Interesting External Papers

BIS Releases Working Paper on ABX.HE Pricing

The Bank for International Settlements has announced the release of Working Paper #279, The pricing of subprime mortgage risk in good times and bad: evidence from the ABX.HE indices by Ingo Fender and Martin Scheicher.

This paper investigates the market pricing of subprime mortgage risk on the basis of data for the ABX.HE family of indices, which have become a key barometer of mortgage market conditions during the recent financial crisis. After an introduction into ABX index mechanics and a discussion of historical pricing patterns, we use regression analysis to establish the relationship between observed index returns and macroeconomic news as well as market-based proxies of default risk, interest rates, liquidity and risk appetite. The results imply that declining risk appetite and heightened concerns about market illiquidity—likely due in part to significant short positioning activity—have provided a sizeable contribution to the observed collapse in ABX prices since the summer of 2007. In particular, while fundamental factors, such as indicators of housing market activity, have continued to exert an important influence on the subordinated ABX indices, those backed by AA and AAA exposures have tended to react more to the general deterioration of the financial market environment. This provides further support for the inappropriateness of pricing models that do not sufficiently account for factors such as risk appetite and liquidity risk, particularly in periods of heightened market pressure. In addition, as related risk premia can be captured by unconstrained investors, ABX pricing patterns appear to lend support to government measures aimed at taking troubled assets off banks’ balance sheets—such as the US Troubled Asset Relief Program (TARP).

The authors observe:

With market liquidity vanishing and entire market segments becoming largely dysfunctional, factors other than credit risk became increasingly important drivers of observed prices. This, in turn, rekindled earlier doubts concerning the validity of currently available models for the pricing of credit risk, particularly for portfolio instruments such as mortgage-backed securities and other complex securitisations.

The results presented in this paper suggest that declining risk appetite and heightened concerns about market illiquidity have provided a sizeable contribution to the observed collapse in ABX prices since July 2007. While fundamental factors, such as indicators of housing market activity, have continued to exert an important influence on the subordinated ABX indices, the AA and AAA indices have tended to react more to the general deterioration of the financial market environment, such as declining risk appetite and market liquidity. These results underline the well-established view that risk premia are important components of observed prices for default-risky products, and that the relative importance of non-default risk factors will tend to increase in periods of strong repricing of credit risk. This suggests that theoretical pricing models that do not sufficiently account for these factors may be inappropriate, particularly in periods of heightened market pressure.

Interesting External Papers

The Value of Liquidity

Assiduous Readers will be well aware that I often include articles in the blog for no other reason than to bookmark them. Having just spent twenty minutes trying to find this article after reading it some time ago, it is clear that I shall have to redouble my efforts!

Paul Fulcher of UBS and Colin Wilson of Barrie & Hibbert wrote a nice summary regarding credit spread decomposition for The Actuary, titled Financial Crisis: The Value of Liquidity. I thought they made the central point very well:

The spread on corporate bonds over the liquid risk-free rate (for example, government bonds) represents compensation for several different factors:

A Expected default losses
B Unexpected default risk, such as default and recovery rate risk
C Mark-to-market risk, such as the risk of a fall in the market price of the bond
D Liquidity risk, such as the risk of not finding a ready buyer at the theoretical market price.

Investors concerned with the realisable value of their investment in the short-term require compensation for all these risks.

However, investors who can hold bonds to maturity need compensation only for A and B. Such investors can enjoy the premiums for C and D, and we refer to these collectively as a ‘liquidity premium’.

There are some good references, too:

Market Action

March 30, 2009

James Hamilton of Econbrowser wrote a very good post on the weekend, Money Creation and the Fed, addressing the near-vertical increase in the monetary base since September 2008 when the credit crunch really started crunching. Of particular interest were remarks by Charles Plosser of the Philadelphia Fed:

However, under current circumstances, the Fed has substituted less liquid assets for Treasuries. It is true that a number of the Fed’s new programs will unwind naturally and fairly quickly as they are terminated because they involve primarily short-term assets. Yet we must anticipate that special interests and political pressures may make it harder to terminate these programs in a timely manner, thus making it difficult to shrink our balance sheet when the time comes. Moreover, some of these programs involve longer-term assets — like the agency MBS. Such assets may prove difficult to sell for an extended period of time if markets are viewed as “fragile” or specific interest groups are strongly opposed, which could prove very damaging to our longer-term objective of price stability. Thus, we must ensure that our current credit policies do not constrain our ability to conduct appropriate monetary policy in the future.

Even more important, credit allocation decisions, in my view, should be under the purview of the fiscal authority, not the monetary authority, since they involve using the public’s money to affect the allocation of resources. The mixing of monetary policy and fiscal policy increases the number of entities that might try to influence Fed decision-making in their favor. Both economic theory and practice indicate that central banks should operate independently from such pressures and resist them when they arise so that their policies benefit society at large over the longer term and not any particular constituency in the near term.
…
Today, an accord to substitute Treasuries for non-Treasury debt on our balance sheet would similarly help ensure that the Fed will be able to implement its policy decisions. After all, the time will come when the Fed will want to begin raising interest rates to achieve its goals. With Treasuries back on the balance sheet, the Fed will be able to drain reserves in a timely fashion with minimal concerns about disrupting particular credit allocations or the pressures from special interests.

Dr. Hamilton concludes on a sanguine note:

Which brings me back to the original question. Does the explosive growth of the monetary base in Figure 1 imply uncontrollable inflationary pressures? My answer: not yet, but stay tuned.

I am confident that the Fed will retain its independence and sell its assets back to the public as soon as the public wishes to pay a reasonable price; I am also confident that most of what the Fed is doing is exactly what central banks are supposed to do: making liquidity available in times of stress at a penalty rate against good collateral.

I will justify the “penalty rate” part of that assertion by noting that, given the excess reserves are on the books paying 0.25%, a 4.5%-5.0% rate on mortgage assets is punitive by any normal measure.

However, I do agree with Mr. Plosser to the extent that direct ownership of assets by the Fed is a nervous thing, and that it should be Treasury stepping up and taking actual ownership risk. In the Fed’s efforts to make credit available, it should always have some degree of first-loss protection, whether that protection is given (explicitly!) by Treasury or by the private sector is immaterial.

Dr. Hamilton followed up his first post with another one, The Fed’s New Balance Sheet:

I am uncomfortable on a general level with the suggestion that unelected Fed officials are better able to make such decisions than private investors who put their own capital where they think it will earn the highest reward. Apart from that general unease, I have a particular concern about the motivation for the Term Asset-Backed Securities Loan Facility, whose goal is to generate up to $1 trillion of lending for businesses and households by catalyzing a revival of loan securitization.
…
But the whole premise behind those Aaa ratings– that securitization could isolate a “safe” component of a pool of fundamentally risky loans– was deeply flawed. It is impossible to diversify away aggregate or systemic risk. All that the device did was to mislead investors into thinking they were protected from those nondiversifiable risks and push those risks onto the taxpayers and the Fed. Before we decide that securitization is the road out of our present difficulties, I would like a detailed and convincing explanation of why the past mistakes are not going to be repeated again.

Dr. Hamilton … you’re going to be deeply disappointed. Financial fads are as old as the concept of money and when we do enough stupid things it requires a recession to show us the error of our ways.

I do not believe that securitization is not “the road out of our present difficulties” nor, I suggest, is the Fed intending to send that signal. What we have now is an ice dam blocking the flow of credit; the pendulum has swung more than half-way; investors are refusing point-blank to invest in securitization paper regardless of the nature of the underlying assets or the credit quality of the paper.

Rational views on credit risk will return – they always do – but the current blind fear is just as far removed from rationality as the recent blind adoration. The Fed must blow up the ice dam to prevent unnecessary damage to the economy as a whole and allow the credit markets to find a new balance gradually.

As stated, however, I do believe that direct purchase of assets by the Fed is a Bad Thing. Loans against assets, with overcollateralization, are good; but direct purchase should indeed be an explicitly political decision.

Bloomberg News points out that the joint Fed/Treasury press release (reported by PrefBlog on March 23) could have more implications than have been commonly discussed:

The release said that while the Fed collaborates with other agencies to preserve financial stability, it alone is in charge of keeping consumer prices stable, its independence “critical.”

The statement was the culmination of a behind-the-scenes, two-month long debate involving the Fed’s Open Market Committee, as well as the Treasury. The discussions were driven by Chairman Ben S. Bernanke’s concern that work with the Bush and Obama administrations on repairing banks and markets not lead to attempts at political pressure later that would delay the start of measures to combat inflation.

Mark-to-Market accounting is being eviscerated, not without controversy:

Four days after U.S. lawmakers berated Financial Accounting Standards Board Chairman Robert Herz and threatened to take rulemaking out of his hands, FASB proposed an overhaul of fair-value accounting that may improve profits at banks such as Citigroup Inc. by more than 20 percent.

The changes proposed on March 16 to fair-value, also known as mark-to-market accounting, would allow companies to use “significant judgment” in valuing assets and reduce the amount of writedowns they must take on so-called impaired investments, including mortgage-backed securities. A final vote on the resolutions, which would apply to first-quarter financial statements, is scheduled for April 2.
…
By letting banks use internal models instead of market prices and allowing them to take into account the cash flow of securities, FASB’s change could boost bank industry earnings by 20 percent, [tax & accounting advisor Robert] Willens said.

The Treasury Market Practices Group has released a few adjustments to its recommended fails charge procedure to lower the administrative burden on implementation.

Bank of Canada Governor Carney today delivered a speech that was remarkable for it’s degree of ass-covering and blame-shifting:

We now face important policy questions about which activities banks should perform, which should be located in sustainable, continuously-open markets, and which should be prohibited.

Markets might be sustainable and continuously open, but that is no guarantee they’re going to be doing any business.

First, banks have become increasingly heavy users of markets to fund their activities. In recent years, many international banks borrowed in short-term markets to finance asset growth and, in the process, to substantially increase their leverage. This made them increasingly dependent on continuous access to liquidity in money and capital markets. In the process, banks conflated a reliance on market liquidity with their access to central bank liquidity.
…
Banks often sold securities to “arms-length” conduits that they were later forced to reintermediate or held onto AAA tranches of structures that proved far from risk-free.

Reliance on liquidity was not regulated by the Basel Committee on which the Bank of Canada has a vote. Forced reintermediation without adequate capital is a fault of the Basel Committee and the national regulators. AAA is an opinion – no more. Why did the Basel Committee interpret this opinion as “risk-free”?

In many banks, a culture that rewarded innovation and opacity over risk management and transparency eventually undermined its creators. Senior managers and shareholders of banks discovered that actual risks were much greater than originally thought. By that time, the more junior traders who had assumed the risks had already been paid, largely in cash. Many large, complex institutions learned too late that there can be principal-agent problems within firms, as well as between firms and their shareholders.

In other words, the Basel Committee failed to assess sufficient capital charges based on size and concentration.

The growth in financial activity and the increasingly complex array of financial players have prompted a dramatic increase in claims within the financial system, as opposed to between the financial system and the real economy, which created risks that were difficult to identify and evaluate.

And therefore ignored by the Basel Committee.

In essence, the shadow banking system practiced maturity transformation without a safety net – that is, it was wholly reliant on the continuous availability of funding markets. The collapse in market liquidity that began in August 2007 crystallized these risks.

The regulatory system neither appreciated the scale of this activity nor adequately adapted to the new risks created by it. The shadow banking system was not supported, regulated, or monitored in the same fashion as the banking system. With hindsight, the shift towards the shadow banking system that emerged in other countries was allowed to go too far for too long.

The problem is not the size of the shadow banking system per se, but that the banks were permitted to rely upon it and that the regulators ignored the risks.

Reopening markets will ultimately require a series of measures to improve the infrastructure of core funding markets, securitization, and credit default swaps (CDS).

A bare assertion, unsupported by anything in the speech.

The U.S. Federal Reserve has improved clearing and settlement arrangements, and has encouraged the move of CDS onto clearing houses. This will encourage the standardization of these products, while making CDS counterparties – often banks – less systemically important at the margin.

If I buy a bond on margin, I’ve got to put up about 10% and give it to the dealer as collateral. If I write a CDS, giving credit protection to a bank, I’m doing the same thing – but Mr. Carney’s Basel Committee decided this was a virtually risk-free banking transaction.

Third, the crisis has demonstrated that there are many firms that have been deemed systemic and worthy of rescue even though they were not deposit-taking banks.

Only because the exposure of the banking system to these firms was not adequately regulated.

Equities were crushed:

Canadian stocks had their biggest drop in four weeks as U.S. Treasury Secretary Timothy Geithner said banks will need more government help and oil’s retreat pushed energy producers lower.
…
Royal Bank of Canada, the country’s largest bank by assets, slid 3.2 percent to C$35.80. Toronto-Dominion fell 4.2 percent to C$42. Manulife lost 8.5 percent to C$13.72.

A measure of 38 financial stocks in the S&P/TSX index retreated 4.1 percent, the steepest decline among 10 industries.

Decent volume today amidst all the equity wreckage, with moderate price movement; PerpetualDiscounts down a bit, fixed-Resets up. If this relative movement makes sense to anybody, let me know, because I don’t understand it at all. Sure, you can always construct an argument that will explain anything; that is the bread and butter of the average stock broker: “Well, the market is assuming huge monetary and fiscal stimulus will cause rampant inflation without an increase in credit risk”; but it’s not all that convincing, really.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices
Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)		 Median
YTW		 Median
Average
Trading
Value		 Median
Mod Dur
(YTW)		 Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 -0.5212 % 863.0
FixedFloater 0.00 % 0.00 % 0 0.00 0 -0.5212 % 1,395.7
Floater 4.58 % 5.52 % 63,920 14.63 3 -0.5212 % 1,078.2
OpRet 5.25 % 4.77 % 128,892 3.87 15 -0.1349 % 2,065.3
SplitShare 6.95 % 10.00 % 49,241 4.78 6 -3.3045 % 1,600.6
Interest-Bearing 6.19 % 10.07 % 33,235 0.73 1 -0.4111 % 1,925.6
Perpetual-Premium 0.00 % 0.00 % 0 0.00 0 -0.2514 % 1,500.8
Perpetual-Discount 7.23 % 7.43 % 154,721 12.07 71 -0.2514 % 1,382.2
FixedReset 6.13 % 5.87 % 577,701 13.66 32 0.3592 % 1,816.8
Performance Highlights
Issue Index Change Notes
LFE.PR.A SplitShare -7.78 % Crushed, but the day’s low was set by small trades in the mid-afternoon. Traded 6,500 shares in a range of 6.57-05 before closing at 6.64-99, 2×1. Asset coverage of 1.0+:1 as of March 13, according to the company.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2012-12-01
Maturity Price : 10.00
Evaluated at bid price : 6.64
Bid-YTW : 18.36 %
MFC.PR.B Perpetual-Discount -4.38 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 15.05
Evaluated at bid price : 15.05
Bid-YTW : 7.82 %
BNA.PR.A SplitShare -4.21 % Asset coverage of 1.7-:1 as of February 28 according to the company.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2010-09-30
Maturity Price : 25.00
Evaluated at bid price : 22.75
Bid-YTW : 13.45 %
DFN.PR.A SplitShare -4.07 % Asset coverage of 1.5+:1 as of March 13 according to the company.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2014-12-01
Maturity Price : 10.00
Evaluated at bid price : 8.01
Bid-YTW : 10.00 %
RY.PR.W Perpetual-Discount -3.23 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 18.30
Evaluated at bid price : 18.30
Bid-YTW : 6.81 %
CIU.PR.A Perpetual-Discount -3.13 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 17.00
Evaluated at bid price : 17.00
Bid-YTW : 6.86 %
MFC.PR.C Perpetual-Discount -2.66 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 14.62
Evaluated at bid price : 14.62
Bid-YTW : 7.79 %
HSB.PR.D Perpetual-Discount -2.35 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 16.21
Evaluated at bid price : 16.21
Bid-YTW : 7.78 %
GWO.PR.H Perpetual-Discount -2.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 15.84
Evaluated at bid price : 15.84
Bid-YTW : 7.72 %
SBN.PR.A SplitShare -1.96 % Asset coverage of 1.6+:1 as of March 19 according to Mulvihill.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2014-12-01
Maturity Price : 10.00
Evaluated at bid price : 8.49
Bid-YTW : 8.77 %
BAM.PR.J OpRet -1.96 % YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2018-03-30
Maturity Price : 25.00
Evaluated at bid price : 17.50
Bid-YTW : 10.75 %
BAM.PR.K Floater -1.84 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 7.47
Evaluated at bid price : 7.47
Bid-YTW : 5.88 %
BAM.PR.H OpRet -1.70 % YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2012-03-30
Maturity Price : 25.00
Evaluated at bid price : 23.10
Bid-YTW : 8.73 %
BNA.PR.C SplitShare -1.52 % Asset coverage of 1.7-:1 as of February 28 according to the company.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2019-01-10
Maturity Price : 25.00
Evaluated at bid price : 11.00
Bid-YTW : 16.01 %
CM.PR.P Perpetual-Discount -1.40 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 18.31
Evaluated at bid price : 18.31
Bid-YTW : 7.53 %
BNS.PR.O Perpetual-Discount -1.38 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 20.66
Evaluated at bid price : 20.66
Bid-YTW : 6.92 %
BNS.PR.N Perpetual-Discount -1.35 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 19.06
Evaluated at bid price : 19.06
Bid-YTW : 7.04 %
NA.PR.K Perpetual-Discount -1.30 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 20.50
Evaluated at bid price : 20.50
Bid-YTW : 7.27 %
BAM.PR.I OpRet -1.16 % YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2013-12-30
Maturity Price : 25.00
Evaluated at bid price : 21.30
Bid-YTW : 9.50 %
TD.PR.P Perpetual-Discount -1.15 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 19.77
Evaluated at bid price : 19.77
Bid-YTW : 6.78 %
BAM.PR.O OpRet -1.14 % YTW SCENARIO
Maturity Type : Option Certainty
Maturity Date : 2013-06-30
Maturity Price : 25.00
Evaluated at bid price : 21.75
Bid-YTW : 8.78 %
W.PR.J Perpetual-Discount 1.05 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 19.86
Evaluated at bid price : 19.86
Bid-YTW : 7.09 %
SLF.PR.B Perpetual-Discount 1.12 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 15.40
Evaluated at bid price : 15.40
Bid-YTW : 7.86 %
GWO.PR.G Perpetual-Discount 1.29 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 17.25
Evaluated at bid price : 17.25
Bid-YTW : 7.60 %
PWF.PR.H Perpetual-Discount 1.30 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 17.96
Evaluated at bid price : 17.96
Bid-YTW : 8.20 %
SLF.PR.C Perpetual-Discount 1.39 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 14.55
Evaluated at bid price : 14.55
Bid-YTW : 7.72 %
BNS.PR.R FixedReset 1.50 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 21.36
Evaluated at bid price : 21.65
Bid-YTW : 4.62 %
RY.PR.R FixedReset 1.54 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-03-26
Maturity Price : 25.00
Evaluated at bid price : 25.75
Bid-YTW : 5.82 %
TD.PR.C FixedReset 1.60 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 24.16
Evaluated at bid price : 24.20
Bid-YTW : 4.99 %
PWF.PR.E Perpetual-Discount 1.72 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 18.31
Evaluated at bid price : 18.31
Bid-YTW : 7.68 %
IAG.PR.C FixedReset 1.85 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 21.96
Evaluated at bid price : 22.00
Bid-YTW : 6.18 %
ACO.PR.A OpRet 1.92 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2009-04-29
Maturity Price : 26.00
Evaluated at bid price : 26.55
Bid-YTW : -14.14 %
CM.PR.K FixedReset 1.95 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 21.96
Evaluated at bid price : 22.00
Bid-YTW : 4.90 %
PWF.PR.K Perpetual-Discount 3.90 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 16.00
Evaluated at bid price : 16.00
Bid-YTW : 7.92 %
Volume Highlights
Issue Index Shares
Traded		 Notes
BNS.PR.X FixedReset 61,652 RBC crossed 54,300 at 25.40.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-25
Maturity Price : 25.00
Evaluated at bid price : 25.40
Bid-YTW : 6.16 %
BMO.PR.O FixedReset 60,374 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 24.95
Evaluated at bid price : 25.00
Bid-YTW : 6.41 %
TD.PR.M OpRet 54,100 Desjardins bought blocks of 20,000 and 30,000 shares from National, both at 25.87.
YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2013-10-30
Maturity Price : 25.00
Evaluated at bid price : 25.77
Bid-YTW : 4.16 %
PWF.PR.K Perpetual-Discount 51,190 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 16.00
Evaluated at bid price : 16.00
Bid-YTW : 7.92 %
RY.PR.R FixedReset 50,343 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-03-26
Maturity Price : 25.00
Evaluated at bid price : 25.75
Bid-YTW : 5.82 %
CM.PR.H Perpetual-Discount 43,948 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-30
Maturity Price : 16.07
Evaluated at bid price : 16.07
Bid-YTW : 7.48 %
There were 27 other index-included issues trading in excess of 10,000 shares.
Seminars

Seminar, April 30: Floating Rate Issues

Update, 2009-8-25: To gain access to the on-line video of this seminar and the ancillary written material, please visit PrefLetter.com

I am pleased to announce the next seminar in the series on the theory and practice of preferred share investing.

These seminars will be aimed at active and potential preferred share investors who wish to review relative valuation techniques in preferred share analysis.

All seminars will be presented by James Hymas, who has written extensively on the subject of preferred share investment and has been referred to as a "top expert" on the subject.

Questions are encouraged throughout the seminars, as well as in informal discussion at the end of the session.

Each seminar is two hours in length; coffee and tea will be served. The cost of attendance is $100, but a discount of $50 will be given to participants who have an annual subscription to PrefLetter with at least one issue remaining at the time of the seminar.

All seminars will be video-recorded for future distribution.

Thursday, April 30

Floating Rate Issues: Theory & Practice

"Floating Rate Issues" are popular with investors who:

  • wish to obtain tax-advantaged income
  • want protection against future inflation

These issues are characterized by:

  • Issued by Operating companies
    • Extant issues are non-financial
  • Dividends are paid by reference to Canada Prime
  • An exchange option may exist to lock in a rate for five years on a given date
  • Issues are Perpetual

This seminar will review the theory of Floating Rate Preferred evaluation, including:

  • Credit Quality
  • Embedded calls
  • Exchange Options
  • The importance of ex-Dividend dates
  • Investment characteristics relative to
    • money market instruments
    • other perpetual instruments

Examples of relative valuation in current markets will be supplied and discussed. Note that Floating Rate issues include the HIMIPref™ Indices:

  • Ratchet
  • FixedFloater
  • Floater

. "FixedReset" issues will not be discussed as part of this seminar.

Attendence is limited; a reservation will avoid disappointment.

Location: Days Hotel & Conference Center, (at Carlton & College, downtown Toronto) Yorkville Room (see map).

Time: April 30, 2009, 6pm-8pm.

Reservations: Please visit the PrefLetter Seminar Page.

Update, 2009-8-24: The seminar and its ancillary material have been accredited for four hours of IDA Professional Development Continuing Education.

Update, 2009-8-24: ◦This program is eligible for four CE credit hours, as granted by CFA Institute. If you are a CFA Institute member, CE credit for your participation in this program will be automatically recorded in your CE Diary.

 
 

Miscellaneous News

Watch the Details on Rate-Reset Preferreds

Barry Critchley of the Financial Post has been all over the map on Fixed-Resets:

… and now he is warning that “redeemable” is different from “retractible”:

If the prefs are not redeemed, in five years holders will be offered a choice of a new fixed-rate pref or an option to convert to a floating-rate pref. The rate will be set at the same spread as the original fixed-rate prefs. (Over time, the spread has widened to 450 basis points from 160 basis points.) The actual rate offered could be lower or higher than the original coupon.
…
Now, Len Ruggins, a former senior financing executive with BCE, has weighed in. He argues the terms are “greatly tilted in the issuer’s favour, primarily because of their option to periodically call the issue at their pleasure.”
…
Ruggins said he “would buy into these issues if they were non-call for financial advantage for at least 25 years. This, in my mind, would establish a level playing field between the issuer and the investor. I am not trying to cut off a source of capital for our Canadian banks. However, I don’t think they should take undue advantage of the financially unsophisticated retail investor.”

By and large, Mr. Critchley’s attitude towards the structure has become more cautionary as the terms of new issues have improved! I consider the recent spate of new issues to be somewhat rich compared to PerpetualDiscounts, but to a much smaller degree than they were a year ago. In fact, there is now enough overlap between the more expensive PerpetualDiscounts and the cheaper FixedResets that the fund I manage has taken some opportunistic positions in Fixed Resets, as disclosed in the portfolio composition review for January 2009.

It is interesting to compare this column with the column by Rob Carrick of the Globe and Mail, published on the same day.

Update, 2009-3-31: In light of the comments to this post by Assiduous Reader GAndreone, I thought it would be interesting to post the HIMIPref™ Option Calculation Box for BMO.PR.O as of 2009-3-30. Note that I do not claim that this represents a perfect and correct calculation of what the price of the option would be if it was separable from the preferred share; I will say, however, that the various parameters used as inputs … er … how shall I phrase this … seem to work pretty much OK when used as part of HIMIPref™’s valuation routine.

Update, 2009-3-31: There’s a great comment on the G&M story:

Bruce King from Canada writes: I think James Hymas is stuck with a lot of straight preferreds that have tanked and he’s hoping to drum up some demand in order to unload them on us. He’s probably salivating at the chance to generate enough cash to buy some of the new rate-reset preferreds.

Curses! Foiled!

Press Clippings

The Preferred Approach

I was quoted in the Globe and Mail by Rob Carrick, who wrote a piece about fixed-resets and preferreds in general with the title “The Preferred Approach“:

Preferred share specialist James Hymas agrees that rising rates would be negative for perpetual preferreds, while rate reset shares would have some protection. Still, he prefers perpetuals. One reason is that perpetuals yield roughly a full percentage point more than the new reset preferred shares.

An example is Canadian Imperial Bank of Commerce series 30 preferred shares, which were issued in 2005 at the usual $25 price and have fallen to about $16, thereby pushing the yield up to 7.4 per cent (price and yield move in opposite directions).

“I would recommend straight perpetuals at this point because you are getting paid more than enough extra income to compensate for the added risk of a fixed rate,” said Mr Hymas, who is president of Hymas Investment Management.

Perpetual preferred offer not only a higher yield than the rate reset version, but also a chance for capital gains as financial market conditions “normalize,” in Mr. Hymas’s words.

He figures that perpetuals issued by banks could rise back to the $23 range under normal conditions, which suggests potential gains of 25 to almost 45 per cent, depending on the individual share issue.

Mr. Hymas said perpetuals also solve the problem of reinvestment risk, where you have money in a high-yield investment that matures and has to be rolled into something paying much less. If the bank rate reset shares being issued today are redeemed in five years, as many expect they will be, then investors will be unlikely to find such high yields again. Meantime, perpetuals bought today can be expected to roll along.

As for rising interest rates, Mr. Hymas said yields on corporate bonds and preferred shares – they have many similarities – typically fall as the economy emerges from recession, while government bond rates rise.

Meantime, there’s the risk that business conditions will deteriorate and force banks to not only break the taboo against common share dividend cuts, but also slash preferred share dividends.

Mr. Hymas plays down this threat. “Such an event is currently so remote that I don’t think the probability is measurable.”

Market Action

March 27, 2009

There is growing support for the idea that Commercial Banking is different from Investment Banking (the “utility banking” and “casino banking” of the Turner Review) and should not be housed under the same roof – and this from one of the conglomerators:

what he would tell Obama if given the chance, [Bank of America Corp. Chief Executive Officer Kenneth] Lewis said it would be that “commercial banks are the fabric of any community in which they operate and we probably need to separate the commercial banks from the investment banking activities.”

The remarks may reopen the debate on whether the U.S. should reinstitute laws put in place after the Great Depression designed to insulate lenders from the risks of investment banking. Bank of America, the biggest U.S. bank by assets, bought Merrill Lynch & Co. in January, helping the largest U.S. brokerage avoid the financial collapse that drove Bear Stearns Cos. out of business.

Mr. Lewis later clarified his remarks:

“I was talking about the rhetoric, not physically separating the two,” Lewis said in an interview with Bloomberg Television. “We have an investment bank, we have a commercial bank as well that is the fabric of every community in which it operates.”
…
Lewis’s earlier comments caused credit-default swaps on Merrill Lynch to climb 85 basis points, or 0.85 percentage point, to 550 basis points as of 1:48 p.m. in New York, according to broker Phoenix Partners group. The swaps earlier touched 595 basis points, according to Credit Derivatives Research LLC. Contracts on Bank of America rose 10 basis points to 375 basis points, Phoenix prices show. An increase typically signals weakened investor confidence.

How much credence can be put into this restatement is something I cannot determine. Was it a genuine clarification of an off-hand remark taken out of context? Or was it the result of pressure from the board, his newly acquired investment bankers and the market? Time will tell!

Glass-Steagall went too far in enforcing a strict separation of the two functions. I have no problems with the commercial banks underwriting issues for their clients, or in selling them. I do, however, feel that the Basel Capital rules should be revised to offer a choice to the regulated entities regarding which regime they wish to be subject to, and to allow crossing the line – but on a more expensive basis.

Bank of America should have a regulated competitive advantage over Merrill Lynch in the “hold and arbitrage business”; Merrill Lynch should have a competitive advantage over Bank of America in the “Originate and Distribute” business.

Decent volume in the preferred share market today, but not much price action. That’s what we like, eh? Nice … calm … markets.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices
Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)		 Median
YTW		 Median
Average
Trading
Value		 Median
Mod Dur
(YTW)		 Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 -0.1041 % 867.6
FixedFloater 0.00 % 0.00 % 0 0.00 0 -0.1041 % 1,403.0
Floater 4.56 % 5.51 % 66,707 14.65 3 -0.1041 % 1,083.8
OpRet 5.24 % 4.85 % 130,797 3.88 15 0.2041 % 2,068.1
SplitShare 6.73 % 9.08 % 49,017 4.81 6 0.5726 % 1,655.3
Interest-Bearing 6.17 % 9.38 % 34,411 0.74 1 -0.2020 % 1,933.6
Perpetual-Premium 0.00 % 0.00 % 0 0.00 0 -0.0265 % 1,504.6
Perpetual-Discount 7.21 % 7.40 % 155,161 12.15 71 -0.0265 % 1,385.7
FixedReset 6.15 % 5.87 % 600,009 13.68 32 0.0081 % 1,810.3
Performance Highlights
Issue Index Change Notes
CM.PR.J Perpetual-Discount -2.47 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 15.00
Evaluated at bid price : 15.00
Bid-YTW : 7.51 %
BAM.PR.M Perpetual-Discount -2.01 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 13.13
Evaluated at bid price : 13.13
Bid-YTW : 9.13 %
LFE.PR.A SplitShare -1.98 % Asset coverage of 1.1-:1 as of March 13 according to the company.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2012-12-01
Maturity Price : 10.00
Evaluated at bid price : 7.20
Bid-YTW : 15.63 %
CM.PR.K FixedReset -1.91 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 21.58
Evaluated at bid price : 21.58
Bid-YTW : 5.00 %
BAM.PR.B Floater -1.73 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 7.96
Evaluated at bid price : 7.96
Bid-YTW : 5.51 %
HSB.PR.C Perpetual-Discount -1.70 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 17.35
Evaluated at bid price : 17.35
Bid-YTW : 7.41 %
TD.PR.R Perpetual-Discount -1.63 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 21.10
Evaluated at bid price : 21.10
Bid-YTW : 6.77 %
PWF.PR.M FixedReset -1.60 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 24.55
Evaluated at bid price : 24.60
Bid-YTW : 5.47 %
BNS.PR.R FixedReset -1.52 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 21.33
Evaluated at bid price : 21.33
Bid-YTW : 4.71 %
ENB.PR.A Perpetual-Discount -1.34 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 22.66
Evaluated at bid price : 22.90
Bid-YTW : 6.07 %
PWF.PR.G Perpetual-Discount -1.24 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 19.16
Evaluated at bid price : 19.16
Bid-YTW : 7.88 %
PWF.PR.I Perpetual-Discount -1.20 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 20.65
Evaluated at bid price : 20.65
Bid-YTW : 7.42 %
NA.PR.K Perpetual-Discount -1.14 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 20.77
Evaluated at bid price : 20.77
Bid-YTW : 7.17 %
TD.PR.S FixedReset -1.13 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 21.06
Evaluated at bid price : 21.06
Bid-YTW : 4.46 %
POW.PR.C Perpetual-Discount -1.12 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 18.61
Evaluated at bid price : 18.61
Bid-YTW : 7.83 %
BNS.PR.Q FixedReset -1.10 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 21.36
Evaluated at bid price : 21.66
Bid-YTW : 4.42 %
BAM.PR.N Perpetual-Discount -1.05 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 13.22
Evaluated at bid price : 13.22
Bid-YTW : 9.07 %
SLF.PR.D Perpetual-Discount -1.03 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 14.36
Evaluated at bid price : 14.36
Bid-YTW : 7.81 %
NA.PR.N FixedReset 1.01 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 22.92
Evaluated at bid price : 22.99
Bid-YTW : 4.55 %
BMO.PR.M FixedReset 1.08 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 22.43
Evaluated at bid price : 22.50
Bid-YTW : 4.18 %
TD.PR.O Perpetual-Discount 1.08 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 18.65
Evaluated at bid price : 18.65
Bid-YTW : 6.63 %
DFN.PR.A SplitShare 1.13 % Asset coverage of 1.5+:1 as of March 13 according to the company.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2014-12-01
Maturity Price : 10.00
Evaluated at bid price : 8.35
Bid-YTW : 9.08 %
HSB.PR.D Perpetual-Discount 1.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 16.60
Evaluated at bid price : 16.60
Bid-YTW : 7.59 %
W.PR.H Perpetual-Discount 1.24 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 19.55
Evaluated at bid price : 19.55
Bid-YTW : 7.21 %
GWO.PR.J FixedReset 1.43 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 24.80
Evaluated at bid price : 24.85
Bid-YTW : 5.15 %
BNA.PR.C SplitShare 1.45 % Asset coverage of 1.7-:1 as of February 28 according to the company.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2019-01-10
Maturity Price : 25.00
Evaluated at bid price : 11.17
Bid-YTW : 15.74 %
CM.PR.A OpRet 1.48 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2009-11-30
Maturity Price : 25.25
Evaluated at bid price : 25.38
Bid-YTW : 3.76 %
SLF.PR.A Perpetual-Discount 1.68 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 15.15
Evaluated at bid price : 15.15
Bid-YTW : 7.91 %
PWF.PR.K Perpetual-Discount 1.78 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 15.40
Evaluated at bid price : 15.40
Bid-YTW : 8.23 %
GWO.PR.H Perpetual-Discount 1.82 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 16.20
Evaluated at bid price : 16.20
Bid-YTW : 7.55 %
RY.PR.W Perpetual-Discount 2.00 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 18.91
Evaluated at bid price : 18.91
Bid-YTW : 6.58 %
SLF.PR.B Perpetual-Discount 2.28 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 15.23
Evaluated at bid price : 15.23
Bid-YTW : 7.95 %
SBN.PR.A SplitShare 2.97 % Asset coverage of 1.6+:1 as of March 19 according to Mulvihill.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2014-12-01
Maturity Price : 10.00
Evaluated at bid price : 8.66
Bid-YTW : 8.33 %
BMO.PR.H Perpetual-Discount 3.12 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 19.86
Evaluated at bid price : 19.86
Bid-YTW : 6.77 %
Volume Highlights
Issue Index Shares
Traded		 Notes
CIU.PR.B FixedReset 182,555 New issue settled today.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-01
Maturity Price : 25.00
Evaluated at bid price : 25.61
Bid-YTW : 6.20 %
PWF.PR.K Perpetual-Discount 60,402 Desjardins crossed 43,400 at 15.24.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 15.40
Evaluated at bid price : 15.40
Bid-YTW : 8.23 %
RY.PR.L FixedReset 53,415 Nesbitt bought 40,000 from National at 23.81.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 23.79
Evaluated at bid price : 23.83
Bid-YTW : 4.99 %
CM.PR.L FixedReset 49,542 National bought 40,000 from Nesbitt at 25.04.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 25.06
Evaluated at bid price : 25.11
Bid-YTW : 6.25 %
TD.PR.I FixedReset 38,473 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-27
Maturity Price : 24.97
Evaluated at bid price : 25.02
Bid-YTW : 6.05 %
TD.PR.M OpRet 36,506 Desjardins crossed 10,000 at 25.87 and bought 20,000 from National at 25.86.
YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2013-10-30
Maturity Price : 25.00
Evaluated at bid price : 25.70
Bid-YTW : 4.22 %
There were 34 other index-included issues trading in excess of 10,000 shares.
Issue Comments

CIU.PR.B Soars to Hefty Premium on Decent volume

The CIU Inc. Fixed-Resets, 6.70%+481 announced last week had a superb opening day, trading 182,555 shares in a range of 25.25-85 before closing with a quote of 25.61-85, 5×15.

Its vital statistics may be summed up as:

CIU.PR.B FixedReset YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-01
Maturity Price : 25.00
Evaluated at bid price : 25.61
Bid-YTW : 6.20 %

An encouraging sign! I can imagine the brokers are now beating the bushes desperately, looking for more potential issuers with a decent credit rating and the ability to offer cumulative dividends!

One interesting thing about this issue is that it still looks cheap against CIU.PR.A, which closed today at 17.55-90, 15×10, to yield a beggarly 6.64% at the bid, supported by the quite extraordinary premium the market is placing on cumulativity of dividends. This implies that the market is evaluating the value of reset feature at only 44bp … not too much!

Interesting External Papers

OCC Releases 4Q08 Bank Trading Report

The Office of the Comptroller of the Currency has released its Quarterly Report on Bank Trading and Derivatives Activities. Credit trading has been a disaster:

A commercial banks was reasonably strong in the fourth quarter, the quarter was particularly difficult for number of reasons, and banks reported a sizable trading loss of $9.2 billion. Market liquidity suffered in the fourth quarter of 2008 and general economic conditions worsened, resulting in escalated write-downs in legacy credit positions, including CDOs, leveraged loans and mortgage-related exposures. These write-downs flowed through trading revenues and dwarfed the underlying strength in trade profitability from wide bid-ask spreads.

Trading results in the fourth quarter also suffered due to an unfavorable combination of rising overall corporate credit spreads and declining credit spreads for the bank dealers themselves. Rising counterparty credit spreads increase the risk of derivatives receivables. Banks account for this increased risk by lowering the fair value of those receivables. Banks report the rising credit costs associated with a write-down of receivables values as trading losses. While these higher credit costs are a part of operating a derivatives business, they can (and in the fourth quarter did) mask otherwise profitable trading operations. Typically, when credit spreads increase, much of the negative impact on bank trading results from write-downs of receivables can be offset by writedowns of derivatives payables. However, in the fourth quarter, government support for the banking industry resulted in lower bank credit spreads. As a result, the fair value of bank derivatives payables increased, and therefore banks reported additional trading losses.

This “net” current credit exposure is the primary metric used by the OCC to evaluate credit risk in bank derivatives activities. A more risk sensitive measure of credit exposure would also consider the value of collateral held against counterparty exposures. While banks are not required to report collateral held against their derivatives positions in their Call Reports, they do report collateral in their published financial statements. Notably, large trading banks tend to have collateral coverage of 30-40% of their net current credit exposures from derivatives contracts.

Continued turmoil in credit markets has led to deterioration in derivatives-related and loan credit metrics. The fair value of derivatives contracts past due 30 days or more totaled $363 million, up $302 million from the third quarter. Past due contracts were 0.05% of net current credit exposure in Q4, up from 0.01% in the third quarter. During the fourth quarter of 2008, U.S. commercial banks charged-off a record $847 million in derivatives receivables, or 0.10% of the net current credit exposure from derivative contracts, up from the 0.02% in the prior quarter. [See Graph 5c.] For comparison purposes, Commercial and Industrial (C&I) loan net charge-offs rose to $5.5 billion from $3.0 billion and were 0.4% of total C&I loans for the quarter, nearly double the ratio of the third quarter.

The report has many fascinating graphs.

Market Action

March 26, 2009

It would appear hedge funds have hired an insufficient number of ex-regulators! Geithner wants to change this:

Treasury Secretary Timothy Geithner will ask Congress to bring large hedge funds, private- equity firms and derivatives markets under federal supervision for the first time as part of a revamp of U.S. financial rules.
…
Geithner’s framework would set up an independent overseer for systemically vital firms. While the Bush administration had proposed that the Federal Reserve take on that authority, Geithner won’t specify which agency should have the job. Bernanke has also called for a systemic-risk regulator, and said the central bank should have some role.
…
The administration’s framework would make it mandatory for large hedge funds, private-equity firms and venture-capital funds to register with the Securities and Exchange Commission, subjecting them to new disclosure requirements and inspections by the agency’s staff.

I will certainly agree that enormous bets by the shadow-banking system have had huge knock-on effects. However, I will note that:

  • enormous bets by the banking system itself – and the equally regulated large brokerages – had effects that didn’t need to be transmitted.
  • if a system can be destabilized by an outside force, it has too much exposure too that outside force

It is well within the purview of extant regulators to clean up their acts and impose concentration limits – by asset class and by counterparty – on their future employers. While they’re at it, they can also impose collateral requirements on these firms trading desks that would have required these firms to have collateralized their AIG exposure themselves, if there was insufficient money at AIG. This would have forced AIG to go under – or to cease writing new business – long before it became a systemic threat.

It would appear the biggest of AIG’s counterparties were brokerages, regulated by the SEC:

Lenders owed money from AIG’s derivative contracts were led by Paris-based Societe Generale with $11 billion, followed by Goldman Sachs with $8.1 billion; Frankfurt’s Deutsche Bank, with $5.4 billion; Merrill Lynch, at $4.9 billion; and Zurich-based UBS, which received $3.3 billion. The totals exclude amounts from securities-lending programs.

Of the biggest U.S. banks, JPMorgan Chase & Co. received $400 million from AIG, and Morgan Stanley got $200 million. Both are based in New York. Bank of America was given $700 million.

While the amounts for banks were large and total write-off could have spoiled a quarterly report, to call them a systemic risk seems a bit of a stretch. But what were the brokerages doing, having that kind of concentration risk? What was the SEC doing, allowing them to have that kind of concentration risk?

To address the problem this way, however, would force the regulators to give up their touching faith in the sanctity of a Credit Rating Agency’s opinions; and it would force regulators to admit that their response to the rise of systemic risk was inadequate. Ain’t gonna happen.

It’s looking like the UK may be heading for a financial crisis:

Brown, who had the backing of 30 percent of the electorate in a ComRes Ltd. poll last week, must now cope with what amounts to a vote of no confidence by investors in his ability to end the recession. Bank of England Governor Mervyn King, his ally for much of the past decade, warned a day earlier that there’s no more money for further spending.
…
The European Commission this week forecast Britain’s budget deficit would touch 9.6 percent of gross domestic product in the year ending March 2010, triple the EU limit.

When the 1995 gilt auction failed, investors were concerned that John Major’s Conservative government was on course to lose the general election and was about to announce tax cuts it couldn’t afford. Now, it’s low interest rates that are to blame, according to Robert Stheeman, the head of the Debt Management Office, which manages gilt sales for the Treasury.

The Bank of England cut its benchmark lending rate to 0.5 percent this month, the lowest ever, and started a program to boost the money supply.

“Yields at these levels are not at all attractive,” Stheeman said yesterday. Opposition lawmakers seized on the comments from Stheeman and King to suggest Brown’s reputation for smooth handling of the economy is in tatters.

This evening’s seminar on SplitShares went quite well, I thought, despite going about fifteen minutes overtime. Geez, you know, I spend all my prep time worrying that I’ll only have fifteen minutes’ worth of material, and the last half of the seminar trying desperately to get back on schedule! The video will, eventually, be available on the Internet for your viewing pleasure.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices
Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)		 Median
YTW		 Median
Average
Trading
Value		 Median
Mod Dur
(YTW)		 Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 -0.0347 % 868.5
FixedFloater 0.00 % 0.00 % 0 0.00 0 -0.0347 % 1,404.5
Floater 4.56 % 5.41 % 66,526 14.81 3 -0.0347 % 1,084.9
OpRet 5.25 % 5.06 % 130,597 3.88 15 -0.1652 % 2,063.9
SplitShare 6.75 % 9.32 % 49,036 4.78 6 -0.3225 % 1,645.8
Interest-Bearing 6.06 % 9.05 % 34,757 0.73 1 0.5076 % 1,937.5
Perpetual-Premium 0.00 % 0.00 % 0 0.00 0 -0.1742 % 1,505.0
Perpetual-Discount 7.20 % 7.33 % 156,235 12.16 71 -0.1742 % 1,386.0
FixedReset 6.13 % 5.80 % 620,969 13.75 31 0.1131 % 1,810.2
Performance Highlights
Issue Index Change Notes
LFE.PR.A SplitShare -3.40 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2012-12-01
Maturity Price : 10.00
Evaluated at bid price : 7.39
Bid-YTW : 14.96 %
NA.PR.M Perpetual-Discount -2.38 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 20.55
Evaluated at bid price : 20.55
Bid-YTW : 7.43 %
HSB.PR.D Perpetual-Discount -1.91 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 16.40
Evaluated at bid price : 16.40
Bid-YTW : 7.68 %
CM.PR.E Perpetual-Discount -1.86 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 18.50
Evaluated at bid price : 18.50
Bid-YTW : 7.58 %
SLF.PR.B Perpetual-Discount -1.78 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 14.89
Evaluated at bid price : 14.89
Bid-YTW : 8.13 %
BMO.PR.H Perpetual-Discount -1.73 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 19.26
Evaluated at bid price : 19.26
Bid-YTW : 6.99 %
BNS.PR.N Perpetual-Discount -1.69 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 19.17
Evaluated at bid price : 19.17
Bid-YTW : 6.99 %
CM.PR.A OpRet -1.54 % YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2011-07-30
Maturity Price : 25.00
Evaluated at bid price : 25.01
Bid-YTW : 5.09 %
ELF.PR.G Perpetual-Discount -1.40 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 13.40
Evaluated at bid price : 13.40
Bid-YTW : 9.13 %
RY.PR.A Perpetual-Discount -1.39 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 17.00
Evaluated at bid price : 17.00
Bid-YTW : 6.65 %
MFC.PR.B Perpetual-Discount -1.38 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 15.73
Evaluated at bid price : 15.73
Bid-YTW : 7.47 %
RY.PR.G Perpetual-Discount -1.36 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 16.65
Evaluated at bid price : 16.65
Bid-YTW : 6.86 %
GWO.PR.I Perpetual-Discount -1.33 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 14.80
Evaluated at bid price : 14.80
Bid-YTW : 7.66 %
RY.PR.F Perpetual-Discount -1.32 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 16.41
Evaluated at bid price : 16.41
Bid-YTW : 6.89 %
MFC.PR.C Perpetual-Discount -1.32 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 15.00
Evaluated at bid price : 15.00
Bid-YTW : 7.58 %
ELF.PR.F Perpetual-Discount -1.27 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 14.76
Evaluated at bid price : 14.76
Bid-YTW : 9.25 %
BNS.PR.P FixedReset -1.21 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 22.71
Evaluated at bid price : 22.81
Bid-YTW : 4.37 %
DFN.PR.A SplitShare -1.19 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2014-12-01
Maturity Price : 10.00
Evaluated at bid price : 8.30
Bid-YTW : 9.32 %
CM.PR.G Perpetual-Discount -1.15 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 18.01
Evaluated at bid price : 18.01
Bid-YTW : 7.51 %
PWF.PR.A Floater -1.13 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 13.16
Evaluated at bid price : 13.16
Bid-YTW : 3.35 %
TD.PR.O Perpetual-Discount -1.13 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 18.45
Evaluated at bid price : 18.45
Bid-YTW : 6.70 %
IAG.PR.C FixedReset -1.10 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 21.51
Evaluated at bid price : 21.51
Bid-YTW : 6.22 %
POW.PR.C Perpetual-Discount -1.05 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 18.82
Evaluated at bid price : 18.82
Bid-YTW : 7.74 %
PWF.PR.F Perpetual-Discount 1.03 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 17.60
Evaluated at bid price : 17.60
Bid-YTW : 7.62 %
GWO.PR.F Perpetual-Discount 1.04 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 19.45
Evaluated at bid price : 19.45
Bid-YTW : 7.65 %
BNS.PR.Q FixedReset 1.15 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 21.86
Evaluated at bid price : 21.90
Bid-YTW : 4.28 %
TD.PR.R Perpetual-Discount 1.42 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 21.45
Evaluated at bid price : 21.45
Bid-YTW : 6.66 %
SBN.PR.A SplitShare 1.57 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2014-12-01
Maturity Price : 10.00
Evaluated at bid price : 8.41
Bid-YTW : 8.96 %
BMO.PR.M FixedReset 1.64 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 22.20
Evaluated at bid price : 22.26
Bid-YTW : 4.11 %
PWF.PR.I Perpetual-Discount 1.65 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 20.90
Evaluated at bid price : 20.90
Bid-YTW : 7.33 %
BNS.PR.R FixedReset 1.69 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 21.62
Evaluated at bid price : 21.66
Bid-YTW : 4.52 %
BAM.PR.B Floater 1.76 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 8.10
Evaluated at bid price : 8.10
Bid-YTW : 5.41 %
PWF.PR.H Perpetual-Discount 1.95 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 17.80
Evaluated at bid price : 17.80
Bid-YTW : 8.27 %
BAM.PR.H OpRet 1.95 % YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2012-03-30
Maturity Price : 25.00
Evaluated at bid price : 23.50
Bid-YTW : 8.05 %
PWF.PR.G Perpetual-Discount 2.05 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 19.40
Evaluated at bid price : 19.40
Bid-YTW : 7.78 %
GWO.PR.G Perpetual-Discount 3.36 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 16.90
Evaluated at bid price : 16.90
Bid-YTW : 7.76 %
Volume Highlights
Issue Index Shares
Traded		 Notes
RY.PR.P FixedReset 51,994 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 25.29
Evaluated at bid price : 25.34
Bid-YTW : 5.96 %
TD.PR.I FixedReset 48,560 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 24.94
Evaluated at bid price : 24.99
Bid-YTW : 5.97 %
TD.PR.E FixedReset 45,550 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 25.21
Evaluated at bid price : 25.26
Bid-YTW : 6.11 %
TD.PR.G FixedReset 36,575 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 25.25
Evaluated at bid price : 25.30
Bid-YTW : 6.09 %
BNS.PR.X FixedReset 30,325 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-03-26
Maturity Price : 25.27
Evaluated at bid price : 25.32
Bid-YTW : 6.14 %
LFE.PR.A SplitShare 28,755 YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2012-12-01
Maturity Price : 10.00
Evaluated at bid price : 7.39
Bid-YTW : 14.96 %
There were 31 other index-included issues trading in excess of 10,000 shares.