Despite financial market volatility, the preferred share market had a solid month in February. Volatility throughout the month was created by on-again, off-again headlines regarding the imposition of tariffs on Canada, Mexico, and China by U.S. President Trump. Preferred share performance was supported by corporate activity during the month, including an unexpected redemption announcement. Also, investors looked to reinvest the $300 million they received from the redemption of the NA.PR.W series. Over the month, average returns by type of preferred share diverged, with floating rate issues losing 0.2%, rate reset issues gaining 0.2%, while perpetuals were strong with a return of 2.5%.  The S&P/TSX Preferred Share index ended the month with a gain of 0.45%.

Data received in February showed that the Canadian economy was performing better than expected prior to the instigation of the trade war by the United States. Canadian GDP grew at a robust 2.6% pace in the fourth quarter of last year, despite a large drop in inventories, while final domestic demand surged higher at a 5.6% pace. In addition, GDP growth in prior quarters was revised higher, especially in the third quarter which was increased to 2.2% from the previous 1.0% estimate. As a result of the better than expected growth, the amount of slack in the Canadian economy (i.e. the Bank of Canada’s output gap) was reduced by half. The unemployment rate also surprised, declining to 6.6% as strong job creation more than offset higher participation. Inflation remained low at 1.9% because the temporary GST/HST holiday caused food, alcohol and clothing prices to weaken.

Corporate activity started early in the month with National Bank completing its acquisition of Canadian Western Bank. Subsequently, CWB preferred share series were exchanged into equivalent National Bank preferred shares. The CWB.PR.B series ticker was changed to NA.PR.I and the CWB.PR.D series ticker was changed to NA.PR.K.

Next up, Innergex Renewable Energy Inc. agreed, subject to common shareholder and regulatory approvals, to be acquired by Caisse de Depot et Placement du Quebec. The transaction contemplates retiring the company’s INE.PR.A and INE.PE.C preferred share series at par plus accrued and unpaid dividends, although the exact dates have yet to be determined. The INE.PR.C perpetual series is currently callable at par. However, the INE.PR.A rate reset series has its next redemption date on January 25, 2026. On the announcement, both the INE.PR.A and INE.PR.C series had strong price gains of more than 50% and 20% respectively and are currently trading as if they are going to be redeemed.

During the month, Fairfax Financial Holdings announced its intention to redeem the $230million FFH.PR.M series, that has a reset spread of 398 basis points, and the $189 million FFH.PR.E series and the related floating FFH.PR.F series, that have reset spreads of 216 basis points. Since the November redemption announcement of the FFH.PR.C and FFH.PR.D series that had reset spreads of 315 basis points, the market had been anticipating the FFH.PR.M redemption, and the issue had been trading close to par before the announcement. However, given the low reset spread on the FFH.PR.E and FFH.PR.F series, the market had not been anticipating their redemption, and these issues had price gains of more than 16%.  The prices of other Fairfax preferred shares, which all have higher reset spreads than FFH.PR.E, moved higher. Over the month, the average gain on Fairfax preferred shares was 5.8%.

In addition, Cenovus Energy Inc announced it will redeem the $200 million CVE.PR.E series that has a reset spread of 357 basis points. The issue had been trading close to par before the announcement as the market had been anticipating this redemption since the November redemption announcement of the CVE.PR.C series that had a reset spread of 313 basis points.

Also, during the month, Aimia Inc. announced the results of its substantial issuer bid to purchase and cancel all its preferred shares in exchange for 9.75% senior unsecured notes maturing in 2030. A total of 7,889,931 preferred shares were tendered, including 89.1% of AIM.PR.A, 40.0% of AIM.PR.C, and 99.8% of AIM.PR.D. Later in the month, AIM announced that it will not be redeeming the AIM.PR.A series that remain outstanding, and the new dividend rate will be set in early March.

There was one new issue of preferred shares in February. Partners Value Split Corp. issued $200 million of a 5.15% retractable series, PVS.PR.M, that will be redeemed in March 2031. The issue size was increased from $125 million due to strong investor demand. Partners Value Split Corp. is a split share structure based on Class A shares of Brookfield Corporation and Class A shares of Brookfield Asset Management.

During the month, only one series of preferred shares reset its dividend. 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 issue were as follows:

The trend of monthly outflows from the seven largest preferred share ETFs, continued in February with only one having an inflow. The aggregate outflow in February was $81 million.

J. Zechner Associates Preferred Share Pooled Fund

In February, the fund returned 0.89%, which outperformed the S&P/TSX Preferred Share index. Fund performance benefitted from holding relatively more perpetual type preferred shares, which was the best performing sector over the month.

Portfolio activity during the month including selling the National Bank 7.5% LRCN which had increased in price. The proceeds were used to add to the NA.PR.S position to pickup approximately 100 basis points in yield to their next call dates. Also, we added to existing positions in ALA.PR.G and MFC.PR.K, and new positions in BMO.PR.E and TA.PR.J.

Outlook and Strategy

A month ago, we thought it was unlikely that Trump would decide to impose 25% tariffs on all Canadian imports (excluding energy). It seems we were both right and wrong. As this is being written, the 25% tariffs were initially imposed on March 4th, but the automotive sector was spared a day later, and on March 6th tariffs on the 60% of Canadian imports covered under the USMCA free trade agreement (NAFTA 2.0) were delayed until at least April 2nd.

It is not known what Trump’s ultimate objective is with the tariffs threatened against Canada. The supposed goal of wanting to eliminate fentanyl smuggling and illegal immigration to the U.S. isn’t credible given how little there is of either coming from this country. As a result, it is difficult to anticipate what sectors will eventually be targeted and what the overall impact will be on the Canadian economy. At a minimum, the uncertainty is causing consumers and businesses to pause spending and investing, while taking a wait-and-see approach. Economic activity will likely slow in this environment.

We believe the domestic reaction in the United States to Trump’s trade war will be crucial regarding how the tariffs are imposed. Numerous sectors and industries in the U.S. recognize the fundamental importance of Canadian imports and are lobbying for the elimination or reduction of tariffs. The Big 3 auto manufacturers, for example, appear to have won a reduction in the tariff rate to 10%, as has the farming sector that needs Canadian potash for fertilizing its crops. Additionally, Trump appears sensitive to equity market weakness which, if it continues, should temper his policies.

Given the economic uncertainty and the volatility, we believe the Bank of Canada will, as a precautionary measure, lower its interest rates by 25 basis points at its next announcement date of March 12th. However, given current bond yields, though, there may not be much of a bond market reaction. The 5-year bond yield should continue to be considerably higher than five years ago for a least the next several months as we are just marking the fifth anniversary of the Covid-19 pandemic that resulted in bond yield plunging to record lows. As a result, issues resetting their dividends this year should increase them substantially. In addition, the redemption trend will continue to support performance. On the last day of March, investors will be looking to reinvest the $619 million they will receive from the redemption of the FFH.PR.E, FFH.PR.F, FFH.PR.M and CVE.PR.E series.

Financial market volatility during the month reflects investors’ concern about the potential of slower economic activity and the outlook for corporate profitability. Despite this, we remain confident in the ability of issuers in the portfolio to navigate this uncertainty, as these corporations have successfully paid their preferred share dividends during previous economic downturns.