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What is a ‘Canada call’ and why was my bond redeemed early?

In April of 2009, I purchased a 10-year Manulife bond that yields 7.768 per cent and matures on April 8, 2019. However, in early October, I looked at my discount brokerage account and was surprised to see that Manulife had "redeemed" the bond. I have never heard of a bond being redeemed at the behest of the issuer. Is this legal?

Yes, it's legal, and it was all disclosed. When Manulife Financial Corp. announced the $600-million offering of senior "medium term notes" in April, 2009, it stipulated in the prospectus that the company "may, at its option, redeem the notes on not less than 30 nor more than 60 days' prior notice to the registered holder." Further, it said the redemption price would be the greater of: the bond's par value; or a price based on a spread of 125 basis points – or 1.25 percentage points – over the yield of a Government of Canada bond with the same term to maturity.

"That's known in the business as a Canada call and it's very common," said James Hymas, president of Hymas Investment Management. "One of the very important things to do when investing in corporate debt is to look at the call provisions, because they will almost always be there somewhere."

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Generally, companies will only redeem bonds when it is in their best interests (or when required because of the terms of the issue). When Government of Canada bond yields were at historic lows, it wasn't advantageous for Manulife to redeem the notes because it would have had to pay a steep price. But when government yields started to spike several months ago – and as the maturity date approached – redemption became attractive, Mr Hymas said.

Let's look at the specifics.

Manulife announced on Aug. 15 that it intended to redeem the notes and, on Oct. 3 it said the redemption price would be $1,073.81 (per $1,000 face amount) plus accrued interest of $38.52. The redemption price was based on the second option in the prospectus, as it was higher than par. This equates to a yield to maturity (YTM) of 2.73 per cent, Mr. Hymas said. (If you're wondering why the YTM is lower than the 7.768-per-cent coupon rate, it's because the notes were trading above par.)

Here's where the benefit to Manulife comes in. On the same day it announced the redemption, the company said it would refinance the debt by issuing $750-million of subordinated debentures that will pay interest "at a fixed rate of 3.049 per cent until August 20, 2024" after which it will convert to a floating rate.

"They essentially bought back their old debt at a yield of 2.73 per cent and were able to replace that with an extension of term of more than five years and with debt that was actually subordinated and that's a good deal for them. They're only paying about 32 basis points [in additional yield] and that's a bargain," he said. (Subordinated debt, with its higher risk from a bondholder's perspective, would normally carry a higher interest rate than senior debt.)

Another benefit is that, unlike the senior debt that was redeemed, the new subordinated debt qualifies as Tier 2 regulatory capital with the Office of the Superintendent of Financial Institutions, Halina von dem Hagen, Manulife's executive vice-president, treasury and capital management, said in an e-mailed statement.

I understand that there's no dividend tax credit applicable to the dividends of U.S. companies, but what about a Canadian company like Magna International Inc. that pays dividends in U.S. dollars?

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Magna says on its website that dividends "received or paid after 2005 on its shares qualify to be designated as eligible dividends and therefore to benefit from the enhanced dividend tax credit regime." The same is true of many other Canadian companies that declare dividends in U.S. dollars, such as Algonquin Power & Utilities Corp., Constellation Software Inc. and Encana Corp. If you are unsure if a company's dividends are eligible, you should visit the investor relations section of its website, read its latest dividend announcement or contact the company directly. If you are a Canadian resident, whether you buy the security on a Canadian or U.S. exchange (many are listed on both) or hold it on the Canadian or U.S. currency side of your account does not affect its eligibility for the dividend tax credit.

May I ask how you decided on the weighting given to the individual securities in your Yield Hog Dividend Growth Portfolio?

First, to avoid excessive concentration, I capped the initial weighting for each stock at about 5 per cent (a few are slightly higher, but I can live with that). Then, I considered the outlook for each company. Generally, stocks with the highest weightings in the portfolio – such as Algonquin Power & Utilities Corp. and Brookfield Infrastructure Partners LP – are the ones that I believe offer the best potential for dividend and capital growth. Others – such as the restaurant royalty stocks and real estate investment trusts – have relatively high initial yields but may not produce the same level of capital growth, which is why I weighted them slightly lower. This is obviously not an exact science: My best performer so far has been A&W Revenue Royalties Income Fund, but it also had the lowest initial weighting in the portfolio. Can't win 'em all, I guess!

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About the Author
Investment Reporter and Columnist

John Heinzl has been writing about business and investing since 1990. A native of Hamilton, he earned a master's degree from the University of Western Ontario's Graduate School of Journalism and completed the Canadian Securities Course with honours. More

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