PrefBlog

Since the politicians won’t bail out Ireland and Portugal, the central bank is doing it:

European Central Bank President Jean- Claude Trichet said the ECB has resumed bond purchases and will offer banks more cash to stop the region’s debt crisis from engulfing Italy and Spain and hurting the economy.
…
ECB purchases of Irish and Portuguese bonds during the press briefing haven’t stamped out investor concern on the 21- month crisis spreading to Italy and Spain, whose yields soared to euro-era highs this week. European officials are trying to put a firewall around Europe’s third and fourth-largest economies to avoid them being forced into seeking external aid.
…
Italian and Spanish 10-year bonds declined, pushing the yields as high as 6.23 percent and 6.33 percent respectively. Irish and Portuguese bonds rose as people with knowledge of today’s transactions said the ECB bought those securities after being absent from the market for 18 weeks. That debt was at 10.4 percent and 11.3 percent as of 5 p.m. in London.

Gee, isn’t it great when a central bank takes on credit risk?

But don’t lose faith in Europe! It’s all America’s fault:

And Mr. Trichet pointed the finger at the U.S. debt ceiling showdown for stoking market tensions in Europe.

“It’s clear the world is intertwined,” he told reporters after the bank opted to leave its key interest unchanged at 1.5 per cent. “What happens in the U.S. influences the rest of the world.”

There are indications Italy is serious about austerity:

The Italian government, seeking to earn the confidence of investors who have driven its bond yields to euro-era highs, will speed up austerity measures and will target a balanced budget a year earlier than planned.

The country will adopt a balanced-budget amendment, liberalize its labor market, and speed asset sales, Prime Minister Silvio Berlusconi and Finance Minister Giulio Tremonti said in a joint Rome press conference today.

While yields on Italian and Spanish debt fell today, borrowing costs have surged since a July 21 European Union summit aimed at heading off contagion from Europe’s debt crisis to the euro zone’s third- and fourth-largest economies. Italian 10-year bond yields are up 76 basis points since the summit, while Spanish yields are up 33 basis points.
…
Berlusconi said the government now won’t wait until 2013-2014 to eliminate tax loopholes and deductions worth 25 billion euros ($36 billion), though he didn’t say when they would be enacted. He also said he agreed with French President Nicolas Sarkozy to hold a meeting of Group of Seven finance ministers within days.

Spanish borrowing costs are below those of Italy for the first time since May 2010 on speculation Italy’s higher debt load makes it less able to withstand contagion from the region’s fiscal crisis. The nation’s debt is set to reach 120 percent of gross domestic product this year, second highest in the euro region after Greece.

S&P downgraded USA:

The U.S. had its AAA credit rating downgraded for the first time by Standard & Poor’s, which slammed the nation’s political process and said lawmakers failed to cut spending enough to reduce record deficits.

S&P dropped the ranking one level to AA+, after warning on July 14 that it would reduce the rating in the absence of a “credible” plan to lower deficits even if the nation’s $14.3 trillion debt limit was lifted. The U.S. was awarded the top credit ranking by New York-based S&P in 1941. It kept the outlook at “negative.”
…
S&P said it may lower the long-term rating to AA within the next two years if spending reductions are lower than agreed to, interest rates rise or “new fiscal pressures” during the period result in higher general government debt.
…
S&P also changed its assumption that the 2001 and 2003 tax cuts would expire by the end of 2012 “because the majority of Republicans in Congress continue to resist any measure that would raise revenues.”

“More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating,” S&P said.

The downgrade process was, apparently, enlivened by a $2-trillion arithmetical error that you can be sure the politicians will harp on (Treasury’s started already). The S&P release highlights:

• We have lowered our long-term sovereign credit rating on the United States of America to ‘AA+’ from ‘AAA’ and affirmed the ‘A-1+’ short-term rating.
• We have also removed both the short- and long-term ratings from CreditWatch negative.The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.
• More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.
• Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon.
• The outlook on the long-term rating is negative. We could lower the long-term rating to ‘AA’ within the next two years if we see that less reduction in spending than agreed to, higher interest rates, or new fiscal pressures during the period result in a higher general government debt trajectory than we currently assume in our base case.

The Fed has issued guidance to banks:

Earlier today, Standard & Poor’s rating agency lowered the long-term rating of the U.S. government and federal agencies from AAA to AA+. With regard to this action, the federal banking agencies are providing the following guidance to banks, savings associations, credit unions, and bank and savings and loan holding companies (collectively, banking organizations).

For risk-based capital purposes, the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities will not change. The treatment of Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities under other federal banking agency regulations, including, for example, the Federal Reserve Board’s Regulation W, will also be unaffected.

That’s how Europe can solve its banking problems! Just allow loans-gone-bad to be risk-weighted at their original rates!

I remember the DBRS downgrade of Canada in Spring, 1994, which the ancients among us will remember as a horrible bear market for bonds, full of nervousness. The downgrade was announced at about 5pm; we were getting pricing data from two brokerages, one of which prepared their run prior to the announcment, the other after. Only a few minutes, but there were literally dollars of difference in the long bond prices! Bids just disappeared as the dealers went short in preparation for overnight selling.

Yellow Media’s sell-side analysts continue to follow the stock:

Canaccord Genuity believes the carnage isn’t over yet. In a new research report today, analyst Aravinda Galappatthige cut his price target to a mere 60 cents, a far cry from his previous guess of $2.75. Not surprisingly, he downgraded Yellow Media to a “sell” from a “hold.”

“The steep decline in our target is due to common equity at now only 20 per cent of the enterprise value of the company,” Mr. Galappatthige explained. “Consequently, even moderate cuts to earnings before interest, taxes, depreciation and amortization and free cash flow, which lowers enterprise value, have the potential to have a magnified impact on equity.”
…
“Yellow Media is in the midst of transforming its business from a directory publisher to a broader, online-centric, marketing solutions company serving mainly small and medium enterprises. While we do expect to see some success for the company in this process, we believe print declines will hit double-digit rates starting fiscal 2011 and more than offset online growth, given that print currently makes up approximately 75 per cent of revenues. Moreover, if the print declines worsen – to 15-20 per cent levels, as we are seeing in most international markets, we believe Yellow Media’s EBITDA and FCF could be impacted significantly.”

CIBC World Markets Inc. analyst Robert Bek today also took a knife to his price estimate, slashing it to $1.25 from $5.50.

“Though the Band-Aid has been ripped off this story, we still believe investors should watch on the sidelines as an equity recovery is tenuous, at best,” he wrote. “Our (new price target) is probably half way to fair value, but downside risks are material, including the potential for a restructuring if conditions worsen.”

In the comments to the recent YLO post, newbiepref instructs me on a feature of the TSX website: Insider Trades by Symbol, through which I see that YLO (almost certainly YLO, but it could be some other insider) bought all four of its preferred share issues today. The total value was only $160,000 (about 2/3 of it in YLO.PR.A) but even so they’re taking these things off the balance sheet at about half-price, on average. Nice work if you can get it!

These are small quantities, to be sure, but it will be remembered that quantities are restricted under the terms of their Normal Course Issuer Bid:

In accordance with the rules of the Toronto Stock Exchange, the maximum numbers of securities that can be purchased on a daily basis by Yellow Media Inc. are 641,849 common shares, 5,248 first preferred shares, series 1, 3,134 first preferred shares, series 2, 3,068 first preferred shares, series 3 and 1,385 first preferred shares, series 5, subject to the block purchase exception

They hit the limits precisely – to the very share! – for three of the four issues; they were sloppy with YLO.PR.B and bought only 3,100 of the allowable 3,134. As discussed in the commented post, they’re not buying the common any more, probably because of bank loan covenants.

It was a weak day for the Canadian preferred share market, with PerpetualDiscounts down 4bp, FixedResets off 3bp and DeemedRetractibles losing 18bp. Good volatility; let’s hope things heat up a little more next week! Volume was average.

Here’s a sign of the times:

Bank of New York Mellon Corp., the world’s largest custody bank, said it will charge clients a 13 basis point fee for “extraordinarily high” cash deposits.

“We have seen a growing level of deposits on our balance sheet from clients seeking a safe haven in light of the global interest rate and credit environment,” the company said today in an e-mailed statement.

It’s not clear whether this means the net yield to clients will be negative. But negative yields are quite fashionable:

Money market rates, which surged during the debate to raise the federal borrowing cap, dropped below zero percent as Europe’s sovereign-debt crisis bolstered U.S. government securities’ appeal as the world’s safest assets.

Demand for short-term government debt instruments is rising as Treasury bills are expected to remain in short supply after the U.S. signaled yesterday it won’t increase sales of the securities even following lawmakers’ agreement to raise the debt ceiling.
…
European Central Bank President Jean-Claude Trichet said today the ECB has resumed bond purchases and will offer banks more cash to stop the region’s sovereign-debt crisis from engulfing Italy and Spain.

One-month Treasury bill rates traded at zero percent today after earlier falling to negative 0.0102 percent. They closed yesterday at 0.0051 percent yesterday and reached 0.1825 percent on July 29, the highest since February 2009.

Equities were interesting today:

A global rout in equities drove the Standard & Poor’s 500 Index to its worst slump since February 2009, while two-year Treasury yields plunged to a record low amid concern the economy is weakening. The yen pared losses, recovering from the biggest drop versus the dollar since 2008 that was triggered by Japan selling its currency.

The S&P 500 tumbled 4.8 percent to 1,200.07 at 4 p.m. in New York with futures on the gauge slipping 0.2 percent as of 6:17 p.m. The S&P 500 has dropped 11 percent since July 22, the biggest loss over the same amount of time since March 2009. The MSCI All-Country World Index slid 4.1 percent as Brazil’s stocks slumped to a two-year low and Switzerland’s entered a bear market. Two-year yields declined as low as 0.25 percent. The yen sank 4.1 percent against the dollar before trimming its loss almost in half. Oil sank 5.8 percent to help the Thomson Reuters/Jefferies CRB Index of materials erase its 2011 gain.

The Canadian preferred share market was also affected, but not to nearly the same degree (unless you own YLO preferreds), as PerpetualDiscounts lost 17bp, FixedResets were down 10bp and DeemedRetractibles were off 10bp. Volatility was high, comprised entirely of losers. Volume was good.

PerpetualDiscounts now yield 5.44%, equivalent to 7.07% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 4.9% (!), so the pre-tax interest equivalent spread is now about 215bp, a sharp increase from the 185bp reported on July 29 as PerpetualDiscounts have remained stable while long corporate yields plummetted.

Dealbreaker has a surprisingly thoughtful piece on the US credit rating:

That’s probably the best way to interpret market reactions. Rates on the $10 trillion of publicly held Treasuries couldn’t be tighter, suggesting that there’s no real market worry about the U.S.’s ability to pay off its debts. But CDS notionals keep increasing (albeit in a still small and illiquid market) and CDS levels are wide of AA corporates because the U.S. is actually more likely to default than Colgate Palmolive is. Because it would not occur to anyone at Colgate Palmolive to just stop paying its debts. But we’re going to have to keep rasing the debt ceiling, and every time we do, half of Congress is going to say that they prefer to default.

The idiotic Federal Aviation Administration crisis is symptiomatic:

The U.S. House of Representatives and Senate finished voting on legislation this week and recessed for the month of August without extending the FAA’s funding authority, which expired at midnight July 22. That idled about 70,000 construction-related workers and furloughed 4,000 FAA employees. The FAA also is forgoing $28.6 million in aviation taxes each day the deadlock continues. That would add up to $1.3 billion by the time Congress resumes legislative business on Sept. 7.
…
Transportation Secretary Ray LaHood said legislators should return to Washington and pass an extension without cutting subsidies for flights to 13 rural airports. The cuts were in a House-passed bill to extend the FAA’s authority through Sept. 16 that was introduced by Representative John Mica, the Florida Republican who chairs the transportation committee in that body.

Senate Majority Leader Harry Reid, a Nevada Democrat, said yesterday he was prepared to accept the House bill. Other Senate Democrats refused, said Adam Jentleson, a spokesman for Reid.

The FAA’s last multi-year funding bill expired in 2007. Congress has passed 20 limited extensions since then without adopting a new long-term authorization measure.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts winning 21bp, FixedResets gaining 9bp and DeemedRetractibles up 14bp. Volatility was minimal. Volume was average.

Yellow Media reports on 11Q2 tomorrow before the opening, so YLO preferreds could have an interesting day!

Christophe Chamley, a professor of economics at Boston University, writes an interesting piece on Bloomberg about the Spanish default of 1575:

At that time of costly communications, periodic commercial fairs were essential events for the economic activity throughout Europe. Credit was rolled over from fair to fair by bankers, and lending agreements were renegotiated. With the Spanish commercial credit market frozen, the fairs couldn’t be held. Indeed, the main fair that was held twice a year at Medina del Campo was canceled. In short, the default caused a banking collapse, which led to a severe recession.

After two years, in November 1577, the cities caved, agreeing to a very large tax increase. The king resumed debt payments to the bankers. As the king explained in the settlement agreement, called Medio General, the bankers were joined in their demands “by the petition of the delegates of the cities with particular urgency about the same business.” In other words, the cities were begging the king to restore the business of trade. The fairs at Medina del Campo resumed late in the next year, but they had lost their preeminence forever.

It was a quiet day on the Canadian preferred share market, with PerpetualDiscounts up 1bp, FixedResets winning 3bp and DeemedRetractibles flat. Volatility was minimal. Volume was pathetic.