Preferred shares are similar to bonds in that they usually pay a fixed dividend and can be redeemed (called) by the issuer at a specified price. There is often a schedule, such that during different periods of time, the shares can be redeemed for different amounts. Usually, the amount will start off high, and drop as time goes on. Typically the final amount is $25.00/share, and sometimes $50.00/share. The final redemption price for both POW.PR.B and BNS.PR.M is $25.00. Consequently, you usually don't want to buy a preferred shared trading at more than the redemption price. I like to buy them at around $20 to $23 to give myself the chance of some capital appreciation if the shares are redeemed.
The risks of my preferred share investments are the same as those for bonds, except that bondholders are ahead of preferred shareholders in the creditor queue during bankruptcy. Fixed-rate preferred shares (such as those mentioned here) have interest rate risk, and preferred shares in general have creditor risk. The issuer could also suspend the dividend payment on the preferred. If it's a cumulative preferred, the issuer will owe the dividends that were not paid. I think you're more likely to see a cut in the dividend on the common if the issuer gets into trouble.
The interest rate risk is that interest rates will go up, and the value of the preferred shares will go down (so the yield goes up), just like bonds. I'm not too worried about that, but you never know about interest rates. There could be a run on government bonds because of the massive debt that governments have racked up, and that could lower the price of all securities.
The credit risk is that the issuer will go belly up. Not to be taken lightly these days. However, I don't think BNS will go bankrupt. Except for CIBC, the Canadian banks are pretty solid. Moreover, BNS doesn't have large US holdings (unlike RY and TD which have been forced to take writedowns on their US holdings). The bigger risk is that BNS cuts the dividend. To assess that we need to look at the financials.
Canada Life (CL.PR.B) which I bought earlier is also pretty safe I think. Power corp is harder to assess. It's a financial conglomerate with holdings in life insurance companies and mutual fund companies (e.g. Putnam). I can't assess all the portfolios of its subsidiaries like I did with Canada Life. So instead, I look at the ratio of total dividends paid on the common to total dividends paid on the preferreds. My reasoning is that they'll cut the common before they cut the preferred. I also look at the payout ratio.
Here's an image of my spreadsheet containing recent data on a bunch of preferreds I looked at.
Click on the image to see a bigger version.CU, and CIU are issues from Canadian Utilities and TCA is TransCanada Pipelines. Power Financial is a subsidiary of Power Corp. (Not too much imagination there).
Anyway, you can see that BNS.PR.M, CIU.PR.A, POW.PR.B, and PWF.PR.F are all still in the right price range, and the yields are pretty good too. The DBRS ratings are pretty good, but how much do you trust DBRS these days? The payout ratios on the common are also pretty good, especially for Power Corp, but not for Power Financial. All the firms pay out much much more in dividends on the common than on the preferreds (that's calculated over all preferred series for each issuer, not just the ones shown in the table). Consequently, if there were dividends to be cut, you might see it on the common only. Another factor in determining credit risk is the extend of debt in the capital structure. However, financial companies and regulated utilities will typically show a lot of liabilities in their cap structure, and that's what we see here.
Note that the payout ratio on the common shares for BCE is quite high (80%) and that makes me uncomfortable (I still own some BCE.PR.A), but the yield is not much higher than the other issues. It's even worse for Power Financial. At least Power Corp has money coming in from somewhere else than Power Financial. Overall, you might consider BNS.PR.M, CIU.PR.A, and POW.PR.B, with POW.PR.B being the riskiest.
Posts
