On an unrelated thread, Assiduous Reader GAndreone asked:
As the official guardian of the pref share patrimony what is your opinion on the recent redemption of sub-debt by both RBC and CIBC. RBC redeemed $1.0G @ 4.18% and CIBC redeem $0.75G @ 4.25%. In the case of RBC just this year alone they issued Net $1.576G of prefs @ 6.22%
These actions are not clear to me but they certainly maybe clear to you!
So, let’s review:
RY has recently redeemed some sub-debt:
Royal Bank of Canada (RY on TSX and NYSE) today announced its intention to redeem all outstanding 4.18 per cent subordinated debentures due June 1, 2014 (the “4.18 per cent debentures”) for 100 per cent of their principal amount plus accrued interest to the redemption date. The redemption will occur on June 1, 2009. There is currently $1,000,000,000 principal amount of 4.18 per cent debentures outstanding.
The redemption of the debentures will be financed out of the general corporate funds of Royal Bank of Canada.
According to their 2008 Annual Report (page 162 of the PDF), these bonds mature June 1, 2014; first par call June 1, 2009; and:
Interest at stated interest rate until earliest par value redemption date, and thereafter at a rate of 1.00% above the 90-day Bankers’ Acceptance rate.
Which leaves us with another puzzle, since Three-months BAs are now at 0.29% (!) and they had the opportunity to cut their interest rate costs by almost 70%; from $41.8-million annually to $12.9-million annually (assuming BAs are constant).
Similarly with CM:
CIBC (CM: TSX; NYSE) today announced its intention to redeem all $750,000,000 of its 4.25% Debentures (subordinated indebtedness) due June 1, 2014 (the “Debentures”). In accordance with their terms, the Debentures will be redeemed at 100% of their principal amount on June 1, 2009. The interest accrued on the Debentures to the redemption date will be paid through CIBC Mellon Trust Company in the usual manner. The redemption will be financed out of the general corporate funds of CIBC.
The 2008 CM Annual Report (page 131 of the PDF) shows the first par call being June 1, 2009, maturity 2014-6-1 … but they make us go to SEDAR to get the May 3, 2004, prospectus supplement, which says:
… until June 1, 2009. Thereafter, interest on the Debentures will be payable at a rate per annum equal to the 3-month Bankers’ Acceptance Rate (as herein defined) plus 1.00%,
Which leaves us with the same conundrum.
This behaviour was also discussed in the post National Bank Honours Sub-Debt Pretend Maturity.
It all stems back to the way the bond market really works. There are not many actual bond analysts in Canada – or the world, for that matter. Bonds are not bought – typically – after rigourous analysis of their terms and comparison with other opportunities. Bonds are bought because Joe at the brokerage has some to sell and says they’re pretty good. In the case of sub-debt, it is understood that the banks will call these issues on their pretend-maturity date, which is just before they go floating, or step-up to the penalty rate, or whatever. When brokerages calculate yields and spreads on these issues, they perform these calculations based on the pretend-maturity date.
This occurs because the value of sub-debt to the issuing bank changes (in Canada, anyway. Most other places, I think, have the same rules, but I haven’t done a survey) five years prior to maturity. On May 31, the issuers can count 100% of this sub-debt towards their Tier 2 capital. On June 1, they can only count 80%, and the rate declines by another 20% every year until formal maturity. Thus, four years and three hundred and sixty four days prior to maturity, the banks are (theoretically) paying full sub-debt prices for their debt, but only getting 80% of sub-debt value. Therefore, the theory goes, they will call, come hell or high water.
Deutsche Bank did the business-like thing and didn’t call their sub-debt on the pretend-maturity. The market ripped their faces off. Why? Because Joe at the brokerage had sold all that paper to his customers while telling them that the pretend-maturity would be honoured, and then it wasn’t. Deutsche made poor old Joe look silly – and worse, uninformed. It is preferable to go bankrupt than to break the comfortable rules of the bond-traders’ boys’ club.
It is clear that the current rules are not working; the rules for sub-debt need to be revised somehow. The most obvious first step is to change the rules so that fixed-floating sub-debt, or paper with a step-up, is simply not allowed (this would also, I hope, affect fixed-resets!). The absence of a clearly defined break in the investment terms might go a little way towards eliminating this type of expectation.
Because this type of expectation is dangerous! It seems pretty clear that BAs+100 is a wonderful rate for banks to borrow five-year money, even with no Tier 2 allowance at all; but they are pseudo-honour bound to conduct business in a non-business-like fashion. I consider any unbusinesslike behaviour to be a destabilizing force on the financial system; and how come the banks are getting 100% sub-debt credit for the paper on May 31, when it is clear that if they don’t cough up the cash PDQ the market will squash them like a bug?
The trouble is, nod-and-wink behaviour is awfully hard to stamp out. If the regulators are truly interested in financial stability, I think they’ll have to come up with other ideas … up to and including elimination of the concept of maturity dates on Tier 2 capital completely (as well as, in Canada, the idiotic redefinition of Tier 1).
L.PR.A: Pricing Clue from New Note Issue
May 6th, 2009Loblaws has announced:
L.PR.A is a very liquid OperatingRetractible, relegated to the HIMIPref™ Scraps index due to credit concerns. It closed last night at 25.40-70 to yield 5.70-47% until its softMaturity 2015-7-31.
The 5.70% bid-side dividend yield is equivalent to 7.98% interest, so we can say that the pre-tax interest-equivalent spread vs. bonds for this issue is over 310bp … balancing the poorer credit vs. the advantages of retraction, I’d say the preferreds are cheap here.
L.PR.A was last mentioned on PrefBlog in the post L.PR.A Goes Stale on Shelf … it had a difficult underwriting in June 2008.
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