Month: May 2014

The scheduled European hyperinflation has been postponed:

Lower inflation forecasts from the European Commission will put more pressure on the European Central Bank to launch measures to prevent falling prices from destabilizing the weak economic revival.

The EC, the executive arm of the 28-country European Union, predicted on Monday morning that euro zone’s inflation rate will land at 0.8 per cent this year and 1.2 per cent next year. Both figures are well below the ECB’s target rate of close to 2 per cent Less than three months ago, the EC had forecast inflation this year at 1 per cent, and at 1.5 per cent next year. The downward revisions came as more evidence emerged that the euro zone’s deflationary pressures are still fully intact, in spite of rock-bottom interest rates, the end of the euro zone’s recession and slightly lower jobless figures.

So there’s one reason to be bond-bullish. But it takes two to make a market!

Junk-bond investors are accepting yields that are 0.74 percentage point lower than the earnings yield on the Standard & Poor’s 500 index, a measure of profit as a percentage of equity prices.

Historically, debt rated below investment grade has yielded an average 4.2 percentage points more than stocks since March 1995. That relationship has been turned on its head.

Could be a little ‘reaching for yield’ is going on. That always ends in tears.

Meanwhile the feds continue to micro-manage the Canadian economy:

The Conservative government’s bid to ease a multibillion-dollar backlog of Prairie grain is one step closer to becoming law, despite ongoing questions about its details and complaints by Canada’s two major railways.

Bill C-30 was tabled March 26 in an urgent bid to force railways to ship more grain after a bumper crop, and passed third reading in the House of Commons on Monday. That came after a weeks-long delay caused by a complaint over a government error, whereby a committee went too far in altering the bill by adding an amendment the Speaker ruled was out of bounds.

Bill C-30 is aimed at easing a backlog by expanding government power to set minimum shipping levels for railways. It also expands grain sellers’ power to choose a different railway – many had just one choice – and creates a new process for the Canadian Transportation Agency (CTA) to force a railway that fails to hold up its end of a deal to repay certain costs to grain shippers.

I was a little puzzled by the “many had just one choice” part. Apparently:

In most cases, shippers’ grain elevators have nearby access to only one of the two major Canadian railways. And by law, they may not transfer grain to the other railroad unless the elevator is within 30 kilometres of them. Yes, that’s anti-competitive. The bill would raise that limit to 160 km, giving more choice to growers and shippers.

The origins of these regulations on “interswitching” go back to 1904. It’s a relic of the long history of heavy-handed government power over grain and railroads, which included fixed freight rates.

Sounds like a pretty crazy law to me. To at least some extent it’s just another form of protectionism:

“A 160 km interchange limit would open up the southern portion of CNR and CP’s network to competition from U.S. carriers, especially BNSF,” [RBC Capital Markets analyst Walter] Spracklin said in a note to clients.
…
Mr. Spracklin noted that unlike market share shifts between Canadian railways that might also result from the interswitching rule changes, the market share losses to U.S. competitors would be more permanent because there are no reciprocal interchange provisions in the U.S.

“Accordingly, cargo losses to U.S. carriers would disappear from the Canadian supply chain altogether weakening all stakeholders’ positions (ports, trucks, etc),” Mr. Spracklin said.

But he said market share losses are not the only issue that might result from the new rules. They also threaten to raise costs for Canadian railways by introducing added complexity to their networks and may require extra infrastructure to be added.

The carriers hate the change:

CN said amended interswitching rules would allow U.S. railroads to poach Canadian rail traffic, erode the rate structure and economic viability of Canadian railways and drive traffic to U.S. ports, thus reducing traffic and employment at Canadian ports.


In a March 28 news release, Canadian Pacific Railway said it was disappointed with Ottawa’s decision to introduce legislation that does nothing to improve grain movement but has the potential to cause “great damage” to the Canadian rail transportation system.


“CP … believes that the expansion of regulated interswitching could seriously impact Canada’s competitiveness, as it effectively transfers traffic that normally would move over Canadian railways and ports to U.S. railroads and ports,” it said.


“Interswitching will also lead to double handling of grain shipments, which will slow down the grain supply chain, negatively impacting transit times.”


Federal officials say there are 18 interswitch locations on the Canadian Prairies.


Only 14 primary elevators in Western Canada are affected by interswitching under the current 30 km provisions.


Increasing the interswitch distance to 160 km would give 150 elevators potential access to service by more than one railway, including U.S. railways.

I’m prepared to listen, but it seems to me that in situations in which ‘natural monopoly’ conditions exist – such as railways, telecommunications and pipelines – interswitching should be mandatory, but at premium rates (so that, for instance, somebody who built a network and rented it out in toto could make a very good profit on the deal).

Of course, such mandatory carriage has its detractors:

While economic theory suggests that more competition always benefits the consumer, that may not be true in Canada’s telecom industry, where concentration in the hands of BCE, Rogers and Telus is good for customers, argue authors Martin Masse and Paul Beaudry in a 60-page report released Tuesday.

“It may be preferable for financial resources … to be concentrated in the hands of a few strong players willing to invest in new technologies and services rather than scattered among several small and feeble competitors trying to survive by selling at prices barely above marginal costs,” the report said.
…
The government, it added, has “lost sight of the ultimate goal of promoting the development of a dynamic, efficient industry.”

For example, Ottawa should drop all remaining foreign ownership restrictions, including in broadcasting, as well as allow the transfer of existing wireless spectrum licenses, the authors said. Even the threat that a major foreign player entering Canada would lead to better service, Mr. Masse said.

The government should also “gradually abandon” so-called mandatory access policies, which allow new entrants to piggy-back on the networks of established players at favourable rates.

I’m all in favour of dropping all remaining foreign ownership restrictions!

It was another (slightly!) positive day for the Canadian preferred share market, with PerpetualDiscounts gaining 2bp, FixedResets winning 11bp and DeemedRetractibles up 3bp. The Performance Highlights table is lengthy again, with a few losses indicating that some of the recent gains are considered to be out of whack; FixedResets dominated the winners. Volume was quite high.

Interesting cat-fight in CRA-land:

Standard & Poor’s underestimated the risk of mortgage-backed securities it had planned to rate before the deal was postponed, according to competitor Fitch Ratings.

S&P’s preliminary rankings, which were pulled yesterday after the issuer said it would delay the sale, relied on optimistic home values, Fitch said today in a report. S&P said in a statement yesterday it had asked for more information from issuer Bayview Asset Management LLC after releasing the planned grades as the deal started to be marketed.

Based on the property-price estimates of realty brokers instead of the computer models relied on by S&P, Fitch said the loans exceed current home values by more than 45 percent. That would increase projections for defaults by about 20 percent and the size of losses after foreclosures by 30 percent, Fitch said in its statement.

The $184.9 million transaction, called Bayview Opportunity Master Fund IIIa Trust 2014-9RPL, would be the first sale since the financial crisis of publicly rated securities backed by once-delinquent mortgages, according to Fitch. Similar deals without credit grades have been completed as recently as July 2013, GlobalCapital reported April 28 on its website.

Ed Sweeney, a spokesman for S&P, declined to comment. S&P said in a statement yesterday that Bayview sought to delay the sale after the ratings company requested more information about property valuations and loss severities.

Supply and demand? Schmupply and Schmemand! The best way to lower long term interest rates is to change the rules:

In a world awash with U.S. government bonds, buyers of the longest-term Treasuries are facing a potential shortage of supply.

Excluding those held by the Federal Reserve, Treasuries due in 10 years or more account for just 5 percent of the $12.1 trillion market for U.S. debt. New rules designed to plug shortfalls at pension funds may now triple their purchases of longer-dated Treasuries, creating $300 billion in extra demand over the next two years that would equal almost half the $642 billion outstanding, Bank of Nova Scotia estimates.

Fewer available bonds, along with a lack of inflation and increased foreign buying, help to explain why longer-term Treasuries are surging this year even as the Fed pares its own bond purchases. The demand has pushed down yields on 30-year government debt by more than a half-percentage point to 3.37 percent, the most since 2000, data compiled by Bloomberg show.
…
Pensions that closed deficits are pouring into Treasuries and exiting stocks to reduce volatility after a provision in the Budget Act of 2013 raised the amount underfunded plans are required to pay in insurance premiums over the next two years. It also imposed stiffer fees on those with shortfalls.

In the next 12 months alone, buying from private pensions will create $150 billion in demand for longer-maturity Treasuries, based on Bank of Nova Scotia’s estimates. That compares with the $40 billion in all maturities of U.S. government debt that the plans bought last year.

There’s a little good news out of CMHC:

The Canada Mortgage and Housing Agency said on Monday that it expects the amount of insurance in force to continue to decline in 2014 to $545-billion, down 2.2 per cent from $557-billion in 2013 and 3.9 per cent from a high of $567-billion in 2011, at the height of the post-recession housing expansion.
…
CMHC senior vice-president Steven Mennill said the decline was part of a normal repayment pattern and comes as the agency trims the value of new insurance it is prepared to write on the mortgages Canada’s lenders – mostly the nation’s biggest banks – offer to home buyers trying to get into the booming market.

“One of the factors that is important in this is we have reduced the total amount of portfolio insurance that we are prepared to underwrite in any given year – the insurance provided to lenders on a post-facto basis for portfolio, low-ratio loans – from $11-billion to $9-billion, in 2014,” Mennill told reporters on a conference call.

It’s not much of a cut, but it’s a start.

One of the great tensions in regulation right now is the role of underwriters in IPOs. Are they there so they can get a good deal for their beloved clients? Or are they just thinking – When then ducks quack, feed them?:

Wall Street is in business to make money; when investors want to buy something (such as an initial public offering), that something is offered for sale. It doesn’t make any difference if Wall Street knows in its heart of hearts that that something (such as an IPO) is overpriced.

“When the ducks quack, feed them” is a Wall Street proverb cited in print from at least 1991. The adage became especially popular with internet IPOs in the 1990s.

I hadn’t heard that one before, but the principle should be obvious – but, of course, some don’t get it.

Along those lines, Barry Richoltz of Bloomberg argues for a Treasury Fifty:

4. The U.S. now funds long-term obligations with shorter-term financing. If we learned anything during the credit crisis, this is a recipe for disaster. Bringing the length of financing into closer alignment with our obligations simply is good financial stewardship.

5. The private sector is showing the way: Fixed-income investors have been lining up to purchase 30-year bonds from Bank of America, Apple, IBM, General Electric, Wal-Mart, Novartis, Pemex and others. Financial firms such as Morgan Stanley and JPMorgan Chase have been issuing perpetual notes with a fixed rate for 10 years, which then become Libor-plus bonds.

I’m pleased to see that a milestone has been reached on solar-powered fuel production:

Several notable research organizations from academia through to industry (ETH Zürich, Bauhaus Luftfahrt, Deutsches Zentrum für Luft- und Raumfahrt (DLR), ARTTIC and Shell Global Solutions) have explored a thermochemical pathway driven by concentrated solar energy. A new solar reactor technology has been pioneered to produce liquid hydrocarbon fuels suitable for more sustainable transportation.

“Increasing environmental and supply security issues are leading the aviation sector to seek alternative fuels which can be used interchangeably with today’s jet fuel, so-called drop-in solutions”, states Dr. Andreas Sizmann, the project coordinator at Bauhaus Luftfahrt. “With this first-ever proof-of-concept for ‘solar’ kerosene, the SOLAR-JET project has made a major step towards truly sustainable fuels with virtually unlimited feedstocks in the future.

The SOLAR-JET project demonstrated an innovative process technology using concentrated sunlight to convert carbon dioxide and water to a so-called synthesis gas (syngas). This is accomplished by means of a redox cycle with metal-oxide based materials at high temperatures. The syngas, a mixture of hydrogen and carbon monoxide, is finally converted into kerosene by using commercial Fischer-Tropsch technology.

I’m a bit surprised that it’s thermochemical / catalytic instead of bio-engineering / enzymatic, but hey – a step forward is a step forward!

Atlantic Power Preferred Equity preferreds (AZP.PR.A and AZP.PR.B) have had a little zip in them since Friday noon, due to a report that they have hired advisors:

• Atlantic Power (AT) spiked to a 9.5% gain this afternoon after SparkSpread reported the power producer has hired advisers to explore a potential merger or sale.
• Atlantic Power reportedly tapped Goldman Sachs and Greenhill to help it consider whether a sale or merger makes sense and can be negotiated.

Today the company commented:

Atlantic Power Corporation (TSX: ATP; NYSE: AT) (the “Company” or “Atlantic Power”) owns and operates a diverse fleet of power generation assets in the United States and Canada. As previously disclosed, the Company continues to focus on how to best position itself to maximize value for its shareholders. In that framework, the Company is considering the relative merits of additional debt reduction, investment in accretive growth opportunities (both internal and external), and other allocation of its available cash. Consistent with the objective of acting in the best interests of the Company, its shareholders and its other stakeholders, the Company, as also previously disclosed, is committed to evaluating a broad range of potential options. These potential options include further selected asset sales or joint ventures to raise additional capital for growth or potential debt reduction, the acquisition of assets, including in exchange for shares, the dividend level, as well as broader strategic options, including a sale or merger of the Company. The Company has engaged Goldman, Sachs & Co. and Greenhill & Co., LLC to assist the Company in its evaluation of these potential options. No assurance can be given as to how the evaluation of any such potential options may evolve. The Company does not intend to comment further on its evaluation of potential options until it otherwise deems further disclosure is appropriate or required.

Well … any of these potential options will almost certainly improve the credit quality of the preferreds, currently rated Pfd-5(high), Trend Negative by DBRS.

Innergex Renewable Energy Inc., pwoud issuer of INE.PR.A and INE.PR.C, has been confirmed at Pfd-4(high) [Stable] by DBRS:

Innergex’s financial risk profile remains weak and is reflective of a B rating range. While Innergex’s EBITDA and operating cash flow continued to increase due to sustained organic growth, DBRS remains concerned about Innergex’s aggressive financing strategy for its development pipeline, combined with the Company’s high dividend payout. As the Company continued to pursue its growth plans, the Company’s deconsolidated leverage increased to 30.5% as of December 31, 2013, from 24.5% as of December 31, 2010. Furthermore, consolidated leverage increased to 68.3% as of December 31, 2013 (from 56.7% as of December 31, 2010), and could exceed 70% over the next several years, further pressuring the balance sheet. Should the Company’s financial profile deteriorate further, this could result in negative rating action.

It was a superb day (again! But they were a long time coming!) for the Canadian preferred share market, with PerpetualDiscounts winning 35bp, FixedResets gaining 13bp and DeemedRetractibles up 30bp. A lengthy list of winners – dominated, strangely enough, by FixedResets – was marred by only one loser. Volume was average.

The build up of corporate cash since the Credit Crunch has a nice side-effect:

Rather than get the euros or pounds they need through currency markets, there’s speculation U.S. companies including General Electric Co. may be dipping into offshore cash piles they’ve built up to mitigate tax liabilities.

“Before the market gets excited that mega takeovers from the U.S. could lift the euro and pound, it’s worth recognizing that U.S. companies are sitting on truly huge cash piles abroad,” Steven Barrow, the head of Group of 10 research at Standard Bank Plc in London, wrote in an April 29 note to clients. “That does change the way we have to look at these takeovers from a currency perspective.”

The New York Times produced an excellent graphic regarding relative price changes over the past decade; regrettably but understandably they’ve made it a PNG which doesn’t reproduce well on this blog. Anyway, the point is that the cost of College tuition and fees has soared relative to everything else. I last complained about the universities’ mission-creep on March 6, 2014.

It was another excellent day for the Canadian preferred share market, with PerpetualDiscounts up 19bp, FixedResets winning 26bp and DeemedRetractibles gaining 15bp. Volatility was high, with a lengthy list of winners dominated by FixedResets. Volume was average.

In honour of May Day, Ontario has a pre-election budget:

Opinion research suggests there are far more swing voters on the Liberals’ left than on their right. So the government’s agenda, which includes a 2014-15 deficit, significantly higher than the one previously forecast, all but abandons hope of appealing to moderate fiscal conservatives. Instead, it is mostly about competing with the NDP.

According to KPMG:

The budget proposes to lower the taxable income threshold for the 13.16% tax rate from $514,090 to $220,000. The budget also adds a new tax rate of 12.16% on taxable income between $150,000 and $220,000. These changes would apply to taxation years ending after December 31, 2013. The new income thresholds would not be adjusted for inflation each year.

Therefore, they estimate:

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… whence we can calculate …

So fear not, preferred share fans! Business as usual.

KPMG continues:

The budget proposes a mandatory new provincial pension plan based on the Canada Pension Plan (CPP). The Ontario Retirement Pension Plan (ORPP), which would be introduced in 2017, is intended to provide additional retirement income. The ORPP would be publically administered at arm’s length from the Ontario government.

The plan would require equal contributions shared between employers and employees (not exceeding 1.9% each, or 3.8% in total) up to a maximum annual earnings threshold of $90,000. The threshold would increase each year, consistent with the CPP maximum earnings threshold. Benefits would be earned as contributions are made.

Enrolment into the ORPP would occur in stages, starting with large employers, with contribution rates phased-in over two years. Individuals that already participate in a similar workplace pension plan would not be required to enroll in the ORPP.
…
The budget proposes to introduce a new asset pooling entity to enable pooling pension plan assets in the public sector. The entity would operate at arm’s length from the government. Legislation is expected in spring 2015.
…
The government also said it intends to address the following pension issues:
• Target benefit pension plans
• Regulation of financial planning
• Changes to the funding rules.

Pooling pension plan assets is a well-intentioned dumb idea (see, for example, March 22, 2013). But there will be some nice jobs going for a few lucky arse-suckers; no performance necessary. However, I think auditions for the CEO role at ORPP have already been held, as discussed on October 16, 2013.

Janet McFarland of the Globe points out:

Unlike the CPP, the ORPP will not cover all workers in the province, the government said.

Instead, it will cover about half of Ontario’s 6 million-person work force, excluding the self-employed, all workers whose companies already offer workplace pension plans, and Ontarians working in federally regulated sectors like banking, transportation and telecommunications. The latter group cannot be included because the province does not have jurisdiction over pensions for workers in federal sectors, while the government is excluding those with existing workplace pension plans because it says the program is aimed at those who most need help saving for retirement.

KPMG continues with the revelation that farmers will be getting yet another government cheque:

The budget announces that Ontario will draft legislation to implement a non-refundable income tax credit for farmers who donate food to community food programs, including food banks for donations beginning January 1, 2014.

And there are the usual favourite targets:

The budget proposes to increase tobacco tax from 12.350 cents to 13.975 cents per cigarette (i.e., from $24.70 to $27.95 per carton of 200 cigarettes) and per gram of tobacco products (other than cigarettes or cigars). This measure would be effective 12:01am on May 2, 2014. As a result, wholesalers of tobacco tax are required to take an inventory of all tobacco products (except cigars) held at the end of May 1, 2014 and remit additional tax on this inventory.
…
The budget proposes to raise the tax on aviation fuel to 3.7 cents per litre (from 2.7 cents per litre) for 2014, with an additional tax increase of one cent per year until 2018. This measure is effective on Royal Assent, with subsequent rate increases effective on April 1 of 2015, 2016 and 2017.

The NYSE’s getting fined for not ticking sufficient boxes:

As SROs, the NYSE exchanges are required to conduct their operations in accordance and compliance with their own rules as well as the federal securities laws. They are required to file all proposed rules and rule changes with the Commission, which publishes them for public comment, before they take effect. This transparency enables all participants trading on the exchanges to understand how their orders are processed and executed.

According to the SEC’s order instituting settled administrative proceedings, the NYSE exchanges repeatedly engaged in business practices that either violated exchange rules or required a rule when the exchanges had none in effect. For example, all of the NYSE exchanges used an error account maintained at Archipelago Securities to trade out of securities positions taken on as a result of their operations despite not having rules in effect that permitted them to maintain and use such an account. In another example, NYSE Arca failed to execute a certain type of limit order under specified market conditions despite having a rule in effect that stated that NYSE Arca would execute such orders.
…
The SEC’s order finds that the NYSE exchanges violated Section 19(b) and 19(g) of the Securities Exchange Act of 1934 through misconduct that included the following:

NYSE, NYSE Arca, and NYSE MKT (formerly NYSE Amex) used an error account maintained at Archipelago Securities to assume and trade out of securities positions without a rule in effect that permitted such trading and in a manner inconsistent with their rules for the routing broker, which limited Archipelago Securities’ activity primarily to outbound and inbound routing of orders on behalf of those exchanges.

NYSE provided co-location services to customers on disparate contractual terms without an exchange rule in effect that permitted and governed the provision of such services on a fair and equitable basis.
NYSE operated a block trading facility (New York Block Exchange) that for a period of time did not function in accordance with the rules submitted by NYSE and approved by the SEC.
NYSE distributed an automated feed of closing order imbalance information to its floor brokers at an earlier time than was specified in NYSE’s rules.

NYSE Arca failed to execute Mid-Point Passive Liquidity Orders (MPLOs) in locked markets (where the bid and ask prices are the same) contrary to its exchange rule in effect at the time.

In addition, the SEC’s order finds that NYSE Arca accepted MPLOs in sub-penny amounts for National Market System stocks trading at over $1.00 per share, in violation of Rule 612(a) of Regulation NMS.

The SEC’s order further finds that Archipelago Securities failed to establish and maintain policies reasonably designed to prevent the misuse of material, nonpublic information in connection with error account trading.

Wow – that’s enough to make you faint, huh? I love that last one, it’s classic: Archipelago didn’t actually do anything wrong, they just failed to write down that they wouldn’t do anything wrong.

I was intrigued by an advertisement for a discussion at Rotman on OSFI … until I saw the speakers list:

Stanley Hartt, Counsel, Norton Rose Fulbright; former Deputy Minister of Finance Canada
Hon. Michael Wilson, former Minister of Finance of Canada; Chairman, Barclays Capital Canada Inc.; Chancellor, University of Toronto
Hon. Barbara McDougall, former Minister of State (Finance) of Canada

Smiley boys. Not a single practitioner. Not even a big-bank zombie who will toe the line nicely. Have a nice time.

Manulife’s 14Q1 Quarterly Report casts broad hints that MFC.PR.D will be redeemed:

If the Company redeems, subject to regulatory approval, $450 million of preferred shares which will become redeemable at par in June, we would expect a further 3 point decline in the MCCSR ratio.

Mind you, a redemption of MFC.PR.D (FixedReset, 6.60%+456) will not actually surprise anybody.

In common with the Ontario government, the Canadian preferred share market celebrated May Day with a very nice pop; PerpetualDiscounts winning 50bp, FixedResets gaining 22bp and DeemedRetractibles up 23bp. Volatility was suitably present, with Floating Rate issues getting hit (gee, I guess the yanking of government policy rates has been postponed again). Volume was above average.