Part 2In part 1, I talked about the fact that I bought some BK this week despite the fact that the math is awful. I touched upon the fact that in the Semi-Annual report, shows that the company took in $0.41 per unit and paid out $1.41 per unit. I neglected to include that the company had $0.12 in expenses in the first half of the year, so their net income was $0.29 per unit ($0.41 - $0,12 + $0.01 from a realized gain). Therefore, the company paid out 4.8x what it received in the form of dividends and a bit of interest.
When the bank stox are booming (see 2021 where the Unrealized Capital Gain was $5.05 per unit), it doesn't matter how much the company pays out as everyone is a hero. In the first half of 2023, things turned pretty ugly as the unit NAV dropped $2.09. Since the NAV of the Prefs are fixed, that means that the BK NAV took the full $2.09 hit which on an annualized basis would be $4.18. Ouch. .
In the last 5 years, Bk has seen it NAV change by (-$2.29 in 2018) and (+$0.34 in 2019) as well as (-$2.35 in 2020) and (+ 4.08 in 2021) and (-$1.84 in 2022). In relative terms, the first half of 2023 was pretty ugly for the NAV of BK.
Ok, enough numbers. What I'm trying to say is that BK is paying out WAY TOO MUCH in dividends based upon what it brings in.
In fact, BK doesn't even bring in enough income to cover the BK.PR.A dividends. The Prefs pay out $0.0667 per month or $0.80 per year. The Pref dividend gets paid no matter what. The institutions (the sophisticated investors versus us) gobble up the Prefs and take home a basically risk free 8%. The Prefs pay out 1.5% above the Bank of Canada Prime Rate (currently at 7.2%) to a max of 8% per year. The Prefs also have a minimum payout of 5% which means that if the BoC Prime Rate drops to 3.5%, the Prefs will still pay out 5%. Given that the BoC Prime Rate is at 7.2%, the Prefs will continue to pay out the full 8% until the BoC drops rates by more than 70 basis points which is going to be awhile.
What am I doing about all of this?
I bought 13,800 shares of BK this week at a cost of $13.01 per share for trading purposes. I intend to sell those share before the ex-dividend date this month. Hopefully the 6 month trading pattern remains in place so that I can pick up a 2.5% win for the three week investment (I bought about a week after the shares went ex-dividend). Going forward I may buy them back and trade them again next month if the trend continues. Note that it is difficult to do volume orders for BK as the market maker loves to scalp retail investors.
I bought a much bigger chunk of BK.PR.A today (significantly more than the Daily Volume shown on Yahoo Finance which is weird). I intend to almost double that position next week. I intend to hold the BK.PR.A shares as the "fixed income" portion of my portfolio. Technically, Pref shares are not fixed income by definition, but if you look at the history of BK.PR.A trading, the shares are much less volatile than bonds.
When you factor in the 1.3x pre-tax benefit factor of receiving Eligible Dividends as opposed to interest received from Bonds or GIC's the equivalent pre-tax yield of the BK.PR.A shares is 10.4%
What about the risk?
The BK.PR.A shares always receive a monthly distribution, even in the Unit NAV drops below $5
In case things go bad, as in real bad, the Pref holders get paid before the Common holders which means the Pref shareholders always get their full $10 per share before the Common holders get paid anything.
Given the fact that BK holds the six Canadian banks (as conservative as Canadian equity investments get) AND the fact that the BK Class A shareholders double down the security of the Pref shareholders, it doesn't get any more secure for a shareholder. The fact that the BK unit only brings in about $0.60 per year and pays out $0.80 to the Pref shareholders is a bit of a risk, but with the Unit Nav at about $20, it would take a long time to chew through that massive buffer that the Pref shares have.
If you look at the MAX history of BK.PR.A shares on Yahoo Finance, you will see that the price only got smacked down once to $7.50 during the financial crisis which was a 25% kick in the pants. At the same time, the BK shares dropped to about $3.50 which was more than a 75% kick in the pants.
An opportunistic BK.PR.A investor would have been able to sell the 25% discounted Prefs and buy the 75% discounted Common shares and could have collected $0.10 per month for the past 14 years (other than a few months when covid began).
Bottom line?
The BK shares are MUCH more risky than the BK.PR.A shares as they common shareholders don't have anything to back them if things turn sour. The 15% yield will only continue as long as the underlying stocks in the BK portfolio have a great year every once in awhile. Is the 15% yield worth it? Not to me other than for play money to trade.
The BK.PR.A Pref shares pay 8% which is equivalent to a 10.4% yield of an interest baring investment. Is the 8% yield worth it? It is for me because the risk is so low IMO.
Do I think the Unit NAV of BK is going to drop under $15 anytime soon which would be disasterous for BK shareholders?
Nope.
Am I willing to take that risk?
Sure, but only with fun money.
None of the above is investment advice. It is simply a recap of what BK and BK.PR.A offer and the risks associated with each. The funds don't tell you this info because if they did, only big risk takers would buy the Common component of the Split funds. Please play responsibly.