Archive for September, 2009

New Issue: GWO 5.65% STRAIGHT!

Thursday, September 24th, 2009

Great-West Lifeco has announced that it:

has today entered into an agreement … under which the underwriters have agreed to buy, on a bought deal basis, 6,000,000 Non-Cumulative First Preferred Shares, Series L … 5.65% per annum

The morons have copy-protected the PDF, since this press release is such a big secret. I’m not retyping all that!

Issue: Great-West Lifeco Inc. Non-Cumulative First Preferred Shares, Series L

Size: 6-million shares (=$150-million) + greenshoe 4-million shares (=$100-million)

Dividends: 5.65% p.a. (= $1.4125); first dividend payable 2009-12-31 for $0.34829 based on closing 2009-10-2

Redeemable: Black-out until 2014-12-31. Redeemable at $26.00 commencing 2014-12-31; redemption price declines by $0.25 p.a. until 2018-12-31; redeemable at $25.00 thereafter.

This issue has great significance: it is the first straight to be issued since RY.PR.H settled 2008-4-29 and … they didn’t fiddle with the standard redemption terms. I had been afraid that issuers would assume that market had been lulled into idiocy by the five-year redemption terms that are standard in the FixedReset sector and try to grab themselves a little more advantage.

The issue may be compared with extant GWO issues outstanding:

GWO Comparables
As of Close 2009-9-23
Ticker Dividend Quote Bid-YTW
GWO.PR.G 1.30 22.61-89 5.77%
GWO.PR.H 1.2125 20.85-90 5.85%
GWO.PR.I 1.125 19.52-63 5.80%
GWO.PR.F 1.475 25.19-43 5.63%

Boston Fed: Securitization and Moral Hazard

Wednesday, September 23rd, 2009

The Boston Fed – a rich source of high quality research – has released a paper by Ryan Bubb and Alex Kaufman titled Securitization and Moral Hazard: Evidence from a Lender Cutoff Rule:

Credit score cutoff rules result in very similar potential borrowers being treated differently by mortgage lenders. Recent research has used variation induced by these rules to investigate the connection between securitization and lender moral hazard in the recent financial crisis. However, the conclusions of such research depend crucially on understanding the origin of these cutoff rules. We offer an equilibrium model in which cutoff rules are a rational response of lenders to perapplicant fixed costs in screening. We then demonstrate that our theory fits the data better than the main alternative theory already in the literature, which supposes cutoff rules are exogenously used by securitizers. Furthermore, we use our theory to interpret the cutoff rule evidence and conclude that mortgage securitizers were in fact aware of and attempted to mitigate the moral hazard problem posed by securitization.

I am astounded that cut-off rules exist, but they do and they are step functions:

One promising research strategy for addressing this question is to use variation in the behavior of market participants induced by credit score cutoff rules. Credit scores are used by lenders as a summary measure of default risk, with higher credit scores indicating lower default risk. Examination of histograms of mortgage loan borrower credit scores, such as Figure 1, reveal that they are step-wise functions.

Using step functions to evaluate differences in complex systems is suspicious at the very least. Any time you hear a portfolio manager talk about a “screen” for instance, you should ensure that the screen is very coarse, throwing out only the most ridiculous of potential investments. For proper, verifiable, assessments of single entitites in a complex universe – whether it is a universe of government bonds, preferred shares, common equity, or mortgage applicants – you need a coherent system of continuous smooth functions.

The only rationale I can think of for using step functions at all is suggested by the authors: lenders must make a decision regarding whether or not to incur costs to collect additional data to feed into (a presumably rational) evaluation system and incurring such a cost – whether it’s a single charge, or a member of a sequence of possible charges – is a binary decision, implying a stepwise preliminary evaluation. But anyway, back to the paper:

It appears that borrowers with credit scores above certain thresholds are treated differently than borrowers just below, even though potential borrowers on either side of the threshold are very similar. These histograms suggest using a regression discontinuity design to learn about the effects of the change in behavior of market participants at these thresholds. But how and why does lender behavior change at these thresholds? In this paper we attempt to distinguish between two explanations for credit score cutoff rules, each with divergent implications for what they tell us about the relationship between securitization and lender moral hazard.

We refer to the explanation currently most accepted in the literature as the securitizer-first theory. First put forth by Keys, Mukherjee, Seru, and Vig (2008) (hereafter, KMSV), it posits that secondary-market mortgage purchasers employ rules of thumb whereby they are exogenously more willing to purchase loans made to borrowers with credit scores just above some cutoff. This difference in the ease of securitization induces mortgage lenders to adopt weaker screening standards for loan applicants above this cutoff, since lenders know they will be less likely to keep these loans on their books. In industry parlance, they will have less “skin in the game.” Because lenders screen applicants more intensely below the cutoff than above, loans below the cutoff are fewer but of higher quality (that is, lower default rate) than loans above the cutoff. We call this the “securitizer-first” theory because securitizers are thought to exogenously adopt a purchase cutoff rule, which causes lenders to adopt a screening cutoff rule in response. Under the securitizer-first theory, finding discontinuities in the default rate and securitization rate at the same credit score cutoff is evidence that securitization led to moral hazard in lender screening.

We offer an alternative rational theory for credit score cutoff rules and refer to our theory as the lender-first theory. When lenders face a fixed per-applicant cost to acquire additional information about each prospective borrower, cutoff rules in screening arise endogenously. Under the natural assumption that the benefit to lenders of collecting additional information is greater for higher default risk applicants, lenders will only collect additional information about applicants whose credit scores are below some cutoff (and hence the benefit of investigating outweighs the fixed cost). This additional information allows lenders to screen out more high-risk loan applicants. The lender-first theory thus predicts that the number of loans made and their default rate will be discontinuously lower for borrowers with credit scores just below the endogenous cutoff.

Such a cutoff rule in screening also results in a discontinuity in the amount of private information lenders have about loans.

We investigate these two theories of credit score cutoff rules using loan-level data and find that the lender-first theory of cutoff rules is substantially more consistent with the evidence than is the securitizer-first theory. We focus our investigation on the cutoff rule at the FICO score of 620. We do this for two reasons: of all the apparent credit score cutoff thresholds, the discontinuity in frequency at 620 is the largest in log point terms; also, 620 is the focus of inquiry in previous research. After reviewing institutional evidence that lenders adopted a cutoff rule in screening at 620 for reasons unrelated to the probability of securitization, we use a loan-level dataset to show that in several key mortgage subsamples there are discontinuities in the lending rate and the default rate at 620, but no discontinuity in the securitization rate. Without a securitization rate discontinuity at the cutoff, the securitizer-first theory is difficult to reconcile with the data.

Having established that the lender-first theory is the more likely explanation for the cutoff rules, we then interpret the evidence in light of the theory. We find that in the jumbo market of large loans, in which only private securitizers participate, the securitization rate is lower just below the screening threshold of 620. This suggests that private securitizers were aware of the moral hazard problem posed by loan purchases and sought to mitigate it.

However, in the conforming (non-jumbo) market dominated by Fannie Mae and Freddie Mac (the government sponsored enterprises, or GSEs), there is a substantial jump in the default rate but no jump in the securitization rate at the 620 threshold. One explanation for this is that the GSEs were unaware of the threat of moral hazard. An arguably more plausible explanation is that, as large repeat players in the industry, the GSEs had alternative incentive instruments to police lender moral hazard.

The authors conclude:

Interpreting the cutoff rule evidence in light of the lender-first theory, our evidence suggests that private mortgage securitizers adjusted their loan purchases around the lender screening threshold in order to maintain lender incentives to screen. Though our findings suggest that securitizers were more rational with regards to moral hazard than previous research has judged, the extent to which securitization contributed to the subprime mortgage crisis is still an open and pressing research question.

September 23, 2009

Wednesday, September 23rd, 2009

Today was Equity Through Education Day, a day on which institutional investors are encouraged to trade through BMO Capital Markets with commissions donated to charity. So far CAD 6.6-million in commissions has been skimmed off the hapless beneficiaries of participating institutional accounts, enabling institutional PMs to feel good about themselves.

Sadly, the website – again! – does not explain how discretionary participation (the kind they are attempting to encourage with their ads) can be squared with a PM’s duty to his client, or regulatory requirement to seek best execution. I’ve never understood that.

Realpoint, a CMBS credit rating agency last discussed on September 9, has been approved by NAIC:

The ruling by the National Association of Insurance Commissioners means state regulators can rely on Realpoint in determining how much capital must be held by insurers, Scott Holeman, spokesman for the group, said today. Realpoint provides analysis to bond buyers through subscription, while S&P and Moody’s are paid by companies that issue securities.

Realpoint started the process as reported June 15, when fears of a mass downgrade of CMBS by S&P led insurance companies to seek their ‘license to invest’ from more optomistic firms.

And there’s even more news on the credit rating front! First, William Galvin, Secretary of the Commonwealth of Massachussets is checking the quality of some ratings:

Massachusetts is reviewing DBRS Ltd.’s grades on investments tied to life insurance policies because they might be inflated like the discredited mortgage bonds at the center of the recession.

“Bundling the policies to create another investment opportunity closely parallels the subprime mortgage market and subsequent meltdown, whose effects investors are still reeling from,” said Galvin, the state’s chief financial regulator, in the statement.

Regulators have said ratings companies were too generous in assigning top credit grades to securities comprised of bundled subprime mortgages before the financial crisis showed many of them were more prone to default than the ratings suggested.

Well, with respect to the last paragraph, hold on a minute! That’s certainly been implied, but I’m not sure whether the regulators have actually gone so far as to state definitely that the ratings were too high. Galvin’s quote, besides conflating two unrelated securities, is also ungrammatical. Was he drunk?

However, help is at hand: Government-Developed Credit Ratings:

“We at the National Association of Insurance Commissioners are studying the viability of creating our own rating agency, a not-for-profit one,” Connecticut Insurance Commissioner Thomas Sullivan said in a telephone interview today.

“The fundamental issue is if the bar is always moving, that makes it very difficult,” Sullivan said. “Magically overnight, what we thought was AAA is no longer AAA. That’s a big problem.”

Insurers, which are suffering from downgrades of their holdings, have urged regulators to seek alternatives. Rating cuts to structured securities in insurance portfolios have triggered increased capital requirements.

The American Council of Life Insurers has asked the NAIC to ease its standards after RMBS rating cuts pushed up carriers’ capital needs fivefold to $11 billion in the six months ended June 30. The ACLI is proposing regulators use “third party” predictions of credit losses on RMBS in place of their reliance on ratings firms.

The NAIC currently conducts some credit analysis on insurers’ investments through the group’s Securities Valuation Office in New York. The deliberations for a new ratings business at the NAIC are still preliminary.

“We’re in the formative stages,” Sullivan said. “Anything’s possible. Financing, legal hurdles, structure; all those things need to be dealt with and we’re examining all of them.”

I can’t wait.

Volume was very good today (possibly quarter end window-dressing / rebalancing, possibly triggered by the YPG.PR.C closing, maybe even clearing the decks for the massive forthcoming TRP settlement), with FixedResets seeing a good spike in volume with lots of blocks. That didn’t do prices much good, though, with PerpetualDiscounts down 11bp on the day and FixedResets losing 2bp.

PerpetualDiscounts closed with a weighted mean average YTW of 5.77%, equivalent to 8.08% at the standard equivalency factor of 1.4x. Long Corporates have backed up to just over 6.0%, so the pre-tax interest-equivalent spread is now about 205bp, a very slight – and possibly completely technical – tightening from the September 16 value and well within its September and Credit Crunch range.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)
Median
YTW
Median
Average
Trading
Value
Median
Mod Dur
(YTW)
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 0.2777 % 1,512.9
FixedFloater 5.74 % 3.99 % 53,875 18.61 1 0.5302 % 2,677.5
Floater 2.42 % 2.08 % 31,909 22.24 4 0.2777 % 1,890.1
OpRet 4.84 % -11.32 % 132,485 0.09 15 0.1654 % 2,298.5
SplitShare 6.42 % 6.80 % 888,843 4.02 2 -0.5501 % 2,061.2
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.1654 % 2,101.7
Perpetual-Premium 5.77 % 5.68 % 152,336 2.82 12 -0.2666 % 1,877.3
Perpetual-Discount 5.72 % 5.77 % 204,167 14.18 59 -0.1065 % 1,800.9
FixedReset 5.49 % 4.03 % 464,162 4.06 40 -0.0203 % 2,111.0
Performance Highlights
Issue Index Change Notes
HSB.PR.D Perpetual-Discount -2.45 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-09-23
Maturity Price : 21.52
Evaluated at bid price : 21.52
Bid-YTW : 5.84 %
RY.PR.G Perpetual-Discount -1.21 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-09-23
Maturity Price : 20.42
Evaluated at bid price : 20.42
Bid-YTW : 5.58 %
CL.PR.B Perpetual-Premium -1.09 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2010-01-30
Maturity Price : 25.25
Evaluated at bid price : 25.51
Bid-YTW : 2.94 %
TRI.PR.B Floater 1.26 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-09-23
Maturity Price : 19.25
Evaluated at bid price : 19.25
Bid-YTW : 2.04 %
BAM.PR.O OpRet 1.94 % YTW SCENARIO
Maturity Type : Option Certainty
Maturity Date : 2013-06-30
Maturity Price : 25.00
Evaluated at bid price : 26.25
Bid-YTW : 3.57 %
Volume Highlights
Issue Index Shares
Traded
Notes
BMO.PR.O FixedReset 616,380 Nesbitt crossed 400,000 at 28.00; RBC crossed 20,000 at the same price; then Nesbitt bought 100,000 from anonymous at 28.01. Finally, RBC crossed blocks of 40,000 and 30,000 shares, both at 28.01.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-06-24
Maturity Price : 25.00
Evaluated at bid price : 28.01
Bid-YTW : 3.88 %
CIU.PR.B FixedReset 211,750 RBC crossed 20,000 at 28.10; Nesbitt crossed blocks of 40,000 and 60,000 at the same price; and RBC then crossed another 85,000 at 28.10.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-01
Maturity Price : 25.00
Evaluated at bid price : 28.05
Bid-YTW : 4.02 %
RY.PR.T FixedReset 152,033 RBC crossed blocks of 100,000 and 45,400 at 27.65.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-09-23
Maturity Price : 25.00
Evaluated at bid price : 27.60
Bid-YTW : 4.09 %
RY.PR.Y FixedReset 150,342 RBC crossed 20,000 at 27.65, then Nesbitt crossed blocks of 102,100 and 17,400 at 27.60.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-12-24
Maturity Price : 25.00
Evaluated at bid price : 27.60
Bid-YTW : 4.04 %
RY.PR.I FixedReset 149,148 Nesbitt crossed two blocks of 50,000 and one of 38,500 at 26.10, YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-03-26
Maturity Price : 25.00
Evaluated at bid price : 26.01
Bid-YTW : 4.13 %
MFC.PR.D FixedReset 131,340 Nesbitt crossed 100,000 at 28.00.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-19
Maturity Price : 25.00
Evaluated at bid price : 27.95
Bid-YTW : 3.96 %
There were 50 other index-included issues trading in excess of 10,000 shares.

YPG.PR.C Listing a Wrong Number

Wednesday, September 23rd, 2009

YPG.PR.C, the 6.75%+417 FixedReset announced September 8 and promptly upsized to 7.5-million shares + greenshoe 1.125-million shares (I don’t know whether or not the greenshoe was exercised) has settled with results that many will find disappointing.

The issue traded 245,490 shares in a range of 24.50-75, before closing at 24.47-55, 6×83.

Vital statistics are:

YPG.PR.C FixedReset YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-09-23
Maturity Price : 24.42
Evaluated at bid price : 24.47
Bid-YTW : 6.90 %

The issue is tracked by HIMIPref™, but is relegated to the Scraps index on credit concerns.

September 22, 2009

Tuesday, September 22nd, 2009

To nobody’s surprise, the banks are starting to harness the hysteria over bonuses to alter the balance of power with their traders:

Canada’s biggest bank, Royal Bank of Canada, is changing the way its investment bankers and traders are paid, according to a memo it sent to employees Tuesday.

The bank’s aim is not to decrease the amount its employees are paid, but rather to ensure that their pay packages are structured in a way that does not encourage them to take excessive risks.

That last paragraph should have been published as “The Morning Smile”.

For instance, a greater proportion of Royal Bank employees’ compensation will now be deferred, and managing directors will be required to own a certain amount of shares in the bank.

So RBC gets to slap the golden handcuffs on their traders for free, and managing directors will have their pay dependent on whether or not some bozo in the president’s office has lent $20-billion to Argentina. Cross your fingers, boys!

When it comes to calculating bonuses, the bank intends to pay more attention to how employees reached their results, not just what their results were. The bank is paying more attention to non-financial measures in part so it can take into account the amount of risk employees take on to achieve their financial goals.

Non-financial measures like ‘Did you suck enough management arse?’

ln addition, RBC told employees it is in the process of finalizing a claw back policy, for cases where misconduct or a failure to abide by proper procedures results in a loss or the need to restate financial results.

Opening up the gates for more abuse of the regulatory process. David Berry can tell you all about that one.

The paper also mentions changes at Scotia, but I haven’t heard much about that. The last major round of compensation rejigging I know of was at CIBC, where changes resulted in a flood of resumes hitting the streets and the institutional sales desks hastily restaffed by high school students.

All this, by the way, is just after the relevation (to me) that RBC routinely spies on its employees:

She accused another of using the made-up word “sensy” rather than “sexy” so that RBC’s monitoring system would not pick up his language.

What a charming example of the Thought Police kicking out any manager with a rational world view.

But where are the RBC guys going to go? Thanks to the Canadian oligarchy, there are very few opportunities to work as a prop trader – with good capital availability and good order flow – at a non-bank trading firm. I continue to believe that the Achilles heel of the Canadian banking sector is the potential for contagion between vanilla banking, wealth management and trading … and we’ll just have to hope it never takes effect, because OSFI won’t do anythng useful about it.

The CME is introducing a new US long bond futures contract, which will have a lower negative convexity that the current contract:

The “ultra” Treasury bond future will begin trading in the first quarter of next year, Chicago-based CME said today in a statement. The contract, designating Treasuries with maturities of 25 years or more for delivery, won’t replace the current 30-year bond future, which allows government bonds that mature in 15 years or more.

“With the increased issuance because of the deficit over the last year and a half we now have an ample deliverable basket” of long-term bonds to underpin the futures contract, [CME managing director of interest-rate products Robin] Ross said. Two to three years ago there wasn’t enough supply of U.S. bonds maturing in 25 years or more to make the futures contract deliverable, she said.

The big excitement today was the new TRP 4.60+192 FixedReset; PerpetualDiscounts gained 3bp total return on the day while FixedResets were down about 22bp. Floaters continued yesterday‘s pop. There were no huge volume outliers, but volume was quite good across the board.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)
Median
YTW
Median
Average
Trading
Value
Median
Mod Dur
(YTW)
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 0.6834 % 1,508.7
FixedFloater 5.77 % 4.02 % 53,580 18.57 1 -0.7368 % 2,663.4
Floater 2.43 % 2.08 % 29,451 22.24 4 0.6834 % 1,884.8
OpRet 4.85 % -12.75 % 133,357 0.09 15 0.0611 % 2,294.7
SplitShare 6.38 % 6.55 % 895,945 4.03 2 0.4198 % 2,072.6
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0611 % 2,098.3
Perpetual-Premium 5.76 % 5.63 % 151,985 2.53 12 -0.1676 % 1,882.3
Perpetual-Discount 5.71 % 5.76 % 206,344 14.19 59 0.0263 % 1,802.8
FixedReset 5.49 % 4.03 % 455,994 4.06 40 -0.2179 % 2,111.4
Performance Highlights
Issue Index Change Notes
RY.PR.W Perpetual-Discount -1.53 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-09-22
Maturity Price : 22.40
Evaluated at bid price : 22.56
Bid-YTW : 5.49 %
BNS.PR.X FixedReset -1.11 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-25
Maturity Price : 25.00
Evaluated at bid price : 27.65
Bid-YTW : 4.03 %
ELF.PR.F Perpetual-Discount -1.04 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-09-22
Maturity Price : 21.03
Evaluated at bid price : 21.03
Bid-YTW : 6.44 %
BAM.PR.K Floater 1.37 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-09-22
Maturity Price : 13.30
Evaluated at bid price : 13.30
Bid-YTW : 2.95 %
BAM.PR.B Floater 1.89 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-09-22
Maturity Price : 13.50
Evaluated at bid price : 13.50
Bid-YTW : 2.91 %
Volume Highlights
Issue Index Shares
Traded
Notes
PWF.PR.M FixedReset 50,300 RBC bought two blocks from (the same?) anonymous, 20,000 and 15,500 shares, both at 27.10.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-03-02
Maturity Price : 25.00
Evaluated at bid price : 27.10
Bid-YTW : 4.13 %
MFC.PR.E FixedReset 50,125 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-10-19
Maturity Price : 25.00
Evaluated at bid price : 26.41
Bid-YTW : 4.40 %
TD.PR.Q Perpetual-Premium 48,175 RBC crossed 28,800 at 25.00.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-09-22
Maturity Price : 24.78
Evaluated at bid price : 25.01
Bid-YTW : 5.68 %
CIU.PR.B FixedReset 48,025 RBC crossed two blocks, 19,900 and 20,000, both at 28.25.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-01
Maturity Price : 25.00
Evaluated at bid price : 28.05
Bid-YTW : 4.02 %
RY.PR.X FixedReset 45,750 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-09-23
Maturity Price : 25.00
Evaluated at bid price : 27.72
Bid-YTW : 4.00 %
CM.PR.L FixedReset 38,307 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-30
Maturity Price : 25.00
Evaluated at bid price : 27.91
Bid-YTW : 4.03 %
There were 48 other index-included issues trading in excess of 10,000 shares.

GBA.PR.A: DBRS Discontinues Rating

Tuesday, September 22nd, 2009

DBRS has announced that it:

has today discontinued its rating on the Preferred Shares issued by GlobalBanc Advantaged 8 Split Corp. (the Company) at the request of the Company.

The company stated that:

The board of directors concluded that there was no benefit to continuing the rating, and incurring the costs associated with the rating.

The company announced yesterday that:

announces a distribution of $0.005 per Preferred Share for the quarter ending September 30, 2009. The distribution will be paid on October 13, 2009 to holders of record on September 30, 2009. A distribution will not be paid on the Class A Shares for the quarter ending September 30, 2009.

The Board of Directors has again decided to maintain the distribution at the same level as the last two quarters even though the Bloomberg Dividend Forecast now anticipates that dividends to be paid by certain of the banks included in the Bank Portfolio may increase slightly in 2010. The Board of Directors will continue to monitor the Bloomberg Dividend Forecast, the Company’s current cash flow and changes in its expenses and may revise the amount of dividends paid on the Preferred Shares in the future.

Unitholders are reminded that the Preferred Shares, as a class, are entitled to receive, as and when paid in the discretion of the Board of Directors of the Company, cumulative dividends not exceeding $0.1125 per share per annum. The shortfall below the prescribed amount of the Preferred Share dividend (currently, $0.2575 in aggregate) will accumulate and, in accordance with the terms of the Preferred Shares and the Class A Shares, will be paid in priority to any payments on the Class A Shares.

GBA.PR.A was last mentioned on PrefBlog when it was downgraded to Pfd-5(low) by DBRS in February. GBA.PR.A is not tracked by HIMIPref™.

KBC Bank of Belgium Buys Back Preferreds at 70% of Face

Tuesday, September 22nd, 2009

KBC Bank has announced:

tender offers in certain countries in Europe and, in respect of one security, in the United States of America to repurchase four series of outstanding hybrid Tier-1 securities with a total nominal value of approximately €1.6 billion. The securities will be purchased at 70% of their face value.

By doing so under current market conditions, KBC Bank offers bondholders an opportunity to exit by paying a premium above the market price. At the same time, KBC Bank will generate a value gain when buying back at a discounted price compared to the nominal value of the securities, which further enhances the quality of its core capital position. If all outstanding securities would be bought back, the after tax value gain would be approx. 0.2 billion euros while the impact on the core Tier-1 ratio, banking would be estimated at +0.25%.

In the past, KBC has issued several hybrid securities that were qualified as regulatory Tier-1 bank capital. Such securities are ‘hybrid’ securities that have both equity and debt features. In general terms, they pay an interest coupon, but have no final maturity and rank junior to other bonds upon bankruptcy.

KBC wishes to reiterate its stance of refraining from exercising its call options on hybrid Tier-1 securities for the remainder of the year.

The tender offers cover the following securities and are being made solely to the relevant holders of such securities:

  •  EUR 280 million hybrid securities issued by KBC Bank Funding Trust II;
  •  USD 600 million hybrid securities issued by KBC Bank Funding Trust III;
  •  EUR 300 million hybrid securities issued by KBC Bank Funding Trust IV;
  •  GBP 525 million hybrid securities issued by KBC Bank.

The last of these recently had its coupon suspended:

Having issued core capital securities to the State in order to strengthen its solvency level, KBC’s company restructuring plan needs to gain clearance from the European Commission. On 6 August, KBC communicated that KBC was advised by the European Commission to refrain, until the end of the year, from payment of “discretionary coupons” on its perpetual subordinated hybrid Tier-1 securities.

  •  The restriction is expected to impact the directly issued perpetual debt securities issued by KBC Bank in a total amount of 525 million sterling (in 2003, 2004 and 2007).
  •  For the KBC Bank funding Trust II 280 million euros 1999 issue, coupon payments in the second half of 2009 remain uncertain as they are subject to ongoing discussions with the European Commission.
  •  For the other hybrid securities, coupon payments in the second half of 2009 are considered to be non-optional and will be paid.


What makes the coupon payment for the KBC Bank 525 millions sterling issue “discretionary”?

Pursuant to conditions 4(i) (“deferred coupons”) and 5(a) (“deferral notice”) of the offering memorandum, and assuming no “net asset deficiency event” occurs (as defined in the prospectus), KBC Bank NV may in its sole discretion defer the payment of interest unless such interest would or would become mandatorily due.

Pursuant to conditions 5(b) (“payment of deferred coupon”) and 6(b) (“mandatory coupons”), interest would be mandatorily due if KBC Group NV or KBC Bank NV were to pay any dividend on or redeem any junior securities or parity Securities. This would, for example, be the case if any dividend is declared on the ordinary shares of KBC Group, which fall under the definition of junior securities. Currently, there are no parity securities (as defined in the prospectus) outstanding.

As at today’s date, KBC does not anticipate to make any payment in respect of any junior securities prior to 19 December 2009. Accordingly, as a consequence of the restrictions imposed by the European Commission, KBC will, absent any such payment, be required to exercise its discretion and withhold the interest payment falling due on 19 December 2009. At this time, it remains unclear if and when KBC will make any payment in respect of junior securities in the course of 2010.

Finally, coupon payments on the sterling hybrid securities do not rank pari passu with coupon payments to holders of other KBC hybrid securities (see condition 3(a) (“Status of the securities”)). Therefore, coupon payments to holders of other KBC hybrid securities in 2009 (whether in the first or second half of the year) do not trigger a coupon payment to the holders of the sterling hybrid securities.

I haven’t drawn any diagrams of the KBC’s capital structure, but it sounds pretty intricate!

Bank Capitalization Requirements & Lending

Tuesday, September 22nd, 2009

Assiduous Readers will remember that I have long complained about the dearth of research on the ill-effects of Canada’s bank capitalization requirements. Various OSFI puff-pieces (e.g., a speech by Mark White; an essay by Carol Ann Northcott & Graydon Paulin of the Bank of Canada and Mark White; a speech by Jule Dickson later clarified for the sub-moronic) have given unreserved praise to the high capitalization required by OSFI. I have long wondered what the through-the-cycle costs of having all this excess (by world standards) capital tied up in banks might be – ain’t NUTHIN’ free! The high levels of bank capitalization certainly helped through the crisis (although not, probably, as much as secure retail funding) but what did that cost us and is it worth that cost?

I don’t know the answer – I’m just annoyed that Canadians are not asking the question.

Into the breach steps the UK Financial Stability Authority, which has just published a paper by their staff members William Francis and Matthew Osborne titled Bank regulation, capital and credit supply: Measuring the impact of Prudential Standards:

The existence of a “bank capital channel”, where shocks to a bank’s capital affect the level and composition of its assets, implies that changes in bank capital regulation have implications for macroeconomic outcomes, since profit-maximising banks may respond by altering credit supply or making other changes to their asset mix. The existence of such a channel requires (i) that banks do not have excess capital with which to insulate credit supply from regulatory changes, (ii) raising capital is costly for banks, and (iii) firms and consumers in the economy are to some extent dependent on banks for credit. This study investigates evidence on the existence of a bank capital channel in the UK lending market. We estimate a long-run internal target risk-weighted capital ratio for each bank in the UK which is found to be a function of the capital requirements set for individual banks by the FSA and the Bank of England as the previous supervisor (Although within the FSA’s regulatory capital framework the FSA’s view of the capital that an individual bank should hold is given to the firm through individual capital guidance, for reasons of simplicity/consistency this paper refers throughout to “capital requirements”). We further find that in the period 1996-2007, banks with surpluses (deficits) of capital relative to this target tend to have higher (lower) growth in credit and other on- and off-balance sheet asset measures, and lower (higher) growth in regulatory capital and tier 1 capital. These findings have important implications for the assessment of changes to the design and calibration of capital requirements, since while tighter standards may produce significant benefits such as greater financial stability and a lower probability of crisis events, our results suggest that they may also have costs in terms of reduced loan supply. We find that a single percentage point increase in 2002 would have reduced lending by 1.2% and total risk weighted assets by 2.4% after four years. We also simulate the impact of a countercyclical capital requirement imposing three one-point rises in capital requirements in 1997, 2001 and 2003. By the end of 2007, these might have reduced the stock of lending by 5.2% and total risk-weighted assets by 10.2%.

Unfortunately for the direct translation of this paper’s conclusions to the Canadian experience, the paper focusses on shocks to bank capital requirements, which may be different from the steady-state effects of a constantly high requirement. For all that, however, the reasoning seems applicable in general terms:

Moreover, a large body of theoretical and empirical literature suggests that, contrary to the predictions of the Modigliani-Miller theorems (Modigliani and Miller (1958)), maintaining a higher capital ratio is costly for a bank and, consequently, a shortfall relative to the desired capital ratio may result in a downward shift in loan supply (Van den Heuvel (2004); Gambacorta and Mistrulli (2004)).

A secondary aim of our paper is to use evidence of systematic association between changes in banks’ balance sheets and banks’ surplus or deficit relative to desired capital levels during economic upturns to develop measures that may assist policymakers in calibrating capital requirements, including proposals for counter-cyclical capital requirements, which are explicitly designed to address the build-up of risk during a credit boom.

Not surprisingly, there is an effect:

Our results show that regulatory capital requirements are positively associated with banks’ targeted capital ratios. We further show that the gap between actual and targeted capital ratios is positively associated with banks’ loan supply (suggesting that loan supply falls as actual capital falls below targeted levels), suggesting that banks amend their supply schedule (for example by raising the cost of borrowing or rationing credit supply at a given price) or take action to raise capital levels (for example, restricting dividends in order to retain profits or raising new equity or debt capital). Taken together, these results indicate that capital requirements affect credit supply, confirming the linkage found by previous researchers and demonstrating a ‘credit view’ channel through which prudential regulation affects economic output. We also find significant and positive relationships with growth in the size of banks’ balance sheets and total risk-weighted assets, and significant and negative relationships with growth in capital.

The effect of increasing regulatory requirements on Italian banks has been examined:

One notable study that addresses the problem of a lack of heterogeneity of capital requirements and assesses the impact on bank lending is Gambacorta and Mistrulli (2004). The authors explicitly examine the effects of the introduction of capital requirements higher than the Basel 8% solvency standard on lending volumes of Italian banks. They find that the imposition of higher requirements reduced lending by around 20% after two years. The results are consistent with the idea that, in the face of rising capital requirements, banks may find it less costly to adjust loans than capital as the risk-based capital requirement becomes increasingly more binding. Frictions in the market for bank capital make adjusting (raising) capital in response to higher regulatory requirements, in this case, expensive, so the result of the trade-off may be a reduction in lending. This result is consistent with the idea of a ‘bank capital channel’.

Panel A: Impact of a 1-point rise in risk-based capital requirement in 2002
  Difference of stock from baseline after:
  1 year 2 years 3 years

4 years
Assuming 65% pass-through to target capital ratio  
Growth in:  
Assets -0.95% -1.19% -1.33% -1.41%
Loans -0.78% -0.98% -1.10% -1.16%
Risk-weighted assets -1.59% -2.01% -2.24% -2.37%
Regulatory capital 1.78% 2.25% 2.52% 2.68%
Tier 1 capital 1.28% 1.62% 1.81% 1.93%

As noted, the paper’s emphasis is on the effect of shocks, not upon the constant effects of higher capital requirements, and the author’s conclusions reflect this bias:

Our simple theoretical model clarifies the link between capital requirements and lending and shows how, in the presence of capital adjustment costs, the “bank capital channel” implies that higher capital requirements lower a bank’s optimal loan growth. That effect, however, depends on the level of excess capitalization, with better capitalized banks (i.e., those with more capital above regulatory thresholds) experiencing less pronounced impacts on their lending. These predictions depend on departures from the Modigliani-Miller propositions and, in particular, increasing marginal costs of capital adjustment.

A full examination of the Canadian experience would include an accounting for the effects on loans of steady-state capital ratios and – perhaps equally importantly – some accounting of the crowding-out effects on risk-capital of other firms of requiring so much equity in banks. Don’t look for any pearls of wisdom from OSFI, though; perhaps the Bank of Canada might do it.

New Issue: TRP FixedReset 4.60%+192

Tuesday, September 22nd, 2009

TransCanada Corporation has announced:

it will issue 12,000,0000 cumulative redeemable first preferred shares, series 1 (the “Series 1 Preferred Shares”) at a price of $25.00 per share, for aggregate gross proceeds of $300 million on a bought deal basis to a syndicate of underwriters in Canada led by Scotia Capital Inc., and RBC Capital Markets.

The holders of Series 1 Preferred Shares will be entitled to receive fixed cumulative dividends at an annual rate of $1.15 per share, payable quarterly, as and when declared by the board of directors of TransCanada, yielding 4.6% per annum, for the initial five-year period ending December 31, 2014 with the first dividend payment date scheduled for December 31, 2009. The dividend rate will reset on December 31, 2014 and every five years thereafter at a rate equal to the sum of the then five-year Government of Canada bond yield and 1.92%. The Series 1 Preferred Shares are redeemable by TransCanada on or after December 31, 2014.

The holders of Series 1 Preferred Shares will have the right to convert their shares into cumulative redeemable first preferred shares, series 2 (the “Series 2 Preferred Shares”), subject to certain conditions, on December 31, 2014 and on December 31 of every fifth year thereafter. The holders of Series 2 Preferred Shares will be entitled to receive quarterly floating rate cumulative dividends, as and when declared by the board of directors of TransCanada, at a rate equal to the sum of the then 90-day Government of Canada treasury bill rate and 1.92%.

TransCanada has granted to the underwriters an option, exercisable at any time up to 48 hours prior to the closing of the offering, to purchase up to an additional 2,000,000 Series 1 Preferred Shares at a price of $25.00 per share.

The anticipated closing date is September 30, 2009. The net proceeds of the offering will be used to partially fund capital projects, for other general corporate purposes and to re-pay short term indebtedness of TransCanada and its affiliates.

The Series 1 Preferred Shares will be offered to the public in Canada pursuant to a prospectus supplement that will be filed with securities regulatory authorities in Canada under TransCanada’s short form base shelf prospectus dated September 21, 2009. The securities referred to herein have not been and will not be registered under the United States Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.

The initial dividend will be payable 2009-12-31 for $0.2899, based on a September 30 closing.

The existing TRP straight perpetuals, TRP.PR.X and TRP.PR.Y, closed yesterday very near par to yield about 5.63%; the Break-Even Rate Shock on this issue is therefore 145bp, a fairly high figure. The analytical concept of Break-Even Rate Shock was introduced in the June PrefLetter; the next edition of Canadian Moneysaver will contain a briefer exposition of the technique.

I am advised that this issue has flown off the shelves and the books are closed, which brings with it the prospect of another flurry of new issues. This leads to interesting possibilities for future issuance and analysis … with the bank issues that reset at spreads of 300bp+, one might reasonably (rather aggressively, too aggressively according to me, but reasonably) have made the assumption that a call at the first reset date was a certainty. At +192bp for an issue of this credit quality, the future is somewhat murkier.

Update: “Flew off the shelves” was a bit of an understatement … TRP has announced that the customers wanted to supersize their orders:

TransCanada Corporation (TransCanada) today announced that as a result of strong investor demand for its domestic public offering of cumulative redeemable first preferred shares, series 1 (the “Series 1 Preferred Shares”), the size of the offering has been increased to a total of 22 million shares. The gross proceeds of the offering will now be $550 million.

There will not be an underwriters option, as was previously granted. The syndicate of underwriters is led by Scotia Capital Inc., and RBC Capital Markets. The anticipated closing date is September 30, 2009.

It should be noted that the TCA.PR.X and TCA.PR.Y issues referenced above are issued by the TransCanada Pipelines subsidiary, with all the usual complexities of determining relative credit quality (diversification vs. proximity to the money). The TransCanada 2008 Annual Report notes:

TransCanada’s issuer rating assigned by Moody’s Investors Service (Moody’s) is Baa1 with a stable outlook. TransCanada PipeLines Limited’s (TCPL) senior unsecured debt is rated A with a stable outlook by DBRS, A3 with a stable outlook by Moody’s, and A- with a stable outlook by Standard and Poor’s.

BoE Releases Quarterly Bulletin 2009-Q3

Monday, September 21st, 2009

The Bank of England has announced the release of the 2009 Q3 issue of the Bank of England Quarterly Bulletin with the usual top-notch research. This quarter’s articles are:

  • Foreword
  • Markets and operations
  • Global imbalances and the financial crisis
  • Household saving
  • Interpreting recent movements in sterling
  • What can be said about the rise and fall in oil prices?
  • Bank of England Systemic Risk Survey
  • Monetary Policy Roundtable

The article on Global imbalances seeks to challenge Taylor’s assertion that there was no global saving glut by focussing on gross, not net numbers:

An important factor was the adoption of managed exchange rate policies by some EAEs [East Asian Economies],(2) whereby a particular level of their currency was targeted, usually against the US dollar. This policy was prompted, in part, by the aim of spurring economic development through exports, thereby addressing extensive rural underemployment.(3)(4) The desire to accumulate foreign exchange reserves as insurance against a repeat of the 1997–98 Asian currency crises was an additional motivation.(5) Another factor may have been the slow pace of financial development in many EAEs which meant that there was a dearth of domestic investment opportunities (see Caballero et al (2008)). This may have necessitated savings being channelled to the deeper and more liquid financial markets in western economies.

Bernanke (2005) has argued that the low and falling savings rates in deficit countries which accompanied the credit boom, were principally the outcome of an endogenous process by which the excess savings of the surplus countries — the ‘global
savings glut’ — were recycled.

Meanwhile, banks were exposing themselves to liquidity risk:

An associated innovation was that banks changed their funding models. In particular, banks sold the new types of securities to
end-investors via the so-called ‘shadow banking system’, encompassing structured investment vehicles (SIVs) and conduits, which provided a framework for lending and borrowing without accepting deposits. This was termed the ‘originate to distribute’ model: aiming to spread the risks associated with securitised assets off their balance sheets, banks sold them to SIVs, which then aimed to sell them on to end-investors.(1) At the same time, banks increasingly relied on wholesale funding markets, including in selling the securitised assets, see the October 2008 Financial Stability Report. The magenta bars in Chart 8 show that the share of funding by UK banks derived from securitisations increased between 2000 and 2008.(2)

The authors repeatedly emphasize this point:

The funding structure of financial institutions, with its reliance on wholesale markets and the use of securitised assets (Chart 8), was a related vulnerability. In particular, this funding model relied on the continued functioning of those markets. This funding often came from foreign investors and this, together with banks’ increased lending overseas and the growth of the shadow banking system, generated the further vulnerability of increased and complex cross-border linkages between both financial institutions and between countries more generally. Such complex international linkages potentially give rise to unappreciated, but potent, interconnections between firms in the global financial system.

The article on oil prices makes a claim of regulatory significance:

The price of oil rose steadily between the middle of 2003 and the end of 2007, rose further and more rapidly until mid-2008 and fell sharply until the end of that year. Commentators agree that a significant part of the increase in the oil price over that period was due to rapid demand growth from emerging markets, but there are substantial differences of view about the relative importance of other factors, and limited work thus far in explaining the large fall in oil prices in the second half of 2008. The purpose of this article is to analyse the main explanations for the rise and fall in oil prices in the five years until the end of 2008. It argues that shocks to oil demand and supply, coupled with the institutional factors of the oil market, are qualitatively consistent with the direction of price movements, although the magnitude of the rise and subsequent fall during 2008 is more difficult to justify. The available empirical evidence suggests that financial flows into oil markets have not been an important factor over the period as a whole. Nonetheless, one cannot rule out the possibility that some part of the sharp rise and fall in the oil price in 2008 might have had some of the characteristics of an asset price bubble.