Canadian preferred share prices declined in the first half of May before rallying back in the second half of the month to finish marginally higher than a month earlier. In part, the weakness early in the month may have been caused by investors lightening up their preferred share holdings in anticipation of attractive new issues coming to market. Later in the month, there was some capitulation in the absence of new supply, with accounts slowly beginning to satisfy their investment needs by picking away in existing issues, leading to a recovery in prices. Trading volume was fairly light in the month. Including dividends, the S&P/TSX Preferred Share index returned 0.52% in May.

S&P/TSX Preferred Share Index - May 16

There was only one new issue in May. One reason for the low quantity of new issues was that the Canadian banks were planning to announce their quarterly results near the end of May and they typically refrain from new issues for a few weeks prior to releasing the data. The sole new issue was from Brookfield Renewable Partners LP, which issued $200 million preferred units with a 5.75% yield and a reset spread of 501 basis points. Institutional interest was relatively low at 14% of the issue and that probably reflected that it was not a preferred share issue. Rather than paying out the 5.75% solely as dividends, the Brookfield issue will pay a combination of dividends, ordinary income, and return of capital totalling the required 5.75% payout. The complexity and uncertainty regarding the payout mixture made the issue less attractive to many investors.

As expected, the issuers of two rate reset series of preferred shares decided in May to extend rather than redeem the respective issues. Manulife Financial announced that it would be extending the MFC.PR.F issue, which resets at 141 basis points above 5-year Canada Bonds, and Shaw Communications said it would not redeem its SJR.PR.A shares that reset at 5-year Canada’s plus 200 basis points. Holders of both issues will have a choice of converting to a floating rate dividend equivalent to 3-month Treasury Bills plus the respective spread. Also during the month, CU Inc. announced that an insufficient number of holders of the CIU.PR.C issue had chosen the floating rate alternative and all would be obliged to stay with the fixed rate dividend that was reset to 136 basis points above the Canada Bond yield.

The fund portfolio performed well in May, returning slightly more than 1.00% (gross) above than the market index. The relatively large allocation to perpetual issues helped, with most earning more than 1.50%. However, security selection was also favourable, with the top three individual gainers in the portfolio being rate reset issues, with each returning 4.25% or more. They compared very favourably to the average rate reset issue that returned only 0.11% in the month.

We agree with the observation that there is a gradual bifurcation occurring in the preferred share market between old rate reset issues and the new rate reset issues with dividend floors (including the recent 5.50% bank issues). The old issues, particularly the ones with reset spreads below 200 basis points, should increasingly be viewed as perpetual issues with variable dividend rates. In our opinion, they are unlikely to ever trade again at their $25.00 par prices. We continue to monitor that segment of the market for opportunities but many issues remain overvalued in spite of trading well below $20.00 per share.

During the month, we reduced our holdings of some recent bank rate reset issues with 5.50% dividends. These issues had appreciated to over $26.00 per share, and potential new issues were expected to offer better value. The sales increased the cash positon in the fund slightly, but we believe the preferred share market is unlikely to rally sharply in the short term, so the cash level should not be a drag on performance. We believe that a few banks may bring new preferred share issues in June following their quarterly financial reports, and the new issue supply should act as a temporary lid on the values of existing issues. On a longer term basis, we believe preferred shares represent outstanding value.