It’s interesting:
1. Preferred Shares and GICs (1)
2. Perpetual and Retractible Preferred Shares (2)
3. Why Invest in Preferred Shares? (5)
4. A Brief Introduction to Preferred Shares (6)
5. Corporate Bonds … or Preferred Shares? (3)
6. Trading Preferreds (8)
7. Interest Bearing Preferreds (4)
8. Modified Duration (9)
9. Break-Even Rate Shock (-)
10. The Bond Portfolio Jigsaw Puzzle (-)
The bracketted numbers give the positions on the December Top 10 List – there’s not much change!
The Federal Reserve Bank of Boston has released a working paper by Sanders Shaffer titled Fair Value Accounting: Villain or Innocent Victim: Exploring the Links between Fair Value Accounting, Bank Regulatory Capital and the Recent Financial Crisis:
There is a popular belief that the confluence of bank capital rules and fair value accounting helped trigger the recent financial crisis. The claim is that questionable valuations of long term investments based on prices obtained from illiquid markets created a pro-cyclical effect whereby mark to market adjustments reduced regulatory capital forcing banks to sell off investments which further depressed prices. This ultimately led to bank instability and the credit effects that reached a peak late in 2008. This paper analyzes a sample of large banks to attempt to measure the strength of the link between fair value accounting, regulatory capital rules, pro-cyclicality and financial contagion. The focus is on large banks because they value a significant portion of their balance sheets using fair value. They also hold investment portfolios that contain illiquid assets in large enough volumes to possibly affect the market in a pro-cyclical fashion. The analysis is based on a review of recent historical financial data. The analysis does not reveal a clear link for most banks in the sample, but rather suggests that there may have been other more significant factors putting stress on bank regulatory capital.
After a discussion of Fair Value Accounting and the criticism that has been leveled against it, the author points out:
Fair value is applied to investment securities depending on how they are classified. Investment securities classified as available for sale are measured at fair value each reporting period. The resulting adjustments are termed unrealized gains or losses. These adjustments are recorded in an equity account called Accumulated Other Comprehensive Income. An important point here is that fair value adjustments related to debt securities and unrealized gains on equity securities are excluded when computing Tier 1 regulatory capital.
The author hypothesizes:
This analysis does not address whether raising capital through the sale of investments in a distressed market would be a first choice or last resort. However, one may be able to infer that if banks were actually being forced into distressed sales, they would first try to reduce more discretionary items. Dividends on common stock are discretionary and can be reduced or suspended as a method to maintain capital ratios.
Further, it does not appear that losses were realized in practice:
To summarize, this analysis looked at the largest financial institutions. It then isolated the impacts that critics have linked to capital destruction, namely the application of fair value to banks’ investment portfolios. The analysis shows that the impact on regulatory capital was quite small and does not appear to be large enough to be considered the driver of the pro-cyclical dynamic whereby declining asset prices lead to lower capital, then on to sales of assets to replenish capital, creating further pressure on prices and so on. In addition, there was no evidence found in reported financial data which would be indicative of distressed selling activity during the crisis period of 2008.
So if mark-to-market wasn’t the villain, what was?:
Based on further analysis of 2008 financial results, it was noted that loan loss provision had a significant impact on regulatory capital for most institutions in the sample.
An example is supplied:
At the height of the crisis, State Street stock fell 59 percent in one day when it was announced that unrealized losses had doubled, and analysts noted that TCE was approaching zero based on pro-forma calculations that added in the impact of consolidating certain off-balance sheet investment conduit programs.
The Simple TCE Ratio is calculated as STCE/tangible assets. Tangible assets = total assets – goodwill – intangible assets (excluding Mortgage Servicing Rights). It is not known how much emphasis was placed on TCE versus other significant factors that were also affecting bank stocks at the same time. That being said, State Street and BNYM are two possible examples in this analysis where fair value accounting may have contributed to bank instability based on the significant affect on TCE. It should be noted though that State Street and BNYM did not sell investment assets in response to capital depletion or market stress. They were able to rely on debt and equity issuances as well as participation in government capital programs. So although fair value may have contributed to some instability, the link between fair value and pro-cyclicality did not necessarily come to fruition here, at least partially due to government intervention.
The author concludes:
Based on this simple analysis it would appear that fair value accounting had a minimal impact on the capital of most banks in the sample during the crisis period through the end of 2008. Capital destruction was due to deterioration in loan portfolios and was further depleted by items such as proprietary trading losses and common stock dividends. These are a result of lending practices and the actions of bank management, not accounting rules. Furthermore, the data suggests that banks were not raising significant capital through distressed asset sales; rather they were relying on government programs as well as debt and equity markets.
This paper is of particular interest given the recent BoC Paper on Systemic Capital Requirements and its concern regarding the contagion effect of Asset Fire Sales.
A very nice piece by John Heinzl in today’s Globe: An Investor with a Preference for Preferreds.
Update: Finally got a heckler in the Globe’s comments section! An individual who was too ashamed to sign his name wrote:
There is a problem with the authors comment about firs loss protection. Pref Shares are equity from a balance sheet stand point, and the financial regulators treat them as such.
Pref Shares are equity investments with stated yield that must be paid before the common share dividend. THIS IS THE ONLY protection. It is not a bond, meaning the issuer does not have to make good on it to stay in business, nor do pref shareholders have any stake in the event of an insolvent company.
For reference, Please read p. 58 of Benjamin Graham’s book The Outstanding Investor. Or have a read at this study of preferred shares. http://www.pallas-athena.ca/Income_Investing_Preferred_Shares.html
Firstly, I don’t understand the author’s problem with my statement regarding first-loss protection. I was not referring to the balance sheet treatment specified by accountants or the regulatory treatment specified by Basel II – I was referring to the investment characteristic of first-loss protection.
I am not aware of any book authored by Benjamin Graham titled The Outstanding Investor and neither is Wikipedia. The commentator may possibly be referring to The Intelligent Investor; I commented on an extract from this book dealing with preferred shares in my early 2009 post, Benjamin Graham et al. on Preferred Stocks. Briefly, Mr. Graham was writing in another time, under a very different tax regime; I agree that under the conditions described, it would be highly unusual for an individual investor to find an attractively priced preferred share – but those conditions no longer apply.
The essay published on the Pallas Athena Investment Counsel website, titled Preferred Shares: A Tutorial again references page 58 of the mysterious book The Outstanding Investor and quotes an extract from it that appears to be a verbatim copy of part of the passage from The Intelligent Investor discussed briefly above.
To be brutally frank, I do not consider the Pallas Athena analysis to be worthy of much detailed comment. Their first example assumes:
the dividend increases by only 27% over the next 4 years to $2.54.
…
Therefore, $2.54 / 4% = $63.50. This is the price that the common shares should be worth at a 4% yield if the Royal Bank dividend on common shares will be $2.54 in 2013. A 27% dividend increase over the next four years is a very likely scenario; especially when we look at the past.
Given these assumptions, why would one ever invest in anything but Royal Bank common?
PA’s second example differs only in the starting price for the common.
This assumption is repeated in the third example. The preferred share used in the example is RY.PR.W at its lowest price, but the authors display their lack of familiarity with the preferred share market with the statement:
We will assume that we the shares are held until the end 2013, a few months prior to the scheduled $25.00 redemption in February 2014. For this reason, we’ll assume that the value of the Series W shares will be $25.00 at the end of 2013.
There is no “scheduled $25.00 redemption in February 2014”. That is when the shares become callable at par, which implies only a ceiling to the potential price, not a floor. This is, of course, favourable to the preferred share, but is inexcusable anyway. Naturally, the authors make the same assumptions about the future common as they do in the other examples (only the purchase price is different), leaving one to wonder yet again: why would anybody ever invest in anything but RY common if these assumptions are to be regarded as solid?
The authors conclude, in part:
The reality is that preferred shares are a tool for companies to increase their profits which is to the benefit of common shareholders or it is a tool for companies to solidify their balance sheet which is to the benefit of the lenders and bond holders.
Certainly, that’s as good a one-sentence explanation of the existence of preferred shares as any, but the authors neglect to inqure as to what price the company is prepared to pay for these benefits.
Preferred shares form a region on the continuum between debt and equity that will be attractive to many. That’s about the only general statement I can make!
I was not able to find composite performance numbers for Pallas-Athena Investment Counsel; if anybody has more luck, please let me know!
The fund performed well in January, outperforming the indices and the closed end funds by a most satisfactory margin.
The fund’s Net Asset Value per Unit as of the close January 29 was $10.7610.
| Returns to January 29, 2010 | |||
| Period | MAPF | Index | CPD according to Claymore |
| One Month | +1.84% | +0.61% | +% |
| Three Months | +7.27% | +5.05% | +% |
| One Year | +53.33% | +25.22% | +% |
| Two Years (annualized) | +26.80% | +3.87% | +% * |
| Three Years (annualized) | +17.39% | +0.71% | |
| Four Years (annualized) | +14.31% | +1.58% | |
| Five Years (annualized) | +12.55% | +1.96% | |
| Six Years (annualized) | +12.40% | +2.39% | |
| Seven Years (annualized) | +14.40% | +3.26% | |
| Eight Years (annualized) | +12.88% | +3.21% | |
| The Index is the BMO-CM “50” | |||
| MAPF returns assume reinvestment of dividends, and are shown after expenses but before fees. | |||
| CPD Returns are for the NAV and are after all fees and expenses. CPD returns to January 29, 2010, are not yet available on the Claymore website. | |||
| * CPD does not directly report its two-year returns. The figure shown is the product of the current one-year return and the similar figure reported for January 2009. | |||
| Figures for Omega Preferred Equity (which are after all fees and expenses) for 1-, 3- and 12-months are +0.8%, +4.7% and +23.3%, respectively, according to Morningstar after all fees & expenses | |||
| Figures for Jov Leon Frazer Preferred Equity Fund Class I Units (which are after all fees and expenses) for 1-, 3- and 12-months are +0.46%, +3.93 & N/A, respectively, according to Morningstar and the Globe and Mail | |||
| Figures for AIC Preferred Income Fund (which are after all fees and expenses) for 1-, 3- and 12-months are +-0.1%, +3.1% & N/A, respectively | |||
MAPF returns assume reinvestment of dividends, and are shown after expenses but before fees. Past performance is not a guarantee of future performance. You can lose money investing in Malachite Aggressive Preferred Fund or any other fund. For more information, see the fund’s main page.
I am very pleased with the returns over the past year, but implore Assiduous Readers not to project this level of outperformance for the indefinite future. The year in the preferred share market was filled with episodes of panic and euphoria, together with many new entrants who do not appear to know what they are doing; perfect conditions for a disciplined quantitative approach.
Sometimes everything works … sometimes the trading works, but sectoral shifts overwhelm the increment … sometimes nothing works. The fund seeks to earn incremental return by selling liquidity (that is, taking the other side of trades that other market participants are strongly motivated to execute), which can also be referred to as ‘trading noise’. There have been a lot of strongly motivated market participants in the past year, generating a lot of noise! The conditions of the past year may never be repeated in my lifetime … but the fund will simply attempt to make trades when swaps seem profitable, whether that implies monthly turnover of 10% or 100%.
There’s plenty of room for new money left in the fund. Just don’t expect the current level of outperformance every year, OK? While I will continue to exert utmost efforts to outperform, it should be borne in mind that beating the index by 500bp represents a good year, and there will almost inevitably be periods of underperformance in the future.
The yields available on high quality preferred shares remain elevated, which is reflected in the current estimate of sustainable income.
| Calculation of MAPF Sustainable Income Per Unit | ||||||
| Month | NAVPU | Portfolio Average YTW |
Leverage Divisor |
Securities Average YTW |
Capital Gains Multiplier |
Sustainable Income per current Unit |
| June, 2007 | 9.3114 | 5.16% | 1.03 | 5.01% | 1.1883 | 0.3926 |
| September | 9.1489 | 5.35% | 0.98 | 5.46% | 1.1883 | 0.4203 |
| December, 2007 | 9.0070 | 5.53% | 0.942 | 5.87% | 1.1883 | 0.4448 |
| March, 2008 | 8.8512 | 6.17% | 1.047 | 5.89% | 1.1883 | 0.4389 |
| June | 8.3419 | 6.034% | 0.952 | 6.338% | 1.1883 | $0.4449 |
| September | 8.1886 | 7.108% | 0.969 | 7.335% | 1.1883 | $0.5054 |
| December, 2008 | 8.0464 | 9.24% | 1.008 | 9.166% | 1.1883 | $0.6206 |
| March 2009 | $8.8317 | 8.60% | 0.995 | 8.802% | 1.1883 | $0.6423 |
| June | 10.9846 | 7.05% | 0.999 | 7.057% | 1.1883 | $0.6524 |
| September | 12.3462 | 6.03% | 0.998 | 6.042% | 1.1883 | $0.6278 |
| December 2009 | 10.5662 | 5.74% | 0.981 | 5.851% | 1.0000 | $0.6182 |
| January 2010 | 10.7610 | 5.81% | 1.001 | 5.804% | 1.0000 | $0.6246 |
| NAVPU is shown after quarterly distributions of dividend income and annual distribution of capital gains. Portfolio YTW includes cash (or margin borrowing), with an assumed interest rate of 0.00% The Leverage Divisor indicates the level of cash in the account: if the portfolio is 1% in cash, the Leverage Divisor will be 0.99 Securities YTW divides “Portfolio YTW” by the “Leverage Divisor” to show the average YTW on the securities held; this assumes that the cash is invested in (or raised from) all securities held, in proportion to their holdings. The Capital Gains Multiplier adjusts for the effects of Capital Gains Dividends. On 2009-12-31, there was a capital gains distribution of $1.989262 which is assumed for this purpose to have been reinvested at the final price of $10.5662. Thus, a holder of one unit pre-distribution would have held 1.1883 units post-distribution; the CG Multiplier reflects this to make the time-series comparable. Note that Dividend Distributions are not assumed to be reinvested. Sustainable Income is the resultant estimate of the fund’s dividend income per current unit, before fees and expenses. Note that a “current unit” includes reinvestment of prior capital gains; a unitholder would have had the calculated sustainable income with only, say, 0.9 units in the past which, with reinvestment of capital gains, would become 1.0 current units. |
||||||
As has been previously discussed, the fund has a position in the high-yielding split-share BNA.PR.C, about half of which was sold in November in a swap for the slightly lower-yielding PerpetualDiscount BAM.PR.N. Additionally, the fund has a position in the high-yielding Operating Retractible YPG.PR.B, about half of which was swapped into the lower-yielding YPG.PR.D in January. Both BNA.PR.C and YPG.PR.B are scheduled to mature (or to be retracted) in the future, hence the sustainability of sustainable yield calculated while incorporating their contribution is somewhat suspect, as discussed in August, 2008.
Significant positions were also held in Fixed-Reset issues on January 29; all of which currently have their yields calculated with the presumption that they will be called by the issuers at par at the first possible opportunity. This presents another complication in the calculation of sustainable yield.
However, if the entire portfolio except for the PerpetualDiscounts were to be sold and reinvested in these issues, the yield of the portfolio would be the 5.89% shown in the MAPF Portfolio Composition: January 2010 analysis(which is in excess of the 5.81% index yield on January 29). Given such reinvestment, the sustainable yield would be $10.7610 * 0.0589 = $0.6338 whereas a similar calculation for December results in $10.5662 * 0.0597 = $0.6308.
Different assumptions lead to different results from the calculation, but the overall positive trend is apparent. I’m very pleased with the results! It will be noted that if there was no trading in the portfolio, one would expect the sustainable yield to be constant (before fees and expenses). The success of the fund’s trading is showing up in
As has been noted, the fund has maintained a credit quality equal to or better than the index; outperformance is due to constant exploitation of trading anomalies.
Again, there are no predictions for the future! The fund will continue to trade between issues in an attempt to exploit market gaps in liquidity, in an effort to outperform the index and keep the sustainable income per unit – however calculated! – growing.
Paul Krugman writes an op-ed in the New York Times, Good and Boring, lauding the resilience of Canadian banks:
Canada has an independent Financial Consumer Agency, and it has sharply restricted subprime-type lending.
Above all, Canada’s experience seems to support those who say that the way to keep banking safe is to keep it boring — that is, to limit the extent to which banks can take on risk.
…
More specifically, Canada has been much stricter about limiting banks’ leverage, the extent to which they can rely on borrowed funds. It has also limited the process of securitization, in which banks package and resell claims on their loans outstanding — a process that was supposed to help banks reduce their risk by spreading it, but has turned out in practice to be a way for banks to make ever-bigger wagers with other people’s money.
…
Actually, the financial reform bill that the House of Representatives passed in December would significantly Canadianize the U.S. system. It would create an independent Consumer Financial Protection Agency, it would establish limits on leverage, and it would limit securitization by requiring that lenders hold on to some of their loans.
I suggest that Dr. Krugman has selected features of Canada’s system to further his domestic political arguments. The IMF has published suggestions that a critical factor is the stable deposit base of Canadian banks – which, I believe, is related to their national scope and oligopolistic position. Another major factor has been the banks’ control over the mortgage market – limited competition (no GSE’s here in Canada!) has allowed them to extract rents from hapless Canadian mortgagees, leaving much less necessity of reaching for yield. The sole Canadian bank that did fail during the crisis, Dundee Bank, failed because its lack of mortgage distribution channels encouraged it to go out on a limb provided by ABCP.
Paul Volcker testified to the Senate banking committee today:
Given strong legislative direction, bank supervisors should be able to appraise the nature of those trading activities and contain excesses. An analysis of volume relative to customer relationships and of the relative volatility of gains and losses would go a long way toward informing such judgments. For instance, patterns of exceptionally large gains and losses over a period of time in the “trading book” should raise an examiner’s eyebrows. Persisting over time, the result should be not just raised eyebrows but substantially raised capital requirements.
This is much more in line with my thinking than a flat prohibition, which will be subject to interpretation.
More generally, proprietary trading activity should not be able to profit from knowledge of customer trades.
That’s what the SEC’s supposed to be worrying about.
Mr. Volcker also noted that he had attached an essay to his official testimony, but I can’t find it!
A relatively directionless day for Canadian preferred shares, with PerpetualDiscounts losing 5bp and FixedResets gaining 1bp on moderate volume.
| 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 | 3.13 % | 3.83 % | 28,844 | 20.03 | 1 | 2.0869 % | 1,766.8 |
| FixedFloater | 5.62 % | 3.69 % | 35,458 | 19.36 | 1 | 0.5714 % | 2,814.6 |
| Floater | 2.10 % | 1.76 % | 39,883 | 23.13 | 4 | 0.6847 % | 2,189.2 |
| OpRet | 4.84 % | -4.75 % | 105,842 | 0.09 | 13 | 0.0797 % | 2,322.0 |
| SplitShare | 6.34 % | 3.81 % | 146,621 | 0.08 | 2 | -0.3917 % | 2,120.4 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.0797 % | 2,123.3 |
| Perpetual-Premium | 5.74 % | 5.57 % | 74,172 | 2.21 | 7 | 0.0564 % | 1,892.1 |
| Perpetual-Discount | 5.79 % | 5.82 % | 170,031 | 14.16 | 69 | -0.0541 % | 1,822.4 |
| FixedReset | 5.43 % | 3.63 % | 317,616 | 3.80 | 42 | 0.0122 % | 2,178.2 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| BMO.PR.H | Perpetual-Discount | -1.27 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-02 Maturity Price : 22.59 Evaluated at bid price : 23.28 Bid-YTW : 5.67 % |
| CIU.PR.A | Perpetual-Discount | -1.27 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-02 Maturity Price : 20.99 Evaluated at bid price : 20.99 Bid-YTW : 5.58 % |
| RY.PR.A | Perpetual-Discount | -1.04 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-02 Maturity Price : 20.02 Evaluated at bid price : 20.02 Bid-YTW : 5.57 % |
| TRI.PR.B | Floater | 1.15 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-02 Maturity Price : 21.82 Evaluated at bid price : 22.06 Bid-YTW : 1.76 % |
| BAM.PR.B | Floater | 1.29 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-02 Maturity Price : 15.70 Evaluated at bid price : 15.70 Bid-YTW : 2.52 % |
| BAM.PR.E | Ratchet | 2.09 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-02 Maturity Price : 25.00 Evaluated at bid price : 18.10 Bid-YTW : 3.83 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| GWO.PR.E | OpRet | 199,230 | Nesbitt crossed blocks of 170,000 and 25,000 shares, both at 25.61. YTW SCENARIO Maturity Type : Call Maturity Date : 2010-04-30 Maturity Price : 25.25 Evaluated at bid price : 25.65 Bid-YTW : -0.21 % |
| PWF.PR.I | Perpetual-Discount | 113,800 | RBC crossed 60,100 at 24.93, then Desjardins crossed 50,000 at 24.95. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-02 Maturity Price : 24.51 Evaluated at bid price : 24.85 Bid-YTW : 6.07 % |
| RY.PR.A | Perpetual-Discount | 61,901 | Nesbitt crossed 34,000 at 20.24. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-02 Maturity Price : 20.02 Evaluated at bid price : 20.02 Bid-YTW : 5.57 % |
| RY.PR.T | FixedReset | 49,200 | RBC crossed 18,000 at 27.70. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-09-23 Maturity Price : 25.00 Evaluated at bid price : 27.71 Bid-YTW : 3.64 % |
| PWF.PR.H | Perpetual-Discount | 48,514 | Nesbitt crossed 25,000 at 24.10 and bought 22,100 from Desjardins at the same price. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-02 Maturity Price : 23.77 Evaluated at bid price : 24.07 Bid-YTW : 6.00 % |
| TRP.PR.A | FixedReset | 33,352 | Nesbitt crossed 17,000 at 26.02. YTW SCENARIO Maturity Type : Call Maturity Date : 2015-01-30 Maturity Price : 25.00 Evaluated at bid price : 26.02 Bid-YTW : 3.79 % |
| There were 35 other index-included issues trading in excess of 10,000 shares. | |||
Turnover stayed constant in January at about 40%. This is yet another indication that things are slowly returning to normal – although I still think that spreads to bonds are elevated!
Trades were, as ever, triggered by a desire to exploit transient mispricing in the preferred share market (which may the thought of as “selling liquidity”), rather than any particular view being taken on market direction, sectoral performance or credit anticipation.
| MAPF Sectoral Analysis 2010-1-29 | |||
| HIMI Indices Sector | Weighting | YTW | ModDur |
| Ratchet | 0% | N/A | N/A |
| FixFloat | 0% | N/A | N/A |
| Floater | 0% | N/A | N/A |
| OpRet | 0% | N/A | N/A |
| SplitShare | 4.2% (0) | 8.09% | 6.99 |
| Interest Rearing | 0% | N/A | N/A |
| PerpetualPremium | 0.0% (-0.5) | N/A | N/A |
| PerpetualDiscount | 76.7% (+4.0) | 5.89% | 14.07 |
| Fixed-Reset | 14.4% (-2.2) | 3.83% | 3.88 |
| Scraps (OpRet) | 2.4% (-2.2) | 9.64% | 5.85 |
| Scraps (FixedReset) | 2.5% (+2.5) | 7.22% | 12.03 |
| Cash | -0.1% (-2.0) | 0.00% | 0.00 |
| Total | 100% | 5.81% | 12.08 |
| Totals and changes will not add precisely due to rounding. Bracketted figures represent change from December month-end. Cash is included in totals with duration and yield both equal to zero. | |||
The “total” reflects the un-leveraged total portfolio (i.e., cash is included in the portfolio calculations and is deemed to have a duration and yield of 0.00.). MAPF will often have relatively large cash balances, both credit and debit, to facilitate trading. Figures presented in the table have been rounded to the indicated precision.
Credit distribution is:
| MAPF Credit Analysis 2010-1-29 | |
| DBRS Rating | Weighting |
| Pfd-1 | 0 (0) |
| Pfd-1(low) | 75.7% (-6.8) |
| Pfd-2(high) | 9.8% (+9.7) |
| Pfd-2 | 0 (-1.1) |
| Pfd-2(low) | 9.8% (+0.1) |
| Pfd-3(high) | 4.9% (+0.3) |
| Cash | -0.1% (-2.0) |
| Totals will not add precisely due to rounding. Bracketted figures represent change from December month-end. | |
The increase in holdings of issues rated Pfd-2(high) was due largely to the purchase of HSB.PR.E, a reversal of last month’s highlighted trading.:
| MAPF & HSB.PR.E & RY.PR.X | |||||
| Date | HSB.PR.E | RY.PR.X | |||
| 12/23 | Sold 28.05 |
Bot 27.95 |
|||
| 12/31 Bid |
28.10 | 28.06 | |||
| 1/14 | Bot 28.02 |
Sold 28.23 |
|||
| 1/29 Bid |
27.96 | 27.75 | |||
| Dividends | 1/22 Missed 0.390625 |
||||
| This table attempts to present fairly the larger elements of a series of trades. Full disclosure of the 1H10 trades will be made at the time the unaudited 1H10 Financials are published. | |||||
Liquidity Distribution is:
| MAPF Liquidity Analysis 2010-1-29 | |
| Average Daily Trading | Weighting |
| <$50,000 | 0.0% (0) |
| $50,000 – $100,000 | 0.0% (0) |
| $100,000 – $200,000 | 26.6% (+7.7) |
| $200,000 – $300,000 | 31.0% (-14.1) |
| >$300,000 | 42.5% (+8.5) |
| Cash | -0.1% (-2.0) |
| Totals will not add precisely due to rounding. Bracketted figures represent change from December month-end. | |
MAPF is, of course, Malachite Aggressive Preferred Fund, a “unit trust” managed by Hymas Investment Management Inc. Further information and links to performance, audited financials and subscription information are available the fund’s web page. A “unit trust” is like a regular mutual fund, but is sold by offering memorandum rather than prospectus. This is cheaper, but means subscription is restricted to “accredited investors” (as defined by the Ontario Securities Commission) and those who subscribe for $150,000+. Fund past performances are not a guarantee of future performance. You can lose money investing in MAPF or any other fund.
A similar portfolio composition analysis has been performed on the Claymore Preferred Share ETF (symbol CPD) as of August 17 and published in the September PrefLetter. When comparing CPD and MAPF:
Performance of the HIMIPref™ Indices for January, 2010, was:
| Total Return | ||
| Index | Performance January 2010 |
Three Months to January 29, 2010 |
| Ratchet | +6.60%* | +17.61%* |
| FixFloat | +2.65% | +17.96% |
| Floater | +6.60% | +17.61% |
| OpRet | -0.63% | +1.30% |
| SplitShare | +1.02% | +2.51% |
| Interest | -0.63%**** | +1.30%**** |
| PerpetualPremium | -0.17% | +1.89% |
| PerpetualDiscount | +1.19% | +5.49% |
| FixedReset | 0.00% | +3.32% |
| * The last member of the RatchetRate index was transferred to Scraps at the February, 2009, rebalancing; subsequent performance figures are set equal to the Floater index | ||
| **** The last member of the InterestBearing index was transferred to Scraps at the June, 2009, rebalancing; subsequent performance figures are set equal to the OperatingRetractible index | ||
| Passive Funds (see below for calculations) | ||
| CPD | -0.53% | +3.66% |
| DPS.UN | +1.39% | +6.38% |
| Index | ||
| BMO-CM 50 | +0.61% | +5.05% |
| TXPR Total Return | -0.29% | +4.03% |
The pre-tax interest equivalent spread of PerpetualDiscounts over Long Corporates (which I also refer to as the Seniority Spread) closed the year at 220bp, a slight tightening from the 225bp at November month-end.
The relative returns on Floaters over the past year continues to impress:
But one must remember how they got there:
FixedReset volume ticked up mid-month with the burst of issuance, but has resumed its downward trend. Volume may be under-reported due to the influence of Alternative Trading Systems (as discussed in the November PrefLetter), but I am biding my time before incorporating ATS volumes into the calculations, to see if the effect is transient or not. The average volume of FixedResets continues to decline, which may be due to a number of factors:
And the yield-to-worst on FixedResets seems to have found a bottom:
As discussed last month, the impressive returns of the past year cannot continue indefinately. The long term return on a fixed income instrument is its yield – 5.8% for a PerpetualDiscount, and about 3.6% to the call date for a FixedReset.
Compositions of the passive funds were discussed in the September edition of PrefLetter.
Claymore has published NAV and distribution data (problems with the page in IE8 can be kludged by using compatibility view) for its exchange traded fund (CPD) and I have derived the following table:
| CPD Return, 1- & 3-month, to January 29, 2010 | ||||
| Date | NAV | Distribution | Return for Sub-Period | Monthly Return |
| October 30 | 16.41 | |||
| November 30, 2009 | 16.77 | +2.19% | ||
| December 24 | 16.76 | 0.21 | +1.19% | +1.98% |
| December 31, 2009 | 16.89 | 0.00 | +0.78% | |
| January 29, 2010 | 16.80 | -0.53% | ||
| Quarterly Return | +3.66% | |||
It is of interest to note that the January total return for CPD’s benchmark, TXPR, was -0.29% and the trailing three-month return was +4.03%; tracking error is therefore -0.24% and -0.37%, of which about 0.04% and 0.11%, respectively, is MER. Their efforts at rebalancing cost unitholders a lot of money! The MER may be only 45bp, but the first 2010 semiannual rebalancing alone cost about 20bp.
Claymore currently holds $397,666,518 (advisor & common combined) in CPD assets, up about $26-million from the $373,729,364 reported last month.
The DPS.UN NAV for December 30 has been published so we may calculate the approximate December returns.
| DPS.UN NAV Return, January-ish 2010 | ||||
| Date | NAV | Distribution | Return for sub-period | Return for period |
| December 30, 2009 | 19.91 | |||
| January 27, 2009 | 20.26 | +1.76% | ||
| Estimated December Ending Stub | -0.36% * | |||
| Estimated January Ending Stub | +0.00% ** | |||
| Estimated January Return | +1.39% *** | |||
| *CPD had a NAVPU of 16.89 on December 31 and 16.83 on December 30, hence the total return for the period for CPD was +0.36%. The return for DPS.UN in this period is presumed to be equal. | ||||
| **CPD had a NAVPU of 16.80 on January 27 and 16.80 on January 29, hence the total return for the period for CPD was 0.00%. The return for DPS.UN in this period is presumed to be equal. | ||||
| *** The estimated December return for DPS.UN’s NAV is therefore the product of three period returns, +1.76%, -0.36% and 0.00% to arrive at an estimate for the calendar month of +1.39% | ||||
Now, to see the DPS.UN quarterly NAV approximate return, we refer to the calculations for November and December:
| DPS.UN NAV Returns, three-month-ish to end-January-ish, 2010 | |
| November-ish | +3.09% |
| December-ish | +1.78% |
| January-ish | +1.39% |
| Three-months-ish | +6.38% |
Comrade Peace-Prize wants to make the Build America programme permanent:
Obama will propose expanding the eligibility of the bonds to include original financing for capital projects when he submits his 2011 budget to Congress tomorrow, according to the official, who requested anonymity.
Under the Build America program, part of the economic stimulus package Obama signed into law last February, the federal government provides a 35 percent rebate on issuers’ interest costs. That would go down to 28 percent under the proposal in the president’s budget, according to a Treasury Department official who spoke on condition of anonymity.
…
Build America Bonds “were successful in helping to repair a severely damaged municipal finance market, making much needed credit available at lower borrowing costs for infrastructure projects that create jobs,” Treasury Secretary Timothy Geithner said in an e-mailed statement released by his office. “By making Build America Bonds a permanent and expanded financing tool for state and local governments, we’re investing in our country’s long term economic growth in a cost-effective way.”
The ever-opportunistic CC&L group is establishing a mutual fund that will invest in these securities:
As at December 14, 2009, securities in the Indicative Portfolio had a weighted average Investment Grade credit rating of ‘‘AA’’
by S&P (or equivalent) and average Effective Duration of 11.1 years.
…
The Fund will have a term of approximately five years, terminating on or about February , 2015, and the Fund’s investments will be liquidated prior to such termination at the then prevailing market prices.
…
‘‘Effective Duration’’ is a measure of the estimated percentage change in price for a 100 basis point change in interest rates and takes into consideration changes in cash flows and values that can occur in bonds with embedded options such as call and put provisions.
“Yep”, says Granny Oakum, “I’m going to invest in long bonds, but it’s safe because the find winds up in five years!”
What I consider fascinating about the whole thing is the indication that municipalities’ financing needs can no longer be met in the US domestic tax-exempt market. Sic transit gloria mundi.
However, there is still a place for derivatives:
Investment bankers in the US have begun using equity derivatives to convert restricted shares paid as bonuses into cash, side-stepping new guidelines on remuneration which were designed to prevent bankers cashing out for at least three years, according to a headhunter.
The bankers are using over-the-counter equity derivatives strategies such as call options, put options and collars to monetise their shares now, albeit at a discount to what they would receive if they waited for the restrictions to lift.
Politicians reaffirmed their total committment to the idea that bank managers should embrace long-term thinking:
“We have to show short-term results,” French Finance Minister Christine Lagarde said in an interview at the conference shortly after chairing a private meeting between bankers, politicians and regulators.
U.K. Chancellor of the Exchequer Alistair Darling, White House economic adviser Lawrence Summers and U.S. House Financial Services Committee Chairman Barney Frank, who were all in Davos, also expressed frustration.
“We simply don’t have years to sort the problem out,” Darling told reporters in Davos on Jan. 29. “There needs to be a sense of urgency.”
Quck! How many years did it take to negotiate Basel II?:
However, despite its contributions, the [Basel I] accord was quickly perceived to be inadequate and since the early 1990s there began an on-going process of updating and reforming the accord to match changing realities in the world of banking, and the preferences and concerns of major players in the system. A series of adjustments were made to the accord in the early to mid-nineties before the inevitable realisation set in that a replacement accord was needed rather than piecemeal reform. In June 1999 the Basel Committee announced that it would begin negotiations on a new capital accord to replace the 1988 agreement.
…
Of particular interest in this story is the continued dominance of the United States over European regulatory authorities. At several moments in the discussions the US has presented its European counterparts with a fait accompli in the content of the new accord, and has been willing only to discuss changes to the wording, not substance. Most damning, in spring 2003 after having gained most of the concessions it sought from fellow Basel members, the US announced that it would likely apply the accord to only a handful of banks, thus greatly weakening the potential impact of the accord and calling into question its validity.
My favourite corporate spokesman – ever – is Goldman Sachs’ Lucas Van Praag.
Not the greatest of days for the Canadian preferred share market, as PerpetualDiscounts lost 17bp while FixedResets gaoing 2bp, on moderate volume.
| 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 | 3.19 % | 3.94 % | 27,516 | 19.91 | 1 | -0.1689 % | 1,730.7 |
| FixedFloater | 5.65 % | 3.74 % | 35,267 | 19.34 | 1 | -0.3623 % | 2,798.6 |
| Floater | 2.11 % | 1.78 % | 41,251 | 23.06 | 4 | 0.3908 % | 2,174.3 |
| OpRet | 4.84 % | -3.49 % | 109,610 | 0.09 | 13 | 0.0472 % | 2,320.2 |
| SplitShare | 6.31 % | 1.24 % | 146,727 | 0.08 | 2 | 0.4152 % | 2,128.7 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.0472 % | 2,121.6 |
| Perpetual-Premium | 5.75 % | 5.56 % | 74,631 | 2.21 | 7 | 0.1639 % | 1,891.0 |
| Perpetual-Discount | 5.78 % | 5.81 % | 175,710 | 14.17 | 69 | -0.1734 % | 1,823.4 |
| FixedReset | 5.43 % | 3.62 % | 318,733 | 3.81 | 42 | 0.0175 % | 2,177.9 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| HSB.PR.C | Perpetual-Discount | -1.47 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-01 Maturity Price : 22.60 Evaluated at bid price : 22.78 Bid-YTW : 5.66 % |
| RY.PR.D | Perpetual-Discount | -1.02 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-01 Maturity Price : 20.39 Evaluated at bid price : 20.39 Bid-YTW : 5.53 % |
| TD.PR.P | Perpetual-Discount | -1.01 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-01 Maturity Price : 23.42 Evaluated at bid price : 23.61 Bid-YTW : 5.59 % |
| BNA.PR.C | SplitShare | 1.03 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2019-01-10 Maturity Price : 25.00 Evaluated at bid price : 19.55 Bid-YTW : 7.95 % |
| CIU.PR.A | Perpetual-Discount | 1.19 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-01 Maturity Price : 21.26 Evaluated at bid price : 21.26 Bid-YTW : 5.51 % |
| BAM.PR.K | Floater | 1.27 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-01 Maturity Price : 15.18 Evaluated at bid price : 15.18 Bid-YTW : 2.61 % |
| BAM.PR.B | Floater | 1.97 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-01 Maturity Price : 15.50 Evaluated at bid price : 15.50 Bid-YTW : 2.55 % |
| IAG.PR.C | FixedReset | 1.99 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2014-01-30 Maturity Price : 25.00 Evaluated at bid price : 27.19 Bid-YTW : 3.95 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| PWF.PR.J | OpRet | 303,035 | RBC crossed 244,600 at 26.08. TD crossed 50,000 at the same price. YTW SCENARIO Maturity Type : Call Maturity Date : 2010-03-03 Maturity Price : 25.75 Evaluated at bid price : 25.91 Bid-YTW : -2.96 % |
| MFC.PR.D | FixedReset | 131,789 | RBC crossed two blocks of 25,000 at 28.09 and 28.10, followed by 49,000 at 28.15. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-07-19 Maturity Price : 25.00 Evaluated at bid price : 28.06 Bid-YTW : 3.83 % |
| TD.PR.M | OpRet | 79,800 | Desjardins crossed 75,000 at 26.25. YTW SCENARIO Maturity Type : Call Maturity Date : 2010-03-03 Maturity Price : 26.00 Evaluated at bid price : 26.25 Bid-YTW : -7.01 % |
| SLF.PR.D | Perpetual-Discount | 57,951 | RBC crossed two blocks of 23,200 at 19.29 and 19.30. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-01 Maturity Price : 19.20 Evaluated at bid price : 19.20 Bid-YTW : 5.87 % |
| TRP.PR.A | FixedReset | 35,154 | YTW SCENARIO Maturity Type : Call Maturity Date : 2015-01-30 Maturity Price : 25.00 Evaluated at bid price : 26.00 Bid-YTW : 3.81 % |
| HSB.PR.E | FixedReset | 32,613 | RBC crossed 25,000 at 28.00. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-07-30 Maturity Price : 25.00 Evaluated at bid price : 28.00 Bid-YTW : 3.87 % |
| There were 29 other index-included issues trading in excess of 10,000 shares. | |||
Fairfax Financial Holdings has announced that it:
has completed its previously announced public offering of Cumulative 5-Year Rate Reset Preferred Shares, Series E in Canada. Fairfax issued 8 million Series E Preferred Shares for net proceeds, after commissions and expenses, of approximately $194 million.
The Series E Preferred Shares were sold through a syndicate of Canadian underwriters led by BMO Capital Markets that included CIBC World Markets, RBC Capital Markets, Scotia Capital, TD Securities, National Bank Financial, GMP Securities, Cormark Securities, Desjardins Securities and HSBC Securities.
The issue suffered through a rather poor first day, trading 117,310 shares in a range of 24.00-50 before closing at 24.10-19, 5×14. I suspect a good chunk is still on the underwriters’ books.
Vital Statistics are:
| FFH.PR.E | FixedReset | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2040-02-01 Maturity Price : 24.06 Evaluated at bid price : 24.10 Bid-YTW : 4.75 % |
The FixedReset 4.75%+216 issue was announced January 21. FFH.PR.E is tracked by HIMIPref™, but is relegated to the Scraps subindex on credit concerns.
XMF.PR.A Approves Reorganization
Wednesday, February 3rd, 2010M-Split Corp. has announced:
I had previously recommended against the reorganization, but does anybody every listen to me? I believe the preferred shareholders have given up a perfectly good, well secured fixed income investment for more speculative securities; they would have been better off reallocating their holdings to the “bond” part of their portfolio and buying better preferreds … but that isn’t what happened.
XMF.PR.A is not tracked by HIMIPref™.
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