Regulation

Leverage, Bear Stearns & Econbrowser

The usually reliable Prof. James Hamilton of Econbrowser disappointed me today with a rather alarmist post on leverage and Bear Stearns:

And the core reason we are in the mess we are today is that these equity stakes were nowhere near sufficient for this purpose. Instead, financial institutions were allowed to take highly leveraged positions whose details are largely opaque to readers of publicly available financial statements. Exhibit A here might be Bear Stearns, whose 2007 10-K reported that Bear had outstanding derivative contracts whose notional value was $13.4 trillion.
…
But, if you were to sell an option through an organized exchange, the exchange would require you to satisfy a margin requirement, delivering for safekeeping good funds such that if the price of the underlying asset against which the derivative is written moves against you, you are able to make good on your commitment.

If anything like a reasonable margin requirement had been in effect, Bear Stearns could not possibly have gotten into contracts totaling $13.4 trillion notional. But these weren’t traded on a regular exchange, so there was no margin requirement, and apparently no real limit on the size of the exposures that Bear Stearns could take on, or the size of what they could bring down with them if they fell.

And that raises the question, Why were counterparties willing to accept these trades with no margin to guarantee payment? To this I’m afraid the answer is, they figured Bear was too big for the Fed to allow it to fail.

There are a number of problems with these statements; first let’s take the question of the counterparties’ willingness to deal with Bear Stearns (BSC). According to their 10-K:

In connection with the Company’s dealer activities, the Company formed BSFP and its wholly owned subsidiary, Bear Stearns Trading Risk Management Inc. (“BSTRM”). BSFP is a wholly owned subsidiary of the Company. BSFP and BSTRM were established to provide clients with a AAA-rated counterparty that offers a wide range of global derivative products. BSFP is structured so that if a specified trigger event (including certain credit rating downgrades of the Company, the failure of BSFP to maintain its credit rating and the occurrence of a bankruptcy event with respect to the Company) occurs, BSFP will perform on all of its contracts to their original maturities with the assistance of an independent derivatives portfolio manager who would assume the active management of BSFP’s portfolio. BSTRM is structured so that, on the occurrence of a specified trigger event, it will cash-settle all outstanding derivative contracts in a predetermined manner. Clients can use either structure. The AAA/Aaa ratings that BSFP and BSTRM have received are based on their ability to meet their respective obligations without any additional capital from the Company. In the unlikely occurrence of a trigger event, the Company does not expect any significant incremental impact on the liquidity or financial condition of the Company. At November 30, 2007, there was a potential cash settlement payable by BSTRM of $210 million on the occurrence of a trigger event.

So, as far as the counterparties were concerned, their counterparty was not BSC per se, but wholly-owned, independently capitalized, highly rated subsidiaries of BSC. Just how adequate the capital, accurate the ratings, and ring-fenced the assets actually were is something I am not qualified to judge – seeing as how I haven’t even seen any of the guarantees and financial statements in question. But neither, it would appear, has Prof. Hamilton.

Now let’s take another aspect of the charges: But these weren’t traded on a regular exchange, so there was no margin requirement. Any private agreement can have any collateral requirement agreed upon. There is no need to seek the imprimatur of an Exchange prior to demanding collateral as part of a private transaction. Page 93 of the PDF with BSC’s 10-K shows a table of their winning positions at year end and a comparison with the collateral received, broken down by credit rating of the counterparty:

The Company measures its actual credit exposure (the replacement cost of counterparty contracts) on a daily basis. Master netting agreements, collateral and credit insurance are used to mitigate counterparty credit risk. The credit exposures reflect these risk-reducing features to the extent they are legally enforceable. The Company’s net replacement cost of derivatives contracts in a gain position at November 30, 2007 and November 30, 2006 approximated $12.54 billion and $4.99 billion, respectively. Exchange-traded financial instruments, which typically are guaranteed by a highly rated clearing organization, have margin requirements that substantially mitigate risk of credit loss.

Their financial statements for 2007 show $15.6-billion “Securities Received as Collateral” and $15.7-billion “Securities Owned and Pledged as Collateral”.

Of particular note is the discussion on page 19 of the PDF:

A reduction in our credit ratings could adversely affect our liquidity and competitive position and increase our borrowing costs. Our access to external sources of financing, as well as the cost of that financing, is dependent on various factors and could be adversely affected by a deterioration of our long-and short-term debt ratings, which are influenced by a number of factors. These include, but are not limited to: material changes in operating margins; earnings trends and volatility; the prudence of funding and liquidity management practices; financial leverage on an absolute basis or relative to peers; the composition of the balance sheet and/or capital structure; geographic and business diversification; and our market share and competitive position in the business segments in which we operate. Material deterioration in any one or a combination of these factors could result in a downgrade of our credit ratings, thus increasing the cost of and/or limiting the availability of unsecured financing. Additionally, a reduction in our credit ratings could also trigger incremental collateral requirements, predominantly in the OTC derivatives market.

The procyclical nature of increased collateral requirements upon a reduction in credit rating could well have been a major factor in the debacle.

However, the sheer fact of the existence of collateral in the derivatives agreements is not the end of the story. There’s also the SEC’s role as supervisor of broker-dealer capital:

Broker-dealers must meet certain financial responsibility requirements, including:

  • maintaining minimum amounts of liquid assets, or net capital;
  • taking certain steps to safeguard the customer funds and securities; and
  • making and preserving accurate books and records.

Getting the details on these calculations is a little hellish, but I did find a statement of the rule – under “Ratio Requirements” is:

[(a)(1)(ii)] No broker or dealer, other than one that elects the provisions of paragraph (a)(1)(ii) of this section, shall permit its aggregate indebtedness to all other persons to exceed 1500 percent of its net capital (or 800 percent of its net capital for 12 months after commencing business as a broker or dealer).

[(a)(1)(ii)] A broker or dealer may elect not to be subject to the Aggregate Indebtedness Standard of paragraph (a)(1)(i) of this section. That broker or dealer shall not permit its net capital to be less than the greater of $250,000 or 2 percent of aggregate debit items computed in accordance with the Formula for Determination of Reserve Requirements for Brokers and Dealers (Exhibit A to Rule 15c3-3).

I will note at this point that I do not purport to be an expert on US Broker/Dealer Regulation!

It seems to me, however, (based on a very quick glance through some areas of interest in the quoted document) that most of the credit calculations are very similar to – if not identical to – the Basel rules for banks. I will also note that:

Off-balance sheet items are multiplied by the appropriate credit conversion factor (CCF) outlined in Table 39, to give a balance sheet equivalent value. The credit equivalent is similarly multiplied by the relevant CRW to calculate a RWA.
…
When banks sell protection, these long credit exposures are treated the same as a written guarantee on the underlying credit. Thus, if the Reference Entity is a corporate, then this will attract 100% CCF and 100% CRW.

When banks buy protection, regulators will typically be willing to allow a degree of capital relief if the default swap is directly offsetting an underlying long credit position. In the UK, for example, the treatment is similar to that of a guarantee. Banks can choose whether to replace the underlying corporate exposure (100% risk weighted) with that of the protection seller (20% if it is an OECD bank).

The exposure on an interest rate swap is equal to its profit-and-loss (there should, however, be some additional capital requirement resulting from “gap risk”, to the extent that there is a mismatched book); writing a naked CDS is equivalent, for risk management purposes, to buying a bond.

What’s the problem with that?

To get back to Prof. Hamilton’s post, I consider his proposal for compulsory exchange trading to be disappointing because it does not, in and of itself, do anything to address the problem that he is attempting to resolve.

The scare number is $13.4-trillion, and Prof. Hamilton alleges: If anything like a reasonable margin requirement had been in effect, Bear Stearns could not possibly have gotten into contracts totaling $13.4 trillion notional.

There is no indication in the post that the actual effects on capital of this $13.4-trillion capital exposure have been examined, let alone an argument made that the current reserves against this exposure are inadequate – or even the easiest representation made, that the “2 percent of aggregate debit items” is too low and should be increased.

It should be clear that we do not want a financial system in which nothing ever fails and nobody ever loses money. As I have argued in the past, we should be aiming for a financial system with a good solid banking core surrounded by a riskier layer of brokerages (or “Large Complex Financial Institutions”, as the BoE calls them) surrounded in turn by a wild-and-wooly shadow-banking system comprised of hedge funds, SIVs and anything else that gets dreamed up so the dreamer can make a buck.

As I indicated yesterday, I don’t like arguments along the lines of “Bear Stearns blew up, so we need to do this”. It’s a non-sequiter, and Bear Stearns is not the greatest example in the world anyway, in that (as far as I have been able to tell) it didn’t blow up for any particular fundamental reason, but simply succumbed to a run-on-the-bank panic. The hysteria of mid-March – very ably chopped off by Bernanke’s action in both ensuring continuity of business with drastic punishment of the owners – is something that cannot be legislated against.

We may agree that a positive social purpose may be served by, say, increasing the capital requirement to 3% of debits from the current 2%. Or we may wish to say that corporate bonds should attract a capital charge of 15% rather than their current 10%. Or we may wish to say that interest-rate swaps are charged at rate of not just their P&L, but their P&L + 1% of notional, to account for gap risk.

But to insist that derivative trading be moved to an exchange simply moves the problem and does nothing either to demonstrate that there is, in fact, a problem or to solve it once it’s defined.

Update: In related news (hat tip: Naked Capitalism), former Fed Governor Volker has called for (as far as I can see) transfer of brokerage supervision to the Fed from the SEC:

Volcker hinted at the Fed’s recent role facilitating the rescue and proposed takeover of Bear Stearns by J.P. Morgan Chase. The Fed, he said, “felt it necessary to extend that safety net” to systemically important institutions by “providing direct support for one important investment bank experiencing a devastating run, and then potentially extending such support to other investment banks that appeared vulnerable [to] speculative attack,” Volcker said.

“Hence, the natural corollary is that systemically important investment banks should be regulated and supervised along at least the basic lines appropriate for commercial banks that they closely resemble in key respects,” he said.

Update #2 : Naked Capitalism also commented on the Econbrowser post and commented (with very little evidence, I must say) that most of the $13.4-trillion was interest rate swaps, not CDS. He’s probably right, mind you, but there’s not much to go on.

Update #3: As reported on PrefBlog on May 7:

And it looks like the big Wall Street dealers are going to have to lift their skirts a bit:

The U.S. Securities and Exchange Commission will require Wall Street investment banks to disclose their capital and liquidity levels, after speculation about a cash shortage at Bear Stearns Cos. triggered a run on the firm.

“One of the lessons learned from the Bear Stearns experience is that in a crisis of confidence, there is great need for reliable, current information about capital and liquidity,” SEC Chairman Christopher Cox told reporters in Washington today. “Making that information public can certainly help.”

We’ll see what the details are, but this is a good development for investors.

Update #4: eFinancial News reported on April 7:

The race to introduce listed credit derivatives products was won last year when four exchanges launched their first contracts. However, thanks to fears over liquidity, the winners gained little more than frustration and embarrassment.

Eurex, the Chicago Mercantile Exchange, the then independent Chicago Board of Trade (now part of CME Group) and the Chicago Board Options Exchange all launched credit derivatives contracts &em; but not one is traded today.

The exchanges and clearing houses have not, however, given up their credit ambitions. At last month’s Futures Industry Association conference in Florida, the chief executives of the four main derivatives exchanges – the CME, Eurex, NYSE Euronext’s Liffe and the Intercontinental Exchange – unanimously agreed credit derivatives were the single biggest growth area for their businesses.

In their “Global Structured Credit Strategy” publication of May 13, 2008, Citi’s Structured Products Group opined that regulators would force either an exchange or a clearing house down the street’s throat, willy nilly (hat tip: An Assiduous Reader).

Update, 2008-6-3: More Bear Stearns discussion from the June 3 Market Action Review:

Accrued Interest has written some more about the Bear Stearns affair with an emphasis on the idea that Lehman now finds itself in much the same position. He also links to a three-part review by the WSJ which, as he says, is excellent.

Market Action

May 13, 2008

A number of regulatory links today! In another post, I discussed Derek DeCloet’s column in today’s Globe, but there were other things.

In a column in VoxEU, Xavier Vives writes a fairly general description of the problem of informational asymmetry, without giving much of a prescription for a cure. I suspect that Dr. Vives supports the Financial Stability Forum’s recommendations on simultaneous public disclosure … but this is not clear.

He makes the assertion:

The problem has been aggravated by the lack of control of who was monitoring the subprime loans. In the old-fashioned banking system institutions would monitor loans, in the world of securitised packages the market failed to provide the monitoring because rating agencies did not do their job properly and fund managers took the risk knowing that the upside was to be cashed in bonus form and the downside protected by limited liability.

… but doesn’t back it up. It should be noted that the linked paper provides no evidence that the “rating agencies did not do their job properly”; that paper by Portes seems to be getting quite a number of links on VoxEU, for reasons that I simply can’t fathom. I’ll review it at some point – I didn’t at the time, simply because it was so thoroughly generic – but in this case I’ll content myself with stating that Dr. Vives’ phrasing is not consistent with his link.

I take issue with his “second aspect”:

A second aspect of the question, made evident in the present crisis, is that, if the central bank intervenes to help institutions that are not under its supervision, it may lack the necessary information to assess whether the origin of the need is a liquidity or a solvency problem. How does the Federal Reserve know when mounting the rescue operation of a non-bank financial firm, for example, that the institution is solvent? By helping an insolvent institution taxpayers’ money is put at risk and the disciplining effect of failure eliminated. The consequence is that the moral hazard problem is exacerbated and bank managers will feel more secure in the future to take excessive risks.

Well, the “non-bank financial firm” business seems to be a tangential reference to Bear Stearns – and in that case, they know about solvency by asking the SEC. Separation of supervisory and lender of last resort functions is standard throughout much of the world – Canada and the UK, for instance – and, while not ideal, isn’t necessarily all that terrible either.

I do agree that propping up an insolvent institution would represent a misuse of the discount window – or equivalent mechanism.

Still on VoxEU, Axel Leijonhufvud wrote a rather prescient piece on inflation targetting in June, 2007:

The sanguine view is that securitisation and credit derivatives have made the world of finance a safer place than it used to be and that, besides, liquidity is ample all around. But it is not likely that the world will stay awash in liquidity forever. At some stage, central banks will have to mop it up or see inflation do it for them. Securitisation and credit derivatives have certainly dispersed risk through the economy and away from the banks where it used to be concentrated. But by the same token, the system has taken on more risk and we know less about where large concentrations of risk-bearing may be located. Risk spreads have narrowed in part permanently because of these new risk-sharing technologies, but in part transitorily because of the extraordinary level of liquidity. Narrow spreads have in turn induced some institutions to assume high leverage in search of yield.

A number of very large failures – LTCM, Enron, Amaranth – have occurred causing nary a macroeconomic ripple, and this is frequently cited as proof of the resilience that recent financial innovations have imparted to the system. It may be, however, that the more appropriate conclusion to draw is that macroeconomic developments are more likely to trigger trouble in financial markets than vice versa.

In his current article, Central banking doctrine in light of the crisis, he joins the chorus blaming Greenspan for allowing the housing bubble in the 2001-05 period:

This strategy failed in the United States. The Federal Reserve lowered the federal funds rate drastically in an effort to counter the effects of the dot.com crash. In this, the Fed was successful. But it then maintained the rate at an extremely low level because inflation, measured by various variants of the CPI, stayed low and constant. In an inflation targeting regime this is taken to be feedback confirming that the interest rate is “right”. In the present instance, however, US consumer goods prices were being stabilised by competition from imports and the exchange rate policies of the countries of origin of those imports. American monetary policy was far too easy and led to the build-up of a serious asset price bubble, mainly in real estate, and an associated general deterioration in the quality of credit.

He then argues that the elements of choice in monetary policy cast doubts on the policy of central bank independence:

Since using the bank’s powers to effect temporary changes in real variables was deemed dysfunctional, the central bank needed to be insulated from political pressures. This tenet was predicated on the twin ideas that a policy of stabilising nominal values would be politically neutral and that this could be achieved by inflation targeting. Monetary policy would then be a purely technical matter and the technicians would best be able to perform their task free from the interference of politicians.
…
When monetary policy comes to involve choices of inflating or deflating, of favouring debtors or creditors, of selectively bailing out some and not others, of allowing or preventing banks to collude, no democratic country can leave these decisions to unelected technicians. The independence doctrine becomes impossible to uphold.

It’s a tricky question! I am fully supportive of the de facto situation … the central banking chief is an unelected technician; he is appointed by the government; but the only power that the government has is to fire him – otherwise they have no say in anything. It depends a great deal on ensuring that the central banker is a paragon of integrity, not dependent upon his salary to keep food on the table.

It is accepted as pretty much a given that if the BoC governor at a given time was to be dismissed, the currency would tank and interest rates would skyrocket which – even to the most zealous investor advocate in parliament – would make it not worth firing him except for the gravest of reasons. But perhaps some thought should be given to ensuring a golden parachute that would withstand even the supremacy of parliament … I don’t know, frankly, what the current arrangements are.

And I’ll take a moment to snipe at the horrible political games-playing in the States, which has resulted in two vacancies out of seven places in the Federal Reserve Board of Governors.

Further to all the regulatory talk in this update is a post by Naked Capitalism, referencing some fashionable grandstanding by the EU:

A group of key EU finance ministers will today launch an assault on the rewards earned by bankers and top managers in a move that poses a potential threat to the City of London.

A confidential document prepared for the gathering in Brussels finds the “short-term” pay structure of modern capitalism has become deformed, causing firms to take on “excessive risk” without regard to the interests of stakeholders or society.

Geez, I’m getting old. I can remember when the short-term nature of quarterly reporting was on the verge of destroying the United States, leaving the (far-sighted and judicious long-term planning) Japanese as rightful masters of the universe.

Has anybody heard anything more about that? What happened to that story, anyway?

The other clipping republished by Naked Capitalism is with respect to a NYT interview with Kenneth C. Griffin:

Kenneth C. Griffin, who runs one of the biggest and most successful hedge fund firms, has a blunt assessment: “We, as an industry, dropped the ball.”

The breakdown happened, Mr. Griffin contends, when big investment banks gambled away money and jobs during the late great credit boom. The bosses let all those young gung-ho traders take far too many risks and now everyone is paying the price.

US brokerages are, from all the accounts I’ve heard, a lot more fun to work at than Canadian ones. In the US, if you have a good idea, you go to your supervisor … and bang! If he likes it you’ve got your funding and a deal: if it works, you, personally, will get rich. If it doesn’t, you’ll get fired. In Canada, of course, if you have a good idea, you write it up for Human Resources to look at and determine whether it’s culturally sensitive, if it harms the environment, and whether it will increase diversity and respect in the workplace. You wait a bit for their answer, then retire.

There are times – such as now! – when the free-wheeling nature of the US system got … er … a little out of hand, but we can be sure the regulatory wannabes will be only too happy to throw the baby out with the bathwater.

But Mr. Griffin isn’t just a serial complainer. He has thought about solutions.

First, “the investment banks should either choose to be regulated as banks or should arrange to conduct their affairs to not require the stop-gap support of the Federal Reserve,” he says.

But that’s not all. He also wants new government oversight of the arcane world of credit default swaps, a business with a notional value and risk of $50 trillion.
…
In particular, Mr. Griffin wants the government to require the use of exchanges and clearing houses for credit default swaps and derivatives.

The first solution is just smarmy, and reminds me of everything I’ve heard about being on (Canadian) Unemployment Insurance … they make you go to moronic seminars lead by twerps who are congenitally unemployable outside government. When you point out an obvious stupidity, they just ask ‘if you’re so smart, why don’t you have a job, while I do?’.

I feel quite certain that Bear Stearns (and the SEC, its regulator) were convinced that they had, in fact, arranged their affairs such that the stop-gap support of the Federal Reserve would not be necessary. They were wrong, they’ve lost nearly all their investment. It’s called business. Business Risk, to be precise.

I’ll be perfectly happy to consider suggested changes to the regulatory regime, capital and liquidity calculations, and to proffer plaudits and criticism as I see fit. Until these suggested changes are available for discussion, however, I suggest that Mr. Griffin and his adulatory interviewer arrange their affairs to make him sound a little less like a smarmy twerp.

Exchange Traded CDS? The Exchanges have been trying to put such a thing together for years. I understand that some of the major brokerages are trying to put together a clearinghouse … but it’s really none of the government’s damn business. The regulators can impose reasonable margin and capital rules, sure; and it’s entirely reasonable that the margin requirements for a clearing-house counterparty will be somewhat less than those for even the strongest of individual counterparties; but determining that the Official Counterparty has a monopoly on trading is going way, way, way too far.

Will I be allowed to guarantee my nephew’s car loan, or will the Official Counterparty insist on doing it and charging a fee?

Getting back to preferred shares for just a moment (sorry!) what’s up with the DFN Rights Issue? Four rights and $24.25 get you one DFN and one DFN.PR.A. Prices are:

DFN Rights Issue Element Prices
Ticker Closing
Quote
5/13
DFN 14.40-53
DFN.PR.A 10.23-34
DFN.RT 0.035-0.050

There are two monthly dividends yet to go … $0.10 each on DFN, $0.04375 each on DFN.PR.A. Total $0.2875. So it doesn’t really look as if there’s any good arbitrage possible … but given that the NAV as of April 30 was $24.81 ($24.63 fully diluted), it seems to me that the rights are cheap. Do your own homework, though, preferably involving the modelling of the underlying portfolio!

The preferred share market put in a good honest day’s work today with good returns and even some decent (and all too infrequent, lately) volume.

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
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.90% 4.94% 43,410 15.68 1 -0.0403% 1,082.8
Fixed-Floater 4.67% 4.65% 62,986 16.02 7 +0.2919% 1,069.7
Floater 4.14% 4.18% 63,215 17.01 2 +0.9223% 911.2
Op. Retract 4.83% 3.34% 89,288 2.60 15 -0.0792% 1,053.6
Split-Share 5.28% 5.56% 70,227 4.15 13 -0.0010% 1,050.9
Interest Bearing 6.13% 6.07% 53,285 3.82 3 0.0000% 1,105.9
Perpetual-Premium 5.89% 5.60% 140,964 6.41 9 +0.0747% 1,021.6
Perpetual-Discount 5.68% 5.72% 305,213 14.10 63 +0.2339% 921.4
Major Price Changes
Issue Index Change Notes
BAM.PR.J OpRet -1.0998% Now with a pre-tax bid-YTW of 5.42% based on a bid of 25.18 and a softMaturity 2018-3-30 at 25.00. Compare with BAM.PR.H (4.73% to call 2009-10-30) and BAM.PR.I (5.17% to softMaturity 2013-12-30).
TD.PR.P PerpetualDiscount +1.0860% Now with a pre-tax bid-YTW of 5.46% based on a bid of 24.20 and a limitMaturity.
POW.PR.C PerpetualDiscount (for now!) +1.1996% Now with a pre-tax bid-YTW of 5.60% based on a bid of 25.31 and a call 2012-1-5 at 25.00.
TCA.PR.X PerpetualDiscount +1.2104% Now with a pre-tax bid-YTW of 5.76% based on a bid of 48.50 and a limitMaturity.
RY.PR.F PerpetualDiscount +1.5664% Now with a pre-tax bid-YTW of 5.56% based on a bid of 20.10 and a limitMaturity.
BAM.PR.K Floater +2.2472%  
Volume Highlights
Issue Index Volume Notes
SLF.PR.B PerpetualDiscount 113,057 National Bank crossed 80,000 at 21.70, then Nesbitt crossed 30,000 at the same price. Now with a pre-tax bid-YTW of 5.58% based on a bid of 21.76 and a limitMaturity.
BCE.PR.C FixFloat 62,795 Nesbitt crossed two tranches of 30,000 shares each at 24.39.
RY.PR.K OpRet 53,797 Now with a pre-tax bid-YTW of 1.67% based on a bid of 25.03 and a call 2008-6-12 at 25.00.
SLF.PR.E PerpetualDiscount 50,300 CIBC crossed 30,000 at 20.34, then Nesbitt crossed 15,000 at 20.31. Now with a pre-tax bid-YTW of 5.60% based on a bid of 20.38 and a limitMaturity.
SLF.PR.D PerpetualDiscount 49,082 Now with a pre-tax bid-YTW of 5.59% based on a bid of 20.22 and a limitMaturity.

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

Issue Comments

SPL.A Downgraded to Pfd-5 by DBRS

DBRS has:

today downgraded the Class A Shares issued by Mulvihill Pro-AMS RSP Split Share Corp. (the Company) to Pfd-5 from Pfd-4; the trend is Negative.

In March 2002, the Company issued six million Class A Shares at $10 per share and six million Class B Shares at $20 per share, both with a redemption date of December 31, 2013 (the Termination Date). The Company invested approximately 34.5% of the gross proceeds in a portfolio of Canadian equity securities to enter into a forward agreement with Royal Bank of Canada (the Counterparty) to provide for the full capital repayment of the Class B Shares on the Termination Date.

The rest of the net proceeds from the initial offering were invested in a diversified portfolio of Canadian and U.S. equities (the Managed Portfolio). After offering expenses, the Managed Portfolio provided asset coverage of approximately 1.8 times to the Class A Shares (downside protection of about 44%). In addition to providing principal protection for the Class A Shares, the Managed Portfolio is used to make distributions to the Class A Shares equal to 6.5% per annum and pay annual fees and expenses. Also, the Company has been making semi-annual contributions of $0.43 per Class A Share from the Managed Portfolio to an account (the Class A Forward Account), which was used to enter a forward agreement with the Counterparty for the repayment of the Class A Shares principal on the Termination Date.

The Managed Portfolio has a current value of $2.65 per share (as of May 8, 2008), a decrease of nearly 85% since inception. About one-third of the decline has resulted from the semi-annual contributions to the Class A Forward Account. The present value of the Class A Forward Account is $6.53, and the future value is $8.08, meaning 80.8% of the Class A Shares principal is now guaranteed by the Counterparty on the Termination Date. In order for the Company to return the $10 principal to each Class A Shareholder on the Termination Date, the Company would still need to contribute approximately $1.54 (present value) to the Class A Forward Account today in order to secure the remaining $1.92 (future value) of required principal protection. Consequently, the Company will find it challenging to meet its annual expenses and monthly dividend payments to the Class A Shareholders.

SPL.A is tracked by HIMIPref™ with a securityCode of A43400. The creditRatings table of the permanentDatabase has been updated to reflect the new information. It was included in the SplitShare Index until the 2002-10-31 rebalancing, when it was transferred to “Scraps” on volume concerns.

This issue was downgraded to Pfd-4 in October, 2007. The rating history is:

SPL.A Rating History
Rating From To
Pfd-2 2002-3-15 2003-4-8
Pfd-3 2003-4-9 2007-10-23
Pfd-4 2007-10-24 2008-5-13
Pfd-5 2008-5-14 ?

Further information is available via the Mulvihill website.

Regulation

DeCloet & National Policy 51-201

Derek DeCloet (last mentioned on PrefBlog regarding a column about regulatory pay scales) has written a column in the Globe titled Pull the Plug on Raters’ Special Status in which he discusses the repeal of the exemption given to credit rating agencies under National Policy 51-201 (to be horrifyingly precise, he discusses Regulation FD, which is the regulatory policy of some foreign country. But in Canada, it’s NP 51-201).

His source material for the column was a speech by David Einhorn, which was reported briefly by PrefBlog on April 18:

From the oh-hell-I’ve-run-out-of-time-here’s-some-links Department comes a speech by David Einhorn of GreenLight Capital, referenced by another blog. Einhorn is always thoughtful and entertaining, although it must be remembered that at all times he is talking his book. The problem with the current speech is that there is not enough detail – for instance, he equates Carlyle’s leverage of 30:1 which was based on GSE paper held naked with brokerages leverage, which is (er, I meant to say “should be”, of course!) hedged – to a greater or lesser degree, depending upon the institution’s committment to moderately sane risk management. But there are some interesting nuggets in the speech that offer food for thought.

Mr. DeCloet first takes care to establish his credentials as a hard nosed analyst, getting straight to the facts of any matter placed before him:

The markets’ most powerful brand is a letter (well, three letters): “AAA.” Or at least it was, until the rating agencies – Standard & Poor’s, Moody’s and others – debased it by handing it out the way parade clowns throw bonbons at little children.

Denigrating the ratings agencies is very fashionable!

Mr. DeCloet does not specify the nature of the debasement, nor does he show how he, or anybody else, did better without the benefit of hindsight. Track records are considered somewhat old-fashioned, these days, and three-hundred pound slobs at baseball parks denigrating the athletes between hot dog bites are considered the epitome of judicious analysts.

For those who are interested, I will reprint some material from the BoE Financial Stability Report, showing expected losses by sub-prime tranche:

Chart A also shows how the projected losses affect securities of different seniority. The more junior securities, with lower credit ratings, bear the first losses. But losses are projected to rise to levels that would eventually affect AA-rated securities. AAA-rated securities do not incur losses in this projection. But there is sufficient uncertainty that even these top-rated securities could conceivably bear some losses. For example, if all seriously delinquent mortgages defaulted after a year and the LGD rate was 55%, projected credit losses would reach US$193 billion, or 23% of outstanding principal. This loss rate would be high enough to affect some AAA-rated sub-prime mortgage-backed securities.

Good heavens, here we are in the middle of a financial cataclysm, and the BoE says “some AAA-rated sub-prime mortgage-backed securities” at the center of it could conceivably be affected.

Gee, Mr. DeCloet, can you get me some of those bonbons? They look pretty good to me!

He then arrives at his main point:

So the rating agencies’ role is a serious one, far more important than that of, say, equity analysts. If Citigroup’s crack research department says Royal Bank is about to be hit with $5-billion in losses, investors can choose to sell, ignore it or just laugh. But beyond that, it doesn’t really affect real-life business decisions. But if S&P were to say the same thing – watch out. The difference is the insider status.

I take issue with that last statement. I assert that there are two differences with an impact that exceeds insider status: reputation and regulation.

Reputation comes from the lengthy track record of the major agencies. They make available their transition analyses which show that – for all their errors and occasional spectacular folly – their advice is pretty good. Much better than most of their detractors, at any rate! Problems occur when investors place blind confidence in the ratings (everything should be checked), misuse the ratings (they are advice on credit. They are not advice on market prices or liquidity or tomorrow’s headline. What’s more, they are credit opinions, not credit facts) or, simply, do not diversify enough (if taking a small position in something is good, taking a large position is not necessarily better).

The problems with regulation is due to the extraordinary confidence placed in the credit ratings agencies – and in the ability of the marketplace to value credit in a sober and analytical manner – by the regulators. Basel I placed far too high confidence in the credit ratings of a bank’s holdings as a measure of its risk, and some regulators did not impose an assets to capital multiple cap on the banks under their supervision as a safety check. Among other things, this meant that there was an entire marketplace for AAA tranches with all the buyers buying the same thing for the same reasons … and that engendered a huge amount of “cliff risk”, sometimes referred to as “crowded trades” (as indicated by BoC Governor Carney in March).

The agencies, on the other hand, have just been trucking along, making their quota of mistakes and dispensing their advice, as they have done for the past 100-odd years.

For all that I disagree with his arguments, I agree with Mr. DeCloet’s conclusion: National Policy 51-201 (and Regulation FD) should be revised, to eliminate the insider advantage held by CRAs that freely distribute the fruits of their labours. The current (April) edition of Advisor’s Edge Report has an article by me on this very subject … the article is currently embargoed for republishing purposes, but will be made available on PrefBlog in the near future.

Update, 2008-5-21: For the article, see Opinion: Credit Ratings – Investors in a Bind.

Market Action

May 12, 2008

Pundits are saying the money market shows the worst is over for credit:

The worst of the credit crisis that prompted banks to restrict lending and the Federal Reserve to rescue Bear Stearns Cos. may be over, short-term borrowing rates show.

The difference between the yield on three-month Treasury bills and the rate on dollar-denominated loans in London, an indication of credit risk known as the TED spread, narrowed 7 basis points to 0.93 basis points, the smallest since Feb. 25. The gap reached 2 percentage points on March 19.

… but the visible effects may be just getting under weigh:

As the Fed’s latest loan survey makes clear, lenders have dropped the guillotine. With the usual delay, the poison is spreading from banks to the real world.

Diane Vazza, S&P’s credit chief, says defaults are rising at almost twice the rate of past downturns. “Companies are heading into this recession with a much more toxic mix. Their margin for error is razor-thin,” she said.

Two-thirds have a “speculative” rating, compared to 50pc before the dotcom bust, and 40pc in the early 1990s. The culprit is debt. “They ramped it up in the last 18 months of the credit boom. A lot of deals were funded that should not have been funded,” she said.

Some 174 US companies are trading at “distress levels”. Spreads on their bonds have rocketed above 1,000 basis points. This does not cover the carnage among smaller firms outside the rating universe.

Meanwhile, some research is being done into the Equity premium in Victorian England:

The stock market experienced negative total returns in only four years between 1825 and 1870. Three of these years (1825, 1826 and 1847) had financial crashes after a period of promotional mania on the stock market. The negative returns in 1853 can be attributed to concerns over the impending Crimean war.
Despite the serious financial crisis of 1866 following the collapse of several banks, the market produced positive total returns in that year.

Those were the good old days, eh? The 1866 crisis was the collapse of Overend-Gurney, which I promised to discuss on March 31, but is still … er … pending.

I have updated the post on the BoE Financial Stability Report to acknowledge Willem Buiter’s objections to the BoE methodology in forecasting ultimate sub-prime losses.

MBIA, whose delays in transferring $1.1-billion from the parent to the insurance subsidiary was reported on May 7 has (as passed on by Naked Capitalism) finally made a move:

MBIA Inc., the ailing bond insurer, rose in New York Stock Exchange trading after saying it will pump $900 million into its insurance unit and reporting a first-quarter loss that was narrower than some analysts’ estimates.

Those who have been taking the Clear Channel takeover as a template for the unfolding of the BCE / Teachers’ deal will no doubt be highly interested in rumours of funding at a reduced price:

Clear Channel Communications Inc. surged as much as 18 percent on reports of settlement talks with six banks on a proposal to finance the radio broadcaster’s acquisition by two buyout firms at a reduced price.

Citigroup Inc. and five other banks may fund the buyout for $36 a share as part of a settlement of lawsuits pending in New York and Texas state courts, the Wall Street Journal reported, without saying where it got the information. That’s below the $39.20 price buyout firms agreed to pay last year and more than an intraday high of $35.30 in New York Stock Exchange trading.

Yet another day with a mysterious discontinuity in the TXPR index:

The jump was probably partly due to BAM.PR.K, which traded 300 shares at $19.40 at 9:30am, then 100 shares at $20.32 at 2:37pm. Ain’t it wonderful! Closing quotation was 19.58-20.49, 1×5. This issue comprises 1.46% of CPD (which can be assumed to be a reasonable proxy for the index, so this 4.74% jump in trading price translates to 6.9bp on the index, or about one-seventh of the total jump. Analysis of the other elements of the discontinuity is left as an exercise for the student.

All in all, though, it was a quiet day.

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
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.94% 4.97% 43,845 15.61 1 -0.7997% 1,083.2
Fixed-Floater 4.68% 4.69% 61,190 15.95 7 +0.7567% 1,066.6
Floater 4.18% 4.22% 61,441 16.93 2 +1.5967% 902.9
Op. Retract 4.83% 3.15% 87,702 2.60 15 +0.0831% 1,054.5
Split-Share 5.27% 5.55% 71,195 4.15 13 +0.0374% 1,050.9
Interest Bearing 6.13% 6.06% 54,004 3.82 3 0.0000% 1,105.9
Perpetual-Premium 5.89% 5.66% 141,742 6.42 9 -0.0253% 1,020.8
Perpetual-Discount 5.69% 5.74% 307,011 14.28 63 -0.0336% 919.3
Major Price Changes
Issue Index Change Notes
PWF.PR.E PerpetualDiscount -1.5422% Now with a pre-tax bid-YTW of 5.65% based on a bid of 24.26 and a limitMaturity.
RY.PR.F PerpetualDiscount -1.3951% Now with a pre-tax bid-YTW of 5.65% based on a bid of 19.78 and a limitMaturity.
CIU.PR.A PerpetualDiscount -1.1707% Now with a pre-tax bid-YTW of 5.69% based on a bid of 20.26 and a limitMaturity.
FFN.PR.A SplitShare +1.1964% Asset coverage of 2.0+:1 as of April 30, according to the company. Now with a pre-tax bid-YTW of 5.04% based on a bid of 10.15 and a hardMaturity 2014-12-1 at 10.00.
FAL.PR.B FixFloat +1.2170%  
BMO.PR.H PerpetualDiscount +1.9450% Now with a pre-tax bid-YTW of 5.45% based on a bid of 24.11 and a limitMaturity.
BAM.PR.K Floater +2.7822%  
BCE.PR.G FixFloat +3.2120%  
Volume Highlights
Issue Index Volume Notes
NTL.PR.G Scraps (Would be Ratchet, but there are credit concerns) 110,736  
IGM.PR.A OpRet 52,532 CIBC crossed 50,000 at 26.95. Now with a pre-tax bid-YTW of 3.32% based on a bid of 26.85 and a call 2009-7-30 at 26.00.
RY.PR.K OpRet 50,345 Now with a pre-tax bid-YTW of 1.03% based on a bid of 25.04 and a call 2008-6-11 at 25.00.
PWF.PR.D OpRet 45,100 CIBC crossed 45,100 at 26.00 in the only trade of the day. Now with a pre-tax bid-YTW of 4.29% based on a bid of 25.95 and a call 2008-11-30 at 25.80.
CM.PR.A OpRet 26,170 Nesbitt bought 12,500 from RBC at 25.95. Now with a pre-tax bid-YTW of -2.18% based on a bid of 25.96 and a call 2008-6-11 at 25.75.
TD.PR.P PerpetualDiscount 25,693 Desjardins was buyer on the last ten trades, totalling 20,850, starting at 24.18, going as high as 24.50, ending with 24.30 (odd lot). Now with a pre-tax bid-YTW of 5.52% based on a bid of 23.94 and a limitMaturity.

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

PrefLetter

May, 2008, Edition of PrefLetter Released!

The May, 2008, edition of PrefLetter has been released and is now available for purchase as the “Previous edition”.

Until further notice, the “Previous Edition” will refer to the May, 2008, issue, while the “Next Edition” will be the June, 2008, issue, scheduled to be prepared as of the close June 13 and eMailed to subscribers prior to market-opening on June 16.

PrefLetter is intended for long term investors seeking issues to buy-and-hold. At least one recommendation from each of the major preferred share sectors is included and discussed.

Note: PrefLetter, being delivered to clients as a large attachment by eMail, sometimes runs afoul of spam filters. If you have not received your copy within fifteen minutes of a release notice such as this one, please double check your (company’s) spam filtering policy and your spam repository. If it’s not there, contact me and I’ll get you your copy … somehow!

Issue Comments

RY.PR.H : Stealth Greenshoe

RY.PR.H, which closed on April 29, appears to have had some of its underwriters’ greenshoe exercised.

According to the prospectus:

The underwriters have been granted an option (the “Option”) to purchase up to an additional 2,000,000 Series AH Preferred Shares (the “Option Shares”) at the offering price exercisable at any time up to 48 hours prior to closing of the offering. This prospectus qualifies both the grant of the Option and the distribution of the Option Shares that will be issued if the Option is exercised. If the underwriters purchase all such Option Shares, the price to the public, the underwriters’ fee and net proceeds to the Bank will be $250,000,0000, $7,500,000 and $242,500,000, respectively, assuming no Series AH Preferred Shares are sold to the institutions referred to in Note (2) below. See “Plan of Distribution”.

According to the TSX, there are now 8.5-million shares outstanding, which implies that 500,000 shares were taken up on a greenshoe.

I am unable to find any issuer disclosure of this, either on the RBC Press Release page or on SEDAR.

Market Action

May 9, 2008

Absolutely nothing happened today, so there’s no commentary.

I was, however, able to devote some thought to the issue of naming rights to TTC stations. It’s a great idea! Just think of the money the TTC could make from station names like:

  • Old Mill-waukee
  • Dundas Westjet
  • The Elephant and Castle Frank
  • Victoria’s Secret Park
  • Viagra Makes Your Coxwell

Why, they might even be able to afford a new bucket at Osgoode Station, to replace the old one they’re currently using to catch the drips from the ceiling when it rains.

Oh, and there’s more news on the Jim Kelsoe story.

But that’s it.

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
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.96% 4.96% 43,347 15.60 1 0.0000% 1,092.0
Fixed-Floater 4.71% 4.75% 61,902 15.88 7 +0.1128% 1,058.6
Floater 4.25% 4.29% 62,001 16.81 2 +2.0765% 888.7
Op. Retract 4.83% 3.21% 86,236 2.75 15 +0.0625% 1,053.6
Split-Share 5.28% 5.55% 72,306 4.16 13 -0.2449% 1,050.5
Interest Bearing 6.13% 6.04% 55,305 3.83 3 -0.2664% 1,105.9
Perpetual-Premium 5.89% 5.43% 145,778 3.80 9 +0.0223% 1,021.1
Perpetual-Discount 5.69% 5.73% 312,887 14.29 63 -0.0698% 919.6
Major Price Changes
Issue Index Change Notes
CIU.PR.A PerpetualDiscount -2.1480% Now with a pre-tax bid-YTW of 5.62% based on a bid of 20.50 and a limitMaturity.
LFE.PR.A SplitShare -1.7143% Asset coverage of just under 2.5:1 as of April 30, according to the company. Now with a pre-tax bid-YTW of 4.51% based on a bid of 10.32 and a hardMaturity 2012-12-1 at 10.00.
FFN.PR.A SplitShare -1.6667% Asset coverage of 2.0+:1 as of April 30 according to the company. Now with a pre-tax bid-YTW of 5.25% based on a bid of 10.03 and a hardMaturity 2014-12-1 at 10.00.
HSB.PR.D PerpetualDiscount -1.1717% Now with a pre-tax bid-YTW of 5.78% based on a bid of 21.93 and a limitMaturity.
BMO.PR.H PerpetualDiscount +1.5287% Now with a pre-tax bid-YTW of 5.49% based on a bid of 23.91 and a limitMaturity.
TCA.PR.Y PerpetualDiscount -1.1270% Now with a pre-tax bid-YTW of 5.78% based on a bid of 48.25 and a limitMaturity.
BMO.PR.H PerpetualDiscount -1.0874% Now with a pre-tax bid-YTW of 5.56% based on a bid of 23.65 and a limitMaturity.
CM.PR.E PerpetualDiscount -1.0105% Now with a pre-tax bid-YTW of 6.00% based on a bid of 23.51 and a limitMaturity.
IAG.PR.A PerpetualDiscount +1.1788% Now with a pre-tax bid-YTW of 5.66% based on a bid of 20.60 and a limitMaturity.
BAM.PR.B Floater +4.1429%  
Volume Highlights
Issue Index Volume Notes
BNS.PR.K PerpetualDiscount 458,925 Now with a pre-tax bid-YTW of 5.53% based on a bid of 21.86 and a limitMaturity.
SLF.PR.B PerpetualDiscount 89,500 Now with a pre-tax bid-YTW of 5.60% based on a bid of 21.65 and a limitMaturity.
RY.PR.H PerpetualDiscount 69,640 Now with a pre-tax bid-YTW of 5.74% based on a bid of 24.77 and a limitMaturity.
BMO.PR.J PerpetualDiscount 58,090 Now with a pre-tax bid-YTW of 5.61% based on a bid of 20.12 and a limitMaturity.
BMO.PR.K PerpetualDiscount 32,800 Now with a pre-tax bid-YTW of 5.78% based on a bid of 22.76 and a limitMaturity.

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

PrefLetter

PrefLetter : May Edition Now in Preparation

The markets have closed and the May edition of PrefLetter is now being prepared.

PrefLetter is the monthly newsletter recommending individual issues of preferred shares to subscribers. There is at least one recommendation from every major type of preferred share; the recommendations are taylored for “buy-and-hold” investors.

The May issue will be eMailed to clients and available for single-issue purchase with immediate delivery prior to the opening bell on Monday. I will write another post on the weekend advising when the new issue has been uploaded to the server … so watch this space carefully if you intend to order “Next Issue” or “Previous Issue”!

Market Action

May 8, 2008

Chalk one up for the License Raj! India has halted futures trading of some commodities:

Communist allies of Prime Minister Manmohan Singh want to ban futures trading in cooking oil, sugar and other commodities, saying speculators are driving up prices. Still, the order comes a week after a government-appointed panel found no evidence a 2007 ban on wheat and rice futures curbed prices of the grains….

In hard times, there is extreme pressure on politicians to Do Something. So they do. Whether or not the actions are useful is a mere quibble. They’d be better off cutting the kerosene subsidy.

Jon Danielsson writes a piece in VoxEU attacking the concept of model-based regulation:

Most models used to assess the probability of small frequent events can also be used to forecast the probability of large infrequent events. However, such extrapolation is inappropriate. Not only are the models calibrated and tested with particular events in mind, but it is impossible to tailor model quality to large infrequent events nor to assess the quality of such forecasts.

Taken to the extreme, I have seen banks required to calculate the risk of annual losses once every thousand years, the so-called 99.9% annual losses. However, the fact that we can get such numbers does not mean the numbers mean anything. The problem is that we cannot backtest at such extreme frequencies.

A very sexy topic nowadays and, to be fair, he is familiar with the proper solution:

I think the primary lesson from the crisis is that the financial institutions that had a good handle on liquidity risk management came out best. It was management and internal processes that mattered – not model quality. Indeed, the problem created by the conduits cannot be solved by models, but the problem could have been prevented by better management and especially better regulations.

This ties in with the International Report on Risk Management Supervision. Unfortunately, he doesn’t really have any good ideas to offer for future use:

What is missing is for the supervisors and the central banks to understand the products being traded in the markets and have an idea of the magnitude, potential for systemic risk, and interactions between institutions and endogenous risk, coupled with a willingness to act when necessary. In this crisis the key problem lies with bank supervision and central banking, as well as the banks themselves.

Very nice, but just a tad lacking in specifics, wouldn’t you say?

You can’t regulate common sense. As I have said before, I think that the current credit crunch represents a triumph of the current regulatory regime: there has been pain, there have been a few failures, and there has most definitely been a pricking of the bubble … but the financial system has withstood the shocks, bloodied and in need of capital, but not in bankruptcy court with a crowd of depositors forming a lynch mob. The Basel Accords need adjustment, not elimination.

In another vein, Luigi Spaventa argues for a Brady Bond style bailout:

In CEPR Policy Insight 22, I recommend the creation of a publicly sponsored entity that could issue guaranteed bonds to banks in exchange for illiquid assets, drawing on US Treasury Secretary Nicholas Brady’s solution to the Latin American sovereign debt crisis in 1989. This new entity, preferably multilateral, would value assets based on discounted cash flows and default probabilities rather than crisis-condition market prices.

As a firm floor is set to valuation and illiquid assets otherwise running to waste are replaced by eminently liquid Brady-style bonds, funding difficulties and, at the same time, the market liquidity problems besetting the banks’ balance sheets would be removed. Shielding the banks’ assets from the vagaries of disorderly markets is a necessary condition to dispel the uncertainty that prevents a proper working of credit markets.

Nope. I don’t buy it. The amount of moral hazard engendered by such a scheme – not to mention investment risk taken by a publicly funded body – is not justified by the scale of the current problems. Dr. Spaventa’s arguments that current procedures are inadequate:

For funding liquidity, emergency liquidity support from central banks has helped lower the temperature in the worst moments, but it is not a long-term solution. Setting a collateral value of illiquid securities does not provide a market for them and hence does not set a floor to their market prices; the collateralized securities remain on the intermediaries’ books, affecting the quality of their balance sheets. Capital increases are also insufficient to break the spiral, as injections of capital may prove inadequate only a few weeks after their announcement.

For market liquidity, suggested remedies are equally inadequate. Mandated full disclosure of losses might reduce uncertainty, but unless market liquidity is instantly restored, full disclosure of the situation at time t offers no guarantee that it will be the same at time t+1. Similarly, retreating from marking financial products to market or model during this time of crisis would face a number of difficulties.

are not impressive. On the capital-raising front, we have today AIG raising $12.5-billion, while there are rumours that CitiBank is going to sell assets.

What we have is a short term crisis brought about by the (over-) financing of long term assets with short term money … this is the root of just about every general financial crisis ever known. The only solution is the passage of time.

One problem with neo-Brady-Bonds is that there will be considerable difficulty regarding negotiation of price – that is probably what killed Super-SIV / MLEC. According to the Bank of England, announced write-downs now exceed expected credit losses. It’s bad enough for the banks to take a stiff haircut when lending the securities; they’re spinning off cash; as long as they can finance them, why should they negotiate a politically palatable horrible price?

Meanwhile, Accrued Interest reviews conflicting signals from the stocks, CDS & bond markets and concludes:

A better explanation is that the market is struggling to price a world where liquidity is improving but real economics are deteriorating. It felt to me like the market, especially stocks, had become a bit too optimistic in recent days, with some even talking like we won’t have any recession at all.

Don’t confuse economic data that’s “better than expected” with “good.” Now if you ask me where the stock and credit markets will be in a year, I’d say both will be better than today. Looking one year out, we’ll probably be through this recession, housing will have bottomed, and there will be much more earnings clarity. But in the near term, I think we need a little more of a recession concession.

A quiet day in the market. Prices drifted up, with spikes in the SplitShare and InterestBearing sectors, on little volume.

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
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.98% 5.00% 45,131 15.50 1 0.0000% 1,092.0
Fixed-Floater 4.72% 4.78% 62,464 15.84 7 -0.0673% 1,057.4
Floater 4.33% 4.37% 62,217 16.63 2 +0.1137% 870.6
Op. Retract 4.84% 3.42% 86,119 2.75 15 +0.0285% 1,053.0
Split-Share 5.26% 5.51% 73,104 4.17 13 +0.3050% 1,053.1
Interest Bearing 6.11% 5.98% 56,943 3.84 3 +0.6778% 1,108.9
Perpetual-Premium 5.89% 5.59% 147,365 6.40 9 +0.0352% 1,020.8
Perpetual-Discount 5.68% 5.73% 316,374 14.17 63 +0.0609% 920.2
Major Price Changes
Issue Index Change Notes
BCE.PR.G FixFloat -1.2739%  
W.PR.H PerpetualDiscount -1.2288% Now with a pre-tax bid-YTW of 5.92% based on a bid of 23.31 and a limitMaturity.
LFE.PR.A SplitShare +1.3514% Asset coverage of just under 2.5:1 as of April 30 according to the company. Now with a pre-tax bid-YTW of 4.07% based on a bid of 10.50 and a hardMaturity 2012-12-1 at 10.00.
BSD.PR.A InterestBearing +1.4583% Asset coverage of just over 1.7:1 as of May 2 according to Brookfield Funds. Now with a pre-tax bid-YTW of 6.69% (mostly as interest) based on a bid of 9.74 and a hardMaturity 2015-3-31 at 10.00.
BMO.PR.H PerpetualDiscount +1.5287% Now with a pre-tax bid-YTW of 5.49% based on a bid of 23.91 and a limitMaturity.
FFN.PR.A SplitShare +1.6949% Asset coverage of just over 2.0:1 as of April 30 according to the company. Now with a pre-tax bid-YTW of 4.94% based on a bid of 10.20 and a hardMaturity 2014-12-1 at 10.00.
BAM.PR.K Floater +1.9786%  
BAM.PR.G FixFloat +2.4775%  
Volume Highlights
Issue Index Volume Notes
CM.PR.J PerpetualDiscount 61,700 Now with a pre-tax bid-YTW of 5.71% based on a bid of 19.90 and a limitMaturity.
SLF.PR.B PerpetualDiscount 49,659 Now with a pre-tax bid-YTW of 5.61% based on a bid of 21.61 and a limitMaturity.
RY.PR.H PerpetualDiscount 28,850 Now with a pre-tax bid-YTW of 5.74% based on a bid of 24.76 and a limitMaturity.
BAM.PR.M PerpetualDiscount 28,050 Now with a pre-tax bid-YTW of 6.60% based on a bid of 18.27 and a limitMaturity.
RY.PR.B PerpetualDiscount 17,000 Now with a pre-tax bid-YTW of 5.60% based on a bid of 21.05 and a limitMaturity.

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