PrefBlog

In the continuing saga of the credit rating agencies, S&P has announced the creation of an ombudsman position, together with other reforms:

Among the changes set to be announced today, S&P will rotate lead rating analysts after five years of following the same company, government bond issuer, or structured-finance arranger. The new practice, which will be phased in, should prevent professional or personal relationships from affecting ratings, company officials said.

Analysts who leave S&P to work at a bond issuer will have some deals they previously rated reviewed to make sure their objectivity wasn’t compromised by the prospect of the new job.

Hey! That makes all kinds of sense, doesn’t it? Perhaps, now that I’ve been offering advice on preferred shares for over five years, the regulators should insist that I be rotated to, say, junior oil equity. Naked Capitalism isn’t much impressed:

The real problem that the agencies are paid by the very organizations they rate, and as long as this conflict remains, all other measures are mere window-dressing. The creation of an ombudsman role is an inadequate, unrealistic remedy for a problematic payment structure.

Well, last I heard, this was still a reasonably free country. Anybody who doesn’t want to take S&P’s advice is (as far as I know) welcome to listen to somebody else. But nothing, particularly not logic, will dampen expectations for certainty and a risk-free investment environment … portfolio managers should, if anything, welcome the provision of bad advice (if we may make the assumption, for the moment, that S&P’s advice is bad), since this will lead to market mispricing that may be exploited.

Andrew Cuomo, well known for his uncanny expertise at fixed income credit analysis, isn’t much impressed either:

New York Attorney General Andrew Cuomo said “supposed reforms” by Standard & Poor’s and Moody’s Investors Service, which gave high ratings to subprime debt that later plummeted, are “too little, too late.”
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“Both S&P and Moody’s are attempting to make piece-meal changes that seem more like public relations window dressing than systemic reform,” Cuomo said in the statement.

In more interesting news, it appears that Credit Default Swaps may have increased the corellation in the mononlines sector:

Separately, the Financial Times reports on yet another largely unrecognized hole in the bond insurers’ balance sheets. Wall Street was apparently fond of a so-called negative basis trades. If they bought a bond, hedged it with credit default swaps, then hedged the risk of the guarantor defaulting (generally a monoline) with a different guarantor (generally a different monoline), they could accelerate the expected profits over the life of the deal into the current period. The result is that the bond insurers have an unknown (to the outside world) but potentially significant number of guarantees written on each other.

There is at least one player trying to whip up the panic:

Deutsche Bank AG Chief Executive Officer Josef Ackermann said rating downgrades for bond insurers pose risks that could match the U.S. subprime market collapse.

“It could be a tsunami-like event comparable to subprime,” Ackermann said in a Bloomberg Television interview in Frankfurt today. Deutsche Bank, Germany’s biggest bank, is “well positioned” on its risk from bond insurers, he said

But there is another player – one not trying to sell a specific product – who has an opinion. Bernanke is concerned that monoline problems could cause banks’s balance sheets to gross-up. And Moody’s has downgraded SCA:

Security Capital Assurance Ltd.’s bond insurance units, hobbled by a decline in subprime mortgage securities, lost their Aaa credit rating at Moody’s Investors Service.

XL Capital Assurance Inc. and XL Financial Assurance Ltd. were cut six levels to A3, New York-based Moody’s said today in a statement. The outlook for both is negative, Moody’s said.

And MBIA, desperate to avoid such a fate, has embarrassed itself even more than it did yesterday by selling even more equity at an even lower price:

MBIA Inc., the world’s biggest bond insurer, raised $1 billion by selling shares at $12.15 each in an effort to protect its AAA insurance rating.

The 82.3 million shares were sold at a 14 percent discount to Armonk, New York-based MBIA’s $14.20 closing price today, according to data compiled by Bloomberg.

MBIA increased the sale from a planned $750 million, though accepted a lower price than it had anticipated. The sale matches the price private-equity firm Warburg Pincus LLC had agreed to pay to backstop the transaction in case no buyers could be found.

Speaking of downgrades, Loblaws was downgraded today, which has implications for Weston. I’ve updated the post about Weston’s credit. 

The Cleveland Fed has updated its estimate of inflation expectations from TIPS … very interesting indeed. The breakeven rate is increasing slightly, but the analytical rate – which attempts to incorporate adjustments for the inflation-risk-premium and liquidity-premium – is skyrocketting. This epsiode will be very useful in determining the validity of these adjustments!

I have opined many times in the past that the Fed’s easing may well rebound in an unfavourable manner vis-a-vis inflation – scarcely the most original of views, but I do what I can. In this context, it was interesting to read the following report on the Treasury Bond auction:

U.S. 30-year Treasuries fell the most since June as demand was weaker than expected at the government’s $9 billion auction of the securities.

Ten- and 30-year securities declined a second straight day as investors balked at buying at this week’s auctions, with yields at record lows. Investors are also betting that the Federal Reserve’s five interest-rate cuts since September will revive economic growth and cause inflation to accelerate, reducing the value of Treasuries’ fixed payments.

“The auction went as poorly as one could imagine,” said Andrew Brenner, co-head of structured products in New York at MF Global Ltd., the world’s largest broker of exchange-traded futures and options contracts. “There isn’t a lot of demand for bonds at these levels.”

These fears are finding support at high levels:

Federal Reserve Bank of Dallas President Richard Fisher, who voted against cutting interest rates last week, warned that aggressive reductions in response to a weak economy may “juice up” inflation.
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“Given that I had yet to see a mitigation in inflation and inflationary expectations from their current high levels, and that I believed the steps we had already taken would be helpful in mitigating the downside risk to growth once they took full effect, I simply did not feel it was the proper time” for more rate cuts, Fisher said.

Another good day! PerpetualDiscounts continued to improve and volume remained above the recent average.

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

Willem Buiter was last mentioned in PrefBlog on January 25 in connection with inflation concerns. He’s back again today, preaching not just the likelihood, but the necessity of a US recession:

Therefore, to restore a sustainable external balance and to accumulate the financial assets that will support a greying US population in the style it would like to and hopes and expects to be accustomed to, the US private and public sectors must save more. To get to a higher saving and wealth trajectory, the US economy will first have to pass through the valley of the shadow of deficient effective demand, rising excess capacity and growing unemployment. Postponing the necessary adjustment will just make the pain of the eventual unavoidable correction that much greater.

The trouble with such a prescription is that it runs headlong into the American “can do” attitude. This attitude is admirable and has served them well … but sometimes it comes a cropper. “Reduce taxes and the deficit while increasing services? Can do!” “Bring Western Democracy to regions where even those who understand it don’t want it? Can do!”.

The failure of a few auctions for American Auction Rate Municipals has attracted some notice lately. Accrued Interest explains the situation … it all comes down to the monolines!

The bank was only willing to provide liquidity if there was some additional credit support. No problem, thought the municipal bond bankers! We’ll bring in a monoline insurer! The bank would therefore agree to provide liquidity so long as the bond insurer was rated at some minimal credit rating level. What that level is depends on the deal. Might be AA, might be A. I haven’t seen any that were actually AAA but they could be out there.

But what happens if the unthinkable happens? A monoline insurer gets downgraded? Well, the bank’s liquidity agreement becomes null and void. Where does that leave bond holders? It leaves them with no credit support at all. Only the issuer itself would remain.

Auction rate securities are a recurring niche in the markets – I remember (a long, long time ago) there were some Hees (remember Hees?) MAPS – Monthly Auction Preferred Shares. It’s really just another mechanism whereby issuers can finance long at short rates and investors can pretend they’re money-market superstars by outperforming the 3-month benchmark with 100-year paper … for a while.

And the mention of monolines reminds me of a funny story … remember MBIA’s line in the sand, discussed on January 31? Well, the tide’s come in:

MBIA Inc., the world’s biggest bond insurer, plans to raise an additional $750 million by selling about 50.3 million common shares, bolstering capital in an attempt to retain its AAA credit rating.

Investment firm Warburg Pincus will backstop the offering by purchasing as much as $750 million of convertible participating preferred stock, the Armonk, New York-based company said in a statement today. MBIA, which has already raised at least $1.5 billion since November, said it would contribute most of the proceeds to its MBIA Insurance Corp. unit.

Another article highlighted by Naked Capitalism delivers a rather vague exhortation for increased bank regulation while one particular example purporting to show the need concerns some recent problems with Wachovia:

AmeriNet was a “payment processor,” a company that creates unsigned checks on behalf of telemarketers to withdraw funds automatically from customer accounts. Such checks, once widely used by businesses collecting monthly fees, are legal if customers approve the transactions.
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In 2006, an executive at Citizens Bank wrote via e-mail that thieves were routing unauthorized checks through Wachovia that stole from Citizens account holders.

“We have spoken to many of our customers who have been victimized by this scam,” wrote the Citizens executive, according to court documents. “We would appreciate it if you would shut down accounts of any customers of yours that may be engaging in improper activity.”

But Wachovia kept that account open until it was frozen by a federal court a few weeks later, as part of a government lawsuit against the client.

This is just more nonsense from the “Everything will be better with just a few more rules” camp. It is very tempting to believe that a few more rules will bring the new millennium, but those who argue in favour of this have never seen what happens in real life. Rules such as this – shutting down accounts due to suspicions of fraud – are not investigated by dispassionate keen-eyed investigators who have the evidence weighed by judicious descendents of Solomon. It is, in fact, a virtually random process in which facts become secondary to ass-covering.

In the quoted text above, the Citizens Bank executive should not have been contacting Wachovia – if they became involved at all, I suggest that police are generally considered the proper authorities for investigation of impropriety.

A bank clerk is not a cop I trust. A branch manager is not a judge I trust. And wishing won’t make it so.

But, that’s what happens when stuff hits the headlines – everybody’s an expert:

Regulators may restrict Moody’s Investors Service and Standard & Poor’s from advising banks on structured debt securities after criticism the firms failed to downgrade subprime-related debt as investor losses mounted.

Ratings firms may face a new code of conduct that limits their business and requires “reasonable steps” to ensure “a credible rating,” the International Organization of Securities Commissions in Madrid said in a statement today. IOSCO is the main forum for regulators, covering more than 100 countries from the U.S. to Japan.

I sure wish there was a code of conduct for regulators forcing them to take reasonable steps to ensure credible regulation!

An IMF research group has summarized a paper on VoxEU arguing that the subprime crisis is not unusual:

The subprime experience demonstrates that even highly-developed financial markets are not immune to problems associated with credit booms.

What can be done to curb bad credit booms? Historically, the effectiveness of macroeconomic polices in reducing credit growth has varied (see, for example, Enoch and Ötker-Robe, 2007). While monetary tightening can reduce both the demand and supply of bank loans, its effectiveness is often limited by capital account openness. This is especially the case in small open economies and in countries with more advanced financial sectors, where banks have easy access to foreign credit, including from parent institutions. Monetary tightening may also lead to significant substitution between domestic and foreign-denominated credit, especially in countries with (perceived) rigid exchange rate regimes. Fiscal tightening may also help reduce the expansionary pressures associated with credit booms, though this is often not politically feasible.

Fiscal tightening didn’t have much chance under a Republican administration! When in doubt, assume the best, right? It is very interesting to speculate as to what might have happened under Prof. Taylor’s counterfactual scenario of Fed tightening during the boom. We are certainly seeing that sub-prime sucked in a lot of money from Europe even with the relatively loose Fed policy during that time.

A very good day for the preferred share market, although I don’t see how the S&P/TSX Index was able to improve by 0.55% … half that, sure, two-thirds, maybe, but I suspect that this is an artefact of calculation caused either by low closes yesterday or high closes today.

Be that as it may, it was a strong day, with volume picking up and good strength throughout the entire PerpetualDiscount index. This index now has an interest-equivalent yield of 7.62% (at a conversion factor of 1.4), which is Canadas +350bp, Long Corporates +180bp. This latter (and probably more meaningful) figure has narrowed in about 30bp since last reviewed October 30, but still has a long way to go before reaching last spring’s levels of Long Corporates + ~110bp.

Hmmmm …. 70bp x 14years duration = … I’ll take it!

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

The roar erupts from the angry crowds: when is PrefBlog going to get any work done? Again today, general commentary will be greatly foreshortened. In my defence, I can only say that I was able to post about Seniority of BAs, ruin Kaspu‘s day with a comment on CCS.PR.C, report on performance of Malachite Aggressive Preferred Fund (my little fund did well! So why is it a little fund?), Best & Worst January Performers and finally January Index Performance.

So, apart from time constraints, my fingers are tired.

Econbrowser‘s Menzie Chinn commented on the Bush Budget and highlights the Reuters report by David Lawder :

“I think the main deceptions in the budget are the same ones we’ve seen for five years. The costs for Iraq and Afghanistan has consistently been $200 billion a year, but they’ve only put aside $70 billion,” said Chris Edwards, economist at the libertarian Cato Institute. “The war will cost $100 (billion) to $150 billion a year until 2012 or so.”

Coupled with unrealistic growth forecasts, the additional war costs mean the fiscal 2008 deficit will likely top $500 billion, he said.

Even Captain’s Quarters, a political blog which can usually be counted on to toe the Republican party line, has thrown in the towel on any hopes for fiscal conservatism. I continue to think that American fiscal profligacy will continue until conditions are in a lot worse shape than they are now – and, as in Canada, it will be the non-(so-called)-conservative party that does it, because they’re the ones who can’t be attacked for preaching hard times and shooting the hippo.

Fun and frolic for CDOs continued, with Fitch revamping its model and taking a gloomier view on the underlying securities chance of default. But nobody trades those things anymore, do they?:

Buying and selling of collateralized debt obligations based on mortgage bonds, high-yield loans or preferred shares has ground to a near-halt, traders said at the securitization industry’s largest conference.

“We’re definitely in a period of very low liquidity at the moment, which has actually been dropping precipitously in the last few weeks,” Ross Heller, an executive director at JPMorgan Securities Inc., said yesterday during a panel discussion at the American Securitization Forum’s annual conference in Las Vegas. “It’s a challenging time.”

I should note that the story is referring to American preferred shares, not Canadian ones. While some American issues are eligible for preferential tax treatment, this is a major bone of political contention, as I noted on January 10 (and continued after the charts, in the “Update” section). Without tax advantages, prefs are simply deeply subordinated debt.

This model revision is also having knock-on effects on … wait for it … the monolines:

MBIA Inc.’s AAA bond insurance ranking was placed back under review for a downgrade by Fitch Ratings less than a month after being affirmed with a stable outlook.

Fitch, which also put CIFG Financial Guaranty back under review, is updating its assumptions for higher losses on U.S. subprime-mortgage securities, the New York-based ratings company said today in a statement. If loss projections rise materially, the AAA ratings on bond insurers may no longer be appropriate regardless of how much capital they hold, the company said.

And it’s not as if the monolines don’t recognize their problems:

XL Capital Ltd., the Bermuda-based business insurer, said it lost $1.06 billion in the fourth quarter as it wrote down the value of investments including a stake in bond insurer Security Capital Assurance Ltd.

XL lost $6.01 a share, compared with a net profit of $481.1 million, or $2.62 a year earlier, the company said today in a statement. Excluding investment losses, XL earned 66 cents a share, lagging the $1.45 average estimate of 14 analysts surveyed by Bloomberg.

It seems, however, that business conditions aside, some portion of the monoline damage is self-inflicted … hedges aren’t perfect (hat tip: MarketRant).

Speaking of hedges … there is much concern and consternation about the BCE deal and the seemingly different probabilities assigned by the stock and bond markets (hat tip: Financial Webring Forum):

When it comes to the chances of the $35-billion BCE Inc. buyout falling through, the bond market isn’t buying what the equity market is selling.

Many stock market investors clearly believe the deal is likely to fail. The stock finished Friday at $36 on the Toronto Stock Exchange, well below the $42.75 that Ontario Teachers’ Pension Plan and its partners agreed to pay last June before global markets went haywire.
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Those in the bond market, on the other hand, are much more convinced the transaction will close later this year.

According to the credit-default swaps (CDS) market, an influential backroom of the financial system where big bond investors place bets, there’s at least a 70-per-cent chance that the deal succeeds.

To me, this sounds normal. Each market is taking a gloomy view. Didn’t the lawsuit over Hemlo take a billion dollars off the combined market cap of the adversaries, when logically it should have been a wash? Seems to me that if I were a hedge fund, I’d be devoting enormous resources to calculating what proportion of equity and bonds I should have in a basket that … maybe, possibly, subject to fearsome market punishment … would have an expected positive return irrespective of the outcome.

A relatively quiet day in the preferred market. I’ll admit, I view the precipituous decline in the number of issues on the “Price Mover” list with mixed feelings … on the one hand, it means I have a whole lot less typing to do (I still haven’t caught up with HIMIPref™ Preferred Indices, so I still have to do it all manually); on the other hand, huge price movements are often a source of wonderful trades. Oh well, we’ll just see how it goes.

WFS.PR.A is behaving strangely … the huge volume today is unusual, but not strange; what’s strange is the day’s high price: $10.75. Holy smokes, at that level you’re amortizing the premium by over $0.20 annually against dividends of $0.525 to wind up with a Yield-to-Maturity of about 3.1%, according to Mr. Calculator (broken link redirected 2024-2-1). Geez, and there I am, thinking it’s overpriced at $10.37, yielding 4.26%! 

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