Archive for March, 2008

HPF.PR.A / HPF.PR.B : DBRS Affirms Ratings Despite Dividend Suspension

Wednesday, March 26th, 2008

I’m astonished at the latest DBRS action:

DBRS has today confirmed two series of cumulative Preferred Shares issued by High Income Preferred Shares Corporation (the Company) following the March 19, 2008 announcement that monthly dividends to both the Series 1 Shares and Series 2 Shares have been suspended following the previously announced March 31, 2008 distribution.

Full repayment of Series 1 Shares principal will be provided via a forward agreement with the Canadian Imperial Bank of Commerce (CIBC). The Series 2 Shares principal relies fully on the Managed Portfolio for repayment of principal. In addition to providing coverage to the Series 2 Shares principal, the Managed Portfolio is used to pay annual fees and expenses, as well as monthly distributions to the Series 1 and Series 2 Shares (5.85% and 7.25% per annum, respectively). The Series 1 and Series 2 distributions rank pari passu to each other. The downside protection available to the Series 2 Shares principal is 12%, based on the current net asset value (NAV) of the Managed Portfolio.

Before dividends were suspended, the Managed Portfolio would be required to generate an annual return of over 20% to maintain its current NAV. The decision to suspend dividends will significantly reduce this annual grind to approximately 5% per annum.

The confirmation of the Series 1 Shares is based on CIBC providing full principal repayment via the forward agreement, as well as the risk that not all Series 1 dividends will be repaid, based on the NAV coverage over the remaining dividends. The confirmation of the Series 2 Shares is based on the current asset coverage available to cover the repayment of the Series 2 principal. The trend for both series of shares remains Negative due to the annual grind on the Managed Portfolio, as well as the additional remaining distribution payments that will now need to be made at maturity.

The termination date for each series of shares is June 29, 2012.

The suspension of dividends was reported on PrefBlog on March 19.

One may compare the insouciant nature of DBRS’ release with their attitude towards Quebecor:

DBRS notes preferred shareholders maintain a level of expectation that these dividends will be paid in a timely manner, and this expectation is reflected in the preferred share ratings. Having not met the expectation of preferred shareholders, DBRS notes the preferred shares are more reflective of a “D” rating.

I will also note that the dividends are cumulative. Given that, the “annual grind” of 20% noted by DBRS might – possibly – be reduced somewhat due to the time value of money, but if all the dividends are to be paid eventually, the reduction will be minimal.

March 25, 2008

Tuesday, March 25th, 2008

Naked Capitalism provides a very good round-up of the BSC/JPM deal commentary. I will quibble with the repeated suggestion that formal bankruptcy Monday morning was the only alternative to a deal. I agree that their options (speaking strictly in terms of their economic interests as shareholders, not as employees and creditors) were both limited and unpalatable – I pointed that out on March 14, but there is the question of the Japanese banks. Naked CapitalismWhy didn’t Bear use its credit lines? – couldn’t understand why they didn’t draw their lines; and the Japanese banks have previously advertised their willingness to lend to any player who is sufficiently desperate.

So – I think – Bear had a choice, albeit one with which Hobson would be familiar. Of particular interest in the post is the discussion of the alleged contract glitch that I briefly mentioned yesterday. Dealbreaker has posted twice on the issue, claiming that the conference call was crystal clear and then backing up his statement with the transcript. Upon thinking about it a little more myself – and reviewing the transcript – I’m inclined to believe that Dealbreaker is correct and the alleged glitch was in fact an explicitly desired thing.

Look: What’s the point of the guarantee in the first place? To ensure that Bear can operate until they’re formally taken over, right? If Bear had difficulties finding counterparties on the Friday, those difficulties were going to double on Monday (assuming that they did not file for bankruptcy at the crack of dawn). In order to serve its purpose, the guarantee had to be absolutely binding – who’s going to enter into a trading committment of a year, say (CDSs and Swaps will typically be 5 years) on the basis of a guarantee that might vanish in a month? JPM had to make the guarantee binding and lengthy, or there was no point going through the motions.

In familiarly cheery news, the US housing price drop is accellerating:

Home prices in 20 U.S. metropolitan areas fell in January by the most on record, a sign the housing recession is deepening, a private survey showed today.

The S&P/Case-Shiller home-price index dropped 10.7 percent from January 2007, after a 9 percent year-on-year decrease through December 2007. The gauge has fallen for 13 consecutive months.

Lehman Brothers Holdings Inc. forecasts home prices as measured by Case-Shiller will decline another 10 percent by the end of 2009. It predicts new-home sales will bottom in the middle of this year and existing-home sales and housing starts will reach a trough in the third quarter.

“Prices have reached what might be called a fair value,” Dan North, chief U.S. economist at Euler Hermes ACI in Owings Mills, Maryland, said in a Bloomberg Television interview before the report. “However, prices have still got to go substantially past that” to trigger demand and a recovery.

A separate report from the Office of Federal Housing Enterprise today showed home values fell 3 percent in January from a year ago, and 1.1 percent from December.

The S&P/Case-Shiller index measures repeat home sales in 20 U.S. cities, regardless of mortgage size, while the Ofheo monthly index excludes sales of homes with mortgages higher than $417,000, the maximum allowed during that time for homes bought by government-chartered Fannie Mae and Freddie Mac.

There is further commentary on the WSJ Blog.

In other news of interest Jeffrey Frankel argues that commodity prices are rising due to low real interest rates rather than due to new demand from the BRIC bloc.

Assiduous Readers will be familiar with my view that banking regulation needs to be improved; primarily by drawing a brighter line between the core banking system and the shadow banking system (e.g., by increasing capital requirements for committed – or effectively committed, as is the case with bank-sponsored SIVs – credit lines) and reviewing capital requirements for non-core-but-still-bloody-important institutions like investment banks (such as margin requirements on derivatives, as mentioned yesterday). I’m not alone in this view: Mark Thoma of Economist’s View got some ink in the WSJ Blog by musing about the need for reform:

There is quite a bit of discretionary authority in the hands of regulators. As the philosophy of both parties has drifted toward a hands off approach over time, and as appointment after appointment to this or that agency has reflected that changing philosophy, the accompanying regulatory oversight has changed along with it. The changes have been more dramatic under Republican administrations, and the current administration strongly prefers a hands off approach on all matters involving economic policy (with the exception of tax cuts for the wealthy), so it’s no surprise that the same philosophy has, over the last several years, filtered into the offices charged with regulatory oversight more so than in the past (and appointments based upon how much someone contributed and the strength of their ideology rather than their competence hasn’t helped).

Very – very! – light on specifics, but it’s a start. I might as well stake out my position pretty clearly right now … I want a core banking system, an investment banking system and a shadow banking system, with exposure between the levels being determined by margin and capital requirements rather than flat prohibitions and directives. What’s more, I believe that the appropriate policy response can better be described as “tweaking” rather than “reform”. The pendulum never swings half-way however, so it will be a fight – and certainly the political response so far has been to erode capital at the GSEs and FHLBs to protect Americans’ God-given right to McMansions.

The Fed has announced that yesterday’s TAF auction ($50-billion, one month) came in at 2.615% for one month money – about 4bp less than current LIBOR. This continues to be a good sign – a rate significantly above LIBOR would imply that there were players shut out of the interbank market desperate for funds. For those having trouble with the plethora of new Fed acronyms, remember that the TAF is restricted to banks and is fully collateralized.

In news that will cause fear and trembling amongst BCE investors (the equity kind, anyway), the Clear Channel buy-out looks sick:

Clear Channel Communications Inc. dropped in extended trading after the Wall Street Journal reported its $19.5 billion private-equity buyout is close to falling apart.

The buyout group, led by Thomas H. Lee Partners LP and Bain Capital Partners LLC, hasn’t been able reach an agreement on terms with the banks financing the transaction, the newspaper said today, citing people familiar with the matter. The lenders include Citigroup Inc., Morgan Stanley, Deutsche Bank AG, Credit Suisse Group, Royal Bank of Scotland Group and Wachovia Corp.

Clear Channel, the largest U.S. radio broadcaster, dropped 14 percent to $28 after closing at $32.56 in New York Stock Exchange composite trading. Since the buyout was announced in November 2006, the stock has traded below the $39.20-a-share offer price because of investor concerns that the deal won’t be completed. Credit-market turmoil has made it harder for buyout firms to obtain financing.

Clear Channel’s 5.5 percent notes due in September 2014 rose 2.75 cents, or 4.4 percent, to 65 cents on the dollar to yield 13.9 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

A day enlivened by the BMO new issue of 5.80% perps. Volume picked up nicely, but perpetualDiscounts got smacked as players adjusted their portfolios to account for … for … for … for what they think the new standard is. Or something.

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 5.38% 5.41% 33,162 14.78 2 +0.3894% 1,092.3
Fixed-Floater 4.78% 5.49% 60,904 14.86 8 +0.1545% 1,039.9
Floater 4.89% 4.89% 78,707 15.70 2 -2.2179% 851.7
Op. Retract 4.84% 3.15% 76,735 2.96 15 +0.0367% 1,047.5
Split-Share 5.39% 6.08% 93,265 4.12 14 -0.1382% 1,021.7
Interest Bearing 6.21% 6.66% 65,753 4.21 3 -0.0672% 1,084.8
Perpetual-Premium 5.80% 5.70% 252,506 11.39 17 -0.0470% 1,018.3
Perpetual-Discount 5.58% 5.64% 294,725 14.42 52 -0.3642% 926.0
Major Price Changes
Issue Index Change Notes
BAM.PR.K Floater -5.2525%
BCE.PR.R FixFloat -2.3569%
RY.PR.W PerpetualDiscount -1.6115% Now with a pre-tax bid-YTW of 5.48% based on a bid of 22.59 and a limitMaturity.
SLF.PR.D PerpetualDiscount -1.4627% Now with a pre-tax bid-YTW of 5.54% based on a bid of 20.21 and a limitMaturity.
BNS.PR.N PerpetualDiscount -1.2879% Now with a pre-tax bid-YTW of 5.61% based on a bid of 23.76 and a limitMaturity.
RY.PR.A PerpetualDiscount -1.1848% Now with a pre-tax bid-YTW of 5.40% based on a bid of 20.85 and a limitMaturity.
FTU.PR.A SplitShare -1.1274% Asset coverage of just under 1.4:1 as of March 14, according to the company. Now with a pre-tax bid-YTW of 8.64% based on a bid of 8.77 and a hardMaturity 2012-12-1 at 10.00.
BMO.PR.K PerpetualDiscount -1.1097% Now with a pre-tax bid-YTW of 5.73% based on a bid of 23.17 and a limitMaturity.
BMO.PR.J PerpetualDiscount -1.0924% Now with a pre-tax bid-YTW of 5.72% based on a bid of 19.92 and a limitMaturity.
SLF.PR.A PerpetualDiscount -1.0909% Now with a pre-tax bid-YTW of 5.47% based on a bid of 21.76 and a limitMaturity.
PWF.PR.L PerpetualDiscount -1.0323% Now with a pre-tax bid-YTW of 5.63% based on a bid of 23.01 and a limitMaturity.
FAL.PR.B FixFloat +1.0101%
BCE.PR.A FixFloat +1.0101%
BCE.PR.Z FixFloat +1.2335%
Volume Highlights
Issue Index Volume Notes
TD.PR.N OpRet 150,300 Nesbitt crossed 150,000 at 26.12. Now with a pre-tax bid-YTW of 3.96% based on a bid of 26.02 and a softMaturity 2014-1-30 at 25.00.
MFC.PR.A OpRet 105,000 Nesbitt crossed two lots of 50,000, both at 25.65. Now with a pre-tax bid-YTW of 3.97% based on a bid of 25.27 and a softMaturity 2015-12-18 at 25.00.
TD.PR.M OpRet 103,206 Nesbitt crossed 100,000 at 26.26. Now with a pre-tax bid-YTW of 3.95% based on a bid of 26.13 and a softMaturity 2013-10-30.
TD.PR.R PerpetualDiscount 34,255 Now with a pre-tax bid-YTW of 5.67% based on a bid of 24.87 and a limitMaturity.
TD.PR.Q PerpetualPremium 30,193 Now with a pre-tax bid-YTW of 5.67% based on a bid of 25.06 and a limitMaturity.

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

Ontario Budget Favours Dividends

Tuesday, March 25th, 2008

The Ontario Budget has just been introduced. According to KPMG:

On the personal tax front, Ontario maintains its original plan to increase the dividend tax credit rate for grossed-up eligible dividends, despite changes to the federal dividend gross-up factor and dividend tax credit rate on eligible dividends. As a result, Ontario’s tax rate on eligible dividends will effectively be reduced.

The 2008 federal budget announced changes to the tax on eligible dividends that would reduce the gross-up factor applying to eligible dividends received by Ontario individuals, beginning in 2010. Ontario proposes to maintain its plan announced in August 2006 to increase the dividend tax credit rate on grossed-up eligible dividends to 7.4% in 2009 (from 7.0% in 2008) and to 7.7% in 2010 and subsequent years.

Taking into account these changes, the top marginal tax rates applying to eligible dividends for Ontario resident individuals will be as follows:

Top Marginal Tax Rates for Eligible Dividends

























In effect, the Ontario top marginal tax rate on eligible dividends will drop to 7.4% (from 7.8%) by 2012. Overall, the combined federal and Ontario top marginal tax rate on eligible dividends will increase to 26.7% (from 24.0%) by 2012.

The quoted top marginal rate is very different from the 30.19% in 2012 estimated earlier!

XCM.PR.A Invokes Priority Equity Protection Plan

Tuesday, March 25th, 2008

Commerce Split Corp. has announced:

was launched on February 16, 2007 and at that time the price of CIBC common shares was $102.15. As of March 24, 2008 the price of CIBC commons shares has declined to $66.80 or a drop of 35% since the inception of the fund. This sharp decline has resulted in the fund’s net asset value being reduced significantly and has required the Company to implement the Priority Equity Protection Plan in accordance with the prospectus. This plan was implemented to maintain a preferred share coverage ratio of 125% as defined in the prospectus. The Company has executed trades to remain in compliance with the Protection Plan by purchasing permitted repayment securities. Currently, the portfolio has over $2.60 (a decrease from $4.25 per unit – please refer to the Press Release dated March 19, 2008 Portfolio Update) in notional value of permitted repayment securities per unit (a unit being 1 Priority Equity Share plus 1 Class A Share) thereby reducing the risk to Priority Equity shareholders to any further declines in the price of CIBC common shares.

The Company’s investment portfolio also has approximately $11.09 in CIBC exposure per unit which is an increase of $1.82 per unit from the last Portfolio Update on March 19, 2008. There is $9.93 per unit in CIBC common shares and the equivalent of $1.16 per unit in exposure through long CIBC call options, which provides exposure to any potential upside in the value of CIBC common shares. The Company has written call options on a portion of these positions at higher levels.

The Company’s portfolio is continually rebalanced based on market conditions to provide both security for Priority Equity shareholders and upside potential for Class A shareholders. The Company may buy or sell additional shares of CIBC, the permitted repayment securities, and or option positions based on market conditions provided that the Company remains in compliance with the Priority Equity Protection Plan.

Dividends on the Capital Units have been suspended, but the Prefs are still paying. The last Capital Unit distribution was in January.

Quadravest has described the PEPP in a previous release.

XCM.PR.A is not tracked by HIMIPref™. They are not rated by any rating organization.

Update, 2008-4-1: The company has announced:

The Company’s investment portfolio has approximately $12.24 in CIBC exposure per unit which is an increase of approximately 10% in exposure per unit from the last Portfolio Update on March 25, 2008. This exposure consists of $11.05 per unit in CIBC common shares and the equivalent of $1.19 per unit in exposure through long CIBC call options. The Company has written call options on a portion of these positions at higher levels. The Company retains $1.69 in notional value of Permitted Repayment Securities for the protection of Priority Equity Shareholders Capital.

The Company’s current net asset value as at the close on April 1, 2008 exceeds the $12.50 threshold for payment of capital share dividends and is no longer in a position that would require the Company to set aside funds into the repayment securities.

HIMIPref™ Evaluates Trade: TCA.PR.X -> CU.PR.A

Tuesday, March 25th, 2008

This potential trade was discussed in the comments to a post that posed the question: TCA.PR.X & TCA.PR.Y : What’s Keeping Them Up?.

So … just for fun, I created a portfolio which held two issues, TCA.PR.X and TCA.PR.Y, 1,000 shares of each. I defined the portfolio as trading according to the issueMethod, with a desired number of issues equal to 2.

I produced a number of reports, most of which will look like complete gobbledy-gook. You can start tracing their meanings with some help from the glossary:

So … the vital number is the trade score … “100” means the trade is recommended even at bid to full offer; “0” means the trade is recommended at full offer to bid (i.e., OK if you can sell at the offering price and buy at the bid price). In this case the trade score is -1,773 … the trade is so far away from being recommended we might just as well stay home.

Looking at the trade evaluation, though, we do see there’s a pretty good pickup; the trade is not recommended because the required pickup is enormous … ridiculously enormous, in fact. It would be very rare for a potential trade to meet such a hurdle.

Looking at the Risk Measurement report, we find that the required pickup is ridiculously big because the change in pseudoConvexityCost is ridiculously big.

The calculation of pseudoConvexityCost in HIMIPref™ is not something I’m very happy with. It will be changed in the next version of HIMIPref™, but I have to play with it. The problem is that in some conditions, the numbers are implausible and counter-intuitive … this is prevented from fooling the trade recommendation engine by various checks and catches in that part of the programme … but I still don’t like it.

Anyway, the derivation of the extremely high pseudoConvexityCost for TCA.PR.X can be traced (part of the way down the route) with:

There’s more in the system. To understand costYield, you have to look at the cash flows, in which the embedded option is treated as a cash flow adjustment to a permanent revenue stream. In order to understand the pricing of the embedded option, you have to look at that report. But, geez, that’s enough detail for one day, eh?

Suffice it to say that pseudoModifiedDurationCost (that is to say, the modified duration calculated, not formulaicly, but by sampling of yield changes, using costYield as the yield measure) changes a lot for TCA.PR.X given its present price. The system has found (via backtesting) that trades that change this number substantially are riskier (in terms of ultimate results) than trades that do not change this number.

So in this case, the system wants to hang on to the existing issue – even though the valuation of CU.PR.A is higher – because the risk profile is so different.

Astute readers will have noticed that the trade size was reduced to zero due to the low volume on the CU.PR.A anyway!

New Issue: BMO 5.80% Perps

Tuesday, March 25th, 2008

Bank of Montreal has announced:

a domestic public offering of $200 million of Non-Cumulative Perpetual Class B Preferred Shares Series 15 (the “Preferred Shares”). The offering will be underwritten on a bought deal basis by a syndicate led by BMO Capital Markets. The Bank has granted to the underwriters an option to purchase up to an additional $50 million of the Preferred Shares exercisable at any time up to two days before closing.

The Preferred Shares will be issued to the public at a price of $25.00 per Preferred Share and holders will be entitled to receive non-cumulative preferential quarterly dividends as and when declared by the board of directors of the Bank, payable in the amount of $0.3625 per Preferred Share, to yield 5.80 per cent annually.

Subject to regulatory approval, on or after May 25, 2013, the Bank may redeem the Preferred Shares in whole or in part at a declining premium.

The anticipated closing date is April 2, 2008. The net proceeds from the offering will be used by the Bank for general corporate purposes.

Issue: Non-Cumulative Perpetual Class B Preferred Shares Series 15

Size: 8-million shares @ $25; underwriters’ greenshoe for an additional 2-million shares.

Dividends: 5.80% p.a., payable quarterly. Long first dividend of $0.57603 payable August 25, based on closing of April 2.

Redemption at Bank’s option: Redeemable at $26.00 commencing 2013-5-25; redemption price declines by $0.25 every May 25 until May 25, 2017; redeemable at $25.00 thereafter.

Ratings: S&P, P-1(low); DBRS, Pfd-1; Moody’s, Aa3

Priority: parri passu with all other prefs.

… More Later …

Later, More: Curve Price (the fair value, which does not include dynamic factors) as of the close 2008-3-24 is $25.43.

Later, Even More: BMO has been busy today! They’ve just announced a $600-million sub-debt issue at Canadas + 260bp, stepping up to BAs+200 March 28, 2018 (at which time it is callable at par), maturing March 28, 2023. Prospectus Supplement dated 2008-3-25; 10-year Canadas are now at 3.47%, so say this stuff comes with 6.07-ish coupon.

Later, So Much More You Just Can’t Believe It!: I am advised the BMO sub-debt issue got done at a size of $900-million, Coupon 6.17%, Price 99.97 to give a yield-to-hoped-for-and-very-well-advertised-call of 6.174%,

Later…: CurvePrice as of the close 2008-3-25 is 25.38.

Update, 2008-3-28: There have been some comments made about BMO.PR.K falling out of bed, with speculation about the implications for the opening price of the issue. First, let’s look at the BMO comparables:

BMO Perps at Close 2008-3-27
Issue Quote Dividend Pre-tax
BMO.PR.H 23.23-54 1.325 5.73% 23.89
BMO.PR.J 19.81-87 1.125 5.75% 20.76
BMO.PR.K 22.35-54 1.3125 5.95% 23.74
BMO.PR.? 25.00
1.45 5.82% 25.26

Assiduous Readers will be familiar with my article on convexity, in which I estimate that a 15bp yield pickup is required to make holding a near-par instrument worth-while. If we may assume a 5.75% base yield for deep-discount BMO prefs, this implies a 5.90% “fair-ish, sorta” yield for the new BMO issue, which implies a price of about 24.60. We shall see!

Note that the convexity stuff is considered a dynamic factor and is not incorporated into the evaluation of curvePrice, which is restricted to static factors.

Update, 2008-3-31: Quarter-end was a bad day thanks to the National Bank 6.00% Perps! Curve price at the close of business was 25.09.

Update, 2008-4-1: Closes tomorrow. Curve price at the close today was 25.08.

March 24, 2008

Monday, March 24th, 2008

Menzie Chinn of Econbrowser reviews the policy response to the credit crunch:

First, methinks the Administration protests too much, about “not bailing out” investors. If it were indeed the case that it was against further contingent liabilities being taken on by the Federal government, it would not have allowed the increase in the maximum size of conforming loans guaranteed by the Government Sponsored Enterprises, Fannie Mae and Freddie Mac. Nor would capital requirements have been reduced at exactly the time that a higher capital cushion would be in order, given the state of the economy. In addition, it would have taken some sort of action to limit the borrowing taking place through the Federal Home Loan Banks (see [5], [6] for discussion of recent actions, and implications).

Second, whatever the reasons for the Administration’s actions, I think a very serious problem is that, by virtue of the Administration’s abdication of a substantive role (see Hubbard’s comment on this point), the Fed is lending to entitites it does not regulate. The Bear Stearns collapse might have been seen as a case where the Fed had to undertake unconventional actions, because of the rapidity of developments. But with the Administration providing an uncompromising stance, who will step in the next episode? If it’s the Fed again, then Blinder’s critique will take on heightened relevance.

I’ll agree with his first point – as I said most recently in the comments to March 20, a slight relaxation in the GSE capital requirements may be justifiable, but should be accompanied by a schedule whereby the capital standards would approach banks. Similarly, the FHLBs should be regulated like the banks they are.

Prof. Chinn’s second concern, the separation of regulatory and last-lender powers, does not seem quite so cut-and-dried to me. The issue was last discussed in PrefBlog in the post regarding Willem Buiter’s Prescription and on December 5 in response to a VoxEU article by Stephen Cecchetti. There are certainly good arguments to be made regarding combination of roles as far as the banks are concerned – and, by and large, I agree with these arguments – but the arguments for extending Fed oversight to the brokerages is a little less clear.

As I have stated so many times that Assiduous Readers are fed up to the back teeth with the incessant drone – we want a shadow banking system! We want to ensure that there are layers of regulation, with the banks at the inner core and a shock-absorber comprised of brokerages that will serve as a buffer between this core and a wild-and-wooly investment market. This will, from time to time, require (or, at least, encourage) the Fed to step in and take action, but the alternative is worse.

Which is not to say that regulation cannot be improved! Regulation can always be improved! Margining requirements for derivatives may have to be reviewed – interest rate swaps and credit default swaps particularly, without simply making the lawyers happy by getting them to invent a new instrument.

If I buy $1-million of a corporate bond from my broker, I have to put up 10% margin. Seems to me that if sell credit protection, I should have to put up 10% of notional. And if I buy credit protection, I should have to put up at least 10% of the present value of the contractual payments.

Similarly with an interest-rate swap: if I pay floating to receive fixed, that is functionally equivalent to going long a fixed-rate bond and short a floating-rate one. If I do this in the physical market, I will be allowed a consideration as far as offsetting credit risk is concerned, but I won’t get away scot-free! When done as a derivative, I should have to put up … 2%? … of notional.

And in both cases, positions should be marked to market at least monthly. As reported by the WSJ, Barney Frank, Chairman of the House Financial Services Committee, wants a review of margin requirements (among other things), but has no concrete proposals at this time:

Reassess our Capital, Margin and Leverage Requirements (and the nature of “capital” itself). This crisis has illustrated that seemingly well-capitalized institutions can be frozen when liquidity runs dry and particular assets lose favor.

The BSC/JPM deal was a big story again today, with the deal value quadrupling in exchange for a couple of things:

  • JPM is getting a new issue of 39.5% of BSC as treasury stock
  • A possibility that JPM will take $1-billion first-loss on the $30-billion Fed financing

Seems to me that this makes the deal a certainty, with the Fed managing to keep its self-respect by being able to point out that the billion dollars extra given to BSC shareholders has been met by a corresponding reduction in their loss-exposure on the financing. The certainty will be good news for JPM in terms of staff retention, as well as considerations that the guarantee of liabilities might have been poorly drafted, as reported upon by Naked Capitalism.

The WSJ has reported:

At the merger’s closing, the New York Fed will take control of about $30 billion of assets as collateral for $29 billion in financing from the New York Fed. The Fed will provide the funds at its primary credit rate, 2.5%, or a quarter percentage point above the benchmark federal funds rate. Under the new terms, J.P. Morgan would have to eat the first $1 billion in losses from those assets; the Fed would have rights to any gains.

The New York Fed plans to provide additional details about the deal’s terms later Monday.

The New York Fed hired BlackRock Financial Management Inc. to manage the $30 billion portfolio “to minimize disruption to financial markets and maximize recovery value,” it said in a statement. Fed officials sought out BlackRock, seeing it as one of the few firms without conflicts of interest that could handle the task in the timeframe that was necessary. The Fed hasn’t provided details of the portfolio, whose assets were valued on March 14, but it’s believed to include hard-to-trade securities tied to riskier home mortgages.

Boy, that BlackRock’s got a good gig, eh? Paid to manage a portfolio that’s virtually untradeable and in run-off mode. A New York Fed press release confirms the terms.

In yet another indication that Regulation FD and its Canadian equivalent, National Policy 51-201, are in urgent need of amendment, the Fitch / MBIA battle has hotted up:

Fitch Ratings said it will still assess MBIA Inc.’s financial strength, snubbing a request by the bond insurer to withdraw the ratings.

Fitch will rate MBIA as long as it can maintain a “clear, well-supported” view without access to non-public information, the ratings firm said today in a statement.

MBIA asked Fitch earlier this month to stop rating the company because of disagreements about modeling for losses. Fitch is the only credit rating company considering a downgrade of MBIA. Moody’s Investors Service and Standard & Poor’s both affirmed the company earlier this month after MBIA raised $3 billion in capital, eliminated its dividend and stopped issuing asset-backed insurance. Fitch will complete its review in “the next few weeks,” Joynt said.

Fitch probably won’t be able to continue rating the company for long, MBIA said today in a statement responding to the announcement.

“The non-public information currently in Fitch’s possession soon will become out of date, and public information alone will be insufficient to maintain the ratings,” MBIA said.

OK. So here we have MBIA saying that investors cannot possibly come to a well-supported conclusion about credit quality without access to material non-public information, which is available only to credit rating agencies that make their credit ratings public (the Lord alone knows what equity investors are supposed to conclude). How many times must this conclusion be repeated before the exemption is repealed and the required information is publicized?

Naked Capitalism has excerpted and colourized a post by Brad Setser regarding reliance of the US on foreign central banks:

So long as they are piling into safe US assets, central banks are contributing the “liquidity” to a market that doesn’t need any liquidity. They are helping to push Treasury rates down. And their activities, while rational from the point of view of conservative institutions seeking to avoid losses (beyond those associated with holding the dollar), also may be aggravating some of the difficulties in the credit markets. Private funds fleeing the risky US assets for the emerging world generally end up in central bank hands and currently seem to be recycled predominantly into safe US assets.

In January, official investors – central banks and sovereign funds – provided the US with $75.5 billion in financing. Annualized, that is about $900b. That’s huge. It is also more than the US current account deficit. Central banks and sovereign funds are effectively financing the runoff of some private claims on the US. If the US were an emerging economy, that might be called “capital flight.”

$53.4b of the $75.5b in overall official inflows came from the purchase of long-term US debt and equities. $22.1b came from a rise in short-term claims (the $15.2b increase in short-term Chinese claims likely explains most of the overall rise in short-term claims).

That $53.4b in long-term inflow was concentrated at the two poles of the risk distribution: Official investors purchased $36.1b in Treasuries, next to no agencies (*), sold corporate debt and bought $13.9b in US equity. This is what an anonymous (but well informed) commentator here called a barbell portfolio. Buy safe stuff or buy risky stuff but don’t buy much in between.

Well – that’s what happens when you run a fiscal deficit for so long … the country’s financial markets become the plaything of foreignors.

Volume picked up a little in the preferred share market today, but was nothing special – no major price trends either.

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 5.42% 5.45% 33,930 14.73 2 +0.0205% 1,088.0
Fixed-Floater 4.79% 5.51% 61,496 14.83 8 -0.2348% 1,038.3
Floater 4.77% 4.78% 79,829 15.91 2 -0.0260% 871.0
Op. Retract 4.84% 3.36% 75,111 2.75 15 +0.1457% 1,047.1
Split-Share 5.39% 6.04% 93,953 4.13 14 +0.5685% 1,023.1
Interest Bearing 6.21% 6.69% 66,556 4.22 3 +0.1365% 1,085.6
Perpetual-Premium 5.80% 5.69% 255,268 10.81 17 -0.0556% 1,018.8
Perpetual-Discount 5.56% 5.62% 297,245 14.46 52 +0.0450% 929.4
Major Price Changes
Issue Index Change Notes
HSB.PR.C PerpetualDiscount -3.1760% Now with a pre-tax bid-YTW of 5.68% based on a bid of 22.56 and a limitMaturity.
SLF.PR.D PerpetualDiscount -1.1566% Now with a pre-tax bid-YTW of 5.45% based on a bid of 20.51 and a limitMaturity.
BAM.PR.G FixFloat -1.1294%
BCE.PR.A FixFloat -1.0000%
FFN.PR.A SplitShare +1.0320% Asset coverage of 1.8+:1 as of March 14, according to the company. Now with a pre-tax bid-YTW of 5.73% based on a bid of 9.79 and a hardMaturity 2014-12-1 at 10.00.
BNA.PR.C SplitShare +1.1405% Asset coverage of 2.8+:1 as of February 29, according to the company. Now with a pre-tax bid-YTW of 7.41% based on a bid of 19.51 and a hardMaturity 2019-1-10 at 25.00. Compare with BNA.PR.A (6.93% to 2010-9-30) and BNA.PR.B (8.26% to 2016-3-25).
PWF.PR.J OpRet +1.2466% Now with a pre-tax bid-YTW of 4.03% based on a bid of 25.99 and a call 2010-5-30 at 25.00.
FTU.PR.A SplitShare +1.3714% Asset coverage of just under 1.4:1 as of March 14, according to the company. Now with a pre-tax bid-YTW of 8.35% based on a bid of 8.87 and a hardMaturity 2012-12-1 at 10.00.
ELF.PR.G PerpetualDiscount +1.5971% Now with a pre-tax bid-YTW of 6.15% based on a bid of 19.72 and a limitMaturity.
SBN.PR.A SplitShare +1.7699% Asset coverage of just under 2.1:1 as of March 13, according to Mulvihill. Now with a pre-tax bid-YTW of 4.66% based on a bid of 10.35 and a hardMaturity 2014-12-1 at 10.00.
POW.PR.D PerpetualDiscount +1.9128% Now with a pre-tax bid-YTW of 5.46% based on a bid of 22.91 and a limitMaturity.
BMO.PR.H PerpetualDiscount +2.4076% Now with a pre-tax bid-YTW of 5.57% based on a bid of 22.91 and a limitMaturity.
Volume Highlights
Issue Index Volume Notes
PWF.PR.K PerpetualDiscount 91,422 Nesbitt crossed 15,100 at 22.56, CIBC crossed 50,000 at 22.57, then Scotia crossed 25,000 at 22.57. Now with a pre-tax bid-YTW of 5.57% based on a bid of 22.55 and a limitMaturity.
TD.PR.R PerpetualDiscount 52,050 Now with a pre-tax bid-YTW of 5.66% based on a bid of 24.92 and a limitMaturity.
BNS.PR.O PerpetualPremium 49,057 Now with a pre-tax bid-YTW of 5.66% based on a bid of 25.11 and a limitMaturity.
PWF.PR.I PerpetualPremium 41,200 Desjardins crossed 20,000 at 25.50 … then did it again! Now with a pre-tax bid-YTW of 5.89% based on a bid of 25.36 and a call 2012-5-30 at 25.00.
SLF.PR.A PerpetualDiscount 35,145 Nesbitt crossed 25,000 at 22.00. Now with a pre-tax bid-YTW of 5.42% based on a bid of 22.00 and a limitMaturity.

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

HIMIPref™ Preferred Indices : December 2006

Monday, March 24th, 2008

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

HIMI Index Values 2006-12-29
Index Closing Value (Total Return) Issues Mean Credit Quality Median YTW Median DTW Median Daily Trading Mean Current Yield
Ratchet 1,360.5 1 2.00 4.10% 17.3 31M 4.10%
FixedFloater 2,361.2 7 2.00 3.61% 4.4 65M 4.78%
Floater 2,193.1 4 2.00 -23.56% 0.1 41M 4.59%
OpRet 1,942.4 17 1.36 2.50% 2.2 75M 4.66%
SplitShare 2,030.9 12 1.92 3.17% 2.7 86M 4.89%
Interest-Bearing 2,382.4 8 2.00 6.05% 2.7 56M 6.88%
Perpetual-Premium 1,554.5 55 1.34 4.23% 5.8 133M 5.00%
Perpetual-Discount 1,656.9 3 1.00 4.50% 16.4 585M 4.50%
HIMI Index Changes, December 29, 2006
Issue From To Because
BNA.PR.A SplitShare Scraps Volume
BAM.PR.M PerpetualDiscount PerpetualPremium Price
CGI.PR.C Scraps SplitShare Volume
CAC.PR.A SplitShare Scraps Volume
MFC.PR.C PerpetualDiscount PerpetualPremium Price
PWF.PR.D OpRet Scraps Volume
PWF.PR.A Floater Scraps Volume
RY.PR.A PerpetualDiscount PerpetualPremium Price
IAG.PR.A PerpetualDiscount PerpetualPremium Price
SXT.PR.A Scraps SplitShare Volume

There were the following intra-month changes:

HIMI Index Changes during December 2006
Issue Action Index Because
RY.PR.D Add PerpetualPremium New Issue
FBS.PR.B Add SplitShare New Issue
FBS.PR.A Delete Scraps Redemption

Index Constitution, 2006-12-29, Post-rebalancing

RF.PR.A Announces Normal Course Issuer Bid

Monday, March 24th, 2008

Holy smokes, that didn’t take long!

RF.PR.A is a new issue that settled on February 22. The exercise of the greenshoe of 100,000 shares was announced March 20. Today’s closing quotation was 23.75-00, 2×3, on volume of 1,300 shares.

The company has announced:

that it intends to purchase up to 145,760 of the preference shares, series 1 of the Corporation (the “Shares”) for cancellation by way of a normal course issuer bid through the facilities of the Toronto Stock Exchange (the “TSX”). The 145,760 Shares represent approximately 10% of the public float of the Corporation. As of March 20, 2008, 1,540,000 Shares are issued and outstanding.

The purchases may commence on March 26, 2008 and will terminate on March 25, 2009, or on such earlier date as the Corporation may complete its purchase or provide notice of termination. Any such purchases will be made by the Corporation at the prevailing market price at the time of such purchases in accordance with the requirements of the TSX.

If Shares are offered on the TSX at prices that are less than or equal to $25.00, the Corporation may offer to purchase such Shares, if it determines that such purchases are in the best interests of shareholders, and subject to compliance with the applicable regulatory requirements and limitations.

The Corporation will not purchase in any 30 day period more than 30,800 Shares, being 2% of the issued and outstanding Shares as at the date of acceptance of the notice of the normal course issuer bid by the TSX.

TCA.PR.X & TCA.PR.Y : What's Keeping Them Up?

Saturday, March 22nd, 2008

I’m really surprised by the resiliency shown by the two TransCanada PipeLines issues – these are very similar perpetuals, with a $50 par value and pay $2.80 p.a. – a coupon of 5.6%. TCA.PR.X is redeemable at par commencing 2013-10-15, while the TCA.PR.Y is redeemable at par commencing 2014-3-5.

TCA.PR.X was issued in October 1998 as TRP.PR.X, while TCA.PR.Y began life 1999-3-5 as TRP.PR.Y. Four million shares of each series are outstanding so they’re a nice size for non-financial issues.

These issues are perennial favourites of mine. They were hard hit when TRP cut its common share dividend, with the low point being 2000-5-23: TRP.PR.Y had closing quote of 34.80-25 on volume of 6,180 shares. I made a fair bit of money on that – tough times do not lead inevitably to default.

There were some credit worries when they made a big investment in Dec 06, but these were taken care of by an equity issue.

More recently, their 5.6% coupon, far higher than most of their competition in recent years (other issues with similarly high coupons have been called) made them exemplars of the virtues of the PerpetualPremium class – when they yielded 4.10% to call, as they did about a year ago, the difference between this yield and the coupon implied a lot of interest-rate protection for investors.

They’ve weathered the storm of the past year beautifully – well down from the high of 55.71-10 on no volume, reached 2006-12-4 by TCA.PR.Y, but not nearly as badly hit as perpetuals without such high coupons … just chugging along, paying their coupon, and still trading above thier call price.

Which is my problem. Why are they still trading above their call price? The cycle has turned, and a coupon of 5.6% is not as extraordinary as it was a year ago – see the new issues of TD.PR.R, TD.PR.Q and BNS.PR.O all with similar coupons and a call date at par that is further away than the TCA calls (and it is unequivocally better for the call date to be further away, since the call won’t be exercised if you want it to be – and vice versa!).

Why are TCA.PR.X and TCA.PR.Y, both rated Pfd-2(low) by DBRS and P-2 by S&P, trading to yield less than the bank issues, rated Pfd-1 [DBRS] and P-1(low) [S&P]? One explanation may be scarcity value (many players are fully loaded on banks in general and these banks in particular) and another might be extreme sector aversion to financials. But it still doesn’t make a lot of sense to me.

I’ve uploaded some charts, comparing these two issues with others that have a 5.6% coupon…

Yield disparity, by the way, is the amount of yield that would have to be added or subtracted from the yield curve in order to achieve a calculated price equal to the market price – some players may know this as the “Z-Spread”. It is not unusual for an issue (such as TCA.PR.X over the past year) to be “always expensive” – this may mean that there is something about the issue that is not incorporated in the model (a restrictive covenant, perhaps, or scarcity value, or … something) but it is clear to see from the chart that TCA.PR.X (and TCA.PR.Y) have become more expensive than usual.

And I completely fail to understand why they’re trading through the banks.

Update, 2008-03-23: In response to prefhound‘s points in the comments, I have uploaded listings for PerpetualDiscount and PerpetualPremium yieldDisparities. Note that these yield disparities contain adjustments for Cumulative Dividends – which I believe to be an artefact, but will admit that I am unsure. The cumulativeDividend adjustment to curve price (and hence curve yield) is quite substantial – without it, TCA.PR.X would appear even more expensive than they do now.