the credit crisis and discount rate determination presentation to the canadian institute of...
TRANSCRIPT
The Credit Crisis and Discount Rate Determination
Presentation to the Canadian Institute of Actuaries
April 15, 2009
Marlene K. Puffer, Ph.D., CFAwww.twistfinancial.com
Agenda
Corporate Bond Market
SpreadsIssuanceOpportunitiesMarket Structure
Discount Rate Determination
Long Term Corporate AA
Various Approaches
Canadian 10-year Corporate Spreads
Source: RBC Capital Markets
Canadian Net New Bond Issuance
-10
0
10
20
30
40
50
Federal, Provincial, Municipal Corporate
(Bln. C$)
Source: Standard&Poor’s
Opportunities
Canadian corporates Significant new issue supply
Mainly investment grade, heavy in financials.
Global investment grade credit
Liquidity and diversification
Detailed credit research required
High yield U.S./EuropeEquity-like risk characteristicsMainly < 10 year term
Emerging markets Good diversifier
Growing corporate market
Credit derivatives Pure credit exposureLimited currency riskLiquid individual names and indicesIncreased standardization and central clearing to reduce counterparty risk
Market Structure - Trading
Average daily corporate bond trading$580m in 2008 vs. $885m in 2007
Source: IIAC
Market Structure Corporate Issuance and trading
Market Structure
Sector Typical trade “Large” trade Typical new issue size
Canada $10-25 m >$100 m $1 to $4 b
Provincial $10-25 m >$100 m $300 - $600 m
Short/mid Corporate
$5-25 m >$50 m $300 - $600 m
Long Corporate $5-10 m >$10 m $200 - $300 m
Gov t of Canada Inflation Linked (RRB)
$5-10 m >$25 m $300 - $400 m
Provincial RRB Very limited Very limited $ 100 m +
Canadian Bond Market - Sectors
Source: CIBC World Markets, ForethoughtRisk
Canadian Bond Market - Rating
Source: CIBC World Markets, ForethoughtRisk
2% of all corps are over 10
years and rated AA or
higher
$3.5b vs. $32b rated A
or lower
Discount Rate Methodology
Term Need full curve, and in particular need to extrapolate beyond 30 year maturity.
Potential confusionWith a normal upward sloping yield curve, semi-annual yield < annual yield < spot yield. Beware of mixing them up.
MethodologyDiscount liability cash flows using corresponding spot rate that reflects corporate AA spot yields.
Long term Government of Canada yield plus “AA” spread
Data
Bank of Canada long term bond yield available daily. Dealers publish daily indicative yields on select corporate bonds by maturity for both secondary market trades and theoretical new issues. Important to understand source data.
Term Maximum 30 year maturity. Data more reliable 10 years and shorter.
UsefulnessDiscretion involved may lead to very different derived discount rates. Standardization is desirable, but some discretion is important in extreme market conditions.
MethodologyDistinction between secondary trading and indicative new issue levels. Selection of bonds to use is discretionary. “Bootstrap” a spot curve from raw semi-annual yields.
CIBC Spot Curve – cash flow matching
DataTheoretical new issue bank spreads (“offered side”). Not a diversified portfolio.Differential between financial and other spreads has increased dramatically recently.
Single dealer CIBC data only. May differ from other dealers, especially when spreads are wide and volatile.
New issue concession
Spreads reflect new issue concession relative to secondary spreads. Wider when spreads are wide and markets are volatile.
Long vs short
termActive market in financials under 10 year maturity. Little to no issuance or trading over 10 years.
PC BOND AA Yield Curves
Data
Bid yields (vs. index mid market ; CIBC spot curve offered). Intended to reflect representative AA rated bond yields at each maturity point. Month end only.; semi-annual and annual yields. Data can very by month i f a new bond is selected at a specific maturity point. Highly dependent on specific bond spread.
Single dealer Scotia data only. May differ from other dealers, especially when spreads are wide and volatile.
Comparison to CIBC spot curve
Long vs short term
Active market in corporates under 10 year maturity, but mainly financials. Little to no issuance over 10 years, and tend to use utilities or industrials which may not compare to financials. May use govt yield plus indicative spread in long end. Inconsistent data approach.
Derived spot curve can have irregular shape. Derived spot rates have typically been close to CIBC spot curve historically, but have diverged in the past year.
DEX long-term AA/AAA bond index yields
DataMarket value weighted average of all AAA and AA corporate bonds. Long index is > 10 year maturities. Only 5 issuers with these ratings! Semi-annual yield calculation.
Multiple DealerSince early 2008, uses all major Canadian dealer data. Gives weight to some dealers who trade very little in the quoted bonds. But omits high and low quotes.
UsefulnessLong term Index yield data is a useful cross-check to guage curve movement over time. Not directly comparable yield level to derived 30-year rates.
TermYields are available for all corporates, or broken down by rating, and/or maturity , or sector.
Conclusion
TermExtrapolation beyond 30 years subject to subtleties of shape or long end (higher yields around 25 year area vs. 30-years).
Judgment
Data source
CIBC spot curve most consistent and no need to “bootstrap” to derive spot curve. Judgment still required due to single dealer, financials, and new issue concession, especially in volatile markets.
Need for new standard based on multi-dealer data and transparent process?
Compare to peers, changes in index yields, changes in yields based on Govt bonds plus spread.
Biography
Dr. Marlene K. Puffer, CFA, Managing Director of Twist Financial Corp., provides strategic advice, analytics, education, litigation support and expert witness testimony, and financing and investment solutions in all areas of fixed income and institutional investment. She was recently appointed to the board of the Hospitals of Ontario Pension Plan (HOOPP). Current projects include pension Liability Driven Investment strategies, mortgage markets, and Asset-Backed Commercial Paper restructuring. Recently, she was an expert witness in the BCE vs. Bondholders case in the context of the BCE leveraged buyout. She has 18 years of capital markets experience, including 13 years on Bay Street and 5 years as a professor of finance at the University of Toronto.
Dr. Puffer holds a Ph.D. in Finance and Applied Statistics and a M.Sc. in Business Administration from the University of Rochester William E. Simon Graduate School of Business Administration, and master's and bachelor's degrees in Economics from the University of Toronto. She is a CFA charterholder. Dr. Puffer sits on numerous boards and committees at the University of Toronto, the Toronto CFA Society, and the Canadian Investment Review.