PrefBlog

The Bank of Nova Scotia has announced:

the applicable dividend rates for its Non-cumulative 5-Year Rate Reset Preferred Shares Series 22 of Scotiabank (the “Preferred Shares Series 22”) and Non-cumulative Floating Rate Preferred Shares Series 23 of Scotiabank (the “Preferred Shares Series 23”).

With respect to any Preferred Shares Series 22 that remain outstanding after January 26, 2014, commencing as of such date, holders thereof will be entitled to receive non-cumulative preferential cash dividends on a quarterly basis, as and when declared by the Board of Directors of Scotiabank and subject to the Bank Act (Canada). The dividend rate for the five-year period commencing on January 26, 2014 and ending on January 25, 2019 will be 3.830%, being equal to the 5-Year Government of Canada bond yield determined as at December 27, 2013 plus 1.88%, as determined in accordance with the terms of the Preferred Shares Series 22.

With respect to any Preferred Shares Series 23 that may be issued on January 26, 2014, holders thereof will be entitled to receive floating rate non-cumulative preferential cash dividends on a quarterly basis, as and when declared by the Board of Directors of Scotiabank and subject to the Bank Act (Canada), based on a dividend rate equal to the 90-day Canadian Treasury Bill yield plus 1.88%, on an actual/365 day count basis, subject to certain adjustments in accordance with the terms of the Preferred Shares Series 23. The dividend rate for the period commencing on January 26, 2014 and ending on April 25, 2014 will be equal to 2.782%, as determined in accordance with the terms of the Preferred Shares Series 23.

Beneficial owners of Preferred Shares Series 22 who wish to exercise their right of conversion should communicate as soon as possible with their broker or other nominee and ensure that they follow their instructions in order to ensure that they meet the deadline to exercise such right, which is 5:00 p.m. (Toronto time) on January 13, 2014.

The extension of BNS.PR.R was previously reported on PrefBlog.

I am making no recommendation as to whether holders of BNS.PR.R should convert or not to the new FloatingReset that will appear on January 25. The five FloatingResets currently outstanding have an average three-month bill breakeven rate of 1.87%; given a current price of 25.33 on BNS.PR.R, this implies a price of 25.24 on the new issue, which is certainly within error. Given a current bill yield of 0.91%, the implication is that the Bank Rate will rise by 200bp over the next five years, assuming a steady rate of increases – this is reasonable. If you have strong views on the future of the Bank Rate, act accordingly (while remembering to ask yourself ‘What if I’m wrong?’) or go with what makes most sense for your portfolio.

On December 30, in all innocence, I posted the following entry in the Volume Highlights table:

Now Assiduous Reader SM writes in and says:

in yesterday’s volume highlights on prefblog, BNS.PR.X is listed as having a 1.44% YTW at $25.63. My use of Shakespeare’s YTC spreadsheet (14/01/06 settlement) tells me the YTW is exactly 2.00%. What gives?

The “Calculators” section of the Right Hand Navigation Panel has links to Shakespeare’s Spreadsheet and a souped-up version that accounts for dividend changes for FixedResets. Some may also be interested in my instruction manual for ytc.xls and a lengthy post discussing compounding frequency.

SM’s figure of 2.00% is derived from the following inputs:

• Current Price = 25.63
• Call Price = 25.00
• Settlement Date = 2014-1-6
• Call Date = 2014-4-25
• Quarterly Dividend = 1.5625/4
• Cycle = 1
• Pay Date = 25
• Include first Dividend = 1
• First Dividend Value = Blank

SM poses a complicated question – there are no less than three-and-a-half different things going on:

• Settlement Date
• Compounding Convention
• Cash Flow Amounts
• Cash Flow Timing

People who compulsively count up items in lists will notice that four lines are required to itemize the three-and-a-half things. The discrepancy arises because “Cash Flow Timing” is a superset of “Settlement Date”. Take some meds, guys.

Settlement Date

This is a more complex question than one might think. Is it really all that great to use the settlement date for yield calculations? After all, if Joe Average is going to buy security X, he’s got to fund the purchase (either with cash or margin) on the trade date – in fact, this has to be done before the trade is executed, never mind settled.

And when valuing the security, it it really all that kosher to use settlement date yields? This will include settlement date accrued interest (where applicable), which hasn’t been earned yet; additionally, financial reporting will show only the accrued interest as of the reporting date, i.e., Trade Date.

On the other hand, market prices are always quoted assuming the normal settlement convention, so if you’re going to use TD yields, you also need to use TD-specific prices. Trading bonds for non-standard settlement is – or at least was, in the old days – an intricate process that required the salesman to get the price from his trader, and then perform a lot of calculations based on the coupon, the yield and the day-count before quoting a price. This required time and swearing, but nowadays there’s probably an app for that.

It will also be noted that the Canadian Yield Calculation Conventions specify use of settlement date.

However, I use TD calculation instead and justify my decision with the argument that your mother wears army boots.

Using TD instead of VD in the Yield Calculator results in a reduction of the calculated yield to 1.88% from 2.00%.

Compounding Convention

Fixed Income Yield Calculations use periodic return rather than Annualized Return (IRR); that is, the yield is calculated per payment period and this yield is multiplied by the number of periods per year to express it as an annual rate (annual rate = y*4), rather than compounding it (annual rate = (1+y)^4 – 1).

In the case under discussion: HIMIPref™ calculates bond-equivalent yields. To convert quarterly compounded annual rates, y, to bond-equivalent semi-annual rates, r:

r = 2 * [(1 + y/4)^2 – 1]

so if the quarterly-compounded rate is y = 2.00%, then the bond-equivalent semi-annual rate is 2 * [1.005^2 – 1] = 2.005%. It is, obviously, a very minor difference at these yields, but can become much larger at higher levels.

Cash Flow Amounts

The YTC calculator calculates (in cell S4) that the final dividend, paid on April 25, will be 0.390625 – that is to say, one quarter of the annual rate, which appears at first glance to be obvious. But is it really all that obvious?

HIMIPref™ shows the prior dividend as being paid 2013-10-31 (which is wrong – the pay date was actually October 29, but a few days difference in pay date doesn’t usually matter), and therefore assumes that the next dividend will be paid on January 31. Then, when HIMIPref calculates in one part of the programme that the issue will be called on April 25, the part of the programme that calculates expected cash flows and yields says to itself, “Aha! It’s being called before the full dividend is due! Six days early, in fact!” So it takes six days’ dividend off the final payment and evaluates the last dividend as $0.36 (rounded to two decimal places in the report I’m looking at, but internal precision is higher). So right away, there’s a few pennies difference and each penny makes a difference of about 13bp in calculated yield, according to ytc.xls.

So we might be tempted to conclude that oh, yes, just another HIMIPref™ error, so what, until we consider the data calculated by ytc.xls. It assumes full payment of the entire quarterly dividend on April 25, reasonably enough since that is essentially what we told it to do when we filled in Pay Date = 25. So that’s wrong, too. If we change Pay Date to 29, it does the same thing HIMIPref™ does and performs its calculations with a pro-rata dividend paid on the April 25 redemption date.

But that’s still wrong, probably, although we can’t say this conclusively until Scotia announces the next dividend.

Consider BNS.PR.S. It will be redeemed on January 26, but the final dividend has been announced as the full amount of $0.3906 payable January 29.

What’s more, the prospectus for BNS.PR.S states:

The holders of Preferred Shares Series 24 will be entitled to receive fixed non-cumulative preferential cash dividends, as and when declared by the board of directors of the Bank (the “Board of Directors”), for the initial period commencing on the Closing Date (as defined herein) and ending on and including January 25, 2014 (the “Initial Fixed Rate Period”), payable quarterly on the third last business day of January, April, July and October in each year (other than January 28, 2009), at a rate equal to $0.3906 per share. The initial dividend, if declared, will be payable April 28, 2009 and will be $0.5865 per share, based on the anticipated closing date of December 12, 2008 (the “Closing Date”). Reference is made to “Details of the Securities Being Distributed”.

That’s valuable information, that is, because it allows us to calculate the precise period over which that first dividend was earned. A little playing around results in the conclusion that the $0.5865 first dividend was equal to 137 days of interest at an annual rate of 6.25% (the figure to six decimal places is $0.586473).

137 days? That’s 19 (December) + 31 (January) + 28 (February) + 31 (March) + 28 (April). So the first dividend payment on April 28, 2009, included an accrual for every single day up to the payment date. Therefore, we may conclude that the final dividend of $0.3906 (equal to every other dividend other than the first) also includes accruals up to the payment date of January 29 … even though Scotia

intends to exercise its right to redeem all outstanding Non-cumulative Preferred Shares Series 24 of Scotiabank on January 26, 2014

This is complicated even more by the amusing happenstance that January 26 is a Sunday and Scotia couldn’t pay the redemption price on that day even if it wanted to. AND, that according to the prospectus:

for the initial period commencing on the Closing Date (as defined herein) and ending on and including January 25, 2014

and therefore by rights a new rate should be calculated for the period 2014-1-26 to the paydate of 2014-1-29. And what’s up with the day count? Will the shareholders be getting their capital back on Monday, January 27, but still earn dividends on that capital to the final dividend pay-date of January 29? Or will the actual payment for the redemption be made on January 29 as well?

Cash Flow Timing

The whole thing’s a minefield, and with respect to BNS.PR.X it will be noted that the redemption date is actually April 26 anyway, which is a Saturday.

Conclusion

The moral of the story is that precise calculation of yields using actual dates is a quagmire and it doesn’t usually matter, but these minor differences can add up to quite a few beeps when the remaining term is very short – as has happened in this case with BNS.PR.X. In such cases, one is better off double-checking all the dates and amounts and valuing the shares as packages of money market instruments with yields calculated according to money market conventions, which is a another kettle of fish.

The Toronto-Dominion Bank has announced:

that it will exercise its right to redeem all of its 10 million outstanding Non-cumulative 5-Year Rate Reset Preferred Shares, Series AA (the “Series AA Shares”) on January 31, 2014 at the price per share of $25.00, for an aggregate total of approximately $250 million.

TD also announced it will exercise its right to redeem all of its 8.8 million outstanding Non-cumulative 5-Year Rate Reset Preferred Shares, Series AC (the “Series AC Shares”) on January 31, 2014 at the price per share of $25.00, for an aggregate total of approximately $220 million.

On December 5, 2013, the Board of Directors of TD declared quarterly dividends of $0.3125 per Series AA Share and $0.35 per Series AC Share. These will be the final dividends on the Series AA Shares and Series AC Shares, respectively, and will be paid in the usual manner on January 31, 2014 to shareholders of record on January 8, 2014, as previously announced. After January 31, 2014, the Series AA Shares and Series AC Shares will cease to be entitled to dividends and the holders of such shares will not be entitled to exercise any right in respect thereof except that of receiving the redemption amount.

Instructions with respect to receipt of the redemption amount will be set out in the Letter of Transmittal to be mailed to registered holders of the Series AA Shares and Series AC Shares shortly. Inquiries should be directed to our Registrar and Transfer Agent, CST Trust Company, at 1-800-387-0825 (or in Toronto 416-682-3860). Beneficial holders who are not directly the registered holder of these shares should contact the financial institution, broker or other intermediary through which they hold these shares to confirm how they will receive their redemption proceeds. Further details and instructions will be posted shortly to our website, http://www.td.com/investor-relations/ir-homepage/share-information/preferred-shares/preferred.jsp.

TD.PR.A is a FixedReset, 5.00%+196bp, announced 2008-9-2 and closing 2008-9-12 … on the Friday before the before the Lehman Bankruptcy Weekend.

TD.PR.C is a FixedReset, 5.60%+274, announced 2008-10-27 and settling 2008-11-5 … slap in the middle of the biggest preferred share rout in memory.

It’s somewhat surprising that TD.PR.A was called – 196bp is a fairly modest Issue Reset Spread.

DBRS has announced that it:

has today upgraded the rating of the Preferred Shares issued by Brompton Lifeco Split Corp. (the Company) to Pfd-4 (high) from Pfd-5 (high). In April 2007 the Company issued 3.1 million Preferred Shares (at $10.00 each), along with an equal number of Class A Shares (at $15.00 each). The termination date for both classes of shares issued is April 30, 2014, but a term extension has been proposed by the Company.

The Company holds a portfolio consisting primarily of common shares of the four largest publicly traded Canadian life insurance companies (the Portfolio). As of September 30, 2013, the Portfolio’s composition was: Industrial Alliance Insurance and Financial Services Inc. (26.0%), Sun Life Financial Inc. (24.9%), Manulife Financial Corporation (24.4%) and Great-West Lifeco Inc. (24.0%). The Portfolio was initially equally weighted and is subject to annual rebalancing.

The Preferred Shares pay a fixed cumulative quarterly distribution of $0.13125 per Preferred Share, yielding 5.25% annually on their issue price of $10.00 per share. Holders of the Class A Shares are expected to receive regular monthly targeted cash distributions of $0.075 per share, yielding 6% annually on their issue price of $15.00 per share. Class A Share distributions were suspended in March 2011, due to the net asset value of the Company falling below $15.00 per unit (i.e., 33% downside protection), but were reinstated in July 2013.

On June 10, 2013, DBRS confirmed the ratings of the Preferred Shares at Pfd-5 (high). Since then, the performance of the Company has been positive, with downside protection climbing to its highest levels in over two years (39.5% as of December 12, 2013). In addition, the short-term outlook for the Canadian life insurance industry has improved. As a result, the rating of the Preferred Shares has been upgraded to Pfd-4 (high).

DBRS will continue to closely monitor changes in the credit quality of the Preferred Shares and provide rating updates as required.

The issue’s downgrade to Pfd-5(high) was reported on PrefBlog. LCS.PR.A is not tracked by HIMIPref™ as it is a very small issue – less than 1.7-million units are outstanding.