John Heinzl was kind enough to mention me in his recent article What is a ‘Canada call’ and why was my bond redeemed early?:
In April of 2009, I purchased a 10-year Manulife bond that yields 7.768 per cent and matures on April 8, 2019. However, in early October, I looked at my discount brokerage account and was surprised to see that Manulife had “redeemed” the bond. I have never heard of a bond being redeemed at the behest of the issuer. Is this legal?
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“That’s known in the business as a Canada call and it’s very common,” said James Hymas, president of Hymas Investment Management. “One of the very important things to do when investing in corporate debt is to look at the call provisions, because they will almost always be there somewhere.”Generally, companies will only redeem bonds when it is in their best interests (or when required because of the terms of the issue). When Government of Canada bond yields were at historic lows, it wasn’t advantageous for Manulife to redeem the notes because it would have had to pay a steep price. But when government yields started to spike several months ago – and as the maturity date approached – redemption became attractive, Mr Hymas said.
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Manulife announced on Aug. 15 that it intended to redeem the notes and, on Oct. 3 it said the redemption price would be $1,073.81 (per $1,000 face amount) plus accrued interest of $38.52. The redemption price was based on the second option in the prospectus, as it was higher than par. This equates to a yield to maturity (YTM) of 2.73 per cent, Mr. Hymas said. (If you’re wondering why the YTM is lower than the 7.768-per-cent coupon rate, it’s because the notes were trading above par.)
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“They essentially bought back their old debt at a yield of 2.73 per cent and were able to replace that with an extension of term of more than five years and with debt that was actually subordinated and that’s a good deal for them. They’re only paying about 32 basis points [in additional yield] and that’s a bargain,” he said. (Subordinated debt, with its higher risk from a bondholder’s perspective, would normally carry a higher interest rate than senior debt.)
In the US preferred are sometimes redeemed for face well before their call date if certain conditions spelled out in the indenture are met. Companies sometimes conveniently find a way to redeem a preferred early when its dividend rate is high and the preferred is trading above face. I shy away from US preferreds trading well above face for this reason. It would be quite painful to have a preferred trading at $27 suddenly called at $25. In face something like this just happened this month with ENH-C which was trading at almost when $27 when the announcement came that it would be redeemed for $25 causing a sudden large loss for holders (I was not a holder). See quantumonline for details.
According to the Quantum Online security description:
The question of how to account for these ‘special case’ redemptions is an often overlooked feature of fixed income investing.
All of the Partners’ Value Split preferred shares, for instance, have provisions for the same sort of redemption [quotation taken from PVS.PR.E prospectus]
Thus, for analytical purposes, I included a potential call at $26.00 from the day of issue when setting up this security on HIMIPref™.
This meant in turn that when I was preparing the August, 2017, PrefLetter, PVS.PR.E had a negative YTW since it was bid at $26.36. This had a strong influence on it not being recommended in August.
In September, however, the issue had weakened to 25.80-95 with a YTW of +4.83% and it was recommended.
I will admit that sometimes I look wistfully at issues such as this and feel some temptation to buy and recommend them … but then I think of stories like this and the temptation fades.
My position on this matter also has implications for Alternative Tier 1 Capital bonds, such as Scotia’s recent issue discussed on October 10. The prospectus states:
That will earn them a similar potential redemption entry (at par!) in any rationally constructed analytical system and have the effect of making them generally unattractive when priced at a premium and less attractive than otherwise when priced at a small discount.