October 3, 2007

The latest passion on the Street is telling everybody how lousy everything is! PIMCO & TIAA-CREF hate the market, Greenspan hates the market, Credit Suisse hates the market … there’s no shortage. But it takes two to make a market! James Hamilton at Econbrowser takes a look at recent indicators and points out that – so far, anyway – the problems in the US housing market haven’t spread to other areas of the US economy. So take your choice!

The BIS Quarterly Review has a good review of the credit crunch.

I’ve updated the post about the Globe’s reporting of Dickson’s speech with a link and extract from the National Post’s article, which is much more reflective of what was actually said. You almost wonder if the reporters are reporting the same speech!

Fitch Ratings has announced that it completed its review of 2006-vintage sub-prime issues:

For first- and second-lien transactions combined, Fitch has affirmed 2,228 classes with a par balance of $155.1 billion and downgraded 1,003 classes with a par balance of $18.4 billion. While Fitch’s reviewed all rating categories, downgrades were most heavily concentrated among classes originally rated ‘BBB+’ or lower. Fitch believes that those classes that have been downgraded to below-investment grade have substantial risk of principal loss. However those bonds remaining investment grade still exhibit the ability to withstand the higher projected collateral default and loss expectations without principal loss. Those classes affirmed at ‘AAA’ are able to withstand a substantial multiple of expected collateral performance without experiencing loss.

This action was gleefully reported by Bloomberg and commented upon by Joseph Mason, an associate professor at Drexel University. Mr. Mason has testified to the Subcommittee on  Capital Markets, Insurance, and Government … woo-hoo! I haven’t read his testimony thoroughly yet, but a quick skim suggests that he doesn’t like the Credit Rating Agencies very much! I’d better get cracking on my reading, because his faculty web-page pointed me to a paper on the value of recourse which has implications for bank-sponsored ABCP. Briefly, it would appear – the authors claim – that the market is implicitly assuming that there will be support for conduits even when there doesn’t need to be; this is very similar to the US mortgage GSEs and implicit ‘off-balance-sheet’ Treasury backing.

By providing recourse in cases where none is explicitly required, the sponsor demonstrates the presence of de facto recourse and therefore previously unreported contingent liabilities. The present paper examines the effects of these revelations on the sponsor. On the face of it, one might expect that revealing previously unreported contingent liabilities could heighten asymmetric information about firm conditions, resulting in poor short- and long-term stock price performance, poor long-term financial performance, and reduced proceeds from subsequent loan sales. However, we find that, conditional on being in a position where honoring implicit recourse has become necessary and conditional on actually providing that recourse, the sponsors, on average, exhibit improved short- and long-term stock price performance, improved long-term financial performance, and similar proceeds from subsequent loan sales.

This is of interest in terms of assessing market discipline and credit analysis of the banks. For example, note 5 of the 2006 BMO Financials discloses that almost CAD 80-billion of liquidity guarantees had been extended, none of which found its way into risk-weighted assets (that’s none. N-U-N. none). Given the bank’s capital of CAD 16,641-billion, reported risk-weighted assets of CAD 162,794 and a CCF of 10%, this would not make a huge difference to the tier 1 capital ratio. But – given recent experience – is the CCF of 10% high enough? Eighty-billion landing suddenly on their balance sheet might give them collywobbles – and Rule #1 states that Everything Bad Happens at the Same Time.

Market discipline is something of a worry, despite the investment industry’s constant reiteration that we’re such a bunch of tough guys. However, Beloved Leader And Economic Genius for Life Stephen Harper is taking care of an oversight, and reminding investors that they are stupid:

Sources told The Canadian Press on Tuesday that Industry Minister Jim Prentice is concerned about foreign state-owned entities snapping up Canadian resource firms.

Among those currently being reviewed, sources said, is the PrimeWest acquisition, part of TAQA’s stated goal of dramatically growing its presence in Canada’s energy sector.

At a late Wednesday news conference in Ottawa, Prime Minister Stephen Harper said his government will address the lack of a national security test for foreign takeovers of Canadian companies.

It’s about time this country was protected from foreigners offering enormous bundles of cash! If such sums ever reach Canadian hands, we’ll just blow it on beer and prostitutes.

Volume picked up today, but perpetuals continued their slide. I confess that I find this continued weakness somewhat odd … but market volatility brings trading opportunities, and the passage of time brings dividends, so my curiosity is somewhat muted.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.67% 4.61% 869,811 16.05 1 -2.0000% 1,043.7
Fixed-Floater 4.90% 4.78% 103,642 15.81 7 +0.2704% 1,033.4
Floater 4.50% 2.84% 79,333 10.71 3 -0.1093% 1,043.9
Op. Retract 4.85% 4.24% 78,184 3.35 15 +0.0310% 1,028.4
Split-Share 5.13% 4.86% 87,498 4.06 15 +0.0134% 1,046.6
Interest Bearing 6.34% 6.44% 55,061 3.63 3 +0.2054% 1,043.7
Perpetual-Premium 5.64% 5.41% 95,431 8.33 17 -0.2414% 1,015.4
Perpetual-Discount 5.32% 5.35% 211,430 14.90 45 -0.1464% 945.6
Major Price Changes
Issue Index Change Notes
POW.PR.C PerpetualPremium (for now!) -2.3990% Closed at 24.41-28, but the low for the day was actually 25.05. Now with a pre-tax bid-YTW of 5.96% based on a bid of 24.41 and a limitMaturity.
RY.PR.G PerpetualDiscount -2.2727% This one actually came back from its low of 21.25, the price at which about one-third of the day’s volume traded. It was one of the big gainers yesterday, but gave all that up and more. Now with a pre-tax bid-YTW of 5.30% based on a bid of 21.50 and a limitMaturity.
BCE.PR.B Ratchet -2.0000%  
RY.PR.C PerpetualDiscount -1.5965% Now with a pre-tax bid-YTW of 5.25% based on a bid of 22.19 and a limitMaturity.
GWO.PR.I PerpetualDiscount -1.2844% Now with a pre-tax bid-YTW of 5.25% based on a bid of 21.52 and a limitMaturity.
SLF.PR.B PerpetualDiscount -1.1648% Giving up most of yesterday’s gain. Now with a pre-tax bid-YTW of 5.27% based on a bid of 22.91 and a limitMaturity.
RY.PR.A PerpetualDiscount -1.1537% Now with a pre-tax bid-YTW of 5.26% based on a bid of 21.42 and a limitMaturity.
CM.PR.J PerpetualDiscount -1.0152% Now with a pre-tax bid-YTW of 5.25% based on a bid of 21.45 and a limitMaturity.
Volume Highlights
Issue Index Volume Notes
NTL.PR.F Scraps (would be ratchet, but there are credit concerns) 224,419 Nesbitt crossed 198,500 at 15.25.
BNS.PR.M PerpetualDiscount 99,715 Nesbitt crossed 25,000 at 21.63. Now with a pre-tax bid-YTW of 5.20% based on a bid of 21.60 and a limitMaturity.
BMO.PR.J PerpetualDiscount 64,500 Now with a pre-tax bid-YTW of 5.26% based on a bid of 21.60 and a limitMaturity.
GWO.PR.E OpRet 51,432 Scotia crossed 48,800 at 25.95. Now with a pre-tax bid-YTW of 3.78% based on a bid of 25.80 and a call 2011-4-30 at 25.00.
GWO.PR.X OpRet 50,598 Scotia crossed 50,000 at 26.70. The appearance of both GWO retractibles in the volume-leader list leads me to suspect that something’s up. Now with a pre-tax bid-YTW of 3.41% based on a bid of 26.65 and a call 2009-10-30 at 26.00.
MFC.PR.A OpRet 50,545 Scotia crossed 50,000 at 25.80. Now with a pre-tax bid-YTW of 3.76% based on a bid of 25.66 and a softMaturity 2015-12-18 at 25.00.

There were nineteen other index-included $25.00-equivalent issues trading over 10,000 shares today.

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