September 24, 2014

PIMCO’s in some kind of trouble with the SEC:

Pacific Investment Management Co. said it’s cooperating with regulators examining how the firm assigned asset prices at Bill Gross’s Pimco Total Return ETF.

“Pimco has been cooperating with the SEC in this non-public matter, and we take our regulatory obligations and responsibilities to our clients very seriously,” Mark Porterfield, a spokesman for Newport Beach, California-based Pimco, said in an e-mailed statement. “We believe our pricing procedures are entirely appropriate and in keeping with industry best-practices.”

“What they’re being accused of is in fact the industry standard accounting process,” Dave Nadig, the chief investment officer at, a San Francisco-based ETF research and analysis firm, said in a telephone interview.

By law, fund managers have to come up with a price, either by asking dealers for quotes or by extrapolating from data points such as credit rating, size, structure, and comparable securities, Nadig said.

“Because Pimco is an 800-pound gorilla, they negotiate a really good price,” he said. “If the SEC wants to change how bonds are priced, then they can do that, but that’s going to change everybody.”

The ETF attributed some of its outperformance against its benchmark to “an allocation to non-Agency mortgages which benefited from limited supply and a recovery in the housing sector,” according to the latest quarterly report on its website.

Kirsten Grind, Gregory Zuckerman and Jean Eaglesham of the Wall Street Journal explain:

The investments believed to be in question, such as small amounts of mortgage securities—or "odd lots" in the terminology of the financial markets—tend to receive lower prices because of their small sizes or because they are backed by smaller institutions, among other factors.

After the launch of the ETF, Wall Street traders were encouraged by Pimco to offer these small securities to the Pimco ETF, according to some of the people familiar with the matter. Mortgage bonds with a relatively small $500,000 face amount, for example, might have sold for only $480,000, because few investors wanted them, due to the small size.

But when Pimco, shortly after purchasing the bonds, placed a value on them, it typically used outside pricing companies that often assigned higher valuations because they used a similar, but much larger, pool of mortgage bonds to compare them with, according to people close to the firm. Placing a $500,000 valuation on a bond purchased for $480,000, for example, would have allowed Pimco to claim a quick 4% gain on the $500,000 bond, or $20,000.

If that maneuver happened with enough bonds, early results of the ETF could have been aided, these people say.

Traders say buying discounted bonds, then using an outside ratings company to place a higher valuation on those bonds, is akin to buying a used car on the cheap because it is in poor shape but having a lender rely on the list price when making a loan.

Matt Levine of Bloomberg points out:

The point of a bond ETF is, in large part, to make the illiquid liquid: to make it easy for small investors to buy and sell diversified bond portfolios in small sizes. The point of the ETF structure, on the other hand, is to use the market to prevent mispricing: The market in the underlying acts as a check on the valuation of the fund. And the point of the bond market sometimes seems to be to slice credit into tiny weird units that trade in idiosyncratic ways and reward cleverness. Those three things don’t really go together. It sounds like the SEC’s worry is that Pimco’s ETF made the illiquid liquid, but at the cost of losing the check on its valuation. Which then provided idiosyncratic opportunities to reward cleverness.

It’s a complex story, and not completely apparent that anything wrong is happening. It is quite well known that investors (even retail investors!) can make very good returns simply by asking their salesman to alert them to any strange odd-lots the brokerage might have hanging around. Brokerages will often provide liquidity for transferable GICs, for instance, by offering a really, really crumby price – like 150bp over market yield. They’ll then sell it for 100bp over market yield, recouping their costs while giving the ultimate buyer a great deal on his GIC … provided he doesn’t mind buying some weird dollar value of GIC with a basically random maturity date. But when you do that as part of an ETF … complications ensue.

But I will point out that a large fund (such as anything run by PIMCO!) might quite rationally take a long view … buy enough discounted small lots of the same issue and eventually that discount is no longer applicable.

But perhaps a new way of potentially scoring excess returns is coming!

With interest rates barely above zero, the typical U.S. savings account has all the excitement of, well, waiting in line at the bank. But what if instead of marketing yet another CD or credit card, banks held raffles and gave millions away each month to savers? The local bank might feel less like the villain behind those big overdraft fees and more like a casino on the Vegas strip.

A bank in South Africa tried this in 2005. The First National Bank’s Million-a-Month Account promised savers a chance to win 113 prizes a month, including a grand prize of 1 million South African rand (about U.S.$150,000 at the time). Within 18 months, the bank had more prize-eligible accounts than regular ones. These new customers, many of them poor, saved an extra 1 percent of their incomes, a recent study found, and boosted their overall saving 38 percent.

The only thing preventing a big bank from doing this in the U.S.: It’s completely illegal. A bill in Congress — which passed the U.S. House of Representatives on Sept. 16 — would change the law. If it’s passed by the U.S. Senate in the next few months and signed by President Barack Obama, banks of all sizes could start tempting savers with “savings promotion raffles.”

In the U.S., federal law already lets credit unions offer prizes to savers, as long as states are okay with it. The Save-To-Win game, started in Michigan in 2009, is available at credit unions in four states. In Michigan, every $25 saved increases the chance that a customer could win dozens of monthly prizes worth up to $3,750, or six $10,000 grand prizes each year. So far, more than 50,000 people have saved more than $94 million through the game.

The fun of competing for prizes does get more people saving, the studies of the South African and Save-To-Win experiments suggest. And low-income people especially benefit from this extra cushion of cash. A quarter of Americans tell researcher they’re certain they’d have no way to come up with $2,000 in the next month.

In a paper titled International Transmission Channels of U.S. Quantitative Easing: Evidence from Canada, Tatjana Dahlhaus, Kristina Hess and Abeer Reza claim:

The U.S. Federal Reserve responded to the great recession by reducing policy rates to the effective lower bound. In order to provide further monetary stimulus, they subsequently conducted large-scale asset purchases, quadrupling their balance sheet in the process. We assess the international spillover effects of this quantitative easing program on the Canadian economy in a factor-augmented vector autoregression (FAVAR) framework, by considering a counterfactual scenario in which the Federal Reserve’s long-term asset holdings do not rise in response to the recession. We find that U.S. quantitative easing boosted Canadian output, mainly through the financial channel.

Standard economic theory, however, provides ambiguous implications for the international spillover of monetary easing (Rogoff [2002]). Through the expenditure-switching effect, a monetary expansion in the United States would depreciate the home currency and deteriorate its terms of trade, making home goods cheaper for foreigners. The resulting increase in home country net exports would then detract from the real output of the foreign economy. The income-absorption effect, on the other hand, implies that as long as expansionary monetary policy in the home country drives up domestic income, home demand for imports would rise, boosting the economy of foreign exporters. Finally, in the presence of global financial market integration, any increase in asset prices and reductions in yields in the domestic financial market resulting from QE may be reflected by similar movements in corresponding foreign financial market variables,2 which in turn would boost foreign consumption and investment through the same mechanism as it does in the domestic case. Therefore, whether Canada benefits from the U.S. expansion through QE depends on which of these effects dominate, and is an empirical question that we attempt to answer here.

R Split III Corp., proud issuer of RBS.PR.B was confirmed by DBRS at Pfd-2:

On September 24, 2013, DBRS upgraded the ratings on the Preferred Shares to Pfd-2 from Pfd-2 (low) based on the increased downside protection levels available to holders of the Preferred Shares over the prior year, as well as the increase in distribution coverage ratio. Since the rating was upgraded, the net asset value of the Company has generally been increasing steadily, rising from $43.55 on September 12, 2013, to $54.22 on September 11, 2014. Downside protection available to holders of the Preferred Shares increased to 74.9% as of September 11, 2014, compared to 68.8% on September 12, 2013. In addition, RBC raised its dividends twice this year, on February 26, 2014, and most recently on August 22, 2014, increasing quarterly distributions to 75 cents per share from 67 cents per share. This dividend boost increases the Preferred Share distribution coverage ratio to 2.9 times (up from 2.6 times in September 2013). The confirmation of the rating of the Preferred Shares is based primarily on the current level of downside protection available and the current distribution coverage ratio.

With a market capitalization of less than $10MM, RBS.PR.B is not tracked by HIMIPref™.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts rocketing up 34bp (more than half of this was due to strength in three BAM issues), FixedResets off 1bp and DeemedRetractibles down 4bp. Volatility was good, highlighted by winning BAM PerpetualDiscounts. Volume was below average.

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 0.5655 % 2,677.1
FixedFloater 4.20 % 3.46 % 24,694 18.43 1 0.0000 % 4,127.3
Floater 2.88 % 3.00 % 59,989 19.71 4 0.5655 % 2,768.3
OpRet 4.04 % 0.40 % 97,480 0.08 1 0.1185 % 2,730.3
SplitShare 4.29 % 3.76 % 108,617 3.89 5 -0.0873 % 3,154.8
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.1185 % 2,496.6
Perpetual-Premium 5.47 % 2.66 % 87,359 0.08 20 0.0531 % 2,441.2
Perpetual-Discount 5.26 % 5.17 % 102,777 15.15 16 0.3439 % 2,595.3
FixedReset 4.25 % 3.80 % 183,208 8.43 75 -0.0098 % 2,555.6
Deemed-Retractible 5.00 % 1.64 % 109,355 0.27 42 -0.0390 % 2,563.3
FloatingReset 2.58 % -2.37 % 70,680 0.08 6 0.0718 % 2,540.3
Performance Highlights
Issue Index Change Notes
TRP.PR.D FixedReset -4.80 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-09-24
Maturity Price : 22.61
Evaluated at bid price : 23.58
Bid-YTW : 4.28 %
FTS.PR.G FixedReset -1.05 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-09-24
Maturity Price : 23.11
Evaluated at bid price : 24.60
Bid-YTW : 3.81 %
BAM.PR.N Perpetual-Discount 1.09 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-09-24
Maturity Price : 21.25
Evaluated at bid price : 21.25
Bid-YTW : 5.62 %
BAM.PF.C Perpetual-Discount 1.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-09-24
Maturity Price : 21.28
Evaluated at bid price : 21.57
Bid-YTW : 5.64 %
BAM.PR.C Floater 1.51 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-09-24
Maturity Price : 17.45
Evaluated at bid price : 17.45
Bid-YTW : 3.00 %
BAM.PF.D Perpetual-Discount 1.77 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-09-24
Maturity Price : 21.55
Evaluated at bid price : 21.86
Bid-YTW : 5.62 %
Volume Highlights
Issue Index Shares
BMO.PR.T FixedReset 152,616 Nesbitt crossed blocks of 50,000 and 31,900, both at 25.29; RBC crossed 30,000 at the same price.
Maturity Type : Limit Maturity
Maturity Date : 2044-09-24
Maturity Price : 23.25
Evaluated at bid price : 25.25
Bid-YTW : 3.82 %
ENB.PF.G FixedReset 121,195 Recent new issue.
Maturity Type : Limit Maturity
Maturity Date : 2044-09-24
Maturity Price : 23.10
Evaluated at bid price : 24.97
Bid-YTW : 4.28 %
IAG.PR.G FixedReset 97,020 RBC crossed blocks of 20,000 and 62,700, both at 26.30.
Maturity Type : Call
Maturity Date : 2017-06-30
Maturity Price : 25.00
Evaluated at bid price : 26.27
Bid-YTW : 2.38 %
RY.PR.H FixedReset 51,421 TD crossed 25,000 at 25.30.
Maturity Type : Call
Maturity Date : 2019-08-24
Maturity Price : 25.00
Evaluated at bid price : 25.28
Bid-YTW : 3.74 %
ENB.PR.D FixedReset 50,469 TD crossed 42,600 at 24.16.
Maturity Type : Limit Maturity
Maturity Date : 2044-09-24
Maturity Price : 22.98
Evaluated at bid price : 24.15
Bid-YTW : 4.14 %
FTS.PR.M FixedReset 41,170 Recent new issue.
Maturity Type : Call
Maturity Date : 2019-12-01
Maturity Price : 25.00
Evaluated at bid price : 25.15
Bid-YTW : 4.00 %
There were 27 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
TRP.PR.D FixedReset Quote: 23.58 – 25.18
Spot Rate : 1.6000
Average : 0.9276

Maturity Type : Limit Maturity
Maturity Date : 2044-09-24
Maturity Price : 22.61
Evaluated at bid price : 23.58
Bid-YTW : 4.28 %

HSB.PR.D Deemed-Retractible Quote: 25.30 – 25.92
Spot Rate : 0.6200
Average : 0.3952

Maturity Type : Call
Maturity Date : 2014-12-31
Maturity Price : 25.00
Evaluated at bid price : 25.30
Bid-YTW : 0.24 %

CGI.PR.D SplitShare Quote: 25.04 – 25.30
Spot Rate : 0.2600
Average : 0.1838

Maturity Type : Soft Maturity
Maturity Date : 2023-06-14
Maturity Price : 25.00
Evaluated at bid price : 25.04
Bid-YTW : 3.76 %

PWF.PR.O Perpetual-Premium Quote: 26.16 – 26.45
Spot Rate : 0.2900
Average : 0.2300

Maturity Type : Call
Maturity Date : 2017-10-31
Maturity Price : 25.25
Evaluated at bid price : 26.16
Bid-YTW : 4.81 %

POW.PR.G Perpetual-Premium Quote: 26.11 – 26.31
Spot Rate : 0.2000
Average : 0.1435

Maturity Type : Call
Maturity Date : 2021-04-15
Maturity Price : 25.00
Evaluated at bid price : 26.11
Bid-YTW : 4.78 %

SLF.PR.D Deemed-Retractible Quote: 22.38 – 22.54
Spot Rate : 0.1600
Average : 0.1045

Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 22.38
Bid-YTW : 5.84 %

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