June 5, 2014

DBRS commented on the Quebec budget:

Following disappointing real GDP growth of just 1.1% in 2013, the new budget assumes accelerating growth of 1.8% in 2014 and 2.0% in 2015, supported by an improvement in domestic demand and the external environment. This is consistent with the private sector consensus tracked by DBRS. Despite a difficult first quarter, the outlook for the U.S. economy is encouraging and a lower Canadian dollar will add further support to Québec exports.

At the time of last year’s rating review, DBRS anticipated that the debt-to-GDP ratio had peaked around 61% in 2012-13 and would begin to decline in 2013-14. As a result of the deterioration in fiscal performance, the latest estimates again point to a debt burden of approximately 61% in 2013-14, with another modest increase projected in 2014-15. After which, the debt burden is forecast to gradually decline to roughly 56% by 2018-19, provided that the fiscal recovery remains on target and capital spending moderates as planned.

Assiduous Reader BC wrote in and said:

One other thing I was curious about and thought you might well be the best source to ask.

Years ago, in 2006, the government outlawed income trusts and in the aftermath, a lot of companies began paying eligible dividends that qualify for the dividend tax credit

What possibility might there be that in the future, a revenue hungry government might decide to take similar action in connection with the dividend tax credit.

Thanks very much for any input you can provide

Well, nothing’s guaranteed. For all I know, the Trotskyists will form the next federal government and then I’ll be harvesting potatoes for a living.

That being said, the dividend tax credit seems politically safe to me; none of the three major parties is making it an issue and the major influence on it since it was introduced in 1972 (over the past ten years, anyway) has been changes in corporate tax rates.

However, it should be noted that the explicit purpose of the DTC is to encourage equity investment:

There will be a major increase in the dividend tax credit. Starting January 1, 1978, the amount of dividends received from taxable Canadian corporations will be grossed-up by one-half, as opposed to the current one-third, and taxpayers will be allowed to claim against tax a credit equal to this higher amount.

This measure will provide benefits in a progressive manner in that the net tax on each dollar of cash dividend received will decline by a larger dollar amount the lower the income of the taxpayer. This is shown in the table included in the Supplementary Information. The table also illustrates how this measure will improve the return on equity investments. The proposed increase in the dividend tax credit should thus make it more attractive for investors in all income brackets to return to the equity market. The federal revenue loss from this measure is estimated to be $120 million in the first full year of operation and the measure will also affect provincial tax revenues.

Geez, those were the days, eh? When a tax expenditure of $120-million wasn’t just a rounding error?

However, there are rising concerns about income inequality and its cause:

More than a quarter (26%) of self-identified Democrats and those who lean Democratic cited the tax system as a main reason for the gap. Just 14% of self-identified Republicans and those who lean Republican said the same.

This is particularly evident at the very top of the tree:

But Mr. Zucman and Mr. Saez show a dramatic increase in wealth inequality at the very top of the distribution, among households with more than $20 million in wealth – and especially among those with more than $100 million.

… and we all remember Warren Buffet’s secretary:

Buffett cited himself, the third-richest person in the world, as an example. Last year, Buffett said, he was taxed at 17.7 percent on his taxable income of more than $46 million. His receptionist was taxed at about 30 percent.

Buffett said that was despite the fact that he was not trying to avoid paying higher taxes. “I don’t have a tax shelter,” he said. And he challenged Congress and his audience to see what the people who “clean our offices” are taxed, to loud applause.

And why does this happen:

You might wonder how Mr Buffett managed such a low tax rate. Most likely, it arose because corporate dividends and capital gains are taxed at only 15 percent. But the corporate income that funded those returns was already taxed at the corporate level, where the tax rate is 35 percent. Mr Buffett seems to be ignoring the first round of taxation. Is it possible that the world’s most successful has failed to pierce the corporate veil? (If you want to more reliable data on the progressivity of the tax code, see this old post for numbers from the CBO.)

Even more striking to me is a fact that Mr Buffett did not emphasize: how low his taxable income is. His income of $46 million represents a mere 0.1 percent of his reported net worth of over $50 billion. That is not an impressive rate of return!

Why is it so low? I can think of at least four possible ways investors like Mr Buffet can keep their taxable income, as opposed to their true income, low:
1.They hold stocks that pay minimal dividends.
2.They avoid realizing capital gains.
3.They hold some of their portfolios in tax-free municipal bonds.
4.They give appreciated assets to charity, getting a deduction for the current market value without ever having to realize and pay tax on the capital gain

… and at least some of the super-rich are indulging in conspicuous consumption:

Money managers may resent Prof. Piketty’s book but they appear to love its takeaway notion, especially the implication that the market for expensive goods is just going to keep on getting bigger.

Further evidence for that viewpoint came this week when McLaren Automotive reported that it had made a profit in only its third year of operation. The British auto maker, which was spun out of McLaren Group, the Formula One racer, sells high-performance but road-legal cars that go for about $1.8-million.

This is a company that considers Ferrari and Porsche to be downmarket. Yet it has had no trouble selling out production of its P1 supercar.

Call it the 0.01 per cent market. Before Prof. Piketty and colleagues such as Emmanuel Saez at the University of California in Berkeley came on the scene, economists tended to pooh-pooh concerns about wealth distribution, since the middle class was clearly getting richer and at a pace not wildly different from that of the top 10 per cent of society.

It’s the old story, one that particularly impressed me when I visited Russia a few times and saw the glorious architecture in Moscow and St. Petersburg and the awesome craftsmanship of the relics in the Hermitage. I was so overwhelmed in the Hermitage that I decided I needed to concentrate my attention on one thing and just wandered from room to room looking at tables. How do you get such awesome craftsmanship? Well, first you spend ten years training a guy to make tables of superb quality. And then you tell him to spend the next five years to make a table for you. You can only afford to do this in conditions of extreme income inequality.

So, given all the above, I think that at some point the Dividend Tax Credit and Gross Up will attract some populist political criticism, as will the capital gains inclusion rate. It might well be that people will decide that double-taxation of distributed corporate profits is a Good Thing, particularly if snooty rich folks on Bay Street are getting the benefit of the tax breaks instead of hard-working ordinary Canadians on Main Street.

On the other hand, perhaps one of the biggest macro-economic problems facing governments nowadays is that hard-working ordinary Canadians on Main Street are showing an increasing preference for personal real-estate as an investment rather than productive investment. So my political prediction is that eventually the DTC and the lower inclusion rate capital gains will be capped at some figure that is extremely high as far as the man in the street is concerned (say, income of $150,000) but is mere pocket change to the about-to-be-soaked rich. And remember: with one of my political predictions and $2.00, you can get a coffee at Timmy’s. After all, I didn’t expect the The Pickton-ization of Communities and Exploited Persons Act.

On a less philosophical note, Draghi has earned himself a chapter in future histories of monetary policy:

Mario Draghi unveiled an unprecedented round of measures to help the European Central Bank’s record-low interest rates feed through to an economy threatened by deflation.

The ECB today cut its deposit rate to minus 0.1 percent, becoming the first major central bank to take one of its main rates negative. In a bid to get credit flowing to parts of the economy that need it, the ECB also opened a 400-billion-euro ($542 billion) liquidity channel tied to bank lending and officials will start work on an asset-purchase plan. While conceding that rates are at the lower bound “for all practical purposes,” the ECB president signaled policy makers are willing to act again.

Draghi announced a new liquidity program designed to encourage lending. Financial institutions will be allowed to borrow money from the ECB equivalent to as much as 7 percent of their outstanding loans to non-financial corporations and households, excluding mortgages.

The negative deposit rate, which means charging banks that want to deposit excess funds with the ECB, has been heralded by Draghi as a way to stem unwarranted increases in money-market rates, as well as to curb euro strength that has contributed to slower inflation.

The measure has been used by a handful of smaller central banks in recent years, including Sweden’s, which conducted a 14-month experiment in 2009-2010. Denmark moved below zero in July 2012 — though the cut was aimed more at protecting its currency than stimulating growth — and ended the policy in April.

“It’s another whatever-it-takes moment in the life of the ECB and the euro zone,” said Carsten Brzeski, chief economist at ING-DiBa AG in Brussels “He threw in all he had.”

Excluding mortgages, mind you. Don’t spend no more damned money on your damned houses, people! Use it to collateralize your carry trades:

The policy divergences will widen even further over the next three years as the Fed and then the BOE raise rates, putting them on a course counter to the ECB and the BOJ, according to Andrew Kenningham, an economist at Capital Economics Ltd. in London. By 2017, he estimates, the gap between the U.S. benchmark and those of the euro area and Japan could be nearing four percentage points.

Such divides, he says, are unusual although not unprecedented. The split between U.S. and Japanese rates has often exceeded four percentage points in recent decades and between the U.S. and Germany it topped three percentage points for much of the 1980s.

There are some very interesting musings about solar power:

Deregulated electricity generators make most of their profits on hot summer afternoons, when air conditioners and offices force grid operators to call up their most expensive electricity: natural gas “peaker” plants. Cheap to build but expensive to operate, these plants are essentially jet engines, producing power on demand for a few hours at a time. However, the entire industry benefits when peaker plants kick in, because every other generator, including the cheapest hydropower operator, receives the same top dollar during those peak hours.

Solar panels — whether utility scale or residential rooftop — generate maximum power on exactly those hot afternoons when demand peaks. What’s more, they do so at no marginal cost; the sun is free. This reduces reliance on peakers, causing prices to fall across the board, including for customers without solar power.

This is what terrifies power companies. In California, the afternoon peak has effectively collapsed. CAISO, the state’s grid manager, projects that the peak will become an afternoon chasm, so low that even power plants designed to operate 24 hours a day as “baseload power” (nuclear energy is a good example) may face difficult decisions about when to operate.

The first victims among utilities will be generators that sell electricity from peakers and other plants in the open market. Soon, their plants will be needed only for the few hours around dusk when the sun is weak but demand is still relatively high.

Arizona has net metering, but is considering changes:

The future of solar net metering in Arizona is under attack, with the state’s largest utility Arizona Public Service (APS) proposing changes that undermine cost benefits for residential solar installations.

Under a plan submitted in July with the state’s public utility commission, APS proposes two options for future residential solar customers – both of which will reduce potential financial returns homeowners would receive on their investment.

One alternative would model net-metering contracts much the same as today but require residential customers to pay what APS calls a “convenience fee” – a monthly charge for sending power to the grid. The other option would give homeowners a small ongoing bill reduction, based on market rates APS pays to other power generators.

Seems to me a two-part electricity bill is what’s required – one part for actual electricity use, one part for access to the grid. This would be similar to Toronto Hydro’s charges, but ideally the grid access charge will be based on capacity rather that usage.

TransCanada, proud issuer of TRP.PR.A, TRP.PR.B, TRP.PR.C, TRP.PR.D and TRP.PR.E, was confirmed at Pfd-2(low) by DBRS:

DBRS has today confirmed the ratings of TransCanada Corporation (TCC or the Company) and its wholly owned subsidiary, TransCanada PipeLines Limited (TCPL), both with Stable trends. The ratings primarily reflect (1) expected improvement in TCC’s overall business risk profile over the medium term, (2) potential medium term pressure on its credit metrics and (3) environmental, regulatory and political risks with respect to its natural gas and liquids pipelines segments.

It was a positive day for the Canadian preferred share market, with PerpetualDiscounts gaining 3bp, FixedResets winning 19bp and DeemedRetractibles up 9bp. The longer-than-usual Performance Highlights table, still reflecting the dislocations of the past two weeks, is dominated by winning FixedResets. Volume was quite low and dominated by recent new issues.

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 0.6947 % 2,516.4
FixedFloater 4.56 % 3.81 % 30,670 17.79 1 0.2404 % 3,768.4
Floater 2.90 % 3.02 % 46,382 19.61 4 0.6947 % 2,717.1
OpRet 4.38 % -14.38 % 29,338 0.09 2 0.0000 % 2,711.6
SplitShare 4.81 % 4.30 % 62,878 4.15 5 0.0159 % 3,114.4
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0000 % 2,479.5
Perpetual-Premium 5.52 % 1.99 % 84,673 0.09 17 -0.0669 % 2,400.9
Perpetual-Discount 5.27 % 5.27 % 104,272 14.99 20 0.0322 % 2,539.8
FixedReset 4.53 % 3.72 % 220,173 8.57 77 0.1852 % 2,519.2
Deemed-Retractible 5.01 % 1.55 % 150,678 0.22 43 0.0895 % 2,523.1
FloatingReset 2.68 % 2.51 % 138,158 3.99 6 0.1461 % 2,479.6
Performance Highlights
Issue Index Change Notes
CIU.PR.C FixedReset -1.74 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 20.93
Evaluated at bid price : 20.93
Bid-YTW : 3.60 %
CU.PR.D Perpetual-Discount -1.35 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 23.79
Evaluated at bid price : 24.17
Bid-YTW : 5.08 %
ENB.PR.N FixedReset 1.03 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 23.06
Evaluated at bid price : 24.60
Bid-YTW : 4.15 %
ENB.PR.T FixedReset 1.09 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 22.80
Evaluated at bid price : 24.06
Bid-YTW : 4.14 %
CU.PR.C FixedReset 1.15 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2017-06-01
Maturity Price : 25.00
Evaluated at bid price : 25.41
Bid-YTW : 3.45 %
ENB.PR.P FixedReset 1.18 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 22.84
Evaluated at bid price : 24.10
Bid-YTW : 4.13 %
BAM.PR.K Floater 1.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 17.44
Evaluated at bid price : 17.44
Bid-YTW : 3.04 %
ENB.PR.B FixedReset 1.26 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 23.03
Evaluated at bid price : 24.11
Bid-YTW : 4.06 %
ENB.PR.F FixedReset 1.34 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 22.92
Evaluated at bid price : 24.15
Bid-YTW : 4.14 %
BAM.PR.B Floater 1.50 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 17.55
Evaluated at bid price : 17.55
Bid-YTW : 3.02 %
Volume Highlights
Issue Index Shares
Traded
Notes
BAM.PF.F FixedReset 598,107 New issue settled today.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 23.12
Evaluated at bid price : 24.94
Bid-YTW : 4.36 %
TD.PF.A FixedReset 335,413 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 23.13
Evaluated at bid price : 24.97
Bid-YTW : 3.71 %
RY.PR.Z FixedReset 178,865 Nesbitt crossed 150,000 at 25.15.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 23.22
Evaluated at bid price : 25.17
Bid-YTW : 3.68 %
RY.PR.H FixedReset 126,844 Recent new issue
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 23.13
Evaluated at bid price : 24.95
Bid-YTW : 3.73 %
ENB.PF.C FixedReset 88,294 Recent new issue.
YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 23.12
Evaluated at bid price : 25.00
Bid-YTW : 4.16 %
SLF.PR.H FixedReset 61,777 Desjardins crossed 11,600 at 25.16; RBC crossed 26,400 at 25.09.
YTW SCENARIO
Maturity Type : Call
Maturity Date : 2016-09-30
Maturity Price : 25.00
Evaluated at bid price : 25.10
Bid-YTW : 3.61 %
There were 21 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
MFC.PR.K FixedReset Quote: 24.60 – 25.07
Spot Rate : 0.4700
Average : 0.3243

YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.60
Bid-YTW : 3.98 %

MFC.PR.J FixedReset Quote: 25.24 – 25.63
Spot Rate : 0.3900
Average : 0.2734

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2018-03-19
Maturity Price : 25.00
Evaluated at bid price : 25.24
Bid-YTW : 3.70 %

CU.PR.D Perpetual-Discount Quote: 24.17 – 24.75
Spot Rate : 0.5800
Average : 0.4653

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 23.79
Evaluated at bid price : 24.17
Bid-YTW : 5.08 %

TD.PR.R Deemed-Retractible Quote: 26.33 – 26.61
Spot Rate : 0.2800
Average : 0.1853

YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-07-05
Maturity Price : 25.75
Evaluated at bid price : 26.33
Bid-YTW : -14.65 %

CU.PR.G Perpetual-Discount Quote: 22.24 – 22.50
Spot Rate : 0.2600
Average : 0.1808

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 21.89
Evaluated at bid price : 22.24
Bid-YTW : 5.07 %

TRP.PR.C FixedReset Quote: 22.30 – 22.65
Spot Rate : 0.3500
Average : 0.2774

YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-05
Maturity Price : 21.80
Evaluated at bid price : 22.30
Bid-YTW : 3.59 %

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