I have a lot of sympathy for the central bankers of the world, as I’ve mentioned before: they cut policy yields to the bone, hoping thereby to get consumers spending and business investing, but all that happens is people drive up the value of real estate. It will take a long period of declines and stagnation before people look upon their houses merely as a place to live, and that hasn’t started happening yet!
To address this problem of what can credibly be argued is misdirected investment – into non-productive assets – politicians from all over have played God with their economies, micromanaging mortgage rules to ensure that only the right sort of people can get financing for real-estate. I deplore this, while at the same time agreeing that a problem is demonstrable.
I would prefer a broader-brush approach to bank capital, based on the precept that while change can be good or bad, rapid changes of emphasis in the economy are very often bad, evidence of bubbles rather than shifts in demand. For instance, mortgages as a share of Canadian bank assets increased from 30% to 40%, fueled by an enormous expansion of CMHC guarantees, and while I would not go so far as to say that is definitive proof of a bubble, I will say that it’s a big change and should be addressed in a cautious manner.
There are two approaches that can be taken: the first is to insist that for risk-management purposes, the loan-to-value ratio of a mortgage be calculated not according to the sale price or to the appraised value, but to an estimate of what this would have been five or ten years ago, adjusted for inflation. So, for instance, if we have a house that sold in 2014 for $567,000 and has a mortgage of $400,000, we would now currently say the LTV is 71%. I suggest that for regulatory risk purposes we use the 2009 price of $395,000, add on 10% to reflect plain vanilla inflation for a notional value of $435,000, and say OK, you’ve got to put up capital reflecting this notional LTV of 92%, which is a different kettle of fish altogether.
The second approach would simply say … 40% of your balance sheet is now mortgages, the average over the last ten years is 30%, the difference is 10% and 10% of that is 1%, so there’s a countercyclical capital surcharge of 1% that will be applied to your risk weighted assets. A solution would need to be more detailed, with meaningful categorizations of bank assets and threshold values for surcharges so that slow change is not discouraged, but that’s the general idea.
An Australian change of mortgage risk-weights last summer:
Under rules coming into force on July 1, 2016, the average risk weight on residential mortgage exposures will rise to at least 25 percent from about 16 percent, the Australian Prudential Regulation Authority said in a statement.
…
The regulator is forcing banks to shore up their capital after a government review last December recommended they should rank among the top 25 percent of lenders globally. The capital increase forms part of the regulators’ attempt to ensure the financial system can cope with any downturn in the housing market, where prices have climbed almost 30 percent in the past three years.Australia & New Zealand Banking Group Ltd. Commonwealth Bank of Australia, National Australia Bank Ltd., Westpac Banking Corp. and Macquarie Group Ltd. will be affected by the new rules, which equate to increasing minimum capital requirements by about 80 basis points, APRA said. The cost of holding more capital may force the lenders to raise their mortgage rates, according to Morningstar Inc. and Bell Potter Securities Ltd.
… and the change appears to have had some effect:
Sydney home prices fell the most in five years in November as a regulatory crackdown forces banks to tighten lending and increase mortgage rates.
Dwelling values in Australia’s largest city dropped 1.4 percent from a month earlier, data from property researcher CoreLogic Inc. showed on Tuesday. That was the biggest drop since December 2010 and the first decline since May. Prices across the nation’s capital cities declined 1.5 percent, with Melbourne leading with a 3.5 percent decrease.
“The fact that mortgage rates have risen independently of the cash rate has, in all likelihood, become a contributor to the slowdown in housing market conditions,” Tim Lawless, head of research at the firm, said in an e-mailed statement. “Tighter mortgage servicing criteria across the board and affordability constraints in the Sydney and Melbourne markets are also having an impact on market demand.”
The drop in home prices is yet another indicator of the cooling Sydney property market after mortgage rates close to five-decade lows and buying by foreigners sent prices up 44 percent in the past three years.
The regulator’s justification for the increase makes much more sense than the micro-economic arguments we’re hearing from Ottawa and the UK!
And in today’s drone news, Amazon has released videos and pictures about its developing Prime Air delivery service!
Click for Big
It was another mixed day for the Canadian preferred share market, with PerpetualDiscounts up 30bp, FixedResets off 42bp and DeemedRetractibles gaining 14bp. FixedResets comprised all of the bad part of the Performance Highlights table. Volume was extremely high.
For as long as the FixedReset market is so violently unsettled, I’ll keep publishing updates of the more interesting and meaningful series of FixedResets’ Implied Volatilities. This doesn’t include Enbridge because although Enbridge has a large number of issues outstanding, all of which are quite liquid, the range of Issue Reset Spreads is too small for decent conclusions. The low is 212bp (ENB.PR.H; second-lowest is ENB.PR.D at 237bp) and the high is a mere 268 for ENB.PF.G.
Remember that all rich /cheap assessments are:
» based on Implied Volatility Theory only
» are relative only to other FixedResets from the same issuer
» assume constant GOC-5 yield
» assume constant Implied Volatility
» assume constant spread
Here’s TRP:
Click for Big
TRP.PR.E, which resets 2019-10-30 at +235, is bid at 19.30 to be $1.30 rich, while TRP.PR.C, resetting 2016-1-30 at +154, is $0.95 cheap at its bid price of 12.64.
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Most expensive is MFC.PR.N, resetting at +230bp on 2020-3-19, bid at 20.60 to be 0.49 rich, while MFC.PR.J, resetting at +261bp on 2018-3-19, is bid at 21.00 to be 0.62 cheap.
Click for Big
The cheapest issue relative to its peers is BAM.PR.R, resetting at +230bp on 2016-6-30, bid at 15.90 to be $1.16 cheap. BAM.PR.X, resetting at +180bp on 2017-6-30 is bid at 15.16 and appears to be $0.77 rich.
Click for Big
FTS.PR.K, with a spread of +205bp, and bid at 18.89, looks $0.92 expensive and resets 2019-3-1. FTS.PR.G, with a spread of +213bp and resetting 2018-9-1, is bid at 17.82 and is $0.58 cheap.
Click for Big
Investment-grade pairs predict an average three-month bill yield over the next five-odd years of -0.35%, with no outliers. There is one junk outlier below -1.50%.
Click for Big
Shall we just say that this exhibits a high level of confidence in the continued rapacity of Canadian banks?
| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
|||||||
| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 4.37 % | 5.25 % | 35,717 | 17.57 | 1 | -0.3831 % | 1,780.6 |
| FixedFloater | 6.28 % | 5.53 % | 28,774 | 16.86 | 1 | -0.5263 % | 3,106.0 |
| Floater | 4.25 % | 4.31 % | 87,423 | 16.71 | 3 | 3.1889 % | 1,856.8 |
| OpRet | 4.85 % | 3.54 % | 28,050 | 0.74 | 1 | 0.1190 % | 2,744.1 |
| SplitShare | 4.77 % | 5.64 % | 128,712 | 4.32 | 5 | -0.2645 % | 3,214.0 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.2645 % | 2,507.7 |
| Perpetual-Premium | 5.74 % | -5.60 % | 89,084 | 0.09 | 6 | 0.2357 % | 2,532.0 |
| Perpetual-Discount | 5.55 % | 5.59 % | 92,851 | 14.47 | 33 | 0.3031 % | 2,578.5 |
| FixedReset | 5.02 % | 4.66 % | 224,971 | 14.99 | 76 | -0.4183 % | 2,043.8 |
| Deemed-Retractible | 5.14 % | 5.14 % | 122,615 | 5.36 | 33 | 0.1423 % | 2,597.7 |
| FloatingReset | 2.63 % | 3.61 % | 65,192 | 5.73 | 10 | 0.4807 % | 2,196.3 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| FTS.PR.G | FixedReset | -2.52 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 17.82 Evaluated at bid price : 17.82 Bid-YTW : 4.47 % |
| MFC.PR.J | FixedReset | -2.51 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 21.00 Bid-YTW : 5.95 % |
| BAM.PF.B | FixedReset | -1.93 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 18.85 Evaluated at bid price : 18.85 Bid-YTW : 4.97 % |
| TRP.PR.A | FixedReset | -1.87 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 15.75 Evaluated at bid price : 15.75 Bid-YTW : 4.66 % |
| BAM.PR.R | FixedReset | -1.79 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 15.90 Evaluated at bid price : 15.90 Bid-YTW : 5.27 % |
| SLF.PR.G | FixedReset | -1.73 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 14.80 Bid-YTW : 8.89 % |
| RY.PR.M | FixedReset | -1.67 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 20.06 Evaluated at bid price : 20.06 Bid-YTW : 4.46 % |
| TRP.PR.D | FixedReset | -1.65 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 18.48 Evaluated at bid price : 18.48 Bid-YTW : 4.69 % |
| BAM.PF.F | FixedReset | -1.64 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 20.34 Evaluated at bid price : 20.34 Bid-YTW : 4.92 % |
| HSE.PR.G | FixedReset | -1.64 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 21.00 Evaluated at bid price : 21.00 Bid-YTW : 5.34 % |
| BMO.PR.S | FixedReset | -1.44 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 19.16 Evaluated at bid price : 19.16 Bid-YTW : 4.45 % |
| FTS.PR.K | FixedReset | -1.41 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 18.89 Evaluated at bid price : 18.89 Bid-YTW : 4.18 % |
| BNS.PR.D | FloatingReset | -1.41 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 19.62 Bid-YTW : 5.61 % |
| BAM.PR.T | FixedReset | -1.33 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 16.36 Evaluated at bid price : 16.36 Bid-YTW : 5.21 % |
| MFC.PR.K | FixedReset | -1.28 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 19.30 Bid-YTW : 6.74 % |
| TRP.PR.C | FixedReset | -1.25 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 12.64 Evaluated at bid price : 12.64 Bid-YTW : 4.92 % |
| TRP.PR.B | FixedReset | -1.19 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 11.66 Evaluated at bid price : 11.66 Bid-YTW : 4.69 % |
| CM.PR.P | FixedReset | -1.10 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 17.95 Evaluated at bid price : 17.95 Bid-YTW : 4.65 % |
| NA.PR.Q | FixedReset | -1.08 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 24.75 Bid-YTW : 3.73 % |
| BNS.PR.Y | FixedReset | -1.07 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 20.30 Bid-YTW : 5.52 % |
| TRP.PR.E | FixedReset | -1.03 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 19.30 Evaluated at bid price : 19.30 Bid-YTW : 4.55 % |
| CU.PR.D | Perpetual-Discount | 1.00 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 21.81 Evaluated at bid price : 22.15 Bid-YTW : 5.55 % |
| CU.PR.E | Perpetual-Discount | 1.01 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 21.70 Evaluated at bid price : 22.00 Bid-YTW : 5.59 % |
| TD.PR.T | FloatingReset | 1.09 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.10 Bid-YTW : 3.39 % |
| CU.PR.C | FixedReset | 1.15 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 19.34 Evaluated at bid price : 19.34 Bid-YTW : 4.38 % |
| GWO.PR.N | FixedReset | 1.17 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 13.83 Bid-YTW : 9.82 % |
| MFC.PR.F | FixedReset | 1.22 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 14.91 Bid-YTW : 8.98 % |
| PWF.PR.G | Perpetual-Premium | 1.27 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2015-12-30 Maturity Price : 25.00 Evaluated at bid price : 25.60 Bid-YTW : -16.42 % |
| CU.PR.H | Perpetual-Discount | 1.44 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 23.62 Evaluated at bid price : 23.95 Bid-YTW : 5.50 % |
| TD.PR.Z | FloatingReset | 1.54 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.06 Bid-YTW : 3.50 % |
| SLF.PR.H | FixedReset | 1.67 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 18.25 Bid-YTW : 7.22 % |
| IAG.PR.A | Deemed-Retractible | 1.68 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 21.80 Bid-YTW : 6.45 % |
| PWF.PR.T | FixedReset | 1.89 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 22.23 Evaluated at bid price : 22.70 Bid-YTW : 3.78 % |
| CU.PR.G | Perpetual-Discount | 1.99 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 20.50 Evaluated at bid price : 20.50 Bid-YTW : 5.52 % |
| BAM.PR.B | Floater | 2.59 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 11.10 Evaluated at bid price : 11.10 Bid-YTW : 4.31 % |
| BAM.PR.C | Floater | 3.25 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 11.13 Evaluated at bid price : 11.13 Bid-YTW : 4.30 % |
| TRP.PR.H | FloatingReset | 3.45 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 10.80 Evaluated at bid price : 10.80 Bid-YTW : 3.99 % |
| BAM.PR.K | Floater | 3.74 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 11.10 Evaluated at bid price : 11.10 Bid-YTW : 4.31 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| BNS.PR.C | FloatingReset | 126,134 | TD crossed 125,000 at 23.05. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.00 Bid-YTW : 3.75 % |
| IFC.PR.A | FixedReset | 62,719 | Desjardins crossed 42,100 at 16.45. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 16.39 Bid-YTW : 8.82 % |
| BNS.PR.R | FixedReset | 59,151 | TD crossed 50,000 at 24.80. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 24.73 Bid-YTW : 3.62 % |
| PWF.PR.P | FixedReset | 43,750 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 14.61 Evaluated at bid price : 14.61 Bid-YTW : 4.36 % |
| TRP.PR.F | FloatingReset | 37,975 | RBC crossed 17,300 at 13.93. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 13.90 Evaluated at bid price : 13.90 Bid-YTW : 4.25 % |
| FTS.PR.K | FixedReset | 36,701 | RBC crossed 17,800 at 19.15. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2045-11-30 Maturity Price : 18.89 Evaluated at bid price : 18.89 Bid-YTW : 4.18 % |
| There were 65 other index-included issues trading in excess of 10,000 shares. | |||
| Wide Spread Highlights | ||
| Issue | Index | Quote Data and Yield Notes |
| HSE.PR.G | FixedReset | Quote: 21.00 – 21.79 Spot Rate : 0.7900 Average : 0.4778 YTW SCENARIO |
| TRP.PR.A | FixedReset | Quote: 15.75 – 16.39 Spot Rate : 0.6400 Average : 0.4307 YTW SCENARIO |
| MFC.PR.K | FixedReset | Quote: 19.30 – 19.84 Spot Rate : 0.5400 Average : 0.3452 YTW SCENARIO |
| RY.PR.M | FixedReset | Quote: 20.06 – 20.51 Spot Rate : 0.4500 Average : 0.2849 YTW SCENARIO |
| MFC.PR.J | FixedReset | Quote: 21.00 – 21.50 Spot Rate : 0.5000 Average : 0.3371 YTW SCENARIO |
| BNS.PR.D | FloatingReset | Quote: 19.62 – 19.99 Spot Rate : 0.3700 Average : 0.2196 YTW SCENARIO |
imho – it would seem that December will also be a rough ride. I’m off the toy store to buy a dart board and I’ll be making labels all evening – maybe the odds will improve. That said – cant wait to add to the TFSA w/ some long positions. RY.PR.W – really?
My best guess is that this December will resemble December 2008 in broad strokes, but hopefully without such extreme price changes. Dec 08 was wild … the market went down down down until the precise end of Tax Loss Selling season, then UP UP UP!
Trouble is, “best guesses” in financial markets aren’t very good!
While I agree that ‘best guesses’ aren’t always good in financial markets, if one doesn’t build likely scenarios and design their portfolio with those in mind, then they are investing blindly (which we could argue is worse).
FWIW James, I agree with your ‘best guess’ – the most likely scenario would be a hard tax loss selling period, followed by a rally on rebalancing flows. We could have the added benefit of a FED raise dragging our rates with it (as we saw a sympathetic rally in late Oct – early Nov) – this would also give a fundamental driver to a rally out of Dec.
We do need to keep the BOC in mind in January though (ie brakes to a rally) – if our rates run too much and energy doesn’t strengthen, there is a non-zero chance of another rate cut here.
While I agree that ‘best guesses’ aren’t always good in financial markets, if one doesn’t build likely scenarios and design their portfolio with those in mind, then they are investing blindly (which we could argue is worse).
I disagree, but I suspect that in the end we’re not too far apart.
I believe that portfolios should be built in accordance with the long-run characteristics of each asset class being used to fit the pieces into a coherent whole that will meet portfolio objectives.
Portfolio construction should be informed by ‘what-if’ scenarios, for risk management purposes, but only “informed” … not “determined”.