Watch the Details on Rate-Reset Preferreds

Barry Critchley of the Financial Post has been all over the map on Fixed-Resets:

… and now he is warning that “redeemable” is different from “retractible”:

If the prefs are not redeemed, in five years holders will be offered a choice of a new fixed-rate pref or an option to convert to a floating-rate pref. The rate will be set at the same spread as the original fixed-rate prefs. (Over time, the spread has widened to 450 basis points from 160 basis points.) The actual rate offered could be lower or higher than the original coupon.

Now, Len Ruggins, a former senior financing executive with BCE, has weighed in. He argues the terms are “greatly tilted in the issuer’s favour, primarily because of their option to periodically call the issue at their pleasure.”

Ruggins said he “would buy into these issues if they were non-call for financial advantage for at least 25 years. This, in my mind, would establish a level playing field between the issuer and the investor. I am not trying to cut off a source of capital for our Canadian banks. However, I don’t think they should take undue advantage of the financially unsophisticated retail investor.”

By and large, Mr. Critchley’s attitude towards the structure has become more cautionary as the terms of new issues have improved! I consider the recent spate of new issues to be somewhat rich compared to PerpetualDiscounts, but to a much smaller degree than they were a year ago. In fact, there is now enough overlap between the more expensive PerpetualDiscounts and the cheaper FixedResets that the fund I manage has taken some opportunistic positions in Fixed Resets, as disclosed in the portfolio composition review for January 2009.

It is interesting to compare this column with the column by Rob Carrick of the Globe and Mail, published on the same day.

Update, 2009-3-31: In light of the comments to this post by Assiduous Reader GAndreone, I thought it would be interesting to post the HIMIPref™ Option Calculation Box for BMO.PR.O as of 2009-3-30. Note that I do not claim that this represents a perfect and correct calculation of what the price of the option would be if it was separable from the preferred share; I will say, however, that the various parameters used as inputs … er … how shall I phrase this … seem to work pretty much OK when used as part of HIMIPref™’s valuation routine.

Update, 2009-3-31: There’s a great comment on the G&M story:

Bruce King from Canada writes: I think James Hymas is stuck with a lot of straight preferreds that have tanked and he’s hoping to drum up some demand in order to unload them on us. He’s probably salivating at the chance to generate enough cash to buy some of the new rate-reset preferreds.

Curses! Foiled!

4 Responses to “Watch the Details on Rate-Reset Preferreds”

  1. GAndreone says:

    As a point of interest, the value of the call options assuming a continous dividend of 6.25%, a risk free return of 1.68% and a GARCH volatility of 10% are Yr5 0.42/share, Yr10 0.19/share Yr15 0.09/share.

  2. jiHymas says:

    At those prices, I’ll buy all the options extant.

  3. GAndreone says:

    Let’s make a deal! Without the dividends the prices are Yr5 3.78/share Yr10 5.72/share and Yr 15 7.38/share. Or 16.88/share assuming a 10% Vol.

  4. jiHymas says:

    At those prices, I’m not quite so eager to buy. I understand why the banks want to get them for free though!

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