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Daily Market Commentary

Some clarification is warranted on the news surrounding the Auction Bond market that has hit the airwaves recently.  These securities act much like our asset backed commercial paper market - longer term underlying obligations are funded by shorter term bonds whose rates reset every 7 to 35 days.  Most have a provision for the existing holders, where if new holders fail to bid the existing holders are paid a high coupon for the period (10 - 15%).  The Banks used to step in and bid should buyers not appear, but because of pressure on their balance sheets, they have stopped doing so.  What is interesting is that the same issuers are not having problems funding themselves with plain vanilla bonds.  Municipalities in particular are not having any problems selling regular bonds, but Auction Bonds are not moving.  This points to a problem in the structure of the markets, not necessarily to a lack of capital.


  Over the past several years, we have been watching new fixed income issues hitting the street (both preferred shares and bonds) with fewer and fewer covenants in favour of the investor.  Prefs are all coming out as perpetuals with optional calls, the advent of Step-Up bonds put all the upside in the hands of the issuer, even Fixed Floater securities left the power to extend with the issuer.  Recently, but only recently, we are starting to see more plain vanilla product hit the street.  This week's BNS 3 year note issue and last week's TD 5 year note are examples of straight bonds, no calls, no fancy coupons, and no covenants that allow the issuer to pull the bond and re-issue on better terms.  THIS is what investors are now demanding.  The capital is out there for these types of issues, but structured debt simply isn't selling.


  Hopefully this crisis will lead to more favourable terms for investors in the fixed income markets.  We're hoping the recent issues are a sign of things to come, a fundamental shift away from complexity that, while profitable especially to the underwriters, have recently crimped the flow of capital.



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