Regulatory Capital

Common and Preferred Dividend Cuts: How Well Correlated?

I was reminded of this topic recently … and reminded some time ago of the perception of relative risks when investing in preferred stock. A stockbroker type was explaining to me that he would never buy bank preferreds due to the risk of default … I pointed out that, while always possible, the banks would surely cut or eliminate their common dividend well in advance of their preferred dividend.

He was flabbergasted … “Do you really think they would cut their dividend? That would be terrible!”

In other words, he very calmly accepted the idea of a default on the perpetuals, but could not conceive of a situation in which a bank would cut its common dividend.

Recently, the poster-boy for credit excesses, Citigroup, cut its common dividend 41% while the preferred dividends just kept on chugging along – even increased in total, as they have raised a lot of capital via preferred offerings … presumably to investors who figured they wanted their interim dividends for the next five-years-odd to be preferred!

So anyway, I was thinking about this a little more and did a little digging … through the RBC Annual Report for 2007:

During 2007, we continued to return capital to our shareholders through dividend increases and share buybacks, delivering a total shareholder return of 16 per cent.
…
For several years, we have made it a management priority to ensure current success was reinvested to fund future growth. This approach allowed us to deliver relatively solid shareholder returns in 2007 while returning capital through increased dividends and share buybacks. We raised dividends twice in 2007 for a total increase of 26 per cent, and we repurchased 11.8 million common shares. Our capital position is strong with a Tier 1 capital ratio of 9.4 per cent, comfortably above our target of greater than 8 per cent.

Share Buybacks are analytically equivalent to dividends – and buyback-suspensions are the easiest way to halt a decline in capital ratios. But what sort of proportion do they make? I’ve had a preliminary look at this via RBC’s Annual Reports for 2001, 2004 and 2007:

RBC Data
Year Income Preferred
Dividends		 Common
Dividends		 Common
Buy-Backs
1999 1,725 157 588 333
2000 2,208 134 689 660
2001 2,435 135 897 509
2002 2,898 98 1,022 764
2003 3,036 68 1,137 852
2004 2,839 45 1,303 892
2005 3,387 42 1,512 226
2006 4,728 60 1,847 844
2007 5,492 88 2,321 646
Total 11,316 5,726

So, this is all pretty rough, it’s only one bank (a strong one!) and it’s taken over a period in which the bank examined hasn’t had anything particularly horrible happen to it. Still, it’s interesting to find that about 1/3 of the total capital returned to common shareholders has been in the form of buybacks rather than dividends … and, as the experience of 2005 shows, the buybacks can be cut quite easily.

Market Action

May 21, 2008

The big news today is a Moody’s methodological scandal:

Moody’s Investors Service said it’s conducting “a thorough review” of whether a computer error was responsible for assigning Aaa ratings to debt securities that later fell in value.

Some senior staff at Moody’s were aware in early 2007 that constant proportion debt obligations, funds that used borrowed money to bet on credit-default swaps, should have been ranked four levels lower, the Financial Times said, citing internal Moody’s documents. Moody’s altered some assumptions to avoid having to assign lower grades after it corrected the error, the paper said.

Naked Capitalism is ecstatic. Publication of the official release from Moody’s was delayed, but it there … albeit scooped by FT Alphaville.

Heads will roll. And quite rightly.

An Accrued Interest post on Freddie Mac was referred to yesterday. For those interested-but-not-all-that-much in the issue, Jonathan Weill reviews the accounting issues.

On the sub-prime front there is (via FT Alphavill) that UBS is having a close-out special on some sub-prime

UBS sold positions with a nominal value of approximately USD $22 billion to the new fund for an aggregate sale price of approximately USD $15 billion. Based on UBS categorizations, the vast majority of the positions are Subprime and Alt-A in roughly equal parts and the remainder is Prime. The fund purchased the securities using approximately USD $3.75 billion in equity raised by BlackRock from investors and a multi-year collateralized term loan of approximately USD $11.25 billion provided by UBS.

UBS is notorious for having an assets-to-capital multiple that was way off the charts. But, holy smokey! Sixty-Eight cents on the dollar? Since UBS is the seller, we may assume that the great bulk of it, if not all, is AAA tranches … and even Greenlaw forecast a mere 18.9% average loss. I think the Blackrock guys – and their investors – are going to make out like bandits on this.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.69% 4.73% 51,544 16.04 1 +0.2020% 1,082.8
Fixed-Floater 4.67% 4.55% 66,824 16.17 7 +0.2123% 1,071.7
Floater 4.14% 4.18% 63,477 17.00 2 -1.6272% 912.7
Op. Retract 4.83% 2.49% 91,589 2.34 15 -0.0192% 1,055.8
Split-Share 5.25% 5.45% 70,516 4.17 13 -0.0008% 1,059.2
Interest Bearing 6.10% 6.11% 53,666 3.81 3 -0.1335% 1,110.4
Perpetual-Premium 5.89% 5.71% 135,724 5.89 9 +0.0178% 1,022.0
Perpetual-Discount 5.65% 5.69% 300,191 14.09 63 +0.0123% 928.0
Major Price Changes
Issue Index Change Notes
BAM.PR.B Floater -2.7237%  
W.PR.J PerpetualDiscount -1.5241% Now with a pre-tax bid-YTW of 5.95% based on a bid of 23.26 and a limitMaturity.
BAM.PR.H OpRet -1.3894% Now with a pre-tax bid-YTW of 5.38% based on a bid of 25.55 and a softMaturity 2012-3-30 at 25.00. Compare with BAM.PR.I (5.03% to 2013-12-30) and BAM.PR.J (5.48% to 2018-3-30).
BNA.PR.B SplitShare +1.9917% Asset coverage of just under 3.2:1 as of April 30, according to the company. Now with a pre-tax bid-YTW of 6.95% based on a bid of 22.02 and a hardMaturity 2016-3-25 at 25.00. Compare with BNA.PR.A (5.79% to 2010-9-30) and BNA.PR.C (6.37% to 2018-1-10).
Volume Highlights
Issue Index Volume Notes
TD.PR.R PerpetualDiscount (for now!) 115,125 Now with a pre-tax bid-YTW of 5.66% based on a bid of 25.20 and a limitMaturity.
TD.PR.O PerpetualDiscount 111,400 Now with a pre-tax bid-YTW of 5.38% based on a bid of 22.75 and a limitMaturity.
NSI.PR.D Scraps (would be OpRet but there are volume concerns) 100,800 Now with a pre-tax bid-YTW of 4.75% based on a bid of 27.00 and a put 2016-2-14 at 24.75.
TD.PR.P PerpetualDiscount 91,412 Now with a pre-tax bid-YTW of 5.46% based on a bid of 24.23 and a limitMaturity.
PWF.PR.F PerpetualDiscount 85,000 Now with a pre-tax bid-YTW of 5.63% based on a bid of 23.50 and a limitMaturity.
BCE.PR.Z FixFloat 82,684  

There were forty-two other index-included $25-pv-equivalent issues trading over 10,000 shares today.

Better Communication, Please!

CU Inc. Issues Long Term Debs

CU Inc. has an issue trading on the Toronto Stock Exchange, CIU.PR.A, now bid at 20.50 for a pre-tax bid-YTW of 5.64% based on a limitMaturity; this is an interest-equivalent of 7.90% at a conversion factor of 1.4x. These are Series 1 Preferred. The company also has an approximately equal value of “Series Second Preferred” outstanding, all of which are held by the parent company.

Today they issued some 30-year debs at 5.58%.

Mainly I was interested in this because of the 232bp interest-equivalent spread between the prefs and the long debs, but there’s a little twist …

A grossly abbreviated statement of their liabilites is:

CIU Inc. Liabilities
Item Value
CAD Millions
Current Liabilities 250.6
Non-Current Non-Capital 229.6
Long-Term Debt 2,459.4
Series 1 Prefs 115.0
Series 2 Prefs 130.0
Equity 1,675.5
Total 4,860.1

According to the prospectus for CIU.PR.A:

In the event of the liquidation, dissolution or winding up of the Corporation, or other distribution of assets of the Corporation among its shareholders for the purpose of winding-up its affairs, the holders of the Series 1 Preferred Shares shall be entitled to receive the amount paid up on such shares together with all accrued and unpaid cumulative preferential dividends thereon and, if such liquidation, dissolution, winding-up or distribution is voluntary, a premium of $1.00 per share if such event commences prior to June 1, 2009, and, if such event commences thereafter, a premium equivalent to the premium payable on redemption if such shares were to be redeemed at the date of commencement of any such voluntary liquidation, dissolution, winding-up or distribution, before any amount shall be paid or any property or assets of the Corporation shall be distributed to the holders of any Class A non-voting shares or Class B common shares or other shares ranking junior to the Series 1 Preferred Shares. After payment to the holders of the Series 1 Preferred Shares of the amounts so payable to them, they shall not be entitled to share in any further distribution of the property or assets of the Corporation.

… which is not entirely satisfactory, because nowhere in the document is the seniority of the “Series Second Preferred Shares” clearly defined relative to the “Series 1 Preferred Shares”.

I have used their contact form to ask the question:

Are the CU Inc. Series 1 Preferred Shares junior, senior, or parri passu to the Series Second Preferred Shares?

Where may I find legal documentation of the relative status?

Update, 2008-5-27: I have received a note from Atco staff denying the existence of Series Second Preferred shares. Further inquiries are in progress.

Issue Comments

BCE / Teachers' Deal : Chattering Classes Humiliated

The Canadian Press has reported:

The purchase of BCE Inc. (TSX: BCE.TO) by a group led by the Ontario Teachers’ Pension Plan hit a snag Wednesday after the Quebec Court of Appeal overturned a lower court’s decision to allow the largest corporate takeover in Canadian history.

The appeal court sided with the company’s bondholders in reversing Quebec Superior Court Justice Joel Silcoff’s decision to allow the takeover of the company in a deal worth $52 billion.

The bondholders had sought to block the proposed leveraged buyout of Canada’s largest telecom company that they say treats them unfairly because it loads the telecom giant up with debt and makes their bonds a much riskier investment.

“BCE never attempted to justify the fairness and reasonableness of an arrangement that results in a significant adverse economic impact on the debentureholders while at that same time it accords a substantial premium to the shareholders,” the five-judge panel ruled.
…
Mark Meland, one of the lead lawyers for the bondholders, said his clients were pleased by the court’s decision that was widely expected to side with the company.

“The chattering classes were virtually unanimous in stating incorrectly that we had no chance in being successful, but our group, the bondholders that I represent, we always believed we had a good case,” Meland said.

Mea culpa, mea culpa, mea maxima culpa, and profound apologies to Mr. Meland!

But congratulations … the plot thickens!

The last report on this deal was regarding sabre rattling by the banks.

BCE has the following preferred shares outstanding: BCE.PR.A, BCE.PR.C, BCE.PR.D, BCE.PR.E, BCE.PR.F, BCE.PR.G, BCE.PR.H, BCE.PR.I, BCE.PR.R, BCE.PR.S, BCE.PR.T, BCE.PR.Y & BCE.PR.Z

I have no idea what’s going to happen … there are financing jitters and now some legal jitters … I have no expertise, special information or analytical advantage in either area. It’s all speculation.

Update: More on Bloomberg:

Today’s decision “rewrites Canadian law relating to the duty of Canadian boards of directors to maximize value for shareholders,” Martine Turcotte, BCE’s chief legal officer, said in the company’s statement.

Update: BCE is seeking leave to appeal to the Supreme Court.

Update: The Globe has published the court judgement. Kudos for them! What I’d really like to see is a decision by the relevant authorities that all paperwork filed in all court cases be made publicly available (via Internet) with no charge … but until that happy day, I’ll settle for the press occasionally publishing scraps.

Market Action

May 20, 2008

Sorry folks! Today was boring on the news front AND I was busy, so there’s no macro-level commentary. Accrued Interest wrote a good piece on How Safe are the GSEs?.

Strength in the Floating Rate sector continues to astound; they’re really coming back a lot from their extreme depths. I don’t think it has anything to do with the credit, because the BAM perpetuals are still bumping along without any huge gains. PerpetualDiscounts are doing well, but this is simply in line with long corporates, which have returned +1.44% in the month to 5/20.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.75% 4.78% 47,734 15.94 1 -0.2820% 1,080.6
Fixed-Floater 4.69% 4.58% 65,517 16.13 7 -0.6110% 1,069.5
Floater 4.07% 4.11% 61,380 17.14 2 +0.8898% 927.8
Op. Retract 4.83% 2.61% 89,192 2.53 15 -0.0766% 1,056.0
Split-Share 5.25% 5.44% 69,956 4.17 13 +0.2382% 1,059.2
Interest Bearing 6.10% 5.99% 53,940 3.81 3 +0.4044% 1,111.9
Perpetual-Premium 5.89% 5.71% 136,790 5.80 9 +0.0573% 1,021.8
Perpetual-Discount 5.65% 5.69% 298,053 14.03 63 +0.0898% 927.9
Major Price Changes
Issue Index Change Notes
BCE.PR.Z FixFloat -1.4517%  
BNS.PR.J PerpetualDiscount -1.3878% Now with a pre-tax bid-YTW of 5.42% based on a bid of 24.16 and a limitMaturity.
BSD.PR.A InterestBearing +1.0309% Asset coverage of just under 1.8:1 as of May 16, according to Brookfield Funds. Now with a pre-tax bid-YTW of 6.62% (mostly as interest) based on a bid of 9.80 and a hardMaturity 2015-3-31 at 10.00.
ELF.PR.G PerpetualDiscount +1.1543% Now with a pre-tax bid-YTW of 6.25% based on a bid of 19.28 and a limitMaturity.
BAM.PR.B Floater +1.2309%  
Volume Highlights
Issue Index Volume Notes
PWF.PR.K PerpetualDiscount 79,425 Nesbitt crossed 75,000 at 22.24. Now with a pre-tax bid-YTW of 5.66% based on a bid of 22.09 and a limitMaturity.
RY.PR.H PerpetualDiscount 75,110 CIBC crossed 50,000 at 24.95. Now with a pre-tax bid-YTW of 5.71% based on a bid of 24.95 and a limitMaturity.
TD.PR.R PerpetualDiscount (for now!) 60,650 Now with a pre-tax bid-YTW of 5.69% based on a bid of 25.05 and a limitMaturity.
PWF.PR.I PerpetualPremium 52,550 Nesbitt crossed 50,000 at 25.30. Now with a pre-tax bid-YTW of 5.80% based on a bid of 25.30 and a call 2012-5-30 at 25.00.
PWF.PR.G PerpetualDiscount 51,800 Nesbitt crossed 50,000 at 25.25. Now with a pre-tax bid-YTW of 5.71% based on a bid of 25.25 and a limitMaturity.

There were twenty-two other index-included $25-pv-equivalent issues trading over 10,000 shares today.

Issue Comments

RBT.PR.A Partial Call For Redemption

R Split II Corporation has announced:

that it has called 23,250 Preferred Shares for cash redemption on May 30, 2008 (in accordance with the Company’s Articles) representing approximately 5.351% of the outstanding Preferred Shares as a result of the special annual retraction of 134,500 Capital Shares by the holders thereof. The Preferred Shares shall be redeemed on a pro rata basis, so that each holder of Preferred Shares of record on May 29, 2008 will have approximately 5.351% of their Preferred Shares redeemed. The redemption price for the Preferred Shares will be $30.50 per share.

The last RBT.PR.A partial call was noted by PrefBlog last year.

RBT.PR.A is not tracked by HIMIPref™

Issue Comments

BXN.PR.B Partial Call for Redemption

B Split 2 Corporation has announced:

that it has called 84,808 Preferred Shares for cash redemption on May 30, 2008 (in accordance with the Company’s Articles) representing approximately 8.920% of the outstanding Preferred Shares as a result of the special annual retraction of 177,808 Capital Shares by the holders thereof. The Preferred Shares shall be redeemed on a pro rata basis, so that each holder of Preferred Shares of record on May 29, 2008 will have approximately 8.920% of their Preferred Shares redeemed. The redemption price for the Preferred Shares will be $9.75 per share.

The last partial redemption of BXN.PR.B was noted by PrefBlog last May.

BXN.PR.B is not tracked by HIMIPref™

Issue Comments

SNP.PR.V Partial Call for Redemption

SNP Split Corp has announced:

that it has called 220,819 Preferred Shares for cash redemption on June 4, 2008 (in accordance with the Company’s Articles) representing approximately 12.091% of the outstanding Preferred Shares as a result of the special annual retraction of 578,638 Capital Shares by the holders thereof. The Preferred Shares shall be redeemed on a pro rata basis, so that each holder of Preferred Shares of record on June 3, 2008 will have approximately 12.091% of their Preferred Shares redeemed. The redemption price for the Preferred Shares will be US$10.25 per share.

SNP.PR.V is not tracked by HIMIPref™.

Miscellaneous News

Critchley of Financial Post: Fixed-Resets Good!

Barry Critchley of the Financial Post had a piece in today’s Financial Post – Ruggins a Master of Tier 1, in which he comes out in favour of the currently fashionable fixed-reset structure:

If a bank was interested in raising Tier 1 capital and wanted to demonstrate that it was investor friendly, a useful starting point would be to call Len Ruggins, the former executive in charge of capital market funding for BCE and Bell Canada.

During his career, Ruggins raised more than $30-billion of capital, or more than any other non-bank executive in the country. Ruggins, now based in Calgary, had a rule: Don’t bag investors. He interpreted that rule by opting never to issue fixedrate perpetual preferred shares. The reason: They aren’t in the best interests of investors. Instead, they serve the interests of issuers that have all the power to let the prefs stay out there forever — and forever is a long time.
…
In five years when the so-called subsequent fixed-rate period comes around, investors have a choice: They can opt to receive other fixedrate pref shares that have a yield equal to the rate on five-year Canada bonds plus 205 basis points. In this way, the spread becomes a permanent part of the formula and means investors won’t be harmed by any improvement in Scotiabank’s credit spread over the period. If in five years the yield on Canada bonds is above 2.95%, then investors will receive a higher nominal yield; if the yield is lower, investors will receive a lower nominal yield.

In five years, investors have another choice: They can opt to convert to non-cumulative floating-rate preferred shares. The floating-rate pref shares will pay a dividend equal to the three-month T-bill rate plus 2.05%. However, the floating-rate pref is available only if there is a minimum-sized float.

From Scotia’s perspective, the issue was attractive: It gets Tier 1 capital, given that OSFI, the federal regulator, signed off on the transaction, and it still gets to control most of the shots. As well, the structure allowed the bank to raise more capital — at a lower yield — than a traditional perpetual.

Since Scotia’s deal — on which it’s understood Desjardins Securities played a key structuring role — Fortis raised $200-million via a similar offering.

The Fortis new issue and the Scotia new issue have both been previously discussed.

There are some critical flaws in Mr. Critchley’s analysis:

  • Credit risk has a high degree of importance in fixed income investing … particularly with instruments that won’t ever just run off the books. Due to the risk that bad times may come, investors must increase their expected returns in the event that good times continue.
  • Contrary to If in five years the yield on Canada bonds is above 2.95%, then investors will receive a higher nominal yield, there is no assurance that the bonds will not be called at such a time.
  • There is an inherent contradiction within As well, the structure allowed the bank to raise more capital — at a lower yield — than a traditional perpetual. Issuers and investors are at war with each other. A lower yield – good for the issuer – can be justified only to the extent that risk is transferred … in this case, there is some show of transferring interest rate risk. The fact that these issues are callable in five years at par means that the transfer inherent in these prefs is minimal.

Incidentally … the portfolio strategy of one major dealer advises investors to retain cash for investment in new, “defensive”, fixed-reset issues … so I suspect that there are a lot of deals in the pipeline waiting for an opportune moment.