The preferred share market ended a remarkable year with another strong month in December. Performance was supported by continued redemption activity. Early in the month investors received $100 million from the redemption of the BIK.PR.A. series, and on the last day of the month, investors received $500 million from the redemptions of the CVE.PR.C, FFH.PR.C and FFH.PR.D series. In addition, five issuers announced $1.35 billon of redemptions in early 2025, some of which surprised the market.  All preferred share types had positive average returns in the month, with rate reset issues earning 2.7%, floating rate issues gaining 2.8%, while perpetuals lagged with a return of 1.6%. The S&P/TSX Preferred Share index ended the month with a gain of 2.59%.

On December 11th, the Bank of Canada lowered its overnight interest rate by 50 basis points to 3.25%. In doing so, the Bank brought the rate down to the top of the 2.25% to 3.25% range that it estimated was neutral, neither restrictive nor stimulative for the economy. Consequently, the Bank suggested that going forward the pace of rate reductions would likely slow. The economic data received in the month confirmed that the Bank could slow its rate decreases. Better than expected economic indicators included GDP growth in October, which showed annual growth accelerating to 1.9% from 1.6%, as well as strong manufacturing sales and housing starts. Job creation remained robust however the unemployment rate rose to 6.8% from 6.5% due primarily to an increase in the participation rate to 65.1% from 64.8% in the previous month. The headline rate of inflation edged down to 1.9% from 2.0%, but higher than expected core measures of inflation reinforced the Bank’s concern that inflation is not yet fully under control.

The first redemption announcement in December came from Loblaw Companies Limited, which surprised the market with its intention to redeem the $225 million L.PR.B 5.30% perpetual series. The issue price increased 9.5% on the news. Given that this is the issuer’s only outstanding preferred share series and it became callable at par this past June, it appears the company was taking the opportunity to simplify its capital structure. Another surprise came the following day when Pembina Pipeline Corp announced the redemption of the $25 million floating rate PPL.PF.B series that paid dividends equivalent to 3-month Treasury Bills plus 326 basis points. The price of this very thinly traded series increased more than 5% on the news. The redemption will be at a price of $25.50 and may have been facilitated by the fact that there was a single registered holder of this issue. The redemption was unusual because the affiliated fixed rate series, PPL.PF.A, will remain outstanding until at least March 2028.

Bank redemption activity started when CIBC announced its intention to redeem the $300 million CM.PR.P series with a reset spread of 224 basis points. This didn’t surprise the market given that last July the company had redeemed the CM.PR.O series with a similar reset spread. The following day, National Bank announced its intention to redeem the $300 million NA.PR.W series with a reset spread of 225 basis points. Since the issuer had not redeemed several issues with higher reset spreads, market participants were surprised by the redemption and the issue price increased 3.5% on the news. National Bank, which is in the process of closing its acquisition of Canadian Western Bank, appears to be taking the opportunity to optimize its capital structure.

Early in December, TD Bank issued a $750 million Limited Recourse Capital Note (LRCN) with an initial coupon rate of 5.909% and a reset spread of 312 basis points. Investors immediately began speculating that the $500 million TD.PF.C series, with a reset spread of 225 basis points, would be redeemed. In October, TD had not redeemed the TD.PF.A series that had a similar reset spread, so the market was surprised by the LRCN issuance. The TD.PF.C share price jumped 5.7% on the news. Later in the month, the bank did announce its intention to redeem the shares.

There were no new issues of preferred shares in December. During the month, two series of preferred shares reset their dividends. Dividend rates continue to reset significantly higher because the 5-year Canada bond yield is substantially higher than five years ago. Details of the resetting issues were as follows:

During the month, both Brookfield Office Properties and Manulife Financial Corp (which reset MFC.PR.M in November) announced insufficient investor interest in making the switch to the respective floating rate series and all their respective shares will remain fixed rate ones for the next five years. In addition, TC Energy announced that while owners of more than half of the TRP.PR.F shares chose to convert to the fixed rate TRP.PR.A shares, there was sufficient remaining interest in the floating rate shares that they will remain outstanding. Going forward, there will be 18,424,004 TRP.PR.A shares and 3,575,996 TRP.PR.F shares outstanding.

In December, the seven largest preferred share ETFs had an aggregate outflow of $36 million. However, two of the ETFs experienced a net inflow in the month.

J. Zechner Associates Preferred Share Pooled Fund

In December, the fund returned 2.11%, which trailed that of the S&P/TSX Preferred Share index. The shortfall was due primarily to the relatively larger holding of perpetual preferred shares and the institutional preferred shares which lags other types of preferred shares.

Portfolio activity during the month included selling the TD.PR.FC position after the TD LRCN issuance but prior to the redemption announcement. The TD.PR.FC price had appreciated close to par and given the issuer had not redeemed the similar TD.PF.A series, we chose to realise profits.  The sale proceeds and cash on hand from dividend payments was used to add to several existing rate reset positions including AQN.PR.D, ALA.PR.G, CPX.PR.E, ENB.PR.N, PPL.PR.E and TRP.PR.D.

Outlook and Strategy

The Bank of Canada’s warning that future interest rate cuts would occur at a slower pace was not a surprise. For some months we have been pointing out that the Bank’s terminal rate (where it stops lowering rates) is more important than the pace the Bank arrives at it. We believe the Bank will probably lower rates by 25 basis points twice more in the first quarter of 2025. If that happens, the overnight target will be 2.75%, the midpoint of the Bank’s neutral range estimate. That seems like a reasonable point for the Bank of Canada to at least pause, given the economy is not in a recession, the scale and pace of easing since the Bank began lowering interest rates last June, and the lag with which the economy responds to rate changes. If we are correct that the Bank will pause at 2.75%, the yields of Canada bonds are unlikely to decline substantially from current levels.

With the 5-year bond yield continuing to be substantially higher than five years ago, the two December resetting issues increased their dividend rates more than 1.25%, and given that they trade below par, the increase in dividend yields was even greater. Notwithstanding strong positive performance in 2024, we believe the preferred share market continues to offer attractive yields and potential for price gains. This March will mark the fifth anniversary of the start of the pandemic and preferred shares resetting in 2025 will benefit from substantial increases in their dividend rates because the 5-year bond yield should be much higher than in 2020 when it fell below 0.50%.

As noted above, the $1.1 billion of announced redemptions of bank rate reset issues in December had reset spreads of 225 basis points or less. Banks have another $1.95 billion of rate reset issues resetting in 2025, with the lowest reset spread being 262 basis points, and $300 million of perpetual issues that could be called at par. The market is currently pricing the redemption of all these issues. In addition, there are several resetting non-bank issues in 2025 with large reset spreads that could possibly be redeemed.  As we have noted for several months, the ongoing redemption trend should benefit all types of preferred shares as investors continue to seek attractive dividend yields and reinvest the proceeds among fewer outstanding issues.