PrefBlog

Spanish CDSs hit a new high:

The cost of insuring against a Spanish default jumped to a record as Prime Minister Mariano Rajoy struggles to prevent the nation from becoming the fourth euro-region member to need a bailout.

Credit-default swaps on Spain rose 17 basis points to 498 as of 4 p.m. in London, surpassing the previous all-time high closing price of 493, according to CMA. The contracts are up from 431 at the start of the month and 380 at the end of 2011, signalling a deterioration in investor perceptions of credit quality.
…
The rate on Spain’s 10-year note rose 17 basis points today to 5.99 percent, 21 basis points up from a week ago.

Given the fun ‘n’ games with Greek CDSs, I think that if I were buying European sovereign CDSs, I would want the trigger to be something other than formal default – maybe have something triggered by subordination to other instruments, or IMF loans.

A lot of Europeans are voting with their feet … or ATM card, anyway:

This analysis suggests that capital flight is happening on a scale unprecedented in the euro era — mainly from Spain and Italy to Germany, the Netherlands and Luxembourg (see chart). In March alone, about 65 billion euros left Spain for other euro- zone countries. In the seven months through February, the relevant debts of the central banks of Spain and Italy increased by 155 billion euros and 180 billion euros, respectively. Over the same period, the central banks of Germany, the Netherlands and Luxembourg saw their corresponding credits to other euro- area central banks grow by about 360 billion euros.

Click for Big

There’s more trouble at Air Canada:

Air Canada … is warning travellers of flight disruptions, saying some pilots are staging an illegal walkout.

There were cancellations of roughly 30 departures and 30 arrivals on Friday morning at Toronto’s Pearson International Airport, mostly affecting Air Canada, said airport spokesman Scott Armstrong.

This is easy to fix, fortunately. If Air Canada is so important that the Feds have to take away the right to strike, then the longer-term solution is to make Air Canada less important. Give the Emirates rights to the Toronto-Dubai route! Allow cabotage! Let anybody fly between any two points, as long as they meet safety standards and have bought the landing rights in a competitive auction!

BPO Properties, proud issuer of BPO.PR.F, BPO.PR.H, BPO.PR.J, BPO.PR.K, BPO.PR.K, BPO.PR.L, BPO.PR.N, BPO.PR.P and BPO.PR.R, was confirmed at Pfd-3 by DBRS:

DBRS has today confirmed the Issuer Rating of BPO Properties Ltd. (BPO or the Company) at BBB and its Cumulative Redeemable Preferred Shares rating at Pfd-3, with trends at Stable. The BBB rating incorporates the following credit strengths: (1) BPO has strong ownership and an experienced management team; (2) BPO has a premier Class-A to AAA office portfolio, located in the downtown markets in three of Canada’s largest office markets, namely Toronto, Calgary and Vancouver, featuring a number of flagship office properties, such as First Canadian Place, Bay Adelaide Centre West Tower, Bay Wellington Tower, Exchange Tower and Bankers Hall; (3) the portfolio has strong occupancy levels, which are above market comparables in each of its markets, with exception to Toronto; and (4) BPO’s reasonable credit metrics and certain debt restrictions.

Conversely, the rating incorporates the following associated risks: (1) BPO’s portfolio’s heavy concentration in the downtown markets of Toronto and Calgary; (2) significant property concentration with the Company’s top five properties, accounting for approximately 54.8% of the Company’s total leasable area in the portfolio; (3) above-average tenant concentration (however, this concern is somewhat mitigated by the high creditworthiness of the Company’s top 15 tenants).
…
The stable outlook takes into consideration DBRS’s expectation for reasonable growth in operating cash flow in 2012, mainly due to the continued lease-up of Bay Adelaide Centre West Tower. In addition, minimal lease maturities in 2012 should continue to contribute stable cash flow and limit the Company’s exposure to market conditions and re-tenanting costs. DBRS expects BPO to maintain a good liquidity position and positive free cash flow position. The Company has no active commercial development projects and has manageable near-term capital commitments. Overall, DBRS expects BPO’s financial profile to remain stable in 2012, with support from higher cash flow levels and reasonable financial flexibility to fund manageable capital commitments (mainly maturing mortgages).

New rules for dark orders on Canadian exchanges will go into effect in in October:

The new framework involves several elements. Among them:

• Visible orders will have execution priority over dark orders on the same marketplace at the same price.
• In order to trade with a dark order, smaller orders must receive a minimum level of price improvement, which is defined as one trading increment or half a trading increment for securities with a bid-ask spread of one trading increment.
• The IIROC has the ability to designate a minimum size for dark orders, although it isn’t doing so at this time.

I confess that I have not yet looked at the details.

The CME had an incident today illustrative of the frictions between visible and dark trading:

Local traders in the CME Group Inc. (CME)’s Eurodollar options pit walked off the job today to protest a block trade yesterday.

“These guys that stand in there all day and make prices would have loved to participate in that particular price, but they weren’t able to,” Rocco Chierici, a broker at R.J. O’Brien & Associates on the floor of the Chicago Mercantile Exchange, said in a telephone interview.

Prices for the block trades of options on Eurodollar futures were higher than offers in the pit, which wouldn’t be allowed in open-outcry trading, Chierici said.
…
“There are rules that prohibit that in the pit, but you can circumvent the pit” in a block trade, Chierici said. “I believe they wanted to make the point that the system is not fair.”

Six block trades totaling 215,200 options traded at 8:11 a.m. Chicago time yesterday, according to CME Group’s website. The trade was rolling positions from April contracts, which expired today, into June contracts.

“The block trade in question was managed by longstanding rules and processes of our exchanges,” Michael Shore, a CME Group spokesman, said in an e-mail. “It was a legitimate, well- managed trade, which was executed within one tick of the market and in one trade.”

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums up 12bp, while both FixedResets and DeemedRetractibles were off 1bp. The Performance Highlights table is comprised entirely of Floating Rate issues (the fact that they are all BAM issues is not indicative – BAM is the only issuer in these indices at this time). Volume was absurdly low.

Nothing happened today, although I was recently gratified to learn I’m not the only one in the world who is worried about central clearing houses:

IF THEY failed, there would be “mayhem”, says Paul Tucker of the Bank of England. Ben Bernanke, the chairman of the Federal Reserve, quotes a Mark Twain character, Pudd’nhead Wilson, to get the same point across: “If you put all your eggs in one basket, you better watch that basket.” Another regulator privately describes them as “too big to fail, on steroids”.

Central Clearing Houses are probably the single dumbest idea to come out of post-Credit Crunch reregulation. Who – other than a politician or a regulator – really thinks that a system susceptible to single-point failure is more stable than a network?

The Canadian preferred share market enjoyed a good uptick today, with PerpetualPremiums up 2bp, FixedResets gaining 14bp and DeemedRetractibles winning 21bp. Volatility was dominated by BAM, evenly split between winners and losers. Volume was light.

Spain’s in trouble again:

European Central Bank Executive Board member Benoit Coeure triggered speculation that the bank will revive its bond-purchase program to lower Spain’s borrowing costs as the region’s debt crisis threatens to boil over again.

Spanish “market conditions are not justified,” Coeure, who heads the ECB’s market operations division, said at an event in Paris today. “Will the ECB intervene? We have an instrument, the securities markets program, which hasn’t been used recently but it still exists.”
…
The yield on Spanish 10-year bonds, which climbed to a four-month high of 5.99 percent this morning, slid to 5.82 percent after Coeure spoke. The euro gained more than a quarter of a cent to $1.3134 at 2 p.m. in Frankfurt and European stocks rose, with the Stoxx Europe 600 Index (SXXP) up 1 percent.

Spain’s 10-year borrowing costs have jumped more than 1 percentage point since March 2, when Prime Minister Mariano Rajoy said the country will miss a 2012 deficit goal approved by the European Union. The euro area’s fourth largest economy is in recession and unemployment is nearing 24 percent.

It will be interesting to see how this plays out. ECB intervention may lower the probability of default, but its super-senior creditor status (seen in the Greek default) will increase the severity of default.

The Canadian preferred share market drifted slightly upward today, with PerpetualPremiums winning 5bp, FixedResets gaining 2bp and DeemedRetractibles up 4bp. Volatility was good, with Floaters notable amongst the losers. Volume was a little below average.

PerpetualDiscounts now yield 5.07%, equivalent to 6.59% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.45%, so the pre-tax interest-equivalent spread (in this context, the Seniority Spread) is now about 215bp, unchanged from the report of April 4.

A mention in the Globe & Mail led me to an IMF publication (Chapter 3 of of the April, 2012, World Economic Outlook) titled Dealing with Household Debt:

Does household debt amplify downturns and weaken recoveries? Based on an analysis of advanced economies over the past three decades, we find that housing busts and recessions preceded by larger run-ups in household debt tend to be more severe and protracted. These patterns are
consistent with the predictions of recent theoretical models. Based on case studies, we find that government policies can help prevent prolonged contractions in economic activity by addressing the problem of excessive household debt. In particular, bold household debt restructuring programs such as those implemented in the United States in the 1930s and in Iceland today can significantly reduce debt repayment burdens and the number of household defaults and foreclosures. Such policies can therefore help avert self-reinforcing cycles of household defaults, further house price declines, and additional contractions in output.
…
Macroeconomic policies are a crucial element of forestalling excessive contractions in economic activity during episodes of household deleveraging. For example, monetary easing in economies in which mortgages typically have variable interest rates, as in the Scandinavian countries,
can quickly reduce mortgage payments and avert household defaults. Similarly, fiscal transfers to households through social safety nets can boost households’ incomes and improve their ability to service debt, as in the Scandinavian countries.

Clearly, it is better to avoid such a situation in the first place, but there is only ineffective policy in place in Canada to do so at this time. Buying a larger house (or a small house or condominium instead of renting) is a means of capital formation, which is encouraged by low interest rates. That’s what lower interest rates are supposed to do, for heaven’s sake! However, housing is non-productive capital; so much so that it can almost be considered consumption.

So the question really is: in times of economic downturns, how should policy act to promote “good” capital formation as opposed to “bad” capital formation?

I suggest that both monetary and fiscal policy are very blunt tools – too blunt to address the issue. Instead, a regulatory response is required:

• Don’t be so damn eager to raise the limits on explicitly (Canada) or implicitly (US) government guarantees of mortgage debt. Set a limit, based on historical experience and rising with nominal GDP, of the amount of such guarantees. In 2006, CMHC insurance outstanding was $291-billion. In 2010 the plan was to have total outstanding of $533-billion. Why? Why do What-debt? and Spend-Every-Penny want to create a housing bubble? I can only assume that it is because this will give them more opportunity to micro-manage the economy, with credit-rationing and rule changes by government fiat, rather than the unexciting process of raising insurance prices when a reasonable limit is approached.
• Impose a capital surcharge the banks when their loan books get distorted. Mortgages are now 40% of the balance sheets; they used to be 30% not so very long ago. Such a sudden change indicates to me a strong possibility that this is simply regulatory arbitrage (why lend to Jimmy’s Barber Shop, with a risk-weighting of 100%, when you can lend to Jimmy himself as a mortgage, with a 35% risk-weight or maybe even a government guarantee with an even lower risk-weight?). So, in this case of distortion, and in every other case of material distortion, impose a surcharge. An extra 10% risk-weight (to 45% on mortgags) on loan book elements in material excess of their historical norms is my prescription.

Three cheers for offshore wind power!

Offshore wind costs about $232 a megawatt-hour of power generated, according to data from Bloomberg New Energy Finance. That compares with about $80 for onshore wind, $62 for gas-fired plants and $77 for coal. The government supports the industry with incentives for power produced by renewable energy sources.

It’s not clear if the price figures include provisions for back-up power and demand-timing differences (the wind tends to blow at night, when demand is relatively low, can sometimes die at highly inconvenient moments and electricity can’t be stored very well. This has a huge effect on honest cost assessment, and no effect on – shall we say – other assessments).

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums losing 4bp, FixedResets gaining 2bp and DeemedRetractibles down 2bp. Volatility was low. Volume was a little below average.

The US jobs number was disappointing:

Employers in the U.S. added fewer jobs than forecast in March, underscoring Federal Reserve Chairman Ben S. Bernanke’s concern that recent gains may not be sustained without a pickup in growth.

The 120,000 increase in payrolls, the fewest in five months, followed a revised 240,000 gain in February that was bigger than first estimated, Labor Department figures showed today in Washington. The March increase was less than the most pessimistic forecast in a Bloomberg News survey in which the median estimate called for a 205,000 rise. Unemployment fell to 8.2 percent, the lowest since January 2009, from 8.3 percent.

Stock lending can be profitable!

The other day on Bloomberg (the paid version), I came across several ETFs with incredibly rich dividends. One of them — Guggenheim’s Solar ETF (TAN/NYSE) — far outshined the others. TAN holds about 30 solar energy companies. Its dividend yield is 9.2%, reports Bloomberg and others. Indeed, its dividend of US$2.11, adjusted for a 1:10 reverse split, divided by its price of US$23.02 works out to 9.2%. But is that possible in what should be a high-growth sector?

Digging deeper, only seven of the companies in the ETF, representing about 28% of the total allocation, have ever paid a dividend. Two have postponed dividends for 2012 and another has cut its dividend by more than half. The weighted average yield on the seven companies is under 1%.

Since holdings can change every quarter, I also checked the holdings as of February 2011. The picture was the same: seven dividend payers with an average yield of below 1%.

Where then did most of TAN’s dividend come from? The answer, as revealed by the fund’s prospectus, is securities lending. Nearly 90% of TAN’s investment income for the 12 months ending last August came from lending about half its shares to short sellers.

Who needs retirement in Florida, when you can retire to sunny Spain?

Banks trying to offload billions of euros of property left on their hands by bankrupt developers are selling new apartments at rock-bottom prices with bargain-basement mortgage deals.

Santander, the eurozone’s largest bank, was responsible for the frenzy in Sesena. It offered two-bedroom apartments around a communal swimming pool for 65,000 euros (US$86,100), with 100% mortgages over 40 years, costing as little as 242 euros a month to service, about a sixth of the average Spaniard’s monthly income.

At the peak of the decade-long property boom that preceded the crash, similar apartments would have sold for at least twice that, and for properties it isn’t selling, a Santander mortgage would cover 80% of the property price over 25 years.

Those with an interest in YLO will be happy to learn there is a market for the assets:

AT&T Inc. (T) agreed to sell a majority stake in its Yellow Pages directory division to Cerberus Capital Management LP for about $950 million as part of an effort to dispose of units that are holding back revenue growth.

AT&T will receive $750 million in cash and a $200 million note, according to a statement from the Dallas-based phone carrier today. AT&T will keep a 47 percent stake in the business, which had about $3.3 billion in revenue in 2011.
…
Sales at the Yellow Pages business declined 16 percent last year, compared with revenue growth of about 2 percent for AT&T as a whole.

So $950-million for 53% of a print company with $3.3-billion revenue …. YLO had revenue of $1.3-billion in 2011, but a buyer will have to assume the debt …

Boyd Erman opines in the Globe:

But giving Cerberus the benefit of the assumption that its people have some idea of what they’re doing, the purchase has set a bar for what Yellow Media bondholders, who are now mobilizing, will expect to receive in a restructuring. While the valuation is not enough to create any real recoveries for stockholders, or even preferred shareholders, it is enough to suggest there are gains in store for bondholders gutsy enough to buy Yellow Media paper at distressed levels.

Broadly speaking, Yellow Media has about $1.5-billion of debt that has been trading at about 50 cents on the dollar. If there’s $1-billion of value, that suggests the bonds should be closer to 67 cents on the dollar.

Some bondholders argue there’s more. Applying market multiples to the free cash flow generated from Yellow Media’s old-line and online operations, some bondholders argue you can get to a range of $1.4-billion to $2.2-billion.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 5bp, FixedResets down 1bp and DeemedRetractibles losing 15bp. Volatility was negligible. Volume was ridiculously low.