The preferred share market had a poor month in March but outperformed both Canadian bond and equity markets. Financial markets moved lower in the month amid substantial volatility caused by the U.S./Israel war with Iran. The lack of clear U.S. goals in the conflict combined with often conflicting and/or contradictory comments from the U.S. president as well as Iran’s effective closure of the Strait of Hormuz resulted in significant day-to-day swings in financial asset values. Interestingly, bonds did not enjoy a safe haven bid in the uncertainty as investors chose instead to focus on potential inflationary risks as the price of oil surged more than 50% in the month. Preferred shares were less volatile than either bonds or stocks, and performance was helped when investors looked to reinvest the $400 million total received from the CVE.PR.A, CVE.PR.B, FN.PR.A and FN.PR.B redemptions on the last day of the month. Notwithstanding, all types of preferred shares had negative average returns in the month, with floating rate and rate reset issues having returns of -0.1% and -0.2% respectively, while perpetual issues lagged significantly at -2.3%. The S&P/TSX Preferred Share Index ended the month with a return of -0.92%.

Economic data received in March continued to show that the Canadian economy was struggling. The unemployment rate rose to 6.7% from 6.5% the previous month, as almost 84,000 jobs disappeared. Growth in Canadian GDP was slightly better than expected in January, but the year over year growth rate fell to only 0.6% from 1.0%. The inflation rate declined to 1.8% from 2.3% a month earlier, but the drop reflected base effects as prices rose 0.5% in the most recent month. The Bank of Canada left its interest rates unchanged at its March 18th meeting and Governor Macklem was dovish in his remarks about the decision:

“With inflation close to target and the economy in excess supply, the risk that higher energy prices quickly spread to the prices of other goods and services looks contained. But the longer this conflict lasts and the wider it gets, the bigger the risks. Governing Council will look through the war’s immediate impact on inflation but if energy prices stay high, we will not let their effects broaden and become persistent inflation.”

The Bank’s willingness to be patient regarding a temporary rise in inflation was in contrast with the sharp rise in short term bond yields that implied multiple interest rate increases would occur later this year.

There were no announced redemptions in March. However, Brookfield Office Properties issued a $200 million hybrid bond with an initial coupon of 7.625% and a reset spread of 458 basis points. The stated use of proceeds includes the redemption of the $200 million BPO.PR.C series, but the earliest the company can officially announce the redemption is 60 days before the June 30th reset date. Given its reset spread of 518 basis points, the market has been anticipating the redemption of the BPO.PR.C series for several months and there was not a significant move in its price on the hybrid issuance news.

In other corporate news, RFA Financial Inc. announced that the Toronto Stock Exchange approved its normal course issuer bid (NCIB) to purchase, for cancellation, up to 10% of the public float of the RFA.PR.E and RFA.PR.I series, representing 277,810 and 413,705 shares, respectively. The price paid for any purchase will be the prevailing market price at the time of acquisition.

There were no new issues of preferred shares in March. Early in the period, two series of preferred shares reset their dividends. The dividend rates reset significantly higher because the 5-year Canada bond yield continues to be substantially higher than the pandemic levels of five years ago. Details of the resetting issues were as follows:

Given that fixed rate dividend rates continue to be higher than floating rate ones, investor interest in floating rate issues has generally declined. During the month, BCE Inc. announced an insufficient number of investors wanted to remain in or switch to the related BCE.PR.N floating rate series to keep it outstanding. Therefore, all BCE.PR.N shares will be delisted and all investors will hold BCE.PR.M shares with a fixed rate dividend for the next five years. In addition, TransAlta announced that enough investors elected to remain in both the TA.PR.D fixed rate series and the connected TA.PR.E floating rate series to have them remain outstanding, although the outstanding number of TA.PR.E shares will be reduced by almost 50%. Consequently, 10,778,462 TA.PR.D fixed rate series and 1,221,538 TA.PR.E floating rate series shares will be outstanding going forward.

In March, the seven largest preferred share ETFs had an aggregate outflow totaling $22 million. The actively managed DXP had an outflow of $26 million, while the other six ETFs had either a small inflow or outflow.

J. Zechner Associates Preferred Share Pooled Fund

In March, the fund had a return -0.56%, which outperformed the S&P/TSX Preferred Share index. Fund performance benefitted from holding relatively fewer perpetual preferred shares, which was the worst performing sector over the month. Also, the portfolio’s rate reset positions were weighted to the better performing issues in the month.

Portfolio activity during the month included completing the switch out of the BCE.PR.F shares into additional BCE.PR.Q shares that was started in February. In addition, we sold some of the CM.PR.S position at a yield to call below 4.25%. These proceeds were used to add to the existing MIC.PR.A position at a yield of approximately 6.15% and initiate a new position in the LB.PR.H series at a yield of approximately 6.30%.  

Outlook and Strategy

Rather than trying to predict the end of the U.S./Israel war with Iran, which seems at least partially dependent on the everchanging whims of a mercurial U.S. president, we are looking at the likely ramifications of reductions in the supply of oil, natural gas, fertilizer, and other goods produced in the Middle East due to war-related damage. Even if the war were to end overnight, repairs to the damaged production facilities will take several months to a few years in the case of liquid natural gas infrastructure. While Canada is largely immune to the supply shortages that are negatively impacting Asian countries as well as Europe, we will be affected by higher prices.

We believe the Bank of Canada will be correct to look through the temporary spike in inflation that seems likely. Higher interest rates won’t lower gasoline prices. With the Canadian economy already struggling due to the U.S. trade war, the potential for demand destruction due to higher energy prices and uncertainty around the Iran war could slow domestic economic activity even more. Global growth also seems at risk. We believe the Bank of Canada is unlikely to raise interest rates this year, while interest rate cuts are a growing possibility.

Preferred shares continue to offer very competitive, tax-advantaged yields. During March, the 5-year Canada bond yield continued to be well above the extremely low levels of five years ago and the resetting issues reset their dividend rates approximately 190 basis points higher. Given that the issues trade below par, the increase in yields was even greater. We continue to anticipate large increases in resetting dividend rates in the near term.

Many preferred share issuers continue to have the ability to issue Limited Recourse Capital Notes and hybrid bonds at coupons and reset spreads that make it economically advantageous to redeem high reset spread series. Even with the high coupon and reset spread of this month’s hybrid bond issue, Brookfield Office Properties will opportunistically reduce its cost of capital if it redeems the BPO.PR.C series. Although redemptions are expected to be lower in 2026 than in 2025, we expect most of any redemption proceeds will be reinvested in other outstanding preferred share series and be supportive of the preferred share market.