PrefBlog

Fabulous Fab, the bond salesman scapegoated for personally causing the Panic of 2007, and useful misdirection from the SEC’s incompetence, has claimed the SEC has no jurisdiction anyway:

The Securities and Exchange Commission can’t sue Fabrice Tourre over a Goldman Sachs Group Inc. deal involving collateralized debt obligations because the transaction wasn’t in the U.S., his lawyers told a judge.

The U.S. Supreme Court ruled in June that U.S. securities laws don’t apply to claims of foreign buyers of non-U.S. securities on foreign exchanges, lawyers for the Goldman executive director said in a court filing yesterday. The collateralized debt obligations known as Abacus at issue in the SEC’s complaint weren’t listed on any exchange and the sole investor in the notes was a foreign bank that purchased them overseas, according to the filing.

Another junk fund is starting:

Brompton Advantaged Tactical Yield Fund is an investment fund established under the laws of the Province of Ontario and governed by the Declaration of Trust. See “Overview of the Legal Structure of the Fund”.

Rationale The Fund has been created to provide investors with the opportunity to gain exposure to a diversified Portfolio focused on North American High-Yield Bond and Dividend Paying Equity securities, which offer attractive yields along with upside participation in the ongoing economic recovery. The Portfolio Manager expects that the Portfolio will initially be invested as to approximately 70% in High-Yield Bonds, 20% in Dividend Paying Equity securities, and 10% in Investment Grade Bonds.

This comes after the launch of the nonsensical iShares(R) DEX HYBrid Bond Index Fund, which has nothing to do with hybrid bonds, as the term is understood by the entire world except for the TMX and Blackrock’s marketting team. They just needed a word with HY in it (for High Yield, since “junk” is considered pejoritive) and didn’t want to use “HYacinth” … or “HYundai” … or … um … er … “HYmas” (licencing fees on that one would have been astronomical).

And, of course, all the junk coming out of new preferred issues. This is going to end badly.

Mixed results in the Canadian preferred share market on continued heavy volume, as PerpetualDiscounts were almost precisely flat on the day while FixedResets continued their recent slide by losing 16bp.

PerpetualDiscounts now yield 5.53%, equivalent to 7.74% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.15%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 260bp, a meaningless apparent tightening from the 265bp reported September 29.

Long corporates have been on a tear this month:

Click for big

And that’s a wrap for another month and another quarter!

Germany will make its final Great War reparations payment on the weekend:

West Germany, formed after defeat in 1945, took on responsibility for most of the outstanding principle and interest, settling the bill in 1983.

But there was a clause in the so-called London Debt Agreement of 1953 that interest on multi-million pound foreign loans taken out in the Weimar Republic era, to pay off the reparations bill, should themselves be repaid if Germany were ever reunited.

Payments on this interest began again in 1996.

‘On Sunday the last bill is due and the First World War finally, financially at least, terminates for Germany,’ said Bild, the country’s biggest selling newspaper.

Most of the money goes to private individuals, pension funds and corporations holding debenture bonds as agreed under the Treaty of Versailles.

The German government did not reveal how the money will be disbursed but it is understood that it is transferred to a holding account before being sent to the relevant bond and debt holders.
Most of these are American and French.

The Ontario prostitution ruling is on-line. The judge’s opinion of the experts (paras 352-358) is hiliarious.

The Canadian preferred share market slid again today, with PerpetualDiscounts losing 10bp and FixedResets down 11bp. After the redemption of CM.PR.R and CM.PR.A was announced, I wondered what would happen to TD.PR.M and TD.PR.N. Well … they’re both on the unpleasant side of the performance highlights table, but nothing too terrible has happened … yet.

PerpetualDiscounts now yield 5.54%, equivalent to 7.76% interest at the standard equivalency factor of 1.4x. Long corporates now yield about 5.1% (!) so the pre-tax interest-equivalent spread (also called the Seniority Spread) now stands at about 265bp, a sharp increase from the 245bp reported September 22, as long corporate yields have plummetted about 20bp while PerpetualDiscount yields are unchanged.

John Hempton of Bronte Capital is keeping the Universal Travel Group pot boiling:

The only communication I have had from Universal Travel Group was a kind email from the acting Chief Financial Officer saying that I needed to provide proof that I was a shareholder to participate in the conference call that they are having on Wednesday, September 29, 2010, to discuss and answer any questions investors may have regarding the Company’s business and financial statements.

I have some questions and I forwarded them in advance to the company as requested.

The purpose of this post is to put the questions on the record in the hope that they are answered and not to entertain my regular readers.

The Fed’s Shared National Credit Review was positive:

Reasons for improvement included improved borrower operating performance, debt restructurings and bankruptcy resolutions, and improved borrower access to bond and equity markets. Industries contributing to improvement in credit quality included automotive, materials and commodities, and finance and insurance. The volume of poorly underwritten credits originated in 2006 and 2007 continued to adversely affect the overall credit quality of the portfolio. Refinancing risk within the portfolio is significant, with nearly 67 percent of criticized assets maturing between 2012 and 2014

I see that the prostitution laws have been struck down, which is a very good thing (unless, of course, you believe that morality can be legistlated). In an amazingly intelligent remark, the judge said:

Judge Himel also said that pimps who threaten or commit violence against prostitutes can still be prosecuted using other sections of the Criminal Code.

When defenders of the faith law wring their hands about human trafficking (it used to be called white slavery), they never explain why such actions don’t fall under the heading of extortion.

However, Judge Himel gave the Crown a 30-day window in which to make arguments against legalizing bawdy houses on account of a concern that “unlicenced brothels may be operated in a way that may not be in the public interest.”

You want to see a bawdy house? Go peek at any of the downtown hotels.

“Any time you are alone with a john, it is dangerous,” federal Crown Michael Morris told Judge Himel. “There is no safe haven when you are involved in prostitution. There is overwhelming evidence that johns can become violent at any moment.”

However, Mr. Young countered that prohibiting communication renders prostitutes unable to “screen” potential clients, hire security or move behind the relative safety of closed doors.

I supposed that somewhere in Canada there is someone who thought Morris’ argument was the killer line, and whose faith in justice would have been shaken if the lawyers had not dutifully plodded through it and its obvious refutation … but it horrifies me to learn I’m paying for the Crown to spout such nonsense, and for the court reporter to write it down, and for courtroom rental while the argument is made, and for the judge to listen to it and note it in her ruling… That’s what’s wrong with the justice system: its being smothered in trivia. Used to be that a murder trial took two days – now it might take two years and I’m not convinced the justice dispensed is commensuraly more just.

The Canadian preferred share market slid again today, with PerpetualDiscounts losing 17bp and FixedResets down 31bp – the median wieghted average yield to worst on the latter index is back up to 3.09%.

Nothing has happened since Friday.

Oh, well, I might as well mention Universal Travel Group, a story brought to my attention by the Divestor. It was savaged by John Hempton of Bronte Capital in a September 15 post … Mr. Hempton makes some very interesting points, which should be trivially easy to refute by a clean company:

It is pretty clear from this analysis that the main reason for owning the stock of Universal Travel Group is dubious. The online booking engine is dysfunctional – and the massive margins that it claims (84 percent for plane tickets) are thus also dubious.

All the profits that the company claimed it made out of the travel booking business (by far the bulk of its claimed profits) are similarly dubious – though there is a real travel company which might be making some profits.

The company claims in its most recent quarterly balance sheet to be carrying 43 million in cash and accounts receivable of almost 20 million. If the airline and hotel business are dubious then the profits generated that cash are dubious. In that case the cash itself is dubious.

I know people will buy this as Ben Graham net-net stock if it collapses. Unless this company can get a big four audit firm to sign-off for them I think you can – at least for the moment question the entire balance sheet.

What makes it interesting is the weakness of the response. On the day the blog post appeared, they issued a press release:

Universal Travel Group (NYSE: UTA) (“Universal Travel Group” or the “Company”), a leading travel services provider in China, today responded to allegations that appeared in the online blog by Bronte Capital. Universal Travel categorically denies all the allegations contained in the blog. The Company is consulting with its legal counsel as to the legal options available to it and will be aggressively pursuing all legal remedies against Bronte Capital and John Hempton for the damages caused to the Company and its shareholders.

“Categorically denies all the allegations”, eh? Very nice. Where’s the detail? Maybe there will be something in the conference call:

Universal Travel Group (NYSE: UTA) (“Universal Travel Group” or the “Company”), a leading travel services provider in China, today announced that it will hold a conference call at 9:00 a.m. ET on Wednesday, September 29, 2010, to discuss and answer any questions investors may have regarding the Company’s business and financial statements.
…
To participate in the call, please dial (877) 779-7834 five minutes prior to the 9:00 a.m. start time and reference conference ID number 12534724. International callers should dial +1 (706) 902-2087.

A replay of the call will be available for 14 days beginning Wednesday, September 29, 2010, at 10:00 a.m. Eastern Time. To listen to the replay, dial (800) 642-1687 and enter the conference ID number 12534724. International callers should dial +1 (706) 645-9291. An audio recording will also be available on the Company’s website at http://us.cnutg.com .
…
The Company’s headquarters and main base of operations is in Shenzhen in the Pearl River Delta region of China. More recently, Universal Travel Group has expanded its business into Western China, opening a second home base in the Chongqing Delta region, and other attractive, under-penetrated tier-two travel markets throughout the country.

C”mon, now! Shenzhen is not exactly the end of the earth any more. It’s basically next door to Hong Kong. And they couldn’t even get one western business reporter to walk around their headquarters and meet some of their “more than 200 professional staff”? Even Enron managed a better Potemkin village than that!

What gets me, though, is the complete lack of analysis I’ve been able to find. It has been over a week since the post appeared – and the stock took a big hit – but representative analysis is:

Universal Travel (NYSE: UTA): This is the latest casualty of a short attack based on rumor in innuendo this week. The free fall was precipitated by a professional short seller- John Hempton of Bronte Capital wrote a scathing “expose” wherein he demonstrated the company’s web sites didn’t provide him with Western style online travel services. He concluded the company is nothing but a phone in travel service, and claimed their numbers must be fraudulent based on their labor overhead vs their revenues. Conveniently, Hempton is located in Australia, and therefore enjoys a level of insulation from both civil law suit and SEC investigation.

There’s a few more examples of companies falling victim to either their own self induced foibles or fabricated attacks from those standing to gain. It’s the perfect storm for the short sellers to have their way with the public- the market environment is one in which investors will sell first to preserve capital, and find out the truth later. This group of short sellers is extremely well organized and knows how to work the media to their benefit.

Not a single point is addressed other than the condescending (and puzzling, considering their bias) sneer that we can’t judge Chinese web design by western standards. Just an ad hominem attack on short-sellers and vagueness.

I take no view on this stock. Before I took a view I would get my guy in Hong Kong to go across the border for an afternoon and knock on their door, among many other things. But the weakness of the management response is … interesting.

Wonder of wonders, the Canadian preferred share market actually fell today, with PerpetualDiscounts down 18bp and FixedResets losing 27bp – taking the median weighted-average yield of the latter back up to 3.00%. Volume continued to be heavy.

I speculated in the post Alpha Trading Systems to Offer Dark Pegged Orders:

I do not profess to be an expert on ATS marketting practices, but this appears to be an attempt by Alpha Group to forestall the creation of internal dark pools by its members (or pool the cost of such systems; Alpha is owned by the major dealers) by offering a sub-pennying mechanism in a manner that is smoothly integrated with extant trading systems.

The Alpha / TMX competition has now attracted some press notice and I am pleased to see that CIBC agrees:

We believe that, as described, the facility will operate more as a third party internalization engine rather than a proper dark pool, and do not have any concerns around this. We believe that the internalization activity enabled by this facility is common practice today, and that Alpha is simply commoditizing technology to offer dealers an alternative to building and operating their own costly internalization systems.

The TMX opposes sub-pennying:

To reiterate our position as outlined in TMX Group’s submission in response to CSA Consultation Paper 23-404, we believe that any dark trading, including internalizing features and practices, whether through a marketplace such as Alpha’s proposed facility, or through a dealer’s own systems, must provide meaningful price improvement over the displayed national best bid or offer (NBBO). It is critical that regulation encourages and supports the continued integrity and value of the visible market and price formation process by providing an incentive for the public display of liquidity. This requires internalized and non-displayed trading to provide meaningful price improvement over the displayed NBBO. Sub-penny price improvement is not adequate improvement to justify the yielding of priority of a previously posted visible quote. A minimum full cent price improvement is meaningful and should be required and enforced by regulators.

Other comments have been published.

Global hysteria over derivatives may engulf European property funds:

Europe’s commercial real estate owners, saddled with 1.9 trillion euros ($2.5 trillion) of debt, may be forced to make billions of euros in cash payments under planned laws that would treat them like hedge funds.

Property fund managers could face demands for cash collateral to cover bets on interest-rate movements, under European Commission proposals to regulate the derivatives industry. Interest-rate swaps were attached to about 130 billion pounds ($204 billion) of U.K. real estate debt at the end of 2009, according to a De Montfort University study. Most would be subject to such a payment.
…
Real-estate buyers use swaps to secure a fixed interest rate when taking out a floating-rate loan to buy a building. That helps ensure that the property’s rental income will be enough to service the loan, even if rates rise unexpectedly. Under the EU plan, a demand for payment, or margin call, could result if rates go the opposite way than the swap anticipates. Businesses unable to pay could be declared to be in default.
…
If the proposed regulations had been in place, U.K. borrowers would have needed to put up collateral of about 10 billion pounds to cover swaps that moved the wrong way, William Newsom, head of valuation at Savills Plc, estimated in June.

Now, all by itself, this isn’t a big deal. What will hapen is that the investment companies will take out a credit line at the same time as entering the swap; any demands for collateralization of the swap will be met by drawing down the credit facility. But it’s just another piece of regulatory garbage – lots of extra paperwork for zero net benefit.

There’s an amusing complication in the US adoption of Basel 3:

A 24-line section of the 848-page Dodd-Frank Act is delaying U.S. implementation of international rules for how much capital banks need to hold against securitized assets.

The financial-overhaul legislation, signed by President Barack Obama in July, requires regulators to remove all references to credit ratings of securities from their rules. Revised standards on how much capital banks need to hold against such assets in their trading books, approved by the Basel Committee on Banking Supervision in 2009, rely on such ratings.
…
Current Basel trading-book rules treat all top-rated bonds the same, allowing banks to hold as little capital against AAA rated mortgage-backed securities as they do against Treasuries. The trading book is a subset of the balance sheet where banks park assets they intend to trade in markets, as opposed to the banking book where assets are meant to be held until maturity or at least for a longer period.

The new rules require higher capital charges for securitized bonds than for corporate or sovereign debt, bringing the trading-book standards in line with the banking book. Ratings scales of outside firms are used to calculate how much capital is required for different securities. The change will increase banks’ capital charges by as much as 4 percentage points, according to a Basel study.

It’s kind of nuts to use credit ratings with no qualifications. It was CDOs that sank the investment banks; say, f’rinstance, you have 10 “normal” securitizations. Each one has a senior tranche of $80-million rated AAA, and junior tranche of $15-million rated BBB, and an equity tranche of $5-million, unrated. You put together a CDO comprised of all the junior tranches, $150-million, and divide that up into a senior tranche of $115-million, rated AAA, a junior tranche of $15-million, rated BBB, and an equity tranche, unrated.

Now, the senior tranche may well be legitimately AAA, in that it has a 0.1% chance of defaulting. But if economic conditions change, you’ve got exposure to the fastest defaulting mortgages in a $1-billion pool (of the original mortgages). The rating is much more volatile, and loss given default is much more severe. See Hull & White on AAA Tranches of Subprime for more discussion.

The moral of the story is: You cannot describe any security, particularly not highly structured securities, with a single number. Credit risk is a vector quantity, not a scalar, no matter how much easier assuming the latter makes life for banks and their regulators

Even credit unions are being consumed by the commercial real estate vortex:

Credit unions in the U.S. may absorb as much as $9.2 billion in losses over the next decade as the industry strives to recover from sour investments in real estate and consumer loans, U.S. regulators said today.

Part of the plan to resolve the credit unions’ financial problems includes the National Credit Union Administration packaging $50 billion in distressed securities for sale as $35 billion in bonds carrying government guarantees, the agency said today. The debt will be backed primarily by bonds tied to home loans, with the first sale scheduled for next month.

The NCUA already sold more liquid securities from two credit unions that failed last year: U.S. Central Federal Credit Union in Lenexa, Kansas and Western Corporate Federal Credit Union in San Dimas, California. The administration said today that it assumed control of Members United Corporate Federal Credit Union of Warrenville, Illinois; Southwest Corporate Federal Credit Union of Plano, Texas; and Constitution Corporate Federal Credit Union of Wallingford, Connecticut.

There was continued heavy volume in the Canadian preferred share market today as the two major classes took divergent paths: PerpetualDiscounts gained 9bp while FixedResets were down 8bp.