# Rate-Reset Preferred Shares - fall in price when interest rates fall?



## leslie (May 25, 2009)

I am furious with the media's campaign of mis-information regarding the pricing of Canada's Rate-Reset Preferred Shares. Experts have been claiming that these shares drop in value when rates fall. You can see these claims by ScotiaMcLeod, RaymondJames, CIBC, another fund manager, and two interviews on BNN yesterday and today, etc, etc, etc. They are singing from the same song book.

Give me a break. In the first half hour of any introductory course in bonds, everyone learns the mantra "rates down, prices up" and vice versa. When interest rates fall, the value of outstanding debt increases in value. Prices do NOT fall. And rate-reset preferred are no different from other debt. So here is a simple example to prove the point.

Yesterday a new issue PrefA of rate reset preferreds was IPO'd by Company 
The 5-yr Treasury rate was 1%
The stipulated spread on the issue was 3%
The coupon for the first 5 years is set at $25 * 4% = $1.00​
Today another new issue PrefB is IPO'd by the same Company
The 5-year Treasury rate dropped in half overnight 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​
In five years from today your expectations are that ..
The 5-yr Treasury rate will be x%. It is ludicrous to think you can predict any rate different from this x% for reset of PrefA one day previous. So the expected Tbill reset rate will be the same for both issues.
The stipulated spread will be the same 3% for both issues.
The new coupon after the reset of both will be the same $25 * (3% + x%) = $$$​
So back to today. Which would you rather own, PrefA or PrefB?
Both issued by the same company with the same corporate risk. 
Both pay the same risk spread over Tbill rates. 
Both will be distributing the same $$ coupon at the next reset date in 5 years (give or take a day)
The only difference is that PrefA pays $1.00/yr for 5 years, while PrefB pay only $0.875/yr. PrefA will pay $0.625 MORE in distributions (5yrs * (1.00 - 0.875))..​The Pref A shares will RISE in value between yesterday and today by the discounted value of their extra dividends. 

*Rates down, prices up. Just like for every other debt security. *

____________________________________________

So what has caused the 20% drop in value of Rate-Reset preferred shares this year?
Well the drop in price has certainly be helped by the campaign of mis-information telling retail investors that their stocks are worth less now because the rates have fallen. 
Also, those stocks in the O&G industry have increased in risk a lot this year. So their stipulated spreads are now too low, Yield up, prices down. 
But never discount the possibility that the market is actually correctly valued and responding to legitimate factors. 

First you have to correctly calculate their effective %yields. The 'experts' may well quote the current yields (= current distribution divided by current stock price). This number is irrelevant and should be TOTALLY IGNORED. If the stock are trading above $25 then they will likely be called at reset, so the normal Yield-to-Call assuming a $25 future value is correct. 

For all the other rate-reset you work with today's 5-year Tbill rate, Calculate the coupon as if reset today. Subtract today's actual distribution and discount that difference in 5 years of payments back to today. Adjust the stock price by this discounted value. Divide the reset coupon $ by this adjusted price. 

Once you have the effective yield, subtract today's 5-yr Tbill rate to find the market's risk spread. Compare that spread to documented spreads on other debt. There is no public information for Canadian debt, so use the US data. This year's spread has increased from 2.2% to 3.3%.

Using all the Rate-reset issues, except for the O&G industry which are too risky IMO, Ignore all those graded Pref-3 or Pref-4. What you are left with is a list of spreads on Investment-grade rate resets that varies from 1.75% to 3.5%. Right in line with the US data - if not more expensive (too low yields mean too high prices). 

For the calculations and data.


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## Woz (Sep 5, 2013)

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.


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## Jets99 (Aug 26, 2011)

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%)


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## leslie (May 25, 2009)

Woz said:


> 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


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## Jaberwock (Aug 22, 2012)

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


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## leslie (May 25, 2009)

Jaberwock said:


> .... 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.


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## Woz (Sep 5, 2013)

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)


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## leslie (May 25, 2009)

Woz said:


> 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​
> ...


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.


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## doctrine (Sep 30, 2011)

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.


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## Woz (Sep 5, 2013)

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.


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## leslie (May 25, 2009)

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"


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## stantistic (Sep 19, 2015)

*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?


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## leslie (May 25, 2009)

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


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## leslie (May 25, 2009)

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?). 



http://www.retailinvestor.org/preferreds.html#reset said:


> 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


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## leslie (May 25, 2009)

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...t-spreads-are-latest-bad-omen-vultures-circle
SeekingAlpha at http://seekingalpha.com/article/358...ets-telling-asset-allocators#comment-62213656


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## OnlyMyOpinion (Sep 1, 2013)

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%.


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## stantistic (Sep 19, 2015)

*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


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## leslie (May 25, 2009)

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.


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## leslie (May 25, 2009)

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...ports/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.


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## andrewf (Mar 1, 2010)

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?


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## leslie (May 25, 2009)

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.


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## atrp2biz (Sep 22, 2010)

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?


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## tkirk62 (Jul 1, 2015)

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.


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## leslie (May 25, 2009)

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.


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## leslie (May 25, 2009)

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.


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## oob (Apr 4, 2011)

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.


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## Causalien (Apr 4, 2009)

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.


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## leslie (May 25, 2009)

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.


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## leslie (May 25, 2009)

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.


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## andrewf (Mar 1, 2010)

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.


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## leslie (May 25, 2009)

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%


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## andrewf (Mar 1, 2010)

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


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## Causalien (Apr 4, 2009)

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.*


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## leslie (May 25, 2009)

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.


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## stantistic (Sep 19, 2015)

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


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## leslie (May 25, 2009)

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


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## tojo (Apr 20, 2009)

leslie said:


> 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
> 
> ...


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.


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## leslie (May 25, 2009)

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?


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## tojo (Apr 20, 2009)

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?


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## andrewf (Mar 1, 2010)

^ 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).


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## leslie (May 25, 2009)

You have not made yourself clear. 

Do you agree with me that all debt prices SHOULD rise when interest rates fall? You seem to agree in your #39 post when talking about '_behaving irrationally_' and market' _inefficiencies_'.
But then you say I '_don't accept the reasoning that has been provided_'. Which implies you disagree with me, and agree with all the experts saying prices should fall when rates fall. 
My objective is to educate people on how the stocks SHOULD be priced? Are you objecting to this thread because you DON'T want people to know - so that you can profit from their errors?
You claimed in #37 that "_Investors are clearly pricing in the effect of low interest rates at reset_." Are they? How do you know? You challenged me with a list of specific stocks and I provided perfectly rational alternate explanations based on risk, which you ignored. I pointed out the logic that interest rates affect all issues equally, yet not all issues have fallen in price - therefore it is illogical to presume that interest rates were the cause of the general drop in price. Which point you also ignored. 



I will make myself clear. These points have been made upstream. 

RateRest preferred shares are debt instruments that obey the same rules as all other debt. * When interest rates fall, the price of existing debt rises, and vice versa*. A drop in rates makes the larger payments from existing securities more attractive. 
If you ignore the possibility of any change in risk, the rateRest should act exactly the same way a normal 5-yr corporate bond will act. Their distributions will be equal and change at the same time, rolling over at the same price. 
Market arbitrage should prevent any divergence (ignoring changing risk). E.g the day a 5-yr bond matures it will be priced at Par because it will be called. The owner could then buy the company's new debt at the then current market yield. If the price of the rateReset were priced lower on the day of the reset, no one would buy the company's new debt. Why pay full value for the debt when you could get the exact same $income forever in the future, for the lower priced rateReset? .
No company would IPO a rateReset with a higher yield than it could issue a normal bond for instead. The yields of bonds and rateResets should stay the same - so rateResets cannot move down in price while normal bonds rise in price (due to lower interest rates). 
If Treasury rates rise to (say) 10% by the next reset date, why would anyone bid up the rateReset price, to drive down its yield to the stipulated 5% that rateReset investors supposedly demand? Why pay more for a 5% yield from a risky company, when you could get 10% at a lower price from the risk-free government?
The proof that there is not some set 5% yield at which this special asset should trade is shown by the widely different stipulated spreads for different issues by the same company. This is also proven by the widely different IPO coupons from different issuers at any point in time.
A company's decision to call an outstanding issue or IP another is not determined by the relation of market interest rates to some set 5% demanded by rateReset investors. The decision is determined by the alternate financing options - no matter what the market rates. 
The two Yield calculations published and quoted by the experts and the media are useless and misleading. When the rateReset price is over $25 then yes, the Yield to Call is appropriate. But when the stock price is lower than $25 neither the Current Yield or the YTC has any meaning. The Current Yield ignores the reality that the distribution will change at the next reset. The YTC presumes a $25 maturity that is not a reality. Investors should calculate the Effective Yield that incorporates the current 5-yr Treasury rate.
There is no way to know exactly what factor is driving market prices. You CAN say for certain that interest rate changes at reset should not change prices. But there is a list of rational possible reasons for the rateReset market to have correctly fallen in price. And there is also the possibility that price fall was irrational - caused by the experts' misinformation.
A change in the risk spread the market demands will have a large impact on the price of a rateReset, because new risk is essentially perpetual. It will not be repriced at the next reset date, like a corporate bond will. A change in risk is the only reason for the price of the rateReset to not = Par value at reset. 
An investor's expectations at the point of purchase have no impact on the stock's /bond's pricing today. The past is irrelevant. Only the options available today are relevant. Also, the investor's expectations today about the future interest rates have no impact on the stock's price. It will impact his decision to buy/sell only. The market has already considered this in its pricing of Treasury and Corporate debt for different maturities.


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## tojo (Apr 20, 2009)

Yes, you have made yourself clear in that you have defined a set of rules that all debt instruments should be following. But is has become obvious that rate resets are not following these rules to the letter. There is an element of investor psychology that is at work here that are not in alignment to your rules. I believe that if an investor were to follow your logic on how you think resets "should" act he/she will lose money, because as interest rates are falling, prices are falling. Your objective to educate people on how resets should be priced will do them a disservice, as these things are acting in the opposite of what you are saying they should. At this point I see no reason to continue this discussion. I have put sufficient capital in the rate reset market. I'm expecting rates to rise in a few years and profit in the process. Lets see if your campaign was a successful one and then we can compare notes.


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## andrewf (Mar 1, 2010)

Depends what one is trying to do here:

1-Change investor behaviour. Good luck with that.
2-Profit from mispricing due to investor confusion about how these products work. 

#2 seems like the fruitful path to follow. Whether rate resets behave one way or another is kind of irrelevant if in the long run your expectation for how they behave (based on the model described here) is accurate--long run performance should converge to the expectation of the model despite short term price fluctuations.


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## Causalien (Apr 4, 2009)

So, I want to get this straight.

According to Leslie. Rate reset price should go down if rate increases.
According to the other camp. Rate reset price should go up if rate increases.
Which means that Rate Reset is a guaranteed buy right now. If Leslie is right, rate reset price is already down, so it won't go down any further. And we've just discounted the future where rate increases.
If the other camp is right, then Rate reset prices will surely go up. 
So the possibilities are: Stay at this price level, or go up. 

All agree? We should buy.


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## tkirk62 (Jul 1, 2015)

I definitely agree. I've been buying a rate-reset for a while now and won't stop. I'm just hoping I can stay liquid longer than the market can stay irrational


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## tojo (Apr 20, 2009)

tkirk62 said:


> I definitely agree. I've been buying a rate-reset for a while now and won't stop. I'm just hoping I can stay liquid longer than the market can stay irrational


Rate resets are now the best performing component in my portfolio. Large gains in the last few weeks. Today is no exception. Hope you have profited as well....


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## leslie (May 25, 2009)

*@ tojo * I stated the topic of this thread at the start - should the price of a rateReset fall as interest rates fall? It seems you refuse to either agree or disagree with the statement. You have decided it does not matter to you, and have concluded that no one else should care either. Beats me why you have posted here then.

*@ andrewf * Your original post asked my opinion on mis-pricing. My answer has not changed. Before concluding the asset is mispriced, you must first determine how it SHOULD be priced. 


Step one - clarify that the math is indisputable, prices should rise when interest rates fall, not the opposite as claimed by the experts. 
Step two, since the price drop was NOT caused by falling interest rates, ask what other possible causes are there? 
Step three - acknowledge that no one can definitively state one subjective cause or another for market movements. Not me and not tojo. 
Step four - conclude there is a possibility of market mis-pricing because investors have been mis-advised by the experts re interest rates. 
Step five - keep your hubris under control and acknowledge that Mr Market is rarely wrong, so look for valid reasons for a price drop. 
Step six - consider the possibility that prices have dropped because the market see more risk. 
Before coming to any conclusions, you must start with the step 1 - the subject of this thread that you both refuse to address. 
All contributors on this thread have refused to consider or acknowledge the possibility of step 6. What prices will do in the future, and whether this is a good buying opportunity depends on your full analysis of all 6 steps. 

*Evidence that the price drop has been correctly priced by the market due to increased risk. *

Mr Market is not stupid and will arbitrage prices to maintain comparable yields across different types of debt.
A few companies have IPO'd recent rateResets at spreads equal to the market's pricing of the spreads of existing shares that have fallen in value. They would not have sourced rateReset financing unless a normal bond issue would also price in this high spread. This proves that the pricing is NOT specific to only rateResets, and is due to the risk faced by owners of all kinds of debt. 
The 'correct' spread is widely variable both over time for the same company, and between companies at the same time. Small changes in sentiment can swing this measure because it is so variable.
If the drop on Treasury rates were the cause of the general rateReset market fall, then all issues would be equally affected. But that is not so. The market is only pricing in a higher spread for those companies that have obviously become more risky.
The corporate spread for US bonds has increased by about 1% this year. (I have no access to Cdn data).
Even assuming the price drop was caused by misled retail investors, that effect would not explain a 20% drop. Since interest rate reset themselves every five years, the sum total of 5 years of 1% smaller payments would only equal $25principal * 1% short payments * 5yrs = $1.25 = a 5% drop in price. Not nearly 20%
The price effect of a 1% increase in the risk premium is much larger because it is not corrected by the next reset. So it's value is as if perpetual. An additional 1% added to a 4% yield causes the price to drop form $25 to $20. About what has happened.
The Treasury rate used for resets has been lower than the rate 5 years previous ever since these shares started being issued in 2008 (except for a short span in the depths of 2008-09). Yet no one freaked out and drove down prices then. What is different today? The difference is the market's opinion of their risk. Even though Treasures were lower for resets in 2013 and 2014 may were priced ABOVE par and called because the market thought their risk premium should be lower.
The risk premium priced by the market (about where it is now, but on the downslope) for investment grade rateResets averaged 3% (above 5-yr Treasuries). The risk premium priced into Perpetuals was the exact same 3% (above longterm Treasuries). Since no one disagrees with the pricing of Perpetuals this implies the risk priced into rateResets is 'correct'. 
By refusing to come to terms with Step 1, you have blinkered yourself to all the rest of the analysis. I don't know what HAS caused the price drop, and neither do you. All that is known is that the price drop is NOT validated by any drop in Treasury rates.


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## tojo (Apr 20, 2009)

^the price of rate resets falls as interest rates fall. And the reverse: Rates resets rise when interest rates rise. The GOC 5 is now at 1.04% and look what is happening to the rate reset market. It has taken off.


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## andrewf (Mar 1, 2010)

leslie, maybe you misapprehend what I have said. I take no position on whether your thesis is correct, I'm only interested in what implications there are if your model for how rate resets should be valued is correct. If we also assume the Mr Market is correct in pricing these securities where they are today, the other moving piece are credit spreads implied by current pricing. It is up to you to assess whether that risk premium is attractive, or the changes in it are justified by the change in circumstance.

Your stated goal for this thread was to see if anyone could disprove your thesis. But absence of evidence is not evidence of absence, so at some point you will have to decide whether you are comfortable with the likelihood you are correct. You're not going to 'prove' that your model is correct.


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## leslie (May 25, 2009)

I recently had correspondence with an ex-regular (now promoted) on BNN MarketCall. Here are his responses to my thinking (presented as questions). I believe I am paraphrasing honestly.

*Q1:* Has the current spread (over Treasuries) of normal corporate debt (investment grade), also increased from the average 2.2% spread stipulated in the RateResets' prospectus to the average 3.0% spread at which RateResets are currently trading? 

*A:* He says there has been a small 0.2% increase this year, but nothing like the 0.8% increase in RateReset spreads. This pretty much demolishes my idea (upthread) that the increased spread (relative to Treasuries) of RateResets is due to an increase in risk - which would be found in normal corporate bonds as well. Seem the references posted at #15 don't apply to Canada.​
*Q2: * If normal debt is NOT trading at these higher spreads, why are companies IPOing new rateReset Preferreds at these high yields? Why would the companies not issue the cheaper normal debt.

*A: * He admits there is a big difference.
E.g. AltaGas Ltd. recently came to market with a 5-year RateReset preferred share with a spread of +4.19%. In comparison, their Jun-2020 senior unsecured bond currently trades at a +1.85% spread over 5-year Treasuries. In comparison, their Aug-2044 bond (that is 29 years) currently trades at at 4.14% spread over 5-yr Treasuries. 

Possible reasons he offers - (i) Preferred shares are perpetuals without a maturity and (ii) rank lower in the capital structure. This is (iii) offset by the preferential tax on dividend income. But those reasons have always been true, and historically debt/preferred yields have been roughly equal. The risk of long-life debt comes from both repayment risk and interest rate risk. The RateReset preferreds get rid of the interest rate risk because they reset. They are not comparable to long bonds. 

He argues that these RateResets are more cheap than issuing more common shares. But at the commons stock's recent price the preferreds will cost the same as common shares. And TransAlta's debt/equity ratio is about normal so there is no reason to prefer 'preferred equity to 'normal debt'. None of which is an argument for why the company did not issue normal debt instead.​
*Q3:* If normal debt IS trading at these same high spreads, is not the reason for the RateReset's drop in price because of this increase in risk, and NOT because of the lower $coupons at reset - as all the experts claim?

*A: * He replies --- _" This is definitely part of it. But what is missing in your analysis is the concept of negative duration. Because these preferred shares are re-setting at low spreads over Canada bonds, their long term cash flow is also going to be much lower, which in turn justifies a discount price."_ I believe he inadvertantly said "... re-setting at low spreads" when he really meant " ... resetting at low coupons". But I dispute the 'negative duration' argument. There is only 'negative duration' when you mistake which interest rate your security is benchmarked against. E.g. for Floating Rate Preferred shares ... 

"Some people may think that since Floating Preferreds go up in price when Prime rates rise, they violate the basic rule that _'when rates rise, bond prices fall_'. The term 'negative duration' is used. But they don't violate the essence of that rule. You just have to rethink what is meant by it. Bonds rise in value when their benchmark's interest rate falls because the securities' distributions are now larger than what the market is paying. 

What matters is the spread between the securities' distributions and the market yield. This spread is changed by either the security's distribution changing, or the market yield changing - the two ends of the spread. The 'market rate' benchmark for Floating Preferreds is the 5-yr Treasury rate, not the Bank Prime. When the Bank Prime rises, the securities' distributions increase, which creates the same effect on the spread as a fall in the benchmark 5-yr Treasury rate. So the Floating Preferred's price rises."(ref)​
In contrast, the RateReset's benchmark is the same 5-year Treasury as dictates their distributions. So there can be no 'negative duration'.​
*Q4:* Is it at all possible for just one type of debt (RateResets) to trade at a set yield, no matter what the interest rates are in the rest of the market? How can the price of RateResets fall (to maintain that higher yield) without arbitragers selling full-priced, but lower yielding normal bonds, and buying the cheaper RateResets with a higher yield?

*A:* He agrees that the current yields of RateResets should stay in line with all other deb - that this is not some set yield (eg 5%) that causes the price to adjust to get that yield. He cites their lack of liquidity and retail investor mispricing as reasons for the failure of arbitrage to keep their yields down. But get real - a 20% mispricing is enough to get any arbitrager's blood boiling. He cites that _"many preferred shares are held in segregated accounts, and so can not be borrowed by trading desks or large institutions hedge funds in order to gain exposure."_ I'm not sure what that is referring to - the arbitrage play would be to short the cheap RRprefs and long the bonds, so there is no need to 'borrow to short sell'.​
added later - *CONCLUSION*
Nothing has been added to the rational of today's pricing - except for the fact that normal bond yield have NOT increased along with the RateReset yields - so their drop in price is not because of increased risk.
He sort-of agrees with me that RateReset yields should trade in line with all other debt in Q4, but he contradicts that stance with his mention of 'negative duration' in Q3.
He thinks there has been market mispricing but cannot give adequate reasons why arbitragers are not doing their job.
He cannot explain why companies are IPOing RateResets at these high yields when they could be issuing normal debt at lower yields. So again the market's normal mechanism for price correction fails.
Since 'risk' is not the explanation, there are only one other options - the market is mispriced ------- which I am loath to accept because 'the markets' are just not that stupid, unless the mispricing has been caused by all the experts's false claims (that prices SHOULD fall when rates fall) ---- the reason I started this thread.


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## andrewf (Mar 1, 2010)

So it does come back to mispricing?

I don't know how else to square the current prices much less than par implying a higher credit spread than at IPO. And if that higher credit spread is not reflected in other debt instruments for the company it strikes me as an opportunity.


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## leslie (May 25, 2009)

I added a list of the unresolved issues at the bottom of my post above. I am not a buyer until I can figure out WHY exactly the market is mispriced. Even if all the retail investors have been actively misled by the 'experts', that does not explain why the smart money and issuers themselves, have not corrected the mispricing. I am wary of what I don;t understand.


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## leslie (May 25, 2009)

I am not the only one shaking my head about the pricing of this market. Canadian Western Bank's Q4 supplemental information shows they booked an unrealized loss from holding preferred shares = $54,457 (,000). That is $0.68 /sh on a stock priced at $24 --- 3%.of the company's value. If you add that value back to the EPS and take its percent of the total quarter's EPS that is 34% of profits. 

I have no idea why the bank is in this market. It is not big enough to be their playground. Maybe they did bought-deals for companies' IPOs and could not offload those shares without a loss ... and concluded they would hold until pricing normalized. Just guessing.


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## leslie (May 25, 2009)

FYI - I have two emails into AltaGas asking them to explain why they financed with preferreds at a 4.2% spread when they could have used normal debt at 1.85% spread. They have not responded. 

In the news today http://cawidgets.morningstar.ca/Art...CAN:RY&MaxCount=10&popup=true&_=1449682159865 is Royal Bank IPOing those 6yr rateReset preferreds that are really more like bonds. Just like AltaGas they are issued at a yield of 5.5% while today's price on their 10 year normal debt (July 2025) is only 2.8% http://www.globeinvestor.com/servle...ta/bonds?order=a&sort=ISSUER&type=corp&page=2


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## stantistic (Sep 19, 2015)

*Preferred shares vs bonds applied to utilities*

Hymas of PrefBlog has an in depth discussion of this subject in Prefblog > Categories > Primers > Utilities and Preferred Shares.


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## stantistic (Sep 19, 2015)

> leslie said:
> 
> 
> > FYI - I have two emails into AltaGas asking them to explain why they financed with preferreds at a 4.2% spread when they could have used normal debt at 1.85% spread. They have not responded.
> ...


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## leslie (May 25, 2009)

If anyone is interested I have posted my list of investment grade rateResets and Perpetuals as of Dec 18 showing the correctly calculated yields at http://www.retailinvestor.org/RateResetPreferredShares.xls . I have added a sheet at the back doing a reconciliation highlighting issues - Should rateResets have the same risk premium (over their relevant Treasuries, not the same Treasury)? Does the fact that they now trade below par make them perpetuals and so requiring the same risk premium (as well as the duration premium)?

@stantistic. Yes that seems to be a good explanation. But still if that were so obvious why would the debt market not also be charging them higher interest? Then there is the growing list of other companies issuing the same high yields with guarantees - some Brookfield entities, Canadian Utilities, Westcoast Energy. Surely CU is not predicting their own demise. 

I have reverted back to believing added risk is the reason for this pricing (of both rateResets and Perpetuals - for the same reasons listed above . The only evidence to contradict that has come from one person's quote of one company's bid price. Found a chart of Canadian Corporate Yields at http://www.ftse.com/Products/FTSE_COM_Assets/TMXFiles/FT_Universe_AllCorp_TR.jpg that show rates have risen. Since fall the risk premium of both Resets and Perpetuals has continued to rise from about 3% to 3.3% - just like the Americans are seeing with their investment grade debt https://research.stlouisfed.org/fred2/series/BAA10Y


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## PharmD (Dec 21, 2011)

With a number of preferred share issues dropping 10% or more in the last 2-3 days I did some buying again. Whether it is increased risk or fears of a further rate cut I am really agnostic, but yields as well as discounts to the call price are too tempting to resist. Whenever it gets to ugly I just reminds myself that eventually they will be called so the price in the meantime is not too important.


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## CA14 (Oct 21, 2013)

PharmD said:


> With a number of preferred share issues dropping 10% or more in the last 2-3 days I did some buying again. Whether it is increased risk or fears of a further rate cut I am really agnostic, but yields as well as discounts to the call price are too tempting to resist. Whenever it gets to ugly I just reminds myself that eventually they will be called so the price in the meantime is not too important.


I have been watching CPD for over a year and strongly considering jumping in at these lows. I can't say I understand them 100%. Can CPD be at this price in 3 years? Looking for a semi-safe 3 year investment. thoughts?


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## leslie (May 25, 2009)

An interview on BNN today had a portfolio manager that effectively shares my POV. See Doug Grieve video at Business Day PM - Air Date: 1/15/2016-3:20 PM

To paraphrase him .... The initial rateResets were IPO'd at high spreads because of the risk during the Credit Crunch. Those were most all called at their reset date because of their high spreads. But since then issues have come to market at much lower spreads. He does not say so explicitly, but implies their stipulated spreads were too low. 

He expects the prices of these to rise if rates rise. He did not say "because" of a rate rise, but only "if ... then". What he thinks the cause of the price rise will be (if rates rise) is made clear by his differentiation between these low-spread issues and the very recent large-spread issues - which he says to buy now for the larger distributions. So, if rateResets increased in price with rising market rates, then the effect would apply to both the low and large spread issues. Which he says won't happen. So the cause is not 'the rise in interest rates'. 

I think what he thinks but did not make explicit was ..._"market rates won't rise until the economy improves. When the economy improves the market will demand a lower risk spread. The shrinking risk spread will cause the rateResets to rise in price_." He talks about the market-valued spreads today being historically wide, as if he agrees with me that the falling prices of the last year has all been about rising risk spreads, not about falling market interest rates.

EDIT LATER - I take back my presumptions about the understanding of Mr Grieve. I just watched an early video interview of him where he clearly says he agrees with the received wisdom that rateResets increase in prive with rising interest rates. http://www.bnn.ca/Video/player.aspx?vid=741435


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## tojo (Apr 20, 2009)

The market is pricing in the anticipated rate cut next week and then some, as if a negative government 5 year bond is a given. I've been a buyer of Enbridge, Intact, Veresen and other rate resets. This feels much like 2008/2009 when I made great money of prefs. Let's hope for the same this time around.


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## tojo (Apr 20, 2009)

CA14 said:


> I have been watching CPD for over a year and strongly considering jumping in at these lows. I can't say I understand them 100%. Can CPD be at this price in 3 years? Looking for a semi-safe 3 year investment. thoughts?


You can do better than CPD / ZPR. I buy individual preferred shares and track every transaction and dividend payment electronically. I've been investing in prefs for about 8 years with an annualized return of 10.3% up to the end of 2015 (ZPR/CPD has returned much less). However, my pref portfolio has been decimated in the last few days. Not deterred as I'm picking up more shares very cheap.

Are they semi-safe? I believe they are if you manage your risk by not having too much junk in your port. I have had one failure, and that was with Yellow Pages. 

Rate resets are extremely volatile however, even more so than common stocks, since a small change in the Canada 5 year bond translates to big moves for resets, regardless of credit quality. If you can handle the volatility, I believe today's pricing is an opportunity for those willing to hold these long term.


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## scorpion_ca (Nov 3, 2014)

The yield of bond and preferred shares has increased significantly for the last couple of months whereas BOC cut the prime interest rate last year and might cut it again. Could anyone please explain the relationship between lower interest rate and higher yield? Thanks!


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## PYI (Sep 16, 2017)

*Mathematics of Rate-Reset Preferred Shares*



leslie said:


> I am furious with the media's campaign of mis-information regarding the pricing of Canada's Rate-Reset Preferred Shares. Experts have been claiming that these shares drop in value when rates fall. You can see these claims by ScotiaMcLeod, RaymondJames, CIBC etc, etc, etc. They are singing from the same song book.
> 
> *Give me a break. In the first half hour of any introductory course in bonds, everyone learns the mantra "rates down, prices up" and vice versa. When interest rates fall, the value of outstanding debt increases in value. Prices do NOT fall. And rate-reset preferred are no different from other debt.
> *
> ...


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## OnlyMyOpinion (Sep 1, 2013)

PYI, so? 
In regurgitating, what exactly is your historical point? Your link is to data that is 4 years old. During the intervening 4 years there were lots of predictions/talking heads that said interest rates had turned the corner and were going to begin rising. They were wrong. Same with predictions of price trends in the thinnly traded pref world. Same with predictions of a major bear market correction....

I lost money during that time on pref prices that slid when they were supposed to rise. I took some lumps and moved on.
I certainly didn't blame anyone for my decisions or weave tales of conspiracy or misunderstanding like the OP of this thread - Leslie aka Chris Reid (or Reed) continues to do right up to the present in other internet venues.

I disagree, I don't think this thread is worth reviving at all.


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## AltaRed (Jun 8, 2009)

Maybe not, but fixed rate reset prefs have had substantial bounces in market price with increases in GoC bond yields, the amount of bounce depending on when the reset date was/is relative to the change in bond yields.... and I think anecdotally the fulcrum is somewhere around the mid-point of a reset's 5 year period.

Example 1: Reset A had a reset date of Jan 1, 2016 and then BoC bond yields went up during 2016. Reset A's market price as of late 2016 and still today will have deteriorated some for a year or two since it is a 'long' time, i.e. Jan 1, 2021 before it can reset based on the increased bond yield.
Example 2: Reset B has a reset date of Jan 1, 2018 and BoC bond yields went up during 2016. Reset B's market price since late 2016 will start to ncrease in anticipation of a higher reset yield forthcoming Jan 1, 2018.

I've seen that with market price of my own rate reset 'ladder'. Since early 2017, I've anecdotally seen prefs with a 2018 reset date have more price recovery than those with a 2020 reset date. I can't say it is a general pattern (no expert here) but in a way, the logic makes sense (same reaction one might have with 5 year GICs). It takes the likes of James Hymas to have the intimate knowledge to play the arbitrage opportunities (and correct hunches) and to make money on them. We are all rank amateurs.


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## agent99 (Sep 11, 2013)

AltaRed said:


> I've seen that with market price of my own rate reset 'ladder'. Since early 2017, I've anecdotally seen prefs with a 2018 reset date have more price recovery than those with a 2020 reset date. I can't say it is a general pattern (no expert here) but in a way, the logic makes sense (same reaction one might have with 5 year GICs). It takes the likes of James Hymas to have the intimate knowledge to play the arbitrage opportunities (and correct hunches) and to make money on them. *We are all rank amateurs.*


I certainly am and as a result hardly ever have owned preferreds except for splits with fixed maturity date. For some reason, I do have one perpetual - PWF.PR.E. (5.5%) bought slightly below par and trading now at par. 

I have started to look at pfds again because of lack of FI options. For rate-resets, rather than try and choose individual shares, I bought $10k of ZPR just to put my toe in the pfd waters! It is strictly rate-resets. Trailing yield about 4.2%, but forward yield uncertain. Should be OK if interest rates hold or increase. May be more liquid than individual shares?

Another thought, was to buy perpetuals. Even large cap pfds from banks and other major corps yield in the 5+% range. These can be called, but 5.5% of dividend income on my PWF.PR.E seems not too bad if plan is to hold for income purposes for a long time (10-15 yrs at my age  )? How long before rate-resets would yield that much? 

My thought is to hold about 5-10% in pfds split 50/50 between ZPR and a few individual perpetuals. Would that make sense? Being cautious after reading this and many other articles about pfds: http://business.financialpost.com/i...o/five-potential-pitfalls-of-preferred-shares


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## like_to_retire (Oct 9, 2016)

AltaRed said:


> ....... fixed rate reset prefs have had substantial bounces in market price with increases in GoC bond yields, the amount of bounce depending on when the reset date was/is relative to the change in bond yields.... and I think anecdotally the fulcrum is somewhere around the mid-point of a reset's 5 year period......


Agreed, and to add to your comment and the complexity of how rate resets move, another consideration is the difference in the reset spread. 

The higher the spread, the more the security looks and acts like fixed 5 year money, so it's easier to predict share price with the knowledge you'll receive the same dividend every quarter until you get $25 when it's called. The accuracy of the prediction increases as the reset deadline approaches, but basically, they act like bonds, as interest rates rise, the share price falls since you don't want to pay as much for that fixed dividend until it's redeemed. But just like a bond's maturity date, it tempers the price as the call date approaches.

With a low spread rate reset, you expect a reset. The share price responds as if you're going to get that new interest rate at reset time. If the interest rate is higher, then you'll pay more to get that new rate. Again, the accuracy of the prediction increases as the reset deadline approaches, but basically, unlike high spread rate resets, as interest rates rise, the share price also tends to rise. Low spread resets have done very well since the 5 year rates started to rise.

Additionally, there's the new Minimum Dividend Rate Reset type. This adds another wrinkle in how pricing is affected by interest rates as the dividend will never be lower
than the initial dividend rate.

Then of course there's the NVCC Rate Reset types that are convertible into common shares. 

To simply say _"rate-reset preferred are no different from other debt"_ just ain't so. They're quite complicated. Depending on the type and present conditions, they can move any number of different ways with respect to interest rates. 

ltr


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## AltaRed (Jun 8, 2009)

There is no right answer in my opinion. I have about 7% of my portfolio in prefs, mostly rate resets. I don't think they are necessarily a replacement for fixed income (they dived in 2008-2009 too) but they do 'juice' my retirement income stream. How long I stay in this segment remains to be seen and likely depends on the longer term trend/result of increasing bond yields. At some point, issuers will recall the rate resets IF bond yields get too high and at that time, I would likely prefer being in a corporate bond ladder anyway. Time will tell.... 5 years? 10 years? Forever?


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## Brainer (Oct 8, 2015)

This is interesting. Do any of you find that the increase or decrease in price of preferreds vary (approximately) proportionately with an interest rate hike or decrease? Cause from my very limited experience/observations, they seem not to.


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## AltaRed (Jun 8, 2009)

YTM is a key metric along with assumptions on duration and/or call date (or in the case of resets, reset date and/or the likelyhood of them being called). High spread resets are more likely to be called than low spread resets. You have an equation with several unknowns and thus market sentiment is a key driver. So the answer is no. 

Straight perpetuals essentially are a long bond..despite having no maturity date. PV diminishes with longer durations.

Added: Most retail investors should likely stay away from this asset class. My learnings cost me real money.


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## like_to_retire (Oct 9, 2016)

AltaRed said:


> Added: Most retail investors should likely stay away from this asset class. My learnings cost me real money.


Yeah, and since institutional investors generally avoid preferred shares, then if retail doesn't buy them, then who?

For sure, many years ago, I was convinced that low spread resets would reap great rewards in the form of capital gains after interest rates failed to rise and they took such a beating, but only this year have I made up the terrible loses after rates didn't rise and continued to drop. I held on, convinced rates would rise, and they have, but I'm only up about 20% in the last year and still not back to where I hoped to be, so it has been a learning curve for sure. Like yourself, I kept the percentage of prefs in my portfolio quite low, thank goodness.

I've had preferred shares over a decade for sure, and the old straight perpetual share that were available in those days was so darn easy to understand. I got lured into their crazy new-fangled types over the years and see now it was all an advantage to the seller. I probably would have fared better with GIC's over that time-frame. One thing for sure, I know lots about preferred shares now. I don't think anyone will be fooling me any more.

ltr


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## stantistic (Sep 19, 2015)

> Added: Most retail investors should likely stay away from this asset class. My learnings cost me real money.


Amen brother.


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## james4beach (Nov 15, 2012)

I stay away from them too. There's too much complexity, too many caveats and expertise needed.

I understand the appeal of investing in asset classes that don't correlate with stocks and bonds, but I think preferreds (looking at CPD and ZPR) are too highly correlated with stocks to offer any real diversification. For true asset class diversification, I'd look to gold and real estate.


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## agent99 (Sep 11, 2013)

like_to_retire said:


> I've had preferred shares over a decade for sure, and the old straight perpetual share that were available in those days was so darn easy to understand.
> ltr


Looking back at my early records, I had about $20k each of 4 or 5 perpetuals back then. Somehow I decided I should get out of them. One did not sell (PWF.PR.E), so I still have it!

Those old style large cap straight perpetuals are still available and yielding 5-6%. Is there a downside to owning those if income is the main objective. What would you do otherwise?


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## AltaRed (Jun 8, 2009)

agent99 said:


> Those old style large cap straight perpetuals are still available and yielding 5-6%. Is there a downside to owning those if income is the main objective. What would you do otherwise?


As long as you realize the market value of these things could drop sharply and ultimately your estate would have to deal with a 'sale' of the asset, perhaps at some loss. The positive is the dividend goes on and on like the energizer bunny. With a long horizon, one is likely to see the market value be both above and below par for several years at a time, depending on the business/economic (bond yield) cycle.


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## AltaRed (Jun 8, 2009)

like_to_retire said:


> For sure, many years ago, I was convinced that low spread resets would reap great rewards in the form of capital gains after interest rates failed to rise and they took such a beating, but only this year have I made up the terrible loses after rates didn't rise and continued to drop. I held on, convinced rates would rise, and they have, but I'm only up about 20% in the last year and still not back to where I hoped to be, so it has been a learning curve for sure. Like yourself, I kept the percentage of prefs in my portfolio quite low, thank goodness.


I am not back to my original investment on rate resets yet either but I did take advantage of swaps for tax loss selling AND have seen decent recovery the last year plus. I suspect we will breakeven and even gain eventually as GoC5 continues its unsteady creep upwards.


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## like_to_retire (Oct 9, 2016)

agent99 said:


> Looking back at my early records, I had about $20k each of 4 or 5 perpetuals back then. Somehow I decided I should get out of them. One did not sell (PWF.PR.E), so I still have it!
> 
> Those old style large cap straight perpetuals are still available and yielding 5-6%. Is there a downside to owning those if income is the main objective. What would you do otherwise?


Since they have no maturity and hence the name perpetual, the share price is quite sensitive to interest rates. As interest rates rise, the share price will drop. With infinite maturity, the duration is considered the inverse of the yield. (i.e. 6% yield = 16.6). If you just want them for income only, they're hard to beat. I notice the coupon is rather high on (PWF.PR.E) and it's post call date, so I'm surprised why it hasn't been called, but what do I know. 

ltr


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## treva84 (Dec 9, 2014)

AltaRed said:


> YTM is a key metric along with assumptions on duration and/or call date (or in the case of resets, reset date and/or the likelyhood of them being called). High spread resets are more likely to be called than low spread resets. You have an equation with several unknowns and thus market sentiment is a key driver. So the answer is no.
> 
> Straight perpetuals essentially are a long bond..despite having no maturity date. PV diminishes with longer durations.
> 
> Added: Most retail investors should likely stay away from this asset class. My learnings cost me real money.





stantistic said:


> Added: Most retail investors should likely stay away from this asset class. My learnings cost me real money.
> 
> Amen brother.


Doesn't this create opportunity, as there is inefficiency?

I've just started doing it this year, but there are a few decent rate resets trading well below par. I think the trick it to specifically buy those only trading below par and ignore everything else. It's like value investing - you have the guaranteed dividend (assuming the company stays in business) and then you have downside protection by buying below par.

An example of such would be CF.PR.A - earlier this year it was trading at ~ 11.00 and now it's up to $14.50 (par of $25). Currently it's yielding 6.65%; resets in 2021 at GOC 5 + 3.21%. Interest rates can't go too much lower (unless they go negative) - you would think in 2021 things may be the same or higher.


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## AltaRed (Jun 8, 2009)

If you can pick off the inefficiencies but just because it is trading below par does NOT make it a bargain. It may never be called (at par) and thus it may never trade at par again. It will only be called (at par) if GoC5 bond yields rise so much that the dividend yield no longer is worthwhile for Canaccord to pay. That is for the investor to decide whether holding this one makes sense.


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## treva84 (Dec 9, 2014)

AltaRed said:


> If you can pick off the inefficiencies but just because it is trading below par does NOT make it a bargain. It may never be called (at par) and thus it may never trade at par again. It will only be called (at par) if GoC5 bond yields rise so much that the dividend yield no longer is worthwhile for Canaccord to pay. That is for the investor to decide whether holding this one makes sense.


I agree with you in that this is a risk. However you can still generate cap gains even if it isn't called at par (i.e. buy at 11 sell at 14)


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## Jaberwock (Aug 22, 2012)

I have used rate re-set preferreds in the last year as a hedge against rising rates. I borrowed on an LOC to invest, and put a portion into rate reset preferreds. Rates have risen and the interest on my LOC is now higher, but the value of those rate resets is up about 40%, more than offsetting any impact from higher rates.

You have to choose carefully, but the reward is there.


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## AltaRed (Jun 8, 2009)

You have got to get the bond yield curve right to win (or to at least win early). Early adopters circa 3 or so years ago thought the bond yield curve would be going up too. It went down even further before it started going back up.. delaying any gratification, some of which the likes of LTR and myself are still not quite above water on some of them. Gotta get it right and/or have patience.


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## agent99 (Sep 11, 2013)

like_to_retire said:


> Since they have no maturity and hence the name perpetual, the share price is quite sensitive to interest rates. As interest rates rise, the share price will drop. With infinite maturity, the duration is considered the inverse of the yield. (i.e. 6% yield = 16.6). If you just want them for income only, they're hard to beat. I notice the coupon is rather high on (PWF.PR.E) and it's post call date, so I'm surprised why it hasn't been called, but what do I know.
> 
> ltr


First call of PWF.PR.E was possible in April this year. That would have been at $26.00. Several more call dates at above par until, 2021, I think? Many more perpetuals of similar caliber with similar yields. Problem is that they are not very liquid, so hard to buy. I just tried to buy CU.PR.H with first call in 2020. But no trading for several days, so not likely to close.

So many possibilities, but found this site that has what looks like a reasonable selection:

http://www.investingforme.com/data-room/perpetual-preferred-shares

Not going overboard with this, but aim is to have about equal amounts of ZPR, PWF.PR.E and one other perpetual. Plus much more already in split prefereds. Total about 9% of overall portfolio. Overall yielding about 5.5% in dividend income in taxable accounts. No problem if called at Par or better.


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## like_to_retire (Oct 9, 2016)

agent99 said:


> First call of PWF.PR.E was possible in April this year. That would have been at $26.00. Several more call dates at above par until, 2021, I think?


We must be looking at a different PWF.PR.E, because if I look at Power Financial Website, it says it's past call in 2013?

in part:

_PWF.PR.E

First Preferred Shares Series D

The 5.50% Non-Cumulative First Preferred Shares, Series D are entitled to fixed non-cumulative preferential cash dividends at a rate equal to $1.375 per share per annum, payable on the last day of January, April, July and October in each year.

On and after January 31, 2013, the Corporation may redeem for cash the Series D First Preferred Shares in whole or in part for $25.00 per share together with all declared and unpaid dividends to, but excluding, the date of redemption._

ltr


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## AltaRed (Jun 8, 2009)

like_to_retire said:


> We must be looking at a different PWF.PR.E, because if I look at Power Financial Website, it says it's past call in 2013?


PrefInfo agrees with you and Power Financial http://www.prefinfo.com/


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## agent99 (Sep 11, 2013)

like_to_retire said:


> We must be looking at a different PWF.PR.E,
> ltr


Well you are right. I read your initial post about calls while doing some late night reading on my BB Playbook! I did a search on it but somehow got to a supplementary prospectus for a different PWF issue, also 5.5% (Series R, I think).

In any event, I originally bought that issue below par and have collected the dividends for quite a few years, so a call at par wouldn't be a problem! 

My buy on CU.PR.H did fill. Maybe you could tell me if that has any pitfalls! I realize they are "seconds"!

My pfd buying is now over


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## like_to_retire (Oct 9, 2016)

agent99 said:


> Well you are right. I read your initial post about calls while doing some late night reading on my BB Playbook! I did a search on it but somehow got to a supplementary prospectus for a different PWF issue, also 5.5% (Series R, I think).
> 
> In any event, I originally bought that issue below par and have collected the dividends for quite a few years, so a call at par wouldn't be a problem!
> 
> My buy on CU.PR.H did fill. Maybe you could tell me if that has any pitfalls!......


Yeah, so now you won't be surprised if they redeem PWF.PR.E on you one of these days. That threat tends to hold it around PAR, so as long as you keep getting that nice dividend, you're good. If it appreciated some day above PAR far enough because of some market anomalies, you can decide if you'd rather take the capital gain and move on rather than the company redeeming it.

The CU.PR.H looks fine. It has a decent time until they would ever call it, so you can enjoy the high dividend. Credit rating is good. Your only concern would be share price declining because of interest rate increases, but you've said your concern is income, so you're good.

I own CIU.PR.C, which is a low spread rate reset that has a pitiful 2.24% coupon for the next 4 years, compared to your nice perpetual 5.25% coupon. You can see in the little graph the striking difference these two different preferred share types have experienced this year as interest rates rose. The rate reset pays terrible, but has enjoyed capital appreciation, while the perpetual has lost some capital, but enjoys healthy quarterly payments. I'm still not above water with CIU.PR.C - I'm hopeful. :redface-new:

View attachment 16306


ltr


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## agent99 (Sep 11, 2013)

like_to_retire said:


> Yeah, so now you won't be surprised if they redeem PWF.PR.E on you one of these days.
> 
> ltr


Ok thanks for input ltr. To be honest, I don't worry much about calls. Nothing I can do about them anyway. Every now and then, I see a chunk of money in our RRIFs and find another bond has been called. Just buy something else and move on.


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## tojo (Apr 20, 2009)

Haven't looked at this thread for a while, but since my last post rate-reset have been my best performer, benefiting from both the increase in the GOC5 rate and narrowing credit spreads. Although Leslie's perspective was complete opposite of mine, I'm glad we had our discussions as it made me look more into resets which affirmed my position and made me buy more....much more and I'm thankful for that. The trick now is developing a plan to unload them, since many of these are approaching par, shifting the risk profile against the investor.


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## stantistic (Sep 19, 2015)

*Canadian preferred shares and StockCharts*

Several CMF members have referenced StockCharts. What format is required to enter a Canadain preferred share (on the Toronto exchange) into StockCharts ? Say, BMO PR. W for example. 
Thanks in advance.


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## like_to_retire (Oct 9, 2016)

stantistic said:


> Sseveral CMF members have referenced StockCharts. What format is required to enter a Canadian preferred share (on the Toronto exchange) into StockCharts ? Say, BMO PR. W for example.
> Thanks in advance.


Stock Charts hold data on very few preferred shares from Canada.

If it were available it would be BMO/PW.TO, but it isn't there.

To find what's available, use the form fill at the top of the page. If you enter POW for example, you will see POW.TO and POW/PB.TO

ltr


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