PrefBlog

5 Responses to “July 4, 2008”

1. prefwatcher says:

   July 6, 2008 at 3:00 pm

   Many TSE listed preferreds have been sliding of late but the NYSE listed preferreds have really fallen out of bed. Take a look at the charts and yields of HBA.PR.F, BAC.PR.B, PUK.PR.A, MET.PR.B as examples. A complete list af US preferreds can be found in the business section of the Sunday NY Times. Many US preferreds fell 20% or more in June. One that held up well was the Nexen US $ pay preferreds (NXY.PR.B) yielding 7.56%. This is the only NYSE listed Canadian preferred that I can find…there used to a lot more.

2. jiHymas says:

   July 6, 2008 at 6:11 pm

   Note that when looking for these symbols on the NYSE website, there are no dots in the symbols.

   HBAPRF – Floating Perp (three month LIBOR + 0.75%), last trade 16.25

   BACPRB – 6.25% TruPS, maturing 2055-3-29, last trade 19.43

   PUKPRA – 6.50% Perps, last trade 17.65

   METPRB – 6.50% Perps, last trade 20.88

   All have a par value of $25.00.

   The yield on the holdings of Vanguard Long-Term Investment-Grade Fund Investor Shares (VWESX) is 6.19%.

   Your point is well taken – but I’m not sure how much arbitrage there might be between the US instruments and Canadian preferreds – the tax situation is so different.

3. prefhound says:

   July 8, 2008 at 12:37 pm

   Here’s why I (generally) don’t like tax-driven swaps — even in cases where there is a well-matched pair: most people vastly overestimate the actual savings from crystallizing a tax loss.

   Here’s an example: suppose you want to sell a pref share with a tax loss of $6.00 (e.g. you bought for $25 and it is now worth $19) to reinvest in a hypothetical perfectly matched pref, which you are able to buy for the same $19. How much does this trade actually save you?

   Suppose you are in the 46% tax bracket now and in the future (and can actually use a capital loss, which means you have net gains for the past several years). A loss of $6.00 today produces tax savings = $6.00 X 46% / 2 for the inclusion rate = $1.38. This might be immediate (if you withhold some otherwise due quarterly tax payments) or you might get it next May. Most people stop here, but

   THIS IS NOT THE COMPLETE STORY….

   You would have got a tax refund LATER anyway, so we have to adjust for the time value of money. There are several scenarios:

   1. The perfectly matched prefs stay at $19 forever. In this case you get the tax refund when you were otherwise going to sell the first pref. If you are an active trader, that might be within a year; if you are a long-term holder of prefs, that might be in 5, 10 or 20 years. Whatever happens, though, you would get the same tax refund in the FUTURE some time. Your cash flow is +$1.38 for taxes now (or soon) vs +$1.38 for taxes N years later, where N is your average holding period for pref shares.

   Scenario 2. The perfectly matched prefs go down some more over time. Again, you crystallize your tax benefit for the loss whenever you would have otherwise sold. Now your cash flow is +$1.38 now (or soon) plus $X for future declines by year N compared with $1.38 + $X in year N if you don’t trade now. Clearly the only difference is the $1.38 now vs in Year N.

   Scenario 3. The perfectly matched prefs go up over time, maybe even get redeemed for $25. If they do, your cash flow is +$1.38 now (or soon) minus $1.38 at redemption in year N (you pay the taxes back) vs no tax in year N if you don’t trade now.

   Thus, in all scenarios, the only difference (if tax rates remain constant) is getting $1.38 now vs in year N. Economics 101 tells us that the present value of this timing difference is:

   Amount X (1 – 1/(1+discount rate)**N)
   [where I use ** as power because the caret blows up the reply window]

   The appropriate discount rate is the after-tax return on the portfolio. You can invest the proceeds in prefs, earn dividends, pay tax and use the proceeds in year N to pay any tax difference on disposition. Let’s say 4.8%, but those who can get their hands on tax refunds now to reinvest in “depressed” prefs might want to use a bigger number.

   So, now we have:

   N = 1; average holding period 1 year; tax savings = $1.38 *(1 – 1/(1.048)) = $0.06. This is hardly worth it! You are likely to recognize this loss for reasons other than tax in the near future.

   N = 5; average holding period 5 years (portfolio turnover = 20%); tax savings = $0.29 (Note that this is only 4.8% of the recognized loss; NOT the 46% marginal tax rate; nor the 23% capital gain tax rate. It is only 1.53% of the present pref value!)
   29 cents is a little better than a holding period of one year, and might even cover some of the bid-ask spreads and commission costs. HOWEVER, on a 1000 share trade, a maximum Present Value of $290 is not worth my time — this trade will take well over an hour to do — especially in illiquid markets!

   N = 10; average holding periiod 10 years (portfolio turnover = 10%); tax savings = $0.52. I show this only for completeness as it is extremely difficult to have pref share portfolio turnover as low as 10%.

   Savings will be greater if your tax rate decreases between taking the loss now and N years from now.

   the present value of savings will be greater if you want to assume a higher after-tax rate of return on your invested tax refund.

   Savings will generally be lower after commissions and bid-ask spreads are imposed on my “ideal” example.

   Savings will be greater or lower (with more risk) if you use an unmatched pref pair.

   But, even for huge unrealized losses, it is seldom worth it to spend the effort on swapping out of (even) perfectly matched pref pairs.

   I like to trade on gross features worth $1.00 a share or more, like selling PWF.PR.I for $24.90 to buy PWF.PR.E for $21.60 ($1.23 pre-tax permanent benefit) so my average holding period is not even 5 years, but more like 3. Thankfully, James brings these swaps to our attention from time to time and they are worth LOTS more than tax loss selling for its own sake.

4. jiHymas says:

   July 8, 2008 at 12:58 pm

   I will certainly agree that the actual savings are better characterized as tax deferral rather than tax elimination – and as well, you only get the tax benefits if you are, indeed, deferring the tax! If you have no capital gains to offset the loss, it’s a mere bookkeeping entry.

   However, you are looking at the situation as, if I may say so, a hedge-fund type player, rather than as a fixed income investor. If you ever see a group of Portfolio Managers, there’s one easy way to pick out the Fixed Income Specialist … he’s the one on his knees, scrabbling around in the dirt for a nickel!

5. prefhound says:

   July 8, 2008 at 1:08 pm

   If I were “hedged” I wouldn’t have huge losses on my prefs 😉
   Fortunately, my attitude is that the income streams I have planned on to fund my retirement are (so far) unaffected…..

   I like to look for dollars on the ground, though. Those nickels ain’t worth what they used to be!