19 Responses to “April 13, 2022”

1. ratchetrick says:

   April 14, 2022 at 8:26 am

   Good morning! A question for James, and anyone else: During the last rate cycle, and subsequent volatility in the rate reset pref space, we saw the banks (and other issuers, but mainly the banks) falling all over themselves with new issues with progressively higher coupons that were needed to move the issues out. This, of course had a negative impact on the secondary market, which needed to constantly adjust to keep pace with the banks-induced flooding of the market with these higher yielding prefs. Does anyone see a repeat of that behaviour, since it’s pretty obvious to everyone that rates, and yields, are leaving the launching pad now?

2. CanSiamCyp says:

   April 14, 2022 at 10:11 am

   Hi RR! It is doubtful that will happen this time cuz a) the banks are well capitalized and b) they are still focussed on moving Tier1 capital from preferreds (where dividends are paid out of after tax profits) into the LRCNs (where interest is paid from pre tax income – thereby reducing after tax profits). The latter point will be of particular interest to them now that the Turdo regime has slapped an additional 1.5% tax on their profits – so they will scramble to reduce that profit any way they can legally! IMHO!

3. ratchetrick says:

   April 14, 2022 at 10:58 am

   Hi CanSC! Yes . . .LRCNs. . . I totally forgot about that little factor. They certainly didn’t even exist last time around. Thank you for jogging my failing memory! As far as Son of Pierre’s little tax pop on the banks, my betting is on a quick move from 22% to 25% (give or take lol) on credit card interest. That should about cover it . . . and besides, anyone carrying balances on bank credit cards at those levels can easily handle a few more percentage points. So what if it means they won’t have a $1000 balance paid off until 2080, instead of 2075?

4. skeptical says:

   April 14, 2022 at 11:21 am

   BEP new issue totally massacred. They really should have offered 5.75% on this issue. The market is already demanding that.

5. ratchetrick says:

   April 14, 2022 at 11:47 am

   skeptical, as we continue down this rate hike road, I think 6 might be the soon to become minimum. The 30yr bond yield is up another 10 bp’s today. At last look some of the corporates are yielding in the high 5’s, nearing 6% to buy. Before anyone reminds me of the dividend tax credit that grosses prefs up, it needs to also be remembered that many investors are putting this income category in accounts such as RRSPs, RRIFs, & TFSAs . . . where the gross up has no benefit. Prefs need to be competitive with bonds, and right now, they’re lagging behind in the traded market, and as you point out in the IPO market as well. Not many people have good reason to sniff around at the long end of bonds, since the price drop/yield rise cycle has only begun . . . so does anyone dare enter reset, or even more dangerous, perpetuals, any time soon?

6. skeptical says:

   April 14, 2022 at 11:57 am

   At 6% we are talking about 7.8% bond. The A rated bonds are still in low to mid 4.xx range. The spread is too wide.
   If the long end shifts upwards and inflation persists, we’ll enter a very interesting zone that very few investors have experience with. I’ve zero experience in trading perpetuals in an environment where the long Canada’s yield 4 or 5%.
   The oldest extant preferreds that I’m aware of are the BCE and BAM floaters, along with perhaps the Thompson Reuters’ floater. They are all tied to the prime. So if we do see persistent inflation and higher rates, we revert to those kinds of issues. Right now, they yield about 1.3 times the prime. If the prime become sticky, expect this multiple to compress.
   After a couple of hikes, all these issues should yield close to 5%, at current prices.

7. skeptical says:

   April 14, 2022 at 12:19 pm

   At a really macro level, BoC and other central banks need to rein in inflation hard. Or the zombie companies and other similar businesses that are barely hanging by the thread (because of the Zirp world) are going to get in major trouble. Same with the zombies in the startup world that have projections of profit a decade out. All these businesses become deeply unappealing in an inflationary, high interest rate environment.

   The western world had it all great- low rates, low inflation and a stable economy. But the central banker’s really wanted the inflationary fire and the arsonist governments were only too happy to fuel it. Now they will have to live with the consequences, which are not going to be pretty for anyone. Let’s hope they can get inflation under control soon, or it’s going to get ugly fast.

8. ratchetrick says:

   April 14, 2022 at 12:28 pm

   I don’t think comparing A rated bonds to any pref is a fair comparison. It might make more sense to compare the same issuer’s pref to their long bonds. Pembina is a good example . . . right now, their 20 year bond is yielding close to 6%, where their prefs are around 5%. This is sort of acceptable, based on the gross up, but as I mentioned above, gross up means little for a registered account investment. Plus, you have a guaranteed exit date, whereas prefs get redeemed when it’s in the issuer’s best interests. The prefs simply need to drop down in price, to get the yield closer to their bond yield . . . but the bond yield is rising literally daily. I’ve experienced the perp meltdown of 2008 from the wrong side . . . and the reset meltdown that came a few years later . . . from the right side. Trust me, it feels way better to look at an account value gain of a half million dollars, than the converse. I suffered through the years of recovery in the perpetuals, struggling to “break even”, as I took James advice to “shut up and clip my coupons” . . . but clipping coupons, followed by a 50% gain on exit is better. Maybe Putin will push his red button, bringing an early end to the rate hike cycle . . . but that’s pretty much what it will take to put a muzzle on these hike crazy central bankers at this point, I think!

9. jiHymas says:

   April 14, 2022 at 8:46 pm

   Pembina is a good example . . . right now, their 20 year bond is yielding close to 6%, where their prefs are around 5%.

   My figures for the close of business today show the lowest-yielding PPL issue is PPL.PF.A, yielding 5.89% at its bid of 24.95. Most of the rest are clustered around 6.25%, but PPL.PR.I yields 6.51% at 23.30 bid, and PPL.PR.S 6.72% at 23.62 bid. How are you calculating the preferred share yields?

10. jiHymas says:

    April 14, 2022 at 10:08 pm

    BEP new issue totally massacred. They really should have offered 5.75% on this issue.

    Why? They sold not just the initial offering amount with a 5.50% coupon, but the underwriters picked up the greenshoe?

11. skeptical says:

    April 14, 2022 at 11:55 pm

    Not from the BEP perspective of course. But for the investors who bought the issue at par. In fact BEP managed to squeeze the best value for themselves.
    I wonder though how keen investors would be for similar aggressively priced issues in future.

12. niagara says:

    April 16, 2022 at 5:10 am

    re the new BEP issue, I think that it was issued at fair value at the time of announcement. 30yr GOC was yielding about 2.44% that day, it is now 2.71%….so a 27bp rise. I don’t think that corp bond spreads over GOCs have really done much in that period. Further, just glancing at the prices for a few perpetuals that I follow, all have dropped in price since April 5.

    But it does go to show that perpetuals, like long bonds, have a high price sensitivity (delta or duration). In our illiquid pref market, these perpetual pref prices can be a bit sticky but they do eventually move when the long bond yields move significantly.

    It is this price sensitivity that keeps me away from them. While yields in the 5.5% range might sound enticing, a mere 50bp rise in long bond rates will cause an ~8% drop in price of the pref (assuming the spread over bond yields remains constant)….and I think long bond yields are still too low – – central banks are going to hike faster and longer than the market is pricing in (IMO of course).

13. skeptical says:

    April 16, 2022 at 7:01 am

    Niagara:what you are saying is theoretically correct, at least directionally.
    But the preferred market is a whole bunch more complex and the correlation between long bond and perpetual yields is varying. I didn’t do any rigorous analysis but an extant issue that has seen a lot of market cycles is EnB.pr.a
    Both these issues are similar rated and offer same yields. Going back to early 2000s, the long Canada’s were well over 3.5 to 4% range and the Enbridge issue traded at close to or above par most of the time.
    In fact our correlations in the preferred market are so broken that floaters have actually fallen since the 75 bps increase by BOC. Nobody back in December saw rates rising by 75 bps by April and definitely a fall in rate resets and floaters since then.
    My theory is that rates play only one part in determining the attractiveness of preferred shares.
    Others are risk sentiment, availability of alternatives, the general state of credit markets amongst numerous others.
    It’s naive to assume that only interest rates affect this market. It should, but that would be only in an ideal world. Would that happen in the long term? Perhaps and I would say that 2021 was the year when most preferred shares were priced in line with this. But for long periods of time , this ideal relationship doesn’t exist. After all, it can be easily argued that this relationship is supposed to be fractured most of the time and will only normalize in times of very low volatility, dearth of alternatives and extreme risk taking. All of this happened in 2021, when both fiscal and monetary spigots were wide open. Now that volatility is back, the idyllic correlations are severed and these issues trade on numerous factors other than the long bond yield. Finally, the rarity of the issue is also a factor. There are way too many things going on here IMHO.

14. niagara says:

    April 16, 2022 at 8:49 am

    skeptical, agreed, I was only focusing on the interest rate aspect of the pref market, especially in the near term. The pref market like any other market is far more complex than that….worse, our lovely little pref market is far more irrational than I can ever account for (so I have given up!).

    Still, I will wait on the sidelines on the perpetual issues until I see yields well north of 6%….or if CPI suddenly drops for several months (I am not holding my breath for the latter).

15. skeptical says:

    April 16, 2022 at 9:06 am

    At 6% plus, the simplistic rule of 72 would imply doubling in roughly 12 years. That’s an exceedingly good return IMHO, especially if we consider the tax ramifications and seniority over common equity. Inflation can be a spoilsport, but it’s going to hit bonds, common equities and real estate as well. At least in the early days.
    The response from Bank of Canada has been strong, especially considering where they were just a few months ago.
    Again everyone has to use their own criteria. At 6%, we might just say that 7% would be more appealing:)

16. stusclues says:

    April 16, 2022 at 12:00 pm

    “or if CPI suddenly drops for several months (I am not holding my breath for the latter)”

    Why not? Reported inflation is backward looking. How does do prices continue to accelerate higher going forward? There are good arguments that we have seen peak pressures already – surging oil and gas prices, global supply chain problems, housing price super escalation, etc. Is it more likely that any of these get worse or that these pressures ease?

    The main argument for inflation taking off from here seems to be the onset of a wage-price spiral, which we are hearing a lot of speculation about but seeing relatively little actual evidence.

17. Rod says:

    April 16, 2022 at 3:31 pm

    The complexity of prefs is predicting what other investors will do. Maybe it’s best not to try and just buy when they are offering yields at extreme premiums to the benchmark 5 year bond. It happened in 2016 and 2020. I’m just waiting to see if it happens again.

18. jiHymas says:

    April 20, 2022 at 11:29 am

    Pembina is a good example . . . right now, their 20 year bond is yielding close to 6%, where their prefs are around 5%.

    It turns out that ratchetrick is using Current Yield as his measure of expected returns, which I consider to be an extremely flawed approach.

19. April 20, 2022 « PrefBlog says:

    April 20, 2022 at 8:04 pm

    […] PerpetualDiscounts now yield 5.66%, equivalent to 7.36% interest at the standard equivalency factor of 1.3x. Long corporates now yield 4.63%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has narrowed to 275bp from the 290bp reported April 13. […]