17 Responses to “April 18, 2022”

1. skeptical says:

   April 19, 2022 at 9:54 am

   It’s an admirable trait of the preferred investors that they panic equally well on rising rates as well as falling rates.

2. Tim says:

   April 20, 2022 at 10:48 am

   @skeptical
   +1 laugh out loud!

   The GOC5 rate just hit 2.76% as of right now.

   Five years ago (end of April 2017), it was 1.03%.

   Looking back on the Bank of Canada posted history of the GOC5 rate vs. 5 years before (starting with Jan. 2010 vs. Jan. 2005 data), this is the *best ever* five year uplift during that whole period. The only comparable period in terms of magnitude change was a cratering down 3% in 2012 vs. 2007.

   After years of pain in a falling interest rate environment, I am very much looking forward to what I hope are a whole series of big jumps up in dividends over the next while. Bring it on.

3. skeptical says:

   April 20, 2022 at 11:14 am

   Is it time yet to start asking a more fundamental question- At what rates would companies begin to redeem rate resets?
   Let’s start with CU.PR.C.
   Assume GOC5 hits 3% by the time of reset next month, resulting in a cost of 5.4%. Is it a fair price for them to pay this much dividend?
   CU’s long term bond yields close to 4.4% this morning.
   What if the rates rise to 4%(not forecasting, but imagining).
   And in the coming months, we’ll see a wave of bank redemptions because of LRCNs and much higher reset dividends.

4. ratchetrick says:

   April 20, 2022 at 11:47 am

   well . . . if you buy CU.PR.C where it is now, you’ll have to “suffer” a $2.50/share exit premium if they redeem . . . and if you buy ENB.PR.B at the current $18.80 level, you’ll be in utter agony absorbing a $6.20/share redemption premium. So you could get a large dividend increase on your shares if they remain unredeemed, . . . or a large capital gain if they get redeemed. This is kinda a “win-win” situation here, isn’t it? Just a thought lol.

5. stusclues says:

   April 20, 2022 at 1:22 pm

   “So you could get a large dividend increase on your shares if they remain unredeemed, . . . or a large capital gain if they get redeemed. This is kinda a “win-win” situation here, isn’t it?”

   That is one way to look at it. However, it ignores the RELATIVE value of the other intra-issuer series.

   The capital gains that could occur with redemption require a speculative bet based on the probability of the redemption event. In ratchetrick’s examples of CU.PR.C and ENB.PR.B, arguably the probability is near (but not) zero.

   The dividend increase of those issues looks certain and is therefore a “win”. However, the total return over the mid- to long term of a sister issue, such as ENB.PF.G, may be much higher and therefore, a bigger “win”. Models based on theories such as James’ own Implied Volatility Theory, clearly can make these bigger wins visible.

   Therefore, while ratchetrick’s “win-win” thinking is not wrong, it is not the best way to look the situation for longer term value creation.

6. skeptical says:

   April 20, 2022 at 1:31 pm

   However, the total return over the mid- to long term of a sister issue, such as ENB.PF.G, may be much higher and therefore, a bigger “win”.
   This is entirely possible, but it’s just another probability. The delta between rates of these two issues is about 24 and 26 bps. Both the G and E reset in 2025. What would be the rates be at that time? Could they fall again? Who knows?
   We now have at least two resets/original issue dates when the GOC5 was very low, as in below 1%. A few issues come to mind:
   ENB.PF.G/ENB.PF.E/RY.PR.J/TRP.PR.G
   RY and TRP both started very low and reset very low again. Could the economic situation change again by 2025? Who knows?
   If there’s some economic cycle of 5 year duration that causes rates to rise and fall at the time of these resets, the value creation projected may not not materialize.
   On the other hand, if we are indeed entering a new interest rate regime with higher rates and potentially higher inflation, all these wider rate resets will be big winners.

7. ratchetrick says:

   April 20, 2022 at 1:58 pm

   Yea, for sure skeptical . . . the only thing I’d add is that any pref that resets in 2025 is essentially a 5 yr bond (from a market view perspective) . . . so, if bond rates rise, this pref’s div yield will as well. It seems not so long ago that the converse was the “rule”, but apparently not at this time. And I suppose, once the near term issues reset, they will instantly be perceived as a 5 yr bond as well, so if rates keep rising, so will the div yield on these as well. idk, maybe the “clip your coupons” idea might be the way to go once we hit a threshold that’s acceptable. A month ago, I thought 6ish was the place to start . . . but now, it’s kinda feeling like 7 is going to be happening sooner than later. One thing for sure . . . once the rate cycle has any hint of stopping, or at this point, just slowing . . . the prices of these things will no longer be red!

8. stusclues says:

   April 20, 2022 at 2:20 pm

   “the only thing I’d add is that any pref that resets in 2025 is essentially a 5 yr bond (from a market view perspective)”

   “This is entirely possible, but it’s just another probability. The delta between rates of these two issues is about 24 and 26 bps. Both the G and E reset in 2025. What would be the rates be at that time? Could they fall again? Who knows?”

   Well, James may have something to say about these quotes 🙂

   I’ll just say the thought processes underpinning these arguments is much different than something like James’ IVT, which aims to view rate reset preferred shares as perpetual instruments whose value ought not to be based on speculation about interest rate increases or decreases. The value creation from a model based on IVT is improved when most people choose to ignore it, so I am not about to push this further 🙂

   BTW: I do use an IVT model based on James’ work, but I also have my own where I incorporate speculation about interest rate spreads by issuer (not rates) that I rely on mostly. Both these models expose the same cheap issues, just different magnitudes. The reason for this is related to the “Pure Price” calculated within James’ model if anyone cares to look deeper.

9. skeptical says:

   April 20, 2022 at 2:33 pm

   I’ll just say the thought processes underpinning these arguments is much different than something like James’ IVT, which aims to view rate reset preferred shares as perpetual instruments whose value ought not to be based on speculation about interest rate increases or decreases.
   Ultimately, the price of a security is nothing but the cash flows it generates over its life, discounted by a certain rate, yours or some interest rate. Without this rate, there really is no model. We can talk about whether the rate is high/low or the assumptions about it are valid or not, but you can’t value a security without using a rate.

   In this specific case, GOC5 has a huge influence on the cash flows generated for each 5 year step, so we can’t blithely ignore that number. It has to be some number, otherwise, we won’t have any model. What would that number be, 5, 10, 15, 20 or 30 years from now? Each of these numbers has a huge impact on the valuation of the security.

   For the same or similar issues, we can obviously look at the spreads and then evaluate the pricing. But what I suggested here was that if there’s some cyclic nature to the reset dates, it’s possible that the wider spread issues keep on getting reset at lower rates and generate lower cash flow for the holder, resulting in poorer overall returns. So the timing of reset and prevailing interest rates at that time can have huge implications for overall returns provided by various issues.
   Once again, this is ultimately forecasting and modeling work that has immense value in generating projections.

10. skeptical says:

    April 20, 2022 at 2:35 pm

    contd…
    and projections can disappoint, as we all know.

11. stusclues says:

    April 20, 2022 at 2:50 pm

    “Ultimately, the price of a security is nothing but the cash flows it generates over its life, discounted by a certain rate, yours or some interest rate.”

    100% true, if by “price”, intrinsic value is meant. Market price is often vastly different.

    To clarify, I am only talking about rate resets. The IVT model generates a theoretical issuer spread that applies to all of the series of a particular issuer. In IVT, the current interest rate is used, but any rate could be used and the same relative cheapness of issues will be apparent. Therefore, speculation about whether rates will be higher or lower in the future does not affect which series is cheaper than its sister issues. [I am simplifying. There are ways to adjust for lumpiness of the rate adjustments in the model but they have only minor effects].

    The eventual total return (for rate resets) absolutely depends on how the path of the 5yr GOC bond plays out.

12. ratchetrick says:

    April 20, 2022 at 2:53 pm

    stusclues . . . for example: AQN.PR.A is trading down today last at $22.70, down $1.60/sh, on relatively sizeable volume of 33K shares.

    The goc5 continues getting sold off today, with it’s yield up 5.5bp at this particular moment.

    “from a market perspective” . . . and I emphasize that caveat, which you apparently missed . . . this pref is essentially a 5 year bond. period.

13. skeptical says:

    April 20, 2022 at 2:57 pm

    The IVT model generates a theoretical issuer spread that applies to all of the series of a particular issuer. In IVT, the current interest rate is used, but any rate could be used and the same relative cheapness of issues will be apparent.
    Yes, this makes sense. I’ve a zero rate for GOC5 in many of my calculations for evaluating the attractiveness of various issues.

    But what I was speculating here was that certain issues could be ‘doomed’ to reset at a lower rate over a long stretch of 5 year periods because of the cyclical nature of rates and how a seemingly better issue as per our model could end up generating worse overall returns.

14. stusclues says:

    April 20, 2022 at 2:57 pm

    ““from a market perspective” . . . and I emphasize that caveat, which you apparently missed . . . this pref is essentially a 5 year bond. period.”

    I’m not disagreeing with how the market actually behaves from time to time. The fact that the market behaves irrationally is exactly why strategies like IVT create long term value.

15. ratchetrick says:

    April 20, 2022 at 4:31 pm

    No problem stusclues! I certainly agree with you there. On that AQN thing today, we also had another AQN pref trade down on substantial volume. Even on the much lower closing price, the yields on both are still well sub 6%. I would wonder if this action was initiated by a fund manager, or some pro insider that’s aware of an upcoming new AQN pref issue, probably at, or above 6%. It might explain the volume, which typically doesn’t come from a “retail” investor, and the willingness to part with a couple pretty high quality prefs at very aggressive looking prices. Don’t be surprised if you see something like this brought to the market by AQN in the near future! 🙂

16. jiHymas says:

    April 21, 2022 at 10:20 am

    And in the coming months, we’ll see a wave of bank redemptions because of LRCNs and much higher reset dividends.

    There is certainly some competition (from the issuers’ perspective) between Preferreds, LRCNs and, to some extent, subordinated debt.

    However, many of the banks don’t have much, if any room to issue more LRCNs due to the cap on their issuance as a proportion of risk-weighted assets, although it is possible that OSFI could increase the cap. Sub-debt? Maybe. Market appetite for sub-debt is a tricky thing and I’m not familiar with that aspect of the market. There are regulatory questions for utilities, too, given that preferreds are classed as equity, which is what their regulators want, and bonds are classed as debt. OSFI – and, it appears, the market as a whole – is perfectly happy with the sleight of hand that transforms a preferred into a bond, but other regulators? I just don’t know.

    However, it is not clear to me that “much higher reset dividends”, taken by themselves, willl trigger a wave of redemptions; If the GOC-5 yield increases, than so will the cost of the issuers’ other potential funding, to a greater or lesser extent.

17. niagara says:

    April 21, 2022 at 12:07 pm

    Hi James, great insight as always. There are a couple of bank prefs coming up for reset in the next month of so. BMO.PR.C should be announcing their decision as to whether to redeem or reset in a few days. This has a reset spread of 333bp. With the 5yr GOC yielding about 2.85%, this would give a new dividend of about 6.15%, a big increase over the current 4.5%. I think that they redeem it, but I’d be happy with 6.15% from a Canadian Bank if they choose to reset it.

    The other issue is CM.PR.R (reset of 338bp) coming up for reset in another month, which I also hold.