PrefBlog

It’s an ill wind that blows nobody any good:

U.S. banks are looking to capitalize on a dearth of financing for Europe’s commercial property market that’s driven lending margins to five times the level prior to the 2008 crisis.

Citigroup Inc. (C), Morgan Stanley (MS), Bank of America Corp. (BAC) and Wells Fargo & Co. (WFC) are following insurers and distressed investors allocating capital to the region as local banks, which overextended during the last boom, are forced to contract amid new regulations. Europe faces an $82 billion shortfall between the amount of real-estate debt maturing through this year and the funding available to replace it, according to real-estate broker DTZ.

The scarcity of capital means lenders can charge as much as 3.75 percentage points over benchmarks for the safest pieces of commercial mortgage debt, about five times the spread in 2007, according to Alvarez & Marsal, an adviser on real estate transactions. Those margins will enable banks to revive the market for commercial mortgage-backed bonds, which parcel loans and slice them into securities of varying risk, after it largely shut in 2008.

Meanwhile, the Fed may find selling is harder than buying:

MSCI applied scenarios devised by the Fed itself for stress-testing the nation’s 19 largest banks.

MSCI sees the market value of Fed holdings shrinking by $547 billion over three years under an adverse scenario that includes an economic contraction and rising inflation. MSCI puts the Fed’s mark-to-market loss at less than half that, or $216 billion, if the economy performs in line with consensus forecasts of gradually rising growth, inflation and interest rates.

The potential losses are unprecedented in the Fed’s 100- year history. Bernanke began describing in detail the risk of lower payments to taxpayers for the first time today in his monetary policy testimony before the Senate Banking Committee saying that “remittances to the Treasury could be quite low for a time” if interest rates “were to rise quickly.” Bernanke didn’t describe the overall interest-rate risk to the portfolio or potential mark-to-market losses. He said the Fed is “confident” it has tools to tighten monetary policy.

But at least the money is going into something other than mortgages:

Money is pouring into leveraged loan funds at an incredible pace. It’s a natural home for investors who are leery of buying bonds at this point in the cycle, when rates could be on the rise, but who still want credit exposure. Leveraged loans are usually floating rate. And that means protection from higher interest rates, unlike bonds, which will fall in price as rates rise.
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Among the biggest users of the leveraged loan market are private equity firms who use the financing for buyouts. The leveraged loan boom will help refinance balance sheets of portfolio companies, and fuel more new takeovers.

And the shadow trading sector is getting bigger:

Earlier today, JPMorgan Chase & Co. announced that it will reduce headcount in its consumer banking arm by 3,000 to 4,000 people this year.

Morgan Stanley and Citigroup Inc. have also unveiled plans in recent months to shed staff. As early as this week, Goldman Sachs Group Inc. will begin its annual exercise to cull 5 per cent of its employees, with deeper cuts possible in equity trading, Reuters reported.
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But [Thomas DiNapoli, the comptroller of New York State] also noted that the industry employed 1,000 fewer people at the end of 2012 than it did a year earlier, adding that he believes “the industry will continue to restructure and downsize until a new business paradigm is established.”

If that doesn’t sound like a lot of fun, that’s probably an accurate assessment. Some traders have already decamped for hedge funds, where they don’t have to contend with the same regulatory constraints or reduced appetite for risk.

Best wishes for Graham Beck, who started working at Burns Fry in 1985, moved to the the preferred share desk in 1991 and today announced his imminent retirement from BMO Nesbitt Burns. As he says: a lot has happened in 22 years; and I’ll add that that extends to the names of his employer as well as the preferred share market!

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 4bp, FixedResets off 1bp and DeemedRetractibles up 15bp. Volatility was minimal. Volume was extremely high.

More bad news out of Europe, even before the Italian election returns:

he euro zone will not return to growth until 2014, the European Commission said on Friday, reversing its prediction for an end to recession this year and blaming a lack of bank lending and record joblessness for delaying the recovery.

The 17-nation bloc’s economy, which generates nearly a fifth of global output, will shrink 0.3 per cent in 2013, the Commission said, meaning the euro zone will remain in its second recession since 2009 for a year longer than originally foreseen.

I was interested to see in an unrelated article that preferred share ETFs are the benchmark du jour for asset gathering:

There are eight minimum/low volatility exchange-traded funds listed in Canada and it’s fair to say the concept hasn’t caught on like wildfire given that assets under management are collectively less than $150-million.

By comparison, the BMO S&P/TSX Laddered Preferred Share Index ETF (ZPR/TSX) grew from zero to $160-million in the span of exactly three months. Judging by the amount of assets that have flocked to ETFs dedicated to the preferred share market, growth in that group is all but certain.

It has now been about three and a half months since the 2012-11-14 inception of ZPR and the fund is now at $243-million. Not bad!

It was a surprisingly negative day for the Canadian preferred share market, with PerpetualPremiums off 5bp, FixedResets losing 31bp and DeemedRetractibles down 16bp. As indicated in the longer-than-usual volatility highlights, it looks like a relatively modest amount of selling pressure found few bids in the last half hour. Overall volume was extremely high, but block trading details are not yet available.

Moody’s downgraded the UK:

Britain lost its top credit rating by Moody’s Investors Service, which cited the continuing weakness in the nation’s growth outlook and the challenges that presents to the government’s fiscal consolidation program.

The rating on the U.K. was lowered one level to Aa1 from Aaa and the outlook on the nation’s debt changed to stable, Moody’s said in a statement today. With the U.K.’s high and rising debt burden, a deterioration in the government’s balance sheet is unlikely to be reversed before 2016, Moody’s said in the statement.

Yen Lee, a successful IT entrepreneur, has some hard truths about Canadians:

Canadians in general are looking for safe day jobs. Because Vancouver and Canada in general have not had the history of the home runs, like the Googles and the Yahoos and the Facebooks. And so, because they don’t see the upside, all they see is the risk involved with a start-up—because start-ups in Canada are sub-scale and don’t end up being big enough to exit. And that leaves the folks who are willing, that have a desire to be disruptive, the folks with an appetite for risk; those folks in Canada usually end up in the U.S.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums down 10bp, FixedResets gaining 4bp and DeemedRetractibles off 4bp. Volatility was minor. Volume was above average.

Poor little Encana’s having a temper tantrum:

A lawyer for Encana Corp. is demanding the deletion of an Internet posting containing audio of an Encana executive swearing.

On Feb. 14, during a quarterly results conference call, microphones caught someone – Encana has not said who – muttering an angry expletive. The audible whisper followed a question from Canaccord Genuity analyst Phil Skolnick, who asked: “But in terms of new investment guidelines which were updated, do you think that prohibits a company like Encana from being acquired?”
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Encana apologized after the conference call. The swearing does not appear in a transcript of the call, nor in a company replay of the audio.

The company now wants the clip off the Internet, too. On Thursday, Chirbit founder Ivan Reyes said he has received a takedown request from Encana.

I wouldn’t have posted anything about this yesterday because somebody swearing during a conference call is stupid, but not interesting. A major corporation getting its shorts in a knot over a triviality and displaying the collective brainpower of a fourteen year old girl, however, is fascinating. Especially when the fourteen year old girl hasn’t even heard of the Streisand effect. One can only assume that Encana management is not very bright.

Speaking of less-than-intelligent corporate management, there’s a bit more news about Scotia Capital’s persecution of David Berry:

“IIROC will not be appealing the decision,” said Elsa Renzella, IIROC’s director, enforcement litigation.
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One interpretation behind the decision not to appeal is that IIROC wanted to wash its hands of the whole affair after at least initially bending over backwards to accommodate the bank.

How accommodating was IIROC? At the time, it said the following: “We are pleased that Scotia Capital recognized in this settlement that, even though supervision was not an issue, it would not be appropriate to retain profits generated by the wrongdoing of its employees.”

In normal circumstances, it would be tough for a bank to get such an overwhelming level of support, given that the Berry/IIROC matter had not been heard and given that almost six years later the three-person panel said that “the preponderance of evidence suggests” that Berry’s immediate superiors knew of his tactics.
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And given the dynamics of Scotiabank upper management, a reasonable expectation would be that an attempt will be made to settle the matter [of Berry’s $100-million unjust dismissal lawsuit].

The dynamics: the bank is undergoing a change, with chief executive Rick Waugh seemingly set to leave in the near term. If the pundits have called it right, it seems Brian Porter, who was named president late last year, will replace Waugh.

Porter was Berry’s ultimate boss at the time the supposed transgressions occurred. If the matter is not settled and if Porter were put on the stand, the session would be well attended.

Berry was vindicated on January 17.

There’s an interesting US court case about Mutual Fund Fees:

>According to a 1982 legal precedent known as the Gartenberg standard, the courts will deem a fund’s management fee excessive only if it is “so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.” In part because it is often difficult to isolate the portion of management fees covering the crucial work of picking stocks and bonds from other more mundane administrative costs, proving that has been virtually impossible.

Until now. In December U.S. District Judge Renee Marie Bumb in Newark, New Jersey, allowed a case known as Kasilag et al. vs. Hartford Investment Financial Services to proceed, denying Hartford’s motion to dismiss.
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According to Kasilag’s complaint, in 2010 Hartford earned $157.6 million in investment management fees from six of its sub-advised funds and paid $57.6 million for subadvisory services to Wellington and Hartford Investment Management Company (HIMCO), a Hartford subsidiary hired as a sub-adviser.
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A key argument plaintiffs put forth in the Hartford case is that competitor Vanguard offers similar funds run by Wellington for much less. Both the Vanguard Health Care and the Hartford Healthcare funds are run by Wellington. Vanguard has a total expense ratio of 0.35 percent, compared with the 1.49 percent charged by Hartford Healthcare’s A share class. That’s on top of the 5.5 percent front-end commission paid to brokers who sell it; Vanguard’s fund is no-load. Wellington declined to comment on the Hartford case.

It was a highly uninteresting day for the Canadian preferred share market, with PerpetualPremiums gaining 2bp, FixedResets up 1bp and DeemedRetractibles off 1bp. Volatility was minimal. Volume was high.

The lawyers and do-gooders at IIROC are continuing their efforts to destroy the Canadian corporate bond market:

>Four years ago, the head of the investment industry’s self-regulator said that a plan to create surveillance to protect fixed income investors was a priority. At last, the final step needed to make that happen appears to be here.

The regulator has been taking things in bites. First, in 2009, there was a demand for better disclosure of what people were paying banks and securities firms to trade debt. Then, in 2011, a rule demanding that all securities firms “ensure clients received fair prices on debt transactions.”
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So now, the Investment Industry Regulatory Organization of Canada is amping up trade reporting requirements to create something at least resembling the kind of surveillance that has long been there in equity markets, where a computer system watches every trade to ensure investors are getting the best available price at any given point.

The new rule will require securities dealers to report every trade, once it’s done. IIROC will use that to build a database that is the start of a real surveillance mechanism. It’s still not the real-time computerized flagging of trades that aren’t done at the best possible price, but it’s perhaps the biggest step yet toward that happening.

As the linked article in the Globe shows, the IIROC honcho who started this mess was Susan Wolburgh Jenah who, as far as I can tell from her official biography, has never traded a security in her life.

To my chagrin, the proposed rule cites a paper promoted by the CFA Institute and published as part of their Codes, Standards and Position Papers and comes complete with an “Issue Brief”. The paper itself is titled An Examination of Transparency in European Bond Markets and I must say I consider it very disappointing in terms of rigour; however, a full rebuttal will require enough work and length that it will be more suitable to PrefLetter than PrefBlog.

The basic problem with this idea is that it makes it less lucrative for bond dealers to hold inventory. This means fewer offerings of individual bonds to retail and it means small size markets being called for institutional players. This in turn leads to a migration of bond issues to the private placement market and decreased functionality of the capital markets in general. Essentially, the problem that fairness brings to bond markets is the same as that of socialisn: in a socialist economy, everything’s cheap but nothing’s available; in a “fair” bond market, all the spreads are narrow, but the market makers won’t back up their quotes – when given – with significant risk capital.

It was a mixed day for the Canadian bond market, with PerpetualPremiums down 11bp, FixedResets up 9bp and DeemedRetractibles off 9bp. Volatility was low. Volume was extremely high.

PerpetualDiscounts now yield 4.90%, equivalent to 6.37% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 4.35%, so the pre-tax interest-equivalent spread is now about 200bp, a small rebound from the 195bp reported February 6.