Canadian Preferred Shares Report - Raymond James Ltd.

Canadian Preferred Shares Report

January 24, 2020

Fixed Income Group

Inside this Report

2019 Was Tough But Ended Positive .......................................... 2 2020 Outlook .................................2 Where to Look for Opportunities....2 Portfolio Positioning.......................3 Highlights: Sample Portfolio ..........4 Most Actively Traded .....................5 New Issues in Q4-2019 .................6 Appendix A: Yield Tables ..............7 Appendix B: Credit Ratings Comparisons .................................7 Appendix C: Education and Glossary ........................................8 Disclaimer .................................. 10

Cautiously Optimistic

The Canadian preferred shares market continued its momentum from the end of the third quarter of 2019 and finished the year higher. For the fourth quarter, the S&P/TSX Preferred Shares Index had a total return of 3.9%, which helped to put the market in the positive for the year with a performance of 3.5%.

In the fourth quarter, market sentiment turned positive on optimism that there was progress being made in the US-China trade war and that a "phase 1" deal would be signed in January. Additionally, after three straight rate cuts, the Fed became less dovish and hit the pause button at their rate meeting in December and signalled no plans to cut in 2020. This pushed yields higher globally and also helped prefs rebound in the fourth quarter.

Performance

130

125

120

115

110

105

100

95 90

S&P/TSX Comp TR

85

S&P/TSX Preferred Shares TR

80

Jan-2019 Feb-2019 Mar-2019 Apr-2019 May-2019 Jun-2019 Jul-2019 Aug-2019 Sep-2019 Oct-2019 Nov-2019 Dec-2019

However, at the latest Bank of Canada (BoC) rate announcement on January 22, the BoC changed their tone and opened the door for a possible rate cut. This soured preferred share market sentiment following a good end to 2019 and start to 2020 pref investors remember the last time the BoC cut in 2015.

We are moving to a market weight in fixed-resets following the recent commentary from the BoC, but we continue to see good value in this area of the market. We do remain cognisant that preferred shares can be volatile, especially with the proliferation of pref ETFs and their flows can exaggerate market movements creating opportunities for investors. We also advise investors to hold some perpetuals and high reset spread fixed-resets to help mitigate the risk of potentially lower yields.

Phil Kwon Fixed Income

Canadian Yield Curve

2.50

2.00

1.50

1.00

0.50 0

31-Dec-2019 28-Jun-2019 31-Dec-2018

5

10

15

20

25

30

Term (years)

Source: Bloomberg, Raymond James Ltd.

Please read domestic and foreign disclosure/risk information beginning on page 10. Raymond James Ltd. 5300-40 King St W. | Toronto ON Canada M5H 3Y2. 2200-925 West Georgia Street | Vancouver BC Canada V6C 3L2.

Jan-2015 Apr-2015 Jul-2015 Oct-2015 Jan-2016 Apr-2016 Jul-2016 Oct-2016 Jan-2017 Apr-2017 Jul-2017 Oct-2017 Jan-2018 Apr-2018 Jul-2018 Oct-2018 Jan-2019 Apr-2019 Jul-2019 Oct-2019 Jan-2020

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

Probability of Rate Cut (%) 01-Jan-2020 03-Jan-2020 05-Jan-2020 07-Jan-2020 09-Jan-2020 11-Jan-2020 13-Jan-2020 15-Jan-2020 17-Jan-2020 19-Jan-2020 21-Jan-2020

Canadian Preferred Shares Report

2019 Was Tough But Ended Positive

In late 2018, the US-China trade war escalated and global yields started to fall on concerns of a global economic slowdown. By that point in time, the Fed had raised rates nine times over the past three years. As the two countries continued to add new tariffs and threaten to increase existing ones the global slowdown became reality. Many central banks cut interest rates in 2019 and we saw Canadian and US yield curves invert in Q2-2019. In response, the Fed cut rates three times. As yields decreased, Canadian preferred shares followed since the pref market is composed of ~70 fixed-resets which use the Government of Canada (GOC) 5-year yield to set dividends. The GoC 5-year yield, which was over 2.4% at the end of 2018, fell below 1.2% by August 2019.

Yields Have Been On a Wild Ride

130

3.0

BoC Rate Cut

120

BoC Rate Hike

2.5

110

S&P/TSX Pref Index TR (LS)

2.0

Govt of Cda 5-Year Yield (RS)

100

1.5

90

1.0

80

0.5

70

0.0

Source: Bloomberg, Raymond James Ltd.

2020 Outlook

Since August of last year, market sentiment turned positive as the US-China trade war closed a chapter with the signing of a "phase 1" deal on January 15. The GoC 5year yield ended 2019 at 1.7% and we saw the pref market follow in trajectory with a total return of ~10% since August. With the largest headwind to global growth now on the backburner, we've seen central banks becoming less dovish and probabilities of rate cuts in 2020 decreasing. The momentum from the end of 2019 has continued into the first few weeks of the new year.

January 24, 2020 | Page 2 of 10

On January 22, 2020, the BoC kept rates unchanged as expected for the 10th straight meeting but left the door open for a rate cut if the current economic slowdown persisted. Governor Poloz stated that the bank chose not to cut because policy makers didn't want to fuel household debt levels that remain a vulnerability to the economy. The accompanying outlook was more negative than recent communications and policy makers revised near-term growth projections lower. The BoC currently has the highest policy rate among advanced economies and was the only major central bank not to cut over the past year.

BoC Changes Turns Dovish

Overnight Rate

9.0

8.0

Fed BoC

7.0

6.0

5.0

4.0

3.0

2.0

1.0

0.0

BoC Dates and Chance of a Rate Cut

60

50

04-Mar-2020 03-Jun-2020

40

30

20

10

0

Source: Bloomberg, Raymond James Ltd.

We expect that the latest dovish commentary will increase the volatility in yields, particularly on the short end, and the movement in the GoC 5-year yield will be rangebound around the 1.5% level over the next several months. The added volatility will not be positive for preferred shares, in particular fixed-resets, but having a well diversified pref portfolio can still deliver ~5% yield.

Where to Look for Opportunities

As we mentioned previously, there is a "sweet spot" in fixed-reset preferred shares, represented by the shaded area of the following table. These fixed-resets were either issued or their dividends were reset when the GoC 5-year was at record lows in 20152016. We believe there is an excellent opportunity to purchase some of these preferred shares which are looking to have their dividends reset higher at the next reset date with an assumed GoC 5-year yield of 1.50%. Do delve a little deeper in

Canadian Preferred Shares Report

each 6-month bracket, looking at credit quality, reset spreads and company sector, and select a fixed-reset appropriate for your risk profile.

Fixed-Reset Dividend Changes at GoC 5-Year Yield = 1.50%

Avg Div

Increasing Dividends

Reset Date (# Yrs Out) # Issues

Change

# Issues

% of Issues

................
................

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