The previously announced redemption of the $400 million BMO.PR.D series occurred on August 25th . The redemption led to a short-lived rally in preferred shares but had little discernible lasting impact.

On the final day of the month, National Bank issued a Limited Recourse Capital Note (LRCN) in the amount of $500 million with an initial coupon rate of 7.50% and a reset spread of 428 basis points. While National Bank did not immediately announce the redemption of any preferred shares, its NA.PR.C series, which has a reset spread of 343 basis points, is eligible to be redeemed November 15th.

In other news, DBRS downgraded the preferred share rating of Canadian Utilities Limited to Pfd-2 from Pfd-2 (high). This reflects the rating agency’s belief that CU could issue more debt in the future. However, the rating remains strong and DBRS notes that the company’s sizable and diversified regulated subsidiaries, particularly CU Inc., provides solid cash flow, strong liquidity, and reasonable leverage. All seven of the largest preferred share ETFs experienced net outflows for the second consecutive month, with outflows totaling $93 million. Preferred share trading volumes were lower than usual in August, with most days having approximately 50% of the average daily volume.

J. Zechner Associates Preferred Share Pooled Fund

The fund returned 1.93% in August, which was somewhat better than the S&P/TSX Preferred Share index return. The portfolio’s overweight allocation to rate reset preferred shares that had negatively impacted performance in July had the opposite impact in August. As noted above, rate reset preferred shares recovered a significant amount of their July underperformance after the two institutional rate reset issues were absorbed by the market.

During the month, we added to the existing holding of EMA.PR.L, and bought a new position in RY.PR.N, both perpetual issues. We also increased the existing holdings of rate reset issues ALA.PR.E, BCE.PR.T, CM.PR.S, CPX.PR.E, and FN.PR.A. In addition, given an initial coupon rate of 7.50% and a reset spread of 428 basis points, we believed the National Bank LRCN was attractively priced and added it to the portfolio.

Outlook and Strategy

As this is being written, the Bank of Canada has increased its benchmark interest rate by 75 basis points to 3.25% as expected. In the accompanying statement the Bank reiterated “that interest rates will need to rise further, and the pace of increases will be guided by the Bank’s ongoing assessment of the economy and inflation”.

In this environment, we believe that higher bond yields are likely, and rate reset preferred shares will benefit from increased dividends resulting from these higher bond yields. At the current level of interest rates, if a series is not redeemed it will be increasing its dividend rate significantly. In the table above, this is evident in the more than 1.60% increase in the dividend rate of the three Canadian dollar issues that reset their dividend rates in August. These high dividend yields continue to look attractive versus alternative fixed income instruments.

With both the Bank of Canada and the U.S. Federal Reserve expected to continue their interest rate increases in the coming months, the potential for a recession by the end of this year or the beginning of 2023 is increasing. However, we are confident in the creditworthiness of the issuers in the portfolio, as these companies have successfully weathered previous economic downturns without impacting their preferred shares.

1 2