PrefBlog

A nervous day in the market today – best illustrated by the fall in US 3-month T-Bills to 3.09%, down 66bp on the day with a Treasury auction coming in at 2.85%.

A serious affront to analyst/portfolio manager independence was delivered by National Bank in the context of their purchase of Asset Backed Commercial Paper that was sold to certain client or held by National Bank branded money market funds:

As a result, our clients can be reassured that the funds will not hold any ABCP until we are convinced of the quality and liquidity of the paper, whether or not it is issued by a major bank.
…
National Bank of Canada, mindful of the best interests of the unitholders of the National Bank Mutual Funds, preferred not to have its clients bear the brunt of this uncertainty and therefore decided to initiate the transaction announced today.

Excuse me? National Bank decided? And ABCP won’t be held until “we” (under the National Bank letterhead) are happy about the credit quality?

I may be a little dense, but Morningstar lists the portfolio manager as Richard Levesque and he works for Natcan, which is registered by the OSC as “Investment Counsel/Portfolio Manager”. He is the only one entitled to make decisions regarding fund investments within the context of the fund’s mandate and the mandate is the sole province of the unitholders. National Bank, CEO Louis Vachon, and any miscellaneous bozos from marketting have no say in the matter.

As always, there’s no telling what the real story is (the press release may have been released in unseemly haste and poorly edited with an emphasis on brevity), but I trust that all unitholders, regulators and trade associations will do what they can to ensure they know just who is running the fund, whose interests are held paramount at all times and how much influence National Bank management has over portfolio management decisions.

Some readers will not consider this a major issue. Some readers are encouraged not to come running to me when the interests of mutual funds and their corporate sponsors  become intertwined in a manner they don’t like.

In less important news, a lot of children are being thrown off sleds to the sub-prime wolves. Capital One is taking a big charge to close its Alt-A mortgage unit, KKR Financial is seeking equity after selling a big chunk of sub-primes, and Thornburg sold a whack of mortgage-backeds in a frantic attempt to delever. Solent Capital may be forced to join them, after investors wouldn’t buy their ABCP. In short, the market is working as it should, although fear continues to rule greed: money market funds are piling into those famous 3% Treasury Bills, and SachsenLB needed emergency liquidity of 17.3-billion Euros.

The blame game continues, with calls for more regulation in Europe and America. Blaming the Fed is always popular. I haven’t seen calls for more regulation in Canada yet, possibly because they’re still trying to find something that isn’t regulated.

The WSJ reminds us that all this has happened before. Brad Setser reports on current Fed thinking on how this will all resolve – which doesn’t appear to involve more regulation, thank heavens – while Jim Hamilton looks at low-investment-grade spreads and wonders where all the risk is being priced. My guess is simply that contagion from lower-quality sub-prime, while knocking hell out of higher-rated sub-prime and affecting investment-grade corporates to some degree … simply has run out of steam.

US Equities experienced a few swings, but closed up on the day, followed by their Canadian counterparts.

Treasury news was dominated by the plunge in short-end yields, while Canada continued steepening. I like steepening.

A quiet day for preferreds, although Nesbitt was able to accomplish some crossing in size. The perpetualPremium sector did well, led by BMO.PR.H and CL.PR.B.

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

All indices were assigned a value of 1000.0 as of December 31, 1993.

Index Constitution, 1999-11-30, Pre-rebalancing

Index Constitution, 1999-11-30, Post-rebalancing

Well, that’s the end of another week-and-a-half! I said the same thing August 10 … I’m gonna start putting in for overtime.

The big news of the day was the Fed cut the discount rate. As the WSJ admirably explains the discount rate is the rate at which financial institutions can borrow directly from the Fed:

Banks were reluctant to access the window because it was associated with a stigma usually reserved for distressed banks. A few years ago the Fed overhauled the discount window to try and alleviate that stigma; the rate was then set one percentage point above the funds rate and subject to far fewer conditions. In spite of that, discount window borrowing has remained paltry.

Discount lending averaged just $11 million in the week ended Aug. 15. Although that was up from $1 million in the prior week it was puny compared to the billions of dollars the Fed has regularly injected into the financial system through open market operations.

There has been some jeering that this is a mere gesture; but some cheering for such a public (and cheap!) jawboning that certainly had an effect on the markets today. The Fed even actively encouraged eligible institutions to take advantage of the cut.

The discount cut sent a message that the Fed will consider Fed Funds Target cuts, which was received loud and clear, although the Fed Funds Futures market seemed a little disappointed that the gesture was only symbolic (what a bunch of cowboys those guys are!). While data for today is not yet posted, the Fed maintained a rate of about 5% in the actual Fed Funds market yesterday, and the low yesterday was 2%, much more reasonable than the recent 0% nonsense. Goldman Sachs changed its prediction again:

Goldman Sachs Group Inc. said the Federal Reserve will cut the overnight target interest rate to 4.5 percent from 5.25 percent this year
…
Until June, Goldman had expected the Fed to cut rates 75 basis points this year. They changed the forecast in June saying the Fed would hold rates at 5.25 percent through year-end

The analyst’s track record was not disclosed, possibly due to confusion regarding just exactly which track record.

At any rate, this signal was considered to be a sign that the world was not about to come to an end and both American and Canadian equities soared, led by financials.

Not surprisingly, government bonds had a super day, with Treasury two-years dropping 6bp in yield and ten-years 2bp, to bring the term premium to 50bp. Canada followed:

The two-year bond added 12 Canadian cents to C$99.25 to yield 4.188 percent, while the 10-year bond gained 23 Canadian cents to C$96.76 to yield 4.411 percent.

The yield spread between the two-year and 10-year bond moved to 22.3 basis points from 17.2 at the previous close.

The 30-year bond fell 28 Canadian cents to C$109.05 to yield 4.448 percent.

Readers might not fully empathize with my joy at seeing a real-live actual term spread again, after all this time … but believe me, it’s there.

A major – and worrisome – fly in the ointment is that the market for asset-backed paper has dried up and now:

The gap between similarly rated asset-backed and direct- issued paper is 79 basis points, the most since Bloomberg began keeping the indexes in 1999.

Brad Setser explains some of characteristics of ABCP and its relevance to the current kerfuffle. Connoisseurs of the preferred share market will recognize some degree of similarity between the two basic types of commercial paper and the preferred share types of “Operating Retractible” and “Split Share”.

Retail ABCP aversion is very pronounced to the point where not having any is a competitive advantage for Canadian money-market funds.

Sadly, I must leave devotees of the preferred share market in suspense. I have a dinner engagement and prices were not available from the source until about 7:30pm. I’ll update tomorrow … but fear not! Today, while volatile, was actually a pretty good day.

Update, 2007-08-17

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

Well, let’s all be happy that day’s done, shall we?

Canadian equities are now down on the year, notwithstanding a monster rally that took it up almost 400 points from the lows.

A record 708.1 million shares changed hands in trading on Toronto today, surpassing the previous record of 499.8 million set on July 12, according to an e-mailed statement. The number of trades was 996,311, exceeding the 707,853 made Aug. 10.

Similarly:

NYSE Euronext (NYSE Euronext: NYX), the world’s largest and most liquid exchange group, today reported record transaction volume in its U.S. cash equities trading operations on NYSE Group exchanges with 5.73 billion shares traded, based on preliminary results.  Additionally, the NYSE also achieved new records in orders, trades and quotes.

So far this month, trading volume on NYSE Group U.S. cash equities markets in August 2007 is 110% higher than August 2006.

as US Equities plunged, then rocketted to close slightly up on the day.

Moody’s warned that a LTCM-like collapse is not entirely out of bounds, and a Wall Street type warned that Moody’s isn’t invited to his next birthday party:

“To see Moody’s make forward-looking negative statements about hedge funds, who may well be suffering in large part as a result of their reliance on Moody’s now evidently worthless ratings, is to witness the height of chutzpah.”

He’s not alone, as Sarkozy wants an investigation into Moody’s. There is, as yet, no indication as to whether Sarkozy will be investigating asset managers who underperformed their benchmarks; Sarkozy’s track record was not disclosed. I am willing to bet that Gary Jenkins will also be relieved that he will not necessarily be investigated:

“Rating agencies should be regulated and they should be paid by the investor — not by the issuer, not by the structurer,” said Gary Jenkins, a partner at London-based hedge fund Synapse Investment Management, which manages $650 million of debt assets. “It’s so obvious, so simple that it’s the one thing that probably won’t happen. They shouldn’t be paid by the people selling the bonds.”

There are others who have the maturity and personal integrity to resist the temptation to blame the rating agencies: they blame the Fed:

The result: a crisis of confidence among investors who say Bernanke must abandon his focus on inflation and prevent a deeper slide in markets that endangers economic growth.

To restore my limited faith in humanity, there is at least one other person arguing, in effect: ‘Sure, the financial markets are risky. That’s what they’re for.’

All the money the Fed has pumped in seems to be going into T-Bills, which wasn’t quite what they had in mind.

The yield on the three-month Treasury bill tumbled 0.48 percentage point today to 3.62 percent, after falling 0.54 percentage point yesterday.

The money certainly didn’t go into the Commercial Paper market, which shrank significantly. About time – have a look at the actual Fed data, particularly the “Outstandings”. It would be a mistake to draw any conclusions from data without investigating further … but boy, it sure looks as if reliance on short-term funding in the US has increased a lot over the past five years!

Amidst all the equity fear and flight to safety, Treasuries had a monster day, and the 2-10 spread widened slightly to 45bp from 44bp yesterday. Given a gappy day like today, though, a lousy beep doesn’t mean too much. Canadas were much more restrained, with more steepening, the 2-10 spread increasing from 14bp to 17bp. Actual corporate bonds are still extremely illiquid.

The Yen did well, on what is presumed to be carry-trade unwinding; outlook for the USD is still probably grim.

There was cheering in the streets early on, as banking executives from all walks of life celebrated what I think must the demise of a competitor … er, I mean, they were happy that investors aren’t being wiped out in the restructuring of the Coventry funds. The commercial paper will be converted into floating rate notes with a maturity matching that of the underlying assets; if you want to pick up a little money-market yield by investing in Asset Backed paper in the future, you are now much more likely to purchase a rock-solid security, issued by a rock-solid trust. One that’s run by, um, a bank.

Given the events of the day – corporates in general not seeing much action; stocks getting hit; retail assuming that a preferred share is simply an equity that hasn’t gone down yet – it should be no surprise that the pref market did not do very well. As has often been the case lately, the Pfd-3(high) & lower issues took a hammering [which makes more sense than the higher issues getting hurt, anyway!]: NTL.PR.G, -5.33%; DW.PR.A, -5.27%; CCS.PR.C, -4.42%; STQ.E, -4.30%; YLD.PR.B, -3.81%; WN.PR.C, -3.61%; BBD.PR.C, -3.30%; BBD.PR.B, -3.18%; WN.PR.E, -2.56%; BBD.PR.D, -2.38%; NTL.PR.F, -1.81%; CGQ.E, -1.56%; WN.PR.D, -1.53%; BPO.PR.K, -1.47%; YPG.PR.A, -1.02%.

I’m not trying to pick on the junky stuff, there are lots of investment grade issues listed below! There was one junky gainer, IQW.PR.D, +1.92%.

Lets have another look at the junky-but-not-quite-junk sampler:

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

Not quite so many links as has been the case lately, thank heavens, but those that I am going to put up are of exceptional interest … so read carefully!

Coventree was able to roll $600-million worth of paper today, which is good news, but noted:

“This ABCP was purchased primarily by investors who elected to renew or roll over their ABCP that matured (Tuesday),” Coventree stated.

I suspect there’s something of Mexican standoff implicit in the above remarks … if Coventree had to enter CCAA Protection it would be worse for both the company and the creditors.

There was a hint that much the same thing might be happening in the States, with Countrywide Financial stock plunging when Merrill Lynch changed its recommendation from “Buy” to “Sell” based on liquidity concerns. The analyst’s track-record was not disclosed. As in many such cases, this accellerated concerns to the point of becoming a self-fulfilling prophecy:

Countrywide credit-default swaps soared 225 basis points to 600 basis points, according to broker Phoenix Partners Group. That means it costs $600,000 a year to protect $10 million of Countrywide bonds from default for five years. The contracts have risen more than sixfold in the past month.  

The rout intensified after CNBC reported that Countrywide’s 30-day asset-backed commercial paper was being quoted by dealers at a 12.54 percent yield. The company previously borrowed at 15 basis points, or 0.15 percentage point, over the London interbank offered rate, which currently is about 5.57 percent for 30-day borrowings, the cable-television network reported

Even one of the bond market’s golden boys is affected, though admittedly the damage is largely self-inflicted: Nestle lost its triple-A status:

Nestle’s was cut one level to AA+ by Fitch and to Aa1 by Moody’s after the Vevey, Switzerland-based company said it plans to repurchase 25 billion Swiss francs ($21 billion) of stock, its biggest-ever share buyback. The downgrade leaves only Johnson & Johnson, Toyota Motor Corp. and Exxon Mobil Corp. holding AAA ratings from both Moody’s and Standard & Poor’s as well as Fitch.

In late news that might broil the markets tomorrow:

Australia’s Rams Home Loans Group Ltd. has been unable to refinance A$6.17 billion ($5 billion) of short-term U.S. loans because of a “lack of market liquidity” caused by the global credit rout.

Rams cited the “tightening of the global credit markets” for failing to sell the so-called extendable commercial paper, the company’s largest source of funding for its loans, it said in a statement today.

The lender has been given temporary funding of A$1 billion by two of its providers, Rams said.

In turn, both American and Canadian equities tanked. Today’s fearless prediction: pundits in tomorrow’s paper will note that the Canadian index is now more than 10% off its peak, meeting the generally accepted definition of a “correction”.

Reminds me of my back-office days back in 1987. I was asked quite seriously if I thought the 502-point drop in the Dow was a “crash” or a “correction”. I said I thought it meant the Dow was down 502 points, which wasn’t considered a particularly penetrating answer.

All the angst got the central banks moving. The Bank of Canada lowered its standards for repurchase agreements and the current month Fed Futures are now showing an expectation of an average Fed Funds rate for August (this month! August!) of 4.99%, twenty-six bps below target. This follows disclosure that the dollar-weighted average of actual Fed Funds transactions yesterday was 4.54%, with a low of half a point. We can be thankful that inflation numbers were benign and were met with cheers. A Fed governor, Poole, reminded the markets not to take anything for granted – the Fed cares about the real economy, not bit of Wall Street paper.

Given the de facto easing, it is not surpising that Treasuries had a really good day, with the two-year yield declining six basis points, although the spoil-sports trading ten-years took yield up 1bp, for a marked steeping. Canadas did not behave in anywhere near so dramatic a fashion, but 2-10 still steepened 2.3bp.

Rotten day in the preferred market, with all but one of the indices down on the day – and that one (FixFloat) was due to exceptional performance by BCE.PR.T, which accomplished this feat on zero volume. It’s very tempting to try to read something into this performance; but then again, in such a retail dominated market, strange things can happen.

Again, lack of interest in the lower rated credits was noticable, with the following performance stand-outs: YLD.PR.B, -4.55%; IQW.PR.D, -4.43%; HPF.PR.B, -4.26%; STQ.E, -3.01%; IQW.PR.C, -2.83%; DC.PR.A, -2.29%; GT.PR.A, -2.15%; NTL.PR.F, -2.07%; BBD.PR.C, -1.40%; BBD.PR.B, -1.32%; BPO.PR.J, -1.22%; and YPG.PR.A, -1.09%. Some of the lower rated credits bounced, but not many: WN.PR.C, +1.06%; WN.PR.D, +1.41%.

Just for fun, I’ll update the ‘Junky but not quite junk’ list (and remember, this is not representative! While the selections were not entirely random, they’re not entirely representative, either!).

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