Archive for January, 2007

Will PWF.PR.J be redeemed early?

Friday, January 26th, 2007

I had lunch today with an industry professional who expressed doubt over my fears (expressed by my according a high weight to Yield-to-Worst) that PWF.PR.J would be redeemed early. So, first, let’s look at the situation – the redemption schedule is:

Option Type Start End Strike
Redemption 2008-04-30 2009-04-29 26.000000
Redemption 2009-04-30 2010-04-29 25.750000
Redemption 2010-04-30 2011-04-29 25.500000
Redemption 2011-04-30 2012-04-29 25.250000
Redemption 2012-04-30 INFINITE DATE 25.000000
Retraction 2013-07-31 INFINITE DATE 26.040000

Since the closing quote on January 25 was $26.82-88, this give rise to the following information from the pseudoPortfolioReportBox:

PWF.PR.J Scenario Analysis
Event Date YTM Restricted YTM Probability
Call 2008-05-30 2.09 % 2.09 % 42.74 %
Soft Maturity 2013-07-30 3.45 % 3.45 % 57.26 %

Perhaps the exact dates, third decimal places and probabilities are arguable, but I think the basic facts above can be agreed by all practitioners.

So, in the HIMIPref™ analysis, the Yield-to-Worst is given a large weight in the REWARD_CLASS_YIELD component of valuation. In addition, the issue is tagged with the tradeSizeCalculationNotes tag of “14” indicating

If pseudoModifiedDurationWorstBid is less than minWorstBidPseudoModifiedDurationBuy, buySize and sellSize are set to 0.

Therefor, HIMIPref™ will not, given current market conditions, recommend the purchase of PWF.PR.J, since the internal calculateTradeSize function will always return a buySize of zero.

My companion said this is a load of hooey. PWF.PR.J has the lowest annual dividend of any of the Power Financial issues and therefore, if they redeem anything, it will be something else. Therefor, investors may assess this issue on the basis that it will survive until its softMaturity … maybe with an allowance for the risk of an early call, to be sure, but the default case is a pre-tax yield of 3.45% until 2013.

Well – I disagree. By me, the worst case is the default case. Remember, a pessimist is an optimist with experience. But let’s look at some details:

First: I agree that PWF.PR.J has the lowest coupon of any PWF issue … readers may confirm this by looking at the appropriate rows of the table on prefInfo. But let’s have a look at some of the details of these issues:

PWF Preferreds
Ticker Coupon Issue Type
PWF.PR.A $1.05 Perpetual Floater
PWF.PR.D $1.30 Retractible
PWF.PR.E $1.375 Perpetual
PWF.PR.F $1.3125 Perpetual
PWF.PR.G $1.475 Perpetual
PWF.PR.H $1.4375 Perpetual
PWF.PR.I $1.50 Perpetual
PWF.PR.J $1.175 Retractible
PWF.PR.K $1.2375 Perpetual
PWF.PR.L $1.275 Perpetual

Now … first off, let’s just guess that PWF could sell new retractibles with a $0.90 coupon. This looks kind of skimpy, but consider the CGI.PR.C, issued last March with a $0.975 coupon, and MFC.PR.A, trading to yield 3.13%, and of course the yield-to-retraction on the PWF.PR.J themselves of 3.45%. In light of this, a coupon of $0.90 on a new retractible doesn’t look all that much out of place.

New perpetuals … well, Sunlife, an equally rated credit (by DBRS) is in the process of selling (or has sold, depending on the terms of their underwriting!) perpetuals with a coupon of $1.125.

If, instead of looking at the gross coupon on PWF’s preferreds, one looks at the savings achievable by refinancing with an issue of similar characteristics, then a lot of the PWF.PR.J cheapness to the issuer disappears.

And that is still not the end of the story! When we look at the Annual Report for 2005, we find a note that regular readers will have got thoroughly sick and tired of by this time:

Effective for fiscal years beginning on or after November 1, 2004, CICA 3860, Financial Instruments — Disclosure and Presentation was amended to require obligations that an entity must or can settle by issuing a variable number of the issuer’s own equity instruments to be presented as liabilities rather than equity. On January 1, 2005, the Corporation adopted the amended standard retroactively with restatement of prior periods. Some of the Corporation’s ($300 million) preferred shares were reclassified from Shareholders’ equity and some of the subsidiaries’ ($1,366 million) preferred shares were reclassified from Non-controlling interests to Liabilities and the associated preferred dividends were reclassified to Financing charges in the Consolidated Statements of Earnings. The change does not have any impact on earnings per share or net earnings available to common share holders since preferred share dividends were previously deducted from net earnings in determining net earnings  available to common shareholders.

The moral of the story being: for reporting purposes, PWF.PR.J is a BOND, not a component of equity, and will get lumped in with bonds when reporting the all important coverage ratios.

So let’s have a look at some bonds. The Great-West Lifeco bond, 6.14% of March 2018, is currently indicated at a spread of 68bp over the Canada 4% 2016. The Canada 4% 2016 are (or were, anyway, at the time the indications I’m reading were prepared) trading to yield 4.208%, so we can say the GWL bonds of 2018 are trading to yield, oh, call it 4.90%.

Now … the important thing about preferred dividends is that the company has paid tax on them. This is an area in which I will not pretend to any great expertise, but let’s just assume, for the sake of an argument, that the company’s average tax rate (disclosed in Note 8 of their annual report) of 26% is equal to the marginal rate they would save if they magically converted the dividends on their retractibles to interest on bonds and were entitled to deduct it. We’ll make this a more familiar by calculating 1/(1-0.26) = 1.35 and calling this the equivalency factor … fortunately, this is pretty close to the Equivalency Factor for Fat Cat Ontarians of 1.4x that I normally use for illustrative purposes.

So … getting back to PWF.PR.J … commencing 2008, the company will, effectively, be borrowing $25.00 at an annual rate of a dividend of $1.175, less the annual saving (a reduction in deemedDividend to the shareholder, so I presume it costs the company extra as well) of $0.25, for a net cost of $0.925. This is an annual rate of 3.7. Multiply by the company’s equivalency factor of 1.35x and this is the equivalent, as far as their treasury department is concerned, of 5%.

AND, I’ll point out, the pref will only be 4-year money. They can issue 10-year paper for 4.90%. You are the treasurer. What do you do?

So, let me summarize my position on PWF.PR.J:

  • Since it is retractable, the proper benchmark as far as the company concerned is a bond, not other prefs.
  • 10-year bonds can be issued at a net cost lower than the 4-year pref
  • At the very least, the chance that the PWF.PR.J holder will get called early and experience the worst-case scenario is significant.
  • Analysis, schmanalysis. We’re fixed income investors here, and we hate risk, especially risks that depend on the day-to-day tone of the market and decisions made on the basis of an individual company’s capital structure
  • There are issues out there that carry significantly more yield
  • Even if we know, absolutely for certain, that the issue will hang on until the day before retraction, the yield is only 3.45%. At an equivalency factor of 1.4, this is an interest-equivalent of 4.83%.
  • Why don’t we simply buy a bond that yields this much, that has better credit protection? Just because the PWF.PR.J is classed as a bond-equivalent for balance sheet purposes, we don’t move closer to the front of the line if the company runs into trouble.

New Issue : Sun Life 4.50% Perpetuals

Thursday, January 25th, 2007

Sun Life Financial has announced that they will be issuing a new series of perpetual preferreds, Series 5.

The dividend rate is 4.50% and the expected closing date is February 2. The redemption schedule is:

Sun Life 4.50% Perp Ser 5 Redemption Schedule
From To Price
2012-3-31 2013-3-30 $26.00
2013-3-31 2014-3-30 $25.75
2014-3-31 2015-3-30 $25.50
2015-3-31 2016-3-30 $25.25
2016-3-31 INFINITE DATE $25.00

It seems rather odd that the dividend rate is the same as on the recent bank issues despite the slightly lower credit on Sunlife: it’s rated P-1(Low) by S&P, Pfd-1(low) by DBRS.

An interesting feature of the terms is that there is a Mandatory Non-Payment of Dividends in the event that the Minimum Continuing Capital and Surplus Requirements (“MCCSR”) ratio of Sun Life Assurance Company of Canada was less than 120% at the end of the preceding quarterly financial reporting period. Another measure of financial strength to attempt to understand and worry about! According to their 2005 Annual Report, this ratio was:

MCCSR Ratio, Historical pro-forma
2003 232%
2004 238%
2005 216%

According to the same document:

Sun Life Assurance continues to be subject to the MCCSR required capital for a life insurance company in Canada. OSFI generally expects life insurance companies to maintain a minimum MCCSR of 150% or greater, based on the risk profile of the relevant insurance company. Sun Life Assurance’s MCCSR ratio as at December 31, 2005 well exceeded the levels that would require any regulatory or corrective action. Additional details concerning the calculation of available capital and MCCSR are included in the 2005 AIF of SLF Inc. under the heading “Regulatory Matters”.

So it would seem that long before there was a Mandatory Non-Payment of Dividends the company’s name would be all over the front page anyway. But it is another thing that has to be reviewed!

Update: Forgot to give the size! Ten million shares @ $25.

Update & Bump: Here’s a comparison of some curve prices:

Curve Price Analysis by Taxable Curve
Component SLF.PR.? SLF.PR.D BNS.PR.L
Price due to base-rate 23.16 23.05 23.15
Price due to short-term 0.04 0.04 0.04
Price due to long-term 0.58 0.58 0.59
Price due to Liquidity 1.45 1.44 1.49
Price due to error 0.02 0.02 -0.03
Price due to Credit Spread (Low) -0.52 -0.52 0.00
Curve Price 24.73 24.61 25.24
Other Data  
Annual Dividend 1.125 1.1125 1.125
1/25 Closing Quote Issue Price 25.00 24.71-75 25.05-07

January 25, 2007

Thursday, January 25th, 2007
Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.01% 4.03% 27,427 17.38 1 +0.2405% 1,036.2
Fixed-Floater 4.74% 3.03% 73,250 8.20 7 +0.2887% 1,049.8
Floater 4.54% -23.4% 61,674 4.16 4 +0.1669% 1,048.6
Op. Retract 4.68% 2.20% 80,508 2.00 17 -0.0086% 1,031.1
Split-Share 5.05% 0.06% 377,084 2.83 11 -0.0259% 1,045.5
Interest Bearing 6.70% 5.94% 72,374 4.49 6 +0.0493% 1,035.5
Perpetual-Premium 5.01% 3.79% 266,212 5.54 56 -0.0649% 1,051.8
Perpetual-Discount 4.50% 4.52% 1,453,490 16.34 5 -0.1763% 1,055.4
Major Price Changes
Issue Index Change Notes
BC.PR.C FixedFloater +1.9335%  
Volume Highlights
Issue Index Volume Notes
BNS.PR.L PerpetualPremium 229,110 Recent new issue. Now with a pre-tax bid-YTW of 4.49% based on a bid of $25.05 and a call 2016-5-27 at $25.00.
RY.PR.E PerpetualDiscount 116,736 Recent new issue. Now with a pre-tax bid-YTW of 4.52% based on a bid of $24.99 and a limitMaturity.
GWO.PR.X OpRet 79,013 RBC crossed 75,000 at $27.65. Now with a pre-tax bid-YTW of 2.42% based on a bid of $27.61 and a call 2009-10-30 at $26.00. I had my rant about this yesterday and even updated my evidence, so I’ll give it a rest for now.
GWO.PR.H PerpetualPremium 59,800 Now with a pre-tax bid-YTW of 4.44% based on a bid of $25.80 and a call 2014-10-30 at $25.00.
BMO.PR.J PerpetualDiscount 58,190 Recent new issue. Now with a pre-tax bid-YTW of 4.52% based on a bid of $24.99 and a limitMaturity.

There were fourteen other “$25 p.v. equivalent” index-included issues with over 10,000 shares traded today.

Novel Redemption Terms for Copernican International Financial Split Corp.

Thursday, January 25th, 2007

This is an otherwise unremarkable split share issue investing in international financial companies.

One of the great headaches for those who invest in the Capital Units of Split-share companies is the immediate drop in NAV on issue – all issue costs come out of their part of the investors, while the preferred shareholders sit back and grin. This, I believe, is one reason why the terms on the Preferred Share portion of these offerings is both so good and restricted to those who also buy capital units … if there’s a fat coupon on the preferred, it should rise in price instantly on issue day and therefore give the investors something, at least, to smile about.

In this issue – Copernican filed a prospectus today – the situation is a little different. Issue expenses estimated to be $750,000 as well as the selling commission of 4.25% of the total raised will be paid by the manager.

They’re not doing this just for their health, of course. The manager will be getting a fee of 1.95% and will be compensated by the company for the service fee of 0.40% of the Capital Unit Value that they will pass on to the agents. And – just to make sure that everybody’s good and locked in – there’s a redemption fee payable to the MANAGER (not the company!) that starts a $1.05 per $20 unit (over 5%!) and declines until it is $0.55 per unit (still 2.75% of original investment!) in June 2013. Then it’s zero for the last six months of the fund’s life.

Deferred Sales Charges come to the split share world!

Still – there won’t be that instant drop in NAV as soon as the Capital Units start trading! That will be meaningful to some.

Unless hounded by vast crowds of importunate clients, I won’t be adding this particular split-share corporation preferred issue to the HIMIPref™ database. The fact that pref holders will only get their original $10 back on any redemptions means that even a small increase in price will lead to a negative YTW and the YTW scenario will always be sufficiently short-term that the system won’t want to trade it.

It would certainly be possible to improve the programme so that the disincentive for early redemptions was recognized … somehow … but until there are a lot of issues like this it hardly seems worth the effort. I will be watching this issue with great, if informal, interest.

HIMI Preferred Indices : June, 1997

Thursday, January 25th, 2007

All indices were assigned a value of 1000.0 as of December 31, 1993.

HIMI Index Values 1997-06-30
Index Closing Value (Total Return) Issues Mean Credit Quality Median YTW Median DTW Median Daily Trading Mean Current Yield
Ratchet 1,492.1 0 0 0 0 0 0
FixedFloater 1,504.6 6 2.00 3.91% 16.7 534M 5.18%
Floater 1,405.0 7 1.70 3.55% 17.9 62M 3.83%
OpRet 1,306.4 29 1.24 4.59% 4.6 96M 6.30%
SplitShare 1,301.7 2 1.50 5.46% 5.2 100M 5.47%
Interest-Bearing 1,306.4 0 0 0 0 0 0
Perpetual-Premium 1,211.2 4 1.00 2.85% 2.1 99M 7.94%
Perpetual-Discount 1,156.3 0 0 0 0 0 0

Index Constitution, 1997-06-30, Pre-Rebalancing

Index Constitution, 1997-06-30, Post-Rebalancing

GWO.PR.E, GWO.PR.X Issuer Bid

Thursday, January 25th, 2007

Great-West has an issuer bid outstanding for

GWO Issuer Bid (Prefs)
Ticker Outstanding Bid for
GWO.PR.E 7,978,900 790,000
GWO.PR.X 22,282,215 2,000,000

These are both retractible and, as stated in their 2005 Annual Report:

The adoption of the amendments to the CICA Handbook section on Financial Instruments – Disclosure and Presentation … resulted in the reclassification of the Series D, 4.70% Non-Cumulative First Preferred Shares [GWO.PR.E, jh] and the Series E, 4.80% Non-Cumulative First Preferred Shares to liabilities.

So, they’re being bought back because they’re bond-like for balance sheet purposes. Unlike many Issuer Bids, this one actually has some meaning: 368,200 of the GWO.PR.X disappeared from the balance sheet from 2004 to 2005, as did 21,100 of the GWO.PR.E.

Not the biggest news to roil the markets, but it’s interesting.

Update & Bump : In their third quarter, 2006, financials, Great-West stated:

During the nine months ended September 30, 2006, 1,077,700 Series E 4.80% Non-Cumulative First Preferred Shares [GWO.PR.X … JH] were purchased pursuant to the Company’s Normal Course Issuer Bid for a total cost of $30 [million … JH] or an average of $27.37 per share. The price in excess of stated value was charged to income.

January 24, 2007

Wednesday, January 24th, 2007
Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.02% 4.05% 28,553 17.35 1 -0.2000% 1,033.8
Fixed-Floater 4.75% 3.10% 73,316 8.39 7 -0.0713% 1,045.8
Floater 4.55% -21.75% 60,753 4.17 4 0.2060% 1,046.8
Op. Retract 4.68% 2.22% 79,864 2.00 17 0.0268% 1,031.2
Split-Share 5.05% -0.17% 380,567 2.83 11 +0.0457% 1,045.8
Interest Bearing 6.71% 5.96% 73,335 4.49 6 -0.0522% 1,035.0
Perpetual-Premium 5.01% 3.75% 268,696 5.54 56 +0.0511% 1,052.5
Perpetual-Discount 4.50% 4.52% 1,460,388 16.36 5 +0.0966% 1,057.2
Major Price Changes
Issue Index Change Notes
There were no index-included issues with major price moves today.
Volume Highlights
Issue Index Volume Notes
BNS.PR.L PerpetualPremium 387,831 New issued settled today. Now with a pre-tax bid-YTW of 4.48% based on a bid of $25.07 and a call 2016-5-27 at $25.00.
BMO.PR.J PerpetualDiscount 85,975 Recent new issue. Now with a pre-tax bid-YTW of 4.52% based on a bid of $24.97 and a limitMaturity.
GWO.PR.X OpRet 67,482 Now with a pre-tax bid-YTW of 2.44% based on a bid of $27.60 and a call 2009-10-30 at $26.00. Buyers are obviously hoping for the softMaturity at $25.00, 2013-9-29, which yields 3.14% pre-tax (still no great shakes compared to normal bonds, bond-equivalent is only 4.40% at the Ontario Equivalency Factor of 1.4x), but why? Great-West has already demonstrated its willingness to pay market prices to retire this issue.
RY.PR.E PerpetualDiscount 66,162 Recent new issue. Now with a pre-tax bid-YTW of 4.51% based on a bid of $25.00 and a limitMaturity.
RY.PR.W PerpetualPremium 59,085 Global crossed 26,800 for cash at $26.66, then crossed the same number for regular settlement at $26.35. Mr. Calculator says that’s a difference of $0.31, and RBC says it went exDividend 1/23, for $0.30625. I’m glad all that’s cleared up! Now with a pre-tax bid-YTW of 4.12% based on a bid of $26.14 and a call 2014-3-26 at $25.00. I say it’s appallingly expensive, that’s what I say.

There were eleven other “$25 p.v. equivalent” index-included issues with over 10,000 shares traded today.

BNS.PR.L Gets a Solid Reception

Wednesday, January 24th, 2007

BNS.PR.L commenced trading today, after having been announced January 8. Scotia announced today that the underwriters’ over-allotment privilege had been exercised to the tune of 1.8 million shares, bringing the total size of the issue to 13.8 million shares valued at $345-million.

The issue traded a healthy 387,831 shares in a range of 24.98-08. The closing quotation was 25.07-09, 67×50.

There may be a little more value left in this issue, as HIMIPref™ calculates a curvePrice of $25.26:

Curve Price Comparison
After-tax Curve
Component BNS.PR.L BNS.PR.K
Price due to base-rate 23.19  24.07
Price due to short-term 0.04  0.04
Price due to long-term 0.57  0.58
Price due to Liquidity 1.50  0.67
Price due to error -0.03  -0.01
Curve Price 25.26 25.34
Closing Quote 25.07-09  25.91-97
Annual Dividend 1.125 1.200
Yield-to-Worst (Pre-Tax)  4.48%  4.24%
Yield-to-Worst (Post-Tax) 3.56%  3.37%
YTW Call-Date 2016-05-27  2014-05-28

The securityCode for this issue is A41009, replacing the preIssue code of P75004. A reorgDataEntry has been created to reflect this change.

The issue has been added to the “PerpetualPremium” Index as of 1/24.

HIMI Preferred Indices : May, 1997

Wednesday, January 24th, 2007

All indices were assigned a value of 1000.0 as of December 31, 1993.

HIMI Index Values 1997-05-30
Index Closing Value (Total Return) Issues Mean Credit Quality Median YTW Median DTW Median Daily Trading Mean Current Yield
Ratchet 1,482.8 0 0 0 0 0 0
FixedFloater 1,465.5 5 2.00 3.83% 17.1 513M 5.20%
Floater 1,396.3 7 1.70 3.53% 17.8 70M 3.83%
OpRet 1,287.2 28 1.21 4.46% 4.5 97M 6.31%
SplitShare 1,283.2 1 2.00 5.33% 5.3 135M 5.64%
Interest-Bearing 1,287.2 0 0 0 0 0 0
Perpetual-Premium 1,198.6 4 1.00 3.30% 2.2 132M 7.98%
Perpetual-Discount 1,144.3 0 0 0 0 0 0

Index Constitution, 1997-05-30, Pre-Rebalancing

Index Constitution, 1997-05-30, Post-Rebalancing

Research : Interest-Bearing Preferreds

Wednesday, January 24th, 2007

Preferred securities are issues that are similar to preferred shares in most respects – except that they pay interest rather than dividends. While conditions for issuance of these shares are no longer as favourable as during their vogue, a number of issues still exist and may be of interest to RRSP investors. I’ve written an introduction to this type of preferred share:

Look for the Research Link!

The current portfolio evaluation for the draft Interest-Bearing index is here.