# preffered shares



## samy44483 (Mar 31, 2015)

So I am fairly new to this forum
have been self investing for a few years
and decided to purchase some blue chip preffered shares (enb,trp,bam )etc for fixed income
these shares have been a total disaster as far as I can see
can anyone explain why?


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## gardner (Feb 13, 2014)

There is a series of useful articles on preferreds on Canadian Couch Potato

http://canadiancouchpotato.com/

They are complex beasts, but the main mark against them is that since the issuer can redeem them at a set price, that defines the absolute upper limit on their price. So for the investor the up-side is capped and may not be very substantial, but the downside, if the value slides, is open ended. The only way I mess with them is via ZPR and PFF and those are a small part of my portfolio.


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## GreatLaker (Mar 23, 2014)

The Globe and Mail had an article on this issue on Mar 31
http://www.theglobeandmail.com/globe-investor/investment-ideas/strategy-lab/dividend-investing/think-preferred-dividends-are-safe-wrong/article23722085/


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## gardner (Feb 13, 2014)

GreatLaker said:


> The Globe and Mail had an article


That's a subscriber-only one.


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## GreatLaker (Mar 23, 2014)

gardner said:


> That's a subscriber-only one.


Sorry, forgot about that. Here's the basics:


> Well, don’t look now but a whole whack of preferred shares – specifically rate-reset preferreds that have come to dominate the market – could soon take a hatchet to their payments.
> 
> This will come as a surprise to investors who depend on the predictable cash flow of preferreds, but Mr. Hymas has done the calculations and they paint a grim picture. In the next year or so, he expects many rate-reset preferreds to slash their dividends by 25 to 45 per cent. Depending on what happens to bond yields, many more rate-reset preferreds will likely reduce their dividends in coming years.
> 
> The preferred share market is already pricing in the bad news. For example, the iShares S&P/TSX Canadian Preferred Share Index ETF (CPD), an exchange-traded fund that invests in a broad basket of preferreds, has dropped nearly 7 per cent since mid-November. The BMO S&P/TSX Laddered Preferred Share Index ETF (ZPR), which invests exclusively in rate-resets, has fared worse: It’s down more than 10 per cent.


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## My Own Advisor (Sep 24, 2012)

I've never liked preferred myself but maybe I don't fully appreciate the benefits of them. 

You have bond-like risk, exposure and you have less capital appreciation when compared to common stocks. I don't see either of these as good things.


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## humble_pie (Jun 7, 2009)

thankx so much greatlaker

re your quote summary (below) i'm asking myself what might the issuers do to their common shares, once they're done whacking dividends on the rate resets? mightn't they tend to whack common dividends even before they whack the preferreds?
.



> Well, don’t look now but a whole whack of preferred shares – specifically rate-reset preferreds that have come to dominate the market – could soon take a hatchet to their payments.
> 
> This will come as a surprise to investors who depend on the predictable cash flow of preferreds, but Mr. Hymas has done the calculations and they paint a grim picture. In the next year or so, he expects many rate-reset preferreds to slash their dividends by 25 to 45 per cent. Depending on what happens to bond yields, many more rate-reset preferreds will likely reduce their dividends in coming years.


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## fatcat (Nov 11, 2009)

My Own Advisor said:


> I've never liked preferred myself but maybe I don't fully appreciate the benefits of them.
> 
> You have bond-like risk, exposure and you have less capital appreciation when compared to common stocks. I don't see either of these as good things.


+1 from me

i think that 5% is good for people that need income and have high income's where they will derive tax advantages

other than than in that situation, i would avoid preffereds


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## humble_pie (Jun 7, 2009)

wy we talkin about preferreds?

imho the question is are the rate resets going to act like canaries in coal mines?

i thought the usual sequence was cut common dividends, then start cutting the preferreds, going class by class.

can ya'll imagine what a broad spectrum common dividend cut would do to everybody, right across the board. From the canada pension plan all the way down to the brand new college graduate with $7k saved up in canadian equity e-fund.

in 08/09 investors went berserk with worry that the bank of montreal might cut its common dividend. They were worried about other dividend payors as well but it was rumoured at the time that, among the banks, the big blue was the one closest to a real cut. There was panic in the streets. I believe BMO's common share price hit $25.


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## AltaRed (Jun 8, 2009)

humble_pie said:


> re your quote summary (below) i'm asking myself what might the issuers do to their common shares, once they're done whacking dividends on the rate resets? mightn't they tend to whack common dividends even before they whack the preferreds?
> .


Think you may be misunderstanding the 'cutting' of pref dividends on fixed resets. Rate resets are generally issued at a dividend rate for 5 years, but then reset for another 5 years at a rate related to 5 yr GoC bond yields. If the bond yield is way down, then the new dividend rate is correspondingly down. Given the yield on GoC5 bonds has come down significantly in the last 5 months, there is some concern this yield curve may be stuck low for some time. Hence the 'renewal' rate for the resets could be lower too.

Example: A new fixed reset might have been issued last year at 4.25% eligible dividend rate when GoC5 was 1.5%, with a reset rate of GoC5 + 275 bp in 2019. The 275 bp is meant to equate to 275 + 1.5% GoC5 = 4.25% (just like the initial dividend yield). 

But what if GoC5 is only 0.7% in 2019? That pref would reset at 0.7 + 275 = 3.45%.... quite a bit lower than the initial 4.25% rate. That is what is meant by a 'cut' in dividend rate. Some fear of that will drive the original issue price of $25 down to a price that compensates for the risk of that lower yield in 2019.

On the other hand, if GoC5 bond yield moves up to 3%, that pref would then reset at 275+3 = 5.75%. The issuing company might be okay with that but if the company feels it could find new capital at 4.25%, then it would 'call' the existing resets at a price of $25 and issue new prefs at 4.25%. Thus the comment about limited upside but considerable risk of downside....especially if bought near par of $25. The key is to buy fixed resets cheap today at $16-22 on the open market so that one is protected on the downside and still get a decent yield. The issue of course is direction of GoC5 bond yields.


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## humble_pie (Jun 7, 2009)

altaRed i do understand all this!

the quoted language from mr Hymas of preflet fame is grim, draconian. He is a responsible & conservative analyst, one who is not in the habit of issuing warnings of this magnitude:



> Mr. Hymas has done the calculations and they paint a grim picture. In the next year or so, he expects many rate-reset preferreds to slash their dividends by 25 to 45 per cent


if rate reset dividends drop by a percentage as great as 25-45%, what i am wondering is how widespread the repercussions could be. I don't see the investing public responding calmly to such events. Common share prices could drop, common dividends could once more be put at risk.

was it not gluskin's david rosenberg who said, 4 or 5 years ago, that dividends were somewhat like bond interests on steroids but sooner or later the twain would have to meet. Either interest rates would have to rise or else dividend rates would have to fall. As i recall, he meant common share dividends.


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## Eclectic12 (Oct 20, 2010)

humble_pie said:


> wy we talkin about preferreds?


 ... 'cause the OP is looking at them (or bought them) ... which prompted the question.




humble_pie said:


> ... imho the question is are the rate resets going to act like canaries in coal mines?
> i thought the usual sequence was cut common dividends, then start cutting the preferreds, going class by class.


I've heard of the preferreds resetting their rates and/or being recalled where nothing was happening on the common share side at all.
As I understand it, it's one of the downsides to them ... too much of a gain or change in the environment triggers the company to make changes resulting in the investor losing out and having to find another place to put their money.

I've also heard of preferred's having liquidity issues.


I'd rather use the common stock to share the risk & gain. 




humble_pie said:


> ... in 08/09 investors went berserk with worry that the bank of montreal might cut its common dividend. They were worried about other dividend payors as well but it was rumoured at the time that, among the banks, the big blue was the one closest to a real cut. There was panic in the streets. I believe BMO's common share price hit $25.


I recall far more of talk that as the Canadian banks automagically had to be in lock-step with the US banks - the Canadian banks would be toppling over in a week or two. This also drove dividend cut fears but the dividend cut was the mouse to the bankruptcy elephant for the articles I read and people I talked to.

According to Yahoo, it looks like just over $24 was the low ... I didn't buy in until $29.




humble_pie said:


> ... if rate reset dividends drop by a percentage as great as 25-45%, what i am wondering is how widespread the repercussions could be. I don't see the investing public responding calmly to such events. Common share prices could drop, common dividends could once more be put at risk.


How many in the public know what a preferred share is or track when it's reset/cancelled?
How many in the public have any idea where there's so many RY or TD listings in the stock tables?

I don't recall anyone noticing or commenting in previous years for the preferred's ... only the common.


Cheers


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## humble_pie (Jun 7, 2009)

Eclectic12 said:


> How many in the public know what a preferred share is or track when it's reset/cancelled?
> I don't recall anyone noticing or commenting in previous years for the preferred's ... only the common.



it's so easy to belittle, isn't it? but i still believe that, if Hymas is correct & preferred divs are cut by 45%, investors will sit up & take notice. Event of such magnitude would not be a normal or ordinary reset.


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## atrp2biz (Sep 22, 2010)

This is principal-agent issue. Common shareholders, preferred shareholders and bond holders are not aligned. What hurts bond holders (I'll put pref shareholders in this camp as well since in my mind they are essentially junior creditors) often helps common shareholders (and vice versa). I don't see how changes to pref dividends impact common shareholders.


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## samy44483 (Mar 31, 2015)

so if I could buy enbridge 4% with a 4 year recall to rate reset, for $19.00 that would make sense?
the $1.00 dividend would equal 5.3% is that correct?


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## Eclectic12 (Oct 20, 2010)

humble_pie said:


> it's so easy to belittle, isn't it?


People's eyes glaze over when talking about basic finance or common stock or REITs ... there's threads on CFM identifying this as common ... CMF has more experienced investors where there's almost no threads about preferred shares ... this thread has different ideas about preferred shares ...

It seems clear that it is not a well known area here on CMF so it does not seem a stretch (or belittling IMO) to think the public knows little and/or is paying even less attention. If there's some proof otherwise, I'm happy to listen.




humble_pie said:


> ... but i still believe that, if Hymas is correct & preferred divs are cut by 45%, investors will sit up & take notice. Event of such magnitude would not be a normal or ordinary reset.


Without knowing who owns them and is paying attention to them ... it may take a while.

Did anyone notice that of the C$10 bln with resets in 2014, just over 80% or $8 bln were redeemed?
Of that, $5.8 bln called were from the Big 6 Canadian banks and only $0.7 bln of the bank issues were reset to the new rate or converted to the floater. 

All this redemption left a large hole in the fixed-reset market, so what filled it?

The new issue market was very active in 2014 with ~$12 bln sold. With respect to the Big 6 Banks, just over $5 bln was issued.

http://www.raymondjames.ca/lewisrosen/preferred.aspx


The banks redeemed then re-issued roughly the same amount so I'm thinking there must be a nice drop in the dividends to compensate for the costs versus letting the new rate kick in.


Cheers


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## atrp2biz (Sep 22, 2010)

samy44483 said:


> so if I could buy enbridge 4% with a 4 year recall to rate reset, for $19.00 that would make sense?
> the $1.00 dividend would equal 5.3% is that correct?


Yes--until the reset. But assuming interest rates remain where they are (ie. low), the dividend will be reset to around 2-3%. At 2.5%, the annual coupon is $0.625. However, the new price of the pref would have to be updated to reflect current yields (say 4.5%). This would mean the price of the pref would drop to 0.625/0.045 = $13.89. So between now and the reset date, the pref will trend towards $13.89. Yes, you'll be getting a higher yield, but it will be offset by a decrease in the pref itself.


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## avrex (Nov 14, 2010)

AltaRed said:


> Think you may be misunderstanding the 'cutting' of pref dividends on fixed resets. Rate resets are generally issued at a dividend rate for 5 years, but then reset for another 5 years at a rate related to 5 yr GoC bond yields. If the bond yield is way down, then the new dividend rate is correspondingly down. Given the yield on GoC5 bonds has come down significantly in the last 5 months, there is some concern this yield curve may be stuck low for some time. Hence the 'renewal' rate for the resets could be lower too.
> 
> Example: A new fixed reset might have been issued last year at 4.25% eligible dividend rate when GoC5 was 1.5%, with a reset rate of GoC5 + 275 bp in 2019. The 275 bp is meant to equate to 275 + 1.5% GoC5 = 4.25% (just like the initial dividend yield).
> 
> ...


@AltaRed. This is an excellent explanation of the mechanics of the rate resets of pref shares. thanks.


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## AltaRed (Jun 8, 2009)

avrex said:


> @AltaRed. This is an excellent explanation of the mechanics of the rate resets of pref shares. thanks.


Just to be clear/transparent, there are a lot of other dynamics/nuances at play that affect pricing, but what I mentioned are the basics. Credit quality is a considerable one. ENB issues suffered pricing drops when they announced the upcoming big drop of assets into ENF for example. That deal was good for common shareholders but not so good for bond or pref share holders (credit quality deterioration). Prefs from the likes of EMA and PPL are sub-investment grade (despite the love affair with the commons). Fun, eh?


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## Eclectic12 (Oct 20, 2010)

atrp2biz said:


> ... So between now and the reset date, the pref will trend towards $13.89. Yes, you'll be getting a higher yield, but it will be offset by a decrease in the pref itself.


CIBC Wood Gundy's Feb 2015 preferred share report was identifying that where usually preferred shares like a rate drop, the preferred share index was down 2.7% while REITs were up 1% (had been up 3.5%) and common stock was up 5.9%. Their claim was that with 67% of the index being of the fixed-reset type - investors were driving the value down as they worry that resets in the short term will have an unacceptably lower rate.


Cheers


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## AltaRed (Jun 8, 2009)

Eclectic12 said:


> Did anyone notice that of the C$10 bln with resets in 2014, just over 80% or $8 bln were redeemed?
> Of that, $5.8 bln called were from the Big 6 Canadian banks and only $0.7 bln of the bank issues were reset to the new rate or converted to the floater.
> 
> All this redemption left a large hole in the fixed-reset market, so what filled it?
> ...


This activity was a result of the 'high spread' resets issues in the 2008-2012 time frame to shore up their (bank and insurance company) capital requirements. These issues had high initial dividends and high reset spreads. It made no sense for the banks, in particular, to let these stay on the market and so they began to call them somewhere between $26-25 when they could, and re-issue lower spread resets. I sold these particular prefs in the last 2 years at premiums to $25 knowing that they were likely to be called.

Also, the bigger issue was the need to have these issues NVCC compliant to meet changes in legislation to make it much harder for the banks to call on the taxpayer to bail them out in the future (prefs can be converted into commons under certain conditions - when the sky is falling). Most of the public is dismissing this 'quirk' and have been buying the new bank issues. I refuse to purchase a pref that can be converted to a common under certain conditions.

I am thus sticking to pipeline and utility and insurance issues, both straight perpetuals and fixed resets. With the unexpected drop in the GoC5 bond yield recently, my straight perpetuals have had substantial unrealized gains (as they should in a decreasing rate environment) and I have some significant unrealized losses in some of my fixed resets. However, if one can buy a fixed reset today for an effective yield around 4% based on a reset at low GoC5 yields, these could be winners in the longer term.

Added later: Prefs are not suitable for everyone. I have them as a pseudo substitute for bonds since I have little room in an RRSP or TFSA for fixed income. The eligible dividends and dividend yield even with downside risk is worth the risk to me. And the mix of straight perpertuals and laddered fixed resets generally will mitigate interest rate risk (have resets renewing every year).


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## Eclectic12 (Oct 20, 2010)

AltaRed said:


> This activity was a result of the 'high spread' resets issues in the 2008-2012 time frame to shore up their (bank and insurance company) capital requirements. These issues had high initial dividends and high reset spreads. It made no sense for the banks, in particular, to let these stay on the market ...


I can see the practical reasons this would happen.

I'm more interested in how often 80% of what's up for reset has been redeemed and whether the drop would qualify for the "slash their dividends by 25 to 45 per cent" criteria that's supposed to ripple into the common shares/dividends and have the investing public up in arms.

If indeed it is such a drop which is happening to such a proportion of the renewal market ... it is interesting that my perception is that common shares are continuing on with little comment by the investing public.


I'm not sure the link is there or that it is so strong but as I've avoided the preferred share arena, it may be something new to learn.


Cheers


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## Silverbird (Mar 5, 2013)

Eclectic12 said:


> I can see the practical reasons this would happen.
> 
> I'm more interested in how often 80% of what's up for reset has been redeemed and whether the drop would qualify for the "slash their dividends by 25 to 45 per cent" criteria that's supposed to ripple into the common shares/dividends and have the investing public up in arms.
> 
> ...


I don't see why there would be a ripple and have common shareholders up in arms.

1) They should be pleased, interest expenses will be lower, leaving more earnings for them.

I think we need to distinguish 2 different actions.

What Altared is describing is no different to someone's 5 year fixed mortgage coming up for renewal. When you signed it 4.5 years ago, the 5% rate you locked in was a good deal.
Now, you can get <3%. Not as a result of your household earnings, credit quality or loan to value or such, purely driven by external factors around the trendsetting rates have dropped.

You can either stick with your current lender with rates adjusted to reflect the current market rates (similar to a company doing a rate reset) or you can move the mortgage to another bank and get the current market rates (similar to exercising your call option)
2 mechanisms with the same result, financing rolled over for another 5 year term at lower rate.

The other option is more negative,
A "canary in a goldmine" issue would be where pref share values of a company decline, because there is credit risk, not a decline to compensate for yield (same as bond pricing) this is noticeable where the calculated yield would climb.


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## humble_pie (Jun 7, 2009)

to quote GreatLakes again, who was quoting from globe & mail article, which in turn was quoting James Hymas, arguably canada's most distinguished preferred share analyst:




> This will come as a surprise to investors who depend on the predictable cash flow of preferreds, but Mr. Hymas has done the calculations and they paint a grim picture. In the next year or so, he expects many rate-reset preferreds to slash their dividends by 25 to 45 per cent. Depending on what happens to bond yields, many more rate-reset preferreds will likely reduce their dividends in coming years.
> 
> The preferred share market is already pricing in the bad news. For example, the iShares S&P/TSX Canadian Preferred Share Index ETF (CPD), an exchange-traded fund that invests in a broad basket of preferreds, has dropped nearly 7 per cent since mid-November. The BMO S&P/TSX Laddered Preferred Share Index ETF (ZPR), which invests exclusively in rate-resets, has fared worse: It’s down more than 10 per cent.



if the forecast dividend plunge (up to 45%) is nothing more than a technical adjustment following a reset according to canada 5-year bonds or similar, then why did CPD & ZPR react by dropping significantly?

it's the magnitude of the possible dividend plunge that concerns me.

as for markets, idk about others but what i'm seeing is that even faintly whispered rumours can set today's popcorn markets off.


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## Eclectic12 (Oct 20, 2010)

humble_pie said:


> ... if the forecast dividend plunge (up to 45%) is nothing more than a technical adjustment following a reset according to canada 5-year bonds or similar, then why did CPD & ZPR react by dropping significantly?


CIBC's Feb 2015 Preferred Share report was looking into why a rate cut which usually increases the preferred share index had the opposite effect (i.e. a drop).

They claim it is because 67% of the index is made up of the reset type shares ... with resets being to such low levels, they say investors are reevaluating it. I expect some has also woken up to why AltaRed was concerned and sold. 

If CIBC is accurate and they are talking about the index ... ETFs following the index should have the same factors in play.





humble_pie said:


> ... it's the magnitude of the possible dividend plunge that concerns me...


Depends ... not that I know a lot about preferred shares but if what's driving the "dividend drop" is along the lines of why AltaRed sold (i.e. the opportunity to shed interest costs) - then as I understand it, this is business as usual. One reason I am wondering about this is there still seems to be a strong market. The amount redeemed is basically the same as the new ones issued/sold.

On the other hand, if it's a true cut similar to a common stock reducing it's dividend ... then I can see market turmoil.


Cheers


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## AltaRed (Jun 8, 2009)

Another short? explanation: FTS.PR.H is going to reset in a few months. It has been paying a 4.25% dividend. Its reset terms are GoC5+145bp. If the current GoC5 bond yield stays around 0.7%, then the new dividend rate will be 2.15% (almost 50% lower). That pref share originally sold at $25 had a closing price today of $16. Those that owned it for the past 5 years did well but are taking a haircut come June with the yield drop. 

Mind you, IF you bought that pref today at $16, your yield would actually be 2.15x25/16= 3.36% until 2020. Not bad at all. Then in 5 years, if GoC5 is 2%, the dividend rate will change to 2.0+1.45=3.45%. IF one had purchased it today at $16, the effective yield would be 3.45x25/16=5.39% in 2020 in this example. Definitely not shabby. IOW, there icould be a buying opportunity today on 'depressed' resets.


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## Squash500 (May 16, 2009)

AltaRed said:


> This activity was a result of the 'high spread' resets issues in the 2008-2012 time frame to shore up their (bank and insurance company) capital requirements. These issues had high initial dividends and high reset spreads. It made no sense for the banks, in particular, to let these stay on the market and so they began to call them somewhere between $26-25 when they could, and re-issue lower spread resets. I sold these particular prefs in the last 2 years at premiums to $25 knowing that they were likely to be called.
> 
> Also, the bigger issue was the need to have these issues NVCC compliant to meet changes in legislation to make it much harder for the banks to call on the taxpayer to bail them out in the future (prefs can be converted into commons under certain conditions - when the sky is falling). Most of the public is dismissing this 'quirk' and have been buying the new bank issues. I refuse to purchase a pref that can be converted to a common under certain conditions.
> 
> ...


*

Thanks for the excellent explanation of preferred shares AltaRed. I own a fair amount of CPD in my non-registered account. I'm getting killed on the CPD share price, but I'm not selling any of it, because I'm getting a decent monthly income from the CPD. I need this monthly income to live on. It's also tax-advantaged canadian dividend income  as well, which helps to lower the taxes that I pay.*


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## dime (Jun 20, 2013)

atrp2biz said:


> Yes--until the reset. But assuming interest rates remain where they are (ie. low), the dividend will be reset to around 2-3%. At 2.5%, the annual coupon is $0.625. However, the new price of the pref would have to be updated to reflect current yields (say 4.5%). This would mean the price of the pref would drop to 0.625/0.045 = $13.89. So between now and the reset date, the pref will trend towards $13.89. Yes, you'll be getting a higher yield, but it will be offset by a decrease in the pref itself.



For me this is where some of my rate reset investments got hit really hard. I did not anticipate the GOC rate reduction when buying rate resets in 2013... all the talk was about the potential for an increase. Some shares had the value of the shares drop 26% as the rate went from 5%+ yield to 3%. Ouch.

So if I sell now I've lost almost a third of my initial investment. (Yes, I can apply the losses against any gains, but a loss is a loss.) At this point I figure the better approach is to just sit on it for the rest of my life and collect the yield for income?? 

I'm much more wary from here on in of the risks of investing in rate reset preferred stock. I think better profts are to be made in common stocks with solid expected growth in EPS and maybe some div yield along the way.


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## Eclectic12 (Oct 20, 2010)

AltaRed said:


> Another short? explanation: FTS.PR.H is going to reset in a few months. It has been paying a 4.25% dividend. Its reset terms are GoC5+145bp. If the current GoC5 bond yield stays around 0.7%, then the new dividend rate will be 2.15% (almost 50% lower). That pref share originally sold at $25 had a closing price today of $16. Those that owned it for the past 5 years did well but are taking a haircut come June with the yield drop.


This is where I can see room for the reset/redeeming-re-issue dropping the dividend rate where those in the preferred share market will be unhappy. Without a business factor instead the company opportunity to cut just the preferred share costs (i.e. dividends) ... there may be no broader market impact beyond the preferred share market.

So without a broader business impact being reported ... the size of cut may not be a canary beyond that particular tunnel of the mine (to borrow an analog).


Cheers


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