PrefBlog

It will be recalled that SJR.PR.A will reset to 2.791% effective June 30.

Holders of SJR.PR.A have the option to convert to FloatingResets, which will pay 3-month bills plus 200bp on the par value of $25.00, reset quarterly. The deadline for notifying the company of the intent to convert is 5:00 p.m. (EDT) on June 15, 2016; but note that this is a company deadline and that brokers will generally set their deadlines a day or two in advance, so there’s not much time to lose if you’re planning to convert! However, if you miss the brokerage deadline they’ll probably do it on a ‘best efforts’ basis if you grovel in a sufficiently entertaining fashion. The ticker for the new FloatingReset, if it is created, will be SJR.PR.B.

The most logical way to analyze the question of whether or not to convert is through the theory of Preferred Pairs, for which a calculator is available. Briefly, a Strong Pair is defined as a pair of securities that can be interconverted in the future (e.g., BAM.PR.R and the FloatingReset that will exist if enough holders convert). Since they will be interconvertible on this future date, it may be assumed that they will be priced identically on this date (if they aren’t then holders will simply convert en masse to the higher-priced issue). And since they will be priced identically on a given date in the future, any current difference in price must be offset by expectations of an equal and opposite value of dividends to be received in the interim. And since the dividend rate on one element of the pair is both fixed and known, the implied average rate of the other, floating rate, instrument can be determined. Finally, we say, we may compare these average rates and take a view regarding the actual future course of that rate relative to the implied rate, which will provide us with guidance on which element of the pair is likely to outperform the other until the next interconversion date, at which time the process will be repeated.

We can show the break-even rates for each FixedReset / FloatingReset Strong Pair graphically by plotting the implied average 3-month bill rate against the next Exchange Date (which is the date to which the average will be calculated).

Click for Big

The market appears to have a distaste at the moment for floating rate product; most of the implied rates until the next interconversion are lower than the current 3-month bill rate and the averages for investment-grade and junk issues are both below zero, at -0.66% and -0.07%, respectively! Whatever might be the result of the next few Bank of Canada overnight rate decisions, I suggest that it is unlikely that the average rate over the next five years will be lower than current – but if you disagree, of course, you may interpret the data any way you like.

Since credit quality of each element of the pair is equal to the other element, it should not make any difference whether the pair examined is investment-grade or junk, although we might expect greater variation of implied rates between junk issues on grounds of lower liquidity, and this is just what we see.

If we plug in the current bid price of the SJR.PR.A FixedReset, we may construct the following table showing consistent prices for its soon-to-be-issued FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to be cheap and trading below the price of their FixedReset counterparts. Therefore, I recommend that holders of SJR.PR.A continue to hold the issue and not to convert. I will note that, given the apparent cheapness of the FloatingResets, it may be a good trade to swap the FixedReset for the FloatingReset in the market once both elements of each pair are trading and you can – presumably, according to this analysis – do it with a reasonably good take-out in price, rather than doing it through the company on a 1:1 basis. But that, of course, will depend on the prices at that time and your forecast for the path of policy rates over the next five years. There are no guarantees – my recommendation is based on the assumption that current market conditions with respect to the pairs will continue until the FloatingResets commence trading and that the relative pricing of the two new pairs will reflect these conditions.

Note as well that conversion rights are dependent upon at least one million shares of each series being outstanding after giving effect to holders’ instructions; e.g., if only 100,000 shares of SJR.PR.A are tendered for conversion, then no conversions will be allowed; but if only 100,000 shares of SJR.PR.A will remain after the rest are all tendered, then conversion will be mandatory. However, this is relatively rare: all 39 Strong Pairs currently extant have some version of this condition and all but five have both series outstanding.

It will be recalled that BPO.PR.N will reset to 3.782% effective July 1.

Holders of BPO.PR.N have the option to convert to FloatingResets, which will pay 3-month bills plus 307bp on the par value of $25.00, reset quarterly. The deadline for notifying the company of the intent to convert is 5:00 p.m. (EDT) on June 15, 2016; but note that this is a company deadline and that brokers will generally set their deadlines a day or two in advance, so there’s not much time to lose if you’re planning to convert! However, if you miss the brokerage deadline they’ll probably do it on a ‘best efforts’ basis if you grovel in a sufficiently entertaining fashion. The ticker for the new FloatingReset, if it is created, will be BPO.PR.O.

The most logical way to analyze the question of whether or not to convert is through the theory of Preferred Pairs, for which a calculator is available. Briefly, a Strong Pair is defined as a pair of securities that can be interconverted in the future (e.g., BAM.PR.R and the FloatingReset that will exist if enough holders convert). Since they will be interconvertible on this future date, it may be assumed that they will be priced identically on this date (if they aren’t then holders will simply convert en masse to the higher-priced issue). And since they will be priced identically on a given date in the future, any current difference in price must be offset by expectations of an equal and opposite value of dividends to be received in the interim. And since the dividend rate on one element of the pair is both fixed and known, the implied average rate of the other, floating rate, instrument can be determined. Finally, we say, we may compare these average rates and take a view regarding the actual future course of that rate relative to the implied rate, which will provide us with guidance on which element of the pair is likely to outperform the other until the next interconversion date, at which time the process will be repeated.

We can show the break-even rates for each FixedReset / FloatingReset Strong Pair graphically by plotting the implied average 3-month bill rate against the next Exchange Date (which is the date to which the average will be calculated).

Click for Big

The market appears to have a distaste at the moment for floating rate product; most of the implied rates until the next interconversion are lower than the current 3-month bill rate and the averages for investment-grade and junk issues are both below zero, at -0.66% and -0.07%, respectively! Whatever might be the result of the next few Bank of Canada overnight rate decisions, I suggest that it is unlikely that the average rate over the next five years will be lower than current – but if you disagree, of course, you may interpret the data any way you like.

Since credit quality of each element of the pair is equal to the other element, it should not make any difference whether the pair examined is investment-grade or junk, although we might expect greater variation of implied rates between junk issues on grounds of lower liquidity, and this is just what we see.

If we plug in the current bid price of the BAM.PR.R FixedReset, we may construct the following table showing consistent prices for its soon-to-be-issued FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to be cheap and trading below the price of their FixedReset counterparts. Therefore, I recommend that holders of BPO.PR.N continue to hold the issue and not to convert. I will note that, given the apparent cheapness of the FloatingResets, it may be a good trade to swap the FixedReset for the FloatingReset in the market once both elements of each pair are trading and you can – presumably, according to this analysis – do it with a reasonably good take-out in price, rather than doing it through the company on a 1:1 basis. But that, of course, will depend on the prices at that time and your forecast for the path of policy rates over the next five years. There are no guarantees – my recommendation is based on the assumption that current market conditions with respect to the pairs will continue until the FloatingResets commence trading and that the relative pricing of the two new pairs will reflect these conditions.

Note as well that conversion rights are dependent upon at least one million shares of each series being outstanding after giving effect to holders’ instructions; e.g., if only 100,000 shares of BPO.PR.N are tendered for conversion, then no conversions will be allowed; but if only 100,000 shares of BPO.PR.N will remain after the rest are all tendered, then conversion will be mandatory. However, this is relatively rare: all 39 Strong Pairs currently extant have some version of this condition and all but five have both series outstanding.

It will be recalled that BAM.PR.R will reset to 3.014% effective July 1.

Holders of BAM.PR.R have the option to convert to FloatingResets, which will pay 3-month bills plus 230bp on the par value of $25.00, reset quarterly. The deadline for notifying the company of the intent to convert is 5:00 p.m. (EDT) on June 15, 2016; but note that this is a company deadline and that brokers will generally set their deadlines a day or two in advance, so there’s not much time to lose if you’re planning to convert! However, if you miss the brokerage deadline they’ll probably do it on a ‘best efforts’ basis if you grovel in a sufficiently entertaining fashion. The ticker for the new FloatingReset, if it is created, will be BAM.PR.S.

The most logical way to analyze the question of whether or not to convert is through the theory of Preferred Pairs, for which a calculator is available. Briefly, a Strong Pair is defined as a pair of securities that can be interconverted in the future (e.g., BAM.PR.R and the FloatingReset that will exist if enough holders convert). Since they will be interconvertible on this future date, it may be assumed that they will be priced identically on this date (if they aren’t then holders will simply convert en masse to the higher-priced issue). And since they will be priced identically on a given date in the future, any current difference in price must be offset by expectations of an equal and opposite value of dividends to be received in the interim. And since the dividend rate on one element of the pair is both fixed and known, the implied average rate of the other, floating rate, instrument can be determined. Finally, we say, we may compare these average rates and take a view regarding the actual future course of that rate relative to the implied rate, which will provide us with guidance on which element of the pair is likely to outperform the other until the next interconversion date, at which time the process will be repeated.

We can show the break-even rates for each FixedReset / FloatingReset Strong Pair graphically by plotting the implied average 3-month bill rate against the next Exchange Date (which is the date to which the average will be calculated).

Click for Big

The market appears to have a distaste at the moment for floating rate product; most of the implied rates until the next interconversion are lower than the current 3-month bill rate and the averages for investment-grade and junk issues are both below zero, at -0.66% and -0.07%, respectively! Whatever might be the result of the next few Bank of Canada overnight rate decisions, I suggest that it is unlikely that the average rate over the next five years will be lower than current – but if you disagree, of course, you may interpret the data any way you like.

Since credit quality of each element of the pair is equal to the other element, it should not make any difference whether the pair examined is investment-grade or junk, although we might expect greater variation of implied rates between junk issues on grounds of lower liquidity, and this is just what we see.

If we plug in the current bid price of the BAM.PR.R FixedReset, we may construct the following table showing consistent prices for its soon-to-be-issued FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to be cheap and trading below the price of their FixedReset counterparts. Therefore, I recommend that holders of BAM.PR.R continue to hold the issue and not to convert. I will note that, given the apparent cheapness of the FloatingResets, it may be a good trade to swap the FixedReset for the FloatingReset in the market once both elements of each pair are trading and you can – presumably, according to this analysis – do it with a reasonably good take-out in price, rather than doing it through the company on a 1:1 basis. But that, of course, will depend on the prices at that time and your forecast for the path of policy rates over the next five years. There are no guarantees – my recommendation is based on the assumption that current market conditions with respect to the pairs will continue until the FloatingResets commence trading and that the relative pricing of the two new pairs will reflect these conditions.

Note as well that conversion rights are dependent upon at least one million shares of each series being outstanding after giving effect to holders’ instructions; e.g., if only 100,000 shares of BAM.PR.R are tendered for conversion, then no conversions will be allowed; but if only 100,000 shares of BAM.PR.R will remain after the rest are all tendered, then conversion will be mandatory. However, this is relatively rare: all 39 Strong Pairs currently extant have some version of this condition and all but five have both series outstanding.

Capstone Infrastructure Corporation has announced:

that it does not intend to exercise its right under the terms of its Cumulative 5-Year Rate Reset Preferred Shares, Series A (the “Series A shares”) to redeem all or part of the currently outstanding 3,000,000 Series A shares on July 31, 2016. As a result, subject to certain conditions, the holders of the Series A shares have the right to convert all or part of their Series A shares, on a one-for-one basis, into Cumulative Floating Rate Preferred Shares, Series B (the “Series B shares”) on August 2, 2016 (the “Conversion Date”) in accordance with the terms of the Series A shares.

Holders of Series A shares who do not exercise their right to convert their Series A shares into Series B shares on the Conversion Date will retain their Series A shares, subject to the conditions set out below.

The dividend rate applicable to the Series A shares for the five-year period from July 31, 2016 to but excluding July 31, 2021, and the dividend rate applicable to the Series B shares for the three-month period from July 31, 2016 to October 31, 2016, will be determined and announced by way of a news release on July 4, 2016.

Beneficial owners of Series A shares who wish to exercise their conversion right should communicate with their broker or other nominee to obtain instructions for exercising such right during the conversion period, which runs from July 4, 2016 until July 18, 2016 at 5:00 p.m. (EST).

The foregoing conversion rights are subject to the conditions, as set out in the terms of the Series A shares, that: (i) if Capstone determines that there would remain outstanding on the Conversion Date less than 1,000,000 Series B shares, after having taken into account all Series A shares tendered for conversion into Series B shares, then holders of Series A shares will not be entitled to convert their shares into Series B shares and all holders will continue to hold Series A shares, and (ii) alternatively, if Capstone determines that there would remain outstanding on the Conversion Date less than 1,000,000 Series A shares, after having taken into account all Series A shares tendered for conversion into Series B shares, then all remaining Series A shares will automatically be converted into Series B shares on a one-for-one basis on the Conversion Date and all holders will hold Series B shares. In either case, Capstone will give written notice to that effect to the registered holder of Series A shares no later than July 26, 2016.

I will report on the rate when determined and my recommendation for converting or holding in due course.

Standard & Poor’s has announced:

• •We believe Royal Bank of Canada’s (RBC) risk appetite has grown relative to peers’.
• •We are revising our outlook on RBC to negative from stable, reflecting credit quality metrics that have recently converged to the peer average and the risk that this may continue (or worsen).
• •We are affirming our ratings on the bank, including our ‘AA-/A-1+’ long- and short-term issuer credit ratings.
• •The negative outlook reflects RBC’s higher risk appetite and aggregate loan risk exposure relative to those of its peers.

…
“The outlook revision reflects concerns over what we see as RBC’s higher risk appetite, relative to peers’,” said S&P Global Ratings credit analyst Lidia Parfeniuk. “We see one example of this in its aggressive growth in loans and commitments in the capital markets wholesale loan book, particularly in the U.S., with an emphasis on speculative-grade borrowers, including exposure to leveraged loans. RBC also has higher-than-peer average exposure to the highly indebted Canadian consumer and to oil and gas-producing regions. These exposures, and potential future growth, in aggregate, could lead to higher loan losses than peers’.”

RBC’s U.S. wholesale loan portfolio has grown very rapidly. The growth has been, on average, 16% per year, adjusted for foreign exchange from 2010 through 2015. We believe that the emphasis has been on speculative-grade loans. We also believe the bank has been increasing risky exposure to improve risk-adjusted returns amid low interest rates.

Adding to the bank’s risk exposures is its higher-than-peers exposure to leveraged loans, which we view as a frothy segment within wholesale lending. We believe that while credit conditions have been benign over the last few years, they may begin to worsen, particularly in a rising-rate environment.
…
The outlook is negative. We could lower the rating over the next two years if RBC’s credit quality metrics remain at the peer average (or worse) for several quarters. This would most likely result in the issuer credit rating falling by one notch to ‘A+’, to reflect the higher risk profile. We could revise the outlook to stable if we were to see evidence that risk appetite is moderating and that credit quality metrics recover to a more favorable stance than the peer average.

Oddly, the press release made no reference to the ‘bail-in’ regime, which the agency has previously assigned a position of some importance and which has been endorsed by the new government, as discussed March 22, 2016.

Affected issues are: RY.PR.A, RY.PR.B, RY.PR.C, RY.PR.D, RY.PR.E, RY.PR.F, RY.PR.G, RY.PR.H, RY.PR.I, RY.PR.J, RY.PR.K, RY.PR.L, RY.PR.M, RY.PR.N, RY.PR.O, RY.PR.P, RY.PR.Q, RY.PR.R, RY.PR.W and RY.PR.Z.