It’s been quite the day of eMails for me! In addition to the relatively technical questions about PrefLetter, I received one that asked:
Can you tell me if there is a rule of thumb in determining rates companies offer for new preferred offerings as it relates to the BOC key rate?
In a word: No.
When a company thinks it might wish to offer preferreds, they contact their Corporate Finance guys at the dealers and ask them where they think they might sell a deal. After looking at comparables, thinking about the tone of the market, talking to the people on the front lines who will actually be selling the deal, all that kind of thing, Corporate Finance comes up with a guess and then the company decides if it makes sense for them.
That being said, there is usually some consistency – look at all the recent Pfd-1 perpetuals done lately with a 4.5% coupon, for example.
At some point, I’m going to get out my records and write an article about the historical trend of perpetual issuance, comparing the grossed-up interest rate equivalent with long Canadas – which is as close to the standard as exists.
In 2005, the new issue spread (according to some third party information I have) varied in a range of Canadas +140bp to Canadas +200bp.
In 2006, it was more like Canadas +200 to Canadas +250.
In 2007 … well, let’s see. High quality perps have been going at 4.50% … use 1.4x to gross that up, that’s 6.30% interest-equivalent. Long Canadas spent the first quarter in the 4.10%-4.30% range, mostly, so that’s a spread of Canadas +200 to Canadas +220, roughly in line with 2006.
Long Canadas are – taking today’s sell-off into account – trading in the 4.45% area, so we’ll say that perpetual prefs should be in the 6.55% interest-equivalent area, which is the 4.68% dividend area, which is more or less where they actually are, as of last night.
The major weaknesses of this back-of-the-envelope calculation are:
- Spreads could change due to perceived corporate weakness, particularly in the banking sector. They certainly changed in 2005/06!
- Ranges of the spreads are very large: 50bp!
- Those are new issue spreads I’m talking about. Logically, spreads on (deep) discount perpetuals should be smaller, as there is the opportunity to make a significant capital gain before your have to worry about the potential of a call.
- Preferreds are dominated by retail, which is prone to panic.
But, all that being said … let’s make a deal: You guess where long Canadas are going to be, and I’ll guess where perpetuals are going to be!
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