PrefBlog

A bit more news came out regarding the Aastra lawsuit mentioned yesterday. In a Globe story:

Mr. Del Sorbo was an investment adviser to Aastra for about seven years, according to the lawsuit. During May and June, rising interest rates caused paper losses in the company’s bond and preferred share holdings. As a result, the company told Mr. Del Sorbo in June “that it wished to invest only in conservative, short-term, liquid securities with no exposure to interest rates and very low default risks,” the suit said.

As the portfolio was being reassessed, Mr. Del Sorbo talked about non-bank asset-backed commercial paper, “which he described as primarily baskets of residential mortgages with limited car loans and credit card debt, bundled together to produce a high-quality short-term investment product,” the suit said.

In July, Aastra put $8.5-million into an ABCP trust called Structured Investment Trust III, which was priced to yield 4.62 per cent.

That’s one of the issuers whose business was frozen under the Montreal Accord.

As it turns out, the underlying assets were about 94 per cent credit default swaps on long-term bonds, the lawsuit said. The claims have not been proven in court.

John Tobia, Aastra’s general counsel, would only say that “from our perspective, the pleadings speak for themselves.”

Finding Structured Investment Trust III on the DBRS website is a little tricky (they’re not exactly unique keywords, are they?), but one can quickly find the May 11 Press Release:

The Trust is a vehicle that is designed to purchase structured securities including CDOs.

The press release also states that Coventree is the sponsor, and a quick trip to Coventree’s site yields the conduit’s page which has links to the full rating report and the Information Memorandum. Coventree’s site also has Monthly Conduit Reports which are password protected; I can’t be bothered to get a password because, well, because I’m not putting $8.5-million into the thing. However, the Information Memorandum states:

The Financial Agent prepares a monthly Investor Report and makes this report available on-line to purchasers of Notes on a password-protected basis at http://www.nereusfinancial.com/. The Investor Reports contain information about the specific Purchased Securities held by SIT from time to time. Purchased Securities are obtained by SIT from Originators in major international credit default, CDO and associated markets. In order to secure optimum execution and terms, in accordance with prevailing practice in these markets, the identities of Originators are shared with the Rating Agency but are otherwise kept confidential by the Financial Agent.

It’s right there, in the summary, page 4, under the heading “Investor Information”. If anybody didn’t know what was in the thing, it’s because they couldn’t be bothered to find out.

Aastra’s counsel is quoted as stating that “from our perspective, the pleadings speak for themselves.”, but oddly, I don’t see the pleadings disclosed on their website; I guess they don’t really have a lot to say. Or maybe it’s just an oversight. Or something.

Speculation is building regarding next week’s Fed meeting, with a cut of 25bp being forecast by some. The November Fed Funds contract implies that this forecast has some general acceptance; trading at 95.54 today implying a projected effective rate of 4.46%. The actual trading rates for this month have been choppy, but it appears that the current 4.75% target is holding and being defended.

Meanwhile, the credit crunch continues, with another SIV indicating it is having difficulty financing:

MBIA Inc., owner of the world’s largest bond insurer, said a $1.8 billion structured investment vehicle it runs through its asset management business is having trouble raising money and is seeking funding alternatives.

MBIA has invested $15.8 million in the capital notes of Hudson-Thames Capital Ltd. and said it has no obligation to provide the SIV with liquidity support or guarantees. MBIA today reported its first quarterly loss ever after marking down the value of mortgage-related debt it guarantees by $342.1 million.

In what may or may not be interpreted as a positive sign (depending on what answer you want) US ABCP outstanding declined by only USD 4.6-billion in the past week – practically a rounding error. November could be interesting, however: there are persistent, if unofficial and unconfirmed reports that there will be a big whack of MTN paper maturing, that may well be very difficult to roll.

One of the more entertaining things I’ve read recently is an ‘I toldja so’ puff-piece by Nouriel Roubini – for instance:

In March, when this author wrote a long (30 pages), serious semi-academic research analysis – with Christian Menegatti – of why the housing recession had not bottomed out and why home prices would sharply fall further, this scholarly analysis was summarily and cheaply dismissed in the most crass terms (“the paper is really just a longer-than-usual blog”) by a popular blogger who had barely bothered even to read it. At least Daniel Gross – a very smart blogger – had the decency to literally eat pages of his own writings – as he had promised he would – when one [of] his financial predictions failed.

Cassandra’s Revenge!

I’ve updated the post regarding the BoE Financial Stability Report and will add more as I work through it. It’s good stuff, it really is; beautifully researched. If I made a special note of everything it contains that is interesting, my post would be longer than the report itself; those with an interest in this sort of thing are strongly encouraged to read the full publication.

As far as preferreds are concerned … PerpetualDiscounts continued to decline, much to my chagrin. One participant on Financial Webring Forum noted today:

I suppose this may have answered my question I had been pondering for some time about the recent MAPF sectoral allocation shift toward discount issues. The low coupon discounts seem like a bit of a trap to me, and although I hadn’t ruled out that you’d simply lost your mind, I suspect you know what you’re doing……………….

Well, it’s nice to know he presumed I had a mind to start with! As it is, I fear that results for the fund for this month will be summed up as “Too Soon”. As has been noted here in the past, sectoral shifts within the fund do not reflect an attempt at market timing; merely an analysis of the curve that shows that one sector has gotten out of whack with another. Over time, this works quite well; but not this time.

HPF.PR.B was down over 7% today, presumably due to yesterday’s downgrade. I suppose there are some non-PrefBlog-reading investors out there who considered the downgrade a surprise.

Good volume today, which is certainly meaningful. Just precisely what it means changes every time, of course, but in a month or so the technical analysts will be pleased to tell us what we obviously should have done.

There were thirty other index-included $25.00-equivalent issues trading over 10,000 shares today.

Well … there won’t be much today!

All my non-preferred-trading-and-carnage-watching time today was spent puzzling over Capital Tax … some bond investments are subject to capital tax and some other bond investments are not subject to capital tax. The difference is, ostensibly, to avoid double taxation; I suspect that the real goal is to

• raise money in a manner that will be invisible to Joe Lunchbucket
• provide employment for retired politicians

Friend Flaherty is, of course, too busy grandstanding with ATM fees, National Securities Regulators and the price of eggs & milk in Buffalo … no, scratch that, the price of eggs and milk in Buffalo SHOULD be cheaper than in Toronto, because otherwise farmers with quota might have to work for a living … the price of Harry Potter books in Buffalo to be worried about doing something useful. Like eliminating busy-work taxes that have economically negative effects.

Some readers might surmise that I’m not in the best of tempers. Some readers might win a kewpie doll if they can do it three times running.

So … just time for one snippet of interesting financial news … there’s an ABCP lawsuit announced:

A potential flood of lawsuits over asset-backed commercial paper could hit courts in the coming weeks after Aastra Technologies Ltd. (TSX: AAH.TO) became the first to launch a legal action against adviser HSBC Securities for exposing the IT company to the troubled investment vehicle.

Aastra’s press release states:

Finally, as previously announced during the quarter, the Company currently holds $13.7 million of non-bank owned asset-backed commercial papers for which, currently, there is no active market. Of these investments, $8.5 million is invested in Structured Investment Trust III and was not repaid to the Company when it became due on October 10th while $5.2 million invested in Lafayette Structured Credit Trust is not yet due until October 30th of this year.

As a result of the developments above, Aastra commenced legal proceedings today against its investment advisor, HSBC Securities (Canada) Inc. and one of its employees, in the Ontario Superior Court of Justice seeking damages relating to investment advice provided with respect to Aastra’s purchase of the Structured Investment Trust III asset-backed commercial paper.

On August 23, they stated:

As of August 23, 2007, Aastra had $13.7 million, or approximately 11% of its cash and short-term investment balances, invested in asset-backed commercial paper.

So … a couple of observations … most of which are really queries:

• HSBC Securities? So it’s a stockbroker they’re blaming? What was his Money-Market track record? I wonder how much due diligence they did before hiring him.
• Frankly, 11% of a money market portfolio in ABCP doesn’t sound all that actionable to me. It’s aggressive, sure, but it doesn’t sound all that reckless.
• Every time the market goes down a nickel, the OSC gets bagfulls of complaints. The favourite story I’ve heard is of a guy who got angry with his advisor during the Tech Boom (not the Wreck … the Boom). He had a portfolio and received a total of sixteen (if memory serves) recommendations. Fifteen of them made money. One of them lost a little bit. His portfolio did quite well. The client went completely berserk over the one unfortunate recommendation and made life miserable for everybody, for literally years, with complaints.
• Is Aastra serious about the lawsuit, or just grandstanding for their shareholders? If they’re serious, they’ll post all the court documents on their website; if they’re grandstanding, they’ll just send out the occasional press release.

Prefhound commented on yesterday’s post regarding current market conditions and – to my gratification – did not cast aspersions on my observation that perpetual/retractible spreads were starting to look awfully juicy! I had hoped to comment further on these spreads today, but as it is, I will set some homework for the blog’s readers (BOTH of them! That means you, too, Dad!).

In my article How Long is Forever?, I compared a perpetual with a retractible by:

• Calculating the total return of the retractible to the Retraction Date
• Determining what price the perpetual would be on that date to provide the same total return
• Determining what yield would give rise to that price
• Laughing

Recent events have increased yields of the retractibles to the point where they’re not completely stupid any more … and increased the term to their presumed retraction/redemption date to the point where meaningful comparisons can be made (if the YTW is just six months off, you’re basically comparing the perp to cash, which is silly). There’s even enough that we can choose pairs for which credit quality will cancel – or, at least, cancel as much as one can for a perp.

So, here’s your homework: What will be the perps’ yield on the retractibles’ end-date in order for the two total returns to the end-date to be equal?

I’ll try to get to this … but maybe somebody else will get there first! Just for fun, I’ll do a really quick back-of-the-envelope calculation for the PWF.PR.J / PWF.PR.L pair:

• L gets about 1.4% more yield annually than J
• For six years
• Total 8.4% more return
• Therefore can withstand 8.4% capital loss and still break even
• Current bid price of L is 21.67
• Less 8.4% is 19.94
• Dividend is $1.275
• Therefore, yield on 2013-7-30 can be 1.275 / 19.94 = 6.39% and still break even

Now, I’m not going to suggest that this calculation automatically shows that PWF.PR.L is a screaming buy for everybody. Hell, they were down 4.58% today! But I do wonder how many people have actually performed the calculation and decided they want the safety of the retractible anyway!

Total carnage for preferreds today – I can only imagine that people saw the Merrill Lynch downgrade and decided that

• All financials were at risk
• The preferreds as much as the common

The PerpetualDiscount index hit a new 18-month low and now has a total return of about negative nine percent for the 15-odd months since 2006-6-30. And, for the first time, the PerpetualPremium index has gone below the 1,000.00 starting figure. I should have stood in bed.

There were twenty-seven other index-included $25.00-equivalent issues trading over 10,000 shares today.

More details are emerging regarding the SIV situation: FT-Alphaville has republished a Fitch graph showing the NAV of the SIVs it rates:

In this case, “NAV” is a measure of the asset coverage provided to the equity noteholders; therefore, when it’s below 100%, they’ve lost money. These numbers have no independent implications for the asset coverage ratios for the senior noteholders; that will depend on the original capital structure of the SIV.

Naked Capitalism discusses this and other tidbits from the SIV front. An anonymous Fed tipster is putting out the word that the Fed’s silence should not be misconstrued. The WSJ has published an extract from an interview with the head of the Basel Committee on Banking Supervision – he’s not impressed by the Super-Conduit idea. One question-and-answer brought tears of gratitude to my eyes:

Might Basel II’s reliance on rating agencies, for instance, come under consideration?

There are problems to be solved with rating agencies. … but you remain responsible at the end of the day, yourself, and you have to make your own assessments.

Fitch Ratings has published an initial review, dated September 20, and an update, dated October 12, of the SIVs it rates (the chart above is taken from the update). Credit Sights, an independent credit rating agency (that is, one paid by its subscribers rather than – gasp! – the issuers) that delights in being gloomier than the the issuer-paid credit rating agencies, has released a report (to paying clients) that claims:

Many structured-investment vehicles may be forced to close in the next few months as defaults by SIVs run by European hedge funds make it harder for others to avoid selling off their assets

So if Super-Conduit ever gets off the ground, there is every indication that it will have plenty of assets to choose from!

I mentioned the issue of bank purchases of ABCP held in their money-market funds on August 20 in the context of managerial independence, but there are other problems with the idea. Mainly, is a MMF a stand-alone investment vehicle, or is it a bank deposit? There are some US banks purchasing SIV paper from their MMFs; this is not a right and proper thing to do. I hope that the OSFI in Canada and the Fed in the US will nail these banks to the wall on their next audit; unless unitholders are taking ALL the risk of the investment, EVERY SINGLE PENNY, then the MMF is not a stand-alone vehicle.

Given all the excitement regarding the issuance of covered bonds, it would seem that if bank-run MMFs are really “covered bank deposits” then the banks’ balance sheets should be grossed up by the size of their funds and capital adequacy determined from these figures. The National Bank, for example, has total assets of about $117-billion and a total of about $1.7-billion in various MMF vehicles: Money Market Fund, Treasury Bill Plus, US MMF, Corporate Cash Management, Treasury Management and Strategic Yield. Grossing up the balance sheet would not be the biggest charge in the world, but if the banks are going to give implicit support to their funds, it is a charge that should be taken in order to protect depositors.

Business Week has a fascinating story on the implosion of the two Bear Stearns hedge funds that triggered the whole crisis. I have updated my post on stress-testing of Australian mortgages with a report from Bloomberg that one of the largest mortgage insurers is being downgraded.

The decline in perpetual preferreds actually accellerated today; to me, the yields have gone beyond “wow!” and into “outlandish” territory … but those who are selling evidently disagree with me!

There are some proxy-variables in the yield curve analysis that lead me to suspect that there is a definite bias towards selling the newer issues – by which I mainly mean everything issued in the last year; this is a change from the situation last spring. I had mentioned at that point that liquidity appeared to be at a premium – and so it was, according to the analysis. I am beginning to suspect, however, that the yield curve needs some kind of – yech! – momentum indicator, because I am now hypothesizing that the liquidity premium was actually a proxy for a “recent issue premium”. Currently, I am analyzing a premium being paid for “cumulative dividends”; this might be a proxy for “recent issue discount”.

There’s always something new, something to be tested, that becomes apparent only in times of extreme stress. ‘Nature reveals her secrets best under torture’, and all that. If Bacon didn’t say it, then I will.

I should note – for those who might be alarmed at the idea that I don’t know everything already – that yield curve analysis is the least of my analytical worries right now. Fits to the curve are excellent; it’s diversification that has me concerned. The yield pick-up of Perpetuals over Retractibles is now so extreme it’s becoming harder and harder to justify any holdings of the latter at all!

There were twenty-eight other index-included $25.00-equivalent issues trading over 10,000 shares today.