PrefBlog

I find the US Municipal bond market of great interest, simply because the investor profile is so similar to that of Canadian preferred shares. I was recently looking for some estimates of holdings by investor group; now that I don’t need it any more, of course, I found it:

Citigroup Inc. analysts say there’s something missing from the Federal Reserve’s tally of the municipal-bond market’s size: more than $700 billion of the securities were bought directly by individual investors.

The Fed’s quarterly figures, released yesterday, put the market at $2.9 trillion, 37 percent of which the central bank says is owned by households. Citigroup’s analysts George Friedlander, Mikhail Foux and Vikram Rai say individuals play an even larger role, holding half of a $3.7 trillion market that has been whipsawed by speculation about municipal defaults that is now starting to ebb.

“The instability in the muni market in late 2010 was exacerbated by individual investors becoming overly concerned about the fiscal strength of state and local governments,” Rai said in an e-mail after Citigroup’s report on the market was published on June 3. “Unsurprisingly, as credit fears abated, it resulted in lower volatility and a rally in the tax-exempt and taxable market.”
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Citigroup’s analysts didn’t challenge the Federal Reserve’s data on holdings by institutional investors such as mutual funds and insurance companies, which can be gleaned from corporate filings and other outside data sources. Without similar information on households, the analysts say, the Fed had to guess.

By underestimating the market, they’ve also diminished the extent to which individuals dominate it, they said. Citigroup estimates individuals they held $1.8 trillion, or half, of the municipal bonds outstanding at the end of 2010, compared with about $1.1 trillion estimated by the Federal Reserve.

“We always believed that the influence of retail investors in the municipal market was understated,” Rai said.

The Federal Reserve said it’s looking into the discrepancy, said Susan Stawick, a spokeswoman.

S&P Discusses Some Observations On Canada’s Consultation Paper For A Proposed Legislative Regime For Covered Bonds:

• On May 11, 2011, the Canadian Department of Finance released a consultation paper on its proposed covered bond legislation.
• We believe that, in general, the introduction of specific covered bond legislation would be positive, and would likely provide further assurances for investors.
• However, we note that the proposed codification of an overcollateralization cap may limit an issuer’s ability to manage and support its covered bond program by increasing the level of collateral and may, under our current analytical approach, potentially constrain the ability of issuers to achieve or maintain the highest potential ratings.

DBRS also commented:

One particular area of concern for DBRS is the proposed cap of 10% on the amount of overcollateralization that will be permitted for a Canadian covered bond program. In the event that additional overcollateralization is necessary to maintain a AAA rating on the covered bonds that have been issued, the 10% cap on overcollateralization may adversely affect the ratings on the existing covered bonds. However, DBRS notes that all of the existing Canadian covered bond programs rated by DBRS to date currently have required overcollateralization amounts that are less than 10%. Another area of concern for DBRS is the proposal to standardize asset valuation, particularly if an issuer is not permitted to issue covered bonds outside of the legislative framework, as the proposed asset valuation method may not be consistent with what is currently used in the Canadian covered bond programs that have been rated by DBRS to date.

Fabulous Fab is going to trial:

Fabrice Tourre, the Goldman Sachs Group Inc. (GS) trader accused of misleading investors in a collateralized debt obligation, failed to get a suit brought by the U.S. Securities and Exchange Commission dismissed.

While U.S. District Judge Barbara Jones in Manhattan did narrow some of the claims against him in her decision today, she said the SEC met its burden that Tourre violated a securities law designed to prevent fraudulent sales of securities and should stand trial on that claim.

The SEC initially sued the London-based trader in April 2010, saying he defrauded investors by not disclosing that hedge fund Paulson & Co. had helped pick the underlying securities for a CDO as Abacus and planned to bet against them. After reaching a $550 million settlement with New York-based Goldman Sachs, the SEC filed a new claim against Tourre, saying he gave the company “substantial assistance” as it misled investors.
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Citing last year’s U.S. Supreme Court ruling in Morrison v. National Australia Bank, the judge threw out some claims involving Duesseldorf, Germany-based IKB Deutsche Industriebank AG, which allegedly lost almost all of its $150 million investment, and ABN Amro Bank NV, which assumed the credit risk associated with a portion of Abacus.
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Jones let the case proceed on a claim against Tourre that he “knowingly, recklessly or negligently” made misrepresentations in the sale of securities to ACA Management LLC, IKB and ABN Amro.

Rhapsody in Yellow? A little cacaphonous today. The issues went ex-Dividend – good luck to anybody attempting to draw conclusions from the Dividend Drop Off Rate, which will be 100% if the total return is to be 0%.

It was an off day for the Canadian preferred share market, with PerpetualDiscounts losing 12bp, FixedResets down 3bp and DeemedRetractibles shrinking 5bp. Volatility was again muted, with no entries in the Performance Highlights table, but volume picked up and was only a little below average – RY DeemedRetractibles dominated the volume table.

Today’s top news is that Interactive Brokers thinks about what they’re doing:

Interactive Brokers Group Inc., the electronic market maker and securities firm, raised margin requirements to 100 percent for some Chinese stocks, because of “elevated risk concerns,” according to a statement on its website. Sina and Sohu were among more than 100 Chinese companies on the list. The increase went into effect June 6 in stages and will be completed by the end of this week, the brokerage said.

Given the fate of other brokerages that think about what they do (by which I mean Goldman Sachs and … and … probably lots and lots of others) we can expect the invective against IB to start pouring out any day now.

The Fed may have overestimated the market’s appetite for risk:

Federal Reserve auctions of mortgage securities that the central bank assumed in the rescue of American International Group Inc. are fueling a selloff in credit markets as Wall Street rushes to hedge against losses on stockpiled debt.

Declines in credit-default swaps indexes used to protect against losses on subprime housing debt and commercial mortgages accelerated this month, reaching almost 20 percent in the past five weeks as the cost of the insurance climbs, according to Markit Group Ltd. The plunge this week started infecting everything from junk bonds to the debt of financial companies.

The Fed has been selling the $31 billion Maiden Lane II portfolio piecemeal after rejecting a $15.7 billion bid from AIG for the entire pool in March.
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Wall Street banks, which through May 25 increased their holdings of corporate and asset-backed debt to the highest level in 13 months, have been using both so-called Markit ABX and CMBX indexes to hedge against the deteriorating values of mortgage debt, said Christopher Sullivan, chief investment officer at United Nations Federal Credit Union in New York. That’s contributing to the drop in prices of the underlying bonds and helped push up relative yields on speculative-grade, or junk, corporate bonds to the widest level this year.

I have complained for a long time that we, as a continent, are not spending enough on infrastructure. Here’s another datapoint:

With its intricately interdependent and increasingly complex electronic components, the U.S. electric grid operates on an ever-shrinking margin for error. The larger and more interconnected the grid becomes, the more vulnerable it is to catastrophic cascading failures. A recent article in Scientific American (see note 1) estimates that there is a one in 20 chance of a solar super-storm in the next 15 years.
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The House Energy and Commerce Committee unveiled the Grid Reliability and Infrastructure Defense Act on May 20, 2011. Among the draft bill’s provisions are requirements that the Federal Energy Regulatory Commission issue orders spelling out procedures and requirements for dealing with immediate and longer-term threats to the grid.

Overview

• The U.S. electricity transmission grid is vulnerable to solar activity.
• Scientists estimate that there is a one in 20 chance over the next 15 years of a disabling solar storm.
• Grid operators are looking at ways to protect it from such events.

More harrassment today from volunteer organizations using automated dialers because their time is ever so much more valuable than mine. Hint to organizers: if you want something from me, don’t insult me before I’ve even picked up the ‘phone.

YLO was boring today, so there is no Yellow Fever Report.

It was another mixed day in the Canadian preferred share market, with PerpetualDiscounts gaining 9bp, FixedResets losing 8bp and DeemedRetractibles up 4bp. There were no entries in the Performance Highlights table. Volume continued to be very sluggish.

Why are so many investors unhappy with their advisors? Because they got what they deserved:

Investors would rather pay commissions for the financial advice they receive than a fee based on assets under management, said Cerulli Associates.

About 47 percent of 7,800 households surveyed prefer paying commissions, compared with 27 percent that would rather contribute a fee based on assets, according to the report released today by the Boston-based research firm. About 18 percent said they prefer paying retainer fees, which are generally lump sums negotiated between advisers and clients, and 8 percent said they opt for an hourly fee structure.
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About 33 percent of investors surveyed said they didn’t know how they pay for the investment advice they receive, and 31 percent said they thought their adviser or broker provided investment advice for free. Those who were unsure of how they pay for advice were most likely to be unhappy with their financial adviser, with 47 percent reporting dissatisfaction, the study said. About 27 percent of those who said they pay commissions reported being dissatisfied.
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About 64 percent of those surveyed said they believe their financial adviser is held to a fiduciary standard of care, and 63 percent of clients of the largest broker-dealers said they thought that as well.

Brokers currently must meet a standard to offer clients “suitable investments,” whereas registered investment advisers have a fiduciary obligation to put clients’ best interests first.

In January, the U.S. Securities and Exchange Commission released a report recommending a common fiduciary standard for brokers and registered investment advisers who provide personalized investment advice. The SEC is scheduled to propose a rule on the standard between August and the end of the year, according to its website. Holding brokers to a fiduciary standard won’t preclude them from accepting commissions, the SEC report said.

Perhaps somebody, somewhere, will somehow explain to me how fiduciary responsibility is compatible with a transaction-based fee structure. But I doubt it.

In trouble over hockey arenas? Try a distraction, like paternalistic, invasive regulation:

The Quebec government, desperate to head off a looming collapse of household finances when interest rates rise, has tabled a bill that would force credit card holders to boost their monthly payments and settle their debts faster.

Among the new rules proposed Wednesday by the Liberal government of Jean Charest, lenders would be required to raise the minimum monthly credit card payment to 5% of the outstanding balance from the current 2%. The measure would be phased in over three years.

The government is worried its citizens will have a hard time paying off what they owe and saving money when interest rates start their inevitable climb.

I don’t pay a lot of attention, but credit card rates aren’t all that sensitive to prime, are they?

There’s another coercive Irish tender:

DBRS Inc. (DBRS) today has downgraded the Dated Subordinated Debt rating of Irish Life & Permanent plc (IL&P or the Group) to “C” from CCC. Today’s downgrade follows the announcement by IL&P that it has commenced an offer to purchase the aforementioned securities for cash and a solicitation of consents in relation to the securities. Moreover, DBRS expects to downgrade the Dated Subordinated Debt to “D” at completion of the buyback; as such, the securities remain Under Review with Negative Implications, where they were placed on 3 December 2010.

In DBRS’s view, the purchase offer, when completed, is tantamount to a default as defined by DBRS policy. DBRS views the proposed purchase offer as coercive as the offer affords bondholders limited options. Should the bondholder reject the proposed offer, at an 80% discount on the majority of the tendered securities, they risk receiving substantially less if the proposed consent amendments are ratified. Remaining bondholders would then receive 0.001% of par value, should the consent to allow the “clean-up” of residual notes be accepted by tendering bondholders.

The FRB-Boston has released a Public Policy Discussion Paper by Christopher L. Foote and Jane S. Little titled Oil and the Macroeconomy in a Changing World: A Conference Summary:

Analysis of oil-price movements is once again an important feature of economic policy discussions. To provide some background for this analysis, this paper summarizes a conference on the oil market held at the Federal Reserve Bank of Boston in June 2010. Four cross-cutting themes emerged from this symposium, which included scientific experts, market participants, business leaders, academics, and policymakers. First, the decline in real oil prices that followed the 1970s’ oil shocks is unlikely to be repeated today, because there are fewer ways in which oil-importing countries can reduce oil demand or expand domestic supplies in response to higher prices. The second lesson of the conference, however, is that any prediction about oil markets is highly uncertain, a fact illustrated by the wide confidence intervals that result when futures-market data are used to quantify forecast uncertainty. Third, there is little consensus on whether new financial investment in commodity index funds has increased the volatility of oil prices. Finally, changes in oil prices still have large effects on the economy. Some research suggests that the rapid run-up in oil prices in 2007–08 may have significantly weakened the U.S. economy in the early stages of the Great Recession.

I don’t expect the third point to get much attention from the politicians and regulators!

The Big Yellow Machine continued to break down:

It was a mixed day on the Canadian preferred share market, with PerpetualDiscounts losing 8bp, FixedResets up 11bp and DeemedRetractibles down 10bp. There was a nice little bit of volatility, mainly to the downsider for the insurer DeemedRetractibles that have done so well lately. Volume continued to be pathetic – all the players must be enjoying the good weather!

The Sino-Forest plot thickens:

Muddy Waters Research, the firm founded by short seller Carson Block, “pre-marketed” its June 2 report on Sino-Forest Corp. (TRE) to hedge funds for the past five weeks, said an analyst at Dundee Securities Ltd.
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“Muddy Waters pre-marketed this smoking-gun report on Sino-Forest to hedge funds over the last five weeks,” said Richard Kelertas, a Montreal-based analyst at Dundee, which helped sell shares in Sino-Forest as recently as December 2009.
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Kelertas said that the Muddy Waters report was inaccurate and there’s nothing fraudulent about Sino-Forest “to the best of our knowledge.” He recommended buying Sino-Forest shares from September 2007 until June 3, when he put his rating on the company under review.

Dundee was among institutions that helped Sino-Forest sell shares in December 2009 and also in May 2009.

Short selling, or selling borrowed shares with the hope of profiting when they fall, more than doubled to a record 35 percent of Sino-Forest’s outstanding stock as of June 3, up from 17 percent at the beginning of May and 13 percent at the end of 2010, according to Data Explorers, a New York-based research firm. Sino-Forest was the most-shorted stock in the Standard & Poor’s TSX Composite Index, which has an average short interest of 4.8 percent.
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Offering a report to hedge funds before making it public is not illegal, said James Fanto, who teaches classes on international financial regulation and securities laws at Brooklyn Law School in New York.

“Muddy Waters can profit from this information itself, or allow others to profit from their insights as well,” Fanto said in an e-mail message. “The only problems emerge when research is in fact based on insider tips. But that doesn’t seem to be the case here.”

I haven’t heard such an impassioned defense of company from a dealer since Bre-X! I hope everybody has popcorn at hand to watch the rest of this show.

Speaking of companies getting trashed, there was another outbreak of yellow fever today:

It was another muted day for the Canadian preferred share market, with PerpetualDiscounts gaining 6bp, FixedResets basically flat and DeemedRetractibles up 3bp. Volume was low.

This is old, but Laurie Carver wrote a good piece on Credit Rating Agencies titled Losing Credit:

Brooks says the NAIC decided to move to the new methodology because of rating agencies’ failure to accurately capture the risk of severity of loss in structured credit (and consequently its flipside – recovery). “Under the old regime, ratings were a kind of blunt tool for determining the risk-based capital, whereas now we’re doing a more detailed analysis of each security held by the insurer.”

He sees the old rating-based RBC charges as creating ‘cliff risk’, because their focus on the first dollar of loss in the whole structure caused sudden downgrades to be assigned to tranches that were actually likely to recoup or profit. For instance, under the old regime, AAA securities would carry a capital charge of just 0.4%, compared to 23% for a CCC security. “This very sharp change in the RBC charge can happen without a material effect on the actual return on the insurer’s investment,” says Brooks.

“The rating agencies’ methodology is binary – they take account of the probability of default but not the severity of loss to the insurer’s specific position. Just because there’s a default, doesn’t mean that the security held by the insurer is going to experience 100% loss.”

Trichet has figured out that maybe the EU should have paid attention when Greece announced it was cooking its books:

The economic crisis in Europe is not a crisis of the euro currency or of the monetary union, says the president of the European Central Bank.

“The current crisis stems rather from insufficient monitoring of economic policies in a number of member states,” Jean-Claude Trichet said in a speech at the Conference of Montreal. “Today, it’s not the monetary pillar of economic and monetary union that is at stake but the economic pillar,” he said.

Gee, and I thought it was all Goldman Sachs’ fault, as mocked 2010-4-19.

I’m tired of YLO – bor-ring! I wish Sino-Forest had preferred shares.

A mildly depressing day on the Canadian preferred share market, with PerpetualDiscounts down 8bp, FixedResets off 4bp and DeemedRetractibles losing 9bp. Volatility was muted. Volume was dead. D-E-D. Dead.