Critchley Sounds Cautionary Note on Fixed-Resets

As noted by Assiduous Reader Tobyone in the comments to a prior post, Barry Critchley of the Financial Post has published a column with a cautionary note regarding this structure: Banks Big on Reset Preferred Shares:

Over the past six months, five of the chartered banks — the Big Six less the Royal Bank–have raised more than $2-billion by way of reset preferred shares, a security they hadn’t previously sold to the public.

But the security has been around for a long time, given that BCE, for example, issued a pile of them.

The Royal Bank announced a new issue today just to ruin his column.

However, it is not strictly correct that BCE issued a pile of them. The BCE issues were reset at a proportion of five year Canadas determined by the board; the floating-rate side were ratchet-rate preferreds that could (and currently are) paying 100% of prime.

Critchley notes the inflation-mitigating effect of this structure:

In a high-inflation world, that new feature allows investors to be offered market-type rates. That feature is better than what existed with the fixed-rate perpetuals where there was no ability in a high-inflation world for investors to receive market rates.

I noted the inflation-mitigating effect of this structure in the previous post on this topic, Harry Koza Likes Fixed-Resets. Naturally, I will grant “that feature is better”. Of course it is. What else am I gonna say? The question is not whether the feature is good or not, but how good is it and how much are we paying for it?

Mr. Critchley continues:

Investors giving up yield compared with buying a fixed-rate non-reset pref share: “In essence, you are paying a premium (in terms of a lower current yield) in exchange for inflation protection down the road that won’t likely materialize unless it is clearly in favour of the issuer,” he noted. “The only thing you know for sure is that you are taking long-term credit risk with a very uncertain compensation that is currently well below fixed-rate issues.”

Exactly my point.

Update, 2008-9-9: The source for the quotations in the column was the screen-name scomac, writing in Financial WebRing Forum.

2 Responses to “Critchley Sounds Cautionary Note on Fixed-Resets”

  1. […] must say, it looks like these things are easy to sell, despite the various doubts (which include my own!), given that the $75-million greenshoe was fully […]

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