PrefBlog

It’s not a preferred share issuer – but it’s a sign of the times:

DBRS has today downgraded the Issuer Rating of Torstar Corporation (Torstar or the Company) to BBB (low) from BBB. The trend is Stable and the rating is no longer Under Review with Negative Implications. The downgrade reflects DBRS’s view that Torstar’s earnings profile has been structurally affected by a consumer shift to digital forms of media as the Company has struggled to sustain organic revenues and profitability. The new rating also reflects DBRS’s view that weakening demand will continue to place pressure on the Company’s revenues, margins and cash flow generation going forward. DBRS’s concern is not based primarily on the Company’s debt level, as Torstar has remained prudent in terms of financial management, but rather the Company’s income and cash-generating prospects.

There’s an interesting conflict of trends in consumer borrowing:

Overall non-mortgage debt loads continued to increase during the third quarter, up 1.8 per cent from the same quarter of last year, the credit-monitoring firm [Equifax Canada] said in its latest Quarterly Credit Trends Report released Tuesday. However, only 1.22 per cent of debts were unpaid after 90 days or more in the July-September quarter.

That’s down sharply from 1.37 per cent in the previous quarter and the lowest delinquency rate on record going back to early 2007, before the recession began.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 13bp, FixedResets off 1bp and DeemedRetractibles winning 15bp. Volatility was average. Volume was average.

The US Treasury’s divestment of AIG is proceeding rapidly:

American International Group (AIG), the bailed-out insurer/ex-pyromaniac at the epicenter of the global financial meltdown, just posted a $1.86 billion quarterly profit, compared with the $4 billion loss it registered last year. The stat that most matters: Uncle Sam now owns just 16 percent of the company, with a complete disposal of its stake likely by the end of the year. The U.S. Treasury Department has recently been offloading hundreds of millions of shares—it sold $20.7 billion worth in September—after having owned as much as 92 percent of AIG in the wake of a government bailout that ballooned to $182 billion, including aid from the Federal Reserve Bank of New York.

If you’re to believe Treasury’s math—no small controversy there—taxpayers actually are in the black from the bailout. The U.S. profits off anything sold above its stated bailout per-share cost basis of $28.73, according to bank Drexel Hamilton. AIG stock now changes hands at $33, having surged 43 percent this year. That is less than half its book value (a measure of its assets minus liabilities) of just under $70 a share. The more of itself AIG repurchases from the government—and the more its business evolves back into bread-and-butter property-casualty, life insurance, and investing—the more it is thought its stock will approximate that book value. “The government ownership has been a real overhang for the company,” said Josh Stirling of Sanford Bernstein (AB), ahead of the quarterly earnings report.

Mind you, there are significant gimmicks in the numbers:

One point of contention is Treasury’s decision to allow AIG—along with TARP recipients Citigroup (C) and Ally Financial—to use operating losses from previous years to eliminate taxes on current income. The allowance, which typically does not apply to bankrupt or acquired companies, added $17.7 billion to AIG’s fourth-quarter earnings and will allow the company to shield profits from taxes for many years to come. “It’s important to remember that a substantial portion of AIG’s recent earnings were attributable to Treasury’s unilateral decision to preserve AIG’s net operating losses,” says J. Mark McWatters, a law professor at Southern Methodist University who was a Republican appointee to the TARP oversight committee.
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Barofsky calls the price [that Treasury quotes as its acquisition cost] “a political manipulation of numbers.” He argues the calculation shouldn’t include 563 million AIG shares that Treasury received from the Federal Reserve in January 2011 because the shares were not acquired as part of the TARP program. Removing those shares from the calculation would lift Treasury’s per-share cost to $43.53, which means TARP would show a $16 billion loss if Treasury sold the rest of its holdings at $29.

Still, even if we give full weight to the carping, the AIG bailout has been much less expensive than Government Motors:

U.S. taxpayers kept the nation’s largest auto maker by sales afloat with a $50 billion bailout in 2009 and now own 26.5% of the Detroit company.
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Earlier this summer, GM floated a plan with Treasury officials to repurchase 200 million of the roughly 500 million shares the U.S. holds in the auto maker, according to people familiar with the discussions. Under the plan, Treasury would sell the remaining shares through a public stock offering.

But Treasury officials aren’t interested in GM’s offer at the current price and aren’t in a rush to offload shares, according to people familiar with the matter. The biggest reason: A sale now would leave the government with a hefty loss on its investment.

At GM’s Friday share price of $24.14, the U.S. would lose about $15 billion on the GM bailout if it sold its entire stake. While GM stock would need to reach $53 a share for the U.S. to break even, Treasury officials would consider selling at a price in the $30s, people familiar with the government’s thinking have said.
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Last month, the Obama administration increased the estimated loss on the $85 billion auto industry bailout, which also included aid to crosstown rival Chrysler Group LLC and auto parts suppliers, by $3 billion to more than $25 billion. That amount is still smaller than the government’s initial estimate of a $44 billion loss. Chrysler is already free and clear from its government bailout after taking out a loan to pay back what it owed.
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The U.S. is still in the red on its investments in Fannie Mae and Freddie Mac, which have received $188 billion in taxpayer support.

How’s this for bad management? Rochdale Securities levered up 300:1 on Apple common:

Rochdale Securities LLC, the brokerage that employs bank analyst Dick Bove, is in advanced talks to save the firm after unauthorized trades in Apple Inc. (AAPL) went sour, said two people with knowledge of the negotiations

The potential deal to recapitalize Stamford, Connecticut- based Rochdale would be a merger or investment and may be announced as early as today, said the people, who requested anonymity because the talks are private. The deal for the 37- year-old firm could still fall apart, one of the people said.

Rochdale, led by President Daniel J. Crowley, has told potential investors that a trader made an unauthorized purchase last month of $750 million to $1 billion in Apple shares, which dropped in value and depleted capital at closely held Rochdale, the people said.

The firm had $3.44 million of capital at the end of last year, according to a filing with the U.S. Securities and Exchange Commission. Crowley didn’t immediately return phone calls seeking comment on the firm’s status.

There are rumours of naughtiness:

A person familiar with the thinking of Rochdale executives said a trader at the firm received an order for stock in Apple Inc. … but bought 1,000 times the number of shares requested. The trader is saying the extra shares were ordered by mistake, the person said, but the firm is alleging the actions were intentional. The company suspects the trader was working with an outside party to execute the trade and profit at the firm’s expense, according to this person.

Despite all the sound and fury over credit ratings, it looks like the ECB doesn’t do its own credit analysis. What a surprise.

The European Central Bank is investigating claims that it used a high credit rating from a Canadian ratings agency to grant loans to Spanish banks at a sweetheart rate that was not offered to another struggling euro zone country.

An ECB spokesman on Frankfurt, Philippe Rispal, said the bank is “currently investigating this matter” and that the probe would determine whether “the correct haircut has been applied” to the Spanish sovereign bonds that were used as collateral for ECB loans.

The term “haircut” refers to varying discounts applied to the collateral based on its credit quality. On the weekend, the German newspaper Die Welt am Sonntag said that about €80-billion ($102.3-billion U.S.) of Spanish treasury bills posted as collateral received only a 0.5 per cent haircut when a 5.5 per cent haircut would have been more appropriate, given Spain’s rising sovereign risks.

The newspaper said the ECB relied on the relatively high Spanish rating produced by Toronto’s DBRS in determining its collateral requirements. DBRS has assigned an A-low rating, with “negative trend” on all of Spain’s public sovereign debt. The other three ratings agencies – Fitch, Standard & Poor’s and Moody’s – have a lower single-B rating on the 18-month T-bills that were posted as collateral by the Spanish banks (DBRS rates the country, not the individual securities).

DBRS’s rating for Ireland is the same as its rating for Spain. Yet Die Welt said the Irish bonds used as ECB collateral were subject to a 5.5 per cent haircut, meaning the ECB apparently considered them much riskier than the Spanish collateral in spite of the identical country rating.

DBRS has released a new methodology titled DBRS Criteria: Preferred Share and Hybrid Criteria for Corporate Issuers (Excluding Financial Institutions). Not much of interest, but there are a few nuggets:

Rate Reset Preferred Shares
Cumulative redeemable preferred shares featuring rate reset provisions are prevalent in Canada. While having no stated maturity, these securities feature a rate reset mechanism, combined with the option to redeem (both typically occurring every fifth year). The redemption option and rate reset are not viewed as impediments to garnering high levels of equity treatment if (1) the reset spread, set at the time of initial issuance, is not viewed as onerous on a basis relative to market, and would therefore not be expected to be a major incentive to redeem (while this is subjective, as an issuer’s credit spread will change over time due to both market- and company-specific factors, DBRS will compare an issuer’s reset spread to its peer group to assess its potential to impact future actions) and (2) DBRS has a high degree of confidence that the securities will remain a permanent part of the issuer’s capital structure.

Preferred Share Default
A preferred share is only assigned a “D” rating (for default) when the security is in default according to the legal documents. As such, the non-payment of a dividend does not necessarily give rise to the assignment of a default rating. When preferred dividends are not declared, the preferred share rating will likely be downgraded by a minimum of one notch to refl ect the non-payment situation. Further downgrades may occur, should the overall ratings for the organization be downgraded as a result of a negative situation that relates to the decision not to pay preferred share dividends. In addition, DBRS may consider additional downward notching of the preferred share rating to refl ect concerns related to either (1) the expectation that non- payment of dividends may continue for several more quarters or (2) the probability of a future default, as defined in the legal documents, which could occur without any defaults of higher rated securities, including coercive exchange offers.

Cumulative vs. Non-Cumulative
Whether a security is cumulative or non-cumulative does not generally have a large impact on treatment and has no impact on ratings. While a non-cumulative security is more beneficial for an issuer, in that missed payments to do not have to be made up in the future, DBRS views this as a modest factor for equity treatment, as an issuer may be more hesitant to miss a payment on a non cumulative security given potential consequences, as already noted.

Additionally, the rating itself is generally rather indifferent to cumulative vs. non-cumulative, given the minimal difference in expected recovery.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums off 3bp, FixedResets up 6bp and DeemedRetractibles gaining 1bp. Volatility was minimal. Volume was very low.

There was a good US jobs number:

American employers added more workers than forecast in October and a rush of people entering the labor force pushed the jobless rate higher, according to the last report on the labor market before next week’s presidential election.

Broad-based gains in employment — from car dealers and hospitals to factories and construction sites — indicate consumers are likely to spend more freely and shore up the three-year expansion in the face of a global economic slowdown and political gridlock in Washington over taxes and spending.

Hiring increased by 171,000 workers after a 148,000 gain in September that was bigger than first estimated, Labor Department figures showed today in Washington. October’s increase exceeded the most optimistic forecast in a Bloomberg survey with a median projection of a 125,000 gain. Unemployment rose to 7.9 percent.

Federal Reserve Bank of San Francisco President John Williams spoke in defense of QE3 today:

Concern that large-scale asset purchases “might ignite a bout of inflation” are unwarranted because price increases are being held in check by elevated unemployment and an economy that “isn’t operating at full speed,” Williams said.

“Unemployment is — and should be — a central focus of monetary policy right now,” Williams said. “This concentration on getting unemployment down in no way represents a lessening of the importance of price stability,” he said, adding that inflation may slow well below the Fed’s 2 percent goal if the U.S. recovery falters.

Williams said central bank purchases of bonds will help spur U.S. economic growth to 2.5 percent next year and 3.5 percent in 2014 while not fueling inflation.

“Our policy measures are having the desired effects,” Williams said today in remarks prepared for a speech in Salt Lake City. “We have substantial scope to use monetary policy to stimulate the economy without creating too much upward pressure on prices.”

It was a modestly good day for the Canadian preferred share market, with PerpetualPremiums up 9bp, FixedResets flat and DeemedRetractibles gaining 8bp. Volatility was at normal levels, all to the upside with a preponderance of insurance issues. Volume was below average.

Today we had a demonstration of the Law of Conservation of Hardware Manufacturers. RIM had a good day:

RIM shares rallied 10 per cent on Thursday, as of late afternoon, sending them to their highest level since July. The jump followed an update on its BlackBerry 10 device on Wednesday: RIM is testing the new smartphone among 50 wireless carriers, marking a big step toward launching the product early next year – likely some time between January and April.

Scott Anthony of Bloomberg has some colour on why RIM isn’t dead yet:

RIM’s proprietary network and tightly interconnected system allow it to use data incredibly efficiently. Here’s one illustration. The other week I was on an 18-hour flight between Newark and Singapore. Singapore Airlines has started rolling out Internet connectivity on this flight. It isn’t cheap, running $1 per megabyte of data. I didn’t dare turn on my iPhone, or open up Outlook, but I thought going to Web mail would be safe. 15 minutes later I had a $15.30 bill. Then I remembered the Blackberry in my bag. I connected it to the WiFi network, and had roughly 14 hours of email connectivity. By the end of the trip my bill had gone from $15.30 to $15.45.

… and Sharp had a bad one:

Sharp Corp. (6753), the world’s worst- performing major stock, dropped in Tokyo trading after forecasting a record $5.6 billion full-year loss and saying there is “material doubt” about its ability to survive.

The shares fell as much as 5.3 percent to 160 yen and changed hands at 163 yen as of 10:00 a.m., extending this year’s decline to 76 percent, the worst performer among more than 1,600 companies in the MSCI World (MXWO) Index.

Sharp follows Panasonic Corp. (6752) in predicting losses worse than analysts estimated after losing ground to Samsung Electronics Co. (005930) in TVs. Sharp has failed to win a planned 67 billion-yen ($835 million) investment from Taiwan’s Foxconn Technology Group and has had difficulty selling commercial paper as it burns through cash.

Samsung is eating everybody’s lunch … for now:

Samsung Electronics Co. (005930), the world’s biggest maker of TVs and mobile phones, reported record profit that beat analysts’ estimates and forecast intensifying competition as the global economy slows.

Net income in the three months ended Sept. 30 rose 91 percent to 6.56 trillion won ($6 billion), the Suwon, South Korea-based company said in a statement today. That compares with the 6.25 trillion-won average of 27 analyst estimates compiled by Bloomberg.

Operating profit from telecommunications more than doubled as Samsung’s Galaxy devices widened their lead over Apple Inc.’s iPhone. Samsung shares dropped amid concern growth in smartphone demand may have peaked after Apple (AAPL) reported earnings that missed estimates and Microsoft Corp. released its Surface tablet, escalating competition for mobile devices.

There’s some bad news for Canadian capital spending:

Suncor Energy Inc.’s three major oil sands projects are facing delays as soaring costs and competitive oil markets force the energy giant to join the growing ranks of Canadian resource companies pulling back from expensive growth plans.

Canada’s largest oil company said its planned Voyageur upgrader is “struggling” to make financial sense, its undeveloped Fort Hills bitumen mine has likely been delayed by about a year, and the timetable for its Joslyn mine remains up in the air. As Suncor reviews the economics of all three projects, it sliced its 2012 budget by 11 per cent.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums down 8bp, FixedResets off 2bp and DeemedRetractibles gaining 3bp. Volatility picked up a little, but it’s still pretty quiet! Volume was a little below average.

It has been a good year for corporate bond issuance:

Corporate bond sales surged to $3.3 trillion this year, challenging the record in 2009, as investors sought higher-yielding alternatives to government securities and companies took advantage of borrowing costs at all-time lows.

General Electric Co. (GE), the biggest maker of power-generation equipment, led issuers this month with a $7 billion bond offering, according to data compiled by Bloomberg. Along with software provider Oracle Corp. (ORCL)’s $5 billion sale, they paced $347 billion of bond issuance in October, a record for the month, and left sales about $116 billion shy of the $3.4 trillion reached by this time three years ago.
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Yields on bonds sold by companies around the world fell to a record 2.676 percent on Oct. 15 from 3.981 percent at the end of last year, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index.

In the spirit of Hallowe’en, here’s an illustration from an absolutely fascinating article titled Animal Mind Control:

DBRS confirmed Valener at Pfd-2(low) (VNR.PR.A):

DBRS has today confirmed Valener Inc.’s (Valener) Cumulative Rate Reset Preferred Shares, Series A at Pfd-2 (low), with a Stable trend. The rating is based on the credit quality of Valener’s 29%-owned Gaz Métro Limited Partnership (GMLP), which guarantees the First Mortgage Bonds (rated “A” by DBRS) of Gaz Métro inc. (GMi). GMi owns the remaining 71% of GMLP. GMLP’s core business is regulated natural gas distribution in Québec, which generates strong cash flow due to a supportive and stable regulatory environment. GMLP also benefits from cash flow diversification from its investments in energy distribution in Vermont and the pipeline business (see the rating report on Gaz Métro inc. dated October 31, 2012). Valener’s rating is one notch lower than the rating of GMi, reflecting its structural subordination to GMLP.

The assigned provisional rating is based on the following factors: (1) Strong and predictable cash flow from GMLP to Valener. GMLP has made cash distributions to its partners in an amount of over 90% of its net income, excluding non-recurring items, for most years over the last 20 years. (2) GMLP is expected to continue to maintain its distributions of at least 85% of its net income, excluding non-recurring items, as set out under the partnership agreement between Valener and GMLP (the Partnership Agreement). In the event that GMi, as general partner of GMLP, intends to distribute less than 85% of its net income, excluding non-recurring items, it would require the approval of at least 90% of GMi’s directors. (3) Valener’s non-consolidated debt-to-capital structure is expected to remain below 20%. If its non-consolidated debt leverage ratio is above 20%, Valener is expected to issue equity to bring the ratio back under the 20% threshold in a timely manner. (4) DBRS expects that the majority of Valener’s cash flow will be derived from GMLP. Any material investment carried out by Valener and not through GMLP could have a negative rating impact. (5) DBRS expects that Valener will maintain its 29% interest in GMLP and its pro rata representation on GMi’s board of directors.

The assigned rating incorporates the limited control of Valener over GMLP due to its limited partnership status. However, this limited control is mitigated by the distribution protection clause in the Partnership Agreement, as mentioned above.

DBRS confirmed Power Corporation at Pfd-2(high) (POW.PR.A, POW.PR.B, POW.PR.C, POW.PR.D, POW.PR.F, POW.PR.G):

DBRS has today confirmed the long-term and preferred shares ratings of Power Corporation of Canada (POW or the Company) at A (high) and Pfd-2 (high), respectively. The trend on the ratings remains Stable. The credit strength of POW is directly tied to its 66.1% equity interest in Power Financial Corporation (PWF; see separate press release), which represents a substantial majority of the Company’s earnings and cash flow, as well as 82% of the Company’s estimated net asset value as of June 30, 2012. The Senior Debt rating of the Company is A (high), or one notch below the AA (low) rating on the Senior Debentures of PWF, reflecting the structural subordination of the holding company’s obligations.

The Company remains exposed to the advice-centered distribution model of protection and wealth management products and services through its indirect investment in PWF’s major subsidiaries, Great-West Lifeco Inc. (GWO) and IGM Financial Inc. (IGM). Correspondingly, it is vulnerable to the financial market and economic volatility that affects asset management fees, required actuarial reserves tied to equity markets, and the level of interest rates, as well as credit loss provisions.
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As the controlling shareholder of PWF, and, by extension, of GWO and IGM, POW defines the strategic vision for its financial services investments, while setting the “tone from the top” in terms of conservative management style and risk analysis and tolerance. The Company’s senior officers and delegates exercise a greater degree of influence through their active participation on the respective boards and board committees of POW’s various subsidiaries than is generally the case at more widely held companies. Such an integrated management and governance approach is seldom encountered, and it has served the Company’s stakeholders well.

On a stand-alone basis, POW’s financial profile is very conservative, with debt and preferred shares representing just 13.1% of capitalization, albeit up from 7.9% at year-end 2007. There is no double leverage in the Company’s capital structure as only shareholders’ equity, and not the proceeds from debt or preferred shares, is invested in the Company’s investment portfolio. Financial leverage appears to be used to fund a portfolio of cash and short-term investments and a modest level of working capital.

DBRS confirmed PWF at Pfd-1(low) (PWF.PR.A, PWF.PR.E, PWF.PR.F, PWF.PR.G, PWF.PR.H, PWF.PR.I, PWF.PR.K, PWF.PR.L, PWF.PR.M, PWF.PR.O, PWF.PR.P and PWF.PR.R):

DBRS has today confirmed the long-term and preferred shares ratings of Power Financial Corporation (PWF, the Company or the Group) at AA (low) and Pfd-1 (low), respectively. The rating trends remain Stable. The financial strength of PWF is largely derived from its controlling interests in two of Canada’s leading financial service providers: Great-West Lifeco Inc. (GWO – senior rating of AA (low)), one of the three largest life insurance concerns in Canada, and IGM Financial Inc. (IGM – senior rating of A (high)), one of the largest mutual fund complexes in Canada as measured by long-term assets under management (AUM) on June 30, 2012. These two interests, accounting for approximately 90% of the Company’s earnings, dividends and asset value, are a source of stable recurring earnings and cash flow. Under the strategic leadership of the Company, both GWO and IGM have become increasingly diversified as they have grown both organically and by acquisition. The Company has correspondingly increased its exposure to the wealth management business in all of its chosen geographies. Both of these subsidiaries, in turn, benefit from the Company’s hands-on governance, and risk-averse culture.
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Given an uncertain economic environment that could limit organic growth, DBRS expects that PWF will take advantage of its strong financial position to pursue small tactical acquisitions in the financial services arena. Pressures on regulatory capital adequacy could conceivably encourage a number of financial institutions to sell certain business lines at opportunistic prices, which would complement and leverage those of the Company. For example, achieving additional scale in Putnam through the acquisition of incremental AUM with a shared distribution channel would bring its financial results closer to the Company’s original target while supporting broader growth initiatives. That PWF retains the ability to consider such value-added acquisitions in the current environment is a testament to its conservative financial profile and its long-term perspective.
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The Company’s financial leverage has been maintained at the same level for the past ten years. At a 17.6% unconsolidated total debt ratio at the end of June 2012, the Company’s capitalization remains conservative, with no double leverage when the perpetual preferred shares are treated as permanent equity. Debt service coverage ratios are similarly strong at between 13 and 15 times on an operating earnings basis and between 8 and 9 times on a cash flow basis. Liquidity is not a source of concern, with close to $1 billion in cash and short-term securities at the holding company at June 30, 2012, in addition to stores of liquidity at both GWO and IGM with which to shore up regulatory capital or to facilitate potential strategic acquisitions. Such retention of liquid assets in the current uncertain economic environment reflects a unified and consistent approach to risk management across the organization. Financial flexibility is additionally enhanced by the proven access by the Company and its investee companies to capital markets funding, notably perpetual preferred shares.

The Canadian preferred share market closed the month on a high note, with PerpetualPremiums up 12bp, FixedResets gaining 2bp and DeemedRetractibles winning 24bp. Given the surge, it was surprising that volatility was so muted. Volume was above average.

PerpetualDiscounts now yield 4.93%, equivalent to 6.41% interest at the standard equivalency factor of 1.3x. Long corporates are now at about 4.3%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now 210bp, a slight (and perhaps spurious) increase from the 205bp reported October 24.