Author Topic: Fairfax preferreds  (Read 8123 times)

obtuse_investor

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Re: Fairfax preferreds
« Reply #10 on: April 22, 2019, 06:42:36 PM »
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It didn't at all focus on ability to pay.  It focussed on risk adjusted return.  FFH has securities in the preferred space, but there are any number of other issuers that also have preferreds, so how to you rank their risk adjusted return?  And, how do you stack up the preferreds vis-a-vis the common? I have not seen much value in preferreds other than the notion that some how, some way, yields-to-worst will tighten and there'll be a capital gain on the back-end.  Maybe.

I agree that there are likely other preferred shares that present much better risk/reward. I just haven't done my homework.

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Or you can buy a chartered bank common with a 4-5% dividend rate which will likely grow and which will likely give you some capital gains.  In the worst case scenario, how many years would it take for one of the chartered bank commons to out-perform an FFH preferred?  Would it be 5 years in the worst case scenario?


With Canada's housing bubble finally unraveling after decades of credit binge, I wouldn't be counting on Canadian chartered banks' dividends to be stable. To me the worst case is quite horrible indeed. If the housing market reverts to the mean, we are likely talking a lot of pain for the Banks' shareholders.

Back on topic... your arguments have convinced me to stay away from the FFH preferreds though. :)
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StubbleJumper

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Re: Fairfax preferreds
« Reply #11 on: April 23, 2019, 05:42:42 AM »
Quote

It didn't at all focus on ability to pay.  It focussed on risk adjusted return.  FFH has securities in the preferred space, but there are any number of other issuers that also have preferreds, so how to you rank their risk adjusted return?  And, how do you stack up the preferreds vis-a-vis the common? I have not seen much value in preferreds other than the notion that some how, some way, yields-to-worst will tighten and there'll be a capital gain on the back-end.  Maybe.

I agree that there are likely other preferred shares that present much better risk/reward. I just haven't done my homework.

Quote

Or you can buy a chartered bank common with a 4-5% dividend rate which will likely grow and which will likely give you some capital gains.  In the worst case scenario, how many years would it take for one of the chartered bank commons to out-perform an FFH preferred?  Would it be 5 years in the worst case scenario?


With Canada's housing bubble finally unraveling after decades of credit binge, I wouldn't be counting on Canadian chartered banks' dividends to be stable. To me the worst case is quite horrible indeed. If the housing market reverts to the mean, we are likely talking a lot of pain for the Banks' shareholders.

Back on topic... your arguments have convinced me to stay away from the FFH preferreds though. :)


While this might constitute "whistling past the graveyard," it's worth taking a historical look at Canadian banks' dividend history and how they've approached other downturns.  In particular, the financial crisis of 2008/09 and the last major recession of 1992/93 are interesting.  Income gets hammered for a year or two as provision for credit losses rises, but the dividends were not cut.  Some of the banks issued equity, but the dividends were not cut.  In some cases, there were no dividend increases, but the dividends were not cut.  In fact, you can go back several decades and not find a dividend cut from a big-5 Canadian bank.  The central theme is that a Canadian bank avoids cutting its dividend at all costs.

As I said, to a certain extent, that's whistling past the graveyard.  If income is vapourized for 3 or 4 years, the story could end up being different this time.


SJ

obtuse_investor

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Re: Fairfax preferreds
« Reply #12 on: April 24, 2019, 04:18:07 PM »

While this might constitute "whistling past the graveyard," it's worth taking a historical look at Canadian banks' dividend history and how they've approached other downturns.  In particular, the financial crisis of 2008/09 and the last major recession of 1992/93 are interesting.  Income gets hammered for a year or two as provision for credit losses rises, but the dividends were not cut.  Some of the banks issued equity, but the dividends were not cut.  In some cases, there were no dividend increases, but the dividends were not cut.  In fact, you can go back several decades and not find a dividend cut from a big-5 Canadian bank.  The central theme is that a Canadian bank avoids cutting its dividend at all costs.

As I said, to a certain extent, that's whistling past the graveyard.  If income is vapourized for 3 or 4 years, the story could end up being different this time.


SJ

I appreciate the historical context. I can totally believe that one of the prime ways of attracting equity capital is to pay a stable or increasing dividend.

It is a complete shame that people who buy equity for the 4% dividend would continue to hold, while the management issues 20% equity, wiping out ~5 years of dividends in one fell swoop.
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StubbleJumper

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Re: Fairfax preferreds
« Reply #13 on: April 25, 2019, 07:57:34 AM »

While this might constitute "whistling past the graveyard," it's worth taking a historical look at Canadian banks' dividend history and how they've approached other downturns.  In particular, the financial crisis of 2008/09 and the last major recession of 1992/93 are interesting.  Income gets hammered for a year or two as provision for credit losses rises, but the dividends were not cut.  Some of the banks issued equity, but the dividends were not cut.  In some cases, there were no dividend increases, but the dividends were not cut.  In fact, you can go back several decades and not find a dividend cut from a big-5 Canadian bank.  The central theme is that a Canadian bank avoids cutting its dividend at all costs.

As I said, to a certain extent, that's whistling past the graveyard.  If income is vapourized for 3 or 4 years, the story could end up being different this time.


SJ

I appreciate the historical context. I can totally believe that one of the prime ways of attracting equity capital is to pay a stable or increasing dividend.

It is a complete shame that people who buy equity for the 4% dividend would continue to hold, while the management issues 20% equity, wiping out ~5 years of dividends in one fell swoop.


In some respects, it depends on your perspective, your objective, and your time horizon.

If you had an investor who desired an eligible Canadian dividend for tax reasons for a 20 year time horizon and wanted "low risk" of it ever being cut, a perpetual preferred share from a lifeco, bank or utility might fit the bill.  You buy the perpetual and you collect up the ~5-6% divvy and then 20 years later you unload your perpetual for what will probably be either a small-ish capital gain or a small-ish capital loss. 

I would propose that a Canadian bank common dividend probably has about the same risk of being cut or suspended, but the dividend runs in the 4-5% range, which is a hair lower than the preferreds.  If the investor with the 20-year time horizon buys that common share, he'll sit back and collect his eligible Canadian dividends for 20 years, and the divvy will almost certainly grow considerably over time.  We know that 20 years will encompass at least one economic cycle, if not two economic cycles.  We know that the banks will likely report low (near zero?) earnings for 3 or 4 years during that time frame, and they might issue more shares during the 1 or 2 downturns (as you've noted, possibly 20% more shares on one or two occasions).  But, despite the share offerings, we also know that the oligopolistic banking sector will probably rack up an annualized ROE of 15-20% over those 20 years which will almost certainly result in a considerable capital gain, irrespective of the share issuance.

All of this sounds like a free lunch, right?  I'd say that it's *almost* a free lunch from the perspective of risk adjusted return.  The common does carry a couple of risks that are not present in the perpetual preferreds, notably that this time might actually be different.  Past practice aside, dividends might not increase in the future, and they could theoretically be cut or suspended.  The ridiculous return on equity might not continue in the future (how much of past ROE was driven by the collapse of the 4 pillars?).  There might be considerable policy risk in holding the common if a future government was ideologically predisposed to breaking down the barriers and fostering greater competition, *or* if a future government was ideologically predisposed to taxing the fat-cats as an avenue to achieve greater social justice.  So, it's not a free lunch, but over a long enough period, I'd say it's an asymmetric bet.

I don't want to seem like a brainless cheerleader for the Canadian banks, but I just like to use them as a point of comparison to preferred shares.  I have nothing against preferreds in particular, but I just don't see much value there at present.  If the preferred yields to worst were half again as large, I might view it differently.


SJ

Cigarbutt

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Re: Fairfax preferreds
« Reply #14 on: August 15, 2019, 05:09:12 AM »
With the evolution of prices (specific securities as well as preferreds in general) and the general level of interest rates, the risk and reward profile has evolved for Fairfax preferred shares. Getting interesting. I remain split between the possibility to buy now versus to wait for a negative rate trajectory to manifest combined with noise related to a major catastrophe.
https://www.raymondjames.ca/branches/premium/pdfs/preferredsharesreport.pdf