March 10, 2016

On Thursday, the S&P 500 was about unchanged and Toronto was down 0.1%.

Liquor Stores N.A. fell 6.9% due to its poor Q4 earnings report.

This morning Canadian Western Bank announced an  issue of $100 million of 6.25% rate reset preferred shares. TD Bank” TD Direct brokerage was offering these and probably a number of other big brokerages were offering these.

The rate reset pref shares that have been issued by banks lately have certain features that qualify them as Tier 1 capital. Tier 1 capital includes common equity shares and certain other relatively permanent capital. Rules have changed (I won’t pretend I know all the details) such that in order for rate reset shares to qualify as Tier 1 capital they have to be such that the bank can turn them into common equity shares automatically if it runs into certain financial trouble (called a triggering event). This is called the bail-in provision. If the bank’s common shares are trading at $10 at the time of a triggering event you would get 2.5 common for each $25 pref share that you held. If the common are at $5.00 OR LESS, you get 5 common shares per pref. These CWB rate reset shares are also non-cumulative and that may be the case with all the recently issued bank rate reset pref shares. These features are designed to protect bank depositors and the federal deposit guarantee corporation. Anything is possible, but it is unlikely that a triggering event will ever happen or that the dividend would be skipped.

All in all, I would judge these 6.25% rate reset shares to be attractive. The market agreed with that and this issue sold out within about an hour even after being increased to $140 million. Those who want to buy shares when they are initially issued like this unfortunately have to act very fast. There may still be a chance to buy it (close to $25) on the market after it starts trading in a week or so.

It seems somewhat remarkable that this bank needs to pay 6.25% on these shares and Royal Bank had to pay 5.5% on its recent issue. This at a time when a 30 year Canada bond pays only 2%. Two years ago banks were issuing rate reset pref shares (albeit without the bail-in provision) at rates more like 4.0%. In part this is likely due to the fact that a lot of investors got “burned” on previous rate reset preferred shares and now don’t want to touch them unless they get these higher dividends.

The existing CWB rate reset share which is on our list pays only 4.4% and trades at $16.40 (to yield 6.7%). As long as new issues pay 6.25% this existing issue is unlikely to rise very much. But it has three years to go before its reset date and it certainly could rise if interest rates stay low. I would buy the existing shares at $16.40 rather than the new at $25. I am not certain, but I don’t think the existing shares count as Tier 1 capital. For that reason there may be a slim possibility that the bank would want to buy them back and might pay something higher than $16.40, though not likely higher than $20 or $21. And they may not buy back at all because they still qualify as bank capital, even if not Tier 1. Also it is logistically somewhat difficult to buy these back. I also think there is more chance for these existing shares to rise rather than fall whereas the new shares at $25 have little room to rise under any scenario since they can be bought back (by the bank) at $25 in five years. Still, they could temporarily go above $25 if market rates on these rate reset shares drop.