Fixed-Resets : Critchley Likes, Ruggins Doesn't

Barry Critchley of the Financial Post has written another column, reiterating his earlier praise of the structure. In the current column, BNS Offers Investors Better Deal he states:

But in five years, investors know that the yield on the new fixed-rate pref will be set at the same spread over Canada bonds as was the original pref share. (Every five years, investors have the ability to move in and out of fixed or floating pref shares.)

In this way, the issuer won’t benefit from any improvement in credit spreads over the five-year period.

This is not correct. If credit spreads improve significantly, the issue will be called. One of the Big Black Marks against this structure is the 5-year call at par; the standard provisions for a normal fixed rate issues are a 5-year-call at a premium, declining to a 9-year call at par. Those extra four years are very important.

Of more interest are the reported comments of Len Ruggins … but I might just be saying that because I agree with him!

In response to an earlier column that focused on Scotia’s original deal, Ruggins called and gave his thoughts. In short, he didn’t like the earlier deal because the issuer is paying a yield that is lower than what it would have paid had it chosen to issue a perpetual pref share.

“The bank has issued a Tier 1 security that will most likely be redeemed in five years’ time [because] a regular bank perpetual [issued today] would require a dividend in excess of 5%.

“If market interest rates and dividend yields return to a more normal level in 2013 it is unlikely that the banks will reset the rate on these prefs. I would have bought this issue, if the bank had said that it would not be callable for, say, 20 years, thereby paying a very good dividend which is reset every five years. I’ll bet that during the last year of this issue, the pref will trade on the assumption that it is going to be called regardless of where the Canada bond is trading,” said Ruggins.

Hat tip to Assiduous Reader tobyone who brought the column to my attention.

Newly Assiduous Reader meander likes the structure, as he explains in his comment on the new issue TD+160. As for myself, I will stick to my previously published analysis: these issues, at these rates, are trading as pretend-five-year money. If they actually WERE five year money, I’d be scooping them up by the hatfull. If there was a 20-year no-call period and I could actually be assured of receiving these headline spreads for a lengthy period … back up the truck!

But since the credit risk is actually perpetual and my absolute best case scenario is that it’s five year money … I’ll wait until I’m actually paid to take on that credit risk.

Or, to put it another way … look at Table #1 in my previously published analysis: would you have bought this structure in February ’07 if the fixed rate had been 4.0% with a +60bp reset? If so, how would you feel?

Fixed-Resets – according to me – share the sales and investment philosophy of Principal Protected Notes:

  • Yes, in bad times there is a degree of risk mitigation
  • At all other times, you pay through the nose for it

9 Responses to “Fixed-Resets : Critchley Likes, Ruggins Doesn't”

  1. prefhound says:

    I actually think these Fixed-Reset prefs are more like rising rate debt than a PPN. A PPN includes a put option for the buyer (principal is protected), which is rather expensive. On the other hand, rising rate debt has only early call options for the seller.

    With rising rate debt, the investor exchanges a lower than market 1 year interest rate for the potential that the interest rate can rise (by e.g. 0.25%) each year for 5 to 7 years. Only problem is, they are likely to be called before a juicy rate can be paid. They are often marketed on the basis of the “average interest rate over the term”, which might look attractive compared with current rates, but is almost never realized due to an early call.

    It seems mostly the banks that issue such rising rate debt, though I have seen some Canada agency issues. Thus it is not surprising to see banks using the same logic in the preferred share market.

    Due to the confusion, I expect they will continue to be popular until the 5th anniversary when the first BNS issue gets called.

  2. jiHymas says:

    I assume you mean the sort of thing described by Rob Carrick in 2004?

    Can they really be called? If “cashable”, then they could be put, but I confess to being a little dubious about an embedded call.

  3. prefhound says:

    Rising rate GICs are similar, but (excuse my vagueness) I was talking about what are called “Extendible Notes”. My TDWaterhouse New Issues Historical Offerings has buckets of them. The extendibility is at the option of the issuer, just as the pref call is at the option of the issuer.

  4. jiHymas says:


    Extendibles are the most horrible things known to man. The extension feature is one reason why I don’t consider Innovative Tier 1 Capital instruments to be bonds, and why I consider Tier 2B Sub-Debt to be only just barely bonds.

  5. prefhound says:

    so, should we conclude that the second cousin of extendible bonds (fixed-reset pref shares) is the second most horrible thing known to man…? I certainly put them in the same basket.

  6. adrian2 says:

    I’ll bet that during the last year of this issue, the pref will trade on the assumption that it is going to be called regardless of where the Canada bond is trading,” said Ruggins.

    Hindsight is 20/20, isn’t it?

    Scotiabank has announced: that it does not intend to exercise its right to redeem the currently outstanding Non-cumulative 5-Year Rate Reset Preferred Shares Series 18 of Scotiabank (the “Preferred Shares Series 18′) on April 26, 2013

  7. […] blog (Canadian preferred shares. Remember?) I’ll highlight Assiduous Reader adrian2’s trip down memory lane to May, 2008, when we were all trying to figure out just what these funny new Fixed-Reset […]

  8. […] it can be called in only five years. I’ve published my thoughts on the matter … but some people like ‘em and they certainly seem to be selling […]

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