Are these preferreds a 5-per-cent solution?

Rob Carrick was kind enough to quote me in his piece Are these preferreds a 5-per-cent solution?:

James Hymas, president of Hymas Investment Management and a preferred-share specialist, said there are roughly a dozen blue-chip perpetual issues that combine a straightforward structure with a share price below their $25 issue price. These shares, issued by Brookfield Asset Management, Canadian Utilities, E-L Financial, Power Corp. of Canada and Power Financial, had an average yield of 5.1 per cent as of earlier this week.

Mr. Hymas said perpetuals could be an attractive option for investors who are looking at long-term corporate bonds, which mature in 10 years or more. These bonds have a yield of roughly 3.6 per cent on average today compared with perpetuals in the range of 5 per cent.

You’d need about 6.6 per cent from a bond to give you the same after-tax yield as a perpetual preferred share. Multiply a dividend yield by 1.3 to get the rough equivalent from a bond after paying taxes, Mr. Hymas said.

The drawback with perpetuals is that they are highly sensitive to rising interest rates. Mr. Hymas sees five-year Government of Canada bonds eventually rising from current levels just above 1 per cent to the 3-per-cent to 3.5-per-cent range. If that happens, expect perpetuals to plunge in price. “It could be quite traumatic,” he said.

Much less of a concern is the security of the dividends paid by perpetuals. The dozen perpetuals highlighted by Mr. Hymas are all rated Pfd-2 by the rating agency DBRS, which means satisfactory credit quality. Pfd-1 is superior quality, while Pfd-5 is highly speculative.

Companies that issue perpetuals have an option to redeem the shares based on terms set out in the prospectus (you can find prospectuses on While you shouldn’t buy these shares based on the potential for a future redemption at the $25 issue price, there are some perpetuals that might actually be in line for this at some point in the next several years.

Mr. Hymas believes that regulations covering the banking sector and its capital structure could, in the next few years, be applied to life insurance companies. Some preferred shares would then become disadvantageous for insurers and, in turn, be candidates for redemption in the years ahead. A redemption would turn a perpetual preferred share into a maturing investment similar to a bond.

Mr. Hymas said he likes three issues of insurance-company perpetuals with redemption potential: Sun Life Financial Series 5 (SLF.PR.E), Manulife Financial Series 3 (MFC.PR.C) and Great-West Lifeco Series I (GWO.PR.I). All have yields at or just below 5 per cent based on recent share prices and dividends. If the shares were redeemed in the next eight to 12 years at $25, that yield would work out to be a bit higher (the shares all currently trade below $25).

For argument regarding my belief “that regulations covering the banking sector and its capital structure could, in the next few years, be applied to life insurance companies”, see the posts DeemedRetractible Review: September, 2016 and OSFI Dovish on Insurance Tier 1 Eligibility Rule.

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