Geez, I hate it when the Financial Post gets desperate for copy. They consult their Journalists’ Handbook, and see that if somebody says “white is white”, it’s an interesting angle to dig up somebody who’ll say “white is black”.
They did it last year and now they’ve done it again: a short piece titled The ‘risk’ of Preferred Shares, by John Greenwood, pointing out that dividends are not guaranteed.
You can almost hear the journalist’s leading questions, which are not reported:
What would happen if a bank were to skip a payment on its preferred dividend?
If a bank were to skip one, the market for the shares would “be vaporized,” said Blackmont Capital analyst Brad Smith.
How many banks would have to skip payments before the market was adversely affected?
“All that would have to happen would be for one bank to miss a payment and the whole market would shut down,” said another analyst who asked not to be named.
Particularly irksome is:
Some European banks have been forced to cut back on dividends after accepting government bailouts.
Can he name any? I’m sure there have been some preferred defaults, but I can’t remember seeing anything about government money being conditional on a preferred dividend cut. Common dividend cuts, sure, that has happened in the States too … let’s just say I want more details.
If he wants to talk about preferred share defaults, he can look at Nortel & Quebecor World right here in Canada!
The only saving grace is:
Preferred shares rank senior to common, so even if the dividend on the common is sacrificed, holders of preferred shares could still collect. According to Sherry Cooper, senior economist at BMO Nesbitt Burns, aside from National Bank, none of the major banks has cut a dividend since the Great Depression. (National chopped twice, most recently in the early 1990s.)
… but still, I find the article annoying in the extreme. Particularly since I don’t understand why the word “risk” in the title is in quotes!
Yes, preferred shares can have their dividend cut. We know that. But if somebody’s going to talk about it in the newspaper, can we PLEASE have some kind of indication of how likely they think that might be? As for myself, I consider the probability immeasurably small for Canadian banks right now …the banks are well capitalized and profitable … anything imminent would be in the nature of a black swan event, immeasurable by definition.
Let the banks here get into trouble and sure, I’ll be happy – eager! – to start taking a view on the chances of them getting into more trouble. But could we at least wait to see some actual signs of definite trouble before discussing the effects on the market of a skipped payment?
I mean, geez, what’s next? A banner headline announcing that a giant asteroid smashing into earth could ruin our whole day?
I think somebody should ask Sherry Cooper when the Great Depression ended. Scotia, for example, shaved their common dividend in 1942 and again in 1943 and yet again in 1944.
The Great Depression, WW2 and the Jurassic era all came before Bloomberg and therefore pretty similar.
Scotia is actually pretty good about this and post the history on their website.
James,
The standard line goes that “they have to cut the common div before the pref can be cut”. As the Bombardier example shows, the common can be eliminated but the pref isn’t. I’m trying to figure out how to quantify the standard line, ie, assess the sustainability of the pref share. ISTM that you look at the cash flow statement and look at the dollars going to the common, the dollars going to the pref(s), and the dollars going into interest payments. It’s probably also worth looking at what bank lines exist and how utilized they are since that will impact the interest payments.
Am I on the right track here?
Mike
Am I on the right track here?
I’d say so. I’ll suggest that the standard metrics of credit analysis apply, with cash-flow-to-debt and cash-flow-to-interest/dividend being of primary importance in a distressed situation. You would also want to look at the availability of tangible assets that could be sold.
The trouble is – as always – that there isn’t much data, meaning that drawing systemic conclusions from individual analysis is a chancy thing. I am looking forward to reviewing the US experience in a few years; they have lots of banks that have slashed or eliminated common dividends without – as yet – systemic defaults in the preferred / Innovative Tier 1 Capital market.
There’s an interesting article about application of the Merton Model at http://www.efalken.com/papers/Mertonmodel.htm.
My main problem with quantifying sustainability is that – by and large – issuers are so far from default that default represents an extreme outcome. Sooner or later in the quantification process you will have to – implicitly or explicitly – estimate the kurtosis (fatness of tail) of a distribution. And at that point, you’re really just guessing.
Or, to put it another way, estimating the default probability of Bombardier prefs is a lot easier than it is for Royal prefs!
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