Well, it happened last March with AR.PR.B and now it’s happened again.
In my last update of the day everything IQW.PR.D was one penny bid and the quote was rejected as an obvious error. Ha!
The issue has been around in various incarnations since 1997-11-12, when it came on the scene as IQI.PR.A. Ave Atque Vale!
I referred to the paper on September 15 and republished the abstract in that post.
The paper is by Amir E. Khandani, a graduate student at MIT, and Andrew W. Low, a Professor at the MIT Sloan School of Management (among other titles).
The paper was written in an attempt to understand the events of August 7th to August 10th:
With laser-like precision, model-driven long/short equity funds were hit hard on Tuesday August 7th and Wednesday August 8th, despite relatively little movement in fixed-income and equity markets during those two days and no major losses reported in any other hedge-fund sectors. Then, on Thursday August 9th when the S&P 500 lost nearly 3%, most of these market-neutral funds continued their losses, calling into question their market-neutral status.
By Friday, August 10th, the combination of movements in equity prices that caused the losses earlier in the week had reversed themselves, rebounding significantly but not completely. However, faced with mounting losses on the 7th, 8th, and 9th that exceeded all the standard statistical thresholds for extreme returns, many of the affected funds had cut their risk exposures along the way, which only served to exacerbate their losses while causing them to miss out on a portion of the reversals on the 10th. And just as quickly as it descended upon the quants, the perfect financial storm was over.
I’ll quibble with the idea that taking losses when the market goes down calls into question their market-neutral status. Ideally, the distribution of gains and losses for such a fund will be completely uncorrelated with market movements; there will be just as many opposites as there are matches over a sufficiently long time period (like, more than a week!).
The authors define the class of hedge fund investigated as:
including any equity portfolios that engage in shortselling, that may or may not be market-neutral (many long/short equity funds are long-biased), that may or may not be quantitative (fundamental stock-pickers sometimes engage in short positions to hedge their market exposure as well as to bet on poor-performing stocks), and where technology need not play an important role.
… but warn that distinctions between funds are blurring (similarly to recently observed private-equity investments in junk bonds).
The authors attempt to reproduce the overall performance of the model-driven long/short equity funds by use of a naive model:
consider a long/short market-neutral equity strategy consisting of an equal dollar amount of long and short positions, where at each rebalancing interval, the long positions are made up of “losers” (underperforming stocks, relative to some market average) and the short positions are made up of “winners” (outperforming stocks, relative to the same market average).
…
By buying yesterday’s losers and selling yesterday’s winners at each date, such a strategy actively bets on mean reversion across all N stocks, profiting from reversals that occur within the rebalancing interval. For this reason, (1) has been called a “contrarian” trading strategy that benefits from market overreaction, i.e., when underperformance is followed by positive returns and vice-versa for outperformance
And at this point in the paper I got extremely excited, because the following paragraph proves these guys have actually thought about what they’re saying (which is extremely unusual):
However, another source of profitability of contrarian trading strategies is the fact that they provide liquidity to the marketplace. By definition, losers are stocks that have under-performed relative to some market average, implying a supply/demand imbalance, i.e., an excess supply that caused the prices of those securities to drop, and vice-versa for winners. By buying losers and selling winners, contrarians are increasing the demand for losers and increasing the supply of winners, thereby stabilizing supply/demand imbalances. Traditionally, designated marketmakers such as the NYSE/AMEX specialists and NASDAQ dealers have played this role, for which they are compensated through the bid/offer spread. But over the last decade, hedge funds and proprietary trading desks have begun to compete with traditional marketmakers, adding enormous amounts of liquidity to U.S. stock markets and earning attractive returns for themselves and their investors in the process.
The concept of “selling liquidity” is central to the Hymas Investment Management investment philosophy.
The naive strategy works extemely well:
In 1995, the average daily return of the contrarian strategy for all stocks in our sample is 1.38%, but by 2000, the average daily return drops to 0.44% and the year-to-date figure for 2007 (up to August 31) is 0:13%. Figure 1 illustrates the near-monotonic decline of the expected returns of this strategy, no doubt a reflection of increased competition, changes in market structure, improvements in trading technology and electronic connectivity, the growth in assets devoted to this type of strategy, and the corresponding decline in U.S. equity-market volatility over the last decade. This secular decline in profitability has significant implications for the use of leverage, which we will explore in Section 6.
These trends are consistent with my own informal observations. The authors suggest that the problem of declining returns may have been addressed by the simple expedient of increasing leverage … where have I heard that one before? But the naive method data is interesting – maybe I’ll do something like this for preferreds some day!
So what happened during the period at issue?
The three days in the second week, August 7th, 8th, and 9th are the outliers, with losses of -1.16%, -2.83%, and -2.86%, respectively, yielding a cumulative three-day loss of -6.85%. Although this three-day return may not seem that significant – especially in the hedge-fund world where volatility is a fact of life – note from Table 2 that the contrarian strategy’s 2006 daily standard deviation is 0.52%, so a -6.85% cumulative return represents a loss of 12 daily standard deviations! Moreover, many long/short equity managers were employing leverage (see Section 6 for further discussion), hence their realized returns were magnified several-fold.
Curiously, a significant fraction of the losses was reversed on Friday, August 10th, when the contrarian strategy yielded a return of 5.92%, which was another extreme outlier of 11.4 daily standard deviations. In fact, the strategy’s cumulative return for the entire week of August 6th was -0.43%, not an unusual weekly return in any respect.
We could quibble over the use of “standard deviations” in the above, but we won’t. We’ve already done that.
The authors provide a variety of rationales for excess losses experienced by real hedge funds, cautioning that they have no access to the books and are therefore only guessing. What makes sense to me is the following scenario:
It all hangs together. The scariest and funniest part of the paper is:
Moreover, the widespread use of standardized factor risk models such as those from MSCI/BARRA or Northfield Information Systems by many quantitative managers will almost certainly create common exposures among those managers to the risk factors contained in such platforms.
But even more significant is the fact that many of these empirical regularities have been incorporated into non-quantitative equity investment processes, including fundamental “bottom-up” valuation approaches like value/growth characteristics, earnings quality, and financial ratio analysis. Therefore, a sudden liquidation of a quantitative equity market-neutral portfolio could have far broader repercussions, depending on that portfolio’s specific factor exposures.
So the scary part is: this is cliff-risk come to equities, cliff-risk having been discussed – briefly – on PrefBlog on April 4. The funny part is: we have an enormous industry with enormously compensated personnel that wind up all making the same bet (or, at least, bets all having extremely similar common factors). It’s all sales!
Update, 2010-8-6: There are claims that the 2010-5-6 Flash Crash had similar origins:
Critics focus on unusual market volatility experienced in August 2007 and again during the “flash crash” of May 2010 to show why HFT has increased rather than reduced volatility. The essential similarity among many quant strategies results in trades becoming crowded, and the application of HFT techniques ensures that when they go wrong it results in a disorderly rush for the exits.
The August 2007 and May 2010 episodes were the only ones involving high-frequency computer-driven trading. But the same basic problem (automated quant-based strategies and crowded trades causing liquidity to disappear in a crisis) can be traced back to previous market crises in 1998 (the failure of Long-Term Capital Management) and October 1987 (portfolio insurance and the stock market plunge), according to critics.
Update, 2022-6-5: The paper may be found HERE
Covered bonds were mentioned in a speech Trichet delivered in Nice:
Another aspect I would underline in this context relates to the issuance of covered bonds. Indeed, the performance of covered bonds proved up to now to be relatively resilient to the financial market correction compared to asset-backed securities. Covered bonds are already the most important privately issued bond segment in Europe’s capital markets with over EUR 2 trillion outstanding at the end of 2007. From a financial stability perspective, they have a number of attractive features, not least the fact that the credit risk stays with the originator, which strengthens the incentives for prudent risk management; generally they are also more transparently accounted for in banks’ published accounts than securitisation transactions.
There was a story on Bloomberg about a massive JPMorgan advance to Lehman:
Lehman Brothers Holdings Inc., the securities firm that filed the biggest bankruptcy in history yesterday, was advanced $138 billion this week by JPMorgan Chase & Co. to settle Lehman trades and keep financial markets stable, according to a court filing.
One advance of $87 billion was made on Sept. 15 after the bankruptcy filing, and another of “a comparable amount” was made the following day — both to settle securities transactions with customers of Lehman and its clearance parties, a bankruptcy court filing today said. Lehman said in a statement today that the second amount was $51 billion.
My guess is that these advances were “overcerts” rather than day-loans (or longer!) … often necessary to get the settlement cycle working. Consider a trade in which you buy $100-million bonds and sell them ten minutes later and make $100,000. When settlement day comes, you have to deliver money to the guy you bought them from (and receive the securities) before you can receive money from the guy you sold them to (and deliver the securities). In order to do this you need a bank facility whereby you can certify a cheque without having actually having the funds in your account. Hence, “overcert”.
Back in the day, there was considerable thought expended on minimizing overcert charges on a minute by minute basis, particularly on settlement days for Treasury bill auctions when money flies around like crazy. Nowadays, electronics and net-settlement sessions has taken over … but I’m guessing the need for overcerts is still there and still with Lehman.
The nascent CDS ClearingHouse has been previously discussed on PrefBlog. Lehman’s bankruptcy has heightened the anticipation, but apparent bureaucratic games-playing by the Fed has lengthened the wait:
In July the 17 dealers agreed to form a clearinghouse, create a system to better manage the collateral that protects trading partners from losses and tear up offsetting contracts to reduce the number of positions that banks have to oversee.
The clearinghouse may fall behind schedule, delaying completion until next year, said a person familiar with the process who asked not to be identified last week because the discussions weren’t made public. The development was postponed after the Fed pushed Chicago-based Clearing Corp. to obtain a banking license, which would place it under the central bank’s watch, the person said.
In the Interesting Factoids Department is news from Across the Curve that non-financial commercial paper is trading way through LIBOR:
Here are a couple of examples. BMW one month CP trades libor less 65 at 2.10percent.
John Deere trades libor less 55 at 2.20 percent in the one month sector.
One month Pfizer CP trades at libor less 65 at 2.10
Must be some kind of record!
Defying the skeptics, Goldman Sachs has vowed independence:
Goldman Sachs Group Inc.’s success avoiding losses during the global credit crisis shows the firm doesn’t need to combine with a bank, Chief Financial Officer David Viniar said today.
“We think our business model works because our business works,” Viniar, 53, said in an interview after the New York- based firm disclosed a 70 percent drop in third-quarter profit. “I don’t think this is a model question. I think this is a performance question. Performance speaks for itself and will continue to speak for itself.”
I suspect that all this will change; in ten years, says I, all the global Large Complex Financial Institutions will be banks with access to multiple discount windows. Another long-back alma mater of mine was saying the same thing as Goldman some time ago and look what happened:
A decade back, after Royal Bank bought investment dealer Richardson Greenshields, CEO Chuck Winograd was asked if clients were leaving now the big bad bank had snapped up the feisty independent.
Mr. Winograd, who took justified pride in how close his Rich Green advisors were to clients, gave a funny smile and explained the opposite was true.
He said long-time customers, including a great many rural investors, were cracking open the vaults to hand their Rich Green stockbrokers even more of their savings, now the dealer enjoyed the backing of familiar, safe Royal Bank. It was a little humbling, admitted Mr. Winograd, now the head of Royal Bank’s investment dealer arm.
Reserve Primary Fund has a long history:
- The Primary Fund is the world’s first and longest running money fund
- The Primary Fund is the fourth largest rated money fund in the nation according to Crane Data as of December 2007
And now it has broken the buck:
Reserve Primary Fund, a money-market mutual fund with $64.8 billion in assets as of Aug. 31, fell below $1 a share in net asset value because of losses on debt issued by Lehman Brothers Holdings Inc.
Investor redemptions will be delayed as long as seven days, the fund’s owner, New York-based Reserve Management Corp., said today in a statement. Withdrawals requested before 3 p.m. New York time today will be paid at $1 a share.
…
The fund held $785 million in Lehman Brothers commercial paper and medium-term notes. The fund’s board revalued the Lehman holdings as worthless effective at 4 p.m. New York time. Lehman filed for bankruptcy protection yesterday.
The Lehman paper constituted about 1.2% of their holdings; by no means an extraordinarily aggressive amount, although there will be many who say otherwise. At the very least, it can’t have broken the buck by much! I was a bit puzzled by the “Medium Term Notes” reference, but their Annual Report dated 2008-5-31 discloses:
250,000,000 Lehman Brothers, 3.11%, 3/20/09
Which is an entirely reasonable thing for them to hold term-wise, however one might second-guess the decision credit-wise.
On a cheerier note, Morgan Stanley’s earnings were well above estimate:
Morgan Stanley, the second-largest U.S. securities firm, said third-quarter profit fell 3 percent, less than estimated, as revenue from investment banking and fixed-income trading declined.
We can look forward to the possibility of a McCain victory in the US Presidential race! If he wins, it will be illegal to lose money on the markets:
“Too many people on Wall Street have been recklessly wagering instead of making the sound investments we expected of them,” McCain told a crowd today in Tampa, Florida. “If I am president, we are not going to tolerate that anymore.”
In other news, it looks … likely? possible? … that Barclays will impose its own good bank/bad bank solution on Lehman by buying just the good bits:
Barclays Plc, the U.K.’s third- biggest bank, struck a deal to acquire the U.S. trading and investment banking business of bankrupt Lehman Brothers Holdings Inc., a person with knowledge of the matter said.
Trading in Lehman shares was halted by the New York Stock Exchange at 3:04 p.m. Barclays’s agreement to buy the Lehman units may be announced as soon as this evening, the person said, declining to be identified because the talks were private. The Wall Street Journal reported that Barclays would seek bankruptcy court approval for the deal at 5 p.m.
Flash!: As I go to press, the deal is done:
Barclays Plc, the U.K.’s third- biggest bank, will acquire the North American investment-banking business of bankrupt Lehman Brothers Holdings Inc. for $1.75 billion, two days after abandoning plans to buy the entire firm.
Barclays is paying $250 million in cash for the Lehman businesses and $1.5 billion for the securities firm’s New York headquarters and two data centers, the London-based bank said in a statement on its Web site today. The operations employ about 10,000 people.
American International Group Inc., the biggest U.S. insurer by assets, may get an $85 billion bridge loan from the Federal Reserve and cede an 80 percent stake, the New York Times reported, citing unnamed people briefed on the negotiations.
Banks led by Goldman Sachs Group Inc. and JPMorgan Chase & Co. couldn’t arrange emergency funding by today, resulting in the planned U.S. intervention, the Times said.
Flash! Just as I go to press, the “might” has become a fact.
Wham BAM! Scare stories about Brookfield crushed their prefs – and their dependent structures:
Commercial real estate could be next on the economic hit list because of Wall Street’s falling fortunes.
U.S. and Canadian property firms, such as Brookfield Asset Management Inc., own many of the buildings in Manhattan and across the United States where the investment firms are housed.
Lehman’s bankruptcy, for example, could result in more offices on the rental market in a time when the U.S. economy is demonstrably slowing.
That situation will hurt property management firms, [BMO Financial Group Inc. chief economist Sherry] Cooper said.
As I have pointed out before, on several occasions, most of Brookfields scary-looking debt is non-recourse. I have not yet seen an analysis done of the Doomsday Scenario in which Brookfield just mails the keys to all its New York property to the bond-holders, walking away from its current investment … but I’ll bet the company survives! Anybody who feels like doing that work, let me know!
The BCE Crush looks a bit more reasonable … Lehman cancelled its fire sale:
Lehman Brothers Holdings Inc., the securities firm that filed for bankruptcy yesterday, canceled an auction of $852 million of high-yield, high-risk loans, according to investors who considered bidding on the debt.
Bids for the loans, some of which helped finance leveraged buyouts for First Data Corp. and TXU Corp., were due by 2 p.m. today in New York, said the investors, who declined to be identified because the auction was private.
The sale was scrapped as Barclays Plc moved closer to a bid for the bankrupt firm’s broker-dealer unit. Leveraged loan prices tumbled near record lows in the past week as New York-based Lehman collapsed, stoking concern that other financial companies may fail. The firm has $7.1 billion of high-yield loans and bonds on its books, the bank said Sept. 10.
“Lehman is probably growing close to a sale of its brokerage business, which prompted the bank to cancel today’s auction,” said Louis Gargour, chief investment officer of LNG Capital, a London-based hedge fund. “Lehman’s leveraged loan book could prove integral to other parts of the business the bank is looking to sell, particularly the brokerage unit.”
… which may indicate that the LBO book is integral to the busines … or it may indicate that LBO debt is impossible to sell at the moment. Place yer bets, gents, place yer bets! Some BCE holders have decided not to chance it (hat tip: Financial Webring Forum).
It was a pretty crummy day all ’round, with generally poor performance and average volume. There are no winners on today’s big price moves table. Equities were down only 20bp, which is practically a win considering this morning and yesterday.
| 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. The Fixed-Reset index was added effective 2008-9-5 at that day’s closing value of 1,119.4 for the Fixed-Floater index. |
|||||||
| Index | Mean Current Yield (at bid) | Mean YTW | Mean Average Trading Value | Mean Mod Dur (YTW) | Issues | Day’s Perf. | Index Value |
| Ratchet | N/A | N/A | N/A | N/A | 0 | N/A | N/A |
| Fixed-Floater | 4.71% | 4.76% | 71,664 | 15.79 | 6 | -1.5373% | 1,087.3 |
| Floater | 4.75% | 4.75% | 48,280 | 15.97 | 2 | -7.0398% | 842.4 |
| Op. Retract | 4.97% | 4.48% | 123,359 | 3.31 | 14 | -0.2684% | 1,050.2 |
| Split-Share | 5.47% | 6.42% | 49,246 | 4.34 | 14 | -1.3459% | 1,022.5 |
| Interest Bearing | 6.59% | 7.72% | 52,818 | 5.15 | 2 | -2.4669% | 1,070.8 |
| Perpetual-Premium | 6.27% | 6.29% | 56,664 | 13.51 | 1 | -0.7965% | 989.4 |
| Perpetual-Discount | 6.05% | 6.12% | 183,685 | 13.70 | 70 | -0.3387% | 881.0 |
| Fixed-Reset | 5.06% | 4.91% | 1,516,127 | 14.27 | 9 | +0.0134% | 1,118.7 |
| Major Price Changes | |||
| Issue | Index | Change | Notes |
| BNA.PR.C | SplitShare | -13.5758% | Asset coverage of 3.2+:1 as of August 29 according to the company. Now with a pre-tax bid-YTW of 11.71% based on a bid of 14.26 and a hardMaturity 2019-1-10 at 25.00. Compare with BNA.PR.A (7.03% to 2010-9-30) and BNA.PR.B (8.92% to 2016-3-25). Note that, given 2.4 shares of BAM.A per BNA preferred and a price of 28.76 on BAM.A, asset coverage is now just under 2.8:1 (BAM.A was actually up a bit on the day). This is truly astounding, but it should be noted that the low for the day was 15.50 … which was a 52-week low, to be sure, but was still well above the closing bid. 2000 shares traded in the last 15 minutes of the day and, it would appear, simply took out the bid in a thin market. |
| BAM.PR.B | Floater | -10.4737% | Closing bid 17.01, but in distinction to the BNA.PR.C above, there was actually some trading at that level … 2100 shares traded in the range 17.00-02 from 3:29pm until 3:49pm. |
| BCE.PR.R | FixFloat | -4.1208% | Financing jitters? See main text. |
| BAM.PR.K | Floater | -3.7948% | Closing quote 18.00-69, 2×3. 1600 shares traded in the range 18.00-01 between 1:40pm and 2:18pm. |
| BCE.PR.G | FixFloat | -2.7038% | |
| BSD.PR.A | InterestBearing | -2.6519% | Asset coverage of just under 1.5:1 as of September 12 according to the company. Now with a pre-tax bid-YTW of 8.48% (mostly as interest) based on a bid of 8.81 and a hardMaturity 2015-3-31 at 10.00. |
| LBS.PR.A | SplitShare | -1.3672% | Asset coverage of just under 2.1:1 as of September 11, according to Brompton Group. Now with a pre-tax bid-YTW of 5.83% based on a bid of 9.85 and a hardMaturity 2013-11-29 at 10.00. |
| BAM.PR.M | PerpetualDiscount | -2.4260% | Now with a pre-tax bid-YTW of 7.24% based on a bid of 16.49 and a limitMaturity. |
| FIG.PR.A | InterestBearing | -2.3000% | Asset coverage of 1.9+:1 as of September 15 according to the company. Now with a pre-tax bid-YTW of 7.03% (mostly as interest) based on a bid of 9.77 and a hardMaturity 2014-12-31 at 10.00. |
| BAM.PR.O | OpRet | -2.2472% | Now with a pre-tax bid-YTW of 8.36% based on a bid of 21.75 and optionCertainty 2013-6-30 at 25.00. Compare with BAM.PR.H (6.32% to 2012-3-30), BAM.PR.I (5.80% to 2013-12-30) and BAM.PR.J (6.19% to 2018-3-30). |
| GWO.PR.H | PerpetualDiscount | -2.1697% | Now with a pre-tax bid-YTW of 6.00% based on a bid of 20.29 and a limitMaturity. |
| BCE.PR.C | FixFloat | -1.8504% | |
| LFE.PR.A | SplitShare | -1.7717% | Asset coverage of just under 2.3:1 as of August 31, according to the company. Now with a pre-tax bid-YTW of 5.39% based on a bid of 9.98 and a hardMaturity 2012-12-1 at 10.00 |
| WFS.PR.A | SplitShare | -1.7391% | Again, I guess on a day like today, something with the name “World Financial … ” is just about an automatic sell! Asset coverage of just under 1.6:1 as of September 4, according to Mulvihill. Now with a pre-tax bid-YTW of 9.23% based on a bid of 9.04 and a hardMaturity 2011-6-30 at 10.00. |
| BAM.PR.N | PerpetualDiscount | -1.6265% | Now with a pre-tax bid-YTW of 7.32% based on a bid of 16.33 and a limitMaturity. |
| FBS.PR.B | SplitShare | -1.5228% | Asset coverage of just under 1.6:1 as of September 11, according to TD Securities. Now with a pre-tax bid-YTW of 5.82% based on a bid of 9.70 and a hardMaturity 2011-12-15 at 10.00. |
| CM.PR.G | PerpetualDiscount | -1.5173% | Now with a pre-tax bid-YTW of 6.62% based on a bid of 20.77 and a limitMaturity. |
| CM.PR.I | PerpetualDiscount | -1.4555% | Now with a pre-tax bid-YTW of 6.55% based on a bid of 18.28 and a limitMaturity. |
| CM.PR.J | PerpetualDiscount | -1.3652% | Now with a pre-tax bid-YTW of 6.61% based on a bid of 17.34 and a limitMaturity. |
| FFN.PR.A | SplitShare | -1.2461% | Asset coverage of just under 1.9:1 as of August 31, according to the company. Now with a pre-tax bid-YTW of 6.30% based on a bid of 9.51 and a hardMaturity 2014-12-1 at 10.00. |
| ALB.PR.A | SplitShare | -1.2341% | Asset coverage of 1.7+:1 as of September 11, according to Scotia Managed Companies. Now with a pre-tax bid-YTW of 6.13% based on a bid of 24.01 and a hardMaturity 2011-2-28 at 25.00. |
| BCE.PR.A | FixFloat | -1.2048% | |
| CM.PR.P | PerpetualDiscount | -1.1781% | Now with a pre-tax bid-YTW of 6.68% based on a bid of 20.97 and a limitMaturity. |
| HSB.PR.C | PerpetualDiscount | -1.1321% | Now with a pre-tax bid-YTW of 6.11% based on a bid of 20.96 and a limitMaturity. |
| TCA.PR.Y | PerpetualDiscount | -1.0849% | Now with a pre-tax bid-YTW of 6.08% based on a bid of 46.50 and a limitMaturity. |
| BMO.PR.J | PerpetualDiscount | -1.0604% | Now with a pre-tax bid-YTW of 6.10% based on a bid of 18.66 and a limitMaturity. |
| Volume Highlights | |||
| Issue | Index | Volume | Notes |
| RY.PR.I | FixedReset | 611,570 | Nine blocks, among which was RBC’s cross of 150,000 at 24.95. New issue settled today. |
| BMO.PR.J | PerpetualDiscount | 315,320 | Nesbitt crossed 200,000, then 50,000, then another 50,000, all at 18.88. Now with a pre-tax bid-YTW of 6.10% based on a bid of 18.66 and a limitMaturity. |
| NTL.PR.G | Scraps (Would be Ratchet, but there are credit concerns) | 102,510 | CIBC crossed 100,000 at 9.55. |
| NTL.PR.F | Scraps (Would be Ratchet, but there are credit concerns) | 102,510 | CIBC crossed 100,000 at 9.80. |
| BNS.PR.R | FixedReset | 48,168 | RBC bought two lots of 10,000 from Nesbitt, both at 25.00. |
| TD.PR.P | PerpetualDiscount | 48,100 | Anonymous bought 20,000 from Nesbitt at 23.40. Now with a pre-tax bid-YTW of 5.69% based on a bid of 23.41 and a limitMaturity. |
| CM.PR.K | FixedReset | 44,675 | Nesbitt crossed 10,000 at 24.95. |
There were twenty-five other index-included $25-pv-equivalent issues trading over 10,000 shares today.
Brompton Group has announced it:
is proposing a meeting of YEARS Financial Trust (“YTU”) to consider the merger of YTU into Dividend Growth Split Corp. (“DGS”). The merger is being proposed to address the economic inefficiencies of operating a small investment fund like YTU and to provide investors with a high quality portfolio at a low cost. Due to its smaller size, YTU’s annual general and administration costs currently represent 0.66% of its net asset value and YTU is becoming too small to operate on its own.
DGS invests on an equally weighted basis in a portfolio of 20 large capitalization Canadian equities that have among the highest dividend growth rates on the TSX and utilizes a split share structure. Over 60% of DGS’s portfolio is invested in Canadian financial equities and it includes nine of the eleven equities currently held in YTU. In addition, Highstreet Asset Management, which acts as portfolio manager of YTU, invests DGS’s assets, rebalances its portfolio and selectively writes covered options to generate additional income for DGS. As such, the Manager considers DGS to be a similar investment to YTU.
DGS had $30-million in assets as of January 31, 2008, while YTU had $23-million as of August 31.
DGS.PR.A is not tracked by HIMIPref™. The issue was announced last November.
The new issue announced September 8 settled today. Oddly, the ticker symbol is RY.PR.I, although the issue is Series AJ. It’s a shame, because they have been doing so well with series AA through AH of keeping the series designation congruent with the ticker … no telling how many trading errors that will cause over the life of the issue! Well, it solidifies PrefInfo‘s status as a useful site, anyway!
Royal announced on September 8:
as a result of strong investor demand for its domestic public offering of Non-Cumulative, 5 year rate reset Preferred Shares Series AJ (the “Preferred Shares Series AJ”), the size of the offering has been increased to 14 million shares. The gross proceeds of the offering will now be $350 million. In addition, the bank has granted the Underwriters an option, exercisable in whole or in part, to purchase up to an additional 2 million Preferred Shares Series AJ at a price of $25 per share.
This was a significant increase, given that the original issue size was announced as 9-million shares (=$225-million) + greenshoe.
I see nothing on Royal’s website or on SEDAR regarding exercise or expiry of the greenshoe.
The issue traded 611,570 shares today in a range of 24.90-00. The closing quote was 24.95-98.
RY.PR.I is tracked by HIMIPref™. It has been added to the FixedReset Index.
My attention was caught by a throwaway line on Bloomberg:
Democratic presidential nominee Barack Obama said regulation of Wall Street needs to “catch up” with changes in financial markets, and investors can’t expect taxpayers to bail them out in bad times.
Obama said the role of ratings services must be examined as part of any revamping of the way markets are monitored and regulated, and he suggested that he doesn’t favor having the government stepping in to rescue failing firms.
The role of ratings services?
So I looked at his Economic Platform:
Improve Transparency in the Market
Investigate Potential Conflict of Interest between Credit Rating Agencies and Financial Institutions: Credit agencies are paid by the issuers of securities, not by the buyers of securities, which creates a potential conflict of interest in favor of issuing strong securities ratings. This problem was illustrated in the subprime market crisis in which credit rating agencies strongly rated subprime mortgage securities even as there were significant indications of large numbers of foreclosures and a weakening housing market. Barack Obama supports an immediate investigation into the ratings agencies and their relationships to securities’ issuers, similar to the investigation the EU has recently announced.
The European Union Kangaroo Court has been previously discussed on PrefBlog.
We can only hope that – in both the Obama campaign and the EU – that these public utterances are made merely for populist appeal and signify nothing. But it’s not a good sign.
I was actually more offended by another line from the Obama Economic Platform (emphasis added):
Obama’s STOP FRAUD Act provides the first federal definition of mortgage fraud, increases funding for federal and state law enforcement programs, creates new criminal penalties for mortgage professionals found guilty of fraud, and requires industry insiders to report suspicious activity.
Yay! Even more Informers and Secret Policemen! The west’s moral fibre is going to hell. But when I start ranting about this stuff, people usually just treat me kindly, so I’ll shut up now.
You guys all think I’m going to talk about the Lehman bankruptcy, the scramble for funding by AIG and, given the devil-take-hindmost nature of short attacks on Large Complex Financial Institutions recently, Merrill’s determination not to be hindmost. But I ain’t, except to note in passing that Merrill’s days have been numbered ever since I quit my Operations Assistant Supervisor position with them in a huff about 20 years ago. Serves ’em right.
All that stuff has been discussed to death; I have no particular insights or comments. Accrued Interest‘s post sounds a little shell-shocked. The Fed turned on the tap full force as the Fed Funds market seemed to lock up:
The Federal Reserve added $70 billion in reserves to the banking system, the most since the September 2001 terrorist attacks, to keep bank borrowing costs low after the bankruptcy of Leman Brothers Holdings Inc.
Fed funds traded as high as 6 percent, or 4 percentage points above the central bank’s target rate for overnight loans between banks, according to ICAP Plc, the world’s largest inter- dealer broker. The margin is the greatest since Bloomberg began tracking the data in 1998. The rate dropped to as low as 1.75 percent after the Fed added the temporary reserves.
…
“If the fed funds rate closes high today, I would be really worried as it would mean that there really is no money out there to be lent,” said Stan Jonas, who trades interest- rate derivatives at Axiom Management Partners LLC in New York.
I’m not too sure about that ‘no money available’ line. I suspect that it’s unwillingness rather than inability that drove the spike … but there will doubtless be more data and commentary in the near future.
There’s a good review piece on VoxEU titled Transmission of liquidity shocks: Evidence from the 2007 subprime crisis:
The results of a very pronounced interaction between market and funding liquidity are consistent with the emergence of re-enforcing liquidity spirals during the crisis period. On the one side of this liquidity spiral, financial institutions were exposed to refinancing needs in the form of issuing ABCP, a situation where market illiquidity in complex structured products led to funding illiquidity. In this regard, the results also show that increased correlations between the ABCP and Libor spreads reduced the possibilities of funding from the interbank money market, thus highlighting systemic risks. On the other side of this spiral, many European banks that had large exposures to US asset-backed securities had difficulties accessing wholesale funding, inducing subsequent market illiquidity in different market segments. Due to the major importance of the interbank money market, central banks in turn intervened by reducing interest rates and providing additional liquidity to the markets in order to reduce pressures.
…
The analysis presented here suggests that innovation, such as structured credit products and banks’ increased ability to move risk off their balance sheets as well as augmented interconnectedness of large complex banks, made market and funding liquidity pressures readily turn into issues of insolvency.
The full paper, on which the column is based, is available from the IMF. It makes an interesting point not highlighted in the column:
Finally, increased correlations between returns of differing asset classes due to algorithmic trading, such as by quantitative hedge funds, has heightened the vulnerability with regard to the transmission of illiquidity.
Which is kind of interesting. The great strength of a quantitative approach is that it allows the quick relative valuation of two assets (whether that relative valuation achieved so quickly is any good or not is another question entirely!) and the great strength of algorithmic trading is that it allows the quick execution of a quantitatively derived plan. Stock market “circuit breakers” were introduced in the wake of the the realization that portfolio insurance had exacerbated the crash of 1987; it is hard to tell how circuit breakers might be implemented across markets, but doubtless some regulator will be jumping up soon to tell us.
The source paper references a fascinating MIT paper by Khandani & Lo, What Happened to the Quants in August 2007? link updated 2022-6-5, which has the abstract:
During the week of August 6, 2007, a number of high-profile and highly successful quantitative long/short equity hedge funds experienced unprecedented losses. Based on empirical results from TASS hedge-fund data as well as the simulated performance of a specific long/short equity strategy, we hypothesize that the losses were initiated by the rapid unwinding of one or more sizable quantitative equity market-neutral portfolios. Given the speed and price impact with which this occurred, it was likely the result of a sudden liquidation by a multi-strategy fund or proprietary-trading desk, possibly due to margin calls or a risk reduction. These initial losses then put pressure on a broader set of long/short and long-only equity portfolios, causing further losses on August 9th by triggering stop-loss and de-leveraging policies. A significant rebound of these strategies occurred on August 10th, which is also consistent with the sudden liquidation hypothesis. This hypothesis suggests that the quantitative nature of the losing strategies was incidental, and the main driver of the losses in August 2007 was the firesale liquidation of similar portfolios that happened to be quantitatively constructed. The fact that the source of dislocation in long/short equity portfolios seems to lie elsewhere – apparently in a completely unrelated set of markets and instruments – suggests that systemic risk in the hedge-fund industry may have increased in recent years.
This paper looks like it has a good chance of being interesting enough to highlight … I’m working through it!
Following a press release regarding its holdings, there has been some press commentary on SunLife’s exposure to Lehman:
RBC Capital Markets analyst Andre-Philippe Hardy said he expects Sun Life to take a pre-tax charge of $167-million, assuming a 50 per cent recovery rate on Lehman exposure.
Most unpleasant, but they earn about $500-million per quarter. So, unless this relatively small exposure (about 0.3% of their investments) is a precursor of Bad Things to Come, this is a non-event for credit. They’ve got $5.2-billion in equities on the books as of June 30 … their mark-to-market losses for today alone will be comparable to their Lehman exposure.
A gory day for PerpetualDiscounts – the worst since July 16, in fact, the infamous nadir of the market – but not as bad as for stocks. Names that will be familiar in the Price Changes section below (hint: they’re all negative) include:
Brookfield Properties dropped 16 percent to C$18.99, the most since August 1993. Brookfield was cut to “market perform” by BMO Capital Markets analyst Karine MacIndoe, who said that the company may face “what is likely to be an accelerated deterioration of fundamentals” in its “core Manhattan market.”
Parent company Brookfield Asset Management Inc. slid 11 percent to C$28.49, the most since the Sept. 11, 2001, attacks on the U.S.
Canadian Imperial Bank of Commerce, which accounted for two-thirds of total Canadian writedowns, fell the most since July 24, losing 4.8 percent to C$61.11. CIBC Chief Executive Officer Richard Nesbitt said at a conference that his bank expects a loss of about C$25 million from Lehman.
Update: Inspired by a thread on Financial Webring Forum, I will post a link to Across the Curve‘s closing commentary for today. The Canadian Market saw massive steepening, but not as much action as the US; two year yield down 28bp to 2.82%; five year down 21bp to 3.09%; ten year down 15bp to 3.60%; thirty-year down 8bp to 4.05%. Bets on an easing run rampant!
| 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. The Fixed-Reset index was added effective 2008-9-5 at that day’s closing value of 1,119.4 for the Fixed-Floater index. |
|||||||
| Index | Mean Current Yield (at bid) | Mean YTW | Mean Average Trading Value | Mean Mod Dur (YTW) | Issues | Day’s Perf. | Index Value |
| Ratchet | N/A | N/A | N/A | N/A | 0 | N/A | N/A |
| Fixed-Floater | 4.63% | 4.67% | 67,806 | 15.92 | 6 | -0.7416% | 1,104.2 |
| Floater | 4.41% | 4.41% | 47,451 | 16.62 | 2 | -0.2373% | 906.1 |
| Op. Retract | 4.96% | 4.34% | 124,632 | 3.31 | 14 | -0.2642% | 1,053.0 |
| Split-Share | 5.39% | 6.12% | 48,769 | 4.37 | 14 | -0.9792% | 1,036.5 |
| Interest Bearing | 6.43% | 7.22% | 51,633 | 5.18 | 2 | -0.1048% | 1,097.9 |
| Perpetual-Premium | 6.22% | 5.99% | 56,654 | 2.20 | 1 | -0.5151% | 997.4 |
| Perpetual-Discount | 6.03% | 6.10% | 183,186 | 13.74 | 70 | -0.5709% | 884.0 |
| Fixed-Reset | 5.07% | 4.92% | 1,410,445 | 14.14 | 9 | -0.1897% | 1,118.6 |
| Major Price Changes | |||
| Issue | Index | Change | Notes |
| WFS.PR.A | SplitShare | -4.5643% | I guess on a day like today, something with the name “World Financial … ” is just about an automatic sell! Asset coverage of just under 1.6:1 as of September 4, according to Mulvihill. Now with a pre-tax bid-YTW of 8.51% based on a bid of 9.20 and a hardMaturity 2011-6-30 at 10.00. |
| ELF.PR.G | PerpetualDiscount | -2.8361% | Now with a pre-tax bid-YTW of 7.08% based on a bid of 17.13 and a limitMaturity. |
| BNA.PR.C | SplitShare | -2.6549% | Asset coverage of 3.2+:1 as of August 29 according to the company. Now with a pre-tax bid-YTW of 9.71% based on a bid of 16.50 and a hardMaturity 2019-1-10 at 25.00. Compare with BNA.PR.A (7.02% to 2010-9-30) and BNA.PR.B (8.92% to 2016-3-25). Note that, given 2.4 shares of BAM.A per BNA preferred and a price of 28.49 on BAM.A (see above), asset coverage is now 2.7+:1. |
| BCE.PR.Z | FixFloater | -2.4280% | |
| W.PR.J | PerpetualDiscount | +1.0348% | Now with a pre-tax bid-YTW of 6.65% based on a bid of 21.48 and a limitMaturity. |
| SLF.PR.D | PerpetualDiscount | -1.9334% | Now with a pre-tax bid-YTW of 6.12% based on a bid of 18.26 and a limitMaturity. |
| GWO.PR.G | PerpetualDiscount | -1.9284% | Now with a pre-tax bid-YTW of 6.11% based on a bid of 21.36 and a limitMaturity. |
| BAM.PR.N | PerpetualDiscount | -1.8913% | Now with a pre-tax bid-YTW of 7.19% based on a bid of 16.60 and a limitMaturity. |
| CM.PR.P | PerpetualDiscount | -1.8047% | Now with a pre-tax bid-YTW of 6.60% based on a bid of 21.22 and a limitMaturity. |
| POW.PR.C | PerpetualDiscount | -1.6632% | Now with a pre-tax bid-YTW of 6.24% based on a bid of 23.65 and a limitMaturity. |
| PWF.PR.G | PerpetualDiscount | -1.5663% | Now with a pre-tax bid-YTW of 6.10% based on a bid of 24.51 and a limitMaturity. |
| GWO.PR.I | PerpetualDiscount | -1.4768% | Now with a pre-tax bid-YTW of 6.05% based on a bid of 18.68 and a limitMaturity. |
| IAG.PR.A | PerpetualDiscount | -1.4400% | Now with a pre-tax bid-YTW of 6.25% based on a bid of 18.48 and a limitMaturity. |
| LBS.PR.A | PerpetualDiscount | -1.3672% | Asset coverage of just under 2.1:1 as of September 11, according to Brompton Group. Now with a pre-tax bid-YTW of 5.26% based on a bid of 10.10 and a hardMaturity 2013-11-29 at 10.00. |
| CM.PR.D | PerpetualDiscount | -1.3274% | Now with a pre-tax bid-YTW of 6.56% based on a bid of 22.30 and a limitMaturity. |
| BNS.PR.J | PerpetualDiscount | -1.3203% | Now with a pre-tax bid-YTW of 5.71% based on a bid of 23.17 and a limitMaturity. |
| SLF.PR.E | PerpetualDiscount | -1.3186% | Now with a pre-tax bid-YTW of 6.04% based on a bid of 18.71 and a limitMaturity. |
| CM.PR.G | PerpetualDiscount | -1.2640% | Now with a pre-tax bid-YTW of 6.52% based on a bid of 21.09 and a limitMaturity. |
| BNA.PR.A | SplitShare | -1.2395% | See BNA.PR.C, above. |
| FFN.PR.A | SplitShare | -1.2308% | Asset coverage of just under 1.9:1 as of August 31, according to the company. Now with a pre-tax bid-YTW of 6.05% based on a bid of 9.63 and a hardMaturity 2014-12-1 at 10.00. |
| CM.PR.H | PerpetualDiscount | -1.1740% | Now with a pre-tax bid-YTW of 6.60% based on a bid of 18.52 and a limitMaturity. |
| SLF.PR.B | PerpetualDiscount | -1.0929% | Now with a pre-tax bid-YTW of 6.06% based on a bid of 19.91 and a limitMaturity. |
| NA.PR.M | PerpetualDiscount | -1.0835% | Now with a pre-tax bid-YTW of 6.16% based on a bid of 24.65 and a limitMaturity. |
| PWF.PR.K | PerpetualDiscount | -1.0521% | Now with a pre-tax bid-YTW of 6.08% based on a bid of 20.69 and a limitMaturity. |
| SBN.PR.A | SplitShare | -1.0081% | Asset coverage of 2.1+:1 as of September 4, according to Mulvihill. Now with a pre-tax bid-YTW of 5.61% based on a bid of 9.82 and a hardMaturity 2014-12-1 at 10.00. |
| PWF.PR.J | OpRet | -1.0066% | Now with a pre-tax bid-YTW of 4.34% based on a bid of 25.57 and a softMaturity 2013-7-30 at 25.00. |
| Volume Highlights | |||
| Issue | Index | Volume | Notes |
| BCE.PR.T | Scraps (Would be FixFloat but there are volume concerns) | 154,220 | Desjardins crossed 144,900 at 24.70. |
| BMO.PR.J | PerpetualDiscount | 104,140 | Nesbitt crossed two blocks of 50,000, both at 18.88. Now with a pre-tax bid-YTW of 6.03% based on a bid of 18.86 and a limitMaturity. |
| BNS.PR.R | FixedReset | 86,125 | Scotia bought 17,600 from anonymous at 25.05, then another 14,500 from a possibly different anonymous at the same price, and finally 12,000 from Nesbitt at 25.04. |
| CM.PR.D | PerpetualDiscount | 60,182 | CIBC crossed 50,000 at 22.40. Now with a pre-tax bid-YTW of 6.56% based on a bid of 22.30 and a limitMaturity. |
| TD.PR.A | FixedReset | 52,660 | |
| CM.PR.K | FixedReset | 48,750 | |
There were seventeen other index-included $25-pv-equivalent issues trading over 10,000 shares today.
There was a host of temporary trading halts and related announcements from CC&L Group today regarding their structured-note-derivative-preferreds.
Lehman’s bankruptcy announcement constitutes a credit event and brings them all a little bit closer to the brink … I will leave my Assiduous Readers to judge whether they are dangerously close to the brink or not, I’m not taking a view.
| Credit Event Countdown | |||
| Ticker (links to Press Release) |
Positions | Credit Events Remaining |
Maturity |
| RPQ.PR.A | 125 | 5.4 | 2011-6-30 |
| RPB.PR.A | 127 | 4.3 | 2012-3-23 |
| RPA.PR.A | 142 | 6.5 | 2009-12-31 |
| PRF.PR.A | 141 | 9.5 | 2009-06-30 |
Connor, Clark & Lunn will host a conference call to discuss the implications of recent events on Tuesday September 16, 2008 at 9:00 AM EST. The conference call number is (416) 644-3415 or 1 (800) 733-7571 and the replay number is (416) 640-1917 or 1 (877) 289-8525. The pass code is 21283536#.
The previous post on these issues was RPA.PR.A / RPB.PR.A / RPQ.PR.A Hit by FannieFreddieFiasco. There is no prior PrefBlog post for PRF.PR.A.
None of these issues is tracked by HIMIPref™.
I recently had a contest about ACO.PR.A which has been won by Assiduous Reader adrian2.
The question was:
So: here’s the question … how might a rational investor reason that paying $27.00 for this issue has enough chance of at least a half-way decent return to make it worth while? This investor knows that the yield to worst is negative and that he’s taking a chance … why might he buy it anyway?
ACO.PR.A closed at 26.62-75 on Friday, so the situation isn’t quite as dramatic as it was when the bid was $27.00. However, the portfolio of possibilities for this issue on Friday, according to HIMIPref™ was:
Call 2008-12-31 YTM: -1.78 % [Restricted: -0.54 %] (Prob: 40.10 %)
Call 2009-12-31 YTM: 2.35 % [Restricted: 2.35 %] (Prob: 1.01 %)
Soft Maturity 2011-11-30 YTM: 3.68 % [Restricted: 3.68 %] (Prob: 58.89 %)
So the YTW was -1.78%.
Why would an investor pay such a rich price for the issue? Well, there was a hint of the answer buried in my article about retractible preferreds and bonds:
One may sometimes make a reasonable argument that YTW is not the most appropriate method of calculating yields. Say, for instance, that a company has the ability to issue preferreds that pay $1.25 p.a. and has an issue outstanding that pays $1.40 and is currently callable at $26.00, with this price declining by $0.25 annually for the next four years. If the issue is trading above $26.00, the YTW scenario will almost certainly be an immediate call. However, since the company can save $0.25 by delaying redemption, the net cost to the company of leaving the shares outstanding for another year is the dividend less the saving, or $1.15 (during the declining call-price period). Since this is less than the rate it would pay on a new issue, the company may well prefer to wait.
The question of what to believe is a complex question—complex enough, in fact, that I am currently devoting a great deal of time to researching the matter. Most investors will be well advised to rely on YTW.
In other words, Atco (the issuer of ACO.PR.A) may look at the issue on 2008-12-1 and say – ‘well, this issue pays $1.4375 annually, or 5.75% of par (as dividends, which costs more than interest) … we’d better redeem.’
But according to the redemption schedule, they can save $0.50 off the redemption price every year by waiting! If we were going to analyze this precisely, we would look at the situation from their point of view as a loan of $26.00 which amortizes down to a $25.00 balloon payment on 2010-12-1 (the first date they can redeem at $25.00) via quarterly blended payments that include principal. But from a back-of-an-envelope, conceptual perspective, we can say that it’s a loan of $25.50 with an cost of $1.4375 dividend LESS the decrease of $0.50 in redemption price, for an all-in cost of $0.9375 … which comes to about 3.67%, a financing cost calculated to bring smiles to the most hardened CFO, even if it as expensive dividends.
These calculations will be incorporated into the next release of HIMIPref™ – yes, I am working on it, albeit slowly – as “Yield to Issuer Best”. To select YTIB from the table of possibilities, I will be determining the disparity of each redemption option from the yield curve – that is, cash flows for the instrument will be discounted by the self-consistent yield curve to arrive at a net present value for each option. The lowest NPV will determine the YTIB. I do not know, at this point, how influential in the valuation YTIB will be relative to YTW … but hey, it’s worth looking at!
Incidentally, ACO.PR.A was added to the TXPR index in the last rebalancing, despite what might be considered to be relatively low average trading value (HIMIPref™ indicates $18,374 worth of shares daily, TMXMoney calculated 1,600 shares (the difference doesn’t bother me; HIMIPref™ is an adjusted exponential moving average; I believe that TMXMoney is an unadjusted rolling average, virtually guaranteed to show a higher result). A large part of ACO.PR.A’s current price may well be buying from indexers.
The following graphs regarding ACO.PR.A have been prepared and uploaded:
NTL.PR.F / NTL.PR.G : DBRS changes trend to "Stable"
Wednesday, September 17th, 2008DBRS has announced:
Nortel prefs got hammered today, but not as badly as the stock:
The stock price has led to suggestions that a takeover is in order:
These issues were last mentioned on PrefBlog on March 10 in connection with their price differential:
Today,
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