PrefBlog

Towers Perrin has released its December 2010 Pension Finance Watch:

Strong equity returns dominated pension financial results in December, as the Towers Watson Pension Index moved up 3.5% to 70.7. The index was still down 1.3% for the full year, however, as positive equity returns were more than offset by the growth in liabilities resulting from falling interest rates.

They also released a report on Treasury Infl ation-Protected Securities (TIPS): A primer on infl ation-linked bonds and their relative value as an inflation hedge:

Inflation derivatives are another option when constructing an infl ation hedge. Recent academic research has shown that TIPS have historically been underpriced relative to a synthetic TIPS portfolio of nominal Treasuries and inflation swaps.** Beyond costs, these are also very complex markets with different risks and liquidity features than the cash/physical market. While there are some managers who are capable of handling such a mandate, because of cost, liquidity and counterparty risk, inflation derivatives are likely to be most suitable for clients
who have an explicit infl ation-linked liability they want to immunize in a highly customized manner.

** Why Does The Treasury Issue TIPS? The TIPS–Treasury Bond Puzzle, Matthias Fleckenstein, Francis A. Longstaff, Hanno Lustig September 2010

BIS has released its Core Principles for Effective Deposit Insurance Systems.

The Federal Crisis Inquiry Commission has released the Financial Crisis Inquiry Report. It’s all the Fed’s fault:

Yet there was pervasive permissiveness; little meaningful action was taken to quell the threats in a timely manner.

The prime example is the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not. The record of our examination is replete with evidence of other failures: financial institutions made, bought, and sold mortgage securities they never examined, did not care to examine, or knew to be defective; firms depended on tens of billions of dollars of borrowing that had to be renewed each and every night, secured by subprime mortgage securities; and major firms and investors blindly relied on credit rating agencies as their arbiters of risk. What else could one expect on a highway where there were neither speed limits nor neatly painted lines?

Jonathan Ratner of the Financial Post reports an interesting fact in Canadian investment-grade bond market shines:

The total return of 6.92% was primarily a result of an average shift of 55 basis points in the yield curve. That was the biggest curve shift of any broad investment-grade index tracked by Bank of America Merrill Lynch, although the United States (-48 bps), Europe (-48 bps) and U.K. (-43 bps) were close behind.

The Canadian market also had fairly long duration on its side in 2010, BofAML analyst Preston Peacock said in a note to clients. At 6.78 years, the Canadian Broad Market Index is about two years longer than the United States and roughly 1.5 years longer than the Euro market. Only the Sterling market at 8.49 years has a longer duration than Canada and was the only outperformer with a 7.95% return in 2010.
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While all sectors of the Canada Corporate Index saw healthy excess returns in 2010, banking (+0.81%) and insurance (+0.88%) had the lowest relative performances. Together, the account for about half the index.

The banking sector, which has a weighting of roughly 40% in the index, didn’t exactly have a bad showing, so its hard to say it dragged down overall index performance. However, the group did lag the 1.31% return of the global bank sector.

Mr. Peacock explained this is due to the 46% allocation to subordinated debt in the Canadian Dollar Bank Index compared to 32% globally. The Canadian group did not sell off as much as its global peers previously and therefore saw less of a bounce-back.

Sub-debt as currently constituted is a bond, since holders can petition into bankruptcy – they will not be bonds under the new regime.

It was a positive day on the Canadian preferred share market amidst continued heavy volume as PerpetualDiscounts gained 9bp and FixedResets were up 7bp.

Brookfield has announced:

that it has agreed to issue approximately 15,300,000 Class A Common Shares (“Class A Shares”), on a bought deal basis, to a syndicate of underwriters led by RBC Capital Markets, CIBC World Markets, TD Securities Inc. and Scotia Capital Inc. (the “Underwriters”) at a price of C$32.85 per Class A Share (the “Offering Price”) for aggregate gross proceeds of C$502.6 million (the “Offering”).

In addition, the Company has granted the Underwriters an over-allotment option, exercisable in whole or in part for a period of 30 days following closing, to purchase up to an additional 2,295,000 Class A Shares at the Offering Price, which, if exercised, would increase the gross offering size to C$578.0 million.

The Class A Shares will be offered by way of a short form prospectus to be filed in all of the provinces of Canada and on a private placement basis in the United States pursuant to an exemption from the registration requirements of the United States Securities Act of 1933, as amended.

As previously announced, the Company has acquired 113.3 million common shares of General Growth Properties, Inc. (“GGP”) from The Fairholme Fund for aggregate consideration of approximately US$1.7 billion. The proceeds of the Offering, together with the proceeds of the Company’s previously announced offering of preferred shares, means that the Company’s purchase of the common shares of GGP is financed almost entirely with permanent equity, thoroughly enhancing the Company’s ability to pursue additional investment opportunities. The Offering is expected to close on or about February 15, 2011 and is subject to receipt of all necessary regulatory approvals.

The SEC has released Study and Recommendations on Improved Investor Access to Registration Information About Investment Advisers and Broker-Dealers:

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or “Act”) was signed into law on July 21, 2010. Section 919B of the Act directs the Securities and Exchange Commission (the “Commission” or “SEC”) to complete a study, including recommendations, of ways to improve the access of investors to registration information about registered and previously registered investment advisers, associated persons of investment advisers, brokers and dealers and their associated persons and to identify additional information that should be made publicly available. The Act specifies that the study include an analysis of the advantages and disadvantages of further centralizing access to registration information, and identify data pertinent to investors and the method and format for displaying and publishing the data to enhance the information’s accessibility and utility to investors. The Act requires the Commission to complete the study within six months after the date of enactment of the Act (i.e., by January 21, 2011), and to implement any recommendations within eighteen months after completion of the study.

If recommendations must be implemented, can they still be called “recommendations”?

Section VII proposes several recommendations. For the near-term, i.e., within the eighteen-month implementation period, the Staff makes the following recommendations: (1) unify search returns for BrokerCheck and IAPD to help investors more easily obtain the data they need to make informed decisions regarding financial services providers; (2) add a search by ZIP code or other indicator of location to BrokerCheck and IAPD to increase the utility of the existing databases; and (3) enhance BrokerCheck and IAPD by adding educational content to make the data currently available more useful to investors.
The Staff also recommends that, subsequent to the eighteen-month implementation period, Commission staff and FINRA continue to analyze, including through investor testing, the feasibility and advisability of expanding BrokerCheck to include information currently available in CRD, as well as the method and format of publishing that information; and that Commission staff continue to evaluate expanding IAPD content and the method and format of publishing that content, including through investor testing. Section VIII concludes the study.

The FOMC Release was ‘steady as she goes’. No dissent from Hoenig this time – he’s no longer a member!

Volume ticked up to “very heavy” levels in the Canadian preferred share market today with mixed returns, as PerpetualDiscounts lost 11bp while FixedResets gained 3bp.

PerpetualDiscounts now yield 5.28%, equivalent to 7.38% interest at the standard equivalency factor of 1.4x. Long corporates now yield about 5.55%, so the pre-tax interest equivalent spread (also called the Seniority Spread) is now about 185bp, a slight and perhaps spurious decline from the 190bp reported on January 19.

European politicians have a problem when talking about the potential for sovereign default – nobody believes them:

Most global investors predict at least one nation will leave the euro-area within five years and that Greece and Ireland will default, sentiment that is intensifying pressure on policy makers to strengthen their response to the debt crisis.

As the World Economic Forum’s annual meeting gets underway, 59 percent of respondents in a Bloomberg Global Poll said one or more of the 17 euro nations will quit by 2016, including 11 percent who see an exit within 12 months. Respondents were divided over whether Portugal would default, while a majority expressed confidence in Spain.

It was a mixed, downish day on the Canadian preferred share market, as PerpetualDiscounts gained 3bp while FixedResets lost 14bp … that brings the Bozo Spread (Current Yield PerpetualDiscounts less Current Yield FixedResets) down to 6bp! Volume continued at elevated levels.

The SEC has released its Study on Investment Advisers and Broker-Dealers:

This Study outlines the Staff’s findings and makes recommendations to the Commission for potential new rulemaking, guidance, and other policy changes. These recommendations are intended to make consistent the standards of conduct applying when retail customers receive personalized investment advice about securities from broker-dealers or investment advisers. The Staff therefore recommends establishing a uniform fiduciary standard for investment advisers and broker-dealers when providing investment advice about securities to retail customers that is consistent with the standard that currently applies to investment advisers. The recommendations also include suggestions for considering harmonization of the broker-dealer and investment adviser regulatory regimes, with a view toward enhancing their effectiveness in the retail marketplace.

I think it’s nuts. Stockbrokers are salesmen. Their job is to sell new issues – full stop. The only regulatory change required is a requirement that the only title allowable for those with a license is “Salesman”, and that this title – and no other – be displayed on all communications beside the salesman’s name.

Two Commissioners basically agree with me:

Two examples from the Study illustrate its shortcomings.

First, a basic premise of the Study’s recommendation to impose a uniform fiduciary duty on broker-dealers and investment advisers is concern that investors are confused about the differences between a broker-dealer and an investment adviser and the duties owed by each. Such confusion is a serious matter. However, the practical consequences resulting from that confusion for those very investors have not been sufficiently studied or documented. Moreover, the Study does not address the possibility that the Study’s own recommendations will not resolve or eliminate investor confusion and may in fact create new sources of confusion.

Second, the Study, in our view, does not appropriately account for the potential overall cost of the recommended regulatory actions for broker-dealers, investment advisers, and retail investors. The Study unduly discounts the risk that, as a result of the regulatory burdens imposed by the recommendations on financial professionals, investors may have fewer broker-dealers and investment advisers to choose from, may have access to fewer products and services, and may have to pay more for the services and advice they do receive. Any such results are not in the best interests of investors; nor do they serve to protect them.

The EFSF may morph into the European Fix-Everything Fund:

European Central Bank Executive Board member Juergen Stark said measures to strengthen the region’s rescue fund could include purchases of government bonds or injecting cash into commercial banks.

“I could imagine the” European Financial Stability Facility “recapitalizing banks or buying sovereign debt,” Stark said in an interview with Dutch newspaper Het Financieele Dagblad published today, according to an e-mailed transcript from the Frankfurt-based central bank. “But this issue has to be decided at the political level.”

Spanish Cajas need a lot of money:

Spain said Monday its banks will need €20-billion ($27-billion U.S.) in new capital to meet new reserve requirements aimed at strengthening their finances.

Finance Minister Elena Salgado said a government fund that has been pouring money into mergers among troubled cajas, or savings banks, might eventually buy stakes in the entities that cannot meet the new criteria by raising capital on the open market.

European banks are issuing samurais:

Debt sold in Japan by overseas issuers yield an average 90 basis points more than government debt, while euro-denominated financial company notes yield 236 more than benchmark German securities, according to indexes compiled by Nomura Securities Co. and Bank of America Merrill Lynch. It costs 315 basis points less in yield for lenders to sell debt in Japan than in Europe, the biggest difference since the gap reached 319 in March 2009.

Barclays Plc and Credit Suisse Group AG led European lenders that raised a record 835.5 billion yen ($10.1 billion) from Samurai bonds last year, according to data compiled by Bloomberg. The growing advantage to issuing bonds in Japan may help Europe’s financial companies refinance 765 billion euros ($1.04 trillion) of debt Barclays estimates matures this year.

“Europe’s top banks may need to pay more spread than last year to sell Samurai bonds, but there’s a difference between investors in Japan and Europe,” said Yasuhiro Matsumoto, head of credit research at Shinsei Securities Co. in Tokyo. While European investors are increasingly cautious amid their region’s financial crisis, for Japanese investors “Samurai bonds are the only option” to get yield, he said.

Econbrowser’s James Hamilton discusses The Fed’s new policy tools:

Let me begin with a little background. Prior to the fall of 2008, the focus of monetary policy was to choose a target for the fed funds rate, which is the interest rate banks charge each other for overnight loans of Federal Reserve deposits. In normal times, this rate was extremely sensitive to the quantity of those deposits created by the Fed, enabling the Fed to achieve its target for the fed funds rate with relatively modest additions or withdrawals of reserves. But by the end of 2008, the Fed had driven the fed funds rate essentially to zero and began paying interest on reserves. Since then, banks have been content to hold an arbitrarily large amount of excess reserves, and the overnight rate has been as low as it could go. In other words, the traditional tools of monetary policy have become completely irrelevant in the current setting.

Meanwhile, Jim Hamilton’s World of Securities Regulation contrasts the differences between US and EU proposals for winding down failed banks:

The proposed EU legislation and the Dodd-Frank Act both provide for a resolution framework for systemic institutions at group level. Both the EU and the US are accordingly working to develop mechanisms which should be capable of resolving or winding down failing financial institutions. The US approach intends to address systemic risk by taking failing institutions into receivership by the FDIC, under which their business will be transferred or wound down and the failed institution will be liquidated.

The EU framework would also allow authorities to put firms into an orderly resolution in which their essential services could be preserved while the failed institution itself was ultimately wound down. However, in the cases where an institution is too large, complex or interconnected to be wound down in an orderly manner, the Commission is also considering equipping authorities with ambitious additional tools which would, under stringent conditions, allow a troubled firm to continue as a going concern, through write down of its debt, in order to preserve its economically important functions and buy time for authorities to sell or wind down its business in an orderly manner. In order to prevent moral hazard, there would need to be strict conditions accompanying any such approach, including the dilution of shareholders, changes to management, haircutting of creditors, and re-structuring so as to ensure that the surviving entity was viable.
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A key power for regulators under this regime would be to write down debt. The consultation seeks views on two broad approaches to achieving this objective. The first approach would involve a broad statutory power for authorities to write down or convert unsecured debt, including senior debt, subject to possible exclusions for classes of senior debt that may be necessary to preserve the proper functioning of credit markets. It is not envisaged that such a power would apply to existing debt that is currently in issue, as that could be disruptive. The second approach would require financial firms to issue a fixed amount of “bail-in’’ debt that could be written off or converted into equity on a specified trigger linked to the firm’s failure. This requirement would be phased in over an appropriate period and, again, it is not envisaged that any existing debt already in issue would be subject to write down.

The Irish government has collapsed, but the budget might pass anyway:

Finance Minister Brian Lenihan will meet today lawmakers from the Green Party, which withdraw from the coalition yesterday, and opposition parties in Dublin to discuss a timetable for passing the Finance Bill. The plan would enact 6 billion euros ($8.2 billion) of tax increases and spending cuts.
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James Reilly, deputy leader of Fine Gael said yesterday the bill can be passed this week. The Labour Party said it will table a confidence motion this week if the government doesn’t commit to passing the law by Jan. 28.

Bank valuations are still low:

Valuations for U.S. financial stocks have fallen so far, it’s like the rebound from the worst crisis since the 1930s never happened.

Banks, insurers and asset managers in the Standard & Poor’s 500 Index trade at 12.3 times estimated earnings, close to the lowest level since the bull market began in March 2009, according to data compiled by Bloomberg. The group is the second-cheapest among 10 industries in the gauge even as analysts say profits will rise 18 percent this year, exceeding the S&P 500, data compiled by Bloomberg show.

This is the sort of thing that usually corrects after a takeover or two, but somehow I think that a takeover of an undervalued, yet healthy, bank will not be particularly popular with the regulators these days.

Still, some have done all right anyway:

Paulson & Co., the $35.9 billion hedge fund run by John Paulson, told clients that it made more than $1 billion on its Citigroup Inc. investment in the last 18 months.

Citigroup was the fund’s most profitable bank holding last year, Paulson said in a letter to clients this month. The stock surged 43 percent in 2010.

But the banks aren’t out of the woods yet:

Bank of America Corp., the biggest U.S. lender, may book an $8.5 billion charge on costs to resolve disputes over faulty mortgages, a figure at the upper end of the range the company gave last week, according to Oppenheimer & Co.

The cost to settle demands from private investors on home loans could be as low as zero and the upper end is $7 billion to $10 billion, the firm said last week in a slide show. The bank may take a charge in this year’s fourth quarter, and costs may expand with lawyers “smelling blood in the water,” Christopher Kotowski, an Oppenheimer analyst, said yesterday in a note.

It would be interesting to take apart the projected earnings that give rise to the “low valuation” claim. Typically, such forecasts are based on analyst-defined ‘core business’, with special charges treated as a mere bagatelle.

National Bank has issued covered bonds:

The wait finally ended Monday morning with the launch of a $1-billion (U.S.) offering. The deal comes just a few weeks after rating agency DBRS assigned a provisional triple-A to the bank’s covered bonds. That rating was given on top of a cover pool worth $1.565-billion, with the vast majority of mortgages located in Quebec.

Barclays, Citi, Morgan Stanley and National Bank Financial are co-lead managers for the offering, which is still being priced near 35 basis points over mid-swaps.

DBRS has made a Quarterly Split Share Market Report available to subscribers.

As Assiduous Readers of the comments will know, I have been advised that La Presse had a piece recommending low-coupon bank preferreds about a month ago, on the grounds that the author believed Basel III will force redemption. I can’t find the link! Any help would be appreciated, acknowledged and rewarded.

The Canadian preferred share market declined slightly today, with PerpetualDiscounts down 4bp and FixedResets losing 9bp. Volume was very healthy.