CIBCWM Likes Prefs

The current issue of Canadian Portfolio Strategy Outlook has a few things to say about prefs:

While trust valuations are likely to bounce back, trust market issuance will be restricted by the new regulations. Hence investors’ search for yield is likely to lead them to new instruments in 2007. A resurgence in preferred share issuance may be one of the new vehicles to pick up the slack.

I’ve been saying this for a while now – every time a trust blew up, in fact – but now the line is being picked up by the majors. I hope that doesn’t mean it’s not likely any more.

An important advantage of preferred shares for taxable investors is that the income, in contrast to the coupon stream from a bond, qualifies for the dividend tax credit. All the more so given Federal tax changes that lowered the effective tax rate on dividend income from 31% to 25% starting this year. Since 2004 preferred shares have offered a higher yield than even long Canada bonds. The average yield at present on Canadian preferred shares is about 5%, versus 4.0% for the GoC 30-year bond and about 4.7% for the typical Canadian corporate bond (Chart 7). However, on an after-tax basis, the spread against the long Canada rises to 150 bps, (Chart 8 ) a huge yield pickup for investors able to tolerate the somewhat larger degree of repayment risk.

I wish I knew where to pick up a basket of good quality prefs yielding an average 5%, but I guess that’s one of the things you learn when you work for a bank. And I think they could have been more specific about taxation. Still – it’s nice to see an organization that has an actual marketting budget talking about these things!

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