The Preferred Approach

I was quoted in the Globe and Mail by Rob Carrick, who wrote a piece about fixed-resets and preferreds in general with the title “The Preferred Approach“:

Preferred share specialist James Hymas agrees that rising rates would be negative for perpetual preferreds, while rate reset shares would have some protection. Still, he prefers perpetuals. One reason is that perpetuals yield roughly a full percentage point more than the new reset preferred shares.

An example is Canadian Imperial Bank of Commerce series 30 preferred shares, which were issued in 2005 at the usual $25 price and have fallen to about $16, thereby pushing the yield up to 7.4 per cent (price and yield move in opposite directions).

“I would recommend straight perpetuals at this point because you are getting paid more than enough extra income to compensate for the added risk of a fixed rate,” said Mr Hymas, who is president of Hymas Investment Management.

Perpetual preferred offer not only a higher yield than the rate reset version, but also a chance for capital gains as financial market conditions “normalize,” in Mr. Hymas’s words.

He figures that perpetuals issued by banks could rise back to the $23 range under normal conditions, which suggests potential gains of 25 to almost 45 per cent, depending on the individual share issue.

Mr. Hymas said perpetuals also solve the problem of reinvestment risk, where you have money in a high-yield investment that matures and has to be rolled into something paying much less. If the bank rate reset shares being issued today are redeemed in five years, as many expect they will be, then investors will be unlikely to find such high yields again. Meantime, perpetuals bought today can be expected to roll along.

As for rising interest rates, Mr. Hymas said yields on corporate bonds and preferred shares – they have many similarities – typically fall as the economy emerges from recession, while government bond rates rise.

Meantime, there’s the risk that business conditions will deteriorate and force banks to not only break the taboo against common share dividend cuts, but also slash preferred share dividends.

Mr. Hymas plays down this threat. “Such an event is currently so remote that I don’t think the probability is measurable.”

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