PrefBlog

Good times to be in corporate finance:

Canadian companies are borrowing more than ever, breaking records for selling new debt in a push to lock in low interest rates before borrowing costs rise.

Corporations and financial institutions have set a new mark for fixed-income sales this year by issuing more than $100-billion in debt, higher than the full-year record set in 2012.
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As usual, Canadian banks dominate bond sales this year, raising $47-billion, up 23 per cent from 2012, according to CIBC. However, non-bank borrowers have increased their game, raising an usually large amount of debt, helping to push total issuance to sky-high levels.

ETFs and mutual funds have the great virtue of increasing liquidity for retail investors – I often recommend bond ETFs to clients. But the mismatch between retail liquidity and underlying liquidity is getting worrisome:

A recent presentation by Citi’s Matt King, includes a chart entitled “Entrance with No Exit” that has been costing me sleep. Mr. King’s chart asserts that if and when a significant percentage of the holders of almost $900-billion (U.S.) invested in U.S. corporate debt mutual funds and ETFs (investment grade plus high yield debt) want to sell, there may not be anyone to bid for them.

In the past, large banks carried enormous portfolios of both investment grade and high yield debt issues and provided liquidity to the market – buying bonds when the market was weak and selling when it was strong.

Since the financial crisis, however, U.S. banks have responded to regulatory pressure over proprietary trading and capital requirements by drastically reducing their holdings – from about $300-billion to less than $100-billion – while mutual fund and ETF fixed income assets have almost doubled from just under $500-billion.

There’s $900-billion in corporate debt funds and ETFs and a tenth of that in the banking system so, there is no way the banks can offset a buyers strike in bond funds if it occurs.

Click for Big

If an apocalypse happens due to this, it will be bargain season for long term investors, but those who need the cash – or even the margin – might find themselves a little embarrassed.

Decreased liquidity in corporate bonds was discussed on November 5, while US regulatory moves to extend their power over asset managers was discussed November 6. Does anybody else see a pattern here? Mark my words, there will be enforced ‘gating’ of mutual fund and ETF redemptions soon (ETF redemptions coming in big blocks from arbitrageurs). All that power has to go somewhere! We will then see ETFs trading at a discount to NAV, and a lot of very unhappy mutual fund fund clients.

So what’s the solution? As far as I can tell, there ain’t one. Companies will have to keep a little extra cash on hand in case the markets decide to shut down for a while; investors will have to keep a little more cash on hand than otherwise for the same reason. Ultimately, the benefits of allowing retail decent access to the corporate bond markets outweighs the harms … but you can bet the regulators won’t see it that way. Nobody must be hurt! If anybody is ever hurt by anything, it’s because of a Wall Street conspiracy!

It was a day of small gains for the Canadian preferred share market, with PerpetualDiscounts winning 10bp, FixedResets gaining 5bp and DeemedRetractibles up 7bp. Surprisingly, the Performance Highlights table is relatively lengthy. FloatingResets traded up a storm today on big blocks through Nesbitt, with an assist from Scotia, although there is no way of telling whether or not they were ‘real’ crosses or internal crosses; volume was above average.

It might be a while before we see tapering:

Federal Reserve Bank of Atlanta President Dennis Lockhart, who has backed record stimulus, said he wants to see inflation accelerate toward the Fed’s 2 percent goal before the central bank reduces $85 billion in monthly bond purchases.

“I’d like to see some movement toward the target” before tapering, Lockhart said today in a Bloomberg Radio interview with Kathleen Hays. Inflation is “stable but too low” and a move up would “give me some confidence we are not dealing with some downside scenario that might develop,” said Lockhart, who doesn’t vote on policy this year.

It was another mixed day for the Canadian preferred share market, with PerpetualDiscounts down 28bp, FixedResets up 20bp and DeemedRetractibles off 5bp. In the Performance Highlights table the three losers are all PerpetualDiscounts while FixedResets dominate the winning side. Volume was above average with the highlights comprised entirely of FixedResets.

Nothing happened today.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts down 8bp, FixedResets up 27bp and DeemedRetractibles off 3bp. A fairly lengthy Performance Highlights table is comprised entirely of winners, mostly FixedResets. Volume was average.

There was a good US jobs number:

The addition of 204,000 workers followed a revised 163,000 gain in September that was larger than initially estimated, Labor Department figures showed today in Washington. The median forecast of 91 economists surveyed by Bloomberg called for an increase of 120,000. The jobless rate rose to 7.3 percent from an almost five-year low.

This didn’t help the Treasury and gold markets much:

Treasuries sank the most since July and gold slid as a bigger-than-forecast increase in American payrolls fueled speculation the Federal Reserve may trim stimulus earlier than expected. The dollar strengthened against all 16 major peers while U.S. stocks advanced.

The yield on 10-year Treasuries jumped 14 basis points to 2.74 percent at 12:58 p.m. in New York and climbed as much as 16 basis points. Gold futures dropped 1.8 percent to $1,285.00 an ounce. The Standard & Poor’s 500 Index (SPX) rebounded 0.9 percent after tumbling 1.3 percent yesterday. French bonds fell after S&P downgraded the country’s debt. The dollar climbed 0.4 percent against the euro. AT&T Inc. and BNP Paribas SA led 21 billion euros ($28 billion) of bond sales in Europe this week, the busiest in two months.

That’s right, S&P downgraded France:

• We believe the French government’s reforms to taxation, as well as to product, services, and labor markets, will not substantially raise France’s medium-term growth prospects, and that ongoing high unemployment is weakening support for further significant fiscal and structural policy measures.
• Furthermore, we believe lower economic growth is constraining the government’s ability to consolidate public finances.
• We are therefore lowering our long-term foreign and local currency sovereign credit ratings on France to ‘AA’.
• The outlook is stable, reflecting our view that the probability that we will raise or lower the rating on France over the next two years is less than one-in-three.

Angst is rising over the Fed exit from QE:

The Fed’s financial-crisis actions — from acquiring debt in the 2008 rescues of Bear Stearns Cos. and American International Group Inc. to three rounds of quantitative easing — have led so far to the record payments. Now, the prospect of a stronger economy and rising interest rates means the value of the Fed’s bond holdings will fall at the same time its funding costs climb because the central bank pays interest on the excess reserves it holds for banks.

This could cause operating losses and invite increased scrutiny from lawmakers already critical of the central bank’s policies.

That’s a risk central bankers are grappling with as they consider when to slow the $85 billion monthly pace of their government and mortgage-backed securities purchases. Federal Reserve Bank of New York President William C. Dudley said in a speech last month that the central bank’s balance-sheet expansion does “create some budget risk” that threatens the institution’s independence.

I know a number of Asset Managers read this blog. How would you guys like a quarter like these guys?

Pacific Investment Management Co., the world’s largest fixed-income manager, had $39 billion in net redemptions during the third quarter as investors fled bonds in anticipation of rising interest rates.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts down 51bp, FixedResets up 22bp and DeemedRetractibles gaining 2bp. As might be expected, the Performance Highlights table is fairly lengthy, with the down side dominated by Perpetual Discounts and winners by FixedResets. Volume was very high.

Maybe we will have a return to Rae Days as well!

Ontario is prepared to miss its deficit-reduction targets to avoid deep program cuts as Premier Kathleen Wynne’s government walks away from austerity.

The shift in priorities – which will effectively see the minority Liberal administration embrace deficit spending as the best way to rev up the province’s sluggish economy – will be signalled in Finance Minister Charles Sousa’s fall economic statement on Thursday, government sources told The Globe and Mail.

Policy rates were slashed in Europe:

The European Central Bank surprised the market today by cutting interest rates to a record low as falling inflation threatened its mission of keeping prices stable in the 17-country euro zone.

Wholly unexpected by the vast majority of economists, the announcement triggered an immediate fall in the euro. My mid-afternoon central European time, it was down almost 1.5 per cent against the dollar. Commodities fell while stock indexes rose.
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ECB president Mario Draghi said he expected a “prolonged” period of low inflation but would not define that period, insisting he would have a better picture in December, when the next inflation gauge and other economic date are due. “It’s not going to be a short, short time,” he said at the ECB’s press conference in Frankfurt.

I’ve always said – they may be in trouble, they may always be in second place to the foreign flavour of the month, but it’s hard to make money betting against America:

Specialty operations are finding new opportunities because of 3-D printers, said Patrick Hunter, senior vice president of marketplace operations for MFG.com in Atlanta. The technology allows three-dimensional designs created on computers to be sent digitally to industrial machines, which put down layers of materials ranging from plastic to metal to create parts or products.

“It’s opened the doors to smaller shops because people aren’t tied to the large mass manufacturers,” said Hunter, whose company has been matching companies with parts makers for about a dozen years.

Low volume typically means runs of products of more than 1,000, which exceeds capacity of a home workshop, and less than 5,000 to 10,000, which is usually the minimum to get work done overseas at a factory in China, he said.

More than 58 percent of small shops added new machines for so-called additive technology in 2012, the third year of gains since the recession ended, according to Wohlers Report 2013, which tracks the industrial market for industrial 3-D printing technology from Fort Collins, Colorado.

I have long criticized the standard five-year term for mortgage loans in Canada – it makes no sense to finance a long-term asset exclusively with a short-term loan, although it makes all kinds of sense for lender. The US model, for all its myriad faults, at least matches financing certainty with asset life. But in Denmark the mismatch is even worse:

Danish mortgage banks have struggled to wean borrowers off loans funded by one-year bonds as deadlines near to demonstrate they can withstand a 12-month funding market freeze. Standard & Poor’s in July told lenders they risked downgrades if they don’t cut use of the securities over the next two years. The central bank has also criticized the bonds and the risks borrowers face if interest rates rise.

One-year bonds fund about 40 percent of home loans in Denmark. Borrowers have been attracted to record-low rates thanks to AAA-rated Denmark’s status as a haven from Europe’s debt crisis. Still, households have grown more exposed to interest-rate shocks as debt burdens soar to a world-record of 310 percent of disposable incomes, according to data compiled by the Organization for Economic Cooperation and Development.

Under the government’s proposed measure, short-term bonds would convert to longer-term securities if refinancing auctions fail or interest rates climb in auctions by more than 5 percentage points. Existing bonds would be excluded from the measure, which would go into effect Jan. 1 if approved by lawmakers.

The bonds convert if the auctions fail? Have the lessons of the financial crisis been forgotten so quickly?

It was a positive day for the Canadian preferred share market, with PerpetualDiscounts flat, FixedResets winning 15bp and DeemedRetractibles gaining 9bp. Volatility was average by long term standards, very low by standards of the past six months. Volume was well above average.

US regulators are making a a big move to extend their power:

BlackRock Inc. (BLK) and Fidelity Investments will be studied by U.S. regulators who are in the early stages of reviewing whether asset managers pose a potential risk to the financial system, two people with knowledge of the matter said.

The Financial Stability Oversight Council’s discussion Oct. 31 and agreement to review New York-based BlackRock and Boston-based Fidelity don’t necessarily mean the companies will be designated systemically important by the council, according to the people, who requested anonymity because the meeting was closed to the public. The panel didn’t take any formal action regarding the companies.

FSOC’s preliminary talks may presage months of wrangling between the industry and officials charged with trying to prevent a repeat of the 2008 financial crisis. Asset managers are among non-bank financial companies that the council is empowered by law to evaluate to determine whether their failure could threaten the entire system and thus require Federal Reserve oversight. BlackRock, Fidelity and the mutual-fund industry’s trade group have said money managers aren’t a threat.

Political cover for the investigation is provided by an Office of Financial Research (who?) report titled Asset Management and Financial Stability:

Reflecting these issues, this report describes:

• • the activities of asset management firms and the funds they manage;
• • the key factors that make the industry vulnerable to shocks: (1) “reaching for yield” and herding behaviors; (2) redemption risk in collective investment vehicles; (3) leverage, which can amplify asset price movements and increase the potential for fire sales; and (4) firms as sources of risk;
• • the key channels through which shocks can be transmitted: exposures across funds and firms and the impacts of fire sales; and
• • the data available to measure those activities, vulnerabilities, and channels, and the nature of the gaps in those data.

The report does not focus on particular risks posed by money market funds. In November 2012, the Council released a detailed analysis of these funds and their risks, and the Securities and Exchange Commission (SEC) recently proposed additional reforms.2
In addition, the activities and risks posed by hedge funds, private equity, and other private funds are not addressed in detail. Additional analysis will be conducted in conjunction with further analysis of data that these funds have begun to file on Form PF. The OFR, SEC, and Commodity Futures Trading Commission (CFTC) are currently evaluating these data for monitoring purposes.

Assiduous Readers will remember that in the case of Money Market Funds, the much-needed regulatory reform was beaten back by the industry and MMFs can continue to operate as zero-capital banks. I have complete faith in the regulators to get everything backwards and regulate the hell out of asset management firms.

Here’s another region with a lousy economy:

Waning European growth and inflation will put pressure on the European Central Bank (ECB) to cut interest rates in an effort to keep the fragile recovery intact.

The autumn economic update released on Tuesday by the European Commission (EC) showed that the euro-zone economy will return to growth in 2014, after two years of recession, but at a slower pace than was forecast in the spring. Inflation in the euro zone fell to just 0.7 per cent in October, the lowest rate since 2009, when the financial crisis was at its peak.

Sometimes – not very often – there is some justice in the world:

Four Deutsche Bank AG (DBK) traders who won reinstatement of their jobs after they were dismissed following an internal probe into rate-rigging were awarded 365,474 euros ($493,370) in missed salary.

The total monthly pay of the four men, who were fired in February, ranged from 10,833 euros to 22,083 euros on average, according to the written version of the judgment made Sept. 11 and released by the Frankfurt Labor Court today. The men, whose names weren’t disclosed, returned to work on Nov. 4, according to the bank.
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The traders said that before they were dismissed, their bonuses for 2011 were reduced as a sanction for their allegedly inappropriate behavior and that an unidentified Deutsche Bank official said they would be compensated once “the situation had calmed down,” according to the ruling.

Deutsche Bank disputes that account, the document shows. A spokesman for Deutsche Bank, Christian Streckert, declined to immediately comment when reached by phone today.

The court said the total value of the wrongful dismissal claims is 1.9 million euros. That number reflects the pay owed to the plaintiffs, including any potential future earnings under their employment contract.

The poor regulators will have to fill in the notch they made in their red pencil! Well, never mind, there are other careers to destroy and lives to ruin. And after all, the the hysteria helps balance government budgets:

A number of finance firms, including Royal Bank of Scotland and Rabobank face billions of euros in fines next month from European Union regulators for colluding on global benchmark interest rates, reinforcing Brussels’ hard line on the sector after the financial crisis.

EU antitrust chief Joaquin Almunia is set to unveil a record fine of at least €1.5-billion ($2-billion) on six banks, including Barclays and RBS, for rigging the yen Libor interest rate benchmark, a banking source said on Wednesday.

There’s a new wrinkle in the Treasury market:

The U.S. Treasury Department will sell $10 billion to $15 billion of its first floating-rate notes Jan. 29 and said a period of political wrangling over the budget requires a delay in plans to reduce coupon auctions.

The floating-rate notes will have a two-year maturity and be the Treasury’s first new security in 17 years, the department said today in its quarterly refunding announcement. Note and bond sales next week will total $70 billion, the lowest since February 2009 and less than the $72 billion auctioned last quarter, the Treasury said.
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Floaters are securities with rates set periodically, and the Treasury’s notes will be referenced to the 13-week bill rate. They are the first new U.S. government debt securities since Treasury Inflation-Protected Securities were introduced in 1997.

It was a mildly positive day for the Canadian preferred share market, with PerpetualDiscounts winning 13bp, FixedResets up 10bp and DeemedRetractibles gaining 3bp. The Performance Highlights table is dominated by FixedResets with low Issue Reset Spreads. Volume was well above average.

PerpetualDiscounts now yield 5.54%, equivalent to 7.20% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 4.7%, so the pre-tax, interest-equivalent spread between the two is now about 250bp, a slight (and perhaps spurious, particularly given the index rebalancing as of October 31) increase from the 245bp reported October 31.