Finally, there is a good crop of links today!
James Hamilton of Econbrowser remarks on a WSJ article about prime no-doc loans, which arose through a Countrywide “Fast and Easy” programme which generated no-doc / low-doc loans which were then sold to Fannie Mae, which has classified them as “Prime”. He has been taken to task in the comments (there are claims that this is not only not news, but isn’t even interesting, since the borrowers were approved due to high credit scores and low loan-to-value). Regardless of whether the story is simply an example of media hysteria, I am as concerned as he is about the big issue:
From page 102 of Fannie’s 2007 Annual Report, as of the end of 2007, the enterprise had leveraged $44 B in stockholders’ equity with $796 B in short- and long-term debt to acquire $761 B in mortgages either held outright or intended for resale or trading. I read that as an equity cushion against a 5.8% loss on the mortgages held directly (44/761 = 0.058). But in addition (page 1), Fannie has guaranteed $2.1 trillion in separate mortgage-backed securities it has sold to outside investors, for a ratio of core capital to total book of business of 1.6%.
From the beginning, my conception of a really big financial meltdown would be one that pulls one of the GSEs into insolvency. Please tell me why it can’t happen.
The GSEs have to start being regulated like banks; there’s no question in my mind about that.
Congress pressured the Fed to rescue the moribund Student Loans securitization market:
A month after the Federal Reserve rescued Bear Stearns Cos. from bankruptcy, Chairman Ben S. Bernanke got an S.O.S. from Congress.
There is “a potential crisis in the student-loan market” requiring “similar bold action,” Chairman Christopher Dodd of Connecticut and six other Democrats wrote Bernanke. They want the Fed to swap Treasury notes for bonds backed by student loans. In a separate letter, Pennsylvania Democratic Representative Paul Kanjorski and 31 House members said they want Bernanke to channel money directly to education-finance firms.
… and, somewhat surprisingly, the Fed responded:
The Federal Reserve announced today an increase in the amounts auctioned to eligible depository institutions under its biweekly Term Auction Facility (TAF) from $50 billion to $75 billion, beginning with the auction on May 5. This increase will bring the amounts outstanding under the TAF to $150 billion.
…
In addition, the Federal Open Market Committee authorized an expansion of the collateral that can be pledged in the Federal Reserve’s Schedule 2 Term Securities Lending Facility (TSLF) auctions.
…
The wider pool of collateral should promote improved financing conditions in a broader range of financial markets.
Bloomberg points out that securitized Student Loans are now eligible:
Fed officials also expanded the collateral they accept under the Term Securities Lending Facility to include AAA rated asset-backed investments. About 95 percent of outstanding student-loan securities are AAA, according to the American Securitization Forum.
In other political news, there are rumblings of tweaking capital requirements for brokerages, which is being puffed up as a major change.
Meanwhile, in deeply upsetting news, I have been advised that the Hershey’s January price increase has percolated through the system to the point where “Mr. Big” chocolate bars are having their price yanked from $1.25 to $1.35. This implies that my total cost of living has increased by 4%; PrefBlog’s future quality may be adversely affected due to malnutrition.
The Globe reports that a decision on ABCP will be delayed:
The judge overseeing the $32-billion restructuring of the seized-up market for asset-backed commercial paper wants to put off a ruling on the plan’s fairness until mid-May, saying he needs more time to review the complex case.
Ontario Superior Court Justice Colin Campbell, who was originally scheduled to rule on the fairness on Friday, said he would like to hold the so-called “sanction” hearing on May 12 and May 13, but could do it sooner in a pinch.
To give more time, the judge asked that a key standstill agreement with banks that prevents a meltdown in the market be extended. The current standstill expires May 9.
“I can’t think possibly how I can get a decision out by May 9,” the judge said.
…
The deal, however, includes a controversial clause that would give all the players in the market immunity from lawsuits, something that has angered many holders and led to challenges in court that the judge wants more time to consider.The lawsuits, if allowed, could run into many hundreds of millions, according to court documents filed Thursday. Aeroports de Montreal, Air Transat A.T. Inc., Cinar Corp., Labopharm Inc. and dozens of other companies laid out the claims they believe they have, which total at least $700-million.
As indicated by Assiduous Reader madequota in the comments to May 1, today was a pretty good day for prefs … but volume was lacklustre. Banks still need to raise cash and we haven’t seen an insurer come to market for quite some time … so there is considerable room for carping regarding the market’s ability to absorb new issues and bad news. Long corporates now yield a hair less than 6.00% so the dividend of 5.72% on PerpetualDiscounts (= 8.01% Interest Equivalent) represents a spread of 200bp … within the range of the last six months.
| 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 | 5.11% | 5.13% | 41,301 | 15.30 | 1 | +0.0000% | 1,095.0 |
| Fixed-Floater | 4.73% | 4.86% | 63,350 | 15.72 | 7 | -0.1899% | 1,054.4 |
| Floater | 4.45% | 4.49% | 61,404 | 16.42 | 2 | +0.5689% | 847.6 |
| Op. Retract | 4.84% | 3.57% | 84,967 | 3.26 | 15 | +0.0080% | 1,051.4 |
| Split-Share | 5.29% | 5.61% | 74,820 | 4.18 | 13 | +0.1931% | 1,047.2 |
| Interest Bearing | 6.17% | 6.25% | 59,161 | 3.84 | 3 | -0.1012% | 1,099.2 |
| Perpetual-Premium | 5.87% | 5.24% | 151,657 | 4.96 | 9 | +0.1060% | 1,021.5 |
| Perpetual-Discount | 5.69% | 5.72% | 331,476 | 14.31 | 63 | +0.3936% | 919.5 |
| Major Price Changes | |||
| Issue | Index | Change | Notes |
| BCE.PR.R | FixFloat | -1.8182% | |
| HSB.PR.D | PerpetualDiscount | -1.2556% | Now with a pre-tax bid-YTW of 5.75% based on a bid of 22.02 and a limitMaturity. |
| BNS.PR.J | PerpetualDiscount | -1.0478% | Now with a pre-tax bid-YTW of 5.54% based on a bid of 23.61 and a limitMaturity. |
| RY.PR.A | PerpetualDiscount | +1.0020% | Now with a pre-tax bid-YTW of 5.53% based on a bid of 20.16 and a limitMaturity. |
| RY.PR.G | PerpetualDiscount | +1.0060% | Now with a pre-tax bid-YTW of 5.62% based on a bid of 20.08 and a limitMaturity. |
| CM.PR.E | PerpetualDiscount | +1.0226% | Now with a pre-tax bid-YTW of 5.94% based on a bid of 23.71 and a limitMaturity. |
| MFC.PR.B | PerpetualDiscount | +1.1080% | Now with a pre-tax bid-YTW of 5.38% based on a bid of 21.90 and a limitMaturity. |
| RY.PR.E | PerpetualDiscount | +1.1569% | Now with a pre-tax bid-YTW of 5.61% based on a bid of 20.11 and a limitMaturity. |
| BAM.PR.B | Floater | +1.1860% | |
| TCA.PR.X | PerpetualDiscount | +1.3234% | Now with a pre-tax bid-YTW of 5.67% based on a bid of 49.00 and a limitMaturity. |
| TD.PR.O | PerpetualDiscount | +1.3292% | Now with a pre-tax bid-YTW of 5.33% based on a bid of 22.87 and a limitMaturity. |
| LBS.PR.A | SplitShare | +1.5842% | Asset coverage of 2.2+:1 as of May 1, according to Brompton Group. Now with a pre-tax bid-YTW of 4.79% based on a bid of 10.26 and a hardMaturity 2013-11-29 at 10.00. |
| W.PR.H | PerpetualDiscount | +1.6343% | Now with a pre-tax bid-YTW of 6.00% based on a bid of 23.01 and a limitMaturity. |
| SLF.PR.C | PerpetualDiscount | +2.0603% | Now with a pre-tax bid-YTW of 5.55% based on a bid of 20.31 and a limitMaturity. |
| IAG.PR.A | PerpetualDiscount | +2.6474% | Now with a pre-tax bid-YTW of 5.67% based on a bid of 20.55 and a limitMaturity. |
| Volume Highlights | |||
| Issue | Index | Volume | Notes |
| BAM.PR.M | PerpetualDiscount | 29,100 | Now with a pre-tax bid-YTW of 6.62% based on a bid of 18.21 and a limitMaturity. |
| RY.PR.G | PerpetualDiscount | 27,455 | Now with a pre-tax bid-YTW of 5.62% based on a bid of 20.08 and a limitMaturity. |
| RY.PR.H | PerpetualDiscount | 27,003 | Recent new issue. Now with a pre-tax bid-YTW of 5.73% based on a bid of 24.78 and a limitMaturity. |
| BMO.PR.L | PerpetualDiscount | 26,455 | Now with a pre-tax bid-YTW of 5.89% based on a bid of 24.90 and a limitMaturity. |
| BNS.PR.M | PerpetualDiscount | 24,300 | Now with a pre-tax bid-YTW of 5.60% based on a bid of 20.26 and a limitMaturity. |
There were eleven other index-included $25-pv-equivalent issues trading over 10,000 shares today.
I draw your attention to the following G & M piece [especially the last paragraph that refers to selling fixed income], and then I have a question:
———————–
Inflation worries will drive interest rates higher: Rubin
JOHN PARTRIDGE
Monday, May 05, 2008
Unrelenting upward pressure on food and energy prices will force the Bank of Canada to reverse course and start raising interest rates to combat inflation over the next year, a high-profile Bay Street economist says.
“While the Bank of Canada may still deliver another rate cut, reflation will compel it to raise interest rates by at least 100 [basis points] next year,” Jeff Rubin, chief economist and chief strategist at CIBC World Markets in Toronto said in a monthly report on portfolio strategy.
The central bank has cut its key overnight lending rate to 3 per cent, down by 1.5 percentage points since last fall.
What is more, Mr. Rubin said he now expects U.S. federal Reserve Board chairman Ben Bernanke, to stop their rate-cutting drive when the key U.S. rate hits 1.5 per cent, rather than 1.25 per cent as CIBC previously forecast.
The fed cut the benchmark federal funds rate by 25 basis points to 2 per cent last week, bringing to 325 basis points the cutting it has done since last summer in a bid to limit economic damage from the U.S. housing and credit crises. (A basis point is one one-hundredth of a percentage point.)
As a result of the consumer price index inflation rate being set to “almost double next year,” Mr. Rubin said the firm is exiting its over-weight position in bonds and moving two percentage points of weighting to equities and the other two points to cash. This leaves it with 55 per cent in stocks, 38 per cent in bonds and seven per cent in cash, he said in the report.
“Moreover, we anticipate that we will be moving further assets out of our fixed income portfolio, as well as shortening duration in that portfolio as our forecast of rising inflation pans out,” Mr. Rubin said, adding that markets will be “surprised at how rapidly” the central bank will be “compelled to take back” its rate cuts next year.
————————
Assiduous readers have explained to me that a declining interest rate environment does not garner buying interest in fixed income instruments, namely preferreds. In fact, it was also said that declining interest rates actually cause preferred share values to drop, primarily the result of widening spreads. Here’s a guy now who, after predicting a shift to a rising interest rate environment, is calling to underweight bonds, and move “further assets out of our fixed income portfolio”.
Am I to deduce then, that there is no interest rate environment, rising or falling, that will stimulate preferred share interest, and further to assume that preferred share values cannot possibly rise from their current levels, only fall . . . no matter what?
madequota
madequota … I think you are deliberately and mischeivously misinterpreting the gist of the exchanges on this blog.
Short term interest rates are determined by monetary policy, both current and expected, current policy being represented by the overnight rate that Rubin discusses.
Long term interest rates are determined largely by inflation expectations, which in turn are determined largely by a comparison of the actual overnight rate with an estimation of where it should be.
Long term corporate interest rates are determined by long term interest rates, default expectations and liquidity concerns.
Perpetual preferred rates are determined by long term corporate interest rates, default expectations, liquidity concerns and tax policy.
There is not necessarily any relationship whatsoever between perpetual preferred rates and the overnight rate.
OK then; if I understand you now, you’re saying that long term interest rates are affected primarily by inflation expectations, . . . and perp pref rates, and values, are in turn affected primarily by long term interest rates. [we’ll take default expectations, liquidity concerns, and tax policy out of this for a moment since for most Canadian perp prefs, these items are static].
Why then over the past year, in an environment of declining inflation have perp pref prices actually gone down? By your well-structured argument above, as well as Rubin’s logic, they should actually have gone up.
I’m back to my original question then –> what kind of inflation environment would stimulate pref prices? declining inflation has proven to cause pref prices to go down . . . and now, according to Rubin, the threat of reflation prompts him to sell prefs, which will also make them decline in value.
madequota
Spreads.
pref prices have gone down over the past year primarily because of . . . “spreads”?
If I asked, “Why did the bank robber get killed by the cop when the bank heist went bad?” . . . would your answer be . . . “bullet”?
maybe I’ll just go back to blaming it all on RBC.
madequota
Try reading What Affects Preferred Share Prices? and When Will Preferreds Recover.
Changes in spreads have been dominant over the past year, since default expectations and liquidity concerns have most emphatically NOT been static.
All right; I appreciate the fact that you continue to address this, but we’re moving way off topic.
My original concern [based on Rubin’s statements] is that pref pricing seems to be adversely affected by both inflationary and deflationary pressures. This is difficult to accept, since it cannot be possible. Either inflation is pref-friendly, or deflation is pref-friendly. One is right . . . the other is wrong.
Therefore, either the general market over the past year has been wrong, or Rubin is now wrong. Since the market’s activity over the past year is now proven history, then Rubin must be wrong.
The market has demonstrated that pref pricing falls in a deflationary environment. Period.
Rubin says he should sell prefs in anticipation of an inflationary environment. The market is in total disagreement with him . . . and the market is never wrong.
madequota
p.s.
of course, Rubin works for CIBC, right? that could explain the whole issue here.
The market has demonstrated that pref pricing falls in a deflationary environment. Period.
You are focussing on a single factor and the market is more complicated than that. Prefs did quite well during the 2002-05 disinflationary period, to take just one example.
I do realize that there are a number of contributing factors, and the default expectation/liquidity concern point you make above is not lost.
Rubin seems to be basing his “sell” recommendation on only one factor:
————————–
“As a result of the consumer price index inflation rate being set to “almost double next year,” Mr. Rubin said the firm is exiting its over-weight position in bonds . . . “Moreover, we anticipate that we will be moving further assets out of our fixed income portfolio, as well as shortening duration in that portfolio as our forecast of rising inflation pans out,” Mr. Rubin said, . . .”
—————————-
for all it’s worth, positive market action of the past week seems to be contradicting Rubin’s thinking as well . . . noteworthy today, is nice upward momentum (and narrowing spreads!) on BNS.PR.L and BNS.PR.M . . . solid “institution-style” depth of market on the bid side on both of these!
madequota
Rubin seems to be basing his “sell” recommendation on only one factor
In his defense, he is talking simply of his recommended “fixed income portfolio”. Since he is not talking about sector allocation within this portfolio, one can – hesitantly! – assume that it reflects the universe index, which is about 70% governments.
fair enough! . . . what do you think of the “XTM eXchange Split Corp.” preferred offering just announced?
madequota
fair enough! . . . what do you think of the XTM eXchange Split Corp. Preferred offering announced earlier this AM?
madequota
See Quadravest Unveils XTM Split Corp.
amazingly, I agree with you fully on this one!
regarding the FTS IPO, I notice that they’ve announced this one the day before their regular prefs go ex . . . as noted by yourself on the last IPO, issued by RBC, the announcement date was also the day before ex . . . the theory being that the IPO yield will be compared to existing issues, which as we all know, can appear artificially low day before ex.
is this a trend we should be watching for now? if so, look for Sun Life to come to market on May 15, and Manulife to come to market on May 24 (approx. since I don’t believe they’ve declared at this point).
another factor to consider when buying prefs, I suppose.
madequota
[…] Congress pressured the Fed to add Student Loans to the eligibility list – and the Fed responded on May 2. It’s hard to say how much the eligibility premium was in this case, but 35bp is a […]
[…] said it most recently on May 2: The GSEs have to start being regulated like banks; there’s no question in my mind about […]