April 30, 2010

I can’t resist picking on Basis Yield Alpha Fund (discussed yesterday; it’s crying about having bought Timberwolf notes from Goldman) a little bit more. It was among the earliest crunch casualties:

[2007-08-28] Basis Yield Alpha Fund, a hedge fund specializing in corporate and structured credit, on Wednesday filed for bankruptcy protection in the United States amid mounting losses from U.S. subprime mortgage assets, court papers show.

Earlier in the month, the hedge fund firm told investors that losses at one of its portfolios had lost more than 80 percent in assets.

Award winning!

Basis earned the “Fund of the Year” title at the 2005 AsiaHedge awards and Macquarie Bank Ltd.’s “Skilled Manager of the Year” in 2004.

The lenders got paid:

Banks that lent to failed hedge fund Basis Yield Alpha, run by Australia’s Basis Capital, are likely to get all their money back and there could be a payment to investors, the fund said. Yield Alpha, which started the year with about $700m, has returned to solvency and can afford to repay banks which seized the fund’s assets when it missed margin calls earlier this year. The development is a result of continued payouts by structured credits in which Basis invested, apparently resolving one of the few situations in which lenders to a hedge fund lost money. Basis became the second hedge fund group this year to see one of its funds collapse amid the US subprime crisis, after the failure of two funds run by Bear Stearns.

Budget cuts in Greece may put Canada’s 1990’s experience to shame:

Greek Prime Minister George Papandreou said the country’s survival was at stake in talks to win a potential $159 billion European Union-led bailout in exchange for budget cuts denounced by unions as “savage.”

Papandreou’s budget cuts may include a three-year wage freeze for public workers and eliminating two of their 14 annual salary payments, the ADEDY union said. Greece’s NET Radio reported that cuts could amount to 10 percentage points of gross domestic product. The deficit was 13.6 percent of GDP in 2009.

Other deficit-cutting steps include increasing sales tax and raising the cap on the number of workers who can be fired to 4 percent from 2 percent, Kathimerini newspaper said, without saying where it got the information.

There is a sort-of encouraging trend for US banks:

Gerald J. Ford, who became a billionaire by purchasing distressed lenders during the last banking crisis, isn’t waiting around during this one for Sheila Bair’s Federal Deposit Insurance Corp. to offer him a deal.

After bidding unsuccessfully on several lenders seized by the FDIC, Ford said he’s pushing ahead with a $500 million injection for Pacific Capital Bancorp, a California lender that has said it may collapse. He’s among the private-equity investors who are now willing to buy banks without an FDIC guarantee on loan losses.

“We’re trying to do this one sooner rather than later,” Ford, 65, said in an interview yesterday. “We’ve been out there looking for a long time.”

Private-equity firms are going after live banks after complaining the FDIC put up too many obstacles and changed the rules for buying failed lenders, which are piling up at the fastest rate in two decades. Three days before Ford’s deal, private-equity firm Thomas H. Lee Partners LP agreed to pay $134.7 million for a stake in Sterling Financial Corp., a Spokane, Washington-based lender that’s still open after posting two annual losses.

Both deals depend on the U.S. Treasury Department agreeing to take a loss on the stake held by its bank bailout fund. The Treasury signed on to the Sterling deal yesterday, according to the bank.

The Sterling accord calls for the bank to raise a total of $720 million and would give Boston-based Lee a 19.9 percent stake. The U.S. agreed to swap its $303 million stake for new securities valued at $75.8 million, Sterling said in a statement on April 29. Treasury spokesman Andrew Williams declined to comment and Richard Walsh Jr. at Thomas H. Lee didn’t immediately respond to a request for comment.

At Pacific Capital, the agency would be required to exchange $180.6 million for common shares at about 20 cents on the dollar, according to a statement. Pacific Capital has told investors it may not survive without new capital.

If Treasury is involved, then it’s a political issue – which it should be. However, the details of the deals would have to be examined very closely to see whether, all in, Treasury taking a loss now is better for taxpayers than the FDIC (maybe) taking a loss later.

The forces of do-goodism have received a mild rebuff:

Spain is lancing an 18 billion-euro ($24 billion) investment bubble in solar energy that has boosted public liabilities, choking off new projects as it works to cut power prices and insulate itself from Greece’s debt crisis.

Industry Minister Miguel Sebastian is negotiating reductions in subsidies for solar plants that would curb energy costs, a ministry spokesman said this week. Grupo T-Solar Global SA, the world’s biggest photovoltaic plant owner, shelved its Spanish stock offering three days ago. Solar Opportunities SL postponed a 130 million-euro deal due to be signed today.

Spain is battling on several fronts to revive its economy and convince government bondholders it can avoid getting dragged into a Greek-style debt spiral after Standard & Poor’s cut its credit rating April 28. Solar-plant owners including General Electric Co. earn about 12 times what’s paid for power from fossil fuels. Most of that is a subsidy charged to customers.

You can only waste money if you’ve got money to waste! Unfortunately, the Smitherman subsidy aimed at making Ontario a hot-bed of world-class lobbying is still considered sane.

OSFI’s Mark White has delivered a speech titled P&C Reinsurance to Fit the Times – A Question of Balance; the limits and collateralization rules on Property and Casualty reinsurance are being revamped. This follows the Response Paper: Reforming OSFI’s Regulatory and Supervisory Regime for Reinsurance, published in late March.

Transcripts from 2004 show that the Fed was perplexed by the early housing boom; at the June meeting a researcher stated:

With regard to the question of owning versus renting, it depends to some extent on what is happening to interest rates because that changes that calculation at the margin. So it’s really important to plot any kind of valuation measure relative to an opportunity cost. Just showing the rent-to-price ratio I think would have been somewhat misleading; it’s really that gap that we think is the meaningful measure of valuation. And it looks somewhat rich, taking account of the fact that interest rates are relatively low and income growth has been relatively strong. I don’t want to leave the impression that we think there’s a huge housing bubble. We believe a lot of the rise in house prices is rooted in fundamentals. But even after you account for the fundamentals, there’s a part of the increase that is hard to explain.

SEC Commissioner Luis A. Aguilar has delivered a speech to the Investment Adviser Association Annual Conference

The Senate Bill, however, has abandoned its strong position in the face of determined lobbying by the insurance and brokerage industries. The revised version that was voted out of the Senate Banking Committee on March 22nd has eliminated the provision applying the fiduciary standard to brokers who provide investment advice. It would, instead, require a one-year study by the SEC concerning the effectiveness of existing standards for “providing personalized investment advice and recommendations about securities to retail customers.”

I continue to have concerns about this retreat from requiring a fiduciary standard for all who provide investment advice. First, I see no need to study the effectiveness of existing obligations for investment advisers. We already have a strong, workable standard that has been in use successfully for decades, and I would not support any attempt to weaken it. Second, as with the House Bill, I question why the protection of the fiduciary standard should be limited to “retail” customers. It is readily apparent from recent Commission enforcement cases — such as the cases involving auction rate securities — that all investors, including institutional investors, need the protection of the fiduciary standard. Third, I question why the study, as well as the reach of the House Bill, should be limited to “personalized services.” This qualification would narrow the range of clients that would be protected by the fiduciary standard, and I fear that it may become a loophole that would make it easy to avoid putting clients first.

This is completely insane. Institutional investors are acting as fiduciaries for the institutions they represent. How many layers of fiduciary responsibility are necessary? How many have to be paid for? Why do F-Class and discount brokerages exist in the first place? As discussed yesterday, an institutional investor will discuss trades with the sell side with the clear understanding that his counterparty wants to clean him out and send him home naked and hungry. Any buy-side investor who does not understand this – and does not understand that there is exactly one layer of fiduciary between the lions and lambs an that he’s it; or who does not devote independent analysis to each investment idea with precisely this fact in mind – should lose his license. I am sick to bloody death of politicians and regulators telling me that I’m too stupid to negotiate deals for my clients — and that only the sell side can be trusted with such important decisions.

Commissioner Aguilar’s background should be noted:

Prior to his appointment as an SEC Commissioner, Mr. Aguilar was a partner with the international law firm of McKenna Long & Aldridge, LLP, specializing in securities law. During his career, his practice included matters pertaining to general corporate and business law, international transactions, investment companies and investment advisers, securities law, and corporate finance. He also focused on issues related to corporate governance, public and private offerings (IPOs and secondary offerings), mergers and acquisitions, mutual funds, investment advisers, broker-dealers, and other aspects of federal and state securities laws and regulations.

A lawyer. Almost certainly has never been on the ‘phone and said “done” in his life.

A long, long month for Canadian preferred share investors shuddered to an end today with, wonder of wonders, gains for both PerpetualDiscounts (up 5bp) and FixedResets (up 3bp). Volume continued heavy.

PerpetualDiscounts now yield 6.35%, equivalent to 8.89% interest at the standard equivalency factor of 1.4x. Long corporates have returned +1.21% on the month (+6.29% on the year-to-date) and now yield about 5.7%, making the pre-tax interest-equivalent spread (also called the Seniority Spread) about 320bp, about the same as was reported April 28 and a massive jump higher than the +285 bp reported March 31.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
(at bid)
Mod Dur
Issues Day’s Perf. Index Value
Ratchet 2.58 % 2.66 % 51,230 20.94 1 -2.1525 % 2,144.0
FixedFloater 4.94 % 3.01 % 45,896 20.36 1 0.0000 % 3,237.9
Floater 1.92 % 1.66 % 45,744 23.47 4 -0.0609 % 2,408.2
OpRet 4.90 % 3.96 % 102,875 1.05 10 0.0703 % 2,303.4
SplitShare 6.40 % 6.53 % 135,075 3.57 2 -0.1982 % 2,133.3
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0703 % 2,106.3
Perpetual-Premium 5.91 % 4.77 % 25,341 15.86 2 -0.0205 % 1,822.8
Perpetual-Discount 6.28 % 6.35 % 215,916 13.41 76 0.0523 % 1,700.1
FixedReset 5.56 % 4.55 % 506,444 3.60 44 0.0296 % 2,128.1
Performance Highlights
Issue Index Change Notes
ELF.PR.F Perpetual-Discount -3.79 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-30
Maturity Price : 18.28
Evaluated at bid price : 18.28
Bid-YTW : 7.34 %
BAM.PR.E Ratchet -2.15 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-30
Maturity Price : 22.52
Evaluated at bid price : 21.82
Bid-YTW : 2.66 %
BNS.PR.T FixedReset -1.46 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-25
Maturity Price : 25.00
Evaluated at bid price : 26.26
Bid-YTW : 4.96 %
BNS.PR.Y FixedReset -1.37 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-30
Maturity Price : 23.68
Evaluated at bid price : 23.72
Bid-YTW : 4.13 %
BAM.PR.B Floater -1.30 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-30
Maturity Price : 17.47
Evaluated at bid price : 17.47
Bid-YTW : 2.26 %
TRP.PR.B FixedReset -1.23 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-30
Maturity Price : 23.97
Evaluated at bid price : 24.01
Bid-YTW : 4.36 %
NA.PR.K Perpetual-Discount -1.07 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-30
Maturity Price : 22.91
Evaluated at bid price : 23.20
Bid-YTW : 6.32 %
GWO.PR.L Perpetual-Discount 1.01 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-30
Maturity Price : 22.01
Evaluated at bid price : 22.10
Bid-YTW : 6.48 %
BNS.PR.P FixedReset 1.15 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-05-25
Maturity Price : 25.00
Evaluated at bid price : 25.50
Bid-YTW : 4.33 %
GWO.PR.G Perpetual-Discount 1.39 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-30
Maturity Price : 20.43
Evaluated at bid price : 20.43
Bid-YTW : 6.45 %
GWO.PR.H Perpetual-Discount 1.64 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-04-30
Maturity Price : 19.16
Evaluated at bid price : 19.16
Bid-YTW : 6.42 %
IAG.PR.C FixedReset 1.72 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-01-30
Maturity Price : 25.00
Evaluated at bid price : 26.05
Bid-YTW : 5.14 %
Volume Highlights
Issue Index Shares
BMO.PR.P FixedReset 105,057 RBC crossed 100,000 at 25.73.
Maturity Type : Call
Maturity Date : 2015-03-27
Maturity Price : 25.00
Evaluated at bid price : 25.70
Bid-YTW : 4.69 %
SLF.PR.A Perpetual-Discount 86,546 TD crossed 50,000 at 18.60.
Maturity Type : Limit Maturity
Maturity Date : 2040-04-30
Maturity Price : 18.57
Evaluated at bid price : 18.57
Bid-YTW : 6.48 %
RY.PR.T FixedReset 74,915 RBC crossed 64,000 at 24.70.
Maturity Type : Call
Maturity Date : 2014-09-23
Maturity Price : 25.00
Evaluated at bid price : 26.70
Bid-YTW : 4.50 %
RY.PR.A Perpetual-Discount 67,551 Nesbitt crossed 50,000 at 18.65.
Maturity Type : Limit Maturity
Maturity Date : 2040-04-30
Maturity Price : 18.64
Evaluated at bid price : 18.64
Bid-YTW : 5.98 %
BNS.PR.R FixedReset 65,984 RBC crossed two blocks of 30,000 each at 25.45.
Maturity Type : Call
Maturity Date : 2014-02-25
Maturity Price : 25.00
Evaluated at bid price : 25.50
Bid-YTW : 4.44 %
RY.PR.X FixedReset 63,946 RBC crossed two blocks of 25,000 each at 26.65.
Maturity Type : Call
Maturity Date : 2014-09-23
Maturity Price : 25.00
Evaluated at bid price : 26.61
Bid-YTW : 4.60 %
There were 55 other index-included issues trading in excess of 10,000 shares.

15 Responses to “April 30, 2010”

  1. beluga says:

    Hi James,

    With PerpetualDiscounts yielding 6.35% and long corporates at 5.7%, I am tempted to buy perpetual discounts in an RRSP. Am I crazy?

  2. jiHymas says:

    There’s nothing intrinsically wrong with the idea; obviously there will be some point at which PerpetualDiscounts are so cheap to long corporates that even the loss of favourable tax treatment doesn’t change the relative evaluation. The only question is whether we’ve reached that point yet.

    PDs have lower seniority and somewhat lower chance of a large capital gain; if corporate yields should decline sharply over the next ten years, then corporates could be trading well above par, while the capital gain on PDs is capped at the call price (more or less).

    On the positive side, they are exchange traded, allowing cheaper trading for those prepared to put in the effort and not on a fixed schedule, yield more, and have an increased chance of a small capital gain, should the Seniority spread narrow. There will also be the chance of an occasional swap between issues; it will be very rare for such an opportunity to present itself to the retail owner of long corporate bonds.

    Your answer to the question will depend on how much weight you place on all of those factors (and other factors that don’t immediately occur to me; the question is clearly worth some thought and an article) and for any given analytical structure there will be some spread between the two that makes PDs in a RRSP attractive.

  3. prefhound says:

    The LOCATION decision (RRSP/RRIF vs Taxable Account) is best determined after asset allocation is set. The criterion should be to put the assets with the highest taxes payable per dollar of asset in the tax deferred account.

    Thus, a bond yielding 5.7% (all interest, no capital loss) to a taxable account will pay 5.7% X Marginal Rate in taxes (e.g. 2.64% in Ontario in the 46.25% bracket). Don’t forget that a premium long term bond (i.e. trading above par) will attract even more tax (higher coupon plus only half the evential capital loss deductible — to those with offsetting capital gains)

    A pref yielding 6.35% (all dividends, no capital gain or loss) will have a top marginal tax rate of around 30%, for total taxes payable of 1.91%.

    Since the asset mix was fixed and the investor should have both prefs and bonds (to quote Mr. Hymas), this calculation says put the bonds in the RRSP/RRIF first, over prefs.

    The same logic can be used with a variety of different assets, and the highest taxed ones should go in the RRSP first. [This simple rule works until age 70 or so, when it gradually switches to having the lowest expected after tax return assets in the RRSP to take advantage of preferential tax rates on dividends and capital gains in a taxable account. E.g. a capital gain earned in an RRSP at age 70 will be fully taxed when it is taken out (on average, 10-15 years later under minimum withdrawal rules).]

    The big location wrinkle is that people have different relative sizes of taxable and tax deferred accounts and different opportunities for retirement income splitting with spouses. Consider an investor with two equal sized assets: bonds and prefs. Only the investor with exactly 50/50 taxable and RRSP funds can split with bonds only in the RRSP and prefs only in the taxable account. An investor with a “small” RRSP of 50% of assets will be holding (some) prefs in the RRSP. Some investors will have only RRSP/RRIF assets, so if they own prefs they would have to be in the registered account.

    Having said all this, the investor has to ask whether a 1.11X increase in gross yield in a tax deferred account (going from bonds to discount prefs; 65 bp) is worth the extra credit risk of being lower on the seniority list PLUS the inflation risk of a discount pref never maturing. While these risks may be worthwhile on an after tax basis, I question whether they would be worth it on a pre-tax basis.

  4. jiHymas says:

    The LOCATION decision (RRSP/RRIF vs Taxable Account) is best determined after asset allocation is set.

    My assumption, perhaps unwarranted, was that beluga either has no investments outside his RSP, or that he is already full-up on prefs in the taxable portion of his portfolio; in either case, that any additional PD exposure had to be in his RSP.

    PLUS the inflation risk of a discount pref never maturing

    Often over-rated. At 5.7%, less than one-fifth of the entire value of the corporate bond is represented by return of principal.

    To put it another way, if we take cash flows of $6.35 per year (the pref) and discount them at 5.7% (the bond rate), those sum to $90.28 over the thirty year period. The difference of $9.72 will be recovered if we can sell the share for 51.25 cents on the dollar.

    In other words, the yield differential over thirty years will offset the loss of nearly half of principal at the end of the period. I wrote a bit about the impact of terminal value in assessing perpetual investments in Perpetual Misperceptions.

  5. beluga says:

    Thanks for the thoughtful discussion!

    Yes, assuming asset allocation is sensible and fixed income purchases in the RRSP is required. (My RRSP is much larger than the taxable account and I have both PDs and straight equities in there).

    Is 65bps plus being exchange traded worth it? What about 106bps?

    At the TD online bond desk today, a GREAT-WEST LIFECO INC, coupon 5.998% and maturity 11/16/2039 has a buy yield of 5.42402% while GWO.PR.L closed April with bid-YTW of 6.48%

    Is this a valid comparison?

  6. jiHymas says:

    I have previously discussed the GWO 5.998 30-year debs.

    Yes, it can be used for an issuer-specific Seniority Spread calculation against the GWO preferreds.

    Is 65bps plus being exchange traded worth it? What about 106bps?

    Sorry, beluga! This is way too specific a question to be answered in comments for free! I’m afraid you’ll have to buy a full consultation if you want a considered response to that question.

  7. prefhound says:

    Well, with the RRSP “much larger” than the taxable account, I would say one might well want to own prefs in the RRSP. However, I would first make sure all the other assets were in their optimal location.

    Compounded on the same basis as the quarterly yield from prefs, your bond has a buy yield of 5.39%

    For appropriate comparison, the ask price (buy price) on the GWO.PR.L pref is $22.40, and there is a 23c downward adjustment for accrued dividends, so the comparable quarterly yield is 1.4125/$22.17 = 6.37% for a gross difference of 98 bp.

    This is much more potentially rewarding than the average of 65 bp and has the bonus that in a “normal world” (should we ever return to such a state), we might find bond yields only slightly lower and pref yields as much as 100-120 bp lower, in which case the RRSP choice would likely be different.

  8. […] spread of PerpetualDiscounts over Long Corporates (which I also refer to as the Seniority Spread) ended the month at +320bp, a sharp increase from +285bp at March month-end and +235bp recorded at February […]

  9. beluga says:

    Thanks. It’s good to know I’m not crazy. And I really appreciate the tips about how to refine the calculations.

    I’m a prefletter and seminar subscriber. Those services have certainly more than paid for themselves. I may go for the consultation in a year or two, after I’ve made a bigger mess of things 😉

  10. […] the pre-tax interest-equivalent spread is now about 330bp, an increase from the +320bp reported at month end, as long corporate yields have come in a little while PerpetualDiscounts have remained […]

  11. […] responsibility which aims to “clarify” earlier remarks (discussed on PrefBlog on April 30: Currently, investors are receiving investment advice from broker-dealers who are not fiduciaries. […]

  12. […] between the interest-equivalent pre-tax PerpetualDiscount yield and the long corporate yield) is exceptionally high at the moment at 320bp. This spread has been exceeded in the past 16+ years only at the depths of the Credit Crunch in […]

  13. […] of the guys who ran Basis Yield Alpha Fund (mocked on PrefBlog on April 30 is haranguing the regulators for a crusade: THE man who blew the whistle on Wall Street banking […]

  14. […] The pre-tax interest equivalent spread of PerpetualDiscounts over Long Corporates (which I also refer to as the Seniority Spread) ended the month at +315bp, a slight (an possibly spurious) decline from the +320bp recorded on April 30. […]

  15. […] between Treasury and the FDIC to deal with private equity purchasers of banks was mentioned on April 30. That trend is continuing: Buyout firms thwarted by regulators from taking over failed banks have […]

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