Depends on the reset date. What you say is true for newly issued/reset preferreds but as you get closer to the reset date, decreases in BOC yields become more significant in the preferred price.

The value of a preferred should be the present value of each of the 5 year terms.

Term 1 (2015-2020): The coupon is fixed during this period. Rates going down increases the value of this term like bonds.
Term 2 (2020-2025): The coupon is not fixed. It depends on BOC 5-year. Rates going down decreases the value as the coupon has been decreased.
Term 3-N: Assume negligible as it’s discounted to present.

For preferreds that have a while to reset, Term 1 is more significant as returns in the 2020-2025 period would have to be discounted to present.

For preferreds that are resetting soon where Term 1 may only last a year. Term 2 is more significant as Term 2 is longer and because it’s only a year away so it’s not reduced as much when discounted to present.

You see this a bit with the current situation. Preferreds that reset soon have been hit harder than the ones that reset in 2018/19. I have started purchasing preferreds that reset in the 2018-2019 as I think they’ve decreased more than they should’ve and now present good value. I think they’re getting swept along with the preferreds that reset soon.

 

For preferreds that are resetting soon where Term 1 may only last a year. Term 2 is more significant as Term 2 is longer and because it’s only a year away so it’s not reduced as much when discounted to present.Term 2 (2020-2025): The coupon is not fixed. It depends on BOC 5-year. Rates going down decreases the value as the coupon has been decreased. .

Disagree. Here is the variation on the example above showing why.

4 years ago Company IPO'd PrefA rate reset preferred.

The 5-yr Treasury rate was 1% back then.
The stipulated spread on the issue was 3%
The coupon for the next year (until reset) is set at $25 * 4% = $1.00​

Today Company IPO's another new issue PrefB rate reset

The 5-year Treasury rate dropped in half yesterday and is now 0.5%
The stipulated spread on the issue is 3% still because the risk of the company has not changed.
The coupon for the first 5 years is set at $25 * 3.5% = $0.875​

What is the difference between the issues?
The coupon of PrefA is expected to reset in one year at $0.875 because of today's lower Tbill rate.
For the intervening period, PrefA will pay an extra $0.125 (=1.00 - 0.875).
I would pay more for PrefA than PrefB - equal to the discounted PV of that $0.125.

When rates fall, both PrefA and PrefB are impacted equally. We can only presume that in one year PrefA will reset according to a Tbill rate of 0.5%. The same as today's rate. Both issues will be paying the same $0.875

 

I agree with WOZ, some good value preferreds that reset in the 2018-2019. For example...

Enbridge Series T
Coupon = $1.00 , Trading today at: $15.41 , Effective Yield = 6.5%
Reset date: June 1/19 , Spread = 2.50% , Potential new Yield = 3.3% (If GCAN5YR remains at 0.8%)

 

I am sure a lot of the rate re-settable preferreds were bought with the expectation that BOC rates would rise before the rate reset date. That hasn't happened, and many of those issues are seeing a big cut in yield at the reset date, making them less competitive when compared with alternative dividend yielding investments such as REITs and ordinary shares, whose yields have not gone down.

The price drop is not a surprise. It was predictable

 

.... making them less competitive when compared with alternative dividend yielding investments such as REITs and ordinary shares,

I disagree with the idea that debt prices are determined by equity distributions.
If that were so then the T-bill rates would ALSO adjust to common equity distributions and the resulting rate resets would stay high as well.

I do agree that the corporate spreads increase when equity markets tank (making stock dividend yields higher) because of higher risk. But no one is talking about rate resets being priced down because of higher risk premiums - that is what only I am arguing.

 

Your modified example is the snapshot after the treasury rate has decreased. In your example PrefA would not have had a $25 value before or after the rate decrease given the PrefB IPO price.

You need to compare before and after the rate hike to determine the impact to price.

Pre Rate Decrease:
4 years ago Company IPO'd PrefA rate reset preferred.
The 5-yr Treasury rate was 1% back then.
The stipulated spread on the issue was 3%
The coupon for the next year (until reset) is set at $25 * 4% = $1.00

In January Company IPO's another new issue PrefB rate reset
The 5-year Treasury rate was 1% in January
The stipulated spread on the issue is 3% still because the risk of the company has not changed.
The coupon for the first 5 years is set at $25 * 4% = $1.00

They’re both worth $25 pre decrease in treasury rate as people are expecting rates to stay at 1%. The treasury rate then unexpectedly decreases by 0.5%:

Post Rate Decrease:
PrefA rate reset preferred.
The coupon for the next year (until reset) is set at $25 * 4% = $1.00 after it will be $25 * 3.5% = $0.875

PrefB rate reset
The coupon for the next 5 years will be $25 * 4% = $1.00

Pre rate decrease, both were roughly the same value. Post rate decrease, I would rather have PrefB (i.e. PrefA will decrease more in value than PrefB, i.e. short dated resets will decrease more than long dated resets)

 

In your example PrefA would not have had a $25 value before or after the rate decrease given the PrefB IPO price.

Why exactly would PrefA NOT have a $25 price until just after the rate change? You say yourself further down your post that ... "They (PrefA and your different PrefB) are both worth $25 pre decrease in treasury rate as people are expecting rates to stay at 1%."

You need to compare before and after the rate hike to determine the impact to price.

But that is exactly what I did. In my modified example I say ... "I would pay more for PrefA than PrefB - equal to the discounted PV of that $0.125 (=1.00 - 0.875). The price of PrefA should increase by that amount.

I'll restate your example, replacing your PrefB with PrefC because it is different from my PrefB. I'll restate the points in time to agree with my example - the rate change happened last night.

4 years ago Company IPO'd PrefA rate reset preferred.

The 5-yr Treasury rate was 1% back then.
The stipulated spread on the issue was 3%
The coupon for the next year (until reset) is set at $25 * 4% = $1.00​

Yesterday Company IPO's another new issue PrefC rate reset

The 5-year Treasury rate was still the same 1% as 4 years ago
The stipulated spread on the issue is 3% still because the risk of the company has not changed.
The coupon for the first 5 years is set at $25 * 4% = $1.00​

Until now they’re both worth $25.
Last night the treasury rate unexpectedly decreases by 0.5%:

What Happens?

Today Company IPO's another a third issue PrefB rate reset

The 5-year Treasury rate is now 0.5%
The stipulated spread on the issue is 3% still because the risk of the company has not changed.
The coupon for the first 5 years is set at $25 * 3.5% = $0.875​

The price of PrefA increases in price by the discounted excess coupons for the next 1 year. This is the same as my original example. The price goes up $0.125 (=1.00 - 0.875).
The price of PrefC also increases in price by the same discounted excess coupon $0.125 but for 5 years, so it is a bigger increase in price.

Post rate decrease, I would rather have PrefC (i.e. PrefA will decrease more in value than PrefC, i.e. short dated resets will decrease more than long dated resets)

But you have not shown how any of them decreased in price. I show why both A and C increase in price ---- because the 'correct' coupon ($0.875) is represented by B, and both A and C pay more.

 

Prefs cut in value are a potential long term play; likely to see some hedge funds picking the ones that are trading in the $14-15 range. You see, the one advantage to those prefs is they will not be called by the company. It's like buying a corporate bond at 3.5% that could potentially give you an 80% capital gain in 8 years if BOC rate returned to 3-4% in the 2020s. That is a potentially very attractive return. Not guaranteed, of course, but most investment grade corporates are already yielding in the 3-3.5% range anyway, with zero change of a major capital gain.

 

Hmm, yeah I think you’re right. We’re both in agreement PrefC (long dated) will do better than PrefA (short dated) when rates decrease. I haven’t shown why they would decrease in price and I tend to agree with you now that they shouldn't. It would have to be caused by the credit spread.

 

And what I want is for people to start spreading the word. What the 'expert' say is bunk.
"Rates up, Prices down." "Rates down, prices up"

 

CPD vs PFF

On a five year chart, why is there such a large divergence in price charts between Canadian CPD and American PFF from 2014 onwards. Don't the Americans have 5 year rate re-sets?

 

Good question. http://stockcharts.com/freecharts/perf.php?CPD.TO,PPS.TO,HFP.TO,HPR.TO,PFF No, they don't have rate resets. But I don't think that fully explains the difference. They traditionally pay a larger coupon - (IMO because they are more risky because they are issued by off-balance-sheet-entities, not the issuing company with all the assets, but I may be wrong about that). The higher distributions plus the higher prices because rates have fallen may explain most. Another reason may be because 2/3 of the holdings they list are trading above par, so investors are mislead by the index's quoted yields which really should be the YieldToCall, which is much lower.

Until recently our Canadian Perpetuals with Investment Grade ratings had a median yield of 5.3% (correctly using YTC for those priced over $25) compared to the PFF's quoted yield 5.3% (not using YTC). That gives a median spread over Long Bonds (Cdn at 2.2% and US at 2.5%) of 3% - which is in line with Corporate Bond spreads. So I think both country's perpetuals are correctly priced. http://www.retailinvestor.org/RateResetPreferredShares.xls

 

I broadcast the challenge to justify the false claims that "RateResets fall in value when interest rates also fall", and got no defensible answers. In total they amounted to these arguments (with my rebuttals) ...
(i) Yes, bonds rise in value when interest rates fall ..... but RateResets are 'special'. Aren't we all.
(ii) They fall because people are disappointed rates did not rise as they expected when originally purchased. They don't want to just suck up the drop in rates like everyone else has had to do, so they make matters worse by driving down the prices so they get a capital loss as well.
(iii) They fall in value because the coupon resets lower, and owners somehow deserve/demand the old higher yields that no other debt holders are now getting.
(iv) They fall in value because they are priced relative to the dividend yields on common shares - while no other debt securities reflect this arbitrage. Heck I don't even value common stock based on the dividend yield.
(v) Their fall in price is validated by companies IPOing new issues at these same high rates. Which does not differentiate the CAUSE of the higher yields (lower Tbill rates or higher corporate rates?).

Prices will fall when the stipulated risk premium is considered too small. This may be industry specific, e.g. the Oil and Gas industry faced higher risk when oil prices were cut in half in 2015. Or, business spreads generally rise when the economy loses steam, as in 2015. Or spreads may rise when the benchmark Treasury changes to higher-yielding Long bonds because prices fall below $25 and the issue become a perpetual. Or spreads may rise because at the original issue, the market was so enchanted with recent capital gains in preferred shares that the issuers were able to IPO at spreads far lower than they should have paid. There are many possible reasons for an increase in the risk spread.

Until the last few days, the average RateReset with an Investment Grade had an effective yield of 3.8% and a spread over 5yrTbills of 3.0% - which is inline with the spread on all other corporate debt http://www.retailinvestor.org/RateResetPreferredShares.xls. So I plump for the last on that list of REASONS for their drop in value. I certainly don't think they are now undervalued unless you believe that the current relatively high 3% corporate spread will drop back. I could argue that the spread may stay high until we see some convincing economic recovery. This last weeks' bounce in Cdn Pref prices may have little support other than a lot of media attention. http://www.theglobeandmail.com/globe-investor/markets/indexes/summary/?q=TXPR-I

 

Two recent articles on the growing risk spread for Corporate debt - the better explanation for the falling RateReset prices:
Buttonwood at http://www.economist.com/news/finan...nd-economics/21669961-rising-credit-spreads-are-latest-bad-omen-vultures-circle
SeekingAlpha at http://seekingalpha.com/article/358...e/3582746-what-are-the-credit-markets-telling-asset-allocators#comment-62213656

 

Just to complicate life, we've seen pref prices rising again. CDP is up early 7% from last Wed. Some issues like TD.PF.D are up over 8%.

 

Rate resets and negative rates

Thanks Leslie for your insightful answers to my post.
Another question I have - the Swiss Central Bank introduced negative interest rates in January, 2015. Suppose that happens in Canada. For preferred shares coming up for reset in this environment, the new rate will be ( BOC rate plus X basis points). If algebraically correct, the new rate for the next 5 years could be utterly disgusting (i.e. less than X basis points). Or am I misunderstanding something ?

http://www.bloomberg.com/news/videos/2015-10-19/the-global-deflation-signaled-by-negative-rates

 

When there is media talk about negative rates you should assume this refers to the overnight rate they control. The premium investors demand for longer maturities would prevent the 5yr rate from going negative unless the world really spirals out of control. But the 5-yr rates would still fall further of course. But if that happens then ALL debt will reflect those smaller yields. New issues will have smaller coupons. Existing issues (of all debt including rateResets) will rise in price until their yields fall enough. As with the point I am trying to make on this thread ...... changing rates does not / will not cause the price of any debt to fall. When rates fall, prices rise. And everyone sucks up the smaller coupon/yields.

The huge bounce back in the prices of rateResets this last week has most probably been driven by the same thing that caused prices to fall ---- the experts talking in the media. First they mislead everyone to think rateReset prices SHOULD fall because of falling interest rates, and last week they started telling everyone that preferred were underpriced (which may, or may not, be true depending on what risk premium you think they should have. It is their risk spread that determines their price changes up and down.

 

Scotia McLeod has a new report on RateReset preferreds that perpetuates this false idea that prices should fall when interest rates also fall. http://www.smlibrary.com/media/docu...om/media/documents/Research-and-Reports/Special-Reports/rate_reset_faq_2015.pdf

8. Q: Which yield is more accurate - current yield or yield to reset?
A: Each valuation has its limitations.

Dispute : The correct yield measure to use is NEITHER the current or the ytw. It is the effective yield that factors in today's 5yr rate and the stipulated spread of the preferred, and the preferred's stock price now, adjusted for the higher payments that will be received until the next reset date. Use the calculator at http://www.retailinvestor.org/RateResetPreferredShares.xls

1. Q: Is the drop in price of preferred shares related to deterioration in the credit quality of the companies?
A: It is not attributable to credit deterioration, but due to lower interest rates causing lower dividends following the reset date.

Dispute: There is no way to factually know what causes the market to move. The authors are in no position to discount any particular subjective reason. Bonds are priced according to math with an overlay of assumptions about unknown risks. The math is categorical. Bond prices RISE when rates FALL. The subjective elements to explain why they did move in the opposite direction may have a variety of causes.

The recent IPOs of rateResets with very high spreads for investment grade companies proves that credit quality HAS fallen. Those companies would never have issued the high-spread rateResets if they could have issued normal debt WITHOUT the same high risk premium. The average investment grade rateReset is now (before this last run up in price) trading at a spread of 3% even though they were issued with a 2.2% spread. In the US corporate bond spreads HAVE risen by about 1% this year.

There is also the probability that retail investors have driven down the prices of rateResets BECAUSE articles like this say they SHOULD BE worth less. Or maybe the shares were originally issued at too-low spreads. Or consider that a lot of Oil&Gas industry player have rateResets. We know they are in trouble. Lots of possible reasons.

Only one reason factually cannnot be true - bond prices do not fall because rates fall.

11. Q: How should rateResets trade as they approach the reset date?
A: Preferred shares trade on a yield basis inline with their peers.

Dispute: At last, something I can agree with. Too bad the authors really meant to limit their definition of 'peers' to only other rateResets. They have simply thrown away logic to create a 'special' type of security.

7, Q: What Government bond yields should be used to evaluate the different types of preferred shares?
A: Rate Reset prices should move WITH moves in the 5-yr yield.

Dispute: While the authors agree that perpetual prices move in the opposite direction of rates, for rateResets they throw away the rules learned in their first day of school, and violate the math proof I gave at the top post of this thread.

2. Q: Why are investment grade rateResets down as much as 40% ytd?
A: The rateReset product as a whole has fallen out or favour due to the risk that at their reset date they may be reset with a lower dividend.

Dispute: If yields in the Treasury market fall, so to do the yields in the corporate bond market. So too do yields in the perpetual preferreds market. So too do the yields in the rateReset market. So too for GICs and savings accounts. When rates fall, EVERYONE settles for lower rates. By being willing to sell at lower prices, rateReset owners got hit twice - first they got hit by the falling market rates, and then they accept a too-low BID price and sell for proceeds that won't even cover the cost of buying a replacement debt security paying the now-lower market rate.

 

leslie,

Do you see any resulting mis-pricing opportunities in ratereset preferreds arising from this confusion/misunderstanding of how to value them wrt changes in interest rates?

 

Normally I would presume that the markets are efficient and correctly priced - allowing only for subjective differences about unknowns like risk of recession, company risk, 5-yr rates vs 20 yr rates, etc. So I would never see generic mis-pricing. But the sheer weight of ALL the broadcasters making the false claim that rateReset prices FALL when interest rates FALL must have created some mis-pricing. The question is how much? As I have listed above there are other risk-based reasons that can be validly argued for the shares' fall in price.

The one un-arguable fact that strongly indicates there is SOME good reason for the fall in price because of higher risks, is the recent IPOing of new issues at their huge spreads. The companies would NEVER have issued these shares if they could have issued normal debt with the now lower interest rates ----- unless the market thinks the company is more risky, and so would demand a higher rate for the normal bond issue too.

It may well turn out that rateReset prices DO increase in value in the future as interest rates rise ..... because investors THINK they should rise, not because they SHOULD. IF (big if) prices fell because investors wrongly thought they SHOULD fall because of falling rates, then you would expect that. Or you might think that investors will start to think for themselves, realize their advisor's errors, and drive up the price long before that.
__________________________________

Another article making the false claim that rateReset prices move WITH interest rates (instead of the in the opposite direction like all debt) by Garth Turner. Maybe an example comparing a rateReset preferred to the same corporation's normal 5-yr bond will help prove my point (that the when rates fall the price existing preferreds RISES by the discounted amount of their higher payments until maturity).

Assume ,,,
Both the debt and the preferred have the same face value and pay distributions on the same schedule.
The debt and preferred were issued at the same date, and at the same market yield. So purchasers invest the same $$ and get the same $$ distributions.
The owner will roll over his 5-yr debt when it matures into another 5-yr newly issued by the company.

What happens when market interest rates drop just before the maturity of the debt and reset of the preferreds?

The debt acts like all debt. the original issue rises in value by the small excess final distribution that is now larger than the new market rates dictate need be paid. But that rise in price is only temporary because the issue matures at par. The owner takes the proceeds and buys the new issue at the same price. This new issue pays a smaller distribution in line with the lower market rates. But so be it. Everyone is in the same boat.
The bond issue continues to trade at par value because there is no reason not to.

The owner of the rate-reset preferred shares also receives the last payment at the old rates and benefits from it being slightly higher than current rates dictate - no different.
His ownership continues in the shares that are now reset to distribute the same smaller coupon as the newly issued debt. This is essentially the same as the maturity and repurchase actions of the debt owner.
So far the cash flows and expectations of the debt and rateResets have been exactly the same.

But the experts claim the the rateReset preferred shares should now drop in price.
Why? The bond's price did not fall. They say 'because the distributions fell'. So what? The bond's distributions fell too, but the new issue is still priced at par.
When the preferred's price drops its yield increases. Why would any company issue any new preferreds at that higher rate, when they could issue debt instead at the lower rate? Why would any investor buy the bonds when both bonds and preferreds pay the same $$distribution but the preferreds are cheaper?

Why? because they have been mis-informed by the industry and mis-advised by advisors and mis-sold by the media.

 

Here's a thought exercise. What should happen to rate-resets if gov't bond rates went to 0% and 10% respectively and stayed there for 10 years?

 

Your reasons are valid and make sense. But thousands of people think one thing, Scotia Mcleod says the same thing, so-called experts all agree on the thing. You say another.

You keep saying that the price of rate-resets go up when interest rates fall. You say the people who say otherwise are wrong. But interest rates fell, the price of rate-resets fell. This makes you wrong. Like it or not the market determines the price, not "what should happen", so if everyone thinks that rate-reset preferred shares are worth less when interest rates decrease, then they are worth less.

 

You have mis=interpreted my point. I do not dispute that rateReset prices have fallen this year. I do not dispute that the 5-yr Tbill rate has fall from 1.4% to 0.8%. Since I am posting all the references I find to experts' wrong advice that prices SHOULD fall because rates fall, obviously I don't dispute that everyone disagrees with me (that is the reason for this thread).

But correlation does not prove causation. I have given you alternate possible causes. There are valid subjective reasons that might explain the sell-off. There are invalid reasons too (investors misinformed by experts). Regardless what other reason can be found, the math and logic still proves that the reason given by the experts is wrong - prices SHOULD rise (not fall) when rates fall. That fact that they have moved the opposite direction in this time period does NOT disprove this.

I agree with your conclusion that "if everyone thinks that rate-reset preferred shares are worth less when interest rates decrease, then they are worth less". That too is the point I have been trying to make -- It is highly probable, given the universality of the wrong advice, that prices have dropped because of that wrong advice. I started this thread to correct that wrong understanding.

 

Found another recent false claim of the cause of the price drop by Raymond James .

I love (not) the chart on the second page which they say proves the claim that the rateRest prices are positively correlated with rates (instead of what I am saying which is the opposite). But just look at the chart !!! Their measured correlation moves over 4 years from highly NEGATIVELY correlated, to highly positively correlated, back to almost perfectly NEGATIVELY correlated, back to almost perfectly positively correlated. That chart proves its a 50:50 (luck) chance they have moved together or in opposite directions. And again - as in my post above - this does not prove causation, or prove that prices SHOULD be affected at all.

Then they come up with another 'reason' for the price fall (that has been happening all year) -the IPO in September of new issues with high spreads plus new goodies.

• The fact that the companies chose to issue rateResets instead of regular bonds, proves the opposite of this article's point. The choice means the market is pricing normal debt with the same risk spread as the market is pricing the spread of rateResets. This is an alternate explanation for the drop in price I have been making here. Prices have fallen because company risk has risen. When yields rise (because of higher risk premium) prices fall - this is the universal rule of debt
• If in fact rateResets were 'special' as they claim - so that their prices fall while other debt prices rise - then the company would never have chosen to issue these preferreds. They would have issued lower-costing debt.

Off-topic ...
They don't seem to have understood why the company needed to provide that bit of extra comfort with the guaranteed lower boundary. The reason is that the spread they IPOd with was roughly the same spread as their oustanding shares were trading at. So no one would buy the IPO because unlike the outstanding issues it would not include the possibility of a large capital gain. IMO their 'extra' does not nearly compensate for this difference - but I suppose few retail investors would be advised of that fact when sold the issue by their advisors.

 

This is the last market anyone should trumpet EMH. There's no volume and few sophisticated investors in this space. Some of the issues that have been beaten down offer attractive tax preferred spreads on credit worthy issuers + option value on rates. Best risk/return in Canada IMO.

 

I see your point Leslie.

However with the rate reset that has been issued, there isn't any maturity date. i.e. the issuer do not have to take any action to buy the preferred debt back and re issue new debt. If there is a maturity date, then yes, it will behave like you said it would. As it currently stands, the only reason why the issuer will need to buy it back, is if the interest rate rise enough to go above the original 5% rate at $25 that they targeted.

If I am the issuer and I only have to pay 1% interest on the rate reset preferred, I will choose to let it extend every time. So if they need more money, they can just issue new preferred stock in another series, instead of buying back the current one and reissue the same amount.

This is why rate reset price is down as interest rate goes down.

 

I don't accept that reasoning. You have missed all my points. (Whenever I talk about 'the risk spread' below I also include in that factor the possibility of an inefficient market driven by wrong advice).

1) Their lack of a hard maturity-at-par does not prove that prices should go up when interest rates go up. The fact that they trade and reset at a price different from $25 results from the market changing its opinion on the risk spread they should demand. (Ref)

"This makes rateResets almost exactly like owning a corporate bond, that matures in 5 years, with the proceeds then being used to buy, at the same price, the company's newly issued bond, with a then-current interest rate. The only difference from bonds is that the interest rate of the newly issued bond reflects both the current Treasury rate and the market's current assessment of the risk spread. The maturity price and issue price is always at par. In contrast the preferred's reset rate reflects the current Treasury rate but not the current risk spread. The price at which you can think of the old maturing and the new being issued, will change to correct for any now-wrong spread. "​

2)You are starting from the idea that these shares have an idealized 5% rate of return that they should earn no matter what happens to interest rates in the rest of the market. But nobody has ever made that claim. Quite the opposite - their returns are explicitly stated as the Treasury rate plus a spread. Even the Perpetual Preferreds, which have a set %coupon forever, adjust in price to make their yields reflect changing market rates. Who exactly came up with the 5% number? Is there any source for this claim? Historically I always checked the corp's bond yield and found it to be pretty much the same as the preferred's rate.

3) Are you saying that there is some firewall that would prevent arbitrage with other debt? Why would any seller of rateResets settle for a lower $price than he will have to pay to get the exact same $income from the exact same company for the exact same maturity in the normal debt market? He would be settling for a guaranteed arbitrage LOSS. The lower rateRest price is only correct if the yields on the company's debt have also risen - making the debt's price fall too.

4) I dispute your statement that ..."As it currently stands (interest rates have fallen), the only reason why the issuer will need to buy it back, is if the interest rate rises enough to go above the original 5% rate." A company would call the shares ..." IF it could issue new debt at a lower coupon (Treasury plus risk premium) than the existing rate-Reset coupon (Treasury plus risk premium) --- no matter what the current market rates" . Notice how both new and old include the same 'Treasury' factor. No matter how much the market rates for Treasuries have changed since the issue of the rateReset, that factor will always be the same for both choices. The only factor making up the total coupon that can be different - that makes the 'call-or-not' decision - is the risk spread factor.

5) I dispute your analysis that ...."If I the issuer only has to pay 1% interest on the rate reset preferred, I will choose to let it extend every time. So if they need more money, they can just issue new preferred stock in another series". When you say 'pay 1%' I presume you mean the reset coupon = 1%. (Say) it would have been issued at Treasury = 2% plus risk premium = 0.5%. 5yrs later Treasury rates are now 0.5% so the reset coupon would be 0.5 * 0.5 = 1%, no matter what the stock trades at. But the owner WOULD indeed call the shares if his risk spread has fallen from 0.5% down to 0.1%. He could issue new debt/preferreds for 0.5 + 0.1 = 0.6%. What determines the choice is the changing risk spread. The market would know he will call the issue and their market price will rise above $25.

6) In my post at #25, in the example I gave, do you agree with everything up to the paragraph starting "But the experts ,,,,"? At that point can you tell me exactly how and who would drive the rateRest price lower?

7) In my post at #1, can you identify where my math is wrong. Why would the shares I own be worth LESS that any newly issued debt when my shares will pay a larger $distribution? That is not logical.

 

Further to the claim that ..."the only reason why the issuer will need to buy the rateReset back, is if the interest rate rise enough to go above the original 5% rate at $25 that they targeted"
Take an extreme example to make a point. Assume Treasury rates have risen to 10% from the 4% at IPO (4% plus 1% spread = 5%). What should the price of rateResets do, and should companies call them at the reset date?

You say that the price of the rateResets should rise because rates rise (rates up = prices up) Since all corporate debt includes some non-zero risk spread over Treasuries, the reset coupon would be higher than 10%. Since you say their benchmark yield is a constant 5%, they would trade above $25 (say $28) to bring the yield down to 5%. But who in their right mind would pay $28 dollars to get a 5% yield from a risky company, when they could pay $25 to get a 10% yield from a risk-free government?

You say the company WILL call the old rateReset because its coupon is over 5%. WHY? If the company's risk has not changed, any replacement issue will cost the exact same 10% plus 1% spread = 11%. If the company risk is higher (say 2%), the replacement issue will cost them more - 10% plus a 2% spread.= 12% So they definitely would NOT call the old issue.

I say the rise in Treasury rates from 4% to 10% makes the price of the issue fall (rates up = prices down), because the distributions the existing pref pays are smaller than the market rates until reset. At the reset date the present value of those differences in payments has deteriorated to $0, so the share price should be back to $25. At reset, the new coupon will be higher than 10% by the same 1% risk spread determined at IP. Assuming the risk has not changed, any new issue would have the same 11% coupon rate. So the company won't care whether it calls-or-not - even at 10% Treasury rates.