a significant part of the performance assessment process.
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The measurement of performance for long-term incentive plans, including those based on the performance of shares, should be risk-adjusted.

These changes will make lawyers very, very happy.

The CIT drama continues with a SEC filing:

As a first step of the restructuring plan, on July 20, 2009, the Company commenced a cash tender offer for its outstanding $1 billion in floating rate senior notes due August 17, 2009 and amended the offer on August 3, 2009. A description of the terms of the offer and the amendment are contained in Form 8-K’s filed by the Company on July 21, July 24 and August 3, 2009.

If the tender offer is successfully completed, the Company intends to use the proceeds of the Credit Facility to complete the tender offer and make payment for the August 17 notes. Further, the Company and a Steering Committee of the bond holder lending group do not intend for the Company to seek relief under the U.S. Bankruptcy Code, but rather will pursue restructuring efforts as part of the comprehensive restructuring plan to enhance the Company’s liquidity and capital position. If the pending tender offer is not successfully completed, and the Company is unable to obtain alternative financing, an event of default under the provisions of the Credit Facility would result and the Company could seek relief under the U.S. Bankruptcy Code.

The Credit Facility contains provisions (i) requiring the Company and the Steering Committee to work together in good faith to promptly develop a mutually acceptable restructuring plan for the Company and its Subsidiaries and (ii) requiring the Company to adopt a restructuring plan acceptable to the majority in number of the Steering Committee by October 1, 2009. The agreement also calls for a draft of the restructuring plan on a “best efforts basis” by August 14, 2009. As a result, the Company currently expects to complete and begin executing on the restructuring plan prior to the required October 1 deadline.

In a successful effort to prove that they are morons, they copy-protected the PDF, so I copy-pasted from the MS-Word version. Just so you know.

Bloomberg had an interesting piece on the market for US RMBS:

Investors are overestimating potential yields in part because they are failing to consider how many loans are becoming delinquent for the first time and in part because they are arriving at incorrect conclusions on how long it will take to liquidate seized homes, the [Amherst Securities Group LP] New York-based analysts led by Laurie Goodman wrote in a report yesterday. Those issues can influence both the size of foreclosure losses and how quickly bonds get paid down.

“Do your homework, and sell securities which are being evaluated incorrectly by the marketplace,” the analysts wrote.
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For example, the most-senior classes of 2006 and 2007 securities backed by prime-jumbo mortgages have rallied to more than 80 cents on the dollar, from as low as 55 cents, according to Amherst. So-called super-senior bonds backed by “option” adjustable-rate mortgages have jumped to about 48 cents, from the “low 30s,” the analysts wrote.

Investors also have been doing too little analysis of the differences, such as the level of home equity, among borrowers with currently non-delinquent mortgages backing non-agency bonds, which lack guarantees from government-supported Fannie Mae and Freddie Mac or U.S. agency Ginnie Mae, they said.

What? Homework? Analysis? Who has time for that stuff, anyway, in between client meetings and sales? Just buy what the smiley-boy at the dealer’s tells you is good.

PerpetualDiscounts had yet another good day today, with a total return of +62bp to bring the median YTW down to 5.84%, equivalent to 8.18% interest at the standard pre-tax equivalency factor of 1.4x for taxable holders. Long Corporates now yield a hair over 6.0%, so the pre-tax interest-equivalent spread is now about 215bp, narrowing in from the 230bp recorded on August 5 and returning to its month-end level.

Volume continued strong, with PerpetualDiscounts dominating the volume highlights table.

There’s an interesting bit of law being litigated, regarding securitization and bankruptcy:

Terms of the two Lehman transactions, named Dante after the entity that issued the notes, specify that investors have first claim on whatever money is available if Lehman defaults or goes bankrupt. While the U.K.-based contract favors the noteholders, U.S. bankruptcy law normally protects a debtor company’s assets. Lehman is asking the bankruptcy judge to rule in its favor.

Not Yet Tested

Not yet tested is whether U.S. law permits the investors to use a written contract to give themselves priority claims after a bankruptcy. In the U.K., the related case was brought against Lehman and Bank of New York by a trustee for Australian noteholder Perpetual Trustee Co.

Rating agencies could start to downgrade credit-linked notes if Peck says Lehman can take away assets protecting the investments, debt research firm CreditSights Inc. said in a July 12 report. Insulating such deals from bankruptcy “forms the bedrock of securitization,” CreditSights analyst Atish Kakodkar said in the report.

Comrade Obama announced today that Americans are too stupid to invest:

The main difference in the proposal from earlier outlines is a provision to “better protect” small municipalities and “unsophisticated investors” by limiting their eligibility to trade derivatives. The rest of the statement mirrors earlier proposals by asking Congress to impose higher capital and margin requirements, move most derivatives to regulated exchanges and clearinghouses and impose supervision over all dealers.
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Frank and Peterson’s proposal also left open whether to ban trading of so-called naked credit-default swaps, which were designed to insure against the default of a company’s bonds. Lawmakers and administration officials say the product has been abused by hedge funds and other investors who used them to speculate on the likelihood of a company’s collapse.

Naked contracts or positions are those in which the buyer doesn’t own the underlying asset or stock on which the trading is based.

Frank told reporters last month that he supports proposals to restrict derivatives sales to municipalities.

Soon all shorting will be illegal, and then everything will always go up!

DBRS downgraded some MAV2 notes today (MAV2 is the reincarnation of ABCP):

Negative rating migration in the underlying asset interests, particularly in CDO transactions with relatively low levels of credit enhancement, has increased the required enhancement level for the Notes to above that commensurate with the “A” rating assigned on January 21, 2009. Numerous reference entities have been downgraded (in some cases by more than ten notches), resulting in higher probabilities of default for the CDO asset interests. Monoline downgrades in particular have put pressure on the rating of the Notes. Any future deterioration in the credit quality of monoline insurers may lead to further ratings action. Figure 1 below lists the most notable downgrades of reference entities since January 1, 2009. In addition, a number of credit events, coupled with historically low realized recoveries, have reduced enhancement levels available to the CDO transactions. Figure 2 below lists the credit events and International Swaps and Derivatives Association (ISDA) protocol recoveries since January 1, 2009. These factors have resulted in a rapid deterioration in the credit quality of certain CDO asset interests.

Preferreds continued their winning ways today (this is the tenth consecutive trading day of gains for PerpetualDiscounts, over the course of which they have gained 4.81%) amidst continued heavy volume.

CIT has amended its exchange offer for its debentures due August 17:

As a result of the amendment, holders of all Notes tendered prior to the expiration date at midnight, New York City time, at the end of Friday, August 14, 2009, will receive the amended purchase price of $875 in cash per $1,000 principal amount of Notes, as total consideration in the Offer. Previously, the purchase price, which included an early delivery payment, was $825 per $1,000 principal amount of Notes.

CIT announced that the amendment to the Offer also reduces the minimum tender condition to 58% of the Notes, an amount approximately equal to the number of Notes which pursuant to the Credit Facility the lenders are committed to tender and not withdraw. As of 5:00 p.m., New York City time, on Friday, July 31, 2009, CIT had received tenders for 64.97% of the Notes.

The withdrawal deadline for the Offer has been extended until midnight, New York City time, at the end of Wednesday, August 5, 2009. All other terms of the Offer remain unchanged.

They have also suspended preferred dividends:

the Company’s Board of Directors has decided to suspend dividend payments on its four series of Preferred Stock in order to improve liquidity and preserve capital while restructuring efforts are ongoing. Payments on the Company’s Equity Units (NYSE: CIT PrZ) are not affected by this decision.

China has claimed that industrial espionage by Rio Tinto has cost the country’s steel mills over $100-billion, in connection with recent arrests. I have no idea whether the charges are well-founded or not; but if true, a vigorous response should provide a hint to Canada and Germany, inter alia, that confident countries don’t just whine about it.

There has been a fascinating hiccup in BAC / SEC lawsuit over the MER bonuses:

U.S. District Judge Jed Rakoff ended the hearing saying that he needs more information on the Aug. 3 accord between the bank and the U.S. Securities and Exchange Commission, which filed the suit. The settlement won’t be final unless Rakoff approves it.

If the SEC is correct that Bank of America lied about whether to pay the bonuses, then the proposed settlement isn’t “remotely reasonable,” Rakoff said.

Not a lot of price action today, but volume continued strong.

The Credit Suisse bonus pool is doing well:

Credit Suisse Group AG, the largest Swiss bank by market value, told bankers a pool of toxic bonds and mortgages set aside as part of their compensation gained 17 percent since January, a person familiar with the matter said.

About 2,000 bankers were told of the return, based on a $5 billion fund of bad mortgages and bonds, the person said, declining to be identified because the matter is private.

When the mechanism was announced on December 18, I commented:

If I am correct – with the support of the BoE – and bank assets have, in general, been written down to far below fundamental value, this is a clever way for the executives to (a) earn brownie points, and (b) give themselves enormous bonuses.

The Globe and Mail had a host of adulatory articles about the MFC Dividend Cut today, by Tara Perkins, Steve Ladurantaye and Andrew Willis, all praising Guloien’s forthright and incisive action in repairing the battered balance sheet. None of them mentioned the pending charge of about $500-million due to changing assumptions or speculated as to whether tough times might cause a decrease to the marketting budget, but the Perkins story did add some colour regarding the hurried changing of the capital rules last fall:

On Sept. 30, the head of Canada’s regulator, the Office of the Superintendent of Financial Institutions, wrote an e-mail to various OSFI officials. “D’Alessandro just called and asked that we try to meet next week with the company to discuss capital,” Julie Dickson wrote, noting that the meeting would replace one that had been arranged for November. Mr. D’Alessandro wanted to discuss the capital requirements for the variable-annuity, or segregated funds, business, other e-mails show.

Discussions took place in October in which he laid out why he felt the rules were too onerous, and OSFI officials had a flurry of internal discussions. On Oct. 28, the rules were changed.

OSFI consulted with more than one insurer that month, but the changes were most important to Manulife.

Federal lobbyist records show that Mr. D’Alessandro also met with Prime Minister Stephen Harper on Nov. 6 to discuss “financial institutions.” It is not known what was discussed at the meeting with Mr. D’Alessandro.

On Nov. 18, Finance Minister Jim Flaherty received a memorandum from OSFI updating him on Manulife.

“In short, while Manulife’s results have been very good historically, the recent downturn in equity markets has had a significant impact on its capital levels,” the memorandum stated.

The arbitrary rule change was highlighted in my opinion piece OSFI and the Third Pillar. Lynx-eyed analysts at Credit Suisse AG and CIBC World Markets, however, noticed that dividend cuts are not a Good Thing and downgraded the common.

Citigroup is considering selling its energy trading unit:

— Citigroup Inc. may give up control of its Phibro LLC energy-trading business to outside investors, a person familiar with the matter said, as the bank faces what may be a $100 million payday for the unit’s chief, Andrew Hall.

Billionaire investor Warren Buffett also held talks with New York-based Citigroup about buying the business, and those negotiations have now ended, according to the person, who declined to be identified because the discussions are private.
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Hall’s payout, which will be determined at the end of this year based on Phibro’s profits, may raise concern among lawmakers and regulators who are scrutinizing Citigroup’s compensation practices after a $45 billion government bailout last year.

On the one hand, I think is good news because I am in favour of a separation of banking & trading – with the strict proviso that this be accomplished by transparent nudges to capital rules, so that any regulated entity may determine whether it is primarily a banker or trader and have its regulatory capital calculated in an appropriate manner.

Even the whisper of this story is bad news, however. Citigroup isn’t examining the issue based on things like risk and reward – that’s too old fashioned for the new era. It appears that the basis for the decision will be cosmetic appeal: it’s a disgrace. I am, however, please to see that they have the moral character to resist the temptation to unleash an army of lawyers and accountants on Philbro, desperately seeking an uncrossed t in the regulatory requirements so they can pretend to be shocked and cancel the contract. There is still some integrity, at least, left in the world.

Today’s fascinating question is: Are Ken Lewis & Mom Boucher related, or what?

Ken Lewis CEO Bank of America

Mom Boucher President Hells Angels, Montreal

This question came to mind during the PrefBlog Sloppy Investment Thinking Awards Ceremony, which honoured Richard X. Bove of Rochdale Securities:

Mr. Bove notes that on Dec. 29 – when the new information concerning Merrill Lynch’s losses were disclosed to Bank of America’s management – that the bank’s stock was selling at $12.94 per share, whereas today the combined banks’ stock is trading close to $17 a share.

“Thus, one cannot argue that shareholders have been harmed by the bank’s decision that this was not a material reason to put off the merger,” he said in the note to clients.

The award is made with the assumption that the published extract has not distorted the main argument, which is akin to suggesting that blowing 90% of your paycheque on beer and prostitutes doesn’t do you any financial harm, since you’ve still got 10% left.

PerpetualDiscounts continued their winning ways of the week, up almost 45bp and leaving FixedResets in the dust again. These results were aided by superb performance from POW, which announced earnings today … no disaster, but held back by sub-par results from PWF (which owns GWO). Volume continued to be quite strong.

DBRS has published a new study Canadian Private Pension Plans – Are They Losing or Cruising?.

The SEC has extended the comment period for the short-selling proposals.

The BoE is monetizing debt like there’s no tomorrow:

The Bank of England expanded its bond purchase program beyond its original limit in an effort to spur lending and fight a recession that’s deeper than previously anticipated.

Bond yields plunged after the Monetary Policy Committee, led by Governor Mervyn King, kept the key interest rate at 0.5 percent and increased its purchase program by 50 billion pounds ($84 billion) to 175 billion pounds.
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The Bank of England’s tone on the economy was less optimistic. It said in a statement that the recession “appears to have been deeper than previously thought.”

“While some recovery in output growth is in prospect, the margin of spare capacity in the economy is likely to continue to grow for some while yet, bearing down on inflation in the medium term,” the bank said.

PerpetualDiscounts continued to roar ahead today, shrugging off the woes of the equity market sparked by the slashing of the MFC common dividend. Somewhat surprisingly, the MFC PerpetualDiscounts were little affected, although one of the two FixedReset issues and the OpRet issue made it into the unpleasant part of the price movement table; both FixedResets were in the volume table.