Category: Issue Comments

Today’s Globe & Mail contained an article by Rob Carrick that mentioned preferred shares.

Riccardo Palombi, a salesperson at the Manitoba-based McLean & Partners had a few words to say:

Mr. Palombi of Mclean & Partners suggests sticking to preferred shares issued by the big banks and other top-quality issuers. As an example, he mentioned the TD preferred series O shares, which pay $1.21 in dividends a year and currently yield about 4.6%.

So, I thought I’d write a bit about TD.PR.O today.

The option schedule for TD.PR.O is:

 A perpetual, paying $1.2125.

Firstly, the 4.6% Carrick mentions is currentYield and I’m saddened, but not surprised that Carrick mentioned it in his article. As readers of my article A Call too, Harms know, I’m not a big fan of Current Yield and greatly prefer yield-to-worst as a measure of preferred share value – assuming, of course, that I’m writing for general publication and am only allowed a single measure of value!

The pre-tax YTW of TD.PR.O is 4.14%, based on the January 12 closing bid of $26.15. So the first thing we want to know is: why accept 4.14% when there are new issues (new bank issues, what’s more, from Royal, Scotia and BMO that yield 4.50%?

One possibility is the implicit degree of interest rate protection afforded to investors by the higher coupon. The TD issue pays $1.2125, as mentioned above, which works out to 4.85% on the original issue price. If rates rise, then all fixed income issue will be hurt, but (for the first little while, at least) TD.PR.O will have some protection, because it will still make sense for the issuer to call the issue at the same price as it would have called them in the absence of a rise.

If, for instance, all perpetual preferreds are trading at 4.80% (pre-tax) in 2014, then we will expect TD.PR.O to be redeemed at $25.00 (or trading slightly above that price), whereas one of the current new issues, paying $1.125 p.a., will be trading at around $23.40, at which price they will be yielding the 4.8% imposed by these hypothetical market conditions. In other words, they will have lost about $1.60 in value, compared to only $1.15 in value for the TD.PR.O. Additionally, the TD.PR.O will have paid about $0.09 more p.a. as dividends.

When HIMIPref™ is used to analyze the cash flows of TD.PR.O for the YTW scenario, we get the the attached report from the cashFlowDiscountingAnalysisBox. This report can also be saved as a text file and uploaded to an Excel spreadsheet.

I hate using Excel spreadsheets to explain things. At some point I’ll write a little feature into HIMIPref that will do this automatically, but that’s way down the list. The purpose of HIMIPref™ is to analyze preferreds write blog posts! While this sort of analysis is implicit in HIMIPref™ it’s buried pretty deeply, in things like curvePrice!

On the tab “Initial Analysis” of the attached spreadsheet, the data provided above has been put into Excel format. Additionally, equivalent data for the RY.PR.? new issue has been approximated by multiplying the cash flows for TD.PR.O by a factor of (4.50 / 4.85) to account for the reduced coupon. The cells highlighted in yellow have been further changed, to reflect an estimated value of $25.00 for the RY.PR.? on 2014-11-30: that is, this analysis projects no change in market interest rates between now and the analysis end-date.

When we sum the values of the individual flows, we find that the net present value for TD.PR.O is, indeed, about $26.10 (there’s some rounding error. So sue me.) which of course it should be since the discounting factors are derived from the Yield that results if it is redeemed on the End Date.

We are amazed and astounded, however, to note that the cash flows of the RY.PR.? new issue sum to about $25.40, which is forty cents more than the price we have to pay for it now. Bonus! Using this analysis, we can say that the TD.PR.O is fairly priced (by definition) but the RY.PR.? is forty cents cheap! So why buy the TD.PR.O.

Some scenario analysis is done on the “Scenarios” tab of the spreadsheet. For each presumed market yield, we calculate the price of each issue, being careful to cap this value at the appropriate redemption price. Then we account for tax effects to derive an exit value. We use the discounting factor from the “Initial Analysis” tab to compute the present value of the exit value, add this to the present value of the dividends, and then come up with the present value of the whole package. In columns “Q” & “R”, we compare this discounted present value to the actual market price to see whether it’s cheap or expensive, given the scenario for market yields. Obviously, if our scenario is for rising yields, they’re both expensive. Any fixed income will be! But the degree of protection has been calculated.

I’ve prepared a chart:

So, if you want some protection from rising interest rates, you may well prefer TD.PR.O to the new bank issues, accepting the fact that this will probably be an underperforming choice if rates are unchanged from this time until the call-date.

I consider this analysis to be very approximate and do not explicitly use it in HIMIPref™. I’m more interested in curvePrice, the price at which an instrument should theoretically trade if all its features are valued the same way as similar features on similar issues, and at Yield-to-Worst, these being two major components of valuation:

A full HIMIPref™ analysis shows this issue roughly comparable to one of the new bank issues. But I like RY.PR.B & RY.PR.C better in that “bank perpetual” space. 

5Banc Split Inc. has announced (via CCN Matthews) that:

it has completed the issuance of an additional 100,000 Class B Capital Shares (the “Capital Shares”) and 100,000 Class B Preferred Shares (the “Preferred Shares”) at prices of $10.00 per Capital Share and $10.00 per Preferred Share pursuant to the exercise of the over-allotment option granted to the Company’s agents in its recently completed offering of Capital Shares and Preferred Shares. All together, the Company has raised total gross proceeds of $282 million under the offering.

The FBS.PR.B new issue closed on December 15. This is good news. Always nice to see these things get a little more liquid.

I was surprised at the hostile reception accorded BNA.PR.C, the new issue that settled today after being announced December 20.

It traded in a fairly narrow range, 24.70-85, on heavy volume of 798,550 shares. The closing quotation was 24.74-78, 10×10.

More later.

Much later, more: I’ve uploaded the Split-Share sub-Index Portfolio Evaluation. Interested readers should be able to tell with a glance at the “Yield-to-Worst” column (and a peek at the “Modified Duration – Yield to Worst” column) that I do have some basis for considering this issue undervalued!

Amendment to Quorum Requirements The Trust Agreement currently provides that quorum for any meeting of Unitholders called to consider a matter requiring the approval of Unitholders by an Ordinary Resolution is two or more Unitholders present in person or represented by proxy holding not less than ten percent (10%) of the Units then outstanding, and the quorum for any meeting of Unitholders called to consider a matter requiring the approval of Unitholders by an Extraordinary Resolution is two or more Unitholders present in person or represented by proxy holding not less than twenty five percent (25%) of the Units. In order to make it easier for quorum to be achieved with respect to any particular meeting, and thus reduce administrative costs associated with the necessity of holding adjourned meetings, Unitholders of Income & Growth Split will be asked to consider and, if deemed advisable, to pass resolutions decreasing the quorum requirement for any meeting called to consider a matter requiring the approval of Unitholders by either an Ordinary Resolution or an Extraordinary Resolution to one or more Unitholders present in person or represented by proxy holding not less than five percent (5%) of the Units then outstanding and to amend the adjournment requirements so that an adjourned meeting may be held at such time and place and on such date as may be fixed by the chairman of the meeting.

Well, we now know why they felt it advisable to change the quorum requirement! 

According to a press release on Canada Newswire: 

A quorum was not present at each of the meetings and as a result, the special meetings for these funds were adjourned to January 23, 2007 at the offices of Stikeman Elliott LLP, Boardroom 3, 51st Floor, 199 Bay Street, Toronto, Ontario M5L1B9.

The merger, therefore, will have to wait … even after I went to the trouble of adding FIG.PR.A to the HIMIPref™ database!

As noted in the January 5, 2007, Commentary, the yieldToWorst on CL.PR.B has gone negative … again! This happened previously on November 29, 2006 and I suggested then – and I still suggest – that this issue is a prime candidate for redemption.

Great-West’s last issue, GWO.PR.I, was issued in mid-April 2006, is still trading heavily and is yielding 4.53% based on a limitMaturity and GWO (who own CL) may well decide that with all the money flying around during RRSP season, now is a good time to refinance.

I’ve uploaded a graph of yieldToWorst for the past year, along with another one of flatBidPrice.

CL.PR.B hasn’t been a particularly enthralling issue to own for the last year, as this data from the performanceBox shows:

The quarterly numbers do not compare well with the quarterly returns posted by Malachite Aggressive Preferred Fund:

Total return for the period 2005-12-30 to 2007-1-5 is 2.8266%

Via CCN Matthews:

Coastal Value Fund (TSX:CVF.PR.A) announced today that it will redeem all of its issued Senior Preferred shares on February 21, 2007 to holders of record on February 20, 2007. The redemption will be made in accordance with the Fund’s articles and results from a retraction of the Capital shares. Shareholders need not take any action relating to the redemption; the Fund’s transfer agent CIBC Mellon will automatically redeem the shares on February 21, 2007 and deposit cash proceeds directly into shareholder’s accounts equal to $25.4125, representing $25.20 per share plus $0.2125 per share representing accrued and unpaid dividends. Post the redemption, the Senior Preferred shares will no long be listed on the TSX.

It closed today at $25.80-25, 2×2, on no volume. Due to its usual low volume, it is not currently included in any of the HIMI Preferred Indices.

More later.

Later, more: From the graph of flatBidPrice, it is apparent that this issue has participated in the excellent returns posted by preferred shares in the last six months. It is also apparent, from the graph of yieldToWorst, that investors have been ignoring the worst-case scenario when investing.

Down 3.73% on the day (bid/bid), but those unimpressed by headlines will be quick to point out that yesterday’s quote of 27.06-62 was an aberration. They’d be right, too, as a quick look at the graph of flatBidPrice shows.

The new issue announced today puts the future of BNA.PR.A in some doubt and should be causing some investors to look very carefully at the negative yield-to-worst on this issue of –5.36%. The pseudoPortfolioReportBox shows us the following optionCalculationList:

The above calculations are based only on price and leave a lot to be desired. I work at improving the algorithm (and there will be a rather interesting idea announced shortly, provided the results of testing are what I think they might be), but the main things to bear in mind are:

• BNA.PR.A pays $1.5624
• BNA.PR.A is callable right now at 25.75
• The new issue is supposed to closed 2007-1-10
• The new issue pays $1.0875

I suspect that BNA.PR.A’s days are numbered!

Besides the graph above, I’ve uploaded graphs of Yield-toWorst and Modified-Duration-to-Worst.

Update! Always check the prospectus! The original prospectus, dated August 24, 2001, states:

Preferred Shares may be redeemed by the Company at any time prior to the Redemption Date at a price (the ‘‘Preferred Share Redemption Price’’) which, until September 30, 2002 will equal $26.20 and which will decline by $0.20 each year to be equal to $25.00 after September 30, 2007. All Preferred Shares outstanding on the Redemption Date will be redeemed for the Preferred Share Redemption Price, equal to the lesser of $25.00 and Net Asset Value per Unit. The Company will only redeem Preferred Shares prior to the Redemption Date if Capital Shares have been retracted or if there is a take-over bid for the Brascan Shares and the Board of Directors determines that such bid is in the best interest of the holders of the Capital Shares.

However, as has been previously noted, the terms of this issue changed 2003-8-21:

The Corporation’s right to redeem the Preferred Shares prior to maturity will be amended to permit the redemption of the Preferred Shares at the then applicable redemption price, including any premium, using the net proceeds of an issuance of a new series or class of preferred shares. The Corporation has no current intention to redeem the Preferred Shares.

Well, it’s not exactly the biggest surprise in the world … Enbridge announced today (via CCN Matthews) that:

Enbridge Inc. (TSX:ENB)(NYSE:ENB) announced today its intention to redeem all 8,000,000 of its outstanding 7.80% preferred securities, at a price of $25.00 each plus accrued interest of $0.2458 per security, for the period following the previously announced December 31, 2006 interest payment date. The redemption date is February 15, 2007, for all of the 7.80% preferred securities, originally issued in February 2002.

So there goes another one of the lovely high-coupon preferred securities!