Critchley: Is this the end for rate resets?

Barry Critchley wrote a column in the Financial Post on April 1 titled Is this the end for rate resets?

The trigger for his column was (besides the obligation to bang out another 750 words, I mean!) the BNS 3.85%+100 new issue. Mr. Critchley believes that such skimpy yields will have the effect of pushing income investors back into common shares.

He concludes with a quote from John Nagel:

So what’s the outlook? John Nagel, a vice-president and director at Desjardins Securities and one of the architects of rate-reset pref shares, said that despite the low yield, there is still a market for the security, in part because investors continue to demonstrate that they don’t want to purchase “straight perpetual pref shares,” or securities that offer no chance of a change of dividend.

“The straight pref share marker is doing nothing but going straight down because investors are very nervous about higher interest rates,” he said, noting that more than $15.5-billion of rate-reset pref shares have been issued over the past two years. Accordingly that sector of the market is larger than the straight pref share market.

Despite the low yields, Nagel says the regulatory authorities have given their approval for rate resets to continue to count as Tier 1 capital. But he said the authorities have not been as kind for continued issues of so-called innovative Tier 1 securities.

It’s my understanding that the BNS issue sold out just as fast as all the other ones, despite its extreme richness vs. BNS Straights.

What do I think? Well, first of all, I think that forecasting investor tastes in new issues has much the same chance of success as forecasting young women’s tastes in new outfits. Some shops, who spend a lot of money on market research and take an intelligent approach to interpreting the data, can be right just often enough to pay for the times their wrong and make a great deal of money – but they’re still left holding the bag every now and then.

Second, I think that FixedResets have been grossly overemphasized in the marketplace through the course of their existence. The banks have been driven to inflate their Tier 1 capital at a time when bank money is pretty expensive. The allure of FixedReset issuance hasn’t been so much the reset provision (although that’s the hook for retail) as the five year call; which fixed income investors in most other markets will simply not allow.

Third, I don’t think the acid test of FixedResets continued existence is low issue yield – which is surely more a sign of fashionability rather than otherwise. I can think of two critical tests:

  • The first wave of redemptions: It is not entirely clear that investors have really thought through the implications of the five-year call and will be most upset when such a call lands most secondary market buyers with a big capital loss and the need to reinvest in a (probably) lower yield environment.
  • The first few downgrades & defaults: Nortel & Quebecor World defaulted on their FixedFloaters; BCE and Bombardier were downgraded. All remaining issues are trading well below par. How will the FixedReset market react when it becomes apparent that interest rate risk is only one of the problems facing fixed income investors?

Straights will always be the little black dress of the preferred share world, but FixedResets have the advantage of allowing the issuer to assume the inflation risk, just like RRBs; there will always be a significant number of new issue investors eager to accept low yields for the chance of offloading that risk. FixedResets have the chance of becoming a permanent feature of the new issue shop.

5 Responses to “Critchley: Is this the end for rate resets?”

  1. GAndreone says:

    RBC Direct still shows the BNS issue as open as of this time. Typically it would close within a couple of hours of opening.

  2. jiHymas says:

    Closed at TDW; still open at CIBC. It is my understanding that the institutional book closed fairly shortly after announcement.

  3. GAndreone says:

    Still open at RBC. James, you have educated retail too well for some!

  4. Louis says:

    I would not take an “open” notation from RBC-direct as an indication that an issue has not been fully susbscribed. About 9 months ago, I did subscribe while it was open to learn a week later that none had been allocated to me. I’ve got upset since it was not the first time I had that kind of problem. In the past I would declare a firm interest for say 1000 shares to only be allowed a ludicrous 100. I had an unpleasant telecon with one of their reps. I was asking him what were their allocations rules since, their offer should have been closed before I put and considering that I had been able to obtain, after that (and even the following day) from the TD and Scotia. I also asked him concerning my earlier problem of getting only 10% of what I was asking for. He said it was on a first come first fully served basis. I said it could not be since it happened me more than once and that I cannot believe I was that often the unlucky one getting partially filled. I said that if I was granted only 10% this must mean that they got subscribed at 900% of what they have before closing the offer for the new issue. If so, they should have closed the offer way earlier and that, in any event, this should mean that whoever is able to place a declaration of interest before the issue is closed should get something, not 0 shares!!!

    He said is supervisor would call me what he never did. A week latter I had half of the account transfered to another institution (Scotia McLeod). They did not even asked why. By mistake, they first transferred the entire account before being told of their mistake by me and Scotia McLeod. They then cancelled it before taking them ages to complete the transfer due to reverse split on one of the stocks (NBD) and eventhough the form was saying to transfer all the shares of that strock in nature without specifying the number of shares.

    Sorry for letting my frustration out here but I feel better now…

  5. jiHymas says:

    Sorry for letting my frustration out here but I feel better now…

    Frustration is good, and I will tuck this information away for later use.

    As an Investment Counsel / Portfolio Manager regulated by the OSC, I am required to have a block trade allocation policy, despite the fact that I do not presently execute block trades. It would be interesting to know what the rules and policies are for new issue allocation at the discount brokerages …

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