Archive for January, 2008

January 31, 2008

Thursday, January 31st, 2008

Econbrowser‘s James Hamilton noted the Fed 50bp rate cut and pondered how long it will take for the easing to reach Main Street:

My bottom line: the Fed’s moves this month have to help relative to where we would have been without them, but it will take some time to see by how much. If indeed a recession began in December (and I repeat that no one knows for sure whether or not it did), things are going to get worse before they get better.

I’m not sure about Prof. Hamilton’s use of the Fed Funds Rate as the independent variable in the regression – it is more usual to use the yield on the 10-year Treasury note, as has been done (casually) by the Federal Reserve Bank of San Francisco … :

Figure 1 shows monthly data for the 10-year Treasury note rate from the beginning of 1995 through June of this year. The figure also shows the average subprime mortgage rate of lenders in the MIC sample (approximately 30 subprime lenders), beginning in January 1998. For comparison, the average mortgage rate for “prime” mortgages also is shown, for the whole period.

it appears that the prime mortgage rate tends to go up and down, by roughly proportional amounts, with the Treasury rate, but the subprime mortgage rate, although positively correlated with the Treasury rate over the period as a whole, does not follow it as closely. Statistics confirm this; the correlation coefficient between the prime mortgage rate and the 10-year Treasury note rate over the 1998-2001 period is 0.9, whereas the correlation coefficient for the subprime mortgage rate is only 0.4. (Two sets of numbers that are perfectly correlated have a correlation coefficient of 1.)

… and in the pricing of RMBS:

There are good reasons to choose the 10-year yield and the spread between this yield and the 3-month T-bill rate for capturing the salient features of MBSs. The MBSs analyzed in this paper have 30 years to maturity; however, due to potential prepayments and scheduled principal payments, their expected lives are much shorter. Thus, the 10-year yield should approximate the level of interest rates which is appropriate for discounting the MBS’s cash flows. Further, the 10-year yield has a correlation of 0.98 with the mortgage rate (see Table 1B and Figure 3). Since the spread between the mortgage rate and the MBS’s coupon determines the refinancing incentive, the 10-year yield should prove useful when valuing the option component.

The Fed Funds Rate may be expected to have influence, to be sure (of course it does! If it didn’t, it wouldn’t be so important, right?) but if this influence is exerted via the 10-year rate, then transmission to the real economy can be hung up by all the things that hang up the 3-month-to-10-year slope … which can vary a lot! 

Professor Jon Faust, however, writes an article for VoxEU that supports my own view about predictions and economic drivers in general:

We find the surprising result that no model clearly outperforms the univariate autoregressive model. This is one of the simplest possible models: it basically forecasts in every period that the GDP growth will simply follow its historical average rate back to the mean. This may be sobering for not only the Fed but for the macroeconomics profession as a whole: knowledge of interest rates, labour market conditions, capacity utilisation, inflation, or any of about 50 additional variables does not systematically improve our ability to foretell where real activity is headed.

In other words … forecasting, schmorecasting. It’s a chaotic world. Meanwhile, Paul Krugman of the NYT asks:

So: is it even possible for the Fed to cut interest rates enough to create a renewed housing boom? (The Fed can cut the overnight rate all the way to zero, but even large changes in the overnight rate can have only modest effects on mortgage interest rates, if the market perceives those changes as temporary.) If it can’t, how much can the Fed really do to help the economy?

Transmission is a hot topic. Menzie Chinn of Econbrowser reviewed the various channels whereby monetary policy influences GDP and concludes:

What is the (policy) upshot of this discussion? In answer to the question of which sector can fulfill the role previously filled by housing, I would say the only candidate is net exports. The decline in the Fed Funds rate has led to a depreciation of the dollar. In the future, net exports will be higher than they otherwise would be. However, the behavior of net exports, unlike other components of aggregate demand, depends substantially on what happens in other economies. If policy rates decline in the UK, the euro area, and elsewhere, additional declines of the dollar might not occur. (And as I’ve pointed out before, if rest-of-world GDP growth declines (as seems likely [2]), then net exports might decline even with a weakened dollar).

I think the main point is that the decreases in interest rates, working through the traditional channels, will have a positive impact on components of aggregate demand. With respect to the credit view channels, the impact on lending is going to be quite muted, I think, given the supply of credit is likely to be limited. In fact, I suspect monetary policy will only be mitigating the negative effects of slowing growth and a reduction of perceived asset values working their way through the system.

While the collapse of the US housing market actually had an effect on the real economy, we are now getting news that the collapse of US housing investments is having an effect on real companies:

Bristol-Myers Squibb Co. narrowed its loss in the fourth quarter as surging sales of its anti- clotting pill Plavix partially offset charges for costs that include investments backed by subprime securities.

The net loss was $89 million, or 5 cents a share. The company wrote off $275 million in investments in the quarter, which could rise to as much as $417 million, said Rebecca Goldsmith, a spokeswoman for the New York-based drugmaker, in a telephone interview today.

Speaking of the real economy (remember that?) today brought another example of the Great Credit Bubble Popping of 2007-??:

New York real estate developer Harry Macklowe will sell the General Motors Building on Fifth Avenue in Manhattan next month to help pay debts he owes to Deutsche Bank AG, said two people with knowledge of the plans.

Macklowe, 70, bought seven Manhattan skyscrapers from billionaire Sam Zell’s Equity Office Properties Trust for $7.2 billion a year ago, spending $50 million of his own money and borrowing the rest. The developer reached an agreement to turn the properties over to lenders because he was unable to refinance as real estate values declined over the past year, the Wall Street Journal reported today.

Holy smokes! I know that there are a lot of seminars on How to Buy Real Estate With No Money Down, but I hadn’t quite realized leverage of 144:1 was possible for big deals!

While Naked Capitalism republishes an essay that takes a much harsher view of the medicine required:

It is easy to lose sight of the overall picture. Main Street consumers have overspent and over-borrowed and are unable to meet their obligations. The fact that households may have so behaved because they were enticed by “teaser loans” does not change the facts; it only assigns blame. Consumption has been above sustainable levels and needs to adjust down, whatever view one has about the responsibility of adults over their financial decisions.

The adjustment of private consumption to sustainable levels is necessary, but is likely to have a negative influence in the short run on the growth of aggregate demand, of which it represents more than 70 per cent. It is hard for this adjustment to take place without bringing down the rate of growth of gross domestic product, possibly to negative numbers.

The US should face its need for adjustment with courage and reason, not fear. It should stop behaving as the whiner of first resort, ready to waste all its dry powder on a short-sighted attempt to prevent a 2008 recession. Many poorer countries with weaker markets and institutions have survived and benefited from an adjustment that involves a year of negative growth. Faster bank recapitalisation, fiscal investment stimulus and international co-ordination should be first on the ­policy agenda.

And inflation is becoming an increasing worry:

“The Fed as well as the government are responding to recession fears,” said Mike Pond, head of Treasury and inflation-linked strategy at Barclays. “At the same time they are sparking inflation concerns from a longer term perspective.” He thinks those concerns are justified. “We see pressures not just from the domestic economy but from import prices as well as global pressures on food and energy prices. And from a longer term perspective, a Fed who was focused more on risks to growth than higher inflation should put upward pressure on inflation risk premiums.”

It should be noted, however, that these data were used using the breakeven rate. Assiduous readers will remember that the Cleveland Fed attempts to adjust the breakeven rate for other factors affecting TIPS pricing. Their data is updated only once per month, on the first … we will see shortly if there is some independent confirmation!

Meanwhile, the monoline question is getting more interesting, with MBIA first reporting a big loss:

The bond insurer announced $2.3 billion of losses for the fourth quarter which included $3.4 billion of writedowns ($3.5 billion according to the Wall Street Journal). Premiums also fell, indicating new business is falling off, not surprising given the doubts about the AAA rating. The press release also stated that Warburg Pincus nevertheless closed on its $500 million investment in the firm.

… and then drawing a line in the sand, daring the ratings agencies and speculators to cross:

MBIA Inc. Chief Executive Officer Gary Dunton said the world’s largest bond insurer has more than enough capital to keep its AAA credit rating and dismissed speculation the company may go bankrupt.

Dunton, speaking on a conference call after Armonk, New York-based MBIA reported a $2.3 billion fourth-quarter loss, blamed “fear mongering” and “distortion” for driving the company’s stock down more than 80 percent in the past year.

S&P has stated, in effect, ‘Don’t be so sure, chum!’, while William Ackman stepped over that line long ago!

Not a bad day on the market! The new issues TD.PR.Q and BNS.PR.O settled, trading lots in a tight range slightly above par … however, trading in the ratchet / fix-float / floater section was again terribly sloppy. Volume was reasonable … but still on the light side of normal.

And, best of all, it’s month-end! The Claymore ETF, symbol CPD, finished with a NAV of 17.95, unchanged on the month, after hitting a low of $17.76 just after the announcement of the new issues. A price of 17.75 would have been near as dammit to a new trough. I am very pleased with the performance of Malachite Aggressive Preferred Fund for the month … my monthly NAV computation chore still awaits, but will show substantial outperformance vs. the indices.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 5.61% 5.64% 52,484 14.51 2 -1.8643% 1,056.2
Fixed-Floater 5.11% 5.68% 75,212 14.65 9 +0.6353% 1,010.2
Floater 4.94% 4.98% 81,184 15.53 3 -0.9674% 856.0
Op. Retract 4.83% 1.79% 83,961 2.72 15 -0.1557% 1,044.5
Split-Share 5.30% 5.57% 100,611 4.22 15 -0.0202% 1,032.8
Interest Bearing 6.54% 6.54% 62,007 3.60 4 -0.2507% 1,073.0
Perpetual-Premium 5.75% 5.54% 424,239 7.53 14 +0.2257% 1,020.6
Perpetual-Discount 5.52% 5.55% 303,728 14.36 54 +0.1126% 931.9
Major Price Changes
Issue Index Change Notes
BCE.PR.B Ratchet -4.1263% Hasn’t anybody shot this market maker yet? Closed at 22.77-24.24, 2×6. Maybe the guy just couldn’t keep up with the fast market – 800 shares traded at 23.01.
BAM.PR.B Floater -2.3517%  
BNA.PR.B SplitShare -2.2263% Asset coverage of 3.6+:1 as of December 31, according to the company. Now with a pre-tax bid-YTW of 7.76% based on a bid of 21.08 and a hardMaturity 2016-3-25 at 25.00. Compare with BNA.PR.A (5.89% to 2010-9-30) and BNA.PR.C (7.78% to 2019-1-10).
BAM.PR.K Floater -1.7526%  
POW.PR.B PerpetualDiscount -1.5365% Now with a pre-tax bid-YTW of 5.68% based on a bid of 23.71 and a limitMaturity.
BSD.PR.A InterestBearing -1.1435% Asset coverage of just under 1.6:1 as of January 25 according to the company. Now with a pre-tax bid-YTW of 7.08% (mostly as interest) based on a bid of 9.51 and a hardMaturity 2015-3-31 at 10.00.
BAM.PR.I OpRet -1.1067% Now with a pre-tax bid-YTW of 5.61% based on a bid of 25.02 and a softMaturity 2013-12-30 at 25.00.
BCE.PR.A FixFloat -1.0522%  
BNA.PR.C SplitShare +1.0638% See BNA.PR.B, above.
IAG.PR.A PerpetualDiscount +1.0890% Now with a pre-tax bid-YTW of 5.45% based on a bid of 21.35 and a limitMaturity.
BCE.PR.R FixFloat +1.2603% Now with a pre-tax bid-YTW of 5.57% based on a bid of 23.30 and a limitMaturity.
PWF.PR.L PerpetualDiscount +2.0000% Now with a pre-tax bid-YTW of 5.46% based on a bid of 23.46 and a limitMaturity.
BCE.PR.C FixFloat +2.0842%  
BCE.PR.G FixFloat +2.3758%  
Volume Highlights
Issue Index Volume Notes
BNS.PR.O PerpetualPremium 550,670 New issue settled today. Now with a pre-tax bid-YTW of 5.62% based on a bid of 25.02 and a limitMaturity.
TD.PR.Q PerpetualDiscount 433,512 New issue settled today. Now with a pre-tax bid-YTW of 5.58% based on a bid of 25.11 and a call 2017-3-2 at 25.00.
BCE.PR.G FixFloat 96,300  RBC crossed 93,900 at 23.75 … closed at 23.70-85, 20×21.
CM.PR.I PerpetualDiscount 39,874 Now with a pre-tax bid-YTW of 5.76% based on a bid of 20.55 and a limitMaturity.
CM.PR.A OpRet 38,000 Nesbitt crossed 30,000 at 25.86. Now with a pre-tax bid-YTW of 0.93% based on a bid of 25.85 and a call 2008-3-1 at 25.75

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

TD.PR.Q Enters Market With Assurance

Thursday, January 31st, 2008

TD.PR.Q, which was announced shortly after BNS.PR.O was announced, commenced trading today and fears of a debacle were not realized. It traded 433,512 shares to close at 25.11-14, 6×19.

The greenshoe was fully exercised:

The Toronto-Dominion Bank (“TD”) today announced that a group of underwriters led by TD Securities Inc. has exercised the option to purchase an additional 2 million Non-cumulative Class A First
Preferred Shares, Series Q (the “Series Q Shares”) carrying a face value of $25.00 per share. This brings the total issue announced on January 22, 2008, and expected to close January 31, 2008, to 8 million shares and gross proceeds raised under the offering to $200 million.
    The Series Q Shares will yield 5.60% per cent annually and are redeemable by TD for cash, subject to regulatory consent, at a declining premium after approximately five years. TD has filed in Canada a prospectus supplement to its January 11, 2007 base shelf prospectus in respect of this issue.

More Later.

Later, More: Curve price at the close 2008-1-31 was 25.23.

BNS.PR.O Starts Off Well

Thursday, January 31st, 2008

BNS.PR.O, which caused a sharp downdraft when it was announced got off to a solid start today, trading 550,670 shares to close at 25.02-08, 48×20.

Not only that, but the greenshoe was fully exercised:

Scotiabank today announced that it completed the domestic offering of 9.2 million, 5.60% Non-cumulative Preferred Shares Series 17 (the “Preferred Shares Series 17”), including the full exercise of the over-allotment option, at a price of $25.00 per share. The gross proceeds of the offering were $230 million.
    The offering was made through a syndicate of investment dealers led by Scotia Capital Inc. Following the successful sale of the initially announced 8 million Preferred Shares Series 17, the syndicate fully exercised the over-allotment option to purchase an additional 1.2 million shares. The Preferred Shares Series 17 commence trading on the Toronto Stock Exchange today under the symbol BNS.PR.O.

More Later.

Later, More: Curve Price at the close 2008-1-31 was 25.26

January 30, 2008

Wednesday, January 30th, 2008

OK, OK, OK. Let’s get this over with. The Fed cut 50bp to 3.00% and the yield curve steepened.

In news that I have not yet become completely fed up with, Fitch has cut the rating of FGIC, a monoline insurer:

Financial Guaranty, a unit of New York-based FGIC Corp., was cut two levels to AA, New York-based Fitch said today in a statement. The company had been AAA since at least 1991. Moody’s Investors Service and Standard & Poor’s are also reevaluating their ratings.

“This announcement is based on FGIC’s not yet raising new capital, or having executed other risk mitigation measures, to meet Fitch’s AAA capital guidelines within a timeframe consistent with Fitch’s expectations,” the ratings company said today.

Speaking of downgrades, how about them sub-primes, eh?

Standard & Poor’s said it cut or may reduce ratings on $534 billion of subprime-mortgage securities and collateralized debt obligations, the most sweeping action in response to rising home-loan defaults.

The downgrades may extend bank losses to more than $265 billion and have a “ripple impact” on the broader financial markets, S&P said in a statement today. The securities represent $270.1 billion, or 47 percent, of subprime mortgage bonds rated between January 2006 and June 2007.

Naked Capitalism has an update on monolines in general and the bail-out in particular and advocates more regulation:

While it’s probably a good idea to keep insurers away from risky instruments they have demonstrated they don’t understand, the remedy, closing a loophole dating from 1998, is a bit late in coming. The article focuses on how this bond insurers muscled their way into a business that it proving to be their undoing. Nevertheless, the regulators sound surprisingly timid, fearful of inhibiting innovation. Someone might point out that lobotomies and zeppelins were also innovations.

In other words, this would be a much better world, if only there were more rules.

Look – there has clearly been a screw-up. I must say, I’m not sure why bond insurers come under the purview of regulators, but let’s assume there’s a good reason … which is a hell of an assumption to make, but otherwise we’re left to mumbling libertarian slogans to each other. In the first place … just how is insuring a municipal bond different from writing a CDS? Not much, is the basic answer. There might be some legal differences in the bankruptcy games (mentioned in a recent update to the CDS Primer); credit risk is (almost certainly) greater; structural risk and analysis is (almost certainly) more complex. But what of it? Analysis of these elements and comfort-offering to potential investors who don’t want to do it, are what monolines do for a living.

If they didn’t do it very well, then they can go bankrupt. Just what, exactly, is the problem here? Which members of the unsophisticated public are we attempting to protect?

The only rational regulatory response I see is that of brokers and banks … and, quite frankly, I’m not 100% convinced about whether the brokers warrant a regulatory response. As I suggested on January 25, there may be cause to protect the banking system by reviewing the concentration rules for capital exposure … if the troubles of a single counterparty have the ability to bring down – or seriously wound – a bank, then the exposure should attract a charge against capital in excess of what the same bundle of risks would if it was spread around a little more …. just as if the counterparty was explicitly a hedge fund, rather than what may well be described as a hedge fund masquerading as a monoline.

There’s some interesting economic news that has added significance due to the precipituous decline in the Fed Funds rate: US GDP growth came in at a mere 0.6% annualized rate. Both the WSJ and Econbrowser pointed out that a chunk of the slowness was due to inventory reduction:

big surprise was a big drop in inventories. That means that production growth was not as strong as sales, and hence, reduces the estimate of GDP, though it may leave businesses in a little better position to weather any further drops in demand. Without the inventory correction, real final sales grew at a 1.8% annual rate in the fourth quarter, somewhat less alarming than the headline GDP numbers alone.

And, to make sure we’re all thoroughly confused regarding signals from the financial markets and economic reports, there is hope for tomorrow’s jobs number:

Nonfarm private employment surged by a seasonally adjusted 130,000 during the month, ADP said. Adding in 22,000 government jobs (the average gain over 12 months), total nonfarm payroll gains are estimated at 152,000 for the month. That’s more than double most economists’ estimates for Friday’s Labor Department report. It would also represent a huge rebound from the 18,000-job increase the government reported for December. (ADP revised its December number down to a gain of 37,000.)

Maybe some suddenly employed Americans will be able to afford some of the vacant housing!

There’s an interesting essay by John Dizard (hat tip: Naked Capitalism) that argues that disintermediation – referred to by its mechanism, securitization – will become more prevalent in the future, and that this is a secular change rather than a mere transient reaction to market forces. The trouble is, the essay makes sweeping statements regarding ‘what central bankers believe’ and I don’t know on what basis the author makes these claims. I have referenced an academic paper that presents evidence that banks’ balance sheets balloon in times of stress, as the madding crowd runs to familiar, regulated entities … but eventually the crisis passes and investors wonder why they’re letting the bank take a spread on their investment. So, until I see a little more meat on the bones of Mr. Dizard’s argument, I’ll remain very skeptical that a fundamental paradigm shift has occurred.

Accrued Interest has finally returned from his vacation and offers an endorsement of junk bonds at current spreads:

If we do have a recession in 2008, high-yield default rates will certainly increase. But at today’s valuation levels, high-yield already has a recession priced in. Given that there is good reason to believe credit losses will be no worse, or perhaps even better than the last two recessions, high-yield looks fundamentally attractive.

I’m not sure about this and a large chunk of my skepticism is based on the new developments in the CDS market, which can create players who have both negative exposure to the firms AND a seat at the creditors’ table (by going long the actual bonds, but even longer on Credit Default Swaps). These players take such positions because they can actively create a lower return for the class of securities they own, contrary to all expectations and procedures in bankruptcy.

The more I think about this development, the less convinced I am that the CDS market has a future. Who will sell CDS protection in such an environment? But a lot will depend on the precise wording of the individual CDS contracts – when does the cash settlement price get calculated? In this counter-intuitive scenario, it is best for the hedge fund to delay calculation until some point during the bankruptcy process, rather than at entry.

So anyway … until somebody shows me different, my attitude is … spreads, schmeads. With holders like those, junk bonds become even more risky than usual.

The continued preoccupation with Jerome Kerviel’s back office background continues. I expressed concern about this on January 25 and I’m going to do so again, in light of an emphasized quote in a Bloomberg story:

Jean-Pierre Mustier, the head of investment banking at Societe Generale, has said Kerviel didn’t take the “usual path to the trading floor.” The bank normally hires traders straight from university with degrees in math or finance, Mustier said on a Jan. 27 conference call with reporters.

Kerviel was promoted from the back office in recognition of his “excellent” work, Mustier said.

This is just another attempt to keep barrow boys out of the club.

Mustier is an example of the type of talent Societe Generale normally grooms.

He took classes at Ecole Polytechnique, a French engineering school that has produced prominent French executives such as BNP Paribas SA Chairman Michel Pebereau, before transferring to Ecole des Mines, which focuses on science and technology.

The system you ran didn’t work very well, did it, M. Mustier? How did it really happen? The triggerman himself has an idea:

I can’t believe that my superiors were not aware of the amounts I was committing, it’s impossible to generate such profits with small positions, which leads me to say that when I’m in the black, my superiors close their eyes about the methods and volumes committed.

A good strong day in the preferred market, but there was some very sloppy trading in the Ratchet / FixFloat / Floater sectors … doubtless people are rather nervous, not just about BCE (common down $0.44 today to $34.00).

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 5.50% 5.51% 53,983 14.67 2 +0.9967% 1,076.3
Fixed-Floater 5.14% 5.72% 75,674 14.62 9 -1.1646% 1,003.8
Floater 4.89% 4.93% 82,724 15.61 3 +0.5549% 864.4
Op. Retract 4.82% 1.46% 84,583 2.61 15 +0.0852% 1,046.1
Split-Share 5.32% 5.58% 102,068 4.24 15 +0.2588% 1,033.0
Interest Bearing 6.27% 6.49% 61,976 3.61 4 +0.5913% 1,075.7
Perpetual-Premium 5.80% 5.56% 64,959 6.98 12 +0.0631% 1,018.3
Perpetual-Discount 5.52% 5.55% 305,999 14.36 54 +0.2945% 930.8
Major Price Changes
Issue Index Change Notes
BCE.PR.T FixFloat -2.9374%  
BCE.PR.Z FixFloat -2.6531%  
BMO.PR.K PerpetualDiscount -2.2941% Now with a pre-tax bid-YTW of 5.65% based on a bid of 23.85 and a limitMaturity.
BAM.PR.G FixFloat -2.0697%  
BCE.PR.R FixFloat -1.3395%  
FTN.PR.A SplitShare -1.2821% Asset coverage of just under 2.3:1 according to the company. Now with a pre-tax bid-YTW of 4.99% based on a bid of 10.01 and a hardMaturity 2008-12-1 at 10.00.
BCE.PR.C FixFloat -1.0525%  
BAM.PR.K Floater +1.0417%  
BCE.PR.B Ratchet +1.0638%  
BAM.PR.M PerpetualDiscount +1.0747% Now with a pre-tax bid-YTW of 6.40% based on a bid of 18.81 and a limitMaturity.
HSB.PR.C PerpetualDiscount +1.1515% Now with a pre-tax bid-YTW of 5.64% based on a bid of 22.84 and a limitMaturity.
BNA.PR.B SplitShare +1.2207% Asset coverage of 3.6+:1 as of December 31, according to the company. Now with a pre-tax bid-YTW of 7.40% based on a bid of 21.56 and a hardMaturity 2016-3-25 at 25.00. Compare with BNA.PR.A (5.92% TO 2010-9-30) and BNA.PR.C (7.91% to 2019-1-10).
GWO.PR.G PerpetualDiscount +1.3141% Now with a pre-tax bid-YTW of 5.49% based on a bid of 23.90 and a limitMaturity.
POW.PR.B PerpetualDiscount +1.5605% Now with a pre-tax bid-YTW of 5.59% based on a bid of 24.08 and a limitMaturity.
POW.PR.D PerpetualDiscount +1.6466% Now with a pre-tax bid-YTW of 5.52% based on a bid of 22.84 and a limitMaturity.
BSD.PR.D InterestBearing +1.7989% Asset coverage of just under 1.6:1 according to Brookfield Funds. Now with a pre-tax bid-YTW of 6.87% (mostly as interest) based on a bid of 9.62 and a hardMaturity 2015-3-31 at 10.00.
CIU.PR.A PerpetualDiscount +1.8824% Now with a pre-tax bid-YTW of 5.39% based on a bid of 21.65 and a limitMaturity.
BNA.PR.C SplitShare +2.0076% See BNA.PR.B, above. Now with a pre-tax bid-YTW of 7.91% based on a bid of 18.80 and a hardMaturity 2019-1-10 at 25.00.
PWF.PR.K PerpetualDiscount +2.0665% Now with a pre-tax bid-YTW of 5.47% based on a bid of 22.72 and a limitMaturity.
IAG.PR.A PerpetualDiscount +2.4248% Now with a pre-tax bid-YTW of 5.51% based on a bid of 21.12 and a limitMaturity.
Volume Highlights
Issue Index Volume Notes
WN.PR.B Scraps (would be OpRet but there are credit concerns) 145,550 Now with a pre-tax bid-YTW of 4.66% based on a bid of 25.28 and a softMaturity 2009-6-30 at 25.00.
CM.PR.I PerpetualDiscount 130,977 Nesbitt crossed 48,300 at 20.52. Now with a pre-tax bid-YTW of 5.79% based on a bid of 20.46 and a limitMaturity.
PIC.PR.A SplitShare 117,351 Asset coverage of 1.5+:1 as of January 24, according to Mulvihill. Now with a pre-tax bid-YTW of 6.11% based on a bid of 14.88 and a hardMaturity 2010-11-1 at 15.00.
CM.PR.E PerpetualDiscount 73,725 Now with a pre-tax bid-YTW of 5.82% based on a bid of 24.18 and a limitMaturity.
BAM.PR.N PerpetualDiscount 50,615 Now with a pre-tax bid-YTW of 6.44% based on a bid of 18.71 and a limitMaturity.
SLF.PR.B PerpetualDiscount 44,800 Now with a pre-tax bid-YTW of 5.42% based on a bid of 22.40 and a limitMaturity.

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

January 29, 2008

Tuesday, January 29th, 2008

Somewhat to my surprise, the problems in the bond insurance industry continue to make headlines – much to the chagrin of the risk-control specialists at Royal Bank:

At the time, “we had noted there that we had exposure to one monoline [bond insurer] that was rated a single-A, that we had taken a provision against that exposure, and [that] the current mark-to-market as of Oct. 31st was $104-million,” RBC chief financial officer Janice Fukakusa told a financial services conference Tuesday.

“That monoline subsequently is in difficulty, so we have written off the balance of our exposure there in our first quarter results,” she said. That quarter ends this week, on Jan. 31, and the bank will release its results in late February.

There is the usual speculation regarding the monolines – Naked Capitalism sticks to its gloomy view:

So the benefit of this operation is not to assure payouts, but to prevent a downgrade because that leads to forced sales by investors who can only hold paper than falls in certain ratings buckets, and in turn forces the Street to price similar holdings lower. But the level of capital required to maintain an AAA is far larger than that required to merely assure that claims are paid for the next year or two 

… while CreditSights (a subscription-based ratings agency often quoted in the press) feels that the monolines are in a losing race against time:

“Given the number of competing interests and levels of commitment of participants involved, we think it is unlikely that an agreement sponsored by Dinallo could be hammered out within the appropriate timeframe,” CreditSights analysts Rob Haines, Craig Guttenplan and Joe Di Carlo in New York wrote in a report. “In the offchance that any deal could be solidified, the rating agencies are likely to have already taken action.”

The Fed will announce its rate decision tomorrow. The target rate for FedFunds is now 3.5%, but the futures contract is showing almost certainty of a cut to 3.0% … and about 2.5% by May. Economic concern is growing as the real (after inflation) rate approaches 0%; this concern is dismissed by others:

To be sure, inflation excluding food and energy prices — so-called core inflation — has exceeded the upper end of the Fed’s implicit comfort zone during most of the past four years. Including food and energy prices, the overage has been much more pronounced. Therefore, the emphasis of some Fed officials on preventing further increases in inflation is understandable. However, core inflation exhibits substantial inertia, so upward movements in inflation usually occur gradually. In contrast, output and employment can slump more rapidly, and the fragile state of the financial system today accentuates the risk of a reinforcing downward spiral. With a possible plunge on one side of the road and a less abrupt embankment on the other, a wise driver stays on the side of the shallower drop.

Not much new regarding the SocGen Futures Fiasco today … but a Jerome Kerviel fansite has been started! (hat tip: Financial Webring Forum). Apparently, SocGen is having a little difficulty convincing the authorities that actual criminal fraud was involved.

French prosecutors will not appeal against a decision to throw out the accusation of fraud levelled against a trader blamed for huge losses at Societe Generale, a senior judicial source said on Tuesday.

If confirmed, the move would represent a blow for SocGen managers, who last week branded trader Jerome Kerviel a “fraudster” and said the bank had been the victim of “massive fraud.”

The refusal to lay fraud charges will, in fact, be appealed, which leaves the “senior judicial source” looking a little silly.

In other enforcement news, the FBI confirms it’s looking at sub-prime:

The Federal Bureau of Investigation is investigating 14 corporations for possible accounting fraud and other crimes related to the subprime lending crisis, officials said.

The probes add to federal and state scrutiny of the home- loan industry as prosecutors and regulators seek to assign culpability for the mortgage rout that has forced people from their homes and resulted in losses to investors. The biggest banks and securities firms have posted at least $133 billion in credit losses and writedowns related to the loans, which are typically made to buyers with the weakest credit.

And also related to sub-prime, the current House Resolution 1540 increases the maximum mortage size for Fannie Mae, Freddie Mac & the FHA, e.g.:

For mortgages originated during the period beginning on July 1, 2007, and ending at the end of December 31, 2008:

  • (1) FANNIE MAE- With respect to the Federal National Mortgage Association, notwithstanding section 302(b)(2) of the Federal National Mortgage Association Charter Act (12 U.S.C. 1717(b)(2)), the limitation on the maximum original principal obligation of a mortgage that may be purchased by the Association shall be the higher of–
    • (A) the limitation for 2008 determined under such section 302(b)(2) for a residence of the applicable size; or
    • (B) 125 percent of the area median price for a residence of the applicable size, but in no case to exceed 175 percent of the limitation for 2008 determined under such section 302(b)(2) for a residence of the applicable size.

… and the jerks are so desperate to appear to be Doing Something that they didn’t even bother to extract any capitalization-related concessions from the GSEs as a condition of increasing the limit.

Naked Capitalism is very concerned about a precipituous decline in non-borrowed reserves at the Fed, but I’m not convinced there’s a story here. In the current H3 release, it is disclosed that, of $41,475-million in reserves, only $199-million are non-borrowed. Usually, non-borrowed reserves will be roughly equal to total reserves – implying that net free reserves is about zero. The chart tells the story:

So … what are reserves? The Fed has the answer:

  • Reserve requirements, a tool of monetary policy, are computed as percentages of deposits that banks must hold as vault cash or on deposit at a Federal Reserve Bank.
  • Reserve requirements represent a cost to the banking system. Bank reserves, meanwhile, are used in the day-to-day implementation of monetary policy by the Federal Reserve.
  • As of December 2006, the reserve requirement was 10% on transaction deposits, and there were zero reserves required for time deposits.

There are two things to note here: first, Canada does not have a fractional reserve requirement and second, banks get ZERO interest on their reserves:

The Fed has long advocated the payment of interest on the reserves that banks maintain at Federal Reserve Banks. Such a step would have to be approved by Congress, which traditionally has been opposed because of the revenue loss that would result to the U.S. Treasury. Each year the Treasury receives the Fed’s revenue that is in excess of its expenses. The payment of interest on reserves would, of course, be an additional expense to the Fed.

Thus, all banks will attempt to keep their reserves as close to their requirements as possible. If they have any excess in the system, they will either try to lend them on the Fed Funds market – at the infamous Fed Funds Rate – or withdraw them, to invest the money in … basically anything. Even a one-week T-bill, even now, pays more than ZERO.

Now, along comes the Term Auction Facility. Its value of $40,000-million is – surely not fortuitously! – roughly equal to the total US bank reserve requirement … and it’s available cheap – 3.123%, as pointed out by Naked Capitalism.

If these borrowed term funds were to be left at the Fed – on top of the reserve balances that had been held there previously – then the banks would be borrowing at 3.123% and lending at ZERO. It is my understanding that this sort of negative margin on loans is not considered the road to riches at banking school. But an American stockbroker heard about this, got all excited and appears to have stampeded Naked Capitalism into unnecessary worry.

A good day in the preferred market – as noted by a New Assiduous Reader on another thread – but the index is still negative on the month. Volume was on the light side, but reasonable.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 5.55% 5.57% 54,952 14.60 2 -0.0576% 1,065.7
Fixed-Floater 5.05% 5.64% 76,760 14.64 9 -0.1107% 1,015.7
Floater 4.91% 4.96% 82,974 15.57 3 +1.0930% 859.6
Op. Retract 4.82% 1.51% 83,553 2.72 15 +0.3561% 1,045.2
Split-Share 5.34% 5.53% 101,376 4.23 15 +0.3860% 1,030.3
Interest Bearing 6.31% 6.59% 62,974 3.59 4 +0.5419% 1,069.4
Perpetual-Premium 5.80% 5.58% 64,317 6.99 12 +0.2494% 1,017.7
Perpetual-Discount 5.54% 5.57% 307,820 14.33 54 +0.5918% 928.1
Major Price Changes
Issue Index Change Notes
SBN.PR.A SplitShare +1.0891% Asset coverage of 2.1+:1 as of January 24, according to Mulvihill. Now with a pre-tax bid-YTW of 4.93% based on a bid of 10.21 and a hardMaturity 2014-12-01 at 10.00.
BNS.PR.M PerpetualDiscount +1.1505% Now with a pre-tax bid-YTW of 5.37% based on a bid of 21.10 and a limitMaturity.
SLF.PR.E PerpetualDiscount +1.1561% Now with a pre-tax bid-YTW of 5.42% based on a bid of 21.00 and a limitMaturity.
RY.PR.A PerpetualDiscount +1.2019% Now with a pre-tax bid-YTW of 5.30% based on a bid of 21.05 and a limitMaturity.
HSB.PR.D PerpetualDiscount +1.2048% Now with a pre-tax bid-YTW of 5.57% based on a bid of 22.68 and a limitMaturity.
SLF.PR.D PerpetualDiscount +1.2136% Now with a pre-tax bid-YTW of 5.40% based on a bid of 20.85 and a limitMaturity.
BAM.PR.K Floater +1.2658%  
BNS.PR.L PerpetualDiscount +1.3384% Now with a pre-tax bid-YTW of 5.34% based on a bid of 21.20 and a limitMaturity.
BAM.PR.I OpRet +1.3649% Now with a pre-tax bid-YTW of 5.42% based on a bid of 25.25 and a softMaturity 2013-12-30 at 25.00.
CM.PR.H PerpetualDiscount +1.4085% Now with a pre-tax bid-YTW of 5.58% based on a bid of 21.60 and a limitMaturity.
SLF.PR.C PerpetualDiscount +1.4493% Now with a pre-tax bid-YTW of 5.36% based on a bid of 21.00 and a limitMaturity.
BSD.PR.A InterestBearing +1.6129% Asset coverage of just under 1.6:1 as of January 25, according to Brookfield Funds. Now with a pre-tax bid-YTW of 7.18% (mostly as interest) based on a bid of 9.45 and a hardMaturity 2015-3-31 at 10.00.
PWF.PR.H PerpetualDiscount +1.6466% Now with a pre-tax bid-YTW of 5.43% based on a bid of 25.31 and a limitMaturity.
BAM.PR.B Floater +2.0997%  
PWF.PR.L PerpetualDiscount +2.1314% Now with a pre-tax bid-YTW of 5.57% based on a bid of 23.00 and a limitMaturity.
BAM.PR.M PerpetualDiscount +2.3090% Now with a pre-tax bid-YTW of 6.47% based on a bid of 18.61 and a limitMaturity.
BAM.PR.H OpRet +2.5130% Now with a pre-tax bid-YTW of 5.15% based on a bid of 25.70 and a softMaturity 2012-3-30 at 25.00.
BAM.PR.N PerpetualDiscount +2.6010% Now with a pre-tax bid-YTW of 6.50% based on a bid of 18.54 and a limitMaturity.
NA.PR.K PerpetualDiscount +2.6016% Now with a pre-tax bid-YTW of 5.58% based on a bid of 25.24 and a call 2012-6-14 at 25.00.
Volume Highlights
Issue Index Volume Notes
SLF.PR.A PerpetualDiscount 113,412 Now with a pre-tax bid-YTW of 5.37% based on a bid of 22.36 and a limitMaturity.
SLF.PR.C PerpetualDiscount 109,060 Now with a pre-tax bid-YTW of 5.36% based on a bid of 21.00 and a limitMaturity.
CM.PR.I PerpetualDiscount 83,426 Now with a pre-tax bid-YTW of 5.79% based on a bid of 20.46 and a limitMaturity.
BAM.PR.M PerpetualDiscount 81,400 Now with a pre-tax bid-YTW of 6.47% based on a bid of 18.61 and a limitMaturity.
BAM.PR.N PerpetualDiscount 76,029 Now with a pre-tax bid-YTW of 6.50% based on a bid of 18.54 and a limitMaturity.

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

HIMIPref™ Preferred Indices : January 2006

Tuesday, January 29th, 2008

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

HIMI Index Values 2006-01-31
Index Closing Value (Total Return) Issues Mean Credit Quality Median YTW Median DTW Median Daily Trading Mean Current Yield
Ratchet 1,355.8 1 2.00 3.47% 18.6 39M 3.48%
FixedFloater 2,289.0 6 2.00 3.18% 18.2 77M 5.12%
Floater 2,063.9 4 2.00 -22.71% 0.1 37M 4.12%
OpRet 1,882.3 18 1.67 2.66% 3.0 87M 4.62%
SplitShare 1,939.7 15 1.93 3.43% 2.6 51M 5.12%
Interest-Bearing 2,323.3 7 2.00 4.87% 1.4 65M 6.74%
Perpetual-Premium 1,479.5 47 1.70 4.31% 5.7 114M 5.13%
Perpetual-Discount 1,607.1 2 1.00 4.58% 16.2 1,897M 4.56%

Index Constitution, 2006-01-31, Pre-rebalancing

Index Constitution, 2006-01-31, Post-rebalancing

Globe & Mail: Dowdy Preferred Shares are Looking Mighty Seductive

Tuesday, January 29th, 2008

Rob Carrick of the Globe and Mail has taken a look at the preferred share market and was kind enough to quote me extensively.

I liked the bit:

You won’t hear Mr. Hymas say so directly because he refuses to make a call on the market. But he does go so far as to offer this bit of wisdom: “Preferred shares are more attractive now than they usually are.”

It’s very frustrating, I know, for a journalist to ask a specialist – “Are these things going up?” and not get a straight answer!

January 28, 2008

Tuesday, January 29th, 2008

There were some very interesting tid-bits of news today. Naked Capitalism posted an article regarding some of the unintended consequences of Credit Default Swaps. I have commented on this news more thoroughly on the PrefBlog CDS Primer Post.

And the SocGen Futures Fiasco continues its fascination:

Europe’s largest futures exchange queried the bank about its trades as early as November.

“Eurex was alarmed by the size of the positions,” Prosecutor Jean-Claude Marin said at a press conference today, citing Kerviel. He said the trader was able to explain away the concerns.

Jean-Pierre Mustier, chief executive officer of Societe Generale’s corporate and investment bank, said on a conference call yesterday that trades by Kerviel that exceeded limits had been caught by the bank’s back office before.

“He would admit he had made a mistake, the transaction would be canceled and he would replace it by another one that would be controlled by another department,” Mustier said. “He wasn’t making more mistakes than other traders.”

The case has raised fresh doubts about risk management at the world’s biggest financial institutions and prompted calls for increased disclosure from French President Nicolas Sarkozy. He also suggested top managers should bear a greater share of the blame.

“When someone is very highly paid, even when it’s probably justified, you can’t avoid responsibility when there’s a major problem,” Sarkozy told reporters today after giving a speech outside Paris.

“There was clearly a fault in the bank’s control systems,” said Jean Peyrelevade, a former CEO of Credit Lyonnais and a member of the board of Barings when Leeson’s losses brought down the bank.

It pains me to have to quote Sarkozy actually saying something sensible on a topic related to capital markets, but hey – even a stopped clock is right twice a day!

Apparently, Kerviel didn’t take his vacations:

He took only four days off last August and postponed a vacation at the end of the year, Societe Generale said. Banks often make trading staff take time off so any concealed positions will become evident in their absence.

… and, although I can no longer find the link, was mentioned somewhere as having a departmental password that gave him some information. Well … maybe a departmental password is acceptable for access to the page that provides information about the staff Christmas party, but I can’t see any other rational use! And, of course, there’s the “calendar of the controls” issue that I mentioned on Friday.

There’s no real information available. It’s in the bank’s interest to make this guy out to be a combination of Einstein and Satan … it’s not in their interest to provide a full and dispassionate account of how the little accident occurred. This is particularly the case since given the short period of time since the discovery, the only people who really have a thorough knowledge of the situation and industry comparables are the ones with their asses on the line.

But really, it’s sounding to me more and more like everybody involved in the policy-making for the controls, from the department manager to the risk committee of the board of directors, now has the onus to explain why they should be allowed to keep their job.

Naked Capitalism also ruminates on the bond insurer bail-out and the failure of the ratings agencies to update the status of their reviews:

there is every reason to expect the rating agencies to knuckle under if Dinallo can raise a modest amount of dough, even as little as, say, $2 billion. The agencies through their mistakes have now created the situation where they could be the ones to Destroy the Financial World as We Know It. They will take any route offered to keep from pushing the button, in the hopes that either the economy will miraculously recover or other events will lead to credit repricing, so that the eventual downgrade of the insurers has far less impact than one now.

I still don’t think a bailout is likely to succeed, despite the considerable costs of a bond guarantor downgrade. But the fact that the rating agencies will probably go along with any remotely plausible scheme means that a smoke and mirrors version might be put into place.

With respect to this particular tale, it is fascinating to learn that JPMorgan has increased its Ambac stake to 7.7% from 5.4%.

And, in news that will be not be welcomed by those speculating that BCE / Teachers will succeed, another LBO in the States has bitten the dust … but for a novel reason:

Blackstone Group LP’s $6.6 billion leveraged buyout of credit-card payments processor Alliance Data Systems Corp. may collapse because bank regulators have placed “unacceptable” requirements on the acquisition.

Alliance Data plunged 35 percent in New York trading today after Blackstone said conditions requested by the U.S. Office of the Comptroller of the Currency would impose “unlimited and indefinite” liability on the firm. It will try to keep the deal alive, the New York-based company said in an e-mailed statement.

The Federal Deposit Insurance Corp. also regulates Alliance Data because it operates an industrial bank. Before today, Alliance Data shares had dropped more than 10 percent four times since Nov. 29 on speculation the transaction will be reworked or abandoned. Three times Alliance Data issued public statements that the two sides were working to complete the deal.

Now, I don’t believe that banking regulators have any direct involvement in BCE / Teachers, but this deal’s collapse seems to have had a ripple effect anyway! BCE was down $1.34 on the day, to close at $34.95.

The TSX is late again with my daily prices. The indices (and HIMIPref™) are being updated at various odd hours, but will be unavailable on a daily basis until the data becomes available at a reasonable time.

HIMIPref™ Preferred Indices : December 2005

Monday, January 28th, 2008

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

HIMI Index Values 2005-12-30
Index Closing Value (Total Return) Issues Mean Credit Quality Median YTW Median DTW Median Daily Trading Mean Current Yield
Ratchet 1,366.6 1 2.00 3.58% 18.4 46M 3.59%
FixedFloater 2,284.7 6 2.00 3.43% 2.1 89M 5.10%
Floater 2,058.5 4 2.00 -16.67% 0.1 40M 3.94%
OpRet 1,881.6 18 1.67 2.56% 3.1 87M 4.61%
SplitShare 1,950.8 14 1.93 3.30% 2.7 63M 5.03%
Interest-Bearing 2,323.4 7 2.00 4.80% 1.5 62M 6.74%
Perpetual-Premium 1,479.4 46 1.72 4.16% 4.4 121M 5.11%
Perpetual-Discount 1,632.5 0 0 0 0 0 0

Index Constitution, 2005-12-30, Pre-rebalancing

Index Constitution, 2005-12-30, Post-rebalancing

SNH.PR.U : Partial Call for Redemption

Monday, January 28th, 2008

SNP Health Split Corp. has announced:

that it has called 220,849 Preferred Shares for cash redemption on February 11, 2008 (in accordance with the Company’s Articles) representing approximately 19.162% of the outstanding Preferred Shares as a result of the special annual retraction of 571,698 Capital Shares by the holders thereof. The Preferred Shares shall be redeemed on a pro rata basis, so that each holder of Preferred Shares of record on February 8, 2008 will have approximately 19.162% of their Preferred Shares redeemed. The redemption price for the Preferred Shares will be US$25.00 per share.

Holders of Preferred Shares that are on record for dividends but have been called for redemption will be entitled to receive dividends thereon which have been declared but remain unpaid up to but not including February 11, 2008.

Payment of the amount due to holders of Preferred Shares will be made by the Company on February 11, 2008. From and after February 11, 2008 the holders of Preferred Shares that have been called for redemption will not be entitled to dividends or to exercise any right in respect of such shares except to receive the amount due on redemption.

SNH.PR.U is not tracked by HIMIPref™.