Format of PrefLetter
PrefLetter is designed to be an executive summary of the preferred share market for investors with a wide variety of investment objectives. To this end, the various segments of the HIMIPref™ Preferred Market Indices are examined and at least one issue from each of the following categories is selected:
- Floating Rate, which is comprised of the sub-segments
- Ratchet Rate: those issues which pay a varying percentage of Canadian Prime, the percentage changing on a regular basis in an effort to maintain the market price of the security at par
- Fixed-Floater: issues which currently pay a fixed rate but which, at some known time in the future, will pay a floating rate (or give the option to do so)
- Floater: those issues which pay a fixed percentage of Canadian Prime
- Operating Retractible: Shares issued by operating companies (i.e., companies that are actually carrying on a business, as opposed to companies that simply hold an investment portfolio) that become retractible by the holder at some point in the future. This retraction may be expressed as a definite maturity of the issue, as an option to convert into common shares at some proportion of market price, or as an option to receive cash directly from the issuer. These shares are the most "bond-like" of preferreds.
- SplitShare: These shares are also defined as being retractible, but are issued by corporations whose value is derived from an investment portfolio. Such portfolios may be restricted to a single stock, several stocks in a particular market segment, or a broad stock market index.
- InterestBearing: this segment is comprised of all issues that pay interest rather than dividends.
- Straights: All these issues will have call provisions of some kind, allowing the issuer to repay the money on certain dates or during a certain period and cancel the shares. They pay a fixed dividend until the issuer either calls them or defaults.
- Perpetual Premium: comprised of all issues which do not have a mechanism whereby the shareholder can be assured of being repaid the capital on or by a certain date - if this ability did exist, the issue would be in the "Operating Retractible" market segment. All issues in this segment trade at a premium to their liquidation value, reflecting an annual dividend payment higher than the issuer would be required to pay for a new issue, but exposing the shareholder to a potential capital loss on redemption. The balance of risks on such issues can be a tricky thing to evaluate!
- Perpetual Discount: These differ from the "Perpetual Premium" issues in that they trade at a discount to their liquidation value — the annual dividends are less than would be required on new issues from the same issuer. On the other hand, a buyer will pay less for them! Of all preferred share issues, these are the most exposed to "interest rate risk".
- Fixed-Reset These issues, introduced in March 2008, pay a fixed rate for their first five years. At that point, the dividend is reset (for the next five years) to a spread to five year Canadas; on every Reset Date the holder has the option to exchange to a "FloatingReset" issue paying a spread against 3-month T-Bills (reset quarterly). Note that many - but not all! - preferred shares issued by banks, insurers and insurance holding companies are considered to be subject to a "Deemed Retraction", due to Hymas' analysis of the NVCC rules (see "Deemed Retractibles", below)
- FixedResetPremium: The probability of a call is increased when the reset spread is higher than the overall market and the issues may be thought of as extendible short term instruments, with a degree of buffer protection from adverse market movement.
- FixedResetDiscount: These issues are fully exposed to changes in credit spreads, but less exposed than "Straights" to changes in inflation.
- Short-Term: PrefLetter is intended for long-term buy-and-hold investors, but there are opportunities - and considerable interest - in short term issues. A recommendation is made of at least one issue included in "OperatingRetractible", "SplitShare" or "InterestBearing" that represents good value for a short-term (1-5 years) investor.
- Deemed Retractibles: "Deemed-Retractibles" were discussed at length in the January, February, March and June, 2011, editions of PrefLetter. This class of preferred shares arises due to OSFI's refusal to grandfather extant Tier 1 Capital which does not have an NVCC clause. This drastically changes the economics behind the issuers' decisions as to whether to call or not to call. As I said on PrefBlog on February 7:
- "Deemed-Retractibles"? Those are the Straight Perpetuals (both PerpetualDiscount and PerpetualPremium) issued by BMO, BNS, CM, ELF, GWO, HSB, IAG, MFC, NA, RY, SLF and TD. I have added a hardMaturity entry to the call schedules for these issues, at par, effective 2022-1-31.
- Due to continuing delays by OSFI in their coming revision of "Definition of Capital" for insurers, I have since changed the Deemed Maturity date for insurers to 2025-1-31
- Who deems them to be retractible? Me. Who chose the issuers included in the list? Me. Who chose the hardMaturity date? Me.
To assist in the visualization of this classification, I have prepared a Taxonomy of Preferred Shares.
Other Technical Terms
- Yield-to-Worst (YTW) : This is the yield that will be realized by the holder if the issuer utilizes the options given to it in the prospectus to minimize this yield; another way to express this is that it is the worst return on investment the investor needs to fear, short of default. For example, if an issue is trading at $26 and the issuer may call this issue at $25 at some point in the future, the scenario that gives rise to the YTW will almost always involve the issuer exercising this call; whereas if the same issue is trading at $24, the YTW Scenario will usually involve the issue remaining extant for perpetuity. For further discussion of this valuation measure, see my article A Call, too, Harms.
PrefLetter is intended to be organized into four sections (originally just pages!), although this format is not inflexible. From time to time, the content may be expanded (perhaps during periods of high market volatility, for example); sometimes a graph of particular interest will be appended to the main reports; and at all times I am responsive to feedback from subscribers who advise that a particular change will enhance the value of PrefLetter. The general content of each page is summarized here; more particular details of each page are explained on dedicated sections of this website.
The first page contains an overview of the market and any important news that may impact subscribers' portfolios, such as reorganizations, credit rating changes and taxation changes.
The second page is the heart of PrefLetter — the list of recommendations and their most vital statistics. As noted above, there will be at least one issue from each major segment recommended in every edition of PrefLetter.
The third page contains more detail regarding the issues recommended on Page 2; a summary of the issues' embedded options is merely the most salient information recorded here. This text explains why the issue has been chosen from amongst its peers for recommendation — in language that does not require specialized knowledge of the preferred share market or the HIMIPref™ analytics.
The fourth page continues the third page in its discussion of the recommendations. Changes to the list of recommended issues are also discussed here.
An appendix discussing some aspect of the Canadian preferred share market in detail is also included with PrefLetter; these appendices attempt to be self-contained in terms of vocabulary.