PrefBlog

Forty! Forty! Forty!:

In its Budget 2013, the government says it’s ready to pounce on “continued low historic rates” and is now assessing the potential of issuing bonds for 40 years  – or  even longer.

“As long-term interest rates remain near historic lows, it remains advantageous and product for the government to continue to lock in additional longer-term funding,” the government says in the document.

Up until now the longest term for a government debt issue has been 30 years but the provinces have been pushing the envelope with longer terms and now Ottawa is considering follow their lead.
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But Ottawa itself seems to like what it sees in the long-term debt market. Just this month New Brunswick issued $225-million in debt at a 3.5% rate that doesn’t mature until June 3, 2065. Quebec issued debt last year that doesn’t mature until 2075.

Looks like I was right yesterday in my musing regarding the end of synthetic tax conversion funds:

This week’s federal budget set the stage to eliminate the tax advantages enjoyed by mutual funds and exchange-traded funds that use derivatives to convert interest income into capital gains.
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Prominent examples of mutual funds that employ these types of strategies include the $3.2-billion Renaissance Corporate Bond Capital Yield , the $1.1-billion Fidelity Canadian Bond Capital Yield and the $843-million TD Corporate Bond Capital Yield .

Also affected by the proposed changes are funds in the small Canadian Synthetic Money Market category. One of the largest of these funds is Mackenzie Sentinel Canadian Short Term Yield Class .
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The budget provision will have a minimal impact on the Canadian ETF industry, said Howard Atkinson, chair of the Canadian ETF Association and CEO of Horizons Exchange Traded Funds Inc. The largest Horizons ETF affected is Horizons Active Advantage Yield HAF , with assets of about $9 million.

Atkinson noted that the budget does not affect total-return swaps, such as those employed by the $1.2-billion Horizons S&P/TSX 60 Index HXT , a derivatives-based fund whose current management fee of 0.05% makes it the cheapest fund in the country. Though Finance Minister Jim Flaherty has taken away one type of derivatives strategy from the managers’ toolkits, derivatives remain very much a part of the investment-funds scene in Canada.

The Spanish bank Bankia has recapitalized:

Spain cut the nominal value of Bankia SA (BKIA) shares to 1 euro-cent from 2 euros in a debt swap that will practically wipe out existing stockholders in the nationalized lender.

The holding company BFA will own about 70 percent of Bankia following a 15.5 billion-euro ($20.1 billion) recapitalization approved by the Frob rescue fund today, an official from the fund said at a briefing in Madrid. Investors who bought subordinated debt or preferred shares will end up with about 30 percent of the bank’s stock.

Spain’s bank rescue fund fixed the price as the basis for converting 4.8 billion euros of hybrid securities including preferred shares and 10.7 billion euros of so-called contingent convertible bonds into stock as part of a 15.5 billion-euro recapitalization of the lender, the fund, known as Frob, said in an e-mailed statement today. Bankia has about 2 billion outstanding shares, which closed today at 25 euro cents.

Cyprus has turned to capital controls – the last refuge of failed states:

Cypriot lawmakers approved capital controls and legislation to wind down banks as they scrambled to secure a European bailout and avert a financial collapse of the Mediterranean island.

The parliament passed nine bills late yesterday after a day locked in talks between Cypriot and international officials in Nicosia. Lawmakers may vote later today on what sort of levy to impose on bank deposits above 100,000 euros ($130,000), four days after rejecting an initial proposal to tax all accounts. Banks have been shut all week and are due to reopen on March 26.

Never let it be said that I never say anything nice on this blog! For instance, on March 25, 2009 and again on April 17, 2012, I said nice things about the Hospitals of Ontario Pension Plan (HOOPP). And now there are more nice things to say:

The Healthcare of Ontario Pension Plan (HOOPP) has posted returns for 2012 of 17.1 per cent, which boosted the pension plan for Ontario healthcare workers to a record $47.4 billion in assets, compared to $40.3 billion at the end of 2011. This strong double-digit return increased HOOPP’s 10-year average rate of return to more than 10 per cent, one of the best long-term records among pension plans worldwide.

At the end of 2012, HOOPP was 104 per cent funded – this fully funded status means the Plan has sufficient assets to pay for every promised member’s pension benefit, with no shortfall.

“HOOPP had a very strong year in 2012 – with our best investment results in more than a decade,” says HOOPP President & CEO Jim Keohane. “This was a year when all of our investment strategies worked. We were firing on all cylinders, with positive returns from every type of investment,” he said. HOOPP’s liability driven investment (LDI) strategy continues to contribute to HOOPP’s success, Keohane added.

“Liability Driven Investment” is the cool way of saying “paying attention to your client’s needs”. HOOPP is in a good position to do this, because they have exactly one client and aren’t looking for new ones, despite idiotic initiatives from Premier Dad’s office that would encourage large plans to stock up on salesmen and get rid of those dreary nerds. That’s the real secret – a focus on return made possible by a complete absence of pressure for sales. Then you can fire the moron whose sole useful attribute is being buddies with a large client; then you can do all kinds of things. In an interview with the Star, though, president and CEO Jim Keohane emphasized scale, which is probably more diplomatic.

It was an unevenly positive day for the Canadian preferred share market, with PerpetualPremiums flat, FixedResets winning 14bp and DeemedRetractibles gaining 8bp. Volatility was minor. Volume was average.

Assiduous Reader KL sends me a link to a critique titled The Paper World of Brookfield Asset Management. which highlights and illuminates many of the issues surrounding the earnings quality of the company. The piece has been published by something called the Southern Investigative Reporting Foundation, which as far as I can tell is Roddy Boyd’s version of self-employment.

Brookfield recently realized $250-million through the sale of some of its BEP.UN Units and is positioning itself for more secondary offerings with an initial spin-off of $900-million of BPY, which is Brookfield Property Partners. Brookfield has not announced any particular plans for spending the proceeds of the BEP.UN position.

Marc Tellier, son of Canadian business legend Paul Tellier, has parted ways with Yellow Media:

Who needs a phone book when you can Google a company’s phone number?

Some might argue there’s nothing Marc Tellier, Yellow Media’s former chief executive officer who left the company Thursday, could do about this. There’s some truth to that. The journalism industry, for one, has been disrupted by the Internet, too.

However, had Yellow Media been more debt-averse, it would have had time to re-tool its business strategy. Remember that when the company reworked its capital structure last year, its cash flows were still relatively strong – so strong that some shareholders argued the debtholders were forcing a restructuring simply to get a better stake in Yellow Media.

Yet the cash flows could only withstand so much debt, which started to become a major problem in early 2011.

I can’t say I’ll be rushing to invest in Paul Tellier’s son’s next venture. However, I continue to be amazed at how quickly YLO’s revenue dropped once the trouble became apparent.

It was the Federal Budget today … some items were:

The lifetime capital gains exemption is increased to $800,000 (from $750,000) on dispositions of qualified property (e.g., qualified small business corporation shares and qualified farm and qualified fishing property) by individuals effective for the 2014 taxation year. The new limit applies to all individuals, even those who previously used the capital gains exemption.

The amount is indexed for inflation for tax years after 2014.
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The budget will phase out the federal tax credit for investments in labour-sponsored venture capital corporations (LSVCC).
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The budget makes the cost to a taxpayer of renting a safety deposit box from a financial institution non-deductible for income tax purposes.
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The International Banking Centre rules exempt certain financial institutions from tax on certain income earned through a branch or office in Montreal and Vancouver.

The budget proposes to repeal these rules. Eliminating the rules is partially in response to the international community having identified these rules as resembling preferential regimes in some tax havens.
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A character conversion transaction generally involves a forward agreement to buy or sell a capital property at a specified future date. The purchase or sale price of the capital property under the forward agreement is not based on the performance of the capital property between the date of the agreement and the future date, but rather is often based on the performance of a portfolio of investments which would generally produce fully taxable ordinary income. If the derivative investment were made separately from the purchase or sale of the capital property (i.e., as a cash settled derivative financial instrument), any income from the derivative investment would be taxed as ordinary income.

The budget proposes to treat the return as being distinct from the disposition of a capital property that is purchased or sold under the derivative forward agreement. This measure will apply to derivative forward agreements that have a duration of more than 180 days.

Any return arising under a derivative forward agreement that is not determined by reference to the performance of the capital property being purchased or sold will be treated as being on income account.

The income (or loss) will be included (or deductible) in computing income at the time of disposition if the capital property is subject to a derivative forward sale agreement and at the time of acquisition if the capital property is subject to a derivative forward purchase agreement.

I think that last one means the end of those silly Mutual Funds that invest in foreign or fixed income securities via a Total Return Swap to call themselves tax-advantaged. But, not having read the budget or the legislation, I’ll wait to see more third party commentary before making that interpretation firm.

Also of interest is The Securities Regulator That Would Not Die:

The Harper government is serving notice that it will impose a federal regulator on Canada’s securities markets if it can’t win sufficient backing from provinces for a jointly-run approach.

The ultimatum, delivered in the 2013 federal budget Thursday, comes after six years of efforts by Finance Minister Jim Flaherty to build support for a common securities regulator among mostly hesitant premiers.

And, wonder of wonders, Genius Boy is doing something useful about mortgage insurance:

In the federal budget tabled Thursday, Ottawa announced further steps to limit taxpayers’ exposure to the mortgage market by cracking down on banks’ ability to use bulk mortgage insurance as a tool to offset their risks and boost their bottom lines.
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Banks started buying more bulk insurance during the financial crisis because it makes it easier for them to package their mortgages into securities, which ultimately helps them to lend more. But they’ve also been upping their purchases because by insuring mortgages they can reduce the amount of capital they’re required to hold.

Ottawa has been concerned about the growth of mortgage insurance for some time. Last year it capped the total amount of mortgage insurance that CMHC can have in force at $600-billion. As a result, CMHC, which was already creeping up toward that level, began rationing its sale of bulk insurance while maintaining sales levels of standard mortgage insurance (that on loans to borrowers with small down-payments).

I’m relieved to learn that access to bulk insurance is being rationed. After all, if it wasn’t rationed it would have to be auctioned, and this would reduce the power of bureaucrats and politicians to influence who gets to make what profits.

Cyprus might sell energy assets to Russia:

The government also submitted a draft law to create an “investment solidarity fund,” state-run CYBC television reported. The fund is intended to help raise the 5.8 billion euros needed to trigger emergency loans, Athens News Agency reported. Finance Minister Michael Sarris said in Moscow that while Russia won’t lend money to Cyprus, it’s looking at investment in the energy industry.

Russia is in talks over its possible role in the fund, the RIA Novosti news agency reported. President Vladimir Putin held talks in Moscow today with Jose Barroso, head of the European Commission, Putin’s spokesman Dmitry Peskov told reporters.

Earlier, Prime Minister Dmitry Medvedev said Cyprus’s financial turmoil may force Russia to review the share of euros in its international currency reserves, the world’s fourth- largest stockpile.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 3bp, FixedResets down 12bp and DeemedRetractibles ahead 2bp. Volatility was average, enlivened by a ridiculous quote on BAM.PR.C which illustrates the careful attention to detail so prevalent among professional Market Makers. Volume was average.

The Fed will continue to pour money into the economy:

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.

And so the stock market continues to rise:

The S&P 500 (SPX) advanced 0.7 percent to 1,558.71 at 4 p.m. in New York, trading within seven points of its record reached in 2007. The Dow Jones Industrial Average rose 55.91 points, or 0.4 percent, to 14,511.73. About 5.9 billion shares traded hands on U.S. exchanges today, 6.3 percent below the three-month average.

Cyprus is scrambling to figure out what comes next:

The Cypriot government is scrambling to find bailout “Plan B” as anxieties rise about the timing of the reopening of the banks.

Cypriot banks remained closed again Wednesday and the government’s self-imposed deadline to reopen them by Thursday seems unlikely to be met. While some ATMs still have cash, businesses fear they will soon get crippled unless they can resume normal banking activities, such as making payments to foreign suppliers.

The Cypriot government was locked in meetings Wednesday in Nicosia to try to create a new bailout plan that would be acceptable to the Euro group – the finance ministers of the 17 euro zone countries.

Cyprus’s finance minister, Michael Sarris, was in Moscow Wednesday to seek financial assistance from the Russian government as Russia emerged as a potential saviour. Cypriot president Nicos Anastasiades used a half-hour phone call with his Russian counterpart, Vladimir Putin, to ramp up the save-Cyprus pressure.

Here’s one way to beat deposit taxes:

Gold use in India, the world’s biggest buyer, may climb for the first time in three years as rising incomes and inflation boost investment demand, undermining efforts to narrow a record current-account deficit.

Consumption may total 865 metric tons to 960 tons this year, compared with 864.2 tons in 2012, Somasundaram P.R., managing director of the World Gold Council for India, said in an interview in Mumbai. The gain in imports will match the increase in demand, he said. The country imported 860 tons last year, according to data from the council.

India has tripled the tax on imports since the start of 2012 to moderate demand as gold accounted for almost 80 percent of the current-account deficit, the broadest measure of trade. Gold rallied for 12 straight years, driven in part by demand from investors looking for a store of wealth amid concern about inflation. Goldman Sachs Group Inc. predicts the rally will end as a U.S. economic recovery gathers momentum.

I mentioned Spend-Every-Penny’s outrageous interference in the Canadian mortgage market yesterday. It appears I’m not the only one:

>Not everyone in the Conservative cabinet is backing Jim Flaherty’s latest intervention in the mortgage market.

Small Business Minister Maxime Bernier says he believes the finance minister overstepped his bounds by having his office phone Manulife Financial and ask they withdraw their discount on five-year mortgages to 2.89 per cent from 3.09.

Bernier told reporters Wednesday he would not have done it.

“Me, personally, I would not dictate to businesses what prices to decide,” he said.

“It’s the market. It’s supply and demand that decides the prices. It is the case for interest rates, it is the case for other products too.”

There were plenty of alternatives to this reckless action:

Toronto-Dominion Bank chief economist Craig Alexander said that if Ottawa feels the need to take more action on this front, one tool at its disposal could be setting a minimum interest rate at which people must qualify for an insured mortgage. That would prove buyers could withstand higher rates. But it would not stop them from enjoying lower rates if banks are willing to offer them.

I have no problem with the ethics of the feds setting their own rules for their own mortgage insurance – although I think their policies for the past decade have been stupid. It’s when they start micromanaging unrelated business that I get upset.

It was another mixed day for the Canadian preferred share market, with PerpetualPremiums up 16bp, FixedResets off 5bp and DeemedRetractibles ahead by 5bp. Volatility seems a bit high, but it’s just the Floaters that make it look good. Volume was on the low side.

PerpetualDiscounts now yield 4.85%, equivalent to 6.30% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.25%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 205bp, a slight (and perhaps spurious) decline from the 210bp reported March 13.

The Fed commented on a deposit tax in 1941:

In our opinion, however, your proposal is not in accord with one of the fundamental principles of taxation in a democracy, namely, that taxes should be imposed in accordance with ability to pay. Under your proposal deposit holders would be taxed on the number of dollars deposited by them. A small business man, for instance, who earns a moderate income may have a very active deposit account which reflects the whole volume of his business transactions rather than his net profits. His deposit tax might exceed that of an individual who is much better off but whose only deposits consist of salary or dividend checks. An equitable tax would bear more heavily on the latter than on the former.

It is this rather simple argument that puts paid to this apology for the Cyprus tax:

Ultimately, taxing bank deposits (or, as Caroline Baum at Bloomberg View says, “confiscating” them) has many of the same effects as a currency devaluation. Whether the devaluation happens overnight, as it did in Argentina in 2002, or over an extended period of inflation, the ultimate hit to savers of all kinds is the same as a tax on deposits.

This is totally nonsensical. The ultimate hit to savers by devaluation or inflation is not even close to the effects of a deposit tax – because a deposit tax is not a wealth tax. Bond holders get off scot-free with a deposit tax. So do stock-holders. So do real estate owners. So do … the list is endless.

However, there are now concerns about banks’ senior debt:

Europe’s unprecedented tax on Cyprus bank deposits is raising concern among holders of senior bank bonds that they’ll be made to take losses should another country need rescuing.

The Markit iTraxx Financial Index of credit-default swaps insuring senior debt of 25 banks and insurers rose as much as 19 basis points to 162 basis points yesterday, according to prices compiled by Bloomberg. That’s the biggest jump since Aug. 2, before the European Central Bank steadied markets by announcing its bond-buying program, and the gauge is now at the highest in more than two weeks.

As noted yesterday, Russia is most upset about the Cypriot deposit tax. Here’s why:

Wealthy Russian individuals do not, as a rule, keep their private fortunes in Cypriot banks. They prefer stronger financial institutions or less transparent jurisdictions. Yet Russian corporations have used Cyprus extensively since the 1990s. The island uses English law, convenient for settling disputes. The corporate tax, at 10 percent, is among Europe’s lowest. Nonresidents’ dividends are exempt from withholding tax. The authorities have always been pro-business and, according to people conducting their affairs in Cyprus, willing to turn a blind eye when necessary.

As a result, in the third quarter of 2012 (the last period for which data from the Russian Central Bank are available), Cyprus was Russia’s second biggest source of foreign direct investment after Luxembourg. Since 2007, more than $114 billion has flowed into Russia from the small Mediterranean nation, practically all of it Russian money paid as dividends by Cyprus- registered holding companies and reinvested into Russian production assets. Much of that money comes into Russia in the form of loans, an approach that minimizes corporate taxes. All of Russia’s big metals exporters and its biggest independent natural gas producer, Novatek, have corporate structures and bank accounts in Cyprus.

However, Cyprus has told the EU to go experiment somewhere else!

Cyprus’s parliament rejected an unprecedented levy on bank deposits, dealing a blow to European plans to force depositors to shoulder part of the country’s rescue in a standoff that risks renewed tumult in the euro area.

Cypriot legislators in the capital Nicosia voted 36 against to none in favor of the proposal in a show of hands today. There were 19 abstentions. Hammered out by euro-area finance chiefs over the weekend, the deal had sought to raise 5.8 billion euros ($7.5 billion) by drawing funds from Cyprus bank accounts in return for 10 billion euros in international aid.
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Outside, the parliament was surrounded by demonstrators singing the national anthem and chanting “this will not pass.” The crowd cheered when the results of the vote came through.

The euro declined 0.6 percent to $1.2878 as of 7:47 p.m. in Frankfurt. The Stoxx Europe 600 Index (SXXP) dropped 0.4 percent, the third straight drop. Spanish 10-year bonds fell for a fifth day, with the yield climbing 8 basis points to 5.03 percent.

You’ve heard of Helicopter Ben? He’s got competition from Akrotiri Osbourne:

The U.K.’s Royal Air Force is flying 1 million euros ($1.3 million) to Cyprus for military personnel stationed on the island to ensure they don’t run out of cash.

The move came after Chancellor of the Exchequer George Osborne said two days ago that the U.K. will compensate military and civilian personnel in Cyprus who lose out as a result of the European Union’s levy on deposits in Cypriot banks to fund a rescue package for the indebted nation.

An RAF flight left for Cyprus this afternoon with 1 million euros on board as a contingency measure to provide military personnel and their families with emergency loans in the event that cash machines and debit cards stop working completely,” the Ministry of Defence in London said in an e- mailed statement today. “We will keep this under review and consider further shipments if required.”

Here in Canada, there is unprecedented federal micromanaging:

Manulife Bank has reversed its move to cut the mortgage rates it offers home buyers after a rebuke from the federal Finance Ministry, The Globe and Mail has learned.

"After consulting with the Department of Finance, Manulife Bank has withdrawn the promotional campaign and reverted to our previous posted rate,” a spokesperson for Manulife Financial Corp. said in an e-mailed statement.
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The Globe and Mail reported Tuesday that Manulife had cut its rate for five-year fixed mortgages to 2.89 per cent from 3.09 per cent, part of a move by lenders to drive down rates to attract home buyers in the spring selling season.

A spokesperson for Finance Minister Jim Flaherty said an official from the Minister’s office contacted Manulife Monday evening to express concern with the rate cut.

The spokesperson said Mr. Flaherty was not happy with Manulife’s decision, and felt the move was unacceptable.

I hadn’t realized that one problem with US student loans was idiotic collection incentives:

The law mandates no minimum payment for a borrower to enter a rehabilitation program, and collection companies may take borrowers’ finances into account.

Yet, under the old contract, the companies received a much higher commission if borrowers made a minimum payment of 0.75 percent to 1.25 percent of the loan each month, depending on its size.

For example, a $20,000 loan would require payments of about $200 a month for the collection company to get its full commission. Then, the collector would receive 16 percent of the loan amount — or $3,200. If the payment fell below that figure, the collector got an administrative fee of $150.

That differential provided an incentive for collectors to insist on the amount triggering the commission and fail to tell borrowers they could pay less, Yu said. Under the new contract, borrowers with high debts and low incomes could get back on track while making payments of as little as $5 a month, while collectors could still make their commission.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums off 2bp, FixedResets roaring ahead by 25bp and DeemedRetractibles up 8bp. Volatility was good and uniformly positive; dominated (as might be expected given the returns) by FixedResets. Volume was high.

Remember the old Traders’ Rule? “If you owe a million, you’ve got a problem. If you owe a billion, they’ve got a problem.” The EU has come up with a variation on this for sovereigns: If you owe €10-billion, you’ve got a problem:

Euro-area finance ministers agreed to an unprecedented tax on Cypriot bank deposits as officials unveiled a 10 billion-euro ($13 billion) rescue plan for the country, the fifth since Europe’s debt crisis broke out in 2009.

Cyprus will impose a levy of 6.75 percent on deposits of less than 100,000 euros — the ceiling for European Union account insurance — and 9.9 percent above that.
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Officials have struggled to find an agreement that would rescue Cyprus, which accounts for just half of a percent of the euro region’s economy, without unsettling investors in larger countries and sparking a new round of market contagion.
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While the tax on deposits carries some risks of setting a precedent for other countries in the euro area, the ECB has shown it’s prepared to do what it takes to preserve the currency union, said Holger Schmieding, chief economist at Berenberg Bank in London.

“We are optimistic that it will not spark massive contagion,” Schmieding said in a note. “Still, with the unprecedented haircut on Cypriot bank deposits we are in uncharted territory again.”

So my question is this: Why would anybody keep anything more than a month’s expenses in a European bank?

The plot thickened over the weekend:

Cyprus’s parliament postponed an emergency session called to approve a levy on bank deposits on Sunday after signs lawmakers could block the surprise move agreed in Brussels to help fund a bailout and avert national bankruptcy.

Early market reaction is unfriendly:

The levy is “a worrying precedent with potentially systemic consequences if depositors in other periphery countries fear a similar treatment in the future,” Joachim Fels, chief economist at Morgan Stanley in London, wrote in a note to clients.

Scenes of Cypriots lining up at cash machines raised the specter of capital flight elsewhere and threatened to disrupt a market calm that settled over the 17-member bloc since the ECB’s pledge in September to backstop troubled nations’ debt. With no government in Italy, Spain in the throes of a political scandal and Greece struggling to meet the terms of its own bailout, more turmoil could hamper efforts to end the crisis.

Anticipating gains in haven markets, Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co. in Newport Beach, California, said on Twitter that the concern in Cyprus “moves risk-on trade to backseat.”

“Sell euro as well,” he wrote.
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Barclays Plc (BARC) said in a report today that the deposit levy is the latest erosion of bondholder protection at European banks and an “ominous” sign of how bailouts are being handled.

The ECB’s pledge to buy bonds should prevail over market panic, though the tax on deposits brings the euro area into “uncharted territory again,” Holger Schmieding, chief economist at Berenberg Bank in London, wrote in a note yesterday.

“Given the fragile state of the banking systems, especially in Greece and Spain, anything that can impede the needed rebuilding of confidence in these banking systems can potentially cause financial and economic damage,” he said.

Early indications were not promising:

The euro dropped to its lowest level this year against the dollar after an unprecedented levy on bank deposits in Cyprus threatened to derail the nation’s bailout and spark a new round in Europe’s debt crisis.

The 17-nation euro declined by the most in three weeks against the yen as investors sought haven assets after Cypriot President Nicos Anastasiades bowed to demands by euro-area finance ministers to raise 5.8 billion euros ($7.5 billion) by taking a piece of every bank account in Cyprus. The yen rose against all of its 16 major peers after Anastasiades delayed a vote on the measure in parliament until today.

It got worse as the day wore on:

The euro slid the most in 14 months against the dollar after a proposed levy on bank deposits in Cyprus threatened to worsen the European debt crisis.

The 17-nation currency fell to a two-week low versus the yen as the nation postponed a vote on meeting demands by regional finance ministers to raise 5.8 billion euros ($7.5 billion) by imposing losses on its depositors. The euro pared its drop as declines in Italian and Spanish government bonds were limited. The New Zealand dollar and Mexican peso weakened as investors sold higher-yielding currencies.

“The biggest fear right now is that there could be a domino effect, which is pushing the euro down,” Douglas Borthwick, a managing director and head of foreign exchange at Chapdelaine & Co. in New York, said in a telephone interview. “What the market doesn’t understand is that people who take out money may still put it elsewhere in the euro zone, so I would argue that it’s not euro-negative.”

So towards the end of the day, the EU suggested a novel adjustment – soak the rich:

European policy makers signaled flexibility on the application of an unprecedented bank tax in Cyprus, seeking to overcome outrage that threatens to derail the nation’s bailout. European shares and the euro fell.

While demanding that the levy raise the targeted 5.8 billion euros ($7.6 billion), finance officials said easing the cost to smaller savers was up to Cyprus. A vote on the tax, needed to secure 10 billion euros in rescue loans, was delayed for a second day until tomorrow. Banks will remain shut through March 20 after a holiday today, a government official said. Euro-area finance ministers plan a conference call at 7:30 p.m. Brussels time today to discuss the matter.

“If the government wants to change the structure of the solidarity levy for the banking sector, the government can decide as such,” European Central Bank Executive Board member Joerg Asmussen said today in Berlin. “What’s important is that the planned revenue of 5.8 billion euros remain.”
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Russian President Vladimir Putin called the tax “unfair, unprofessional and dangerous,” according to a statement posted on the Kremlin website. Russian companies and individuals have $31 billion of deposits in Cyprus, according to Moody’s.

Cypriot banks had 68.4 billion euros in deposits from clients other than banks at the end of January. Of that, 21 billion euros, or 31 percent, were from clients outside the euro area, 63 percent were from domestic depositors, and 7 percent were from other nations within the euro region, according to data from the Central Bank of Cyprus.

Now it’s finger-pointing time:

As after German Chancellor Angela Merkel’s beach-front walk with France’s then-President Nicolas Sarkozy in Deauville, the Cypriot package set off a flurry of recriminations, with European and national officials alternately taking credit for and distancing themselves from the deal.

First up was German Finance Minister Wolfgang Schaeuble, who blamed the idea of a confiscatory tax — and by implication, the market fallout — on the unelected technocrats at the European Commission and the European Central Bank.

“We of course would have respected the deposit insurance that guarantees accounts up to 100,000 but those who opposed a bail-in — the Cypriot government, also the European Commission and the ECB — they decided on this solution and now they have to explain it to the Cypriot people,” Schaeuble said.

What he neglected to say, on ARD television late yesterday, was that Germany favored an even more radical “bail-in” that would have exploded Cyprus’s banking system and propelled the country toward a euro exit, potentially making for a bigger mess than the one that unfolded on the markets today.

Schaeuble drew criticism from the Cypriot side for heavy- handed tactics. At one point, a Cypriot official said under cover of anonymity, he demanded a 40 percent depositor tax. A Schaeuble aide contacted by Bloomberg didn’t immediately respond to that observation.

And now the US Treasury’s getting involved:

The U.S. called for a “responsible and fair” resolution to the financial crisis in Cyprus, where a proposed tax on bank deposits roiled global markets.

The Treasury Department is “monitoring the situation in Cyprus closely,” and Secretary Jacob J. Lew has been speaking with his European counterparts, the department said in an e- mailed statement today. “It is important that Cyprus and its euro-area partners work to resolve the situation in a way that is responsible and fair and ensures financial stability.”

Hands up whoever is in favour of responsibility and fairness!

Bloomberg wants in on the action:

Of all the many steps that the euro area has taken to contain its debt crisis, the decision to force ordinary savers in Cyprus to contribute to their country’s bailout is the worst.
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Technically, the rescue package for Cyprus doesn’t violate the euro area’s guarantee that all deposits up to 100,000 ($130,000) are insured. That’s because the proposal for the Cypriot government to take 6.75 percent of all bank deposits less than 100,000 euros, and 9.9 percent above that amount, is defined as a tax. Depositors, however, will see this for what it is: a raid on their savings.

Megan Greene chimes in:

If there were a bank run in the euro area, the ECB would probably finance the run by allowing national central banks to provide emergency lending assistance. Such borrowing by banks is guaranteed by the government, further blurring the line between the finances of the commercial banks and the state.

Second, the Cyprus bailout deal makes a mockery of deposit insurance in Europe. This doesn’t bode well for the credibility of a European Union-wide deposit guarantee, one of the basic tenets of a banking union.

The bailout agreement will fail to deal with the Cyprus problem and may reintroduce the risk of a financial collapse in the region, which had been significantly reduced. If this is the case, then market pressure on the weaker economies in Europe could reach levels not seen since last August, only this time against a backdrop of much higher austerity fatigue. That is an explosive combination.

In a development that I would like to stress has NO RELATIONSHIP WHATSOEVER to the Cyprus mess, the Europeans are beating up on the Credit Rating Agencies again:

Credit rating companies are falling short of standards set by European Union, the bloc’s chief markets regulator said.

The regulator highlighted failings in the “process of disclosure and implementation of changes” to the methodology used to rate the creditworthiness of Europe’s banks, the Paris- based European Securities and Markets Authority said in an e- mailed statement today.

“Considering the continued importance of credit ratings in financial markets it is extremely important that credit rating agencies identify and remedy those issues in their businesses which may undermine the independence, objectivity and the quality of credit ratings,” Steven Maijoor, ESMA’s chairman said in the statement.

If you owe €80-billion, they’ve got a problem:

Euro-area finance ministers agreed to extend maturities on rescue loans to Ireland and Portugal, easing the terms on two recipients of European bailout aid in a show of support for their commitment to austerity.

The ministers gave no details on the extension. Those will be worked out by the so-called troika that oversees euro-area bailouts and the European Financial Stability Facility, the currency bloc’s temporary rescue fund, the finance chiefs said today. The details will be presented to euro ministers at the same time as the memorandum of understanding underlying a rescue program for Cyprus.

Dallas Fed President Richard W. Fisher made a speech titled Ending ‘Too Big to Fail’:

Their exalted status also emboldens a sense of immunity from the law. As Attorney General Eric Holder frankly admitted to the Senate Judiciary Committee on March 6, when banks are considered too big to fail, it is “difficult for us to prosecute them … if you do bring a criminal charge, it will have a negative impact on the national economy.”[Footnoted Link]
…
The 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act was a well-intentioned response to the problem. However, its stated promise—to end too big to fail—rings hollow. Running 849 pages and with more than 9,000 pages of regulations written so far to implement it, Dodd–Frank is long on process and complexity but short on results.

Regulators cannot enforce rules that are not easily understood.

Nor can they enforce these rules without creating armies of new bureaucrats. Congress’s Financial Services Committee aggregates information from the Federal Register that estimates the cumulative hours needed for the affected agencies, like the Fed, to fulfill new requirements called for by Dodd–Frank. The committee presently estimates that it will take 24,180,856 hours each year to comply with new rules already finalized for implementation of the act.[7] And we have yet to complete the rulemaking process!

Fisher did not address the critique of the “TBTF Funding Advantage” discussed on March 11.

I mentioned Chesapeake Energy’s bonds on March 7 in connection with “Covenant Arbitrage”, a fancy way of saying “Reading the Prospectus”. That situation, in which some were betting that the company would be forced to redeem some bonds at a premium, appears to have been resolved:

Chesapeake Energy Corp. (CHK) issued a notice to redeem $1.3 billion in bonds early, at par, after a judge ruled that the gas producer would probably prevail in court over any demand to pay $400 million in extra interest.

The company said in a statement today that it will continue to pursue a federal lawsuit to confirm that it has met the deadline to redeem without triggering a “make-whole” provision that would require paying the extra interest. The 6.775 percent notes fell the most since May.
…
The $1.3 billion of 6.775 percent notes due March 2019 fell 2.75 cents on the dollar to 104.5 cents to yield 5.87 percent at 11:30 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The shares rose 40 cents to $22.92 at 11:40 a.m. in New York Stock Exchange composite trading.

Chesapeake, the second-biggest natural gas producer in the U.S., argued that today is the deadline for it to issue a notice of early redemption and avoid the make-whole provision. BNY Mellon (BK) said the call would have to be completed today and it’s now too late. Payment will be made on May 13 subject to a court ruling that Chesapeake met its deadline, according to today’s statement.

Engelmayer, in his ruling, said the contract was ambiguous and he would need to see evidence about how it was drafted before deciding at a trial which side is correct.

Here’s a law of interest:

From July 1, parents in China can sue their kids who don’t visit often enough, under a broadened law mandating children take better care of the aged. With China’s elderly population forecast to more than double to 487 million in the next 40 years, the government needs to try and limit the cost of caring for seniors.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 3bp, FixedResets down 8bp and DeemedRetractibles off 5bp. Volatility was negligible. Volume was on the high side of average.

Revolving door regulation is usually more subtle than this:

Lerner, 60, pleaded guilty this week to public-corruption charges. Commerzbank hired him from the Internal Revenue Service in 2011 while he was an examiner responsible for negotiating a tax-fraud settlement with the bank, according to the criminal complaint that prosecutors filed in September. Commerzbank paid the IRS $210 million one day before offering Lerner the job, which he accepted immediately. The figure was 62 percent of the potential taxes due. Bank employees later told federal investigators it had been willing to pay much more money to settle the audit.
…
The government’s complaint said Lerner met in New York with unidentified Commerzbank executives in July and August 2011 to discuss the IRS’s audit and his possible employment at the bank. After Lerner told the IRS he was resigning in August 2011, his supervisor there gave him a document describing his lifetime prohibition on attempting to influence IRS employees regarding matters he had worked on at the agency. Lerner’s resignation letter didn’t identify Commerzbank as his new employer. Later that month, Lerner participated in a meeting at the IRS about the bank’s settlement, according to the government’s complaint.

The $210 million tax settlement Lerner negotiated with Commerzbank was still pending final approval when he left the IRS. After Lerner began working at Commerzbank in September 2011, the government said he spoke repeatedly with IRS examiners involved in the audit, asking about the status of the case and arguing on Commerzbank’s behalf to bring it to a close. Some of the discussions took place with another Commerzbank employee present.

I have previously criticized Modigliani-Miller in the context of bank capitalization. Here’s another critique:

Capital gains on a private equity investment reflect any value added in restructuring the company, for example by raising revenues and increasing margins. These gains should, to a certain extent, be determined by the skill of the general partner in setting strategy and, in some cases, introducing new management. But they are also a function of deal leverage: in certain cases, the total cost of an acquisition will fall with the amount of debt funding used, implying that returns can be increased through greater leverage.[Footnote]

[Footnote reads:] This results from a failure of the Modigliani-Miller (M-M) Capital Irrelevance Theorem (1958). A failure of M-M rests on there being financial frictions that distort the relationship between the cost of debt and the amount of equity. If capital markets were fully efficient, the capital structure of a transaction would have no impact on its overall cost of funding. A variety of information and incentive problems and policy distortions (for example the tax deductibility of debt) are widely believed to cause deviations from this theoretical equilibrium.

That paper, by the way, had the usual things to say about private equity:

Private equity fund performance and leverage

Data published by trade bodies (for example, the British Venture Capital Association and European Venture Capital Association) show that buyout fund returns consistently outperform other forms of private equity investment, as well as other, alternative, asset classes.

Academic studies, however, reveal more mixed results. For example Kaplan and Schoar (2005) and Phalippou and Gottschalg (2009) show that private equity funds earn gross returns that exceed the S&P 500 average, but that once fees are taken into account, the net return is equal to or lower than S&P 500 average returns.

Axelson, Strömberg and Weisbach (2009) highlight the procyclical nature of the private equity industry, with a theoretical paper arguing that general partners have the incentive to invest in ‘bad deals’ in periods of loose credit conditions. A follow-up empirical paper by Axelson et al (2012) finds that variation in economy-wide credit conditions is the main determinant of leverage in buyouts, and that greater deal leverage is associated with higher deal values and lower investor returns.

That paper appeared in The Bank of England Quarterly Bulletin. One interesting point they made was:

Click for Big

The lack of primary issuance has made it difficult to know for certain at what cost UK banks would be able to finance themselves were they to issue new debt. Available secondary market bond spreads imply that there has been little change in the cost of market funding over the period (Chart 7).

Meanwhile, UK bank credit default swap (CDS) premia, which represent the cost of insuring against default on bank debt, and are sometimes used as an indicative measure of long-term wholesale market funding costs, have fallen (Chart 7). But they remain well above comparable secondary market bond spreads. That gap reflects, in large part, the lack of supply of cash bonds, in conjunction with limited arbitrage between the cash and CDS markets. On balance, while contacts tend to consider secondary market spreads to be a better proxy of bank funding costs than CDS, it may be that secondary spreads would rise were banks to begin to issue more debt.

Stacey Anderson, Jean-Philippe Dion and Hector Perez Saiz have published a BoC Working Paper titled To Link or Not To Link? Netting and Exposures Between Central Counterparties:

This paper provides a framework to compare linked and unlinked CCP configurations in terms of total netting achieved by market participants and the total system default exposures that exist between participants and CCPs. A total system perspective, taking both market participant and CCP exposures into account, is required to answer an important policy question faced by some smaller jurisdictions: whether or not to consider linking a domestic CCP with one or more offshore CCPs. Generally, a single global CCP results in the lowest total system exposure as it allows for multilateral netting across all participants while avoiding the creation of inter-CCP exposures via links. However, global clearing may not be appropriate for all markets. Using a two country model, with a global CCP serving both markets and a local CCP clearing only domestic country participants’ transactions, we show that establishing links between two CCPs leads to higher exposures for the domestic CCP and can result in a decrease in overall netting efficiency and higher total system exposures when the number of participants at the local CCP is small relative to the number of participants at the global CCP. As the relative weight applied by decision makers to CCP exposures as compared to market participants’ exposures increases, so does the number of domestic participants required to make the linked case preferred from a total system perspective. Our results imply that the establishment of a link between a small domestic CCP and a larger global CCP is unlikely to be desirable from a total system perspective in the majority of cases.
…
Establishing links between CCPs in di¤erent jurisdictions could allow any of the above mentioned lost netting opportunities to be regained. Links are contractual agreements whereby two CCPs agree to multilaterally net exposures across their combined membership. Market participants, through their access to a linked domestic CCP, would therefore net exposures across a broader range of counterparties. The creation of links between CCPs does, however, pose challenges. By creating credit exposures between CCPs themselves, links create new channels for risk propagation. If a linked CCP were to default, the surviving CCP would need to ful…ll the contractual obligations of cleared contracts to its members. Although not the subject of this paper, links may also create oversight challenges due to additional operational, legal and liquidity risks and increase complexity while reducing the transparency of exposures in the clearing system (CGFS (2011)).

I am pleased to see an acknowledgement that placing all of one’s eggs in a single Too Big To Fail basket is not necessarily a wonderful idea. Perhaps at some point the Bank will sponsor research into risk propogation via CCPs, but I’m not holding my breath on that one.

There’s an interesting point in Rohinton Medhora’s Global rankings: Although inequality between countries is falling, inequality within countries is rising:

>First, integral to the rise of the South is the growth of a middle class the world over. Citing a Brookings Institution study, the UN report estimates that the middle class numbered 1.8 billion in 2009, about one billion of whom lived in Europe and North America. Globally, the number is expected to rise to 3.3 billion in 2020 and 4.9 billion in 2030, the entire growth occurring in Asia, Africa and Latin America.

At the same time, although inequality between countries is falling, inequality within countries – especially the growth success stories such as China and India – is rising.

Just like their counterparts in developed countries, policymakers in developing countries will increasingly be preoccupied with managing middle-class vulnerability. Their challenge will be to fight inequality, not poverty, so as to preserve political stability.

So now, instead of the also-rans in rich countries living well by sponging off the local hot-shots at the expense of everybody in poor countries, we now have more localized inequality that can’t be enforced militarily. It will be most interesting to see how the localized tension plays out…

On an obscurely related note, I had great fun today arguing in favour of a downtown casino in the Globe’s comments section. My comment is the most disliked comment of all – the place of honour!

DBRS confirmed Enbridge Gas Distribution at Pfd-2(low):

EGD’s low business risk profile is supported by a large customer base (approximately two million customers, the largest in Canada), which has allowed the Company to achieve operational efficiency and generate stable earnings and cash flow. In 2013, the rebasing year, EGD’s approved return on equity increased to 8.93% (8.39% in 2012) and distribution rates increased to $1,021 million ($1,004 million in 2012). However, the deemed equity component of the Company’s capital structure remained unchanged at 36%. The Company benefits from a stable regulatory system, having no exposure to gas price risk in Ontario, where it generates approximately 98% of its revenue. EGD’s franchise area (largely in the Greater Toronto Area) is viewed as one of the most rapidly growing and economically strong service areas in Canada. Approximately 94% of the Company’s earnings are generated from relatively stable regulated distribution, transportation and storage business. The remainder is generated from the unregulated storage business, which benefits from strong demand due to its strategic locations.

Note that Enbridge Gas Distribution is a different company than Enbridge Inc., which is its parent:

The Company owns 100% of the outstanding common shares of EGD; however, the four million Cumulative Redeemable EGD Preferred Shares held by third parties are entitled to a claim on the assets of EGD prior to the common shareholder. The preferred shares have no fixed maturity date and have floating adjustable cash dividends that are payable at 80% of the prime rate. EGD may, at is option, redeem all or a portion of the outstanding shares for $25 per share plus all accrued and unpaid dividends to the redemption date. As at December 31, 2012, no preferred shares have been redeemed.

EGD’s Annual Report (SEDAR) states these are:

Group 3, Series D, Fixed / Floating Cumulative Redeemable
Convertible

There are four million oustanding at $25.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums up 11bp, FixedResets down 13bp and DeemedRetractibles gaining 4bp. Volatility was low. Volume was below average.

To the astonishment of many, a Senate committee criticized a bank:

JPMorgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon sought to hide escalating trading losses that surpassed $6.2 billion, misled investors and dodged regulators as a “monstrous” derivatives bet deteriorated last year, a Senate probe found.

The largest U.S. bank “mischaracterized high-risk trading as hedging,” and withheld key information from its primary regulator, sometimes at Dimon’s behest, according to a report yesterday by the Senate Permanent Subcommittee on Investigations. The 301-page document also shows how managers manipulated internal risk models and pressured traders to overvalue their positions in an effort to hide growing losses in a credit derivatives portfolio in London.

“We found a trading operation that piled on risk, ignored limits on risk taking, hid losses, dodged oversight and misinformed the public,” Chairman Carl Levin, a Michigan Democrat, told reporters yesterday after his investigators spent nine months combing through 90,000 documents and interviewing current and former executives.

The full report is available on the committee’s website. The conclusion is fore-ordained:

The JPMorgan Chase whale trades provide a startling and instructive case history of how synthetic credit derivatives have become a multi-billion dollar source of risk within the U.S. banking system. They also demonstrate how inadequate derivative valuation practices enabled traders to hide substantial losses for months at a time; lax hedging practices obscured whether derivatives were being used to offset risk or take risk; risk limit breaches were routinely disregarded; risk evaluation models were manipulated to downplay risk; inadequate regulatory oversight was too easily dodged or stonewalled; and derivative trading and financial results were misrepresented to investors, regulators, policymakers, and the taxpaying public who, when banks lose big, may be required to finance multi-billion-dollar bailouts.

However, there are points of interest for the connoisseur. It appears that gross incompetence in back- and mid- offices is still just as much a problem as it ever was:

For five days, from March 12 to 16, 2012, Mr. Grout prepared a spreadsheet tracking the differences between the daily SCP values he was reporting and the values that would have been reported using midpoint prices. According to the spreadsheet, by March 16, 2012, the Synthetic Credit Portfolio had reported year-to-date losses of $161 million, but if midpoint prices had been used, those losses would have swelled by another $432 million to a total of $593 million.
…
One result of the CIO’s using more favorable valuations was that two different business lines within JPMorgan Chase, the Chief Investment Office and the Investment Bank, assigned different values to identical credit derivative holdings. Beginning in March 2012, as CIO counterparties learned of the price differences, several objected to the CIO’s values, resulting in collateral disputes peaking at $690 million. In May, the bank’s Deputy Chief Risk Officer Ashley Bacon directed the CIO to mark its books in the same manner as the Investment Bank, which used an independent pricing service to identify the midpoints in the relevant price ranges. That change in valuation methodology resolved the collateral valuation disputes in favor of the CIO’s counterparties and, at the same time, put an end to the mismarking.
…
According to Ina Drew, the large collateral disputes generated a series of questions internally about the CIO’s valuation process. She told the Subcommittee that Jamie Dimon “felt that one way to find out [about the validity of the disputes] was to ask [head of the CIO’s International Office] Mr. Macris, [head of the CIO’s equity and credit trading operation] Mr. Martin, and [senior CIO trader] Mr. Iksil to narrow the bid-offer spreads.

Two months to resolve a collateral deficiency? and at J.P. Morgan, collateral disputes being resolved by the trading department? Ridiculous.

Westjet hopes to have seen the last of Ottawa’s golden boys:

Competitor WestJet Airlines Ltd., which has a very different pension structure based on share purchase plans rather than Air Canada’s more traditional pension packages, opposed the arrangement. “While we recognize this has been a difficult decision for the government, we are disappointed with this announcement,” said WestJet president and chief executive officer Gregg Saretsky.

“We are supportive of a strong and competitive aviation industry in Canada. To that end, we trust this marks the end of special treatment for Air Canada as such treatment at the expense of other industry players has become too common,” he added in a written statement.

They (and we) will be lucky. Air Canada isn’t good at much, but it is good at sucking federal arse.

Capital Power Corporation, proud issuer of CPX.PR.A, CPX.PR.C and the new CPX.PR.E, was confirmed today at Pfd-3(low) by DBRS:

DBRS has today confirmed the ratings of the Preferred Shares of Capital Power Corporation (CPC or the Company) at Pfd-3 (low) with a Stable trend. CPC’s preferred shares rating is based on the credit quality of its subsidiary, Capital Power L.P. (CPLP; rated BBB). The one-notch differential in the ratings of CPC and CPLP reflects structural subordination at CPC, which is largely dependent on its own resources and dividends from CPLP. Dividends from CPLP could be curtailed if the viability of CPLP needs to be safeguarded.
…
CPC has no debt issued at the parent level and is not expected to issue any debt in the foreseeable future. In March 2013, CPC issued $200 million of preferred shares, with the net proceeds (approximately $194 million) to be lent to CPLP to repay the outstanding balance under its credit facilities and to finance growth projects, including the Shepard Energy Centre. Pro forma the $194 million issuance, CPC will have $462 million of preferred shares outstanding, $131 million of which is treated as debt by DBRS in CPC’s adjusted debt-to-capital calculation (with a pro forma adjusted debt-to-capital ratio of approximately 6%). In the adjusted debt-to-capital calculation, the amount of preferred shares over the 20% preferred shares-to-equity threshold (defined as the percentage of preferred shares outstanding divided by total equity, excluding preferreds and minority interest) is treated as debt. CPC’s adjusted debt-to-capital ratio remains in line with its rating category. In addition, the pro forma unconsolidated fixed charge coverage ratio is expected to remain high, at above five times.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 3bp, FixedResets down 8bp and DeemedRetractibles off 1bp. Volatility was minimal, but the floaters continue their usual gyrations. Volume was average.