More details are emerging regarding the SIV situation: FT-Alphaville has republished a Fitch graph showing the NAV of the SIVs it rates:
In this case, “NAV” is a measure of the asset coverage provided to the equity noteholders; therefore, when it’s below 100%, they’ve lost money. These numbers have no independent implications for the asset coverage ratios for the senior noteholders; that will depend on the original capital structure of the SIV.
Naked Capitalism discusses this and other tidbits from the SIV front. An anonymous Fed tipster is putting out the word that the Fed’s silence should not be misconstrued. The WSJ has published an extract from an interview with the head of the Basel Committee on Banking Supervision – he’s not impressed by the Super-Conduit idea. One question-and-answer brought tears of gratitude to my eyes:
Might Basel II’s reliance on rating agencies, for instance, come under consideration?
There are problems to be solved with rating agencies. … but you remain responsible at the end of the day, yourself, and you have to make your own assessments.
Fitch Ratings has published an initial review, dated September 20, and an update, dated October 12, of the SIVs it rates (the chart above is taken from the update). Credit Sights, an independent credit rating agency (that is, one paid by its subscribers rather than – gasp! – the issuers) that delights in being gloomier than the the issuer-paid credit rating agencies, has released a report (to paying clients) that claims:
Many structured-investment vehicles may be forced to close in the next few months as defaults by SIVs run by European hedge funds make it harder for others to avoid selling off their assets
So if Super-Conduit ever gets off the ground, there is every indication that it will have plenty of assets to choose from!
I mentioned the issue of bank purchases of ABCP held in their money-market funds on August 20 in the context of managerial independence, but there are other problems with the idea. Mainly, is a MMF a stand-alone investment vehicle, or is it a bank deposit? There are some US banks purchasing SIV paper from their MMFs; this is not a right and proper thing to do. I hope that the OSFI in Canada and the Fed in the US will nail these banks to the wall on their next audit; unless unitholders are taking ALL the risk of the investment, EVERY SINGLE PENNY, then the MMF is not a stand-alone vehicle.
Given all the excitement regarding the issuance of covered bonds, it would seem that if bank-run MMFs are really “covered bank deposits” then the banks’ balance sheets should be grossed up by the size of their funds and capital adequacy determined from these figures. The National Bank, for example, has total assets of about $117-billion and a total of about $1.7-billion in various MMF vehicles: Money Market Fund, Treasury Bill Plus, US MMF, Corporate Cash Management, Treasury Management and Strategic Yield. Grossing up the balance sheet would not be the biggest charge in the world, but if the banks are going to give implicit support to their funds, it is a charge that should be taken in order to protect depositors.
Business Week has a fascinating story on the implosion of the two Bear Stearns hedge funds that triggered the whole crisis. I have updated my post on stress-testing of Australian mortgages with a report from Bloomberg that one of the largest mortgage insurers is being downgraded.
The decline in perpetual preferreds actually accellerated today; to me, the yields have gone beyond “wow!” and into “outlandish” territory … but those who are selling evidently disagree with me!
There are some proxy-variables in the yield curve analysis that lead me to suspect that there is a definite bias towards selling the newer issues – by which I mainly mean everything issued in the last year; this is a change from the situation last spring. I had mentioned at that point that liquidity appeared to be at a premium – and so it was, according to the analysis. I am beginning to suspect, however, that the yield curve needs some kind of – yech! – momentum indicator, because I am now hypothesizing that the liquidity premium was actually a proxy for a “recent issue premium”. Currently, I am analyzing a premium being paid for “cumulative dividends”; this might be a proxy for “recent issue discount”.
There’s always something new, something to be tested, that becomes apparent only in times of extreme stress. ‘Nature reveals her secrets best under torture’, and all that. If Bacon didn’t say it, then I will.
I should note – for those who might be alarmed at the idea that I don’t know everything already – that yield curve analysis is the least of my analytical worries right now. Fits to the curve are excellent; it’s diversification that has me concerned. The yield pick-up of Perpetuals over Retractibles is now so extreme it’s becoming harder and harder to justify any holdings of the latter at all!
| 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 | 4.85% | 4.82% | 515,214 | 15.65 | 1 | 0.0000% | 1,043.7 |
| Fixed-Floater | 4.88% | 4.79% | 102,556 | 15.80 | 7 | +0.1108% | 1,039.9 |
| Floater | 4.52% | 4.54% | 69,471 | 16.29 | 3 | -0.1101% | 1,038.4 |
| Op. Retract | 4.86% | 3.91% | 79,823 | 3.13 | 15 | -0.0733% | 1,029.4 |
| Split-Share | 5.16% | 5.03% | 86,188 | 4.13 | 15 | -0.0030% | 1,043.5 |
| Interest Bearing | 6.20% | 6.16% | 58,669 | 3.64 | 4 | +0.7660% | 1,067.6 |
| Perpetual-Premium | 5.74% | 5.60% | 98,396 | 9.89 | 17 | -0.2768% | 1,002.1 |
| Perpetual-Discount | 5.51% | 5.55% | 321,954 | 14.61 | 47 | -0.5871% | 915.7 |
| Major Price Changes | |||
| Issue | Index | Change | Notes |
| CM.PR.H | PerpetualDiscount | -3.6697% | Now with a pre-tax bid-YTW of 5.75% based on a bid of 21.00 and a limitMaturity. |
| PWF.PR.K | PerpetualDiscount | -3.3095% | Now with a pre-tax bid-YTW of 5.74% based on a bid of 21.62 and a limitMaturity. |
| ELF.PR.F | PerpetualDiscount | -2.7706% | Now with a pre-tax bid-YTW of 5.94% based on a bid of 22.46 and a limitMaturity. |
| ELF.PR.G | PerpetualDiscount | -1.9990% | Now with a pre-tax bid-YTW of 5.96% based on a bid of 20.10 and a limitMaturity. |
| RY.PR.G | PerpetualDiscount | -1.7435% | Now with a pre-tax bid-YTW of 5.49% based on a bid of 20.50 and a limitMaturity. |
| SLF.PR.E | PerpetualDiscount | -1.6941% | Now with a pre-tax bid-YTW of 5.45% based on a bid of 20.89 and a limitMaturity. |
| PWF.PR.L | PerpetualDiscount | -1.6883% | Now with a pre-tax bid-YTW of 5.64% based on a bid of 22.71 and a limitMaturity. |
| BAM.PR.M | PerpetualDiscount | -1.4742% | Now with a pre-tax bid-YTW of 6.00% based on a bid of 20.05 and a limitMaturity. |
| CM.PR.I | PerpetualDiscount | -1.4078% | Now with a pre-tax bid-YTW of 5.62% based on a bid of 21.01 and a limitMaturity. |
| GWO.PR.H | PerpetualDiscount | -1.3093% | Now with a pre-tax bid-YTW of 5.61% based on a bid of 21.86 and a limitMaturity. |
| BSD.PR.A | InterestBearing | +2.3037% | Asset coverage of just under 1.8:1 as of October 19 according to Brookfield Funds. Now with a pre-tax bid-YTW of 6.55% (mostly as interest) based on a bid of 9.77 and a hardMaturity 2015-3-31 at 10.00. |
| Volume Highlights | |||
| Issue | Index | Volume | Notes |
| PWF.PR.K | PerpetualDiscount | 260,500 | Now with a pre-tax bid-YTW of 5.74% based on a bid of 21.62 and a limitMaturity. |
| BMO.PR.J | PerpetualDiscount | 220,300 | Now with a pre-tax bid-YTW of 5.38% based on a bid of 21.25 and a limitMaturity. |
| MFC.PR.B | PerpetualDiscount | 140,482 | Now with a pre-tax bid-YTW of 5.33% based on a bid of 22.05 and a limitMaturity. |
| CM.PR.E | PerpetualPremium | 59,025 | Desjardins crossed 50,000 at 25.15. Now with a pre-tax bid-YTW of 5.52% based on a bid of 25.10 and a call 2012-11-30 at 25.00. |
| BAM.PR.M | PerpetualDiscount | 51,880 | Now with a pre-tax bid-YTW of 6.00% based on a bid of 20.05 and a limitMaturity. |
There were twenty-eight other index-included $25.00-equivalent issues trading over 10,000 shares today.
I looked back at pref share declines in the year 2000, which were similar to those of recent months — very sharp for the most recently issued prefs, which in an environment of GENERALLY declining interest rates were the ones with the LOWEST dividends (and highest Duration!).
So, one factor is that the most recent pref issues have the highest duration and hence we would expect them to be “hit” the most in a downturn. I don’t think we will see the most very recent new issues (BNS, TD, BMO 5.25% issues in Sep/Oct) fall as sharply as the less recent issues at 4.25% or below.
Two other factors driving discount pref prices downward are: tax loss selling and “bail out” of declining issues.
I myself looked at selling some losing prefs (to reinvest in similar ones) in order to harvest some tax losses for this year. So far, I have concluded that finding a perfect replacement match is not always possible, and my positions are large enough that there may not be enough liquidity to switch without bid-ask risk. I need the total costs of a switch to be less than 1% of the loss to be harvested (i.e. around 4% of the tax saved) to justify tax loss harvesting.
Meanwhile, others who are not so analytical about the costs of tax loss harvesting may be selling current holdings to buy different issues (which may have ocurred with BMO, TD and BNS) and may have signed up for the recent IPOs with the intent of selling “losers”. I don’t like this strategy since the switch is not matched: upside from the new issues is limited, while that of the existing (now lower priced) issues is much more generous.
The third “Bail Out” factor cannot be ignored either and applies not only to retail, but perhaps also to institutional owners. Retail is presumably panicking that something sold to them as “safe” could deteriorate so rapidly. Once an illiquid security goes down sharply in price (particularly if it goes down faster than the “average” of such securities — like discount prefs are these days), it draws out more sellers and/or buyers become cautious.
There was a similar pref share dip in 2000 which was quite general across income securities — REITs were yielding 12%. I attribute the 2000 dip to many people selling fixed income to buy tech stocks at the peak. The 2000 dip lasted 9-12 months before there was an almost complete recovery (and then some as interest rates resumed their long-term fall).
In 2007, we can hope for a 9-12 month valley of doom again, even if interest rates do not decline. So far, we would be half-way through, which will hopefully be near the bottom — although TAX LOSS SELLING CAN CONTINUE FOR ANOTHER TWO MONTHS. I am amazed that US high yield bonds (e.g. ETF HYG) and corporate bonds (ETF LQD) have more or less completely recovered from the summer blues, while Canadian prefs are wandering their own peculiar course.
For my money, outside the RRSP, discount pref shares currently represent a “best buy” for forward investment prospects, compared with equities (long run return of inflation plus dividends plus real growth in EPS totalling 6%) and good quality income trusts (bond equivalent returns of 8-9%). I’ve been nibbling off and on for months, but will get a lot more aggressive if tax loss selling presents sufficiently juicy opportunities in the next several weeks.