On Monday, the S&P 500 was down 0.5% which was blamed on news a decline in China’s imports and exports in December. The market did not seem to pay much attention to the latest news about Trump. (Allegedly took steps to keep secret his discussions with Putin and continued coverage of the news that the FBI had opened an investigation on Trump as soon as he fired the FBI director – and openly said that he did it because of the Russian investigation).
Toronto was up 0.2%.
CN Rail was a notable gainer, up 2.2% as its traffic was up 9% year-over-year in the first week of 2019. This is also potentially a positive indicator of economic activity. However, in this case the increase appears to be almost entirely related to increased oil by rail.
Regarding rate reset preferred shares, there was an interesting development today. CIBC came out with an issue yielding 5.2% which is 3.3% higher than the 5 year Canada bond yield. When you consider that in retirement, 4% is often considered the maximum safe withdrawal rate, this 5.2% cash yield could certainly be attractive to those looking to generate cash yield for withdrawals. By the time I saw it, it had already sold out and it was likely available for only an hour or two.
This issue has implications for existing rate reset shares. These CIBC shares will reset in five years at the 5 year Canada bond yield plus 3.31%. This 3.31% “spread” is far larger than most or all of the existing bank rate reset preferred shares and is larger than the spread on many of the non-bank issuers as well, such as utilities. The implication is that if these new 5.2% CIBC 3.31% spread rate reset shares are worth about their issue price of $25 today, then all those issues with lower spreads are definitely worth somewhat less (at least today) and perhaps considerably less than $25. For example the Canadian Western Bank issue on out list that will reset at a spread of 2.76% on April 30 would yield only 4.66% at $25. As a smaller bank those probably need to yield at least 5.4% to compete with the likes of this CIBC issue and that suggests a price of $21.57. And those shares closed today at $22.64 which suggests an April 30 yield of 5.15%. That suggests to me that the CWB shares may be a little over-priced but the explanation could be that the CIBC shares were scarce and snapped up quickly and the Canada bond could move higher by April 30, and if so, the CWB shares will yield more than 5.15% at their current price.
The fact that the market “spread” on bank rate reset preferred shares has risen to 3.31% explains why most rate reset shares are trading well under $25. They could come back to $25 if the market spread declines significantly enough. That spread tends to decline as the Canada bond yield increases.
On another note, some may wonder how a bank makes money lending mortgages at rates as low as 3% or whatever while paying a much higher rate on its own preferred shares. The answer is “leverage”. Preferred shares, along with common shares, and bonds issued by banks are part of a bank’s owner’s capital. And they are allowed to leverage that capital considerably. Basically when they lend mortgage money at 3.0% that is funded largely by deposits on which they are paying less than 3.0% and in some cases 0%. This was explained in our article on how banks make money.