October 29, 2010

The EU is now openly discussing mechanisms for sovereign default:

European Union leaders endorsed German calls for a rewrite of EU treaties to create a permanent debt-crisis mechanism, while sparring over whether to force bondholders to help pay the bill for rescuing financially distressed states.

As the biggest contributor to this year’s hastily arranged 860 billion euros ($1.2 trillion) in loans and pledges to stem the debt crisis, Germany won backing to set up a permanent system by 2013. Deficit-strapped Spain warned that provisions to reschedule or cancel some debts would expose its markets to renewed selling pressure.

“We won’t allow only the taxpayers to bear all the costs of a future crisis,” German Chancellor Angela Merkel told a press conference in Brussels today after a summit of EU leaders. There is “a justified desire to see that it’s not just taxpayers who are on the hook, but also private investors.”

Germany rules out extending this year’s emergency taxpayer- funded financial assistance mechanisms when they expire in 2013. Merkel’s follow-up system would extend debt maturities, suspend interest payments and waive creditor claims, Handelsblatt newspaper reported yesterday, citing an unidentified government official.

Assiduous Readers will remember that on July 23 I reported:

But the best line in the farce comes from a central banker:

ECB Vice President Vitor Constancio called the tests “severe” and explained they didn’t include a scenario of a national default because “we don’t believe there will be a default.”

That’s just great, Vitor! Maybe you’ll be put in charge of the government run credit rating agency the Europeans are thinking about, you know, the ones that will be much nicer to sovereigns than those mean old-style CRAs!

There is no word yet regarding whether Vitor Constancio has resigned.

The Bank of Canada has released a working paper by Ali Dib titled Capital Requirement and Financial Frictions in Banking: Macroeconomic Implications:

The author develops a dynamic stochastic general-equilibrium model with an active banking sector, a financial accelerator, and financial frictions in the interbank and bank capital markets. He investigates the importance of banking sector frictions on business cycle fluctuations and assesses the role of a regulatory capital requirement in propagating the effects of shocks in the real economy. Bank capital is introduced to satisfy the regulatory capital requirement, and serves as collateral for borrowing in the interbank market. Financial frictions are introduced by assuming asymmetric information between lenders and borrowers that creates moral hazard and adverse selection problems in the interbank and bank capital markets, respectively. Highly leveraged banks are vulnerable and therefore pay higher costs when raising funds. The author finds that financial frictions in the interbank and bank capital markets amplify and propagate the effects of shocks; however, the capital requirement attenuates the real impacts of aggregate shocks (including financial shocks), reduces macroeconomic volatilities, and stabilizes the economy.

Commissioner Elisse B. Walter of the SEC delivered an interesting speech regarding the SEC review of the US Municipal market. A lot of familiar cross currents – exchanges for bonds! the Credit Rating Agencies are no good! brokers should tell us what to buy! – and discussion of the move from the Municipal rating scale to the global scale:

Three participants endorsed the principle of a global rating scale. However, one pointed out that during this time — where some rating agencies are moving to a global scale — investors may find it increasingly difficult to compare municipal credits against each other. Further, he thinks that despite recalibration, investors will continue to have a hard time comparing munis to corporates because municipal risk remains overstated relative to corporate risk.

Several others were critical of the notion of a global rating scale, arguing that municipal bonds and corporate securities are just not comparable. One panelist stated that munis should not be rated on a scale that focuses on default risk and recovery, since governments rarely default. Some of the participants would prefer a new rating scale for governments that could be tailored to the unique characteristics of governmental entities. We heard suggestions for a simple pass/fail scale, a three-part scale or a scale of 1-100.

Another area of concern was the impact of ratings on the cost of issuance. One panelist pointed out that higher ratings lead to lower borrowing costs and lower ratings lead to higher borrowing costs. He and a co-panelist highlighted the consequence of lower ratings: increased costs to taxpayers for financing critical infrastructure projects.

That last panelist should take a tip from the Europeans: set up a new rating agency with a mandate to be chipper and upbeat at all times.

Themis Trading points out signs of a high-level regulatory battle, with the NYSE opining:

NYSE Euronext Chief Executive Officer Duncan Niederauer said regulators will probably respond to the May 6 stock-market crash by extending obligations to buy and sell shares to more traders.

Niederauer, speaking in Washington today, said too many traders reap the benefits of making markets without responsibilities to keep providing liquidity when stocks are plunging. New rules may be in place as soon as January, he said.

Securities and Exchange Commission Chairman Mary Schapiro called on the agency in September to examine whether the loss of “old specialist obligations” has hurt investors after measures such as trading stocks in penny increments cut the number of market makers. With the facilitation of trading now dominated by hundreds of automated firms with few rules for when they must buy and sell, the SEC is considering ways to keep the biggest from abandoning the market at the first sign of trouble.

The astonishing part is in the third paragraph. Imagine! The regulators made it less profitable to be a specialist … and fewer firms wanted to be specialists. Well, who woulda thunk it?

NASDAQ takes the other view:

The head of Nasdaq OMX Group Inc (NasdaqGS:NDAQ – News) said on Friday he does not expect any new obligations or privileges for U.S. “market-makers” until 2012 at the earliest, calling any regulatory change “a slippery slope.”

“I don’t think something will happen in 2011,” Nasdaq OMX Chief Executive Officer Robert Greifeld said on a conference call, adding it would be “a difficult road to try to properly define what responsibility and privileges to give participants.”

Mervyn King made an excellent point in a speech at the Second Bagehot Lecture:

Second, the Basel approach calculates the amount of capital required by using a measure of “risk-weighted” assets. Those risk weights are computed from past experience. Yet the circumstances in which capital needs to be available to absorb potential losses are precisely those when earlier judgements about the risk of different assets and their correlation are shown to be wrong. One might well say that a financial crisis occurs when the Basel risk weights turn out to be poor estimates of underlying risk. And that is not because investors, banks or regulators are incompetent. It is because the relevant risks are often impossible to assess in terms of fixed probabilities. Events can take place that we could not have envisaged, let alone to which we could attach probabilities. If only banks were playing in a casino then we probably could calculate appropriate risk weights. Unfortunately, the world is more complicated. So the regulatory framework needs to contain elements that are robust with respect to changes in the appropriate risk weights, and that is why the Bank of England advocated a simple leverage ratio as a key backstop to capital requirements.

He also mentioned the Too Big To Fail problem:

But in most other countries, identifying in advance a group of financial institutions whose failure would be intolerable, and so are “too important to fail”, is a hazardous undertaking. In itself it would simply increase the subsidy by making it explicit. And it is hard to see why institutions whose failure cannot be contemplated should be in the private sector in the first place. But if international regulators failed to agree on higher capital requirements in general, adding to the loss-absorbing capacity of large institutions could be a second-best outcome.

… which has been a hot issue lately:

“Are we a systemically important bank in the world? I think (we’re) not. Nothing in my strategy is trying to make us that,” Toronto-Dominion Bank CEO Ed Clark said last week, although he also acknowledged that regulators may not agree with him.

“It’s not obvious that there will be no impact on us, and I don’t know that and I can’t get any assurance on that,” he said at a presentation in Toronto. TD is Canada’s No. 2 bank.

Rick Waugh, CEO of third-ranked Bank of Nova Scotia , has also said his bank is not systemically important.

Gord Nixon, head of Royal Bank of Canada , which is considered the Canadian bank most likely to be deemed “too big to fail,” said at a presentation Wednesday that the whole debate was “ridiculous” and suggested labeling a bank “too big” might compel it to shed assets to shrink.

It’s so far unclear how many banks will fit the bill, with some speculating regulators could name 30 or more lenders.

Canada’s bank regulator, which has objected to the idea of singling out large banks, is also pushing the point that Canadian banks should be left off the list.

“I’d say that 80 per cent of global financial intermediation goes through 20 institutions … and no Canadian financial institutions fit that bill,” said Julie Dickson, Canada’s Superintendent of Financial Institutions.

It is precisely to avoid such irresolvable arguments that I propose that regulation eschew the TBTF label; what should happen is that there should be a progressive surcharge on Risk-Weighted-Assets, so that the first 100-billion is requires less capital than the next 100-billion and so on.

The SEC has $450-million available for paid informers! Denounce your neighbor today!

Alackaday! TMX DataLinx has advised:

The daily Toronto Stock Exchange and TSX Venture Exchange Trades & Quotes files for Friday October 29, 2010 will be delayed due to systems testing and are expected to be available by 5:00 AM, Sunday October 31, 2010. We regret any inconvenience this may cause.

They like to do this on PrefLetter weekends and monthends. So we’re all gonna hafta wait. I will update with the day’s action when I can.

Update, 2010-10-31: The Canadian preferred share market closed the month with a small gain, PerpetualDiscounts up 3bp and FixedResets winning 2bp. Volume continued at elevated levels.

PerpetualDiscounts now yield 5.41%, equivalent to 7.57% at the standard equivalency factor of 1.4x. Long Corporates now yield about … oh, call it a hair over 5.2%, so the pre-tax interest-equivalent spread is now about 235bp, a slight (and perhaps meaningless) increase from the 230bp reported on October 27, but a sharp decline from the 260bp reported on September 30. The tightening was driven on both sides, as PerpetualDiscount yields fell while long corporate yields rose modestly; the performance of the BMO Long Corporate ETF shows how returns on the asset class plateaued in October.

Click for Big
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 0.0911 % 2,184.3
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.0911 % 3,308.9
Floater 2.87 % 3.17 % 88,576 19.29 3 0.0911 % 2,358.4
OpRet 4.90 % 3.60 % 94,867 0.73 9 -0.0086 % 2,374.7
SplitShare 5.88 % -17.20 % 67,984 0.09 2 -0.3030 % 2,396.2
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 -0.0086 % 2,171.5
Perpetual-Premium 5.70 % 5.05 % 152,219 5.33 19 0.0639 % 2,015.8
Perpetual-Discount 5.40 % 5.41 % 246,879 14.71 58 0.0324 % 2,024.4
FixedReset 5.26 % 3.00 % 379,806 3.24 48 0.0227 % 2,276.5
Performance Highlights
Issue Index Change Notes
IAG.PR.C FixedReset -1.49 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-01-30
Maturity Price : 25.00
Evaluated at bid price : 27.10
Bid-YTW : 3.63 %
CM.PR.G Perpetual-Discount -1.12 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-29
Maturity Price : 24.49
Evaluated at bid price : 24.77
Bid-YTW : 5.47 %
Volume Highlights
Issue Index Shares
BAM.PR.T FixedReset 229,985 New issue settled today.
Maturity Type : Limit Maturity
Maturity Date : 2040-10-29
Maturity Price : 23.03
Evaluated at bid price : 24.83
Bid-YTW : 4.16 %
TRP.PR.C FixedReset 108,075 RBC crossed 100,000 at 25.53.
Maturity Type : Limit Maturity
Maturity Date : 2040-10-29
Maturity Price : 25.46
Evaluated at bid price : 25.51
Bid-YTW : 3.55 %
BNS.PR.P FixedReset 104,900 RBC crossed 100,000 at 26.53.
Maturity Type : Call
Maturity Date : 2013-05-25
Maturity Price : 25.00
Evaluated at bid price : 26.54
Bid-YTW : 2.43 %
TD.PR.O Perpetual-Discount 62,665 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-29
Maturity Price : 23.55
Evaluated at bid price : 23.80
Bid-YTW : 5.11 %
BAM.PR.B Floater 48,161 Nesbitt crossed two blocks of 20,000 each, both at 16.65.
Maturity Type : Limit Maturity
Maturity Date : 2040-10-29
Maturity Price : 16.61
Evaluated at bid price : 16.61
Bid-YTW : 3.18 %
RY.PR.L FixedReset 45,660 RBC sold 11,200 to Nesbitt at 26.89 and 11,000 to TD at the same price.
Maturity Type : Call
Maturity Date : 2014-03-26
Maturity Price : 25.00
Evaluated at bid price : 26.93
Bid-YTW : 3.01 %
There were 37 other index-included issues trading in excess of 10,000 shares.

3 Responses to “October 29, 2010”

  1. […] spread of PerpetualDiscounts over Long Corporates (which I also refer to as the Seniority Spread) ended the month at 235bp, a significant decline from the 265bp reported at August month-end. Long corporate yields […]

  2. […] PerpetualDiscounts now yield 5.37%, equivalent to 7.52% interest at the standard equivalency factor of 1.4x. Long Corporates now yield 5.2% (OK, a little over. Sue me) so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 230bp, a slight (and perhaps meaningless) tightening from the 235bp reported on October 29. […]

  3. […] as the Seniority Spread) ended the month at 220bp, a significant decline from the 235bp reported at October month end. Long corporate yields increased to 5.4% from 5.2% during the period while PerpetualDiscounts […]

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