Natixis Canada Blog

Month: March 2015

Policy Flip-Flop: Preferred Share Commentary from Jeff Herold

Jeff Herold
Jeff Herold, J. Zechner Associates, Lead Fixed Income Manager

The preferred share market stabilized in February, following the downdraft in January. Rate reset issues continued to fall in price, but slower than the month before. On average, rate reset preferred share issues returned -0.60% in the month. Floating rate and perpetual issues fared better, earning +1.01% and +0.68%, respectively. The overall S&P/TSX Preferred Share Total Return index gained 0.17% in February.

After its January 21st surprise interest rate reduction, the Bank of Canada gave every indication that it would reduce rates again, likely as soon as its March 4th meeting. The Bank’s January rate cut caused rate reset preferred share issues that are to reset in the next two years to fall in price the most. Our research shows that there is little correlation between preferred returns and bond yields. However, clearly the level of interest rates at the future reset dates affects the new dividend yields on rate reset issues. The prospect of lower yields in the future combined with low rate reset spreads could result in new dividend rates on preferred shares resetting in the next two years being much lower and investors sold as a consequence. We have generally been avoiding these low reset spread issues since the inception of the fund as we believe they have the risk of becoming perpetual in nature with low dividend rates. Unfortunately, the Bank’s policy flip-flop in February did not cause a rebound in the rate reset prices.Read More…

Interpreting the Economic Data – Fixed Income Commentary from Jeff Herold

Market Activity Last Month

Following the outsized gains of January, the Canadian bond market consolidated in February. Bond prices initially moved higher, pushing yields to all-time record lows. However, prices subsequently fell and yields edged higher. Economic data was mixed, although slightly positive on balance. Central bankers, including the U.S. Federal Reserve, gave mixed messages, and the Bank of Canada, in particular, executed a monetary policy flip-flop. Factors which have had substantial impacts on bond markets in recent months appeared to stabilize in the month. Oil prices, for example, were little changed and the European debt crisis did not worsen. The FTSE TMX Canada Bond Universe returned -0.13% in the period.

In Canada, unemployment eased to 6.6% from 6.7%, but the details of the jobs data were less positive as the number of full-time positions fell, while lower-paying part time jobs increased. Manufacturing sales and wholesale trade were stronger than forecasts, but retail sales were below expectations. The drop in retail sales reflected lower gasoline prices, but sales of clothing and electronics were also sharply lower. The Canadian trade deficit was smaller than expected as higher precious and base metals exports helped offset the declining value of energy exports. Housing starts were better than expected, but remained within their recent range. Inflation fell less than expected, dropping to 1.0% from 1.5%. Core inflation, which is thought to be a better indicator of underlying inflationary pressures, remained at 2.2%. The Canadian dollar traded in a fairly narrow range around US$0.80 during the month.Read More…

The Worst Rate Reset Pref Share is Extended

Jeff Herold
Jeff Herold, J. Zechner Associates, Lead Fixed Income Manager

The rate reset issue with the lowest reset spread in the Canadian market, BNS.PR.Y, is to be extended. The $265,000,000 issue, which currently has a dividend rate of 3.85%, will reset its dividend rate at 100 basis points over 5-year Canada bond yields on April 26th. If bond yields were unchanged from current levels, that will mean a new dividend rate below 2.00%.

We had thought there was a possibility that the Bank of Nova Scotia would exercise its option to redeem the issue because of its diminishing value as regulatory capital, but the bank clearly felt the very low dividend rate made the issue too attractive to pass up.

Caveat emptor!

Pref Update: Two Canadian Banks shift from Perpetuals to Rate Resets

Dax Letham, CFA
Dax Letham, CFA

With most of the Canadian Banks reporting decent earnings (Scotiabank reports March 3rd), two banks decided to replace high yielding perpetual preferreds with lower yielding rate reset preferreds. Last Thursday, CIBC launched a 3.60% rate reset preferred that resets at 279 bps over 5 year Canada Bonds/T-Bills on July 2020 and then announced a few days later that they would be redeeming their CM G perpetual preferreds which have a 5.4% dividend. Then on Friday, TD Bank came to the market with its own 3.60% July 2020 rate reset and today announced their intention to redeem the 5.60% TD series R perpetual preferred.

In the current rate environment, replacing perpetual shares with rate resets makes good financial sense for both issuers, as they are able to lower their financing costs by 1.8% and 2.0% and adds further evidence that perpetual shares with yields over 5% are expensive capital for issuers. With the average preferred share in the NexGen Preferred Share Fund yielding over 5.0%, we believe that our holdings offer excellent value compared to new and outstanding issues. Due to the low dividend yield of the new CIBC and TD rate resets, the fund did not participate in either issue.

Dax Letham, CFA

Portfolio Manager

Negative Interest Rates Return: Comments from Toron AMI’s Managing Partner

Arthur Heinmaa, CFA Managing Partner, Toron AMI

January results were different depending on what side of the border you are on. In U.S. dollar terms, the major indexes were down approximately 3%, but in Canadian dollar terms the markets were up around 6%. The difference is the large 9% decline in the Canadian dollar during the month. These results highlight the reasons why diversification outside Canadian markets is a key part of controlling risk in portfolios – you protect your purchasing power. With the Canadian dollar inextricably linked to the direction of oil, we expect that volatility in the exchange rate will continue during the coming months.

The movements in both exchange rates and equity markets were certainly the most discussed economic events, but the drop in interest rates across the globe may turn out to be far more important. Read More…

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