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Format of PrefLetter: Page 2

The second page of PrefLetter is the raison d'etre of the entire exercise. It is on this page that the recommendations will appear in tabular format.

The process by which issues are selected for recommendation is described elsewhere; this section will seek merely to convey an understanding of the information presented in the table "Overview: HIMIPref™ Monthly Recommendations" in its various columns:

• Ticker: This is the ticker symbol currently used on the Toronto Stock Exchange to denote the stock.
• Index: The HIMIPref™ index in which the issue is tracked. See the main format page for a description of the indices.
• Quote: The closing quotation on the preparation date. This should be checked prior to executing an investment in the recommended shares, since if there is a major change in the price of the recommended issue the recommendation may no longer be valid.
• DBRS: The creditRating of the recommended shares, according to the Dominion Bond Rating Service.
• S&P: The Standard and Poors credit rating of the issue.
• Dividends: The amount of dividends expected to be paid annually, with a note as to the payment schedule (monthly or quarterly). For some issues, a note is added regarding assumptions have been made in the analytical process; e.g. for floatingRate shares, I will specify the presumed rate of future dividends. Notes will be also be made if the issue pays a ratchetFloatingRate, or if the income payments are taxed as interest
• YTW Scenario: describes the event that results in the Yield-to-Worst; that is, the worst thing that could happen to the issue (in terms of yield to the stockholder) while still meeting the terms of the prospectus (that is: use of all embeddedOptions is considered; outright default is not). The date on which the issuer will redeem the shares in this scenario is noted, except in the case of some perpetual issues), as is the amount per share which will be returned to the stockholder. Special terms used in this section include:
  • Hard Maturity: A maturity which is specifically called for in the prospectus. Note that "Deemed Maturities" are reported on PrefBlog as Hard Maturities, but this is a matter of programming convenience only; see the section dealing with "Deemed Retractibles" for more details.
  • Soft Maturity: A call that is deemed to be certain due to an imminent put which would, in all likelihood, be more expensive for the issuer. Note, however, that this is usually dependent on the price of the issuer's common shares; if the price of these shares declines below a certain point, the value of the preferred shareholders' put option declines and the call becomes increasingly unlikely (as happened with IQW.PR.C
  • limitMaturity: thirty years from the analytical date, this being deemed to be limit to which analytical resources can be usefully employed. For more discussion, see the post LimitMaturity on PrefBlog.
  • Deemed Maturity: A maturity that is deemed to occur due to the imposition of Non-Viability Contingent Capital rules on banks (as has occurred), insurers and insurance holding companies (which Hymas expects to occur); such maturities are expected as the result of analysis, not due to any formal commitment of the issuers. The NVCC rules significantly alter the economics of outstanding preferred share issuers; see the section dealing with "Deemed Retractibles" for more details. Note that on PrefBlog, these maturities are referred to as "Hard Maturities", but this is a matter of programming convenience only.
• Pre-tax Bid-YTW: The Yield-to-Worst calculated prior to taking account of any taxes, using the bid price of the quotation shown in the third column.
• Modified Duration YTW : The modified duration of the sequence of cash flows (income payments and maturity payment) specified by the "YTW Scenario" described in the seventh column. This can, very roughly, be viewed as a measure of the sensitivity of the price of the issue to interest rates. To a first approximation, we may say that the percentage change in price of an issue will be equal to its modified duration multiplied by the change in interest rates, so that, for example, a decline in interest rates causing a decline of 1% in the interest rate of a particular instrument will change the price of the instrument by (1% times Modified Duration) or 5% for an instrument with a modified duration of 5. But see below!
• Pseudo-Convexity (YTW): The "pseudoConvexityWorst" of an issue measures the sensitivity of the Modified Duration (YTW) to changes in interest rates. In instruments without embeddedOptions, convexity works in favour of the holder: as rates go down, modified duration goes up, increasing the sensitivity of the issue to interest rates (which are going down!). This is an example of "Positive Convexity". In the presence of embedded options, however, this relationship will not necessarily hold true - a decline in rates will always be beneficial to the holder, but some of this benefit might be appropriated by the issuer by calling the issue. This number is reported in the table not because I seriously expect subscribers to calculate the effects of interest rate changes with high precision, but as a qualitative measure of how "bond-like" the instrument is. It should be noted that the only ways in which a preferred share can be "non-bond-like" are detrimental to the holder; therefore, issues with a negative pseudoConvexityWorst should be bought only if there exists sufficient inducement in the form of extra projected yield to justify the risk.