October 27, 2008

The extraordinary Money Market disintermediation (discussed on the weekend) continues, with Morgan Stanley badly hit:

Morgan Stanley clients withdrew almost one- third of their cash from money-market accounts last month, forcing the firm to buy $23 billion of securities held by the funds to keep them afloat.

Redemptions were $46 billion in September, mostly from funds that invest in corporate debt, Morgan Stanley said in an Oct. 9 regulatory filing. The New York-based company made sure the money-market funds had enough cash to repay investors by acquiring some of their assets with financing from “various available stabilization facilities.”

Not surprisingly, US Commercial Paper rates are spiking:

Yields on commercial paper rose as the Federal Reserve began buying the debt directly from companies, showing the central bank’s efforts to unfreeze short- term credit markets have yet to take hold.

Rates on the highest-ranked 30-day commercial paper, which many corporations use to finance their day-to-day operations, jumped 25 basis points to 2.88 percent, according to yields offered by companies and compiled by Bloomberg.

The Fed today set the rate it’s willing to accept for 90-day unsecured commercial paper at 1.88 percent plus a 1 percentage point credit surcharge. The 90-day secured asset-backed rate was set at 3.88 percent, according to Fed data compiled by Bloomberg.

The Fed’s graph tells the tale:

There is a note from Bloomberg that overnight US Equity futures and the cash market opening are decoupling:

U.S. stock-index futures are becoming less reliable as predictors of market moves.

With equity investors around the world contending with the worst drop since the Great Depression, futures on the Standard & Poor’s 500 Index misstated gains or losses by an average 1.4 percentage point in October, twice the gap in the third quarter, data compiled by Bloomberg show. One of the biggest misses was Oct. 24, when futures fell as much as 60 points, while the index itself dropped 37 points in the first half hour of trading, before closing down 31.

… which may be related to derivatives losses at Deutsche Bank:

Deutsche Bank AG, Germany’s biggest bank, lost more than $400 million on equity derivatives trades as stock markets headed for their biggest rout since the 1930s, two people with direct knowledge of the matter said.

The loss, equal to almost half of the Frankfurt-based company’s second-quarter revenue from equity sales and trading, is a black eye for Richard Carson, global head of equity derivatives, and may signal more job losses at the bank.

Econbrowser‘s James Hamilton has posted supporting a Fed cut to 1.00%, on grounds that:

  • The three month bill rate is 1.00%
  • inflation is unlikely with oil below $70; unemployment is a greater concern, and
  • risks to the dollar are minimal considering the global nature of the crisis

Viral Acharya and Raghu Sundaram have posted an analysis of the UK & US bank loan guarantees on VoxEU:

In the UK, an institution seeking a guarantee on an issue will be charged an annual fee of 50 basis points plus that institution’s median 5-year credit-default swap (CDS) spread observed in the 12 months before 7 October 2008.

In the US, each participating institution will pay a flat 75 basis points per annum on the entire amount of its new senior unsecured liabilities (subject to the 125% cap mentioned above). If the institution has informed the FDIC of its intent to also issue non-guaranteed long-term debt, then the 75 basis points fee applies to the guaranteed portion of its new debt issues. But in the latter case, the institution must also pay a one-time fee of 37.5 basis points of that portion of its senior unsecured liabilities as of 30 September 2008, that will mature on or before 30 June 2009.

Even a casual glance at these numbers suggests that the British Treasury’s fees are a great deal higher than the proposed American flat fee structure (0.75% versus anything between 109 basis points for HSBC to over 178 basis points for Nationwide).

If the entire available guarantee amount of GBP 250 billion is taken up, the resulting subsidy to be borne by UK taxpayers is of the order of about GBP 0.675 billion per year, or about GBP 2 billion over the three years of the scheme.

Assuming a total guarantee figure of $1.5 trillion (an estimate that is likely on the lower side), this means an annual [US] government subsidy to the participating banks of $18 billion, or well over $50 billion over the three years of the scheme.

By way of comparison, the Canadian Lenders’ Assurance Fund:

Insurance provided through the facility will be priced on a commercial basis. The base annualized fee will be 135 basis points [note 2]. There will be a surcharge of 25 basis points for eligible institutions rated at or above A- or equivalent. There will be a further surcharge of 25 basis points for other eligible financial institutions. There will also be a further surcharge for insurance on non-Canadian dollar denominated debt.

Note 2: This is the average over the twelve months ending August 2008 of the spread between the yield on Canadian dollar five-year senior unsecured bonds issued by the five largest Canadian banks and the comparable Government of Canada bond

Spend-every-penny Flaherty announced today that Desjardins will be eligible for the facility.

I reported in early September that the five-year TIPS note was in danger … any more auctions like today’s will eliminate the uncertainty!

The average yield was 3.27 percent which means that the new bond yields more than the nominal 5 year note. The so called breakeven spread is the spread at which inflation would need to average for the holder of the TIPS to breakeven with the nominal bond and it generally predicts a positive rate of inflation.

In this case, the TIPS is yielding above the nominal bond by about 70 basis points in which case the market is saying that it thinks that inflation will average negative 0.7 percent per year for the next 4 ½ years.

Another post on VoxEU, by Romain Ranciere, Aaron Tornell and Frank Westermann, takes the somewhat heretical view that the credit crunch is not a big deal:

How big is the current US bailout? The $700 billion bailout bill is equivalent to 5% of GDP. Adding to it the cost of other rescues – Bear Stearns, Freddie Mac and Fannie Mae, AIG – the total bailout costs could go up to $1,400 billion, which is around 10% of GDP. In contrast,

  • Mexico incurred bailout costs of 18% of GDP following the 1994 Tequila crisis.
  • In the aftermath of the 1997-98 Asian crisis, the bailout price tag was 18% of GDP in Thailand and a whopping 27% in South Korea.
  • Somewhat lower costs, although of the same order of magnitude, were incurred by Scandinavian countries in the banking crises of the late 1980s. 11% in Finland (1991), 8% in Norway (1987), and 4% in Sweden (1990).
  • Lastly, the 1980s savings and loans debacle in the US had a cumulative fiscal cost for the taxpayer of 2.6% of GDP.

The bailout costs that the taxpayers are facing today can be seen as an ex post payback for years of easy access to finance in the US economy. The implicit bailout guarantees against systemic crises have supported a high growth path for the economy – albeit a risky one. In effect, the guarantees act as an investment subsidy that leads investors to (1) lend more and (2) at cheaper interest rates. This results in greater investment and growth in financially constrained sectors – such as housing, small businesses, internet infrastructure, and so on. Investors are willing to do so because they know that if a systemic crisis were to take place, the government will make sure they get repaid (at least partially).

Perhaps the financial sector lent excessively, leading to overinvestment in the housing sector today and the IT sector in the late 1990s. But the bottom line remains that risk-taking has positive consequences in the long run even if it implies that crises will happen from time to time. Over history, the countries that have experienced (rare) crises are the ones that have grown the fastest.1 In those countries, investors and businesses take on more risks and as a result have greater investment and growth. Compare Thailand’s high-but-jumpy growth path with India’s slow-but-steady growth path before it implemented liberalisation a few years ago. Over the last 25 years, Thailand grew 32% more than India in terms of per-capita income despite a major financial crisis. Similarly, easier access to finance and risk-taking explains, in part, why the US economy has strongly outperformed those of France and Germany in the last decades.

Hear, hear! It is a natural human preference that things we cannot control be predictable … but to suffocate the financial system with scads of new rules and restrictions would be the equivalent of the school board banning running in the playground because occasionally a kid falls and skins his knee.

The loonie got killed today:

The Canadian dollar depreciated by as much as 1.5 percent to C$1.2972 per U.S. dollar, from C$1.2775 on Oct. 24, the lowest since Sept. 21, 2004. It traded at C$1.2914 at 2:24 p.m. in Toronto. One Canadian dollar buys 77.44 U.S. cents.

as did Canadian equities

The Standard & Poor’s/TSX Composite Index slid 8.1 percent to 8,537.34 in Toronto, the most since a 11 percent plunge on “Black Monday” of Oct. 19, 1987. The S&P/TSX, which derives three-quarters of its value from resource and finance shares, has fallen 27 percent in October, poised for its biggest monthly decline since January 1919.

Prefs did not escape unscathed, with PerpetualDiscounts closing at a yield of 7.00%, a level last seen in April 1995. This is equivalent to interest of 9.80% at the standard 1.4x equivalency factor, while long corporates now yield about 7.25% for a pre-tax interest-equivalent spread of 255bp.

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.
The Fixed-Reset index was added effective 2008-9-5 at that day’s closing value of 1,119.4 for the Fixed-Floater index.
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet N/A N/A N/A N/A 0 N/A N/A
Fixed-Floater 5.50% 5.76% 67,748 14.67 6 +0.2466% 941.1
Floater 6.96% 7.06% 46,577 12.44 2 -5.6391% 495.0
Op. Retract 5.36% 6.29% 131,496 4.04 14 -0.8102% 987.0
Split-Share 6.41% 11.25% 57,664 3.96 12 -1.0120% 914.6
Interest Bearing 8.50% 15.65% 60,182 3.16 3 -3.4857% 830.4
Perpetual-Premium 6.83% 6.91% 48,313 12.60 1 -0.5217% 908.8
Perpetual-Discount 6.93% 7.00% 173,519 12.59 70 -2.1472% 783.0
Fixed-Reset 5.37% 5.09% 833,816 15.17 10 -0.7326% 1,070.9
Major Price Changes
Issue Index Change Notes
IAG.PR.A PerpetualDiscount -14.9697% Now with a pre-tax bid-YTW of 8.34% based on a bid of 14.03 and a limitMaturity. Closing quote 14.03-16.12, 10×13. Day’s range 16.12-50.
BAM.PR.B Floater -11.3158%  
BSD.PR.A InterestBearing -8.4079% Asset coverage of 0.9+:1 as of October 24 according to Brookfield Funds. Plunge is probably related to the suspension of retractions … but mind you, the preferreds now have full exposure to declines in the underlying portfolio – so maybe it’s just that. On Review-Negative by DBRS. Now with a pre-tax bid-YTW of 20.26% based on a bid of 5.12 and a hardMaturity 2015-3-31 at 10.00. Closing quote 5.12-33, 33×5. Day’s range 5.11-81.
RY.PR.H PerpetualDiscount -8.3410% Now with a pre-tax bid-YTW of 7.08% based on a bid of 20.00 and a limitMaturity. Closing Quote 20.00-22.13 (!). Day’s range of 21.00-81.
POW.PR.B PerpetualDiscount -7.2456% Now with a pre-tax bid-YTW of 7.50% based on a bid of 18.05 and a limitMaturity. Closing Quote 18.05-85, 4X1. Day’s range of 18.45-27.
POW.PR.D PerpetualDiscount -6.4871% Now with a pre-tax bid-YTW of 7.44% based on a bid of 17.01 and a limitMaturity. Closing Quote 17.01-05, 1X4. Day’s range of 17.05-18.20.
CM.PR.D PerpetualDiscount -5.3508% Now with a pre-tax bid-YTW of 7.74% based on a bid of 18.75 and a limitMaturity. Closing Quote 18.75-18, 26X5. Day’s range of 18.75-19.81.
FIG.PR.A InterestBearing -5.3455% Asset coverage of just under 1.4:1 as of October 15, according to Faircourt. Now with a pre-tax bid-YTW of 13.06% based on a bid of 7.26 and a hardMaturity 2014-12-31 at 10.00. Closing quote 7.26-38, 7X5. Day’s range of 7.25-66.
FTN.PR.A SplitShare -4.9875% Asset coverage of 2.2+:1 as of September 30 according to the company. Now with a pre-tax bid-YTW of 10.21% based on a bid of 7.62 and a hardMaturity 2015-12-1 at 10.00. Closing quote of 7.62-80, 32X11. Day’s range 7.80-01.
BMO.PR.J PerpetualDiscount -4.7187% Now with a pre-tax bid-YTW of 7.31% based on a bid of 15.75 and a limitMaturity. Closing Quote 15.75-24, 7X3. Day’s range of 16.00-69.
TD.PR.O PerpetualDiscount -4.7040% Now with a pre-tax bid-YTW of 6.77% based on a bid of 18.03 and a limitMaturity. Closing Quote 18.03-38, 2X4. Day’s range of 18.00-90.
PWF.PR.F PerpetualDiscount -4.6384% Now with a pre-tax bid-YTW of 6.92% based on a bid of 19.12 and a limitMaturity. Closing Quote 19.12-89, 5X4. Day’s range of 19.05-20.10.
PWF.PR.E PerpetualDiscount -4.5000% Now with a pre-tax bid-YTW of 6.59% based on a bid of 21.01 and a limitMaturity. Closing Quote 21.01-29, 2X10. Day’s range of 21.25-00.
BAM.PR.M PerpetualDiscount -4.4328% Now with a pre-tax bid-YTW of 9.52% based on a bid of 12.72 and a limitMaturity. Closing Quote 12.72-04, 1X1. Day’s range of 12.72-50.
SLF.PR.C PerpetualDiscount -4.3098% Now with a pre-tax bid-YTW of 7.37% based on a bid of 15.32 and a limitMaturity. Closing Quote 15.32-50, 4X10. Day’s range of 15.40-00.
GWO.PR.H PerpetualDiscount -4.2254% Now with a pre-tax bid-YTW of 7.24% based on a bid of 17.00 and a limitMaturity. Closing Quote 17.00-70, 5X5. Day’s range of 17.01-85.
RY.PR.B PerpetualDiscount -4.1622% Now with a pre-tax bid-YTW of 6.64% based on a bid of 17.73 and a limitMaturity. Closing Quote 17.73-90, 4X3. Day’s range of 17.50-26.
CM.PR.G PerpetualDiscount -4.1621% Now with a pre-tax bid-YTW of 7.79% based on a bid of 17.50 and a limitMaturity. Closing Quote 17.50-75, 2X5. Day’s range of 17.50-36.
MFC.PR.C PerpetualDiscount -4.1029% Now with a pre-tax bid-YTW of 7.31% based on a bid of 15.66 and a limitMaturity. Closing Quote 15.66-75, 3X4. Day’s range of 15.70-20.
BNA.PR.B SplitShare -4.0984% Asset coverage of just under 2.8:1 as of September 30 according to the company. Coverage now of 2.O-:1 based on BAM.A at 20.50 and 2.4 BAM.A held per preferred. Now with a pre-tax bid-YTW of 11.18% based on a bid of 17.55 and a hardMaturity 2016-3-25 at 25.00. Compare with BNA.PR.A (18.77% to 2010-9-30) and BNA.PR.C (13.24% to 2019-1-10). Closing quote 17.55-39. Day’s range 17.55-40.
RY.PR.A PerpetualDiscount -4.0090% Now with a pre-tax bid-YTW of 6.56% based on a bid of 17.00 and a limitMaturity. Closing Quote 17.00-22, 5X3. Day’s range of 17.00-93.
ELF.PR.G PerpetualDiscount +4.1667% Now with a pre-tax bid-YTW of 8.01% based on a bid of 15.00 and a limitMaturity. Closing Quote 15.00-94, 20X10. 700 shares traded in three transactions at 14.75.
NA.PR.N FixedReset +6.5217% Now trading through the BNS issues. So go figure.
Volume Highlights
Issue Index Volume Notes
MFC.PR.A OpRet 251,045 RBC sold 9 lots to (various?) anonymous(es) at 24.10, totalling 181,000 shares. Now with a pre-tax bid-YTW of 5.03% based on a bid of 23.76 and a softMaturity 2015-12-18 at 25.00.
TD.PR.M OpRet 75,800 CIBC crossed 60,000 at 24.65, then another 12,000 at the same price. Now with a pre-tax bid-YTW of 5.17% based on a bid of 24.51 and a softMaturity 2013-10-30 at 25.00.
TD.PR.P PerpetualDiscount 56,380 National bought 12,100 from Nesbitt at 21.00; anonymous bought 10,000 from TD at 21.50. Now with a pre-tax bid-YTW of 6.34% based on a bid of 20.84 and a limitMaturity.
CM.PR.A OpRet 53,900 TD crossed 10,000 at 25.15, then another 30,000 at the same price, then bought 11,500 from CIBC at the same price again. Now with a pre-tax bid-YTW of 5.32% based on a bid of 25.01 and a softMaturity 2011-7-30 at 25.00.
MFC.PR.B PerpetualDiscount 41,901 CIBC crossed 25,000 at 17.50. Now with a pre-tax bid-YTW of 6.93% based on a bid of 17.05 and a limitMaturity.

There were forty-three other index-included $25-pv-equivalent issues trading over 10,000 shares today.

8 Responses to “October 27, 2008”

  1. lystgl says:

    Starting to get chest pains and breathing is becoming somewhat laboured. I too, would like your opinion on possible bank common share dividend curtailment or cessation altogether.

  2. prefhound says:

    Two points:

    1. I thought US TIPS were guaranteed to pay out at least 100 cents on the dollar (i.e. deflation would not erode principal, while inflation increases it). If so, it is all the more remarkable that TIP yields would be higher than nominal. Similar action is going on in the TIP ETF, with most of the underlying bonds trading at a discount to par.

    2. Should you really use a $10.00 maturity value for BSD.PR.A to calculate Yield to Worst? I would think that with a NAV of $9.00, YTW would assume $9.00 and therefore be lower.

  3. prefhound says:

    To save you the trouble: here is the official word on TIPS from http://www.savingsbonds.gov:

    “Treasury Inflation-Protected Securities (TIPS) are marketable securities whose principal is adjusted by changes in the Consumer Price Index. With inflation (a rise in the index), the principal increases. With a deflation (a drop in the index), the principal decreases.

    The relationship between TIPS and the Consumer Price Index affects both the sum you are paid when your TIPS matures and the amount of interest that a TIPS pays you every six months. TIPS pay interest at a fixed rate. Because the rate is applied to the adjusted principal, however, interest payments can vary in amount from one period to the next. If inflation occurs, the interest payment increases. In the event of deflation, the interest payment decreases.

    At the maturity of a TIPS, you receive the adjusted principal or the original principal, whichever is greater. This provision protects you against deflation.”

    Thus, while the principal is protected, the interest payment could decrease. I looked up the data on the TIP issue you cited:
    Issue Oct 31, 2008 Maturing Apr 15, 2013, Price = 92.38, Coupon = 0.625, Index Ratio 1.035

    IF there is no change in inflation, the investor gets 0.625X1.035 interest per $100 face plus $103.50 at maturity. This gives the 3.27% yield quoted.

    If there is inflation, the interest and maturity payment both increase to give a 3.27% real yield.

    If there is deflation, the principal paid back cannot go below $100 (I am not sure why a newly issued bond has an index ratio of 1.035 and not 1.00). In this case the Yield to Maturity is 2.43% at worst, which is still less than the 2.57% corresponding 5-year nominal bond (3.27% TIPS yield minus 70 bp quoted in the article).

    Thus, the market is not that irrational, and is assuming the CPI Index is about 3.5% lower in five years than now (0.7% deflation per year).

    What appeals to me in this case is the small coupon and discount bond — attractive for taxable accounts.

    Thus, the reason market TIP real yields look high is that near term inflation expectations have fallen negative, so gains in principal of outstanding issues are threatened with erosion — despite deflation protection in new issues. What is interesting is that even long term TIPS now have real yields of 3+%, so investors are behaving like deflation will last for many years.

    I wonder if the real risk is that after a bout of near-term deflation, inflation might be back with a vengeance if fiscal and monetary policy don’t rebalance smoothly and effectively.

  4. jiHymas says:

    lystgl … see the comments to the new issue, where the question of bank common dividend sustainability was originally raised. But my main advice is to stay calm and stay diversified.

    prefhound … The link I found (about principal protection on TIPS) was this one.

    NAV of BSD.PR.A is actually 9.98. For conveniences, YTW assumes that the committments made in the prospectus will be kept – it is the credit rating that provides the opinion regarding the probability of the compank keeping those committments.

    However, low-grade issues – and BSD.PR.A is now a low-grade issue, it’s only a matter of time before DBRS makes it official – are special situations. They are not particularly susceptible to the investment-grade-style analysis of HIMIPref™ and ever investor will have his own methodology. For instance, you could assume an end-value of $5 with a rating of Pfd-2 if you liked

  5. prefhound says:

    Oct 24 BSD.PR.A NAV was $9.44 (but I was using my estimate of $9.00 assuming the June 30 portfolio was intact).

    Credit rating or not, the expected value at maturity (disregarding income greater than dividends paid, MER, trading, et al) has to be the minimum of the promise or the NAV. With NAV<10 it should be the NAV. Plain and simple.

    On the TIPS, your link and my link are basically the same as savingsbonds.gov links to treasurydirect.gov. I think the whole inflation-protected bond sector has gotten very interesting in this latest phase of the crisis — real yields look very enticing (for a government bond that is effectively insured against default, at least) for the first time in a long while.

    btw I love the BoE report and your Fed balance sheet discussions. You are beautifully finding and summarizing some important stuff on a timely basis and your efforts are very much appreciated!

  6. jiHymas says:

    Credit rating or not, the expected value at maturity (disregarding income greater than dividends paid, MER, trading, et al) has to be the minimum of the promise or the NAV.

    Can you generalize this to strip bonds?

    The trouble is that BSD.PR.A’s credit quality has deteriorated to the point where it is no longer susceptible to fixed income analysis – it must be considered an equity substitute and concepts like “YTW” do not really apply. We’ve looked at this before in the context of FTU.PR.A.

  7. […] Treasury guarantee of bank debt – reported on October 27 as seeming cheap – is mired in confusion: Almost three weeks after the government threw its […]

  8. […] bid-YTW of 17.21% based on a bid of 5.87 and a hardMaturity 2015-3-31 at 10.00 … though as pointed out by Assiduous Reader prefhound, use of $10.00 maturity value is, at the very least, something of a […]

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