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 |
|||||||
| 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 |
I totally agree that investors should be cognizant of the fact that preferred shares will probably be completely wiped out if the issuing institution becomes insolvent.
But, I would argue that preferred shares in general offer an unwarrantedly high premium over senior debt. And that NVCC preferred shares offer an excessive premium over non-NVCC preferreds.
Take your TD example. Its rate reset NVCC’s pay on the order of 1.5%/year over non-NVCC’s. Both are non-cumulative. If TD goes under I assume that both types will be bailed in. I would think that a scenario where the NVCC’s are bailed in, saving both the non-NVCC’s, and TD itself, is very unlikely. Banco Popular’s scenario is the model: common shares and sub debt wiped out, senior debt saved.
Also, the failure of a bank like TD is very unlikely, a once in a 100 year event. TD is not Banco Popular or WaMu. Not a single premier bank failed, or even got bailed in, during the credit crisis. I don’t think that TD’s sub debt even warrants a 1%/year premium.
But, I would argue that preferred shares in general offer an unwarrantedly high premium over senior debt.
I quite agree. I did some calculations a few years ago and determined to my satisfaction that the credit risk premium on Straight Perpetuals relative to bonds should be somewhere around 20bp. Say there’s another 20bp allowance for credit risk uncertainty and that means that all the remainder, 260bp at last count, is liquidity premium.