PrefBlog

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums down 2bp, FixedResets up 11bp and DeemedRetractibles off 1bp. Volatility was low. Volume was well above average.

Everything you ever suspected about municipal employees is true:

The City of Hamilton fired 29 public-works employees Monday for time theft, breach of trust and neglect of duties.

The employees, frontline road-maintenance workers whose main duties involve filling potholes, used company time and vehicles to “go to shopping malls, go to coffee shops, go have a snooze in the park,” according to Councillor Lloyd Ferguson, chair of the public-works committee.
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On one work day, the private investigators found one crew only worked for 30 minutes, Mr. Ferguson said.
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he investigation isn’t over yet; now the city’s public-works managers and internal auditing staff are interviewing supervisors and doing a full forensic of work records to understand how this alleged deception took place. Supervisors could face discipline, too.

“The supervisors should know what they assign in the morning and what’s done at the end of the day. They should be going around to these job sites and checking on their crews,” Mr. Ferguson said.

But that still leaves the question of what happened to the asphalt the crews were to use to repair roads. “If they took 10 tons of asphalt in the morning and brought back nine and a half at the end of the day, it would draw attention to them,” Mr. Ferguson said. “So that’s one of the other things we’re investigating is the dumping of asphalt.”

It was another mixed day for the Canadian preferred share market, with PerpetualPremiums up 9bp, FixedResets off 5bp and DeemedRetractibles gaining 4bp. Volatility was above average and skewed to the upside, but there was no clear pattern. Volume was quite heavy.

Call the papers! A Chadian official was corrupted!

Griffiths Energy International Inc. to the wife of an African diplomat, a transaction that led the company to pay a $10.35-million fine in a bribery case this week.

According to people familiar with the case, the junior oil and gas company turned to the blue chip corporate law firms to help guide it in the late 2000s through a series of difficult negotiations with officials from Chad, which ranks as one of the world’s most corrupt countries. When a new slate of Griffiths executives uncovered the $2-million (U.S.) bribe in 2011, it alerted police, sparking an investigation that culminated this week in a settlement agreement and fine that a Calgary judge on Friday called “an embarrassment to all Canadians.”

For the life of me, I don’t understand why I should be embarrassed by other people’s actions, nor do I understand why it is against Canadian law to bribe foreigners. We should cooperate with their investigations, certainly, and extradite when necessary, but why is it against Canadian law? Which Canadians were harmed? How much tax is Chad paying to cover the cost of the investigation, trial and paperwork? Who made it my job to look out for Chad’s interests, as defined by me? Ah well … just another example of the white man’s burden, I suppose.

I missed this when it was new … OSFI likes the banks in capital markets:

Policymakers in Europe and the U.S. are getting set to prohibit banks from getting into risky capital markets activities, but such a step would not make sense in Canada, according a senior executive at the country’s top banking regulator.

Speaking to an industry conference in Toronto, Mark Zelmer, assistant superintendent of the Office of the Superintendent of Financial Institutions, said that for Canada to adopt such a strategy would “be akin to conducting surgery on the [banking system] in the hope of” finding a miraculous solution to the problem of excess risk.
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Canada has no need to follow the U.S. approach because for decades banks in this country have benefitted from owning capital markets businesses. Ever since lenders were able to own investment dealers back in the 1980s the increased diversification of revenue “helped them weather several financial storms,” he said. “For example, profits from investment banking activities helped cushion bank profits a few years ago when commercial banking activities were experiencing rising loan loss provisions. By the same token, commercial bank profits over the years have helped some banks weather the occasional stumble in capital markets.”

Mr. Zelmer cautioned that the issue is not for OSFI alone to decide, but his comments make clear which way the regulator is leaning.

There’s another delay in Basel III implementation:

EU nations may seek to push the start date for mandatory disclosure of this so-called leverage ratio from Jan. 1, 2015, to Jan. 1, 2016, said the people, who couldn’t be named because the talks are private. The revised date was discussed by diplomats at a meeting today, they said.
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The EU, like the U.S. missed the January deadline to start phasing in parts of Basel III. The Basel Committee on Banking Supervision, the international group that drew up the standards, agreed earlier this month to delay and water down another key part of the package designed to ensure banks have enough easy- to-sell assets in a crisis.

The possible delay to the leverage ratio was triggered by the EU’s failure to meet the January deadline. Officials will hold further talks on the timing for the leverage ratio and other parts of the Basel III rules in the coming weeks, two of the people said.

There’s some interesting data from the equity markets:

The lockstep moves in global stocks that dominated equity markets for the past six years are breaking down at the fastest rate on record, a sign investor confidence is finally returning from the financial crisis.

A measure of how much the 2,073 companies in the FTSE All- World Developed Index (FTAD01) swing in unison has dropped 31 percent since June, the biggest retreat since at least 1993, according to data compiled by Societe Generale SA and Bloomberg. The indicator ended last month at the lowest level since 2007.

Equities are responding to earnings and merger speculation again after being pushed up and down by events from the credit freeze to Europe’s debt crisis to the stalemate in U.S. budget negotiations. Diminishing correlation was a buy signal in 1998 and 2003 (SPX) and has coincided this year with the biggest January rally for the Standard & Poor’s 500 Index since 1997, according to data compiled by Bloomberg.

The reading, a measurement of how much returns in individual stocks are attributable to swings in the broader market, stood at 32.4 at the end of last month, down from 47.2 in June, according to Societe Generale in Paris. The drop was the biggest since the data started in 1993, indicating stocks are moving with greater independence.

The index reached a high of 49.6 in December 2011. A reading of 100 indicates shares are trading in lockstep.

The divergence in returns is prompting Morgan Stanley to send more money to managers who buy stocks based on profit growth and takeover odds, [Morgan Stanley Alternative Investment Partners co-manager Jose] Gonzalez-Heres said in a telephone interview on Jan. 16. Bears say the improvement will be temporary as U.S. lawmakers confront March deadlines on spending plans and elections are held in Italy and Germany.

Speaking of market timing I wrote a passage in an outgoing eMail recently dealing with Malachite Aggressive Preferred Fund and was able to recycle it into another eMail almost immediately afterwards. Must be a trend:

While I agree that government rates are currently unsustainably low, that is the easy part of the investment question! While it is easy to say that such-and-such a situation is unsustainable, it is very risky to predict when the situation will resolve or the nature of its resolution and as a matter of investment philosophy I eschew market timing (see LINK and LINK). Investors are generally much better off by forming an asset allocation plan based on the long term characteristics of each asset class and then attempting to perform as well as possible while retaining those characteristics.

Thus, the fund will not take a view on overall market movements and I do not recommend that any clients take a view.

The US is continuing its campaign to make securities trading more of a kindergarten level kiddie-game:

A former Jefferies & Co. managing director was arrested and accused of defrauding customers of more than $2 million on trades of residential mortgage-backed securities, prosecutors said.

Jesse C. Litvak, 38, of New York, was arrested today at his home and charged with 16 counts including securities fraud, fraud connected with the Troubled Asset Relief Program and making false statements to the federal government, Connecticut U.S. Attorney David Fein said in a statement.
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“Every Jefferies counterparty in each transaction in this indictment got the exact bond bargained for at a price each wanted to pay,” Patrick J. Smith, an attorney with DLA Piper in New York who is representing Litvak, said in a statement.

“These were principal transactions between sophisticated market participants. There were no ‘commissions’ on any of these trades. All of the profits that Jefferies earned on each trade were well within industry norms for the mortgage-backed bonds in this case.”
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Litvak is accused of misrepresenting the asking price of sellers of residential mortgage backed securities to buyers or vice versa, keeping the difference for Jefferies, according to Fein’s statement.

Litvak is also accused of misrepresenting to buyers in other transactions that the bonds in Jefferies’s inventory were being offered for sale by a fake third-party seller, according to Fein’s statement.

According to the SEC press release:

According to the SEC’s complaint filed in federal court in Connecticut, Jesse Litvak arranged trades for customers as part of his job as a managing director on the MBS desk at Jefferies. Litvak would buy a MBS from one customer and sell it to another customer, but on many occasions he lied about the price at which his firm had bought the MBS so he could re-sell it to the other customer at a higher price and keep more money for the firm. On other occasions, Litvak misled purchasers by creating a fictional seller to purport that he was arranging a MBS trade between customers when in reality he was just selling MBS out of his firm’s inventory at a higher price. Because MBS are generally illiquid and difficult to price, it is particularly important for brokers to provide honest and accurate information.
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“Brokers must always tell their customers the truth, particularly in complex securities transactions in which it is difficult for investors to determine market prices on their own,” said George Canellos, Deputy Director of the SEC’s Division of Enforcement. “Litvak repeatedly lied to his customers and invented facts to bring additional profits into his firm and ultimately his own pocket at their expense.”

The SEC complaint states:

Jefferies’ customers owed fiduciary duties to their clients. Jefferies’ customers included funds which were established by the United States government under a program designed to help strengthen the markets for MBS during the financial crisis. Had Jefferies’ customers been aware that they could have paid less for the MBS they purchased, they would have made an effort to do so.
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the U.S. Treasury selected nine investment advisers to serve as PPIP managers, including several that became customers of Jefferies’ (AllianceBernstein, LP (“AllianceBernstein”); Angelo, Gordon & Co., LP (“Angelo Gordon”); Blackrock, Inc. (“Blackrock”); Invesco, Ltd. (“Invesco”); and Wellington Management, LLP (“Wellington”)). Other customers were hedge funds or non-PPIP funds.

It’s a pity the SEC doesn’t spell out which of the fiduciaries were involved in the case, or how much money they lost for their clients as a result of their incompetent price discovery. But, of course, most of them were working for the US Treasury. Returns, schmeturns! They got paid no matter what and will get another turn at the trough no matter what.

It was another mixed day for the Canadian preferred share market, with PerpetualPremiums off 1bp, FixedResets up 12bp and DeemedRetractbles gaining 7bp. Volatility was minimal. Volume remained at above-average levels.

Memo to Scotia: this is what reasonable management might consider grounds for firing a star trader:

Deutsche Bank AG (DBK)’s Christian Bittar, one of the firm’s best-paid traders, lost about 40 million euros ($53 million) in bonuses after he was fired for trying to rig interest rates, three people with knowledge of the move said.

The lender dismissed Bittar in December 2011, claiming he colluded with a Barclays Plc (BARC) trader to manipulate rates and boost the value of his trades in 2006 and 2007, said the people, who requested anonymity because they weren’t authorized to speak publicly. His attempts to rig the euro interbank offered rate and similar efforts by derivatives trader Guillaume Adolph over yen Libor are the focus of the bank’s probe, the people said. Both traders declined to comment for this story.
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Bittar, who joined Deutsche Bank in 2001, was a proprietary trader specializing in short-term derivatives contracts and entitled to a percentage of the profit from his trades, the people said. He took billion-euro positions on the direction of short-term interest rates with the firm’s own money and reaped hundreds of millions of euros in profit for the bank, the people said. The bonuses Deutsche Bank pays its staff typically vest over a three-year period.
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Bittar was also alleged to have had inappropriate communications with colleagues responsible for making the bank’s Euribor submissions, the people with knowledge of the firm’s internal processes said.

I mentioned Illinois’ pension woes on January 17. They’re getting worse:

Illinois had its debt rating cut one level to A- by Standard & Poor’s, which threatened to downgrade the state again following lawmakers’ failure to bolster the nation’s worst-funded pension system.

The rating action comes before the state’s planned sale next week of $500 million of general-obligation securities. The move affects $26.6 billion of debt, according to Robin Prunty, an S&P analyst. It leaves Illinois’s bond grade six levels below AAA and ties it with California as S&P’s lowest-rated state.

The combination of the pension burden and budgetary stresses may push Illinois closer to speculative grade, the company said.
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The state has the weakest pension system in the U.S., with 39 percent funding for five major groups of public employees, according to the Civic Federation, a Chicago-based nonprofit research group.

Maybe they can raise more money by cutting taxes:

Kansas Governor Sam Brownback has a prairie-wide smile, a friendly manner and an abiding hatred of his state’s income tax. He pushed an unprecedented cut for individuals and small businesses through the legislature last year and is now plotting, as he says, to “take it to zero.”
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Kansas lawmakers haven’t figured out how to pay for the tax cuts without potentially crippling public schools and other local government functions. Reducing the income tax has left a projected $2.5 billion revenue hole through fiscal 2018, according to the Kansas Legislative Research Department. On Jan. 11, a state court ruled that the legislature was illegally underfunding schools and ordered a payment of $440 million.
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The tax-cut drama in Topeka, the state capital, pits competing visions of economic development. Brownback and other Republicans share the bedrock belief that eliminating income taxes will spur economic growth that would make those levies unnecessary. Texas, one of seven states that don’t have a levy on wages, is held out as the example of how growth thrives when income isn’t taxed.
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Critics say education and other government services are important components of economic development and are at risk under the governor’s plan. Texas has the good fortune of living on an ocean of oil, they say, and Brownback’s belief in the power of tax cuts is misguided.

I wonder … if taxes are zero, is revenue infinite?

George Soros says the Sharpe Arithmetic has come to hedge funds:

George Soros, the billionaire philanthropist and former hedge-fund manager, said institutions that invest in the industry should expect poor performance, in part because managers charge high fees.

Since hedge funds are now a dominant force in the market, they can’t, as a group, outperform the market,” Soros said today in a Bloomberg Television interview with Erik Schatzker from the World Economic Forum in Davos, Switzerland. The funds’ fees, typically 2 percent of assets and 20 percent of returns, eat into profits, Soros said.

Soros’s hedge fund operated until 2011, when he turned New York-based Soros Fund Management LLC into a family office that now oversees $24 billion. He averaged returns of about 20 percent a year since 1969 at the firm and its predecessor.

Hedge-fund performance will also be impeded because managers and investors are reluctant to take risks, Soros said.

“Outperforming the market with low volatility on a consistent basis is an impossibility,” said Soros, 82. “I outperformed the market for 30-odd years, but not with low volatility.”

I join him in cheering for volatility. It may well be that he is right and that hedge funds have effectively become the market and hence cannot, as a group, outperform, but there’s another factor: Soros and his ilk, skilled, intelligent practitioners, showed that hedge funds could be enormously profitable. Then the salesmen and charlatans moved in …

DBRS confirmed Fairfax Financial at Pfd-3, proud issuers of FFH.PR.C, FFH.PR.E, FFH.PR.G, FFH.PR.I and FFH.PR.K:

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Senior Unsecured Debt of Fairfax Financial Holdings Limited (Fairfax or the Company) at BBB. The Preferred Shares are confirmed at Pfd-3. The trends are Stable. The Company’s consolidated underwriting result has been weak in recent years, aggravated by competitive conditions in the commercial lines of the general insurance industry globally and several years of relatively high catastrophic insurance claims, primarily related to the Japan tsunami, Thai floods, New Zealand and Chilean earthquakes and various storm events in North America. Some firming in the market and a recovery in written premiums in 2012 gave rise to a positive underwriting result in the first nine months of 2012. However, DBRS expects that much of this improvement will prove to have been undone by the adverse impact of Hurricane Sandy when Q4 2012 financial results are reported.
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The Company is continuing to grow through strategic acquisitions that have been largely funded through increasing financial leverage. Consolidated debt plus preferred shares as a percentage of capitalization has increased from just over 25% in 2009 to over 36% at September 30, 2012, which is above the current DBRS guidance for a BBB-rated credit. Financial leverage is increasingly taking the form of more tax-efficient preferred share capital and borrowings at the holding company rather than at the operating subsidiary level. With reduced earnings, the corresponding fixed-charge coverage ratios in the past two years have averaged less than 1.5 times, which is below the threshold for an investment-grade company, recognizing that underwriting results have been at a cyclical low point and aggravated by unusual catastrophic claims. The recent addition of $250 million in debt, which will increase the financial leverage ratio in the short term, is mitigated by the fact that the proceeds will be used to retire maturing debt before the end of 2013.

Much of the residual concern that DBRS has for the Company’s increased financial leverage and coverage ratios is mitigated by the close to $1 billion in liquid assets at the holding company level as of September 30, 2012, and a strong component of “permanent” preferred share capital. The Company remains committed to keeping at least $1 billion in cash and liquid securities at the holding company in addition to the excess capital embedded in its operating subsidiaries. The strong liquidity at the holding company helps ensure that the fixed charges can comfortably be paid over time, even though the coverage ratios may tend to suffer through the cycle.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 2bp, FixedResets down 5bp and DeemedRetractibles off 4bp. Volatility was average. Volume was above average.