In July, the preferred share market had another strong month. Performance was supported by corporate activity that included an anticipated redemption announcement and two acquisitions of preferred share issuers. Preferred share performance was also driven by investors needing to reinvest $650 million to be received from the redemptions of the CM.PR.Q and TD.PF.D series on the final day of the month. All types of preferred shares had positive average returns in the month, with floating rate and rate reset issues having returns of 5.3% and 3.8% respectively, while perpetual issues lagged slightly at 3.3%. The S&P/TSX Preferred Share Index ended the month with a return of 3.19%, which compared favourably with the S&P/TSX Composite index of common shares that earned 1.69%.

Canadian economic data received in July was generally better than expected. The unemployment rate declined to 6.9% from 7.0%, with 83,100 new jobs created and a small rise in the participation rate. Housing starts were better than expected, manufacturing sales in May were less bad than forecasts, and retail sales in the same month were in line with expectations at a time of maximum trade uncertainty. Of particular importance for the Bank of Canada, the CPI inflation rate rose to 1.9% from 1.7%, while core measures increased to slightly above 3.0%. On the final day of the month, Canadian GDP was estimated to have declined 0.1% in May, but on a year over year basis, the Canadian economy grew 1.2%. For the third consecutive meeting, the Bank of Canada left interest rates unchanged.

During the month, Bank of Montreal announced that on August 25th it will redeem the $200 million BMO.PR.Y series, which has a reset spread of 271 basis points. The market had been anticipating that BMO would continue the recent trend of bank redemptions and there was not a significant move in its price on the news.

Later in the month, First National Financial Corporation and RF Capital Group Inc. each announced that they were being acquired. First National is being acquired by Birch Hill Equity Partners and Brookfield Asset Management. The issuer’s two preferred shares, FN.PR.A and FN.PR.B, will remain outstanding. However, the news caused both issues to have price increases of over 13% in the month. RF Capital Group’s $89 million RCG.PR.B series fared even better, increasing 55% on the news that it would be redeemed when the company is acquired by iA Financial Corporation.

The acquisition of Innergex Renewable Energy Inc. by Caisse de Depot et Placement du Quebec was completed in July. The company’s INE.PR.A and INE.PE.C preferred share series were acquired by the Caisse at par plus all accrued and unpaid dividends. The INE.PR.C perpetual series was callable at par. However, in the case of the INE.PR.A rate reset series, an additional amount was paid in cash per share equal to the dividends that would have been payable on a share until January 15, 2026, their next redemption date. The preferred shares were delisted from the Toronto Stock Exchange on July 22nd.

One series of preferred shares reset its dividend during July. Dividend rates continue to reset significantly higher because the 5-year Canada bond yield is substantially higher than the pandemic levels of five years ago. Details of the resetting issue were as follows:

As this is being written, Emera announced that investors holding more than 50% of the connected EMA.PR.B floating rate series had elected to switch into the EMA.PR.A fixed rate series. This resulted in fewer shares than the minimum needed for the floating rate series to remain outstanding. All EMA.PR.B shares will be converted into EMA.PR.A shares which will be the only series outstanding for the next five years.

In July, the quarterly S&P/TSX Preferred Share Index rebalancing featured no additions and one deletion, GWO.PR.S. Also, during the month, the seven largest preferred share ETFs had an aggregate outflow totaling $23 million, which was largely driven by a single day outflow of $55 million from the actively managed DXP fund.

J. Zechner Associates Preferred Share Pooled Fund

In July, the fund returned 2.41%, which underperformed the S&P/TSX Preferred Share index. The shortfall was largely a function of security selection. The fund held relatively few issues with low reset spreads (i.e. less than 200 basis points) that had the strongest performance in the month. The fund also held relatively few shares that have reset/redemption dates in the next two years, as we preferred greater certainty re the dividend yield. In addition, speculation about potential hybrid issue led to rallies in issues not held in the fund.

Portfolio activity during the month was limited to adding a new position in NPI.PR.A, which resets in September.

Outlook and Strategy

We believe the Bank of Canada will keep interest rates at current levels unless significant economic weakness becomes evident. So far, the trade war has created plenty of uncertainty, sapping both consumer and business confidence in this country. However, the Canada US Mexico trade agreement (CUSMA) has protected most of Canadian exports to the United States from tariffs. Only the sectoral tariffs targeting steel, aluminum, and autos have led to a significant reduction in sales to the United States. A recent increase in U.S. tariffs on Canadian softwood lumber will likely add to the economic pain, but most of the Canadian economy remains relatively unscathed from the trade war. Negotiations between Canada and the United States regarding tariffs continue, and any agreement would likely be viewed as positive for the Canadian economy. Unlike other countries, CUSMA gives Canada and Mexico the ability to be patient in their negotiations and for the U.S. public to react more negatively to the trade war raising prices and slowing U.S. growth.

In July, the 5-year Canada bond yield remained well above the extremely low levels of five years ago, and the sole resetting series of preferred shares raised its dividend rate 277 basis points. At this point in 2020 the 5-year Canada bond yield was below 0.50% and didn’t rise above that level until February 2021. We are not anticipating substantial change to current bond yields, so we should continue to see large increases in resetting dividend rates for the next several months.

The redemption trend should continue to support preferred share performance. Investors will receive $200 million from the BMO.PR.Y series redemptions on August 25th. Looking out further, both the $170 million ALA.PR.A shares and the $186 million FFH.PR.G shares are trading as if they will be redeemed on September 30th. In addition, the $200 million TD.PF.E shares and the $300 million RY.PR.M are expected to be redeemed in October and November, respectively. We expect most of the redemption proceeds will be reinvested in other outstanding series of preferred shares.