Category: Miscellaneous News

Market Regulation Services Inc. has announced:

Commencing on October 29, 2007 for five (5) days, an RS Hearing Panel will convene at RS, 9th floor, 145 King Street West, Toronto to consider whether David Berry has contravened certain Requirements of UMIR as set out in the Statement of Allegations. The proceeding is open to the public.

This is the first news to emerge in the case since the McQuillen settlement.

There was a discussion at Financial Webring Forum in which one of the participants expressed a view that recent market declines proves that buying perpetuals at a premium to their ultimate redemption price is a bad idea.

So, I thought I’d provide a brief review of the arguments in favour of premiumPerpetuals as a sub-class of preferreds. The advantages are two-fold:

(i) A premium to redemption price implies that a redemption will be favourable to the issuer. Thus, an investor in such issues has at least some chance of having his capital returned in a timely manner without having to accept the usually very low yields offered on retractibles. This also mitigates the credit risk inherent in lending a company money “forever”.

(ii) A premium to redemption price, to the extent that it implies a coupon that is higher than required for new issues, provides a buffer against adverse changes in interest rates.

A quick understanding of the second point can be achieved by considering two imaginary issues. The numbers in this example are not mathematically precise – should a reader wish mathematical precision he is more than welcome to work them out!

The first issue is callable in 4 years at $25 and is currently priced at $26.00 with a coupon of 6% (that is, the annual dividend is $1.50). The holder would be very happy to hold it forever at this coupon, but must account for an expected capital loss when the issue is called of $1. The amortization of this premium amounts to $0.25 annually, thus his net income is $1.50-$0.25 = $1.25 which, taken as a fraction of $25.00 (I told you the numbers wouldn’t work out precisely!) is a net yield of 5% p.a., or, to put it another way, 6% coupon – 1% annual capital loss = 5% net income.

The second issue has a coupon of 4% and it trades at $20.00. The holder cannot rely on it being called at $25 (why would the issuer call an issue with a 4% coupon to refinance at 5%?), so the net yield is 5%.

Thus, in terms of expected annual yield, these issues are basically the same. Suppose, however, that yields increase massively … from 5% to 6%. The first issue, with its coupon of 6% will be trading at $25 … only $1 of capital has been lost and that was a dollar the holder was expecting to lose anyway! Lose it in 4 years, lose it now … it’s not the biggest deal in the world.

The second issue, with a coupon of 4%, implying an annual dividend of $1.00, will fall in price to about $16.70 (in order to keep the yield for new purchasers equal to the new market rate of 6%) – a capital loss of $3.30, or about 16.5% of the capital invested.

Thus, the premium issue provides greater protection against interest rate increases.

This doesn’t come for free, however: if interest rates fall, the discount issue will rise in price, just as dramatically. The premium issue will also rise in price, but not nearly so much – a rational buyer will still be expecting the same call at $25.00 at the same time … that will have even greater likelihood, as the issuer will cut costs even more on refinancing.

Additionally, premium issues will generally trade so that their yield-to-expected-call is a little less than discounts. Ain’t nuthin’ free in this world! Each investor has to assess the risk/reward trade-offs of each investment for himself, and come up with a diversified portfolio that meets his needs. You can’t just buy a premium issue simply because it has a premium … the yield give up might be too much. Even now, with all the recent carnage in the market, GWO.PR.F is bid at 26.95, with a yield-to-worst of 2.75% based on a call 2008-10-30 at $26. Obviously, buyers are hoping that it won’t be called at that time, that it will take longer … but even if it lasts until a $25.00 call on 2012-10-30, it will only have yielded 4.22%! One can find many high quality perpetuals yielding far in excess of 4.22% without any pious hoping that the treasurer won’t notice the fat dividend. The market obviously disagrees with me, but I say that issue is just too damn expensive.

In my article How Long is Forever?, I made the point that yield spreads between perpetuals and retractibles can be so large that rates would have to be extremely high in the future for total return over the period to favour the retractible. In Perpetual Hockey Sticks, I look at the trade-off between “expected yield” and “protection from future higher interest” in more detail. Enjoy!

Note: We can get some idea of the differences by looking at the NAV of the Claymore Preferred ETF. This peaked at 20.05 on 4/12 and the bottom (so far!) is yesterday, 6/8, at 19.08. In that time, the HIMI PerpetualPremium index has had a total return of -4.35%, the PerpetualDiscount index has returned -10.12%.

The sky is not falling.

The above is from The Bank of Canada.

Today’s data shows long Canadas at 4.50%, long corporates at 5.64%.

As I mentioned in the June 7 Comments, recent events have had a major effect on the preferred share market … first the BCE rumblings, then tough talk from the Bank of Canada.

But as far as skyrocketting interest rates, doom and destruction are concerned? Yawn … another day of excited market chatter. Wake me up in time for the next end of the world, OK?

As mentioned earlier, I was on BNN’s “Stars & Dogs” programme tonight.

It went reasonably well but, alas, I don’t think I’ll ever be one of those guys who can smoothly chatter about complex things in simple ways!

For those interested, BNN has posted the video and I think it will be on their site for the next week. The archived show for May 11, I come on at about the 20 minute mark.

I will be appearing on BNN’s Stars & Dogs programme at the captioned time.

Sure wish I was the star!

There are a number of posts that will be forthcoming. In the near future. I swear!

Drew asked some questions on April 5:

1. HIMIPref currently gives high valuation scores to several P3 issues. You, however, have noted that HIMIPref is less reliably values P3’s as compared with investment grade. Is the credit risk worth the potential reward? The yield differential alone does not seem to warrant taking on the risk.

2. Widely accepted equity portfolio theory says that adding risk in small amounts to an otherwise conservative portfolio can increase returns and actually decrease risk, where risk is measured in terms of volatility. Does the same hold true for preferred shares where risk is measured in terms of credit and not duration?

3. My intuition is that not all P3’s are in principle alike in terms of risk/return potential. A P3 (high) of a utility-like business such as Yellow Pages seems substantially less risky from a credit perspective than a cyclical issuer with a P3 rating. Further, a P3(high), it seems, has substantially higher reward potential than any P3 due to the bump in price that will no doubt result from a credit upgrade. Should these issues – issuer specific and differences between P3(high) and all other P3’s – play a role as we move down the food chain?

I will answer these briefly in this blog, but this is high-level fixed-income stuff … I think it’s probably worthy of an article.

I have been asked recently to comment on Brompton Lifeco Split Corp, LCS.PR.A. This is too small an issue to warrant inclusion in the HIMIPref™ universe but since I was asked by a subscriber to PrefLetter (cough, cough) I will write something more formal shortly. Not article-formal, not full-analysis-formal, but something.

Also, I haven’t yet commented on the closing of CIU.PR.A, other than to note its role in the redemption of CU.PR.T, CU.PR.V & CU.PR.D. This will be rectified shortly.

No rest for the wicked!