PrefBlog

On March 28 I highlighted an issue of structured notes from TD. Assiduous Reader AB writes in and provides me with a link to the National Bank Structured Solutions Group page, who issued five separate notes “linked to a Canadian preferred share ETF” between April 10 and April 18.

There was a disorderly close in the market today, as TXPR lost 49bp in the last five minutes to close down 28bp from yesterday on high volume of over 4-million shares.

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One of the hard-working geniuses who are such a feature of Canadian investment management made extensive use of the Market-on-Close facility, which I assume helped him leave early for the long weekend.

On March 18 I reported:

Assiduous Readers will remember that Manulife was bailed out by the regulators again after a hedge fund claimed the terms of its contract with the firm allowed it to deposit unlimited funds with the firm at a guaranteed rate of up to 5%.

It turns out the bail-out was unnecessary! Manulife won the court case

‘Not so fast!’ scream the plaintiffs:

A pivotal court ruling that dismissed three lawsuits against Canadian life insurers has been formally appealed, extending a battle between the companies and three investment funds over the fine print of decades-old contracts.
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This week the funds appealed all three cases, arguing that the core argument made by Justice Brian Scherman of the Court of Queen’s Bench for Saskatchewan when dismissing the lawsuits is incorrect. Justice Scherman ruled that the contracts were designed to be used for insurance purposes only, and that “in the some 30 years since universal life insurance policies have been sold, there is no judicial record of these policies being used in the manner proposed” by the investment funds.

In its appeal of the ruling that related to Manulife, Mosten Investment LP argued “the learned Chambers Judge erred in law in his interpretation of the contract.”

There is a fascinating chart made available in the OECD release of its publication “Taxing Wages”:

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Of course, this just refers to taxes on wages; it does not include things like sales tax and property tax. In the interest of avoiding vitriolic attacks by worshippers of the Awesome and Holy United States of Free America, I will also publish a chart more favourable to that glorious nation:

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Of course, neither chart includes the cost of health insurance, which is a big ticket item in the Awesome and Holy United States of Free America, but that’s because health insurance is FREE ENTERPRISE, dammit, and any free citizen has a CHOICE between between buying Health Insurance, dying, or being bankrupted by medical bills.

Reasonable people can argue all day and all night regarding whether a single-payer system like Canada’s is better or worse than the US system. Each has its own advantages and disadvantages. But to take tax rates as a straight-up, single-number meaningful comparison of anything at all is simply ridiculous and annoys me.

PerpetualDiscounts now yield 5.45%, equivalent to 7.08% interest at the standard equivalency factor of 1.3x. Long corporates now yield 3.82%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 325bp, unchanged from the figure reported April 10.

I noticed another recent corporate long bond issue, this one some thirty-year notes from Pembina:

Pembina Pipeline Corporation (“Pembina” or the “Company”) (TSX: PPL; NYSE: PBA) is pleased to announce that it has closed its previously announced offering of $800 million of senior unsecured medium-term notes (the “Offering”). The Offering was conducted in two tranches consisting of $400 million in senior unsecured medium-term notes, series 12 (the “Series 12 Notes”) having a fixed coupon of 3.62% per annum, paid semi-annually, and maturing on April 3, 2029, and $400 million in senior unsecured medium-term notes, series 13 (the “Series 13 Notes”) having a fixed coupon of 4.54% per annum, paid semi-annually, and maturing on April 3, 2049.

I am pleased to pass on another data point illustrating just how absurdly cheap the preferred share market is at the moment:

DBRS Limited (DBRS) assigned a rating of A (low) with a Stable trend to TransCanada PipeLines Limited’s (TCPL or the Company) $1.0 billion 4.34% Unsecured Medium Term Note Debentures (the Notes) due 2049. The rating being assigned is based upon the rating on already-outstanding series of the above-mentioned debt instruments.

DBRS notes that the proceeds from the Notes issue will be used to repay existing indebtedness and for general corporate purposes.

The Notes will rank pari passu, except as to sinking funds and other claims preferred by operation of law, with all other unsecured and unsubordinated indebtedness of the Company.

Sadly, TRP does not have any Straight Preferreds outstanding, but they do have a slew of FixedResets, ranging from TRP.PR.C yielding 5.70% to TRP.PR.G yielding 6.04%. So, for the sake of an argument and assuming a reasonably normal relationship, let’s say a TRP discounted Straight Perpetual would yield about 6.00% dividend, equivalent to about 7.80% interest. Its interest-equivalent Modified Duration as a perpetual annuity will be the inverse of this, or about 12.8. I can’t be bothered to work out the Modified Duration of a 30-year par bond yielding 4.34, but it will be more than this. Options on either instrument will lower the Modified Duration, but basically we can say that the Straight Perpetual preferred will have a little bit lower interest rate risk than the new bond.

Credit Risk will be a little higher for the preferred, but I worked out a long time ago that reasonable assumptions regarding default rates lead to a required credit risk premium of about 20bp. OK, so the preferreds are issued by the holding company and the bonds are issued by the operating company. So tack on another 20bp for credit risk, if you’re so inclined. It doesn’t make much difference to the conclusion!

There’s markedly lower liquidity for the preferred, but not so much of a difference that most of us need to care. If you do have an investment portfolio in which such a liquidity difference is significant, please contact me because I would like to make a proposal to manage your account!

So we’re left with 4.34% on the bond and 7.80% on the notional Straight, with about 20bp of the difference accounted for by Credit Risk. And, what’s more, this difference is in-line with the overall Seniority Spread that I estimate weekly (with a bond indicator that has an average term of about 21.25 years), so it’s not just these particular issues, it’s the whole damn market.

Yep, preferreds are cheap, all right!

DBRS also has a warning for Premier Ford:

DBRS Limited (DBRS) confirmed the Issuer Rating and the Senior Unsecured Debentures rating of Hydro One Inc. (HOI or the Company) at A (high) and the Commercial Paper rating at R-1 (low). All trends are Stable.
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However, should political interference adversely affect the Ontario Energy Board’s (OEB) independent regulatory rate making framework or HOI’s operating and financial decisions, DBRS could take a negative rating action.

PerpetualDiscounts now yield 5.40%, equivalent to 7.02% interest at the standard equivalency factor of 1.3x. Lonc corporates now yield 3.75%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 325bp, a significant narrowing from the 335bp reported April 3.

Well, today’s Canadian jobs report wasn’t too encouraging:

Following increases in January and February, employment held steady in March. The unemployment rate remained unchanged at 5.8%.

In the first quarter of 2019, employment rose by 116,000 (+0.6%).

On a year-over-year basis, employment grew by 332,000 (+1.8%), with gains in both full- (+204,000) and part-time (+128,000) work. Over the same period, total hours worked rose by 0.9%.
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More people were working in the finance, insurance, real estate, rental and leasing industry, and in public administration. At the same time, employment declined in health care and social assistance; in business, building and other support services; and in accommodation and food services.

The number of employees held steady in March in both the public and private sectors. Self-employment was also virtually unchanged.

Both men and women aged 55 and older posted employment gains in March, while core-aged women experienced declines. At the same time, employment held steady for core-aged men and for youth.

… which didn’t do the loonie much good:

The Canadian dollar weakened to a one-week low against its U.S. counterpart on Friday as domestic data showing an unexpected decline in jobs diminished prospects of the Bank of Canada turning more upbeat on the economy.

A six-month string of employment gains, including blockbuster increases in January and February, had helped bolster investor sentiment for the loonie, offsetting weak gross domestic product data and a slowdown in the global economy that could hurt Canada’s exports.

But that sequence ended in March, as Canada shed 7,200 jobs. Analysts in a Reuters poll had forecast a marginal gain of 1,000.
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Perceived chances of an interest-rate cut this year from the central bank nudged up to 40 per cent from 38 per cent before the data, the overnight index swaps market indicated.

Meanwhile, south of the border:

After an unexpectedly weak February — just 20,000 new jobs were initially reported — concerns arose that the remarkable wave of hiring might be ebbing. But employment surged again last month, beating the expectations of most economists with 196,000 new jobs, the Labor Department said Friday.

Even lowly February looked better: The department revised its report upward to 33,000 jobs. And unemployment remained at 3.8 percent in March, while wage growth kept its momentum, ensuring that pay is growing faster than inflation.
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For years, even as the economy added jobs and unemployment kept falling, wage increases were lackluster. But employees now appear to be getting solid raises. Hourly wages in March were 3.2 percent higher than a year earlier, slightly lower than the 3.4 percent growth in February but still roughly double the annual inflation rate.

… and Trump continues to lobby the Fed for policy rate cuts and Quantitative Easing:

“Well I personally think the Fed should drop rates,” Mr. Trump said. “I think they really slowed us down. There’s no inflation. I would say in terms of quantitative tightening, it should actually now be quantitative easing. Very little if any inflation. And I think they should drop rates, and they should get rid of quantitative tightening. You would see a rocket ship. Despite that, we’re doing very well.”