Regulatory Capital

Background on US TruPS

TruPS are Trust Preferred Securities, sold in the States. There’s an article on Bloomberg today with some interesting background. Note that TruPS pay interest since, if the Bush tax cuts are not extended, there is no preferential tax rate on dividends that offsets the tax on the profits paid by the issuer.

So-called community banks and larger lenders have sold trust-preferred securities, known as TruPS, for about a dozen years. Collateralized debt obligations became the biggest buyers, generating enough demand to expand the market 10-fold, according to Merrill Lynch & Co. index data. The CDOs packaged the shares and sliced them into pieces with varying credit ratings.

Community banks such as FirsTier were too small to attract insurance companies or mutual funds and sold the securities to CDOs instead, in issues of $10 million or $20 million at a time, according to Fitch Ratings analyst Nathan Flanders.

The market was upended after mortgage foreclosures reached a record high of 2.47 percent for all loans in the U.S., starting a credit-market meltdown that sent investors fleeing to safer government securities.

As the preferred market seized up, the Standard & Poor’s Small Cap Regional Banks Index has fallen 34 percent this year, leaving banks unable to sell common stock without diluting existing shareholders. Cut off from fresh capital, some lenders may file for bankruptcy, according to ICBA’s Cole.
…
Trust-preferred shares were attractive to banks because dividends are paid out of pre-tax income and may be suspended without penalty. The stock is considered Tier 1 capital, a lender’s most basic layer.
…
Only 10 banks out of about 2,000 issuers halted dividends in the seven years ending in September, and all but two resumed distribution, according to Flanders.

Since September, 23 banks, including Pasadena, California- based IndyMac Bancorp Inc. and Omni Financial Services Inc. of Atlanta, stopped making preferred-stock dividend payments. IndyMac has fallen 89 percent and Omni 81 percent this year.
…
About $46 billion of trust-preferred CDOs were sold since 2000, Flanders said. None has been created since November. [Fitch Ratings analyst Nathan] Flanders said May 21 that he may downgrade parts of 59 CDOs because so many banks had defaulted or deferred dividends.

Moody’s Investors Service said today that it will review all CDOs backed by bank trust-preferred securities, according to a report by analysts John Park and James Brennan.

There is a specialty US-based ETF based on TruPS, PGF trading on AMEX. As of March 31, it was down 11.54% for the prior year, vs. -11.48% for the S&P Preferred Index and -8.42% for the propietary Wachovia index it reflects.

Update: According to FRB Atlanta:

The Federal Reserve Board has amended its capital guidelines to allow bank holding companies (BHCs) to continue including trust preferred securities—commonly known as TRUPS—in their core,1 or tier 1, capital although in lesser amounts than previously permitted. By 2009, most BHCs will have to limit restricted core capital elements,2 which include TRUPS, to 25 percent of the sum of their core capital, and very large or internationally active BHCs will have to limit restricted elements to 15 percent of core capital.
…
TRUPS are created when a special purpose entity, which is controlled by a bank holding company, issues preferred stock. Then the controlling BHC issues debt, which the special purpose entity purchases. Interest payments on that debt provide cash flows for paying preferred stock dividends.

Thus, it is structurally equivalent to Loan-Based Innovative Tier 1 Capital.

Issue Comments

GBA.PR.A Downgraded to Pfd-5 by DBRS

DBRS has announced that it:

has today downgraded the Preferred Shares issued by GlobalBanc Advantaged 8 Split Corp. (the Company) to Pfd-5, with a Stable trend, from Pfd-4 (high).

In June 2007, the Company raised gross proceeds of $54 million by issuing 2.7 million Preferred Shares (at $10 each) and an equal amount of Class A Shares (at $10 each), to provide downside protection of approximately 47% to the Preferred Shares (after issuance costs).

The net proceeds from the initial offering were used to purchase a portfolio of Canadian securities that were pledged to the National Bank of Canada (the Counterparty) to enter a forward agreement (the Forward Agreement) in order to gain exposure to a portfolio of common shares (the Bank Portfolio) issued by eight of the world’s largest banks, Citigroup Inc., Bank of America Corp. (DE), Royal Bank of Scotland Group plc, UBS AG, Banco Santander Central Hispano S.A., BNP Paribas, Société Générale Group and Deutsche Bank AG.

Holders of the Preferred Shares receive fixed cumulative quarterly distributions equal to 4.5% per annum. The Company provides Class A Shareholders with distributions of capital gains when declared by the Board of Directors. Since inception, the Capital Shareholders have received a total of $0.0485 per share, a return of less than 0.5% of the initial share price.

Based on the most recent dividends paid by its underlying companies, the Bank Portfolio can generate enough yield to pay the fixed preferred distributions and other annual expenses. However, changes in dividend policy by any of the banks included in the Bank Portfolio could cause a potential grind on the net asset value (NAV).

Since inception, the NAV has dropped from about $19 to $9.70 (as of June 30, 2008), a decline of nearly 50%. Since the NAV is currently below the $10 principal value of the Preferred Shares, the holders of the Preferred Shares would experience a loss of 3% of their initial investment if the portfolio were to be liquidated and proceeds distributed. The decline in NAV can be attributed to the Bank Portfolio’s 100% concentration in the international banking industry, as well as its exposure to those banks that have experienced credit writedowns during the past year.

The downgrade of the Preferred Shares is primarily based on the lower level of asset coverage available to cover the Preferred Shares principal.

The redemption date for both classes of shares issued is December 15, 2012.

This follows a downgrade to Pfd-4(high) on April 17. Anybody feeling like swearing at the Credit Rating Agencies? It was rated Pfd-2 until January 17, 2008 … that’s fast, eh? Pfd-2 (reasonable investment grade) to Pfd-5 (deep junk) in less than six months. Even the sternest critics will agree, I’m sure that losing half your money in a year while invested in …

a portfolio of common shares (the Bank Portfolio) issued by eight of the world’s largest banks, Citigroup Inc., Bank of America Corp. (DE), Royal Bank of Scotland Group plc, UBS AG, Banco Santander Central Hispano S.A., BNP Paribas, Société Générale Group and Deutsche Bank AG

… is a tad unusual. If there is such a thing, I wonder how “GlobalBanc Disadvantaged 8 Split Corp.” is doing!

GBA.PR.A is not tracked by HIMIPref™.

Update: The company has stated:

Current Net Asset Value (“NAV”) per Unit is $9.70, comprised of $9.70 per Preferred Share and $0.00 per Class A Share. Since the NAV per Unit is currently below the $10 principal value of the Preferred Shares, the holders of the Preferred Shares would receive less than $10 if the portfolio were to be liquidated and proceeds distributed as at today’s date. Based on the most recent dividends paid by the underlying companies, the Bank Portfolio currently generates enough yield to pay the fixed cumulative quarterly preferred dividends in the amount of $0.1125 per Preferred Share and the expenses of the Company. However, future changes in dividend policy by any of the banks included in the Bank Portfolio, among other things, may require the Company to further reduce NAV per Unit in order to sustain the dividend on the Preferred Shares. The redemption price payable for each Preferred Share outstanding on December 15, 2012 (the final redemption date) is equal to the lesser of: (i) $10.00 plus accrued and unpaid distributions; and (ii) the NAV per Preferred Share on that date.

This press release is not yet available on the company’s website.

Issue Comments

CBW.PR.A Downgraded to Pfd-5[Trend Negative] by DBRS

DBRS has announced that it:

has today downgraded the Preferred Shares issued by Copernican World Banks Split Corp. (the Company) to Pfd-5, with a Negative trend, from Pfd-3 (low).

In November 2007, the Company raised gross proceeds of $96.1 million by issuing 4.805 million Preferred Shares (at $10 each) and an equal amount of Class A Shares (at $10 each). The initial structure provided downside protection of 50% to the Preferred Shares as all issuance costs were paid by AIC Investment Services Inc. (the Manager).

The net proceeds from the offering were used to invest in a portfolio of common shares (the Portfolio) issued by bank-based financial institutions with strong credit quality (World Banks). The Portfolio is actively managed by the Manager to invest in World Banks that have at least a US$1 billion market capitalization and exhibit the potential for attractive dividend yields and strong earnings growth momentum. It is expected that a minimum of 80% of all foreign content will be hedged back to Canadian dollars at all times to mitigate net asset value (NAV) volatility relating to foreign currency exchange fluctuation.

Holders of the Preferred Shares receive fixed cumulative quarterly dividends yielding 5.25% per annum. The Company aims to provide holders of the Class A Shares with monthly distributions targeted at 8.0% per annum.

There is an asset coverage test in place that does not permit the Company to make monthly distributions to the Class A Shares if the dividends on the Preferred Shares are in arrears or if the NAV of the Portfolio is less than $15.00 after giving effect to such distributions. Since the Company’s NAV has decreased below $15.00, distributions to the Class A Shares are currently suspended, which greatly reduces the grind on the Portfolio going forward. The Company is currently required to generate a return of approximately 3% from sources other than dividend income to maintain a stable NAV. The required return will vary based on fluctuations in the Portfolio’s NAV and changes in the dividend policies of the World Banks.

The credit quality of the Portfolio is strong and globally diversified, but the NAV of the Portfolio has experienced downward pressure due to its concentration in the financial industry. Since inception, the NAV has dropped from $20 to $10.39 (as of June 30, 2008), a decline of 48%. As a result, the current downside protection available to the Preferred Shareholders is approximately 4%.

The downgrade of the Preferred Shares is primarily based on the greatly reduced asset coverage available to cover repayment of the Preferred Shares principal. The Negative rating trend is due to the additional return required to avoid further deterioration in the Company NAV.

The redemption date for both classes of shares issued is December 2, 2013.

This follows a downgrade to Pfd-3(low) on April 17. CBW.PR.A is not tracked by HIMIPref™.

Issue Comments

CIR.PR.A Downgraded to Pfd-4(low)[Trend Negative] by DBRS

DBRS has announced that it:

has today downgraded the Preferred Shares issued by Copernican International Financial Split Corp. (the Company) to Pfd-4 (low), with a Negative trend, from Pfd-3.

In March and April of 2007, the Company raised gross proceeds of $158.4 million by issuing 7.92 million Preferred Shares (at $10 each) and an equal amount of Class A Shares (at $10 each). The initial structure provided downside protection of 50% to the Preferred Shares as all issuance costs were paid by AIC Investment Services Inc. (the Manager).

The net proceeds from the offering were used to invest in a portfolio of common shares (the Portfolio) issued by international financial institutions (IFS) with strong credit quality. The Portfolio is actively managed by the Manager to invest in IFS that have at least a US$1 billion market capitalization and exhibit the potential for attractive dividend yields and strong earnings growth momentum. It is expected that a minimum of 80% of all foreign content will be hedged back to Canadian dollars at all times to mitigate net asset value (NAV) volatility relating to foreign currency exchange fluctuation.

Holders of the Preferred Shares receive fixed cumulative quarterly dividends yielding 5.0% per annum. The Company aims to provide holders of the Class A Shares with monthly distributions targeted at 8.0% per annum.

There is an asset coverage test in place that does not permit the Company to make monthly distributions to the Class A Shares if the dividends on the Preferred Shares are in arrears or if the NAV of the Portfolio is less than $16.50 after giving effect to such distributions. Furthermore, the Company cannot make special distributions to the Class A Shares if the NAV drops to less than $20 unless the distribution is required to eliminate tax on net capital gains. Since the Company’s NAV has decreased below $16.50, distributions to the Class A Shares are currently suspended, which greatly reduces the grind on the Portfolio going forward. The Company is currently required to generate a return of approximately 2% from sources other than dividend income to maintain a stable NAV. The required return will vary based on fluctuations in the Portfolio’s NAV and changes in the dividend policies of the IFS.

The credit quality of the Portfolio is strong and globally diversified, but the NAV of the Portfolio has experienced downward pressure due to its concentration in the global financial industry. Since inception, the NAV has dropped from $20 to $11.20 (as of June 30, 2008), a decline of 44%. As a result, the current downside protection available to the Preferred Shareholders is approximately 11%.

The downgrade of the Preferred Shares is primarily based on the greatly reduced asset coverage available to cover repayment of the Preferred Shares principal. The Negative rating trend is due to the additional return required to avoid further deterioration in the Company NAV.

The redemption date for both classes of shares issued is December 2, 2013.

This follows a downgrade to Pfd-3 on April 17. CIR.PR.A is not tracked by HIMIPref™.

Issue Comments

Best and Worst Performers: June, 2008

I have been posting a lot lately about how horrible June has been for preferred shareholders – see, for example, Party Like it’s 1999!, New Trough for Preferreds? and Market Timing?. And I will be posting more! Without wishing to rub salt into the wounds of other preferred share investors, this month has been very interesting from an academic perspective … but for now, the table of best and worst performers in June is a sufficient tale of woe.

These are total returns, with dividends presumed to have been reinvested at the bid price on the ex-date. The list has been restricted to issues in the HIMIPref™ indices.

Issue Index DBRS Rating Monthly Performance Notes (“Now” means “June 30”)
BNA.PR.C SplitShare Pfd-2(low) -13.35% Asset coverage of just under 3.6:1 as of May 30, according to the company. Now with a pre-tax bid-YTW of 8.48% based on a bid of 18.05 and a hardMaturity 2019-1-10 at 25.00. Compare with BNA.PR.A (6.00% to 2010-9-30) and BNA.PR.B (8.63% to 2016-3-25).
GWO.PR.H PerpetualDiscount Pfd-1(low) -12.18% Now with a pre-tax bid-YTW of 6.18% based on a bid of 19.76 and a limitMaturity.
GWO.PR.I PerpetualDiscount Pfd-1(low) -10.51% Now with a pre-tax bid-YTW of 6.02% based on a bid of 18.82 and a limitMaturity. This was a top performer in May, so at least part of this drop is simply reversion.
CM.PR.J PerpetualDiscount Pfd-1 -9.95% Now with a pre-tax bid-YTW of 6.43% based on a bid of 17.52 and a limitMaturity.
BNA.PR.B SplitShare Pfd-2(low) -9.24% See BNA.PR.C, above. This was a top performer in May, so at least part of this drop is simply reversion.
… … … … …
BCE.PR.G FixFloat Pfd-2(low) [Review – Negative] +0.96%  
FIG.PR.A InterestBearing Pfd-2 +1.66% Asset coverage of just under 2.5:1 as of June 27, according to Faircourt. Now with a pre-tax bid-YTW of -1.05% based on a bid of 10.06 and a call 2008-7-30 at 10.00.
DFN.PR.A SplitShare Pfd-2 +1.80% Asset coverage of 2.4+:1 as of June 13 according to the company. Now with a pre-tax bid-YTW of 4.65% based on a bid of 10.34 and a hardMaturity 2014-12-1 at 10.00.
FAL.PR.H PerpetualPremium Pfd-2(low) +1.81% Called for Redemption in May.
BCE.PR.I FixFloat Pfd-2(low)
[Review – Negative]		 +2.53% This was a bottom performer in May, so at least part of this drop is simply reversion.
Market Action

June 30, 2008

BCE announced after the markets closed that it would skip its common dividend for the second quarter, following reports the bank/purchaser negotiations are “grinding” and deal might not close – if, in fact, it does close – until December. The ClearChannel story, by the way, continues:

Citigroup Inc. and Deutsche Bank AG are leading banks offering the debt to investors in the mid-80 cent range, down from 90 cents to 91 cents last week, said the people, who declined to be identified before the loans are sold.

The price cut reflects a decline in average actively traded loans. Prices fell to 89.9 cents on the dollar from 92.1 on June 19, the first time it dipped below 90 cents since April, according to data compiled by Standard & Poor’s LCD. The discounting indicates that a rally in loan prices in April and May has ended.

Another horrible day to end a horrible month. CPD is down about 4.26% on the month; MAPF is down between 6.25% and 6.50% – I will have precise figures tomorrow.

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 4.25% 3.86% 47,247 0.08 1 -0.0786% 1,118.4
Fixed-Floater 4.89% 4.64% 60,867 16.05 7 -1.3351% 1,029.1
Floater 4.24% 4.24% 70,790 16.91 2 -0.7533% 903.8
Op. Retract 4.88% 2.93% 202,484 2.80 16 -0.1206% 1,052.9
Split-Share 5.39% 6.04% 65,282 4.11 15 -0.0894% 1,036.4
Interest Bearing 6.13% 3.53% 46,393 2.00 3 -0.1656% 1,122.7
Perpetual-Premium 5.94% 4.70% 319,249 11.09 13 -0.1721% 1,011.4
Perpetual-Discount 6.02% 6.07% 218,423 13.82 59 -0.3707% 877.2
Major Price Changes
Issue Index Change Notes
BNA.PR.C SplitShare -4.7425% On zero volume, as the bids just disappeared and it closed at 18.05-00, 7×5 (great market making!). Asset coverage of just under 3.6:1 as of May 30 according to the company. Now with a pre-tax bid-YTW of 8.48% based on a bid of 18.05 and a hardMaturity 2019-1-10 at 25.00. Compare with BNA.PR.A (6.00% to 2010-9-30) and BNA.PR.B (8.63% to 2016-3-25).
BCE.PR.C FixFloat -4.4613%  
NA.PR.K PerpetualDiscount -3.3319% Now with a pre-tax bid-YTW of 6.40% based on a bid of 23.21 and a limitMaturity.
BCE.PR.A FixFloat -3.0833%  
WFS.PR.A SplitShare -2.9819% Asset coverage of just under 1.7:1 as of June 19, according to Mulvihill. Now with a pre-tax bid-YTW of 8.75% based on a bid of 9.11 and a hardMaturity 2011-6-30 at 10.00.
BCE.PR.R FixFloat -2.0851%  
BCE.PR.G FixFloat -2.0888%  
CM.PR.P PerpetualDiscount -1.8936% Now with a pre-tax bid-YTW of 6.32% based on a bid of 21.76 and a limitMaturity.
BAM.PR.K Floater -1.5377%  
GWO.PR.H PerpetualDiscount -1.4464% Now with a pre-tax bid-YTW of 6.18% based on a bid of 19.76 and a limitMaturity.
ELF.PR.G PerpetualDiscount -1.4428% Now with a pre-tax bid-YTW of 6.72% based on a bid of 17.76 and a limitMaturity.
HSB.PR.C PerpetualDiscount -1.3744% Now with a pre-tax bid-YTW of 6.17% based on a bid of 20.81 and a limitMaturity.
CM.PR.E PerpetualDiscount -1.3010% Now with a pre-tax bid-YTW of 6.15% based on a bid of 22.76 and a limitMaturity.
HSB.PR.D PerpetualDiscount -1.2255% Now with a pre-tax bid-YTW of 6.25% based on a bid of 20.15 and a limitMaturity.
PWF.PR.K PerpetualDiscount -1.2136% Now with a pre-tax bid-YTW of 6.20% based on a bid of 20.35 and a limitMaturity.
PWF.PR.L PerpetualDiscount -1.0849% Now with a pre-tax bid-YTW of 6.20% based on a bid of 20.97 and a limitMaturity.
BAM.PR.O OpRet -1.0417% Now with a pre-tax bid-YTW of 6.24% based on a bid of 23.75 and optionCertainty 2013-6-30. Compare with BAM.PR.H (5.06% to 2012-3-30), BAM.PR.I (5.47% to 2013-12-30) and BAM.PR.J (5.92% to 2018-3-30).
BCE.PR.G FixFloat +1.1111%  
RY.PR.F PerpetualDiscount +1.1206% Now with a pre-tax bid-YTW of 5.96% based on a bid of 18.95 and a limitMaturity.
SBN.PR.A SplitShare +1.6162% Asset coverage of 2.2+:1 as of June 19, according to Mulvihill. Now with a pre-tax bid-YTW of 5.19% based on a bid of 10.06 and a hardMaturity 2014-12-1 at 10.00.
Volume Highlights
Issue Index Volume Notes
TD.PR.P PerpetualDiscount 105,399 Nesbitt sold 64,000 to National Bank in two tranches at 23.05, then another 37,900 to “anonymous” in another two tranches at the same price. Now with a pre-tax bid-YTW of 5.80% based on a bid of 23.01 and a limitMaturity.
TD.PR.Q PerpetualDiscount 55,505 Nesbitt crossed 50,000 at 24.80. Now with a pre-tax bid-YTW of 5.74% based on a bid of 24.80 and a limitMaturity.
BMO.PR.J PerpetualDiscount 37,000 CIBC crossed 30,000 at 19.26. Now with a pre-tax bid-YTW of 5.93% based on a bid of 19.25 and a limitMaturity.
SLF.PR.A PerpetualDiscount 20,600 Nesbitt crossed 17,000 at 20.10. Now with a pre-tax bid-YTW of 5.97% based on a bid of 20.05 and a limitMaturity.
NA.PR.K PerpetualDiscount 13,200 Now with a pre-tax bid-YTW of 6.40% based on a bid of 23.21 and a limitMaturity.

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

Regulation

de Verteuil Supports "A Collateral Proposal"

Today’s Globe and Mail contained an op-ed piece by Ian de Verteuil which is supportive, at least in principal, of the opinion piece I had published earlier this year A Collateral Proposal.

Mr. de Verteuil is a research analyst with BMO-CM (and also a Chemistry grad!); he writes:

Since banks and insurers are regulated as to their safety and soundness, a “Reputationally Supported” or RS product would clearly have more value than a product that isn’t. A great example of this product is a money market fund. Banks around the world have essentially already committed not to “break the buck” and many here in Canada have gone to extreme lengths not to price these funds below $10. Other products such as straight equity funds and various structured products probably wouldn’t carry the RS brand.

I’m not saying that banks couldn’t sell the riskier products (as that would limit customer choice), I am just saying that we try to more clearly brand the product so the degree of support by the seller is apparent. If the bank wants to sell no RS branded products, so be it.

We both have the objectives of forcing banks to recognize their de facto exposure to branded Money Market Funds as an element of their balance sheet risk. Mr. de Verteuil proposes formalizing the process with an explicit “Reputationally Supported” moniker that would be assigned by the banks; my proposal does not include such formality but states that, for instance, “RBC Canadian T-Bill Fund” is reputationally supported by RBC simply due to the fact that they put their name on it.

Well … it’s nice to see some support for the idea!

Update: Mr. de Verteuil was a participant in the January ’08 CBA Investor Event … which I haven’t linked before, but don’t want to lose!

Spreads to Bonds

The Swoon in June: Could it be Tax?

An old thread regarding preferreds has come to life on Financial Webring Forum, with one poster speculating that the Swoon In June is tax-driven – there are two tax changes scheduled to have an effect on preferreds in the next few years, Federal Bad and Ontario Good, netting out to a modest negative.

It is my feeling that the recent decline is driven more by portfolio window-dressing by retail stockbrokers more than any fundamental factor.

If fundamental factors were to blame – or even if they were fundamental factors mis-applied! – I would expect to see that the market would retain some degree of internal consistency.

This is not what’s happening. Deeply-discounted perpetuals are being hit harder than slightly-discounted perpetuals (the discount of market price relative to potential call price, that is) – I gave the example of the CM issues on June 26 and two RY issues more recently.

This has happened to the extent that deeply discounted perps yield more than slightly-discounted perps. This simply should not happen (see the links in the June 26 post) and, I will emphasize, is not due to any historic spread relations or anything like that … the causation is the other way round. Convexity is a pretty basic fixed-income analytical tool, with a negligible effect for normal bonds, but a huge factor in callables (or other type of embedded option).

You can, if you like, make an argument that convexity has zero value and that therefore any perpetual discount from a given issuer should trade at the same yield, regardless of its combination of price and dividend. I might laugh at your pathetic little arguments, but you can make them with some semblance of rationality. But it is not possible to argue that convexity has a negative value and that therefore a discounted perpetual with a relatively high coupon should trade at a lower yield than its lower-coupon, otherwise identical, sibling. There might possibly be other things going on that would lead to that effect – but it wouldn’t be a direct effect and I haven’t been able to come up with any actual evidence that such an effect is even remotely possible.

The fact that it has happened anyway has convinced me that it’s retail window-dressing. We are approaching quarter-end and stockbrokers do not want to remind their clients, yet again, that the new issue they bought at $25 is now trading at $20. So, of the two or three issues in the client’s portfolio, they sell the lowest priced one, regardless of yield.

It’s only a hypothesis and it’s completely untestable … but I have not been able to think of anything else!

The fact that the relative prices are out of whack – and not based on any kind of normal fixed-income analysis – causes me to be very suspicious of the fundamental underpinnings of the overall decline.

If we plug in the projected Ontario tax rate on dividends for 2012 of 26.7% and the projected rate on income of 46.41%, we arrive at an equivalency factor of (1-0.267)/(1-0.4641) = 1.37. This is marginally lower than current, but PerpetualDiscounts now yield 6.04%, while long corporates are about 6.1%. Even the lower equivalency factor results in a spread of about 215bp, well in excess of historical norms and very hard to justify in fundamental terms (although, it should be noted, you can always justify anything you like in fundamental terms).

When the market re-establishes some degree of internal consistency (as far as the pref market ever is internally consistent!) we can have a look and see what the spreads really are. Until then, the situation is too clouded by clear signs of panic to allow any conclusions to be drawn.

Issue Comments

RY.PR.F & RY.PR.W & the Swoon in June

Just doing a little playing around … and thinking of today’s market commentary … and I thought I’d post a few graphs regarding these two issues, taking data from the last approximate trough of November 30, 2007 until now.

“Disparity” is a proprietary HIMIPref™ measure of rich/cheap. It is not the same thing as valuation … but it is very influential in this calculation. It should be noted that in the above graphs, the disparity is calculated according to the pre-tax yield curve, which I never use for valuation purposes. So caveat lector … just enjoy the trends!

Update: See also previous post for RY.PR.F.

Market Action

June 27, 2008

A nasty piece on VoxEU today – How to prick local housing bubbles in a monetary union: regulation and countercyclical taxes. A very prescriptive, central-planning approach … for example:

Whenever ECB interest rates become inappropriately low for a member state, for example, aggressive reductions in tax breaks on housing should aim to reduce the stimulus coming from ECB policy. For example, mortgage interest relief could be conditional on the real rather than the nominal interest rate. At the same time, tax incentives that favour fixed- over flexible-rate mortgages might be called for, as well as changes to the property tax and capital gains tax regime so that they act automatically as countercyclical stabilisers. In some cases, additional temporary tax measures to contain an emerging bubble will be required.
…
All told, the three Divisions have examined the references to credit ratings in 44 of our rules and forms. The staff is recommending changes to 38 of them. Specifically, they are recommending the complete elimination of any reference to credit ratings in 11 rules and forms. They are recommending the substitution of a standard based on a more clearly stated regulatory purpose or other concept in 27 rules and forms. And they are recommending leaving the reference unchanged in 6 rules and forms.

Trouble is, bubbles are only apparent after the fact. And there is no evidence to suggest that, ultimately and in aggregate, the Wise Men have any better an idea of how to accomplish market-timing than anybody else. Canada, for example, can be thought of as resembling the EU to some extent, in that our different regions have very different economies – we periodically hear massive complaints about monetary policy, for instance, tightening when a particular region is already in the doldrums. Can you imagine the reaction to special taxes and mortgage regulation in response to, say, Calgary’s oil-fueled housing boom?

Christopher Cox of the SEC introduced some SEC rule changes regarding credit ratings on Wednesday:

The third part of this rulemaking, which we take up today, is focused on the way the Commission’s own rules refer to and rely upon credit ratings. For some time before the recent subprime crisis, we had been re-evaluating the basis for the SEC’s use of ratings as a surrogate for compliance with various regulatory conditions and requirements. The recent market turmoil, and the role that credit ratings played in it, has only further motivated our consideration of reform in this area.

To begin with, the SEC’s own rules don’t distinguish between ratings for corporate bonds and ratings for structured finance products. As a result, our own regulatory regime might be vulnerable to criticism on the same grounds as the ratings agencies’ use of common symbology: namely, that it doesn’t properly reflect the different risk characteristics of structured products, and the different kinds of information and ratings methodologies that go into ratings for structured products.

Second, several of our regulations implicitly assume that securities with high credit ratings are liquid and have lower price volatility.But since structured finance products can be very different from other rated instruments in these respects, there is good reason for us to examine the precise way that credit ratings are used in our rules as a surrogate for measurements of liquidity and volatility.

Third, several observers, including the Financial Stability Forum, have leveled the criticism that the official recognition of credit ratings for a variety of securities regulatory purposes may have played a role in encouraging investors’ over-reliance on ratings.

Eminently sensible stuff. It’s the Portfolio Manager’s job to evaluate risk.

In other encouraging news, the Fed has quorum:

Elizabeth Duke, a Virginia banker, was confirmed today by the Senate to a seat on the Federal Reserve Board of Governors, breaking a yearlong impasse between the Bush administration and Congress.
…
Duke, who has been a banker for more than 30 years, was the first woman to chair the American Bankers Association, the industry’s Washington trade group, since its founding in 1875. She served as chairman from 2004 to 2005 and was on its board of directors from 1999 to 2006.

Duke served on the Richmond Fed bank’s board from 1998 to 2000. “She made great contributions then, and I know she’ll make tremendous contributions to the system now,” said Jeffrey Lacker, the bank’s president, who was research director at the time.
…
Duke held at least $8.2 million in assets, including more than $5 million of stock in Wachovia, according to a financial- disclosure filing last year. Fed officials are required to divest themselves of bank shares.

Well … her shares in Wachovia are probably worth less now! Every little bit helps!

The Fed will report the value of its “Bear Stearns Portfolio” regularly, commencing July 3.

Fortis Bank is cutting its dividend to zero and raising funds with prefs:

The Belgian-Dutch financial services group was forced to take what it called “exceptional measures” by tough market conditions as well as its purchase of parts of its former Dutch rival ABN AMRO, sealed just as the credit crisis hit last year.

It said it would sell about 6 per cent more shares to institutions to raise €1.5-billion, plus up to €2-billion of non-dilutive preference shares. It will save €1.3-billion by not paying an interim 2008 dividend, sell €2-billion of non-core assets and sell and lease back real estate, and pay its full-year dividend in shares.

In the comments to June 26, Assiduous Reader prefhound professed himself insufficiently impressed by the +31bp spread between CM.PR.E & CM.PR.J to take a position.

So I’ll try again … the RY issues aren’t as good a sample, since most of them come with very, very similar coupons. But how about if we just look at the two yield extremes:…

Two RY Perpetuals
Issue Dividend Quote Pre-Tax
Bid-YTW
RY.PR.F 1.1125 18.74-98 6.02%
RY.PR.W 1.225 22.23-33 5.58%

Ha! +44bp when it should be negative! How about them apples, prefhound?

Another way to look at is that the difference in dividend is $0.1125 and the difference in bid price is $3.49 … payback time just over 31 years. Don’t show such investments to your accountant.

Now, whenever anybody wants to make an argument about, say, PWF being a significantly better/worse credit than SLF … go for it! Maybe I’ll learn something! And we can certainly discuss at length just how much yield premium is required to hold a preferred with a limited upside (aka negative convexity). Hey, make a case that it should be zero! I’ll listen! But if anybody were to tell me that the yield premium really should be significantly negative, as it was with the CM issues today and as it is with these two RYs … it will probably be a short conversation! The only things I can think of – given that the issuer is the same – are:

  • A big difference in term to call
  • A big difference in liquidity
  • A big difference in other terms of the issue (e.g., voting rights, restrictive covenants, etc.)

None of these differences are applicable with the CM & RY issues I’ve highlighted. This is a very, very strange market.

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 4.24% 2.89% 49,180 0.08 1 +0.0787% 1,119.3
Fixed-Floater 4.82% 4.56% 62,074 16.18 7 -0.2844% 1,043.1
Floater 4.21% 4.21% 71,591 16.99 2 -2.7508% 910.6
Op. Retract 4.88% 2.55% 209,872 2.85 16 +0.2272% 1,054.2
Split-Share 5.39% 6.07% 66,395 4.13 15 -0.7824% 1,037.4
Interest Bearing 6.12% 3.78% 46,436 2.02 3 +0.3042% 1,124.6
Perpetual-Premium 5.93% 4.63% 327,440 11.11 13 -0.0566% 1,013.1
Perpetual-Discount 6.00% 6.04% 221,146 13.86 59 -0.1233% 880.5
Major Price Changes
Issue Index Change Notes
HPF.PR.A SplitShare (for now!) -5.2021% Strange issue often discussed.
BAM.PR.K Floater -3.5114%  
BNA.PR.C SplitShare -2.7124% Asset coverage of just under 3.6:1 as of May 30 according to the company. Now with a pre-tax bid-YTW of 7.80% based on a bid of 19.01 and a hardMaturity 2019-1-10 at 25.00.
POW.PR.D PerpetualDiscount -2.5145% Now with a pre-tax bid-YTW of 6.23% based on a bid of 20.16 and a limitMaturity.
CU.PR.B PerpetualPremium (for now!) -2.3320% Now with a pre-tax bid-YTW of 6.13% based on a bid of 24.71 and a limitMaturity.
BCE.PR.G FixFloat -2.0888%  
BAM.PR.B Floater -2.0088%  
BMO.PR.H PerpetualDiscount -1.7818% Now with a pre-tax bid-YTW of 5.91% based on a bid of 22.60 and a limitMaturity.
HSB.PR.D PerpetualDiscount -1.6867% Now with a pre-tax bid-YTW of 6.17% based on a bid of 20.40 and a limitMaturity.
SBC.PR.A SplitShare -1.6782% Now with a pre-tax bid-YTW of 5.31% based on a bid of 9.96 and a hardMaturity 2012-11-30 at 10.00.
PWF.PR.E PerpetualDiscount -1.5551% Now with a pre-tax bid-YTW of 6.12% based on a bid of 22.79 and a limitMaturity.
BAM.PR.M PerpetualDiscount -1.4218% Now with a pre-tax bid-YTW of 7.19% based on a bid of 16.64 and a limitMaturity.
HSB.PR.C PerpetualDiscount -1.2172% Now with a pre-tax bid-YTW of 6.08% based on a bid of 21.10 and a limitMaturity.
PWF.PR.K PerpetualDiscount -1.2136% Now with a pre-tax bid-YTW of 6.20% based on a bid of 20.35 and a limitMaturity.
CIU.PR.A PerpetualDiscount +1.2658% Now with a pre-tax bid-YTW of 5.82% based on a bid of 20.00 and a limitMaturity.
MFC.PR.C PerpetualDiscount +1.4418% Now with a pre-tax bid-YTW of 5.76% based on a bid of 19.70 and a limitMaturity.
IAG.PR.A PerpetualDiscount +1.5504% Now with a pre-tax bid-YTW of 5.89% based on a bid of 19.65 and a limitMaturity.
ELF.PR.G PerpetualDiscount +1.7039% Now with a pre-tax bid-YTW of 6.62% based on a bid of 18.02 and a limitMaturity.
BAM.PR.J OpRet +1.8402% Now with a pre-tax bid-YTW of 5.78% based on a bid of 24.35 and a softMaturity 2018-3-30 at 25.00.
Volume Highlights
Issue Index Volume Notes
MFC.PR.B PerpetualDiscount 182,245 RBC crossed 175,000 in three tranches at 20.25. Now with a pre-tax bid-YTW of 5.83% based on a bid of 20.12 and a limitMaturity.
MFC.PR.C PerpetualDiscount 132,381 RBC crossed 50,000 at 19.75, then 75,000 at 19.65. Now with a pre-tax bid-YTW of 5.76% based on a bid of 19.70 and a limitMaturity.
TD.PR.P PerpetualDiscount 80,027 Anonymous bought 43,900 from Nesbitt at 23.02, then (another?) anonymous bought 10,000 at 23.05 from Nesbitt. Now with a pre-tax bid-YTW of 5.80% based on a bid of 21.30 and a limitMaturity.
PWF.PR.K PerpetualDiscount 62,800 RBC crossed 50,000 at 20.70. Now with a pre-tax bid-YTW of 6.20% based on a bid of 20.35 and a limitMaturity.
TD.PR.O PerpetualDiscount 45,700 CIBC crossed 40,000 at 21.30. Now with a pre-tax bid-YTW of 5.80% based on a bid of 21.30 and a limitMaturity.
CL.PR.B PerpetualPremium 40,428 CIBC crossed 38,000 at 25.45. Now with a pre-tax bid-YTW of 5.52% based on a bid of 25.45 and a call 2011-1-30 at 25.00.
TD.PR.R PerpetualPremium 27,500 Scotia crossed 20,000 at 25.00. Now with a pre-tax bid-YTW of 5.74% based on a bid of 25.00 and a limitMaturity.

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