October 24, 2011

Assiduous Reader BG sent me a link to a NYT article Bank’s Collapse in Europe Points to Global Risks:

Among Dexia’s biggest trading partners are several large United States institutions, including Morgan Stanley and Goldman Sachs, according to two people with direct knowledge of the matter. To limit damage from Dexia’s collapse, the bailout fashioned by the French and Belgian governments may make these banks and other creditors whole — that is, paid in full for potentially tens of billions of euros they are owed. This would enable Dexia’s creditors and trading partners to avoid losses they might otherwise suffer without the taxpayer rescue.

Whether this sets a precedent if Europe needs to bail out other banks will be closely watched.

This highlights my single largest complaint about the Basel I, II, and III rules: interbank loans are risk-weighted according to the credit rating of the sovereign; the only way this makes sense is if the regulators have taken an explicit view that inter-bank bail-outs will happen.

Note that the regulators’ moronic desire to see centralized clearing for derivatives will simply make matters worse.

Interbank loans should be risk-weighted according to the credit quality of the bank – or the collateral posted – not according to the sovereign. And, what’s more, the regulators should stop their pretense at surprise when this is what happens.

Dexia is also suffering losses on about 11 billion euros ($15.3 billion) in credit insurance it has written on mortgage-related securities, the same instruments that felled A.I.G., echoing that insurer’s troubles. In this business, too, Dexia’s problems have been worsened by aggressive demands by some trading partners for additional collateral. According to a person briefed on the transactions, Goldman Sachs, one of Dexia’s biggest trading partners, has asked for collateral equal to nearly twice the decline in market value of its deals. As was the case with A.I.G., Dexia must provide the collateral when the prices of the underlying securities fall, even if they have not defaulted.

Lucas van Praag, a spokesman for Goldman, said “we have no reason to believe that Dexia will not continue to meet its contractual obligations after it is restructured.”

As for the aggressive collateral calls by Goldman, Mr. van Praag said: “Our dealings with Dexia have been perfectly normal. In an environment of widening credit spreads and increased volatility, collateral calls are to be expected.” The suggestion that Goldman has been more aggressive than Dexia’s other trading partners is “quite odd,” he said, adding: “If collateral is owed, we ask for it.”

This looks like AIG: The Sequel for Lucas van Praag, World’s Greatest Corporate Spokesman. First, Goldman was vilified for needing a bail-out when AIG went bust. Then, when they proved to the Congressional Committe that they had no exposure to AIG because they (a) were collaterallized on most of the deals and (b) had purchased CDS protection on their uncollateralized exposure, they were vilified for creating a cash drain at AIG.

As far as I can tell, Goldman is the only financial institution in the world that behaves as if somebody, somewhere, is thinking about what they’re doing.

Assiduous Reader BG points out:

….problem is the contracts called for double in collateral for the amounts that the fixed interest rate borrow cost went offside when interest rates declined so much. So, while Dexia might have successfully hedged its net interest income spread over a 10-year term, the posting of collateral in the short term seems to have destroyed the bank.

Quite right, but it all seems somewhat peculiar. If Dexia is still solvent, but the overcollateralization has made it illiquid, then this is a classic study in central banking: the ECB should give them a loan at a punitive rate. But my question is: why double collateral? That’s a pretty fierce haircut! So my guess – and it’s only a guess, I haven’t been following the Dexia story closely – is that the collateral is no damn good; that the “double collateral” being talked about is computed according to the face value of the collateral, and that when the collateral is marked to market you arrive at a much more sensible figure. Any commentary from readers more familiar with the saga than I am would be appreciated!

Sadly, the Solvency Fairy did not arrive on the weekend:

Spanish and Italian government bonds fell as Europe’s leaders struggled to convince investors they can craft an effective response to the region’s debt crisis.

“The main disappointment was that there was no agreement on increasing the size” of the European bailout fund, said Alessandro Giansanti, a senior interest-rates strategist at ING Groep NV in Amsterdam. “Spreads will continue to widen ahead of the upcoming supply from Italy.”

Italy’s 10-year yield increased six basis points, or 0.06 percentage point, to 5.95 percent as of 4:56 p.m. in London. The 4.75 percent security due September 2021 lost 0.380, or 3.80 euros per 1,000-euro ($1,387) face amount, to 91.75. Rates on similar-maturity Spanish securities increased seven basis points to 5.55 percent.

… and tempers are fraying:

David Cameron has begun a week of intense political infighting over Europe by becoming embroiled in a furious row with Nicolas Sarkozy over Britain’s role in talks to solve the crisis enveloping the euro.

The bust-up between Cameron and Sarkozy held up the conclusion of the EU-27 summit for almost two hours, with the French president expressing rage at the constant criticism and lectures from UK ministers.

Sarkozy bluntly told Cameron: “You have lost a good opportunity to shut up.” He added: “We are sick of you criticising us and telling us what to do. You say you hate the euro and now you want to interfere in our meetings.”

Being whined at by a petulant Frenchman isn’t going to do Cameron any harm:

Mr. Cameron is in the midst of a potentially destructive political meltdown within his Tory party, whose more right-wing backbenchers are adamantly opposed to Britain’s membership in the 27-member European Union.

On Monday, Mr. Cameron is facing a private members’ bill, proposed by one of his Tory backbenchers, that would ask the government to hold a referendum asking citizens if they want Britain to withdraw from Europe.

This, the Prime Minister knows, would be disastrous: A poll this week shows that almost half of Britons would vote positively in such a vote (the EU has never been popular in Britain).

Assiduous Reader BG also sends me a link to The Little State With a Big Mess:

After decades of drift, denial and inaction, Rhode Island’s $14.8 billion pension system is in crisis. Ten cents of every state tax dollar now goes to retired public workers. Before long, Ms. Raimondo has been cautioning in whistle-stops here and across the state, that figure will climb perilously toward 20 cents. But the scary thing is that no one really knows. The Providence Journal recently tried to count all the municipal pension plans outside the state system and stopped at 155, conceding that it might have missed some. Even the Securities and Exchange Commission is asking questions, including the big one: Are these numbers for real?

Analysts also took a close look at the projected long-term investment return for the pension system: 8.25 percent. Everything rested on hitting that target, but the state’s actuary said there was less than a 30 percent chance that would happen over the next 20 years. The board voted to lower the assumption to 7.5 percent. (Given the recent run in the financial markets, even that figure may seem optimistic.)

As a result of that change, the state’s pension shortfall instantly rose to $9 billion from $7 billion. The unions said Ms. Raimondo had manufactured a crisis.

Then, as if on cue, Central Falls declared bankruptcy. The city’s pension fund wasn’t just underfunded. It was completely out of money. A receiver for the city sought court permission to reduce by as much as half the base pensions of retired police officers and firefighters.

Suddenly the pension crisis wasn’t an abstraction any more. The unthinkable had happened, and the odds were that it would happen again unless the state acted quickly.

Feeling smug? Don’t. Here in Toronto, we like to pretend that a garbageman can lead a nice middle class existence ($22 / hour + pension + benefits, which is not much less than a Registered Nurse gets).

The US Treasury is contemplating floating-rate or reset bonds:

The U.S., seeking to attract investors who might otherwise avoid Treasuries amid a $1.3 trillion budget deficit, is considering the sale of floating- rate notes in what would be its first new security since it began offering inflation-linked debt 14 years ago.

The Treasury Department said this month it asked Wall Street’s biggest bond dealers for recommendations on structuring securities with coupons that rise or fall with benchmark rates. Officials are scheduled to gather with the 22 primary dealers, who include Goldman Sachs Group Inc. and JPMorgan Chase & Co., on Oct. 28 as it decides whether to go further during their regular meeting that precedes each quarterly refunding.

PWF was confirmed at Pfd-1(low) by DBRS:

DBRS has today confirmed the ratings on the Senior Debt and Preferred Shares of Power Financial Corporation (PWF or the Company) at AA (low) and Pfd-1 (low), respectively. The rating trends remain Stable.

Given an uncertain economic environment that could limit organic growth, DBRS expects that PWF will take advantage of its strong financial position to pursue small tactical acquisitions in the financial services arena. Pressures on regulatory capital adequacy could conceivably encourage a number of financial institutions to sell certain business lines at opportunistic prices, which would complement and leverage those of the Company. Achieving additional scale in Putnam through the acquisition of incremental AUM with a shared distribution channel, for example, would bring its financial results closer in line with the Company’s original targets for Putnam, while supporting broader growth initiatives. That PWF retains the ability to consider such value-added acquisitions in the current environment is a testament to its conservative financial profile and its long-term perspective.

With a 16.9% total unconsolidated debt ratio at the end of June 2011, the Company’s capitalization remains conservative, with only modest double leverage, exercised through the use of perpetual preferred shares. If such shares are treated as permanent equity, double leverage is close to non-existent. Debt service coverage ratios are strong at over 15 times on an earnings basis and just under 8.5 times on a cash flow basis. Liquidity is also not a source of concern, with close to $525 million in cash and short-term securities at the holding company pro forma the November 1, 2011, dividend payment of close to $250 million and additional stores of liquidity at both GWO and IGM. Such retention of liquid assets in the current uncertain economic environment reflects a unified and consistent approach to risk management across the organization. Financial flexibility is additionally enhanced by the proven access by the Company and its investee companies to capital-market funding should the Company require funding for an opportunistic acquisition.

If they want to make opportunistic acquisitions, they may find themselves bidding against the banks:

Phones are ringing steadily in the offices of Canada’s big banks as capital-starved European lenders seek buyers for assets.

For companies like Royal Bank of Canada and Canadian Imperial Bank of Commerce, which want to get bigger in the asset management business, there are plenty of tasty morsels on offer.

And there’s a belief in some of Bay Street’s bank towers that better deals will come to those who wait – that European banks have not cut their prices as much as they will be forced to do, by the time the euro zone mess is cleaned up.

Barrie McKenna has a good piece on milkfare in today’s Globe, All farmers are equal – but some are more equal than others.

It was a day of contrasts in the Canadian preferred share market, with PerpetualDiscounts losing 3bp, FixedResets gaining 11bp and DeemedRetractibles winning 27bp. Volatility was good and skewed to the upside. Volume was heavy.

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 1.2483 % 2,000.9
FixedFloater 0.00 % 0.00 % 0 0.00 0 1.2483 % 3,009.3
Floater 3.60 % 3.60 % 158,814 18.28 2 1.2483 % 2,160.4
OpRet 4.83 % 2.67 % 64,163 1.54 8 0.3940 % 2,458.0
SplitShare 5.41 % 1.41 % 53,858 0.34 4 0.1212 % 2,480.5
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.3940 % 2,247.6
Perpetual-Premium 5.69 % 4.81 % 106,557 0.51 13 0.0729 % 2,125.8
Perpetual-Discount 5.35 % 5.43 % 108,444 14.77 17 -0.0328 % 2,254.8
FixedReset 5.15 % 3.23 % 201,450 2.47 61 0.1140 % 2,331.0
Deemed-Retractible 5.08 % 4.45 % 217,284 4.42 46 0.2728 % 2,197.7
Performance Highlights
Issue Index Change Notes
IAG.PR.C FixedReset -1.09 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-12-31
Maturity Price : 25.00
Evaluated at bid price : 26.41
Bid-YTW : 3.71 %
IAG.PR.A Deemed-Retractible -1.03 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 22.16
Bid-YTW : 6.19 %
NA.PR.M Deemed-Retractible 1.09 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-05-15
Maturity Price : 26.00
Evaluated at bid price : 26.94
Bid-YTW : 3.15 %
MFC.PR.B Deemed-Retractible 1.11 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 21.93
Bid-YTW : 6.40 %
RY.PR.B Deemed-Retractible 1.16 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-08-24
Maturity Price : 25.00
Evaluated at bid price : 25.30
Bid-YTW : 4.27 %
SLF.PR.F FixedReset 1.27 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-06-30
Maturity Price : 25.00
Evaluated at bid price : 26.28
Bid-YTW : 4.16 %
FTS.PR.H FixedReset 1.54 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-10-24
Maturity Price : 23.50
Evaluated at bid price : 25.66
Bid-YTW : 3.05 %
BAM.PR.B Floater 1.66 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2041-10-24
Maturity Price : 14.67
Evaluated at bid price : 14.67
Bid-YTW : 3.60 %
Volume Highlights
Issue Index Shares
BNS.PR.N Deemed-Retractible 234,859 RBC crossed five blocks: 33,000, two of 60,000 each, 28,200 and 20,000, all at 25.77.
Maturity Type : Call
Maturity Date : 2017-01-27
Maturity Price : 25.00
Evaluated at bid price : 25.85
Bid-YTW : 4.52 %
GWO.PR.H Deemed-Retractible 205,521 TD crossed 99,600 at 23.47 and 98,800 at 23.45.
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.26
Bid-YTW : 5.84 %
BMO.PR.M FixedReset 93,795 Nesbitt crossed 75,000 at 26.10.
Maturity Type : Call
Maturity Date : 2013-08-25
Maturity Price : 25.00
Evaluated at bid price : 26.11
Bid-YTW : 2.98 %
POW.PR.C Perpetual-Premium 92,701 Desjardins crossed 24,900 at 24.97; Nesbitt crossed 34,100 at the same price.
Maturity Type : Limit Maturity
Maturity Date : 2041-10-24
Maturity Price : 24.69
Evaluated at bid price : 24.95
Bid-YTW : 5.85 %
BMO.PR.P FixedReset 79,978 TD crossed blocks of 50,000 and 25,000, both at 26.94.
Maturity Type : Call
Maturity Date : 2015-02-25
Maturity Price : 25.00
Evaluated at bid price : 26.94
Bid-YTW : 3.23 %
CM.PR.D Perpetual-Premium 62,319 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2012-04-30
Maturity Price : 25.00
Evaluated at bid price : 24.99
Bid-YTW : 5.60 %
There were 45 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
IAG.PR.F Deemed-Retractible Quote: 25.85 – 26.59
Spot Rate : 0.7400
Average : 0.4682

Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 25.85
Bid-YTW : 5.55 %

ELF.PR.G Perpetual-Discount Quote: 20.70 – 21.24
Spot Rate : 0.5400
Average : 0.3627

Maturity Type : Limit Maturity
Maturity Date : 2041-10-24
Maturity Price : 20.70
Evaluated at bid price : 20.70
Bid-YTW : 5.78 %

BAM.PR.N Perpetual-Discount Quote: 22.01 – 22.52
Spot Rate : 0.5100
Average : 0.3418

Maturity Type : Limit Maturity
Maturity Date : 2041-10-24
Maturity Price : 21.65
Evaluated at bid price : 22.01
Bid-YTW : 5.43 %

ENB.PR.A Perpetual-Premium Quote: 25.62 – 26.08
Spot Rate : 0.4600
Average : 0.3042

Maturity Type : Call
Maturity Date : 2011-11-23
Maturity Price : 25.00
Evaluated at bid price : 25.62
Bid-YTW : -14.18 %

IAG.PR.C FixedReset Quote: 26.41 – 26.74
Spot Rate : 0.3300
Average : 0.2176

Maturity Type : Call
Maturity Date : 2013-12-31
Maturity Price : 25.00
Evaluated at bid price : 26.41
Bid-YTW : 3.71 %

SLF.PR.G FixedReset Quote: 24.37 – 24.75
Spot Rate : 0.3800
Average : 0.2681

Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.37
Bid-YTW : 3.89 %

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