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Preferred shares
September 5, 2020
9:10 pm
Norman1
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asiamalekas said

You can buy and sell preferreds at the market value any time. Expecting the issuer to redeem the preferred is the wrong reason to invest in preferreds. Redemption should be considered as a bonus.

On your example with BC Tel. I don't know anything about but I am sure the market would have brought the price of the preferred to a level where the yield was at least 15% (1.5 times what the bonds paid). To me it sound like it was a great time to buy. I assume it was issued at $25 and trading at $4-$5 with a current yield of 15%.

Well, one is kind of stuck in that case. If one bought the BC Tel preferreds decades before at $25 and they are now trading at $4 to $5, then one is facing an 80% loss on the principal.

For those preferred shares, a drop in interest rates would rescue the buyers. But, no-one in the 1980's would have expected the low interest rates we have today.

That's the problem some buyers don't really appreciate. One may never recover the original purchase price if the issuer never redeems.

Don't expect other buyers would come to the rescue. If one bought some rate resets that reset to GOC5 + 1% and the going reset is GOC5 + 3%, then no buyer would be stupid enough to pay par for the GOC5 + 1% preferred when paying par value would get GOC5 + 3%.

Even the floating rate preferreds are risky. Some BCE floating preferred shares that were issued at $25 are trading these days around $15. 40% loss for those who bought at original issue price of $25 for something that floats with the prime lending rate.

September 6, 2020
3:48 am
Jon
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And the problem mention by Norman in the last post is not serious with long bond because they always have maturity. So if the yield increase, the investor of long bond can always protect its capital by holding it to maturity (although that could be a while, and there will certainly be better investment out there).

When someone look at an investment, I believe they should should ignore the tax benefit. If it is not a worthwhile investment without a tax benefit, one should not invest in it.

September 6, 2020
5:08 am
canadian.100
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Jon said

When someone look at an investment, I believe they should should ignore the tax benefit. If it is not a worthwhile investment without a tax benefit, one should not invest in it.  

So, that would leave out today's 5 year GICs @0.9% - 1.0% as "worthwhile".

September 6, 2020
7:56 am
Bill
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Good point, AltaRed, about low inflation as long as globalism prevails. But my sense is that period's over in our region of the world, young folks especially seem to prefer to pay higher prices to "shop local" instead of spending their money to keep very poor people far away employed, and their political choices reflect that. And with the speed of events today, I can see a relatively quick and unexpected return to high inflation. That would be bad news for (among other investors) preferred shareholders.

To me getting less than 1% in a GIC is not worthwhile. I increasingly hold just cash as the few bucks I lose are not worth tying up my money for, especially as I hold the view re returning inflation that I do. However there's also a risk, I think, in having large amounts of cash sitting in my discount brokerage accounts, I believe not even the 1st $100K is CDIC covered.

September 8, 2020
5:25 pm
asiamalekas
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Bill said
Good point, AltaRed, about low inflation as long as globalism prevails. But my sense is that period's over in our region of the world, young folks especially seem to prefer to pay higher prices to "shop local" instead of spending their money to keep very poor people far away employed, and their political choices reflect that. And with the speed of events today, I can see a relatively quick and unexpected return to high inflation. That would be bad news for (among other investors) preferred shareholders.
 

Hi Bill,
I must correct you in respect to the preferred shares.

This is not bad news for preferred shareholders. I do not think you understand how preferreds work. With interest rate going up all floaters will be getting higher yields each every 3 months following the rise in interest rates. (how is this bad news ????).

5 Year reset will be resetting at the higher yields providing higher dividends .

The price of both the resets and floaters will go up thus providing you with capital gains.

The price of perpetuals will go down since the market will try to bring up their yield. (Great time to pick up some at discounted price).

Total Canadian Preferreds Market broken down by type: (
-5 Year resets Total market cap: 46,261,949,639
-Perpetuals Total Market cap: 14,542,448,574
-Floaters Total Market cap: 2,038,771,319.

September 8, 2020
6:45 pm
Jon
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asiamalekas, not everyone wants to buy pref as if they are annuity, many people simply cannot risk lost of principal due to interest rate change and/or default risk.

Pref, and junk bonds, have proven itself that they can be extremely volatile when the economy turns sour.

Moreover, for people that rely on interest or dividend income, may pref suspend their payment of dividend when the economy turn sour. This may imply the owner of such pref may have to sell in the worst time possible to pay for their expenses.

You may suggest diversify is the solution here, however, there are plenty of tools to diversify already. Pref have quite a bit of risk of common share (when the company goes into bankruptcy, they are only "preferred" to common stock's shareholder), but not the upside of common share (success of the company). If that is the case, why don't people only diversify with common stocks and investment grade bonds ?

September 8, 2020
7:09 pm
Bill
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Thanks, asiamalekas, sounds like preferreds are a sure bet.

September 9, 2020
5:35 am
savemoresaveoften
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In general, a rising rate environment is great for resettable prefs. However if rates rise significantly AFTER a pref just reset, that pref may come under pressure, as the market rate is now much higher than the pref which is now "fixed" at a lower than market rate for the next 5 years.

Re seniority when a corp goes bankruptcy, even bond holders may only get 10 cents back, so whether its common, pref, or bonds, the investor will still get a massive hit.

I think of pref to be similar to the corp bonds, both are highly illiquid with a big bid/offer spread, and both earn you a good income in a low rate environment.
Cad corp pref enjoys the div tax credit too. The key is to diversify across multiple names.

September 9, 2020
5:37 am
canadian.100
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Bill said
Thanks, asiamalekas, sounds like preferreds are a sure bet.  

I would never use the word "sure bet" for anything in life - however if one buys Preferreds from such issuers as the big banks (eg Royal , Scotia etc.), insurance (eg Manulife, Sunlife etc.) , others such as Enbridge, Pembina, Power Corp, etc. you will likely do just fine as long as you hold for the long term. If you go into panic when an investment drops in value for no real reason other than market cycles or gyrations, stocks are probably not for you.

September 9, 2020
10:10 am
Bill
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canadian.100, we have a prime minister, a finance minister and a populace that is looking to get off carbon-based energy and to move to non-carbon energy sources asap. Do you believe Enbridge and Pembina's (as examples of legacy energy industry companies) preferred shares "long term" prospects are unimpacted by that?

September 9, 2020
12:43 pm
canadian.100
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Bill said
canadian.100, we have a prime minister, a finance minister and a populace that is looking to get off carbon-based energy and to move to non-carbon energy sources asap. Do you believe Enbridge and Pembina's (as examples of legacy energy industry companies) preferred shares "long term" prospects are unimpacted by that?  

While the PM and his govt talk a good line about energy, are u aware that he just bought a pipeline? I think it is going to be quite a while before Canada is off oil and gas - probably not in the next 20 to 30 years. Even if Canada did move to non-carbon, it would still export to other nations who will continue to use oil and gas.
Energy shares whether common or preferred have higher yields than other industries probably for the reason that they will be impacted. My Pembina Pref shares which I have had for 10 years pay around 7% dividend and that is not going to stop tomorrow - but perhaps I will sell my Pembina Prefs in case your prediction of a noncarbon Canada is coming sooner than I believe. I will keep the Big Banks and Insurance company Prefs.

September 9, 2020
7:01 pm
Bill
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Thanks, though I'm not really predicting anything, I have no clue what's coming but I do notice around me a general consensus that we need to get off carbon-based energy asap. Personally I don't agree but I seem to be in the minority, at least in my part of Canada.

September 10, 2020
1:09 pm
asiamalekas
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Jon said
asiamalekas, not everyone wants to buy pref as if they are annuity, many people simply cannot risk lost of principal due to interest rate change and/or default risk.

Pref, and junk bonds, have proven itself that they can be extremely volatile when the economy turns sour.

Moreover, for people that rely on interest or dividend income, may pref suspend their payment of dividend when the economy turn sour. This may imply the owner of such pref may have to sell in the worst time possible to pay for their expenses.

You may suggest diversify is the solution here, however, there are plenty of tools to diversify already. Pref have quite a bit of risk of common share (when the company goes into bankruptcy, they are only "preferred" to common stock's shareholder), but not the upside of common share (success of the company). If that is the case, why don't people only diversify with common stocks and investment grade bonds ?  

Hi Jon,
For those considering annuities here is why i think preferreds are better. https://canadianpreferredshares.ca/what-is-better-than-an-annuity-for-retirement/

Pref, and junk bonds, are not in the same category. Preferreds issuers have Credit ratings of A+ AA etc. (some of the highest corporate credit ratings in the market). They issue bond and preferreds. Here is sample of these issuers https://canadianpreferredshares.ca/rank-perpetual-preferreds-with-credit-score-pfd-2h/

Yes preferreds can suspend dividends but history shows us this has not happened yet. Do you know of a company with a credit rating of pfd-2h or pfd-2 or pfd-2l has suspended preferred dividends ??? ( I do not)

If a company goes bankrupt Preferreds get paid after bonds (Big IF there is any money left). In case of bankrapsy I dont think you will get much for your bonds. The idea is to hold solid companies with no chance of bankrapsy. As an investor you should be doing your homework and staying away from these type of companies.

For any investor not willing to do some homework, the best option is to put your money in a savings accounts across multiple banks.

September 10, 2020
3:27 pm
Loonie
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There was something in the news a few years ago about making preferred share investments take some of the load for corporate failures in a way that common shares were not liable. I can't remember how it was supposed to work. Does anyone know if that ever went through?

Jon made a reference to using preferred share income to fund expenses. I don't think anyone should rely on something that doesn't have a guaranteed income for this purpose. If you don't have enough from salary, pensions or capital for expenses, you should be looking at annuities to top it up so that you know you will have enough.

September 10, 2020
3:49 pm
Righand
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asiamalekas said

Hi Jon,
For those considering annuities here is why i think preferreds are better. https://canadianpreferredshares.ca/what-is-better-than-an-annuity-for-retirement/

Pref, and junk bonds, are not in the same category. Preferreds issuers have Credit ratings of A+ AA etc. (some of the highest corporate credit ratings in the market). They issue bond and preferreds. Here is sample of these issuers https://canadianpreferredshares.ca/rank-perpetual-preferreds-with-credit-score-pfd-2h/

Yes preferreds can suspend dividends but history shows us this has not happened yet. Do you know of a company with a credit rating of pfd-2h or pfd-2 or pfd-2l has suspended preferred dividends ??? ( I do not)

If a company goes bankrupt Preferreds get paid after bonds (Big IF there is any money left). In case of bankrapsy I dont think you will get much for your bonds. The idea is to hold solid companies with no chance of bankrapsy. As an investor you should be doing your homework and staying away from these type of companies.

For any investor not willing to do some homework, the best option is to put your money in a savings accounts across multiple banks.  

One thing that no one seems to mention is that before the prefs suspend a dividend the common share dividend must be completely eliminated. If one buys only investment grade prefs, how likely is that ?

September 10, 2020
4:18 pm
canadian.100
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Loonie said
There was something in the news a few years ago about making preferred share investments take some of the load for corporate failures in a way that common shares were not liable. I can't remember how it was supposed to work. Does anyone know if that ever went through?

Jon made a reference to using preferred share income to fund expenses. I don't think anyone should rely on something that doesn't have a guaranteed income for this purpose. If you don't have enough from salary, pensions or capital for expenses, you should be looking at annuities to top it up so that you know you will have enough.  

Re your first paragraph, I think you are referring to NVCC - Non-viability Contingent Capital. You can read about it online yourself for the specifics.

Re you second paragraph, I agree with asiamalekas post 93. I have researched annuities recently and in 2020 they are not a great investment (probably because of the low interest rates). Perpetual preferred shares (from high quality issuers A, B quality) are superior for a long dependable stream of dividend income (again see asiamalekas post). As well you have capital at the end (unlike an annuity where there may be no lump sum capital returned after expiry of the annuity term or death.)

September 10, 2020
5:18 pm
AltaRed
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canadian.100 said

Re your first paragraph, I think you are referring to NVCC - Non-viability Contingent Capital. You can read about it online yourself for the specifics.

Re you second paragraph, I agree with asiamalekas post 93. I have researched annuities recently and in 2020 they are not a great investment (probably because of the low interest rates). Perpetual preferred shares (from high quality issuers A, B quality) are superior for a long dependable stream of dividend income (again see asiamalekas post). As well you have capital at the end (unlike an annuity where there may be no lump sum capital returned after expiry of the annuity term or death.)  

Very good points I will reinforce with an expanded post. Loonie was referring to NVCC compliant prefs. Generally speaking, at a crisis point when bank common equity share price dropped to $5/share, OSFI could force the conversion of the new NVCC compliant prefs into five common equity shares. The world would have pretty much come apart by then so not sure why that might matter anyway at that point.

I wish I would have stuck to plain vanilla perpetual preferred shares all along rather than diversifying into fixed reset prefs which have been heartburn for many investors. The dividend on the perpetual is firm into perpetuity until and if the issuer calls the shares at par. They are as close to fixed income (investment income) as one can get with bonds or GICs, and especially bought from AA or A+ firms (banks and lifecos). There is nothing wrong with an eligible (DTC) dividend at 5-5.5%. Sure as hell beats an interest bearing bond or GIC these days.

The big downside of course, which is why they are not popular, is they have no maturity date and in a case of hyperinflation, become relatively worthless. OTOH, if one holds them to death like an annuity, who then cares if they are worthless? I think they can certainly stand in for an annuity and those thinking of annuitizing some income at age 75 or 80 anyway, these are a viable alternative.

September 10, 2020
11:42 pm
Loonie
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Thanks for the info.

Annuities are not good or necessary for everyone. It's very likely that AltaRed and canadian 100 don't and won't need what they offer. I don't expect to need them either.

And I'm not suggesting that anyone necessarily put a huge amount of money into them.

But I still think they may be the best thing for some people.
For example, a retiree in their 70s finds that their fixed income is not keeping up with their basic living expenses. Let's say income is 40K but basic non-discsretionary expenses are 45K. They are worried that their nest-egg, part RIF and part non-registered or TFSA, will not last them, and the numbers support that fear. I would still recommend that this person gradually buy annuities to provide a reliable fixed income. By staggering purchases, they have a way to deal with inflation since returns are higher if you wait longer to buy, interest rates notwithstanding. I don't see that Preferred Shares offer this kind of guaranteed income which can be relied upon to fund necessities.
If they have enough capital, it might be possible for them to effectively annuitize their own income. If this person has perhaps 500K, they could buy perhaps 3 x 100K in annuities over a five to seven year period, and still have some left over for when inflation gets beyond them again. And if it comes from non-registered, income tax is negligible, so you require less from annuities.

I realize the rates are lower now, but they have not declined as much as GIC rates. If the person started buying their annuities a couple of years ago, averaging out over time, they would be in a stronger position.

It's also true that you may have nothing left over at the end, although you can buy them with riders so that a minimum is paid out regardless. But the primary purpose at this stage of life must be to fund one's own needs. As a taxpayer, I don't want to hear that anyone is receiving GIS because their dividends have not met expectations or because they have ongoing income hidden away in TFSAs which is not counted as income for GIS purposes. (Same thing could apply to those with lowered GIC returns.)

I would not suggest this person necessarily put all their money into annuities, only what they need to guarantee their necessary income. If not annuities, how else would you guarantee that income? - remembering that it is essential for living expenses.

As I said, I don't anticipate needing to do this. However, I might buy annuities for other reasons. For one, it makes it harder for a Power of Attorney to abuse their privileges as they have access to less money.

I would also urge anyone to only buy what they fully understand. There are risks in everything, alas. Until you've identified and evaluated the risks, you are not ready to buy.

September 11, 2020
6:21 am
canadian.100
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Righand said

One thing that no one seems to mention is that before the prefs suspend a dividend the common share dividend must be completely eliminated. If one buys only investment grade prefs, how likely is that ?  

Righand - excellent point. I am unaware in over 10 years of any Pref dividends being eliminated, even if the common share dividend was reduced. (I am a long time owner of both perpetuals and resets).
This has been useful to discuss/review perpetual preferred shares - it confirms to me that they are an attractive alternative to GICs for some investors/savers - of course it always depends on individual circumstances/situations - and Loonie is correct - always do your homework - understand what you are buying and the risks. Perpetual prefs have served me well for over 10+ years - dividends these days are great and the DTC is a bonus. I will admit (same as AltaRed) that the Resets (I bought 10 years ago at issue price) have been a "royal pain" but on the other hand I am not selling them either - they have and will provide a steady flow of dividends (with DTC) which is superior to HISA and GIC interest rates these days. The Resets I have will serve as the "ANNUITY" portion for my purposes.
If interest rates start to increase in 3, 4 or 5 years from now, I would think the Resets will appreciate from their present low market values. Actually, resets purchased at current market values are probably low risk in risk terms, but that is another topic.

September 11, 2020
7:21 am
Norman1
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Royal Trustco had suspended the dividends for some years on both on its preferred and common shares. They were investment grade. The company was so blue chip that it could issue non-cumulative preferred shares that don't have to make up skipped dividends.

Central Guaranty Trustco went bankrupt after CDIC took control of its Central Guaranty Trust subsidiary. Its preferred shares became worthless. I still have the nice looking share certificates as a reminder.

Twenty to thirty years is a long time. Lots can happen in that time.

One is not receiving 4% to 5% from preferred shares, while Government of Canada bonds are yielding under 1%, without taking on risk. That risk is that of being a shareholder. If one does not see that risk, then one is actually blind to the risk and has not found a "bargain" that no-one else realizes.

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