To heck with the dreams of the bondholders.
Great-West Lifeco, a Canadian financial services conglomerate which operates subsidiaries in Canada, the US, Europe, and Asia – including Putnam Investments in the US – and with over $1 trillion in consolidated assets under management, just crapped beautifully on its bondholders.
It wasn’t illegal. Bondholders had agreed to it in the terms of the bond issue. But they’d believed Great-West would never ever dare to do it. Now it did, and it cost those bondholders dearly.
Canadian financial companies issued a total of $45 billion of a special kind of hybrid bonds. And now that Great-West has become the trailblazer, they might all be subjected to the same treatment.
These bonds come with an option to be called after 10 years. If the option is not exercised, maturity is extended by another 30 years and the coupon is converted from the nice fixed-rate payment of yore to a floating-rate coupon based on an interest rate of “Libor plus,” in a world of ZIRP and NIRP.
“Canadian investors never believed a Canadian bank or issuer would do that kind of thing in Canada,” Marc Goldfried, CIO at Canoe Financial LP in Toronto which manages $3.5 billion, told Bloomberg.
But Great-West decided to become a trailblazer by not exercising this option on US$300 million in notes issued in 2006. Now the coupon converts to a floating rate based on the 3-month US-dollar Libor (currently 0.63%) plus 2.54 percentage points, so at the moment 3.17%. And investors have to wait another 30 frigging years before they get their money back! 40 years in total. And they believed they had a 10-year note! And had priced it like one!
Clearly, Great-West sees in its crystal ball that the floating rate is a good deal for a 30-year bond. The cost at the moment of around 3.17% is a lot lower than the 4.65% US financial companies have to pay on average for 30-year bonds, according to Bank of America Merrill Lynch data.
It’s a risk. Rates might rise, and coupon payments along with them. Then those bonds would get very expensive for Great-West. But apparently it believes that rates won’t rise. And to heck with the dreams of its bondholders.
“It’s a wake-up call,” James Dutkiewicz told Bloomberg. As chief investment strategist at Sentry Investments in Toronto, he manages $18 billion and owns some of Great-West’s US dollar notes. “Having a Canadian institution take advantage, on an economic basis, of a floating rate is the first.”
The market’s reaction was swift. The bonds – and similar bonds – sold off and yields soared. Bloomberg:
Great West’s US dollar note saw the yield investors demand to hold it to the call date almost triple….
Another Great West note, this one denominated in Canadian dollars with a year to go before its call date, saw its yield to the call date go from 2.4% to 7.1% as investors increased the odds it could be extended as well. If it isn’t called, those $1 billion in notes don’t have to be paid back until 2067.
The fervent belief among yield-chasing bondholders that Canadian companies would always call these fixed-to-floating-rate notes kept yields low, and thus allowed companies to borrow more cheaply. Now bondholders have woken up. As Goldfried said, it “should create a risk factor on any Canadian company with this kind of debt outstanding.”
Companies in the financial sector constantly have to issue bonds. And newly woken-up bondholders, smarting from the losses they just took, suddenly see the risks they didn’t see before. And they want to be paid for those risks. So these kinds of fixed-to-floating-rate notes might get more expensive for issuers.
But it won’t last long. Bondholders, condemned by central banks to chasing yield wherever they can find it, have a very short memory.
See Argentina. It just sold $16.5 billion in US-dollar denominated bonds – up from its initial guidance of $15 billion – with maturities of five, 10, and 30 years, though it spent 75 of the last 190 years defaulting on these kinds of foreign-currency bonds, including 2013-15, 2000-04, and 1980-92. The offering was very successful. Buyers were jostling for position. Argentina received more than $69 billion in orders!
Bondholders simply forget. These folks are institutional investors. They invest other people’s money. Chasing yield is all that counts. Central banks have now made that the golden rule. Great West knew exactly what it was doing by crapping on its bondholders: next time, these bondholders will eagerly line up again for more.
Foreign investors, particularly Chinese and Canadian investors, have been dumping US stocks in large numbers starting last year. But someone has been buying. Read… Who the Heck Is Buying the US Stocks that Chinese and other Foreign Investors Are Massively Dumping?