PrefBlog

BofA was able to raise significant equity capital yesterday:

Bank of America Corp., the biggest U.S. bank by assets, said it raised about $13.5 billion in a sale of common stock as part of an effort to boost capital and weather an extended recession.

The bank issued 1.25 billion shares at an average price of $10.77 each, according to a statement today. The Charlotte, North Carolina-based company plans to boost common equity capital by $17 billion through the sale of stock and by converting preferred shares mostly held by institutional investors, Chief Executive Officer Kenneth Lewis said May 7.
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Bank of America expects to add $10 billion more in capital through asset sales and at least $7 billion from improved pretax profits, the company said on May 7. Those numbers may change as the bank considers options to achieve its $33.9 billion target, spokesman Jerry Dubrowski said.

The Pension Benefit Guaranty Fund in the States is having about as much fun as other guarantors:

Pension Benefit Guaranty Corp.’s deficit tripled to $33.5 billion in the past six months as more companies canceled retirement plans amid the U.S. recession, according to the head of the government-owned corporation.

About $11 billion is for “completed and probable terminations,” and $7 billion is from an increase in interest rates that boosted liabilities, Vince Snowbarger, the acting PBGC director, said in written testimony to be delivered tomorrow to the Senate Special Committee on Aging.
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The potential for General Motors Corp. and Chrysler LLC to end their plans has left the PBGC facing the prospect of adding 900,000 current and future beneficiaries. The PBGC, which pays retirement income to almost 44 million Americans, estimates that $77 billion of the automotive industry’s pensions are underfunded, with about $42 billion of that not funded at all.

There’s a report by internal audit of the fund that claims former PBGC director Millard was, at least, sloppy in separating his various activities – with the Placement Agent scandal still being whipped up, the response could be draconian.

Looks like the SEC is losing the jurisdictional catfight with the Fed:

The Obama administration may call for stripping the Securities and Exchange Commission of some of its powers under a regulatory reorganization that could be unveiled as soon as next week, people familiar with the matter said.

The proposal, still being drafted, is likely to give the Federal Reserve more authority to supervise financial firms deemed too big to fail. The Fed may inherit some SEC functions, with others going to other agencies, the people said. On the table: giving oversight of mutual funds to a bank regulator or a new agency to police consumer-finance products, two people said.

The politicians have to assign blame and shuffle responsibilities in order to make it clear that nothing was their fault.

The Obama administrations shameful conduct in the Chrysler bankruptcy is having some repercussions:

Hedge fund manager George Schultze says he may avoid lending to any more unionized companies after being burned by President Barack Obama in Chrysler LLC’s bankruptcy.

Obama put Chrysler under court protection on April 30 after lenders balked at a proposal giving them about 29 cents on the dollar for their $6.9 billion in debt. The investors said the president’s plan favored a union retiree medical fund whose claims ranked behind them for repayment. It was offered a 55 percent equity stake in the automaker.

Pacific Investment Management Co., Barclays Capital and Fridson Investment Advisors have joined Schultze Asset Management LLC in saying lenders may be unwilling to back unionized companies with underfunded pension and medical obligations, such as airlines and auto-industry suppliers, because Chrysler’s creditors failed to block Obama’s move.

Whether or not the rhetoric influences yield spreads and whether those yield spreads influence conduct is something we’ll just have to wait and see.

Anne Sibert pens a provocative thesis on VoxEU, Why did the bankers behave so badly?:

Greedy bankers are getting most of the blame for the current financial crisis. This column explains bankers did behave badly for mainly three reasons. They committed cognitive errors involving biases towards their own prior beliefs; too many male bankers high on testosterone took too much risk, and a flawed compensation structure rewarded perceived short-term competency rather than long-run results.
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In a fascinating and innovative study, Coates and Herbert (2008) advance the notion that steroid feedback loops may help explain why male bankers behave irrationally when caught up in bubbles. These authors took samples of testosterone levels of 17 male traders on a typical London trading floor (which had 260 traders, only four of whom were female). They found that testosterone was significantly higher on days when traders made more than their daily one-month average profit and that higher levels of testosterone also led to greater profitability – presumably because of greater confidence and risk taking. The authors hypothesise that if raised testosterone were to persist for several weeks the elevated appetite for risk taking might have important behavioural consequences and that there might be cognitive implications as well; testosterone, they say, has receptors throughout the areas of the brain that neuro-economic research has identified as contributing to irrational financial decisions.

Well, I don’t know what’s up with the Toronto Stock Exchange. There was a problem last Friday retrieving prices that were available and today there’s a problem with availability. So I’m using an approximate, late-in-day-update to prepare today’s report. I did update the details for SLF.PR.F, though, since that one’s important.

It was another really good day for the preferred share market – and here’s a landmark for you: BAM floaters are now trading in the double digits! The low close of 6.40-69 was reached on 2008-12-18 on volume of 27,351 shares.

PerpetualDiscounts now yield 6.39% (pre-tax bid-YTW), equivalent to 8.95% interest at the standard equivalency factor of 1.4x. Long Corporates are now at 7.0%, having returned 4.63% Month-to-date and 9.29% Year-to-Date, so the pre-tax interest-equivalent spread is now about 195bp.

The Bank for International Settlements has released its report on OTC derivatives market activity in the second half of 2008:

Facing significant price drops, markets for commodity and equity derivatives recorded volumes which were 66.5% and 36.2% lower, respectively. Against a background of severely strained credit markets combined with efforts to improve multilateral netting of offsetting contracts, credit default swap (CDS) volumes decreased by 26.9%. Foreign exchange and interest rate derivatives markets recorded their first significant downturns. Amounts outstanding of foreign exchange contracts fell by 21.0%, while amounts outstanding of
interest rate contracts slid by 8.6%.

Gross market values, which measure the cost of replacing all existing contracts, represent a better measure of market risk than notional amounts. Despite the drop in amounts outstanding, significant price movements resulted in notably higher gross market values, which increased by 66.5% to $33.9 trillion at the end of December 2008 (Graph 1, right-hand panel). The higher market values were also reflected in gross credit exposures, which grew 29.7% to $5.0 trillion.
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In the second half of 2008 the market for OTC interest rate derivatives declined for the first time, after recording an above average rate of growth in the first half of the year. Notional amounts of these instruments fell to $418.7 trillion at the end of December 2008, 8.6% lower than six months before (Graph 2 and Table 3). Despite the decrease in notional amounts outstanding, declining interest rates resulted in a notable 98.9% increase in the gross market value of interest rate derivatives, to $18.4 trillion.

Their statement Gross market values, which measure the cost of replacing all existing contracts, represent a better measure of market risk than notional amounts. is incorrect. If I short a bond future, the market value at time of execution is zero, but I have full market exposure and counterparty risk to the extent that I might win money that doesn’t get paid. If the market moves in my favour, that increases my counterparty risk but doesn’t affect my market exposure.

There are straws in the wind that the too-big-to-fail problem will not be addressed by fixing extant rules, but by adding another layer of new rules that will grant politicians more discretionary power:

Neel Kashkari, former administrator of the $700 billion U.S. bank-rescue program, said firms deemed too big to fail have an unfair advantage over smaller rivals because they can more cheaply raise money in the debt markets.

Kashkari, who left government May 1, said in a speech last night that some officials have discussed the possibility of a “debt tax” or “systemic tax” on those institutions, without saying if he supported that approach.

“If you have some huge, global institution that is systemically important, too big to fail, too interconnected to fail, in a sense it will always be able to issue debt cheaper,” said Kashkari, 35, at the San Francisco campus of the University of Pennsylvania’s Wharton School. “People who buy that debt believe that the government is standing behind it.”

“Debt Tax”? “Systemic Tax”? Presumably this is much the same idea as existing deposit insurance, except that the degree of protection received in exchange for premia will not be spelled out. It is very simple to address the TBTF problem and systemic risk problem by adjusting extant rules:

• End the practice of risk-weighting bank debt according to the credit of the sovereign
• Impose an upwards adjustment to Risk-Weighted Assets based on size of the bank

Here’s a scary proposal: inflation targetting of 6%:

What the U.S. economy may need is a dose of good old-fashioned inflation.

So say economists including Gregory Mankiw, former White House adviser, and Kenneth Rogoff, who was chief economist at the International Monetary Fund. They argue that a looser rein on inflation would make it easier for debt-strapped consumers and governments to meet their obligations. It might also help the economy by encouraging Americans to spend now rather than later when prices go up.

“I’m advocating 6 percent inflation for at least a couple of years,” says Rogoff, 56, who’s now a professor at Harvard University. “It would ameliorate the debt bomb and help us work through the deleveraging process.”

Another strong day in the preferred market, with volume returning to elevated levels after the long weekend.

Those contemplating reverse mortgages would do well to incorporate the new OSFI advisory into their planning … the rules for qualification for optimal capital treatment will indubitably influence the packages offered by banks, notably:

• initial loan-to-value of less than 40%
• Ongoing loan-to-value of less than 60%

I regret that it is not possible for me to prepare the market report. There is a difficulty recovering prices from the TSX.

Update, 2009-5-16: Well, it took a little while, but eventually the TSX’s little computer that could spit out the data: Volume was down sharply in pre-holiday trading (which is always something of a mystery to me) but PerpetualDiscounts had a good up-day while FixedResets were flattish.

The Bank for International Settlements has announced standardized guidelines for debt market statistics:

The Handbook is the first publication of its kind dealing exclusively with the conceptual framework for the compilation and presentation of securities statistics. As such, it directly addresses a recommendation of one of the Group of Twenty (G20) working groups concerning the need to fill data gaps and strengthen data collection. The aim of the Handbook is to assist national and international agencies in the production of relevant, coherent, and internationally comparable securities statistics for use in financial stability analysis and monetary policy formulation.

The Handbook is available from the IMF. It is not clear whether Canada will be producing and publishing statistics in accordance with the guidelines; both the Bank of Canada and Statistics Canada participated in the development of the guidelines.

Judicial Watch has released documents regarding the inauguration of TARP. Paulson made the first injection of TARP money an offer they couldn’t refuse:

This is a combined program (bank liability guarantee and capital purchase). Your firms need to agree to both.

• We don’t believe it is tenable to opt out because doing so would leave you vulnerable and exposed.
• If a capital infusion is not appealing, you should be aware that your regulator will require it in any circumstances

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And, we want each of you to contact your Boards of Directors and confirm your participation this evening

Further to the Exchange Traded CDS idea the SEC is musing about a TRACE-like system:

U.S. regulators may impose the same price reporting and transparency requirements on over-the- counter derivatives that reduced bank profits by almost half in the corporate bond market when the Trace system was adopted seven years ago.

“I think it’s something we’ll look at very closely as a potential model,” Securities and Exchange Chairwoman Mary Schapiro said yesterday at a news conference in Washington, in which regulators laid out potential structural changes to improve policing of the $684 trillion OTC derivatives market.

Trace, the bond-price reporting system of the Financial Industry Regulatory Authority, gives anyone with an Internet connection access to trading data for corporate bonds. The system, in full operation since February 2005, reduced the difference in prices that banks charge to buy and sell bonds by almost half.

The BoC has published a working paper by Fuchun Li titled Testing for Financial Contagion with Applications to the Canadian Banking System:

The author’s new test is applied to investigate contagion from a variety of recent financial crises to the Canadian banking system. Three empirical results are obtained. First, compared to recent financial crises, including the 1987 U.S. stock market crash, 1994 Mexican peso crisis, and 1997 East Asian crisis, the ongoing 2007 subprime crisis has been having more persistent and stronger contagion impacts on the Canadian banking system. Second, the October 1997 East Asian crisis induced contagion in Asian countries, and it quickly spread to Latin American and G-7 countries. The contagion from the East Asian crisis to the Canadian banking system was not as strong or as persistent as that of the ongoing subprime crisis. However, it had a stronger impact on emerging markets. Third, there is no evidence of contagion from the 1994 Mexican peso crisis to the Canadian banking system. Contagion from that crisis occurred in Argentina, Brazil, and Chile, but the contagion effects of that crisis were limited to the Latin American region.
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The stock returns of Canadian banks are used to measure the banks’s vulnerability to a financial crisis.

As in Forbes (2001), and Hartmann, Straetmans, and de Vries (2005), a stock return is chosen as an indicator to investigate whether there exists contagion for several reasons. First, since stock returns are measured at a much high frequency, they can more accurately pinpoint the effects of a specific crisis and are available for a large sample of countries. Second, since stock returns incorporate the immediate impact of a crisis as well as its expected longer-term effects, stock returns should capture the total impact of a crisis on a particular country. Third, the choice of bank stock prices for measuring banking system risk is also motivated by Merton’s (1974) option theoretic framework toward default. This approach has played an important role in risk analysis.

I question the utility of stock market prices in demonstrating anything other than stock price contagion. Evidence of contagion of effects impacting the real economy would be much more useful – not that I disagree that such is the case now, mind you, but stock market hiccups are not, in and of themselves, really all that important.

Financial Webring brings to my attention an essay by Keith Ambachtsheer & Rob Bower, Losing Ground (published in the Spring, 2007, Canadian Investment Review), that makes the claim:

The measured Canadian mutual fund average return
shortfall (before sales charges) of 3.8% per annum relative to similar mandates executed by Canadian pension funds suggests the average Canadian mutual fund has not been producing fair value for its customers.

Well, all I can say is … substituting “the benchmark” for “similar mandates executed by Canadian pension funds”, that’s not the experience of my fund, MAPF, which, somewhat to my chagrin, is still accepting new clients. Why do Canadians typically get lousy performance on their managed investment? Because that’s what they want.

A regulatory initiative that would help would be the regulatorially mandated disclosure of performance for all funds under management vs. appropriate benchmarks, for all time (i.e., a composite compliant with CFA Institute Standards) for all advisors. I should be able to click on “Joe Broker” and determine whether or not his claims of stock market acuity are backed up by actual dollar-and-cents returns. And that goes double for somebody with discretionary power over client assets.

I have previously written of the soon-to-be Exchange-Traded CDS market and debt decoupling (the idea that bankruptcy rules are based on actual creditors having a vote and using it in the best interests of holders of the debt; an assumption that is not necessarily true if they are hedged or – particularly – over-hedged). There are some new twists on this process with respect to Elliott Management and Clear Channel:

Elliott Management Corp., the hedge fund that almost pushed the government of Peru into default in 2000, is now seeking to profit from the failure of distressed companies.

About 11 percent of Elliott’s $13 billion of assets were in so-called basis trades at the end of the first quarter, meaning it bought bonds and credit-default swaps that protect against losses on the debt, according to a report dated April 29 sent to investors and obtained by Bloomberg News.
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“Investors will hold out if they would benefit more if there’s a default than a successful distressed debt exchange,” said Kingman Penniman, president of high-yield research firm KDP Investment Advisors in Montpelier, Vermont. “It’s an easy decision to say ‘No’ and put the company into bankruptcy.”
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CreditSights Inc. and Barclays Capital analysts have cited the rise in basis trades for restructuring attempts that floundered. Residential Capital LLC faced bondholder resistance to its debt-exchange proposal in December partly because the investors also held derivatives, Bradley Rogoff, an analyst at Barclays in New York, said in a report that month. Minneapolis- based mortgage lender ResCap was later bailed out by taxpayers.
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In some cases, the wide basis has helped companies refinance because it boosts demand from investors who can buy the new debt while also purchasing relatively cheap insurance against default, Barclays’ Rogoff said in an interview in March.
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In mid-November, investors could buy both Clear Channel’s 5.5 percent bonds due in 2014 and protection against a default for five years for about 80 cents on the dollar, according to CMA DataVision and Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

As default concerns increased, the combined cost jumped to 94 cents on the dollar. Investors can sell the bonds and unwind the credit-swap trade to cash in on that profit. Or, if they think a default remains likely, they could hold out for par.

Volume continued to be elevated today and the market continued its previously schedule ascent. PerpetualDiscounts now yield 6.51%, equivalent to 9.11% interest at the standard equivalency factor of 1.4x. Long corporates, however, are on fire, now yielding 7.0% (with a 4.13% Month-to-Date return), so the Pre-Tax Interest-Equivalent spread is now about 211bp.