A Spanish bank went bust, so obviously the sky is falling:
The collapse of Banco Popular Espanol SA and a subsequent wipeout of its junior debt serves as a reminder for Canadian investors lapping up similar bonds why these securities offer a higher yield than others.
The 1-euro rescue takeover of what was Spain’s sixth-largest bank by rival Banco Santander SA left holders of its stock and contingent convertible bonds with losses of 3.3 billion euros ($3.7 billion). Senior debt was protected as authorities averted a run on the bank and saved taxpayers from bearing costs.
The move comes as investors across the ocean have been buying non-viability contingent capital bonds, securities which convert to equity when certain crisis triggers are hit. While no major Canadian lender is anywhere near the trouble Banco Popular was in, the Bank of Canada warned on Thursday of increased financial system vulnerabilities associated with household debt.
So a Canadian NVCC bond was highlighted in the story:
The spread on the 2.982 percent NVCC bonds of Toronto-Dominion Bank, Canada’s largest bank by assets, with a call date in September 2020 has fallen 160 basis points from its peak in February 2016, while that on the lender’s 2.045 percent deposit notes maturing in March 2021 has shrunk 54 basis points over roughly the same period, according to Bloomberg data.
“It should be a bit of a wake-up call for Canadian investors,” said Bill Girard, who manages corporate bond portfolios at Bank of Nova Scotia’s 1832 Asset Management, arguing that Canadian investors have been buying higher-yielding NVCC bonds without fully realizing the risk. “Banco Popular investors might have thought the same. You’re safe right until the point you aren’t.”
It should be a bit of a wake-up call, but it won’t be. The reason it should be a wake-up call is because … well, first off, let’s take a look at the financial statements for PHILLIPS, HAGER & NORTH SHORT TERM BOND & MORTGAGE FUND (I don’t want to pick on Royal Bank’s subsidiary – it was just the first one I found).
On page four of the document, we find that this fund holds just over $17-million of these things.
WHAT THE #$$%**@$ IS AN NVCC ISSUE DOING IN A SHORT TERM BOND & MORTGAGE FUND?
I have noted in the past that OSFI wanted this stuff incorporated into bond indices, even though they’re not actually bonds as the term is generally understood. OSFI’s desire for this was publicly reported and was consistent with other sleaze-bag regulatory rip-offs of unsophisticated retail bond index investors globally. So, naturally, the bank-owned TSX happily incorporated them in their bond indices. This was a problem for quite some time, but I am pleased to report that May, 2017, revision of the FTSE TMX Canada Universe and Maple Bond Indexes contains section 3.1.4:
Exclusions
The indexes do not include floating-rate notes, convertible bonds (which convert to equity at the option of the holder), Non Viable Contingent Capital bonds (NVCC which convert to equity if the regulator determines a firm is “Non Viable”), residential and commercial mortgage-backed securities (CMBS and MBS), other monthly-pay securities, other prepayable securities, inflation-indexed securities, or securities specifically targeted to the retail market. It also excludes securities that are not priced, which would typically be securities that are closely held and do not trade.
It doesn’t happen very often, but sometimes things do get better!
HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
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Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
Ratchet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.8707 % | 2,115.2 |
FixedFloater | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.8707 % | 3,881.3 |
Floater | 3.71 % | 3.75 % | 78,070 | 17.88 | 3 | 0.8707 % | 2,236.8 |
OpRet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.1022 % | 3,046.9 |
SplitShare | 4.72 % | 4.42 % | 70,925 | 3.92 | 5 | -0.1022 % | 3,638.7 |
Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.1022 % | 2,839.1 |
Perpetual-Premium | 5.28 % | 1.33 % | 70,381 | 0.09 | 25 | 0.0875 % | 2,795.2 |
Perpetual-Discount | 5.08 % | 5.09 % | 99,995 | 15.27 | 12 | 0.0849 % | 3,003.9 |
FixedReset | 4.54 % | 4.11 % | 198,436 | 6.53 | 95 | 0.5465 % | 2,282.8 |
Deemed-Retractible | 4.98 % | 4.99 % | 123,822 | 6.26 | 30 | 0.0449 % | 2,902.5 |
FloatingReset | 2.52 % | 3.12 % | 49,051 | 4.39 | 10 | 0.0657 % | 2,520.7 |
Performance Highlights | |||
Issue | Index | Change | Notes |
SLF.PR.J | FloatingReset | -1.18 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 15.12 Bid-YTW : 9.25 % |
BAM.PF.F | FixedReset | 1.04 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-08 Maturity Price : 22.02 Evaluated at bid price : 22.27 Bid-YTW : 4.41 % |
MFC.PR.O | FixedReset | 1.05 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2021-06-19 Maturity Price : 25.00 Evaluated at bid price : 26.98 Bid-YTW : 3.46 % |
MFC.PR.N | FixedReset | 1.06 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 19.96 Bid-YTW : 6.91 % |
BAM.PF.A | FixedReset | 1.07 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-08 Maturity Price : 21.45 Evaluated at bid price : 21.79 Bid-YTW : 4.50 % |
SLF.PR.G | FixedReset | 1.07 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 16.03 Bid-YTW : 8.87 % |
MFC.PR.J | FixedReset | 1.09 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 21.31 Bid-YTW : 6.03 % |
MFC.PR.K | FixedReset | 1.14 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 19.45 Bid-YTW : 7.08 % |
HSE.PR.A | FixedReset | 1.19 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-08 Maturity Price : 15.22 Evaluated at bid price : 15.22 Bid-YTW : 4.29 % |
TRP.PR.C | FixedReset | 1.26 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-08 Maturity Price : 15.23 Evaluated at bid price : 15.23 Bid-YTW : 4.04 % |
MFC.PR.G | FixedReset | 1.29 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 22.70 Bid-YTW : 5.36 % |
CU.PR.I | FixedReset | 1.31 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2020-12-01 Maturity Price : 25.00 Evaluated at bid price : 26.22 Bid-YTW : 3.05 % |
BAM.PR.X | FixedReset | 1.74 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-08 Maturity Price : 15.78 Evaluated at bid price : 15.78 Bid-YTW : 4.41 % |
IFC.PR.A | FixedReset | 1.87 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 16.87 Bid-YTW : 8.95 % |
Volume Highlights | |||
Issue | Index | Shares Traded |
Notes |
CM.PR.R | FixedReset | 331,425 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-08 Maturity Price : 23.14 Evaluated at bid price : 24.95 Bid-YTW : 4.25 % |
MFC.PR.O | FixedReset | 106,705 | YTW SCENARIO Maturity Type : Call Maturity Date : 2021-06-19 Maturity Price : 25.00 Evaluated at bid price : 26.98 Bid-YTW : 3.46 % |
SLF.PR.H | FixedReset | 102,685 | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 18.61 Bid-YTW : 7.37 % |
SLF.PR.I | FixedReset | 80,295 | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 22.21 Bid-YTW : 5.55 % |
TRP.PR.D | FixedReset | 60,950 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-08 Maturity Price : 20.15 Evaluated at bid price : 20.15 Bid-YTW : 4.24 % |
BMO.PR.S | FixedReset | 30,741 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2047-06-08 Maturity Price : 21.04 Evaluated at bid price : 21.04 Bid-YTW : 3.99 % |
There were 31 other index-included issues trading in excess of 10,000 shares. |
Wide Spread Highlights | ||
Issue | Index | Quote Data and Yield Notes |
SLF.PR.J | FloatingReset | Quote: 15.12 – 15.38 Spot Rate : 0.2600 Average : 0.1958 YTW SCENARIO |
BMO.PR.Q | FixedReset | Quote: 21.18 – 21.40 Spot Rate : 0.2200 Average : 0.1591 YTW SCENARIO |
GWO.PR.R | Deemed-Retractible | Quote: 23.92 – 24.14 Spot Rate : 0.2200 Average : 0.1626 YTW SCENARIO |
BAM.PF.H | FixedReset | Quote: 26.27 – 26.56 Spot Rate : 0.2900 Average : 0.2344 YTW SCENARIO |
CCS.PR.C | Deemed-Retractible | Quote: 24.15 – 24.37 Spot Rate : 0.2200 Average : 0.1653 YTW SCENARIO |
PWF.PR.P | FixedReset | Quote: 15.46 – 15.65 Spot Rate : 0.1900 Average : 0.1387 YTW SCENARIO |
BAM.PR.X : Convert or Hold?
Friday, June 9th, 2017It will be recalled that BAM.PR.X will reset to 2.727% (paid on par) effective July 1.
Holders of BAM.PR.X have the option to convert to FloatingResets, which will pay 3-month bills plus 180bp 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. (Toronto time) on June 15, 2017; 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 issued, will be BAM.PR.Y.
BAM.PR.X is a FixedReset, FixedReset, 4.60%+180, that commenced trading 2011-2-8 after being announced 2011-1-19. Thus, the new rate represents a dividend reduction of 41%. Ouch!
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.X and the FloatingReset BAM.PR.Y 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 well below current market rates, at -0.04% and -0.16%, 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.X FixedReset, we may construct the following table showing consistent prices for its soon-to-be-issued FloatingReset counterpart BAM.PR.Y given a variety of Implied Breakeven yields consistent with issues currently trading:
Price if Implied Bill
is equal to
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.X 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.
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