[leslie]

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.

 

[atrp2biz]

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?

 

[tkirk62]

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.

 

[leslie]

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.

 

[leslie]

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.

 

[oob]

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.

 

[Causalien]

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.

 

[leslie]

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.

 

[leslie]

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.

 

[andrewf]

I'm the long run, these should effectively behave as floating rate bonds. The price action is due to the fact that the rate only resets every five years rather than monthly or whatever for floating rate bonds.

 

[leslie]

Well I don't see why Andrewf's comparison to floating rate debt is more appropriate. RateReset rates don't float, but are fixed the same way a typical 5-yr corp bond is fixed, and their market price gets affected in the exact same way by changing rates and company risk in the interim between resets.

Regarding Causalien's idea that the rate-Resets have some special yield (5%) at which they all trade no matter what the market rates are doing ...... If that were true then all new issues would come out at that set rate. But when you compare the different rateReset issues of the same company you find widely different IPO coupons.

E.g Brookfield Properties
BPO - N issued 2011 at 6.2%
BPO - T issued 2013 at 4.6%

E.g. Bk of Nova Scotia
BNS - X issued 2009 at 6.25%
BNS - Z issued 2011 at 3.7%

 

[andrewf]

They are similar. The only difference is how frequently they reset rates and the benchmark rate they use.

 

[Causalien]

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. "​

It does not prove that prices go up when interest rates go up, but it also eliminate the counter argument that they should respect the risk spread as the hard maturity (reckoning date) is not there. So as a holder of the prefer, I do not have a date where I can go and get back the price at issue (i.e. $25). Having a maturity date means it will effectively make everyone flock to preferred, buy up all the $13 shares and wait 5 years to redeem it at $25, thus driving the price back up to coupon rate($25) - risk premium = current price.

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.

I was too lazy to type out the long way, but here we go so we can get to the bottom of this. 5% is an arbitrary number I used for a company when they sell preferred (which is the norm that I am seeing). As a seller of preferred, I deem that paying 5% on this debt I am selling is good. So say if the price of the preferred is $25, I would sell that debt at 5% interest rate. With rate reset, I'll take the current interest rate (assuming 1%) plus 4% coupon rate and make it a rate reset preferred with a 4% premium over the 5 year average of GOC interest rate.

So if the interest rate goes further down, it'll mean that as the issuer of these debt, I pay less interest rate, hence no need to call these debt back because it is performing better than I expected (i.e. debt payment lower). Remember, I already sold these debt as an issuer, so the price these preferred trades at do not concern me, it is only the interest I have to pay. Unless of course, if I happen to have a lot of cash on hand when the economy is doing well. Then I will look at possibly buying back these preferred because it is so cheap.


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.

The problem is this. Rate reset resets their yield every 5 years based on the average of past 5 years (normally, look into prospectus on the actual calculation). So as interest rate goes down, the predicted rate at reset time goes down. After 5 years, a rate reset holder is looking at a 2% interest rate on $25 vs the original 5% interest rate payment on $25. The capital cost remained the same so the interest rate calculation has to be based on the original $25. Sure, the share price at 2% currently might be $14 or something which brings the interest rate up, but that's if you bought just now and not 5 years ago. SO yes, if I were to compare the preferred vs a bond issuance of the same company TODAY, there is no reason to buy one or another as they both yields the interest rate of the bond. But for someone who bought at $25 5 years ago, selling it at $14 and buy the bond at 5% is the same thing. So might as well sell it and buy the bond.

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.

Yeah so if it can issue the debt at 5%, but current treasure rate is at 3%. Meaning the risk premium is 2%. The rate reset preferred they issued 5 years ago was issued at 4% premium while the treasury rate is at 1% (take our example from before). The premium in the preferred will stay the same today but treasury rate has changed. So TODAY, the premium will be 4% plus 3% = 7%. This will mean that the preferred is mispriced so as the company, I might as well recall the preferred at $25 and reissue the debt and most likely at this point, the preferred will be priced at $35. This is a win win so as a company I must recall.

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.

Well, there's a problem with this as the share price would have fallen by a lot then as the current buyer will not buy the preferred shares if it yields less than the yield they are chasing. On balance sheet, the issuer will have to spend $25 to recall the shares that are worth maybe $10 when interest rate is 0.5% + 0.1%. Why would they do that? It's better if they just outright buy it back from the open market... BUT that is assuming that they have the capital to do that. On the other hand, once they recall and buy it back to resell. Can they issue any preferred at a 0.6% yield? If they can, then at what volume? For investors to consider preferred for less than a 5% yield, it means that our market is probably going through a huge fear based yield chasing. i.e. negative interest rate? Preferred are not as safe as bond, so less than 3% yield is unheard of. At less than 3%, you might as well buy bond. As an issuer, why do I want to go through the capital intensive operation of spending free cash flow to buy back the shares, then reissue when I can just be contend with a 40% decrease in interest payment?


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?

So for the post at #25. Notice that the graph used for correlation is based on all preferred shares which includes rate reset and perpertuals. The graph changed dramatically because in 2015, the Volcker rules that was voted in 2010 after the financial crisis is finally in play. The 2015 graph is dominated by rate reset issuances as previous preferred can no longer be deemed Tier 1 capital as perpertuals cannot be forcefully called. During 2013~2015 we saw a great number of preferred getting redeemed and before the 2010 period, it was a whole other world for preferred. Rate reset, is a very recent phenomena. Rate reset with a guaranteed 5% floor on yield, is an even more recent phenomena that is sucking capital away from previous rate resets. Instead of correlation = causation, the correlation chart reflects more on the regulatory change and new type of preferred coming onto market than the traditional sense of preferred shares.

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.

You need to mention which ones it is. Rules change dramatically based on prospectus. You seem to take the shotgun approach to preferred and treat them all the same.

 

[leslie]

1) I don't think anyone disagrees that the lack of a hard maturity value means the price will float and never be guaranteed to revert to Par. But that reply does not counter my arguments that (i) the price floats long-term to compensate for changing company risk - not interest rates and that (ii) prices rise when rates fall (by the PV of higher distributions until reset) - not the opposite.

2) I still dispute there is any 'set' or 'normal' yield at which rateResets are either IPO'd or trade at later. My #31 reply below gives proof that companies IPO at very different coupons at different times. (i) You did not address that proof. (ii) Nor did you counter my claim that the rateReset's IPO coupon is set relative to all other debt types of the company - the closest being the normal 5-yr corporate debt.

No one disagrees that when interest rates fall, a company can issue new debt at a cheaper % than before, or that the cost to the company will fall relative to before when rateResets reset to that lower % --- when changes to the risk spread are ignored. But nobody cares about 'before'. 'Before' is history, is irrelevant. Your options today are what matter. and determine prices and actions.

The old rateReset at reset, a newly issued rateReset, and newly issued normal debt will ALL reflect today's Treasury yield, so any change in rates will not determine the choice. The outstanding issue will not be 'cheap' just because interest rates have fallen from 'before'. The choice is decided by the difference in risk spread between the options. All new issues of any type of debt will pay the current market-valued spread. The company will only continue the rateReset when the risk spread at IPO was lower than the risk spread today ---- making the total reset coupon smaller than the coupon of newly issued debt.

3) I dispute that the reset coupon is determined by some average of past Treasury rates. Maybe some issues are, but none I have seen. The following taken from BAM is typical.....

""The annual fixed dividend rate for each subsequent 5 year fixed rate period will be equal to the sum of the Government of Canada Yield on the 30th day prior to the first day of such Subsequent Fixed Rate period plus 2.84%. "​

I also dispute your claim that pricing pressures on any security depend on what price people bought it at. Again - 'before' is irrelevant. Pricing pressure depends on today's options to arbitrage one asset for another.

Your original argument was that rateResets should maintain some 'set' 5% yield (so prices fall when the coupon resets lower). I argued that arbitrage with other types of debt or new issues of rateResets will keep the yields of all types in line with each other. In my #29 post I went into this in detail. You have not been able to answer (using that example) 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? Why won't arbitrage work??

4) I could not figure out your argument here. You had claimed the rateReset would only be called when the reset coupon is higher than the 'set' 5%. I argued that rateResets would be called whenever the reset coupon is greater than the rate at which they could issue other debt - no matter what the %coupon. And since the Treasury rate will be the same for all debt, the decision is determined by the risk spread.

You give an example where the rateReset was IPO'd at a spread = 3%, but today's spread is only 2%. According to my argument this means the rateReset should be called .... which conclusion you also come to somehow. ??? Sorry. Don't get your point.

5) Your original argument was that issuers will never call shares when the reset coupon is lower than some 'set' 5%. I gave an example where they would be called, even though the reset coupon was only 1% (because a new issue would IPO at 0.6%). Your argument used circular logic, starting with the presumption that the shares called will be priced to yield that same 'set' 5%. See (3) above where you failed to prove that presumption.

6) You did not respond to my challenge. I asked ....In the example given at post #25, 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? In other words, why would arbitrage fail?

Regarding the article referenced in that #25 post ---- If you want to claim that rateReset prices go down when Treasury rates go down (which you do and the articles does), and you publish a graph that you say proves your point - it had better actually DO that - instead of disproving your point. Finding a long list of excuses doesn't cut it.

7) You did not respond to my challenge to find math/logic fault with my #1 post.

 

[stantistic]

My mother never told me that life would get as complicated as the above. :rugby:

 

[leslie]

If you never believed in the first place that 'RateReset shares are issued, and subsequently trade, at a stable preset yield" then you can ignore all that above. But it is probable that a lot of people DO believe it. IF these shares have some 'set' yield (say 5%) then they would originally come to market at that 5% yield. That is only time when issuers and 'experts' have some control of the pricing. For the 135 rateReset shares, I mapped their $coupon against their next reset date. If that presumption were true you would see a pretty narrow straight line up and down at 5% (or whatever). Ignore the securities at the top resetting in 2019 - 2020 because they may well be the $coupon resulting from the reset, rather than the IPO.

But that is not what you see. You see that there are a wide variety of coupons at any date. They range from $0.80 to $1.70. That is a coupon of 3.2% to 6.8%. Clearly there is no 'set' yield because different issuers have different risks which demand different spreads.

And those risk spreads change. If you correctly calculate their effective yields and subtract today's Treasury rate to give you the risk spread that the market is now pricing in ---- you see that the risk spread of the super-safe companies has barely budged this year (and so they trade near Par) . While the industries you would recognize as having increased risk HAVE been priced lower to create a much larger risk spread.

At Sept 11 when prices were pretty close to where they are today, these shares have seen the greatest increase in their priced risk spread.

• CSE.E issued at 2.71%, now 8.25% for a 5.54% increase in the spread
• TA.D issued at 2.03%, now 6.59% for a 4.56% increase in the spread
• AZP.B issued at 4.18%, now 8.53% for a 4.35% increase in the spread
• GMP.B issued at 2.89%, now 7.18% for a 4.29% increase in the spread
• DC.B issued at 4.1%, now 7.9% for a 3.8% increase in the spread

 

[tojo]

If you never believed in the first place that 'RateReset shares are issued, and subsequently trade, at a stable preset yield" then you can ignore all that above. But it is probable that a lot of people DO believe it. IF these shares have some 'set' yield (say 5%) then they would originally come to market at that 5% yield. That is only time when issuers and 'experts' have some control of the pricing. For the 135 rateReset shares, I mapped their $coupon against their next reset date. If that presumption were true you would see a pretty narrow straight line up and down at 5% (or whatever). Ignore the securities at the top resetting in 2019 - 2020 because they may well be the $coupon resulting from the reset, rather than the IPO.

View attachment 6737
But that is not what you see. You see that there are a wide variety of coupons at any date. They range from $0.80 to $1.70. That is a coupon of 3.2% to 6.8%. Clearly there is no 'set' yield because different issuers have different risks which demand different spreads.

And those risk spreads change. If you correctly calculate their effective yields and subtract today's Treasury rate to give you the risk spread that the market is now pricing in ---- you see that the risk spread of the super-safe companies has barely budged this year (and so they trade near Par) . While the industries you would recognize as having increased risk HAVE been priced lower to create a much larger risk spread.

At Sept 11 when prices were pretty close to where they are today, these shares have seen the greatest increase in their priced risk spread.

• CSE.E issued at 2.71%, now 8.25% for a 5.54% increase in the spread
• TA.D issued at 2.03%, now 6.59% for a 4.56% increase in the spread
• AZP.B issued at 4.18%, now 8.53% for a 4.35% increase in the spread
• GMP.B issued at 2.89%, now 7.18% for a 4.29% increase in the spread
• DC.B issued at 4.1%, now 7.9% for a 3.8% increase in the spread

So how would you explain the fairly high spreads of investment grade issues such as:
TRP.PR.C: issued at 1.54% now priced at 4.45% at reset
SLF.PR.G: issued at 1.50% now at 3.64%
IFC.PR.A: issued at 1.72% now at 3.98%.

These are still fairly high spreads, given the fact they are not equivalent to the "junkier" issues above, so these should not be pricing in the input of economic/issuer risk that have greater effect on non-investment grade issues. Investors are clearly pricing in the effect of low interest rates at reset.

 

[leslie]

No one can definitively state 'why' the market prices things as it does. Because there are subjective issues in pricing, and there is no way to test which issue drives people's choices. Presenting some specific stock and saying 'explain this' cannot ever be done definitively. I have given you, up-thread, a variety of possible explanations for the price drop.

By the way I looked up two of those stocks. You are comparing the stipulated spread at IPO with today's effective total yield.
TRP.C. effective yield = 4.4% Its market-valued spread =3.6% (before 5r Treasuries just rose). Its stipulated spread at IPO i= 1.5%. So the increased spread of 3.6% - 1.5% = 2.1%.
SLF.G effective yield = 3.3% Its market-valued spread =2.6% (before 5r Treasuries just rose). Its stipulated spread at IPO i= 1.4%. So the increased spread of 2.5% - 1.4% = 1.1%.
The larger increase for TRP reflects all the oil&gas companies increased risk.. An increase spread of 1.1% puts SLF half way down the range of increases. Its stipulated spread at 1.4% was probably set too low. Later IPOs (eg SLF.I were issued 2.73% spread. I case you don't understand the Intact Financial business plan, their debt is most often issued with first-dibs on specific assets. That is why they finance so cheaply. Those new debts mean that the assets left to support the preferred shares are reduced - making them more risky. Even so, that IFC.A share has only increased its spread by 1.3% But I cannot 'prove' any of these factors are what has determined any price drop.

But you CAN state what is NOT driving the market when the issue is purely math. The debt market is driven by math and risk. The math is unarguable, the risk is subjective. Falling interest rates make debt prices rise - not the opposite. This is a universal truth. You COULD argue that, because investors have been mislead by the experts into thinking prices should drop, prices have dropped because of market inefficiency But you cannot attribute the price drop to a drop in rates.

Just using the proof in my last post - consider the different YTD results. If interest rate drops were the cause of the overall market drop, then all rateResets would be impacted equally, because they all are exposed to changing rates equally. Yet that is now what has happened. Some industries (big banks and insurance) have seen next to no price drop ((increased market-valued spread). While other industries that have had obvious increases to their risk, have seen large increases in their market-valued spread. What differentiates them is their risk, not the Treasury rate.

I have repeatedly shown why the claim "prices fall when rates fall' cannot be correct. In a world where prices are determined by investors free to choose between options, arbitrage will prevent prices in this specific assets moving in a direction completely opposite to the prices of all other debt. Arbitrage will prevent it.

Using the example of a drop in interest rates in the first post of this thread, can you identify any error? When PrefA pays $1.00/yr for 5 years, while PrefB pay only $0.875/yr, why on earth would anyone pay LESS for PrefA?

 

[tojo]

I really don't know if we are getting anywhere with this thread. I know you don't accept the reasoning that are being provided, and that you are on a campaign to refute the claim that "prices fall when rates fall". The fact is that this investment product (rate reset prefs) has attracted a niche of investors that are demanding 4-5% yields. Rate resets are not a popular investment product; are thinly traded and behave for the most part, very irrationally. This to me has created an opportunity, whether its rational or not. I believe that current GOC 5 year yields are not sustainable and when rates move back up, the same irrational behavior will take prices back up when rates rise. I suppose we have different objective with respect to this class of investment: You can spend your time refuting the "false claims" or simply accept the fact that things are irrational and perhaps take advantage of the inefficiencies?

 

[andrewf]

^ This is what I was getting at with my earlier question. It should be possible using other sources for credit spreads (similar bond issues for the same company, say) and current risk-free yields to create a fair value model and identify potential mispricing opportunities. Given that preferred are not the most liquid market, it is not beyond the realm of possibilities for there to be significant mispricing (based on your model) in this market.

On the flip side, it should be possible to calculate the implied credit spread given current prices and risk free rates. It seems to me that some of the implied credit spreads are quite high (Transalta, for example).