David Tremblay on Basel III Effects, Junk

The La Presse article mentioned on January 24 and in the comments to January 21 may have been identified!

Wind of change for equities (translation courtesy of Google):

Under the Basel III, the Bank for International Settlements, which monitors the financial stability around the world confirmed that the preferred shares that do not meet the new requirements will be phased out between 2013 and 2023.

To replace the existing preferred shares, banks will now issue the contingent capital. These titles are automatically converted into common shares if the bank becomes insolvent. Thus, holders of these securities pay the price, just as ordinary shareholders, should the unlikely situation where the government is forced to inject money to save the institution.

While this change was already planned, the news had a slight positive impact on the existing preferred shares: as they do not meet future requirements, banks will be more motivated to buy them. The preferred shares of banks that are trading at a discount currently should perform well in this context.

But it will take the next step is the confirmation by the Office of the Superintendent of Financial Institutions of Canada, for treatment of these instruments in the Canadian context.

… which isn’t quite the ringing endorsement I had been led to expect, but it is an endorsement and it was published in La Presse, so it’s the best suggestion so far.

I have previously published a review of Basel III effects on PrefBlog, with more depth in the January, 2011, edition of PrefLetter. Note that the La Presse article was published on January 15, after the awesome events of January 13 and January 14, but presumably the interview was conducted prior to this.

Mr. Tremblay, the PM for Omega Preferred Equity Fund, had some very sensible things to say about junk FixedResets:

I suggest to be careful with certain adjustable rate preferred shares that were issued in recent years. Their dividend adjusted every five years, depending on interest rates, which protects investors against the risk of rising interest rates which would lose value in preferred shares.

But shareholders are not protected against credit risk. These securities houses of perpetual preferred shares (no redemption at the option of the holder). We must carefully analyze the credit risk of the issuer if you do not want to be stuck with a bad credit forever!

Ask your advisor if he has done his homework, particularly for preferred shares with a credit valued at P3. On a scale from P1 to P5, titles that get a rating of P1 and P2 are the strongest. At P3, some issuers are good, others less. It must be very selective, buying preferred shares that are trading at a discount and that offer acceptable credit risk.

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