{"id":1394,"date":"2007-10-31T12:32:32","date_gmt":"2007-10-31T16:32:32","guid":{"rendered":"http:\/\/www.prefblog.com\/?p=1394"},"modified":"2007-10-31T12:32:32","modified_gmt":"2007-10-31T16:32:32","slug":"a-bear-checks-in","status":"publish","type":"post","link":"https:\/\/prefblog.com\/?p=1394","title":{"rendered":"A Bear Checks In"},"content":{"rendered":"

After having given so much attention to the neighborhood bull<\/a>, it seems only fair to allow some comments from the bears!<\/p>\n

\n

Hi James:<\/p>\n

Here is the result of a little calculation I did with Royal Bank bond yields and pref yields.\u00a0 It looks similar (today at least) for other banks, but I don’t have lots of historical bond data.<\/p>\n

\n\n\n\n\n\n\n\n\n
Comparing RY Bonds and Prefs<\/font><\/strong><\/td>\n<\/tr>\n
\u00a0<\/td>\n11-May-07<\/td>\n26-Oct-07<\/td>\n<\/tr>\n
Bond Yield (Dur = 5)<\/td>\n4.21%<\/td>\n5.14%<\/td>\n<\/tr>\n
Discount Pref Yield<\/td>\n4.50%<\/td>\n5.49%<\/td>\n<\/tr>\n
Disc Pref Duration<\/td>\n22.1<\/td>\n18.6<\/td>\n<\/tr>\n
Spread<\/td>\n0.29%<\/td>\n0.35%<\/td>\n<\/tr>\n
Yield Ratio<\/td>\n1.069<\/td>\n1.068<\/td>\n<\/tr>\n<\/table>\n<\/div>\n

Although we seem to be comparing bond apples (duration 5) to pref oranges (duration 18-22), the arithmetic spread, and especially the yield ratio (which I like better for many things and many reasons) is basically the same today as it was\u00a05 months ago.\u00a0 I happen to have some data from May 11 for two RY bonds, but have no older data.<\/p>\n

Perhaps you have access to more historical bond and pref data to investigate this further, but\u00a0one conclusion I would draw is that pref yields are not currently out of line with bond yields.\u00a0 Furthermore, a 5.14% bond yield is consistent with (perhaps slightly below) US bond yields.\u00a0 If the corporate yields hold, then discount prefs will NOT recover, so investors today should only expect the yield component, and give up\u00a0hoping for\u00a0capital gains — and could suffer more losses if corporate yields increase.\u00a0 I wish I knew more about this apparent relationship over the past couple of years of Pref purchasing!<\/p>\n

I also note that the bond equivalent yield ratio (at least at this wildly different duration) is 1.07 in the market, rather than 1.40 for taxable investors.\u00a0 No reason they should be the same because the buyers and sellers of prefs and bonds are quite different. You are welcome to use this with attribution, if you like. ******************************************<\/p>\n

[Later]<\/em> One minor glitch on this, the 1.07 Yield ratio is the inverse of the 1.40 bond equivalent yield, so for direct comparison should be more like 0.93.\u00a0 Thus there is a 50% (1.40\/0.93) after-tax yield advantage to pref shares compared with Duration = 5 bonds.<\/p>\n<\/blockquote>\n

Well! The first problem I see is with the data. I looked up the issue Royal Bank 4.53% May 7, 2012. This is a deposit note, the most\u00a0senior bank debt issued\u00a0(and thus, in terms of credit quality, as far as you can get from a preferred while remaining with the same issuer). It’s basically a liquid institutional GIC and there\u00a0is $950-million outstanding. According to Bloomberg, the yield on 5\/11 was 4.53%.<\/p>\n

This is quite the discrepency! If we go to Canadian Bond Indices<\/a>, we can look at a graph of short-term yields – for both corporates and Canadas. The quoted figure, 4.21%, looks more like a plausible yield for a Canada 5-year, while 4.53% looks like an entirely reasonable value for a 5-year Royal Bank DN.<\/p>\n

I suggest it’s better to compare long indices with the PerpetualDiscount index; this reduces the duration mis-match and diversifies away the asystemic risk introduced by using a single corporate for a comparison. Using data from the Bank of Canada<\/a> we see that the Scotia \/ PC-Bond \/ Dex long-term all-corporate index was yielding 5.42% on May 9; going back to Canadian Bond Indices<\/a>, we can say it’s about 5.8% now; and construct the following table:<\/p>\n

\n\n\n\n\n\n\n\n\n\n\n
Comparing\u00a0Corporate Bonds and Prefs<\/font><\/strong><\/td>\n<\/tr>\n
\u00a0<\/td>\n27-Dec-2006<\/a><\/td>\n9-May-07<\/a><\/td>\n30-Oct-07<\/a><\/td>\n<\/tr>\n
Bond Yield<\/td>\n5.18%<\/td>\n5.42%<\/td>\n~5.80%<\/td>\n<\/tr>\n
Bond Duration<\/td>\n~11.7<\/td>\n~11.6<\/td>\n~11.3<\/td>\n<\/tr>\n
Discount Pref Yield<\/td>\n4.51%<\/td>\n4.65%<\/td>\n5.64%<\/td>\n<\/tr>\n
Disc Pref Duration<\/td>\n11.73<\/td>\n16.12<\/td>\n14.45<\/td>\n<\/tr>\n
Disc Pref
\nInterest
\nEquivalent<\/td>\n		6.31%<\/td>\n6.51%<\/td>\n7.90%<\/td>\n<\/tr>\n
Interest-
\nEquivalent
\nYield Ratio
\n(Prefs : Bonds)<\/td>\n		1.22:1<\/td>\n1.20:1\u00a0<\/td>\n1.36:1<\/td>\n<\/tr>\n
Interest-
\nEquivalent
\nYield Spread
\n(Prefs – Bonds)<\/td>\n		113bp<\/td>\n109bp<\/td>\n210bp\u00a0<\/td>\n<\/tr>\n<\/table>\n<\/div>\n

So, pending further discussion, it does not appear to me that a bearish argument based on yield spreads in the current year is very convincing!<\/p>\n

Update<\/strong>: My correspondent was the commentator prefhound<\/em>. The delay in attribution was due to my wanting to check how he wanted the attribution made.\n<\/p>\n

<\/p>\n","protected":false},"excerpt":{"rendered":"

After having given so much attention to the neighborhood bull, it seems only fair to allow some comments from the bears! Hi James: Here is the result of a little calculation I did with Royal …<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[23,28],"tags":[],"class_list":["post-1394","post","type-post","status-publish","format-standard","hentry","category-reader-initiated-comments","category-spreads-to-bonds"],"_links":{"self":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts\/1394","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=1394"}],"version-history":[{"count":0,"href":"https:\/\/prefblog.com\/index.php?rest_route=\/wp\/v2\/posts\/1394\/revisions"}],"wp:attachment":[{"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=1394"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=1394"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/prefblog.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=1394"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}