February 26, 2015

February 27th, 2015

Assiduous Reader DW brings to my attention a piece titled BXF no longer a strip tease, which points out:

When First Asset created Canada’s first strip bond ETF in 2013, they claimed that the ETF was expected to be more tax-efficient than other short term bond products currently available in the marketplace.

With a full tax year behind us, and armed with a new methodology for calculating the after-tax returns of ETFs, we can put First Asset’s claim to the test. Spoiler alert: the results are not only impressive, but they make you wonder why other firms haven’t followed suit by offering their own brand of strip bond ETFs.

The results above should not be considered a fluke – as long as the other bond ETFs continue to have an average coupon that is significantly higher than their yield-to-maturity, BXF will be expected to outperform these plain-vanilla ETFs on an after-tax basis (for more information on this concept, please read Why Use a Strip Bond ETF? by Dan Bortolotti).

This has previously been an issue in the preferred share world – see the article Beware the tax trap of these tempting preferreds and the post Tax Impact on FixedResetPremium Yields. Remember the good old days, when FixedResets traded at a premium?

Strips are generally too expensive to hold in any account, let alone a taxable one, but the fact that they are treated as par bonds as of the purchase date is a very useful wrinkle. Regrettably, most strips are governments and to a large extent the tax savings will be offset by the liquidity premium – which retail shouldn’t pay for, because the ability to transact $50-million in one ‘phone call without moving the market isn’t exactly an attribute that should be of much interest to retail.

I have advised many clients in the past to open accounts at full-service brokers with the sole objective of gaining access to current coupon corporate new issues. This has worked out OK for them – the biggest problem is putting the fear of God into the broker so he never calls unless he’s got a new issue that meets pre-defined standards!

US brokers are attempting to whip up some fear-inspired trading in bonds:

While the Federal Reserve considers raising overnight borrowing costs from about zero, where they’ve been since 2008, central banks in Europe are dropping deposit rates into negative territory.

This backdrop has pushed a measure of expected Treasury price swings to levels that are about 40 percent higher this year than in the same period in 2014, according to Bank of America Merrill Lynch’s Option Volatility Estimate MOVE index.

“The risk in bonds has gone up,” Francesco Garzarelli, London-based co-head of macro and markets research at Goldman Sachs Group Inc., said in a Bloomberg Television interview Thursday. “The sensitivity to small changes in yield expectations from here will command very sizable price swings, and I just think that makes fixed income a very dangerous asset class.”

While the biggest banks have cut back on their positions in risky, speculative-grade debt, it’s steadily migrated to large institutions, insurance companies and mutual funds. Such firms have boosted their holdings of corporate and foreign bonds to $5.1 trillion, a 65 percent increase since the end of 2008, according to data compiled by UBS.

This has more than offset the $800 billion decline in holdings at banks and securities firms in the period, a regulator-prompted retrenchment that was intended to reinforce the financial system, UBS analysts Matthew Mish and Stephen Caprio wrote in a Feb. 26 report.

What we’re left with instead — ballooning bond funds that own more and more risky debt — may be a less bad option, but one that still threatens to wreak havoc in credit markets.

Rob Carrick highlights a TD publication in his piece What if interest rates never return to ‘normal’?:

I’m on record as having warned many times about rising rates, but I’m now in adjustment mode. What has me reconsidering is the kind of thinking found in a new report by TD Economics titled The New Normal: Low Rates in Advanced Economies for the Long Run. It argues that rates are low today because of weak global economic growth, and that they will move higher as the economy improves. However, rates will not return to levels we used to consider “neutral.” The reason: Aging, and in some cases, shrinking populations across the industrial world. They’ll keep a lid on growth in economic productivity and thereby reduce the need to crank rates higher.

The TD report THE NEW NORMAL: LOW RATES IN ADVANCED ECONOMIES FOR THE LONG RUN forecasts modest rates for years to come:

  • • Trend economic growth is likely to remain slower than it has been historically throughout advanced economies. The two key determinants, labor force and labor productivity growth, have been slowing nearly everywhere.
  • • Record low interest rates in many advanced economies is a result of both cyclical and structural factors. However, even once they begin to normalize, lower potential GDP growth will keep the long-term equilibrium level of interest rates lower than in the past. By extension, bond yields are also slated to be lower across the maturity spectrum.
  • • The equilibrium level of interest rates in the UK is set to be relatively similar to Canada’s and slightly below that of the US. In the euro area, the equilibrium level will be a notch below the UK’s, while it will be substantially lower in Japan.
  • • In the near term, it is perfectly clear that interest rates are set to remain far lower than their expected neutral level. Nonetheless, for long-term investors, such as pension funds, investing over multiple business cycles, lower neutral rates will make for a particular challenge.


In a recent paper, TD Economics estimated the long-run neutral level of the federal funds rate to be 3.25%, relative to a 1992-2007 average of 4.10%, and the long-run neutral Bank of Canada overnight rate to be 3.00%, compared to an average of 4.20% over the same time frame. This decline reflects slower labor force growth and modest productivity growth. A central question is whether this is a global phenomenon? In this paper, we explore the long-run neutral level of interest rates for the UK, euro area and Japan. Our conclusion is that across the advanced world, the long-term equilibrium level of interest rates will be lower than in the past.

And the paper referenced in the quoted paragraph is DIVERGENT VIEWS ON NEUTRAL INTEREST RATES

  • • With the Fed signaling an end to QE in October, financial markets are now debating both the timing of future rate hikes and, more importantly, the level to which interest rates will ultimately rise. The latter requires an understanding of the neutral level of interest rates.
  • • Disagreement over how high rates will rise in the future seems to be embedded in different timeframes under discussion. The view of a ‘new neutral’ real fed funds rate of close to zero (2.00% in nominal terms) is usually grounded in a shorter timeframe that is not consistent with the long-run level of rates of an economy in equilibrium – growing at a trend pace with stable inflation.
  • • TD Economics believes that the long-run neutral level of the fed funds rate is around 3.25% (1.25% real) and the neutral level of 10-year Treasury yields is close to 4.00% (2.00% real). However, the Fed is expected to reach those points slowly, over the course of more than three years, assuming the economic recovery remains on track. The result is that our real fed funds rate averages -0.5% from 2015 to 2017.


For some time, TD Economics has viewed the future long-run neutral level of rates as lower than the pre-recession experience. We forecast a neutral level of interest rates in a range of 3.00% to 3.50% (equal to 1.00%-1.50% real), and we use the middle of that range (3.25%) to anchor our long term interest rate projection.

Meanwhile, preferred share investors are contemplating inspirational public art:

scaffold
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It was a rough day for the Canadian preferred share markets, with PerpetualDiscounts down 18bp, FixedResets losing 40bp and DeemedRetractibles off 10bp. MFC issues of all types are notable on the bad side of a lengthy Performance Highlights table, while ENB issues made an appearance on the good side. Volume was 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:

impVol_TRP_150226
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The new issue has caused a large change in the curve-fitting for the TRP series of FixedResets, which is discussed at greater length on the post announcing the new issue. TRP.PR.E, which resets 2019-10-30 at +235, is bid at 24.07 to be $1.24 rich, while the new issue, resetting 2020-11-30 at +296, is $0.87 cheap at its issue price of 25.00.

impVol_MFC_150226
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Another excellent fit, but the numbers are perplexing. Implied Volatility for MFC continues to be a conundrum, although it declined substantially today. It is still too high if we consider that NVCC rules will never apply to these issues; it is still too low if we consider them to be NVCC non-compliant issues (and therefore with Deemed Maturities in the call schedule).

Most expensive is MFC.PR.N, resetting at +230 on 2020-3-19, bid at 24.18 to be $0.38 rich, while MFC.PR.H, resetting at +313bp on 2017-3-19, is bid at 25.80 to be $0.46 cheap.

impVol_BAM_150226
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The fit on this series is actually quite reasonable – it’s the scale that makes it look so weird.

The cheapest issue relative to its peers is BAM.PR.X, resetting at +180bp on 2017-6-30, bid at 17.24 to be $0.84 cheap. BAM.PF.E, resetting at +255bp 2020-3-31 is bid at 24.39 and appears to be $1.03 rich.

impVol_FTS_150226
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This is just weird because the middle is expensive and the ends are cheap but anyway … FTS.PR.H, with a spread of +145bp, and bid at 16.86, looks $0.83 cheap and resets 2015-6-1. FTS.PR.K, with a spread of +205bp and resetting 2019-3-1, is bid at 23.51 and is $0.94 rich.

pairs_FR_150226
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Most of the investment grade break-even rates are close to zero.

On the other hand, the market’s distaste for product linked to Money Market rates does not extend to prime, as shown by the FixedFloater/RatchetRate pairs:

pairs_FF_150226
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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 0.00 % 0.00 % 0 0.00 0 0.1262 % 2,294.0
FixedFloater 4.37 % 3.52 % 18,699 18.38 1 1.0233 % 4,041.0
Floater 3.14 % 3.29 % 64,663 18.94 4 0.1262 % 2,438.6
OpRet 4.08 % 1.39 % 110,236 0.31 1 0.0000 % 2,760.4
SplitShare 4.40 % 4.28 % 28,352 3.55 6 0.2370 % 3,220.0
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0000 % 2,524.1
Perpetual-Premium 5.33 % -0.17 % 55,716 0.08 24 0.0049 % 2,515.3
Perpetual-Discount 4.95 % 4.92 % 106,817 15.65 10 -0.1791 % 2,795.8
FixedReset 4.45 % 3.41 % 213,018 16.83 78 -0.3973 % 2,401.8
Deemed-Retractible 4.92 % 0.11 % 100,920 0.17 39 -0.0989 % 2,650.0
FloatingReset 2.43 % 2.85 % 94,896 6.38 7 0.1022 % 2,326.6
Performance Highlights
Issue Index Change Notes
MFC.PR.C Deemed-Retractible -2.64 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.61
Bid-YTW : 5.22 %
MFC.PR.L FixedReset -2.42 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.42
Bid-YTW : 4.09 %
PWF.PR.P FixedReset -2.15 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 18.20
Evaluated at bid price : 18.20
Bid-YTW : 3.23 %
SLF.PR.H FixedReset -2.03 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.66
Bid-YTW : 3.61 %
ENB.PR.F FixedReset -2.02 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 19.40
Evaluated at bid price : 19.40
Bid-YTW : 4.28 %
TRP.PR.C FixedReset -1.75 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 16.31
Evaluated at bid price : 16.31
Bid-YTW : 3.52 %
BAM.PR.X FixedReset -1.54 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 17.24
Evaluated at bid price : 17.24
Bid-YTW : 4.00 %
BAM.PF.G FixedReset -1.42 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 23.14
Evaluated at bid price : 25.00
Bid-YTW : 3.67 %
CU.PR.G Perpetual-Discount -1.38 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 23.29
Evaluated at bid price : 23.62
Bid-YTW : 4.77 %
TRP.PR.E FixedReset -1.35 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 22.83
Evaluated at bid price : 24.07
Bid-YTW : 3.33 %
PWF.PR.A Floater -1.33 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 17.76
Evaluated at bid price : 17.76
Bid-YTW : 2.82 %
MFC.PR.N FixedReset -1.31 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.18
Bid-YTW : 3.80 %
VNR.PR.A FixedReset -1.20 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 23.33
Evaluated at bid price : 24.70
Bid-YTW : 3.55 %
MFC.PR.M FixedReset -1.14 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.26
Bid-YTW : 3.82 %
MFC.PR.B Deemed-Retractible -1.10 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.30
Bid-YTW : 5.00 %
TRP.PR.D FixedReset -1.05 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 22.63
Evaluated at bid price : 23.56
Bid-YTW : 3.37 %
MFC.PR.I FixedReset -1.04 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-09-19
Maturity Price : 25.00
Evaluated at bid price : 25.63
Bid-YTW : 3.28 %
BAM.PR.G FixedFloater 1.02 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 21.90
Evaluated at bid price : 21.72
Bid-YTW : 3.52 %
TRP.PR.B FixedReset 1.17 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 14.42
Evaluated at bid price : 14.42
Bid-YTW : 3.35 %
ENB.PF.A FixedReset 1.23 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 21.77
Evaluated at bid price : 22.17
Bid-YTW : 4.01 %
BAM.PR.K Floater 1.47 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 15.20
Evaluated at bid price : 15.20
Bid-YTW : 3.31 %
ENB.PF.G FixedReset 1.50 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 21.89
Evaluated at bid price : 22.40
Bid-YTW : 4.02 %
ENB.PF.C FixedReset 1.55 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 21.81
Evaluated at bid price : 22.25
Bid-YTW : 3.99 %
CGI.PR.D SplitShare 1.58 % YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2023-06-14
Maturity Price : 25.00
Evaluated at bid price : 25.70
Bid-YTW : 3.35 %
Volume Highlights
Issue Index Shares
Traded
Notes
RY.PR.J FixedReset 144,700 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 23.15
Evaluated at bid price : 25.02
Bid-YTW : 3.32 %
OSP.PR.A SplitShare 110,207 Recent new issue.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2020-03-31
Maturity Price : 10.00
Evaluated at bid price : 10.12
Bid-YTW : 4.77 %
CM.PR.O FixedReset 73,930 TD crossed 50,000 at 24.70.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 23.09
Evaluated at bid price : 24.67
Bid-YTW : 3.11 %
ENB.PR.F FixedReset 65,111 RBC bought 10,100 from Scotia at 19.80.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 19.40
Evaluated at bid price : 19.40
Bid-YTW : 4.28 %
ENB.PR.N FixedReset 63,458 Scotia crossed 14,000 at 20.30.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 20.34
Evaluated at bid price : 20.34
Bid-YTW : 4.24 %
BMO.PR.S FixedReset 49,288 Scotia crossed blocks of 17,600 and 25,000, both at 24.95.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 23.20
Evaluated at bid price : 24.93
Bid-YTW : 3.05 %
There were 41 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
MFC.PR.C Deemed-Retractible Quote: 23.61 – 24.34
Spot Rate : 0.7300
Average : 0.4221

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.61
Bid-YTW : 5.22 %

MFC.PR.L FixedReset Quote: 23.42 – 24.25
Spot Rate : 0.8300
Average : 0.6360

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.42
Bid-YTW : 4.09 %

RY.PR.F Deemed-Retractible Quote: 25.50 – 25.91
Spot Rate : 0.4100
Average : 0.2356

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-05-24
Maturity Price : 25.25
Evaluated at bid price : 25.50
Bid-YTW : 0.35 %

BAM.PF.G FixedReset Quote: 25.00 – 25.39
Spot Rate : 0.3900
Average : 0.2405

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 23.14
Evaluated at bid price : 25.00
Bid-YTW : 3.67 %

BAM.PR.N Perpetual-Discount Quote: 23.28 – 23.65
Spot Rate : 0.3700
Average : 0.2318

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 22.86
Evaluated at bid price : 23.28
Bid-YTW : 5.16 %

ENB.PR.F FixedReset Quote: 19.40 – 19.85
Spot Rate : 0.4500
Average : 0.3197

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-26
Maturity Price : 19.40
Evaluated at bid price : 19.40
Bid-YTW : 4.28 %

New Issue: CM FixedReset, 3.60%+279

February 26th, 2015

The Canadian Imperial Bank of Commerce has announced:

that it had entered into an agreement with a group of underwriters led by CIBC World Markets Inc. for an issue of 10 million Basel III-compliant Non-cumulative Rate Reset Class A Preferred Shares, Series 43 (the “Series 43 Shares”) priced at $25.00 per Series 43 Share to raise gross proceeds of $250 million.

CIBC has granted the underwriters an option to purchase up to an additional two million Series 43 Shares at the same offering price, exercisable at any time up to two days prior to closing. Should the underwriters’ option be fully exercised, the total gross proceeds of the financing will be $300 million.

The Series 43 Shares will yield 3.60% per annum, payable quarterly, as and when declared by the Board of Directors of CIBC, for an initial period ending July 31, 2020. On July 31, 2020, and on July 31 every five years thereafter, the dividend rate will reset to be equal to the then current five-year Government of Canada bond yield plus 2.79%.

Subject to regulatory approval and certain provisions of the Series 43 Shares, on July 31, 2020 and on July 31 every five years thereafter, CIBC may, at its option, redeem all or any part of the then outstanding Series 43 Shares at par.

Subject to the right of redemption, holders of the Series 43 Shares will have the right to convert their shares into Non-cumulative Floating Rate Class A Preferred Shares, Series 44 (the “Series 44 Shares”), subject to certain conditions, on July 31, 2020 and on July 31 every five years thereafter. Holders of the Series 44 Shares will be entitled to receive a quarterly floating rate dividend, as and when declared by the Board of Directors of CIBC, equal to the three-month Government of Canada Treasury Bill yield plus 2.79%.

Holders of the Series 44 Shares may convert their Series 44 Shares into Series 43 Shares, subject to certain conditions, on July 31, 2025 and on July 31 every five years thereafter.

The expected closing date is March 11, 2015. CIBC will make an application to list the Series 43 Shares as of the closing date on the Toronto Stock Exchange. The net proceeds of this offering will be used for general purposes of CIBC.

CIBC has two other series of FixedResets outstanding, CM.PR.O and CM.PR.P – sadly, insufficient to perform an Implied Volatility analysis.

I find it interesting that the issue won’t close until March 11 – two weeks is a relatively long marketing period for a major bank. The sluggishness of sales of current issues has been remarked upon both in comments on PrefBlog and elsewhere.

Rush to liquidity leads to junk sell-off

February 26th, 2015

Andrew Allentuck was kind enough to quote me in his January, 2015, piece Rush to liquidity leads to junk sell-off:

Given the higher level of risk caused by increased duration and the reduced liquidity caused by a bank’s need to cut holdings of dicey bonds, spreads between corporate bond prices and, especially, subinvestment-grade bonds are going to increase, says James Hymas, president of Hymas Investment Management Inc. in Toronto: “It is liquidity, not default risk, that is moving prices and yields in the junk debt market.”

Bonds can improve portfolio stability

February 26th, 2015

Andrew Allentuck was kind enough to quote me in his November, 2014, piece Bonds can improve portfolio stability:

Still, care should be taken not to err too far on the side of safety. “When you compare a 10-year – and longer – Government of Canada bond with a high, investment-grade corporate bond of similar term, you can see a spread of 150 bps,” says James Hymas, president of Hymas Investment Management Inc. in Toronto. “The spread on yield is not all compensation for risk. Only 20 bps to 30 bps covers the credit risk. The rest is liquidity, and most retail investors give up too much yield to get the liquidity.”

“Burrito bonds” may cause indigestion

February 26th, 2015

Andrew Allentuck was kind enough to quote me in his November, 2014, piece “Burrito bonds” may cause indigestion:

The 8% cash interest payment is £80 a year on the £1,000 note, or £320 over four years. The weekly free burrito boosts the return. During the four-year term, a bondholder would get 208 free burritos. Each burrito costs £6; that’s £1,248 worth of burritos. Add the £320 cash interest and the total return on the investment would be £1,568 – or 157% of an interest-equivalent return.

In contrast, the Bank of England currently offers 1.5% on its five-year gilts. On a £1,000 note, that would buy you two and half burritos a year. Not surprising, the burrito bond issue was heavily oversubscribed, given the current climate of low interest rates that provide insufficient income.

Even without the nosh, the Chilango bond would find takers, says James Hymas, president of Hymas Investment Management Inc. in Toronto, “especially when you offer 8% on a bond.”

Chilango has very fancy website and trumpet the success of the bond issue.

It’s time to get used to low interest rates

February 26th, 2015

Andrew Allentuck was kind enough to quote me in his October, 2014, piece It’s time to get used to low interest rates:

So, how long can the price of money hover in the low single digits?

“Yields at present are not sustainable, for real rates are below the replacement cost of capital,” says James Hymas, president of Hymas Investment Management Inc. in Toronto. “However, if we get into deflation, then the negative real interest rates prevailing now will turn positive. For now, investor sentiment does not show deflationary expectations, but there are many tripwires in the Middle East, Ukraine, and in the Baltic republics.”

Product shelf now includes green bonds

February 26th, 2015

Andrew Allentuck was kind enough to quote me in his October, 2014, piece Product shelf now includes green bonds:

In January 2014, the Commonwealth of Massachusetts issued a green bond called the Juvenile Justice Pay for Success Initiative. That US$9-million issue – and companion issues from Bank of America in negotiation at time of writing – are designed to provide funds to deter young criminals from committing more crimes.

Each person the program keeps out of jail for a year saves Massachusetts US$12,500 a year, according to a Bloomberg LP report. The state would win, social service agencies would win and the deterred criminals presumably would win. It’s all good economics designed to capture and monetize external matters, but there’s a critical flaw in the plan: those who are to be deterred have no direct interest in paying the bondholders.

It’s early in the life of these bonds and, so far, there have been no defaults. But bonds with an iffy payment mechanism need justification beyond yield to maturity.

These “stay out of jail” bonds were priced with huge payoffs if they work – and, of course, big losses if they don’t. In August 2012, the State of New York issued a US$9.6-million “social impact bond” designed to reduce recidivism. The investor, Goldman Sachs Group Inc. in this case, will receive US$9.6 million. But if recidivism were to drop by more than 10%, Goldman would get a payoff of up to US$2.1 million. If recidivism does not drop by at least that much, Goldman could lose as much as US$2.4 million.

The balance point is a change of plus or minus 10% in the recidivism rate of a defined set of convicted felons. “The risk is great,” says James Hymas, president Hymas Investment Management Inc. in Toronto. “And this is really equity in bond clothing.”

February 25, 2015

February 25th, 2015

There are many revolving doors in the world … this one is minor:

Michelle Choi, an analyst for Moody’s Investors Service, gave a credit rating to bonds issued by a New Jersey town in September. In October, she switched sides and started working for the town’s underwriter, Morgan Stanley.

Choi is one of hundreds of employees at Moody’s and other credit-rating companies, including Standard & Poor’s and Fitch Ratings, who’ve gone to work for Wall Street since the 2008 financial crisis exposed the conflicts at the heart of the ratings business.

While there’s no evidence that Choi’s job-hunting influenced the grade she gave Evesham Township’s debt, the rising number of job changes in the industry raises a question: can credit analysts be impartial about grading bonds while looking for employment at banks that underwrite them?

The ratings companies say the answer is yes. An academic study by longtime industry observers suggests otherwise.

Meanwhile, the SEC proudly trumpeted its compliance results:

Each year, the BSA Review Group makes hundreds of referrals based on information gleaned initially from SAR reporting. Some statistics drive home the usefulness of the information we receive through SARs:
• In the last six months or so we have been averaging around one temporary restraining order or asset freeze per month that was initiated based upon SARs reviewed by that group.
• In the last year or so, the SEC has brought actions against seven alleged Ponzi or pyramid schemes collectively involving over $100 million, and has opened a number of investigations or examinations into other possible Ponzi schemes, based on information we first obtained from SARs.
• Also in the last year or so, we’ve charged eight people with insider trading in cases where we allege they collectively earned well over $10 million – again based on information we first obtained from SAR reporting.
• Over the past three and a half years, the SEC has initiated hundreds of exams and investigations based on the leads generated by the group from SARs and other BSA reports.
• And the number of investigations or exams that the SEC has opened based on information first discovered in SARs has essentially doubled each of the past two years.

I share these statistics to illustrate the important point that the AML programs you oversee are critical in helping to expose fraud, the exploitation of vulnerable investors, and other misconduct. The quality of the reporting, and the industry expertise that you lend to your reports, often makes it possible for us to act more quickly than we otherwise could. And it increases the chance that we will be able to hold wrongdoers responsible and, we hope, recover investor losses.

It doesn’t sound like much to justify $7-billion in annual costs and the impetus given to terrorists, does it? And, of course, the whole programme was portrayed as an anti-terror weapon, since that is a more popular idea than just another intrusive “crime detection” programme.

And here’s a little more evidence that compliance costs are out of control:

Costs remain a challenge for the [HSBC] Group, with adjusted operating expenditure up by USD 2.2 billion, due to higher regulatory and compliance costs as well as inflationary pressures. Reporting a cost-income ratio of 67% in 2014 (59.6% in 2013), the Group has moved away from its previous target of a cost-income ratio in the mid-50s and is now just aiming to achieve positive jaws on an adjusted basis.

Who cares if any business gets done, as long as regulators are employed?

Here’s a view that the bond market doesn’t care much about the Fed:

Traders are taking the Federal Reserve chair’s comments over the past two days — labor market market isn’t fully healed and inflation is too low — as confirmation that the Fed is very unlikely to raise interest rates in the first half of the year. Economists including UBS Group AG’s Drew Matus and JPMorgan Chase & Co.’s Michael Feroli saw in her message reasons to reaffirm their calls for the first increase to come by June.

But there’s a third view about how Yellen’s testimony applies to the bond market, as expressed by Jim Bianco, the founder of Bianco Research LLC in Chicago: It doesn’t really matter.

In his alternative scenario, “everybody’s right,” Bianco said, in that the Fed could start raising its benchmark rate from near zero, like economists predict, and yields remain low, like traders seem to be anticipating.

With almost $2 trillion of sovereign debt in Europe offering negative yields, demand for U.S. fixed-income assets is unlikely to evaporate regardless of what the Fed does. That demand — coming in part from overseas — will ensure that bond prices remain high and yields low.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts gaining 13bp, FixedResets off 7bp and DeemedRetractibles down 10bp. The Performance Highlights table is lengthy, dominated by FixedResets on both sides of the fence. Volume was high.

PerpetualDiscounts now yield 4.93%, equivalent to 6.41% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 3.65%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 275bp, a sharp widening from the 260bp reported February 18.

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:

impVol_TRP_150225
Click for Big

The new issue has caused a large change in the curve-fitting for the TRP series of FixedResets, which is discussed at greater length on the post announcing the new issue. TRP.PR.E, which resets 2019-10-30 at +235, is bid at 24.40 to be $1.36 rich, while the new issue, resetting 2020-11-30 at +296, is $1.03 cheap at its issue price of 25.00.

impVol_MFC_150225
Click for Big

Another excellent fit, but the numbers are perplexing. Implied Volatility for MFC continues to be a conundrum, although it declined substantially today. It is still too high if we consider that NVCC rules will never apply to these issues; it is still too low if we consider them to be NVCC non-compliant issues (and therefore with Deemed Maturities in the call schedule).

Most expensive is MFC.PR.L, resetting at +216 on 2019-6-19, bid at 24.00 to be $0.57 rich, while MFC.PR.H, resetting at +313bp on 2017-3-19, is bid at 25.92 to be $0.57 cheap.

impVol_BAM_150225
Click for Big

The fit on this series is actually quite reasonable – it’s the scale that makes it look so weird.

The cheapest issue relative to its peers is BAM.PR.X, resetting at +180bp on 2017-6-30, bid at 17.51 to be $0.67 cheap. BAM.PF.E, resetting at +255bp 2020-3-31 is bid at 24.63 and appears to be $1.11 rich.

impVol_FTS_150225
Click for Big

This is just weird because the middle is expensive and the ends are cheap but anyway … FTS.PR.H, with a spread of +145bp, and bid at 16.90, looks $0.80 cheap and resets 2015-6-1. FTS.PR.K, with a spread of +205bp and resetting 2019-3-1, is bid at 23.63 and is $1.01 rich.

pairs_FR_140225
Click for Big

Most of the investment grade break-even rates are a little below zero.

On the other hand, the market’s distaste for product linked to Money Market rates does not extend to prime, as shown by the FixedFloater/RatchetRate pairs:

pairs_FF_140225
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 0.00 % 0.00 % 0 0.00 0 -1.7968 % 2,291.1
FixedFloater 4.42 % 3.57 % 18,906 18.30 1 -1.1494 % 4,000.0
Floater 3.15 % 3.29 % 65,511 18.96 4 -1.7968 % 2,435.6
OpRet 4.08 % 1.38 % 110,211 0.31 1 0.0000 % 2,760.4
SplitShare 4.41 % 4.20 % 28,416 3.55 6 0.4648 % 3,212.4
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0000 % 2,524.1
Perpetual-Premium 5.33 % -0.55 % 56,589 0.08 24 0.0768 % 2,515.2
Perpetual-Discount 4.94 % 4.93 % 142,172 15.64 10 0.1293 % 2,800.8
FixedReset 4.42 % 3.37 % 212,278 16.79 79 -0.0655 % 2,411.3
Deemed-Retractible 4.91 % 0.17 % 102,710 0.17 39 -0.0961 % 2,652.6
FloatingReset 2.43 % 2.86 % 93,221 6.39 7 -0.0861 % 2,324.2
Performance Highlights
Issue Index Change Notes
BAM.PR.K Floater -2.16 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 14.98
Evaluated at bid price : 14.98
Bid-YTW : 3.36 %
BAM.PR.C Floater -2.14 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 15.12
Evaluated at bid price : 15.12
Bid-YTW : 3.33 %
ENB.PF.C FixedReset -1.66 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 21.57
Evaluated at bid price : 21.91
Bid-YTW : 4.06 %
BAM.PR.X FixedReset -1.63 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 17.51
Evaluated at bid price : 17.51
Bid-YTW : 3.93 %
BAM.PR.B Floater -1.61 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 15.30
Evaluated at bid price : 15.30
Bid-YTW : 3.29 %
ENB.PF.E FixedReset -1.61 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 21.67
Evaluated at bid price : 22.06
Bid-YTW : 4.06 %
MFC.PR.F FixedReset -1.59 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 18.55
Bid-YTW : 5.81 %
ENB.PF.A FixedReset -1.48 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 21.58
Evaluated at bid price : 21.90
Bid-YTW : 4.07 %
PWF.PR.A Floater -1.37 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 18.00
Evaluated at bid price : 18.00
Bid-YTW : 2.78 %
SLF.PR.G FixedReset -1.25 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 17.41
Bid-YTW : 6.20 %
BAM.PR.G FixedFloater -1.15 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 21.79
Evaluated at bid price : 21.50
Bid-YTW : 3.57 %
MFC.PR.M FixedReset -1.05 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.54
Bid-YTW : 3.68 %
MFC.PR.N FixedReset -1.01 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.50
Bid-YTW : 3.64 %
ENB.PR.F FixedReset 1.02 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 19.80
Evaluated at bid price : 19.80
Bid-YTW : 4.19 %
MFC.PR.L FixedReset 1.05 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.00
Bid-YTW : 3.79 %
PVS.PR.B SplitShare 1.09 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2019-01-10
Maturity Price : 25.00
Evaluated at bid price : 25.12
Bid-YTW : 4.20 %
TRP.PR.A FixedReset 1.28 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 19.85
Evaluated at bid price : 19.85
Bid-YTW : 3.49 %
MFC.PR.I FixedReset 1.33 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-09-19
Maturity Price : 25.00
Evaluated at bid price : 25.90
Bid-YTW : 2.84 %
TRP.PR.C FixedReset 1.53 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 16.60
Evaluated at bid price : 16.60
Bid-YTW : 3.46 %
FTS.PR.H FixedReset 1.99 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 16.90
Evaluated at bid price : 16.90
Bid-YTW : 3.13 %
CU.PR.C FixedReset 2.49 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 23.25
Evaluated at bid price : 24.33
Bid-YTW : 3.16 %
Volume Highlights
Issue Index Shares
Traded
Notes
TD.PF.A FixedReset 118,915 TD crossed blocks of 12,000 at 24.80 and 25,000 at 24.77, sold 11,900 to Desjardins at 24.80 and 25,800 to anonymous at 24.82. Nesbitt crossed 40,000 at 24.80.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 23.10
Evaluated at bid price : 24.75
Bid-YTW : 3.02 %
BMO.PR.S FixedReset 113,266 Scotia crossed blocks of 25,000 and 50,000, both at 25.00. TD crossed 15,000 at the same price.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 23.20
Evaluated at bid price : 24.92
Bid-YTW : 3.06 %
OSP.PR.A SplitShare 78,932 Recent new issue.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2020-03-31
Maturity Price : 10.00
Evaluated at bid price : 10.10
Bid-YTW : 4.81 %
BMO.PR.T FixedReset 75,733 RBC crossed 20,000 at 24.70. TD crossed blocks of 25,000 and 15,000 at the same price.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 23.05
Evaluated at bid price : 24.57
Bid-YTW : 3.04 %
RY.PR.E Deemed-Retractible 62,900 Nesbitt crossed 60,000 at 25.53.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-03-27
Maturity Price : 25.25
Evaluated at bid price : 25.49
Bid-YTW : -6.80 %
SLF.PR.G FixedReset 44,686 YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 17.41
Bid-YTW : 6.20 %
There were 43 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
PWF.PR.T FixedReset Quote: 25.04 – 25.59
Spot Rate : 0.5500
Average : 0.3383

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 23.27
Evaluated at bid price : 25.04
Bid-YTW : 3.11 %

NEW.PR.D SplitShare Quote: 32.43 – 33.43
Spot Rate : 1.0000
Average : 0.8380

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-06-26
Maturity Price : 32.07
Evaluated at bid price : 32.43
Bid-YTW : 2.94 %

BAM.PR.G FixedFloater Quote: 21.50 – 21.99
Spot Rate : 0.4900
Average : 0.3745

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 21.79
Evaluated at bid price : 21.50
Bid-YTW : 3.57 %

CM.PR.P FixedReset Quote: 24.42 – 24.75
Spot Rate : 0.3300
Average : 0.2150

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-25
Maturity Price : 22.96
Evaluated at bid price : 24.42
Bid-YTW : 3.09 %

MFC.PR.B Deemed-Retractible Quote: 24.57 – 24.94
Spot Rate : 0.3700
Average : 0.2720

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.57
Bid-YTW : 4.86 %

MFC.PR.G FixedReset Quote: 25.54 – 25.77
Spot Rate : 0.2300
Average : 0.1541

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2016-12-19
Maturity Price : 25.00
Evaluated at bid price : 25.54
Bid-YTW : 3.02 %

February 24, 2015

February 25th, 2015

Unintended consequences? Or a simple macro-economic effect on free markets?

When the federal government tightened mortgage rules in 2012, overheated condo markets in Toronto and Vancouver were widely seen as the main target. But little more than two years later, it’s many smaller cities that are bearing the brunt of stricter regulations.

Winnipeg, Montreal and Moncton are grappling with a surplus of unsold condo units driven by a surge in new construction and a dwindling supply of first-time buyers in the wake of Ottawa’s decision in June, 2012, to limit mortgage insurance to amortization periods of 25 years or less from 30 years.

Meanwhile…:

Home loans from $1 million to $5 million were the fastest growing part of the jumbo market in January, according to purchase application data from the Mortgage Bankers Association. Wealthy borrowers are seeking even bigger loans this year while luxury housing prices rise and lenders lure them with competitive terms.

As first-time homebuyers struggle to qualify for mortgages in a market that’s shrinking after the housing collapse, lenders are providing more multi-million dollar loans to Americans who pose less risk. These borrowers are using the loans to purchase high-end homes in cities such as San Francisco and Miami, where prices have been climbing.

Yellen spoke gentle words of dovish restraint in her Humphrey-Hawkins testimony:

The yield on the benchmark note fell below 2 percent for the first time in a week as Yellen repeated in testimony before Congress a pledge to be “patient” means an increase is unlikely for “at least the next couple” of meetings. She said the labor market wasn’t fully healed and that she saw no evidence that inflation was rising toward the central bank’s 2 percent goal.

The benchmark 10-year yield fell eight basis points, or 0.08 percentage point, to 1.98 percent at 1:32 p.m. New York time, according to Bloomberg Bond Trader data. It rose as high as 2.10 percent earlier. The price of the 2 percent note maturing in February 2025 rose 22/32, or $6.88 per $1,000 face amount, to 100 6/32.

Treasuries remained higher after the U.S. sold $26 billion of two-year notes at a yield of 0.603 percent as the Fed’s 22 primary dealers were left with their smallest share of the securities in almost a year.

“It is important to emphasize that a modification of the forward guidance should not be read as indicating that the committee will necessarily increase the target range in a couple of meetings,” Yellen said. “We are reasonably confident that inflation will move back to our 2 percent inflation target over time.”

The Fed’s preferred gauge of inflation, the personal consumption expenditures index, has stayed below 2 percent since April 2012, and it rose just 0.7 percent in the year through December.

Traders saw a 45 percent chance the Fed will raise the benchmark rate from between zero to 0.25 percent by its September meeting, according to fed funds futures data compiled by Bloomberg. That’s down from 51 percent prior to Tuesday’s testimony.

Meanwhile, it appears that Lapdog Carney has received instructions to undermine capitalism in order to do his electoral duty for the guys that hired him:

Bank of England chief Mark Carney warned employers on Tuesday not to use near-zero inflation as an excuse to offer staff low wage settlements, as that might derail Britain’s economic recovery.

British wages have only recently started to rise faster than inflation after years of real-term falls.

Many firms will agree 2015 wage deals in coming months amid falling inflation and political uncertainty before national elections in May that are likely to be closely fought.

Carney said risks from low inflation in Britain related mainly to the labour market, not to deferred consumption as occurred in Japan, where deflation became entrenched.

Other policy makers are more concerned about the risk of inflation overshooting, however.

MPC member Martin Weale told the same parliamentary panel rates could rise sooner than markets expected. They currently price in a first rise in around a year.

Both Weale and fellow policy maker Ian McCafferty voted five times late last year to raise rates, before dropping this call in January in the face of tumbling oil prices.

Another MPC member, Kristin Forbes, said earlier on Tuesday that there could be a case to start raising rates soon due to potential future pressure from wages, financial stability risks or unsustainable borrowing patterns.

“Any could factor into a case to tighten monetary policy in the near future. But they do not currently appear to be generating a sufficient cost to merit a change in interest rates today,” she said.

This “supply and demand” nonsense is so old fashioned, isn’t it?

Speaking of government policy, it seems that Parakeet Poluz wants to be less accountable:

Stephen Poloz says the time has come for the Bank of Canada and other central banks to reinvent monetary policy by moving beyond solely targeting inflation.

Central bankers need do a better job of making sense of a host of new risks buffeting the financial system, such as exchange rate moves and globalized production chains, the Bank of Canada governor said Tuesday.

“We need to develop a monetary policy framework that integrates inflation risks and financial stability risks, both statically and dynamically, and captures much more accurately the uncertainties we face,” he said.

After all, OSFI is given a free ride on incompetence, as long as the whole system doesn’t blow up. Why shouldn’t everybody else?

However, reduced US expectations of tightening were met with reduced Canadian expectations of loosening:

Market participants, however, keyed in on one statement that strongly suggests another rate cut from the central bank is not as imminent as one would have imagined.

“So the downside risk insurance from the interest rate cut buys us some time to see how the economy actually responds,” Mr. Poloz said in his concluding remarks.

The implication of this statement is that the central bank will wait to determine whether more monetary stimulus is required to offset the “unambiguously negative” effect of the decline in oil prices.

Market participants quickly digested this new information and began to bet against a Bank of Canada rate cut next week.

On Monday, the overnight index swap market was pricing in an 82 per cent chance of 25 basis point reduction in the overnight rate to 0.5 per cent on March 4th. This belief was supported by persistently low oil prices and underwhelming economic data. Soon after Mr. Poloz’s remarks were released, the overnight index swaps suggest the consensus view is for the bank to stand pat: the implied odds of a rate cut, as of the close on Tuesday, stand at 42 per cent.

And the feds continue to make taxation more regressive:

Parliamentary Budget Officer Jean-Denis Fréchette says the Conservative government’s plan to double the contribution limit for tax-free savings accounts would cost Ottawa and the provinces billions in revenue.

In a new report released Tuesday, the PBO notes that if the current annual limit of $5,500 is doubled to $11,000, Ottawa would lose $14.7-billion a year in federal revenue by 2060 and the provinces would lose $7.6-billion a year.

The PBO also notes that doubling the contribution rate would primarily benefit well-off Canadians, making the tax break “much more regressive.”

“By 2060, gains for high wealth households project to be twice the median and ten times that of low-wealth households,” the report states.

The PBO report comes on the same day as a similar report from Simon Fraser University Professor Rhys Kesselman, who also noted that while the program’s cost in terms of lost revenue is relatively small for now, it will grow significantly over time.

“Like a little baby who looks cuddly and cute, this proposed initiative would grow up to be the hulking teenager who eats everyone out of house and home,” Dr. Kesselman’s report for the SFU School of Public Policy states.

I have no objections at all to tax expenditures that encourage Canadians to save for a comfortable retirement – that strikes me as being very good political policy. However, I have seen very little discussion of proposed limits in terms of actual outcomes – and no, I’m not so short-sighted and ignorant as to suggest the outcome is ‘saving a few thousand in tax this year’. The actual outcome is measured in terms of the standard of living in retirement; while I am all in favour of programmes that will help Joe Lunchbucket save a bit so he can have total retirement income of $50,000 p.a., I am firmly opposed to tax expenditures that help Edwin Plutocrat III to have total retirement income of $150,000 p.a. But we never see discussion – by which I mean actual evidence and analysis – of the cost effectiveness of this.

Just as an example – and this is not only not an actuarial study, it’s also not an intensively researched post – look at the OTPP contribution limits:

This chart shows the total contributions that will be deducted in 2015 for your Teachers’ pension based on various gross salaries.

  Annual contributions
Annual salary 2015* 2014**
$30,000 $3,450 $3,450
$40,000 $4,600 $4,600
$50,000 $5,750 $5,750
$60,000 $7,002 $7,020
$70,000 $8,312 $8,330
$80,000 $9,622 $9,640
$90,000 $10,932 $10,950
$100,000 $12,242 $12,260

The Ontario government and other employers match total annual member contributions.

So, making the (possibly erroneous) assumption that the contribution rates are intended to maintain the standard of living implied by the related salary, this leads me to conclude that RRSP contribution limits should be about $14,000 p.a.; and that this limit should be adjusted downward to reflect the impact of TSFAs. Why are we taxing Joe Lunchbucket extra in order to assist Edwin Plutocrat III to achieve retirement income far in excess of the average Canadian salary?

However, just so you know … I think that when retirees downsize their home, the cash they take out on the transaction should be eligible (up to limits reflecting the above principles) for rollover to a TSFA. Saving via mortgage payments is still saving!

S&P has given something called the Floating Rate Investment Grade Preferred Fund a rating of P-2f, but I can’t find anything more regarding this new entrant.

There were modest gains in the Canadian preferred share market today, with PerpetualDiscounts gaining 8bp, FixedResets up 9bp and DeemedRetractibles winning 17bp. The Performance Highlights table continues to be lengthy, with ENB FixedResets prominent among the winners. Volume was above average; it is noteworthy that the larger blocks changed hands well below the closing bids.

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:

impVol_TRP_150224
Click for Big

The new issue has caused a large change in the curve-fitting for the TRP series of FixedResets, which is discussed at greater length on the post announcing the new issue. TRP.PR.E, which resets 2019-10-30 at +235, is bid at 24.43 to be $1.40 rich, while the new issue, resetting 2020-11-30 at +296, is $1.15 cheap at its issue price of 25.00.

impVol_MFC_150224
Click for Big

Another excellent fit, but the numbers are perplexing. Implied Volatility for MFC continues to be a conundrum, although it declined substantially today. It is still too high if we consider that NVCC rules will never apply to these issues; it is still too low if we consider them to be NVCC non-compliant issues (and therefore with Deemed Maturities in the call schedule).

Most expensive is MFC.PR.N, resetting at +230 on 2020-3-19, bid at 24.75 to be $0.65 rich, while MFC.PR.H, resetting at +313bp on 2017-3-19, is bid at 25.91 to be $0.57 cheap.

impVol_BAM_150224
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The fit on this series is actually quite reasonable – it’s the scale that makes it look so weird.

The cheapest issue relative to its peers is BAM.PR.Z, resetting at +296bp on 2017-12-31, bid at 25.31 to be $0.46 cheap. BAM.PF.E, resetting at +255bp 2020-3-31 is bid at 24.50 and appears to be $0.92 rich.

impVol_FTS_150224
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This is just weird because the middle is expensive and the ends are cheap but anyway … FTS.PR.H, with a spread of +145bp, and bid at 16.57, looks $1.05 cheap and resets 2015-6-1. FTS.PR.K, with a spread of +205bp and resetting 2019-3-1, is bid at 23.50 and is $0.96 rich.

pairs_FR_150224
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Most of the investment grade break-even rates are a little below zero.

On the other hand, the market’s distaste for product linked to Money Market rates does not extend to prime, as shown by the FixedFloater/RatchetRate pairs:

pairs_FF_150224
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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 0.00 % 0.00 % 0 0.00 0 -1.4050 % 2,333.0
FixedFloater 4.37 % 3.51 % 18,322 18.38 1 0.0000 % 4,046.5
Floater 3.09 % 3.24 % 66,507 19.09 4 -1.4050 % 2,480.1
OpRet 4.08 % 1.37 % 111,855 0.31 1 0.1992 % 2,760.4
SplitShare 4.42 % 4.50 % 28,270 3.55 6 0.4068 % 3,197.6
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.1992 % 2,524.1
Perpetual-Premium 5.33 % 2.11 % 57,807 0.08 24 -0.0539 % 2,513.3
Perpetual-Discount 4.95 % 4.82 % 111,101 15.29 10 0.0835 % 2,797.2
FixedReset 4.44 % 3.41 % 210,354 16.87 79 0.0931 % 2,412.9
Deemed-Retractible 4.91 % -0.58 % 106,636 0.10 39 0.1726 % 2,655.2
FloatingReset 2.43 % 2.83 % 88,016 6.39 7 0.1664 % 2,326.2
Performance Highlights
Issue Index Change Notes
ENB.PF.G FixedReset -3.11 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 21.69
Evaluated at bid price : 22.10
Bid-YTW : 4.09 %
BAM.PR.C Floater -2.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 15.45
Evaluated at bid price : 15.45
Bid-YTW : 3.26 %
BAM.PR.K Floater -1.86 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 15.31
Evaluated at bid price : 15.31
Bid-YTW : 3.29 %
BAM.PR.B Floater -1.71 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 15.55
Evaluated at bid price : 15.55
Bid-YTW : 3.24 %
CGI.PR.D SplitShare -1.36 % YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2023-06-14
Maturity Price : 25.00
Evaluated at bid price : 25.30
Bid-YTW : 3.70 %
MFC.PR.I FixedReset -1.08 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-09-19
Maturity Price : 25.00
Evaluated at bid price : 25.56
Bid-YTW : 3.38 %
MFC.PR.J FixedReset -1.06 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 25.15
Bid-YTW : 3.41 %
ENB.PR.N FixedReset 1.03 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 20.63
Evaluated at bid price : 20.63
Bid-YTW : 4.18 %
ENB.PR.D FixedReset 1.08 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 18.80
Evaluated at bid price : 18.80
Bid-YTW : 4.24 %
ENB.PR.B FixedReset 1.14 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 18.71
Evaluated at bid price : 18.71
Bid-YTW : 4.24 %
CU.PR.G Perpetual-Discount 1.31 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 23.56
Evaluated at bid price : 23.92
Bid-YTW : 4.70 %
GWO.PR.G Deemed-Retractible 1.58 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-03-26
Maturity Price : 25.00
Evaluated at bid price : 25.75
Bid-YTW : -20.25 %
ENB.PR.F FixedReset 1.66 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 19.60
Evaluated at bid price : 19.60
Bid-YTW : 4.23 %
ENB.PR.T FixedReset 1.83 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 20.08
Evaluated at bid price : 20.08
Bid-YTW : 4.17 %
MFC.PR.F FixedReset 1.89 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 18.85
Bid-YTW : 5.61 %
PVS.PR.B SplitShare 2.31 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2019-01-10
Maturity Price : 25.00
Evaluated at bid price : 24.85
Bid-YTW : 4.50 %
PWF.PR.P FixedReset 2.61 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 18.50
Evaluated at bid price : 18.50
Bid-YTW : 3.18 %
Volume Highlights
Issue Index Shares
Traded
Notes
OSP.PR.A SplitShare 351,334 New issue settled today.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2020-03-31
Maturity Price : 10.00
Evaluated at bid price : 10.11
Bid-YTW : 4.78 %
ENB.PR.N FixedReset 286,126 Nesbitt crossed 250,000 at 20.45.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 20.63
Evaluated at bid price : 20.63
Bid-YTW : 4.18 %
IFC.PR.A FixedReset 181,890 RBC crossed 164,200 at 19.50.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 19.85
Bid-YTW : 5.83 %
PWF.PR.P FixedReset 68,678 RBC crossed 47,100 at 18.15.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 18.50
Evaluated at bid price : 18.50
Bid-YTW : 3.18 %
NA.PR.W FixedReset 54,825 Nesbitt crossed 11,300 at 24.86.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 23.11
Evaluated at bid price : 24.85
Bid-YTW : 3.01 %
BNS.PR.Y FixedReset 47,949 RBC crossed 28,600 at 22.00.
YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 22.00
Bid-YTW : 3.72 %
There were 38 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
ENB.PF.G FixedReset Quote: 22.10 – 22.79
Spot Rate : 0.6900
Average : 0.4260

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 21.69
Evaluated at bid price : 22.10
Bid-YTW : 4.09 %

HSB.PR.D Deemed-Retractible Quote: 25.37 – 25.95
Spot Rate : 0.5800
Average : 0.3867

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-03-26
Maturity Price : 25.00
Evaluated at bid price : 25.37
Bid-YTW : -3.77 %

CGI.PR.D SplitShare Quote: 25.30 – 26.05
Spot Rate : 0.7500
Average : 0.5644

YTW SCENARIO
Maturity Type : Soft Maturity
Maturity Date : 2023-06-14
Maturity Price : 25.00
Evaluated at bid price : 25.30
Bid-YTW : 3.70 %

ENB.PR.J FixedReset Quote: 21.31 – 21.84
Spot Rate : 0.5300
Average : 0.3812

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 21.31
Evaluated at bid price : 21.31
Bid-YTW : 4.08 %

MFC.PR.I FixedReset Quote: 25.56 – 25.94
Spot Rate : 0.3800
Average : 0.2370

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-09-19
Maturity Price : 25.00
Evaluated at bid price : 25.56
Bid-YTW : 3.38 %

VNR.PR.A FixedReset Quote: 24.90 – 25.40
Spot Rate : 0.5000
Average : 0.3672

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-02-24
Maturity Price : 23.41
Evaluated at bid price : 24.90
Bid-YTW : 3.51 %

OSP.PR.A Well Bid On Good Volume

February 25th, 2015

Brompton Funds Ltd. has announced:

that Brompton Oil Split Corp. (the “Company”) has completed its initial public offering of 2,800,000 Class A shares and 2,800,000 Preferred shares for total gross proceeds of $70 million. The Class A and Preferred shares will commence trading today on the Toronto Stock Exchange under the symbol OSP and OSP.PR.A, respectively.

The Company will invest in a portfolio (the “Portfolio”) of equity securities of at least 15 large capitalization North American oil and gas issuers selected by the Manager from the S&P 500 Index and the S&P/TSX Composite Index, giving consideration to, among other metrics, attractive valuation, growth prospects, profitability, liquidity, sustainability of dividends and a strong balance sheet. The Portfolio will be focused primarily on oil and gas issuers that have significant exposure to oil, and will initially include equities of the following oil and gas issuers:

ARC Resources Ltd. Chevron Corporation Occidental Petroleum Corporation
Canadian Natural Resources Limited Encana Corporation PrairieSky Royalty Ltd.
ConocoPhillips EOG Resources Inc. Suncor Energy Inc.
Crescent Point Energy Corp. Husky Energy Inc. Vermilion Energy Inc.
Cenovus Energy Inc. Imperial Oil Limited Exxon Mobil Corporation

The investment objectives for the Class A shares are to provide holders with regular monthly non-cumulative cash distributions targeted to be 8.0% per annum on the $15.00 issue price, and the opportunity for growth in net asset value. The investment objectives for the Preferred shares are to provide holders with fixed cumulative preferential quarterly cash distributions in the amount of 5.0% per annum on the $10.00 issue price, and to return the original issue price on the maturity date, March 31, 2020.

Brompton Funds Limited is the manager and portfolio manager of the Company. In addition to Brompton Oil Split Corp., the Manager currently manages 4 other split-share funds with assets under management over $900 million. The portfolio management team is led by Laura Lau, an award winning portfolio manager with over 20 years of experience in financial services, who has a proven track record in managing flow-through funds and resource assets. The team also includes Michael Clare, an experienced energy and flow-through portfolio manager who specializes in the analysis of crude oil and natural gas markets.

The syndicate of agents for the offering was led by Scotiabank, CIBC and RBC Capital Markets and included TD Securities Inc., BMO Capital Markets, National Bank Financial Inc., GMP Securities L.P., Raymond James Ltd., Canaccord Genuity Corp., Desjardins Securities Inc., Dundee Securities Ltd., Industrial Alliance Securities Inc. and Mackie Research Capital Corporation.

OSP.PR.A commenced trading today right on schedule. It is a Split Share, 5-Year, with a 5% coupon.

The issue traded 354,334 shares today (consolidated exchanges) in a range of 10.00-15 before closing at 10.11-14.

DBRS has confirmed its provisional rating of Pfd-3(high):

DBRS Limited (DBRS) has today finalized the provisional rating of Pfd-3 (high) to the Preferred Shares to be issued by Brompton Oil Split Corp. (the Company). The Company issued an equal number of Preferred Shares and Class A Shares at an issue price of $10.00 per Preferred Share and $15.00 per Class A Share. The Preferred Shares and Class A Shares are scheduled to mature on March 31, 2020.

Net proceeds from the offering were used to invest in the common shares of at least 15 large capitalization North American oil and gas issuers (the Portfolio). The Portfolio is initially equally weighted and will be rebalanced at least semi-annually. A portion of the Portfolio’s investments are denominated in U.S. dollars; however, this exposure is expected to be hedged completely back to the Canadian dollar.

The Company has advised DBRS that 2,800,000 Preferred Shares and 2,800,000 Class A Shares were issued on the initial offering, for gross proceeds of $70,000,000. The initial downside protection available to holders of the Preferred Shares is approximately 57.3% (after offering expenses). Dividends received on the Portfolio are used to pay a fixed cumulative quarterly distribution to holders of the Preferred Shares of $0.1250 per Preferred Share ($0.50 per annum or 5.0% per annum on the initial issue price of $10.00 per Preferred Share), while holders of the Capital Shares are expected to receive a regular monthly non-cumulative cash distribution of $0.10 per Class A Share. The Preferred Share dividend coverage ratio is approximately 0.9 times, based on the initial offering size. The Company has the ability to write covered call options or engage in securities lending in order to generate additional income. The Company has also granted a security interest in the Portfolio to RBC Investor Services Trust, in its capacity as custodian of the Company’s property (the Custodian), as security for any obligations owing by the Company to the Custodian. The Custodian also has a right to exercise set-off against the Company’s property (including the Portfolio) to the extent that the Company fails to satisfy any obligations owing to the Custodian.

Vital statistics are:

OSP.PR.A SplitShare YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2020-03-31
Maturity Price : 10.00
Evaluated at bid price : 10.11
Bid-YTW : 4.78 %