October 25, 2010

A lot of corporate debt is being called for redemption:

Not since 2004 have borrowers had as much incentive to tender for their bonds, prompting companies from mining firm Rio Tinto Plc in London to New York-based television network CBS Corp. to redeem debt.

Companies tendered for $30.5 billion of bonds last month, the most since April, and are on pace to buy an additional $24.3 billion this month, according to data compiled by Bloomberg.

A measure of company bond yields that takes into account the risk that the debt will be redeemed — the so-called yield- to-worst — has dropped to an average 3.44 percent from 4.49 percent a year ago, according to Bank of America Merrill Lynch index data. During that time, the average bond coupon has declined to 5.25 percent from 5.46 percent. The difference between yields and coupons reached as much as 191 basis points on Oct. 11.

“There’s quite an incentive to retire outstanding debt and replace it with lower-coupon newly issued bonds to reduce the cost of debt capital,” said John Lonski, chief economist at Moody’s Capital Markets Group in New York. “The effect of refinancing has been overwhelmingly positive for corporate credit.”

A bit more discussion of the flash crash:

More importantly, in the case of the fateful trade it was not actually Waddell’s own algorithm that executed the trade, as implied by the SEC-CFTC report, but that of its broker, Barclay’s Capital. Further complicating matters, researchers and people close to the trade are disagreeing with the report’s characterization of the algorithm that executed the trade, pointing out that it has been many times for much larger trades with no similar fallout.

“Based on our data, this was actually a very good algorithm,” says Nanex founder Eric Hunsader, who has analyzed the trade data. “It’s portrayed [in the report] as a very simple algorithm, but you can clearly see that it did take into account things like price—if it hadn’t, you could have really seen a market collapse…What really caused the collapse was firms re-selling these contracts incredibly quickly and just drying up all the liquidity.”

There are a number of things wrong with this analysis. First, the fact that the algorithm has been used before is not really a defense. If I’ve managed to cross the street with my eyes closed three times in succession, should this become an acceptable practice? Additionally, the fact that Barclays was the executing broker and algorithm supplier muddies the waters, but is not strictly relevant. Waddell Reed gave the instructions to use it and must have been – or should have been – comfortable with the embedded logic. Finally, it does not make much sense to exonerate Waddell Reed on the basis that their initial counterparties sold off the contracts “incredibly quickly”, although again that complicates matters. How was the stream of orders from WR to the ultimate (or, at least, end of day) buyers affected by passing through this layer? Did the presence of the “HFT Layer” accentuate or attenuate the price effect, or did it have no meaningful impact at all? Some might say it accentuated the effect due to the volume increase due to the “hot potato” trading, and that’s the end of the story … but is it? Nanex clearly considers the effect to be an accellerator:

The algorithm was very well behaved; it was careful not to impact the market by selling at the bid, for example. And when prices moved down sharply, it would stop completely.

The buyer of those contracts, however, was not so careful when it came to selling what they had accumulated. Rather than making sure the sale would not impact the market, they did quite the opposite: they slammed the market with 2,000 or more contracts as fast as they could. The sale was so furious, it would often clear out the entire 10 levels of depth before the offer price could adjust downward. As time passed, the aggressiveness only increased, with these violent selling events occurring more often, until finally the e-Mini circuit breaker kicked in and paused trading for 5 seconds, ending the market slide.

Assuming that we may accept Nanex’ analysis, it may be useful to consider the HFT effect to be – at least in this instance – as of an electrical capacitator, storing up contracts until the limit was reached, then discharging violently.

There was a very interesting TIPS auction today:

The Treasury sold $10 billion of five-year Treasury Inflation Protected Securities at a negative yield for the first time at a U.S. debt auction as investors bet the Federal Reserve will be successful in sparking inflation.

The securities drew a yield of negative 0.55 percent, the same as the average forecast in a Bloomberg News survey of 7 of the Fed’s 18 primary dealers. The sale was a reopening of an $11 billion offering in April. Conventional Treasury notes erased gains amid speculation on the amount of debt the Fed may buy to spur the economy in a tactic called quantitative easing.

The US mortgage market gets more interesting by the day:

Home lenders are making it tougher to get loans as investors step up demands for refunds on defective mortgages, damaging the housing market, executives said today at an industry conference.

Already beset by billions of dollars in forced buybacks, originators have imposed standards on new loans that are stricter than those set by mortgage buyers and insurers, according to Todd Chamberlain, an executive vice president who oversees mortgage lending at Birmingham, Alabama-based Regions Financial Corp.

Fannie Mae, Freddie Mac and bond insurers such as MBIA Inc. are pressing lenders including Bank of America Corp. to honor promises to buy back mortgages if they’re later found to be based on inaccurate data. Known as representations and warranties, the promises cover defects such as inflated appraisals or inaccurate data about a borrower’s job or income. Bank of America said last week it will resist paying claims.

The industry needs to be “more united” in dealing with the demands, said William C. Emerson, Chief Executive Officer of Detroit-based Quicken Loans Inc., ranked as the 10th-largest lender in the first half of this year by newsletter Inside Mortgage Finance. Bankers have attributed mortgage defaults to the poor economy rather than defects in the loans.

“We all know we signed up for reps and warranties, but I don’t know if we thought we signed up to be an insurance company,” he said, speaking on the panel with Chamberlain and McCord.

Sorry Charlie! Finance is NOT A COOPERATIVE KIDDIE GAME. There is nothing unethical about jingle mail; there is nothing wrong with ultimate buyers exercising their put option. Next time, try reading the fine print on your own contract, rather than crying that the rules of the game are unfair halfway through.

Rob Ford was elected Toronto Mayor, which I attribute largely to PrefBlog’s endorsement (emphasis added):

Get set for a shakeup at City Hall that includes a tilt to the political right after seven years of Miller’s left-leaning reign, presuming the new mayor is able to heal campaign wounds and convince his council, rich with fresh faces, to approve key elements of his election blueprint.

Even better a good swath of incumbents got cut down, including my guy Saundercook, aka “Mr. Invisible”.

It was a good solid day on the Canadian preferred share market, with PerpetualDiscounts up 9bp and FixedResets gaining 3bp, with continued heavy volume.

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 0.00 % 0.00 % 0 0.00 0 -0.3285 % 2,172.3
FixedFloater 0.00 % 0.00 % 0 0.00 0 -0.3285 % 3,290.8
Floater 2.88 % 3.19 % 87,265 19.25 3 -0.3285 % 2,345.5
OpRet 4.93 % 3.92 % 96,092 0.10 9 -0.1037 % 2,363.6
SplitShare 5.88 % -25.31 % 68,654 0.09 2 0.3255 % 2,394.2
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 -0.1037 % 2,161.3
Perpetual-Premium 5.69 % 5.15 % 139,918 5.34 19 0.1422 % 2,016.3
Perpetual-Discount 5.42 % 5.44 % 244,221 14.69 58 0.0927 % 2,016.7
FixedReset 5.27 % 3.04 % 342,197 3.25 47 0.0345 % 2,275.7
Performance Highlights
Issue Index Change Notes
PWF.PR.K Perpetual-Discount -1.13 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-25
Maturity Price : 22.56
Evaluated at bid price : 22.74
Bid-YTW : 5.46 %
GWO.PR.M Perpetual-Discount -1.06 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-25
Maturity Price : 24.88
Evaluated at bid price : 25.10
Bid-YTW : 5.84 %
MFC.PR.E FixedReset 1.02 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-10-19
Maturity Price : 25.00
Evaluated at bid price : 26.82
Bid-YTW : 3.76 %
MFC.PR.C Perpetual-Discount 1.28 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-25
Maturity Price : 19.80
Evaluated at bid price : 19.80
Bid-YTW : 5.76 %
BMO.PR.J Perpetual-Discount 1.57 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-25
Maturity Price : 23.07
Evaluated at bid price : 23.26
Bid-YTW : 4.90 %
Volume Highlights
Issue Index Shares
BAM.PR.K Floater 71,900 Nesbitt crossed 50,000 at 16.65; Desjardins crossed 15,000 at 16.57.
Maturity Type : Limit Maturity
Maturity Date : 2040-10-25
Maturity Price : 16.56
Evaluated at bid price : 16.56
Bid-YTW : 3.19 %
TRP.PR.C FixedReset 63,725 RBC crossed blocks of 15,000 and 25,000, both at 25.65.
Maturity Type : Limit Maturity
Maturity Date : 2040-10-25
Maturity Price : 25.50
Evaluated at bid price : 25.55
Bid-YTW : 3.54 %
BAM.PR.B Floater 58,814 Nesbitt crossed 50,000 at 16.50.
Maturity Type : Limit Maturity
Maturity Date : 2040-10-25
Maturity Price : 16.46
Evaluated at bid price : 16.46
Bid-YTW : 3.21 %
BNS.PR.L Perpetual-Discount 50,159 Desjardins crossed 25,000 at 22.42.
Maturity Type : Limit Maturity
Maturity Date : 2040-10-25
Maturity Price : 22.24
Evaluated at bid price : 22.38
Bid-YTW : 5.05 %
CM.PR.A OpRet 42,254 Called for redemption. Desjardins bought 40,000 from Nesbitt at 24.98.
Maturity Type : Call
Maturity Date : 2010-11-30
Maturity Price : 25.00
Evaluated at bid price : 24.98
Bid-YTW : 5.29 %
RY.PR.N FixedReset 38,263 TD crossed 25,000 at 27.65.
Maturity Type : Call
Maturity Date : 2014-03-26
Maturity Price : 25.00
Evaluated at bid price : 27.56
Bid-YTW : 2.88 %
There were 44 other index-included issues trading in excess of 10,000 shares.

2 Responses to “October 25, 2010”

  1. […] mortgage rep & warranty issue in the States, briefly mentioned on October 25 is getting more interesting: Total losses from repurchases by the banks, which also include Wells […]

  2. […] is consistent with my speculation on October 25 that HFT acts as a capacitator that will discharge if a certain inventory level is breached. We […]

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