Dividends on the preferred shares of Canadian banks are exceptionally high, right now. Blogger Michael Jamesrecently noted that the Bank of Nova Scotia series 12 preferred shares were paying 6%. For many Canadians, this is equivalent to more than an 8% bond yield once the dividend tax credit is applied. Other bank preferreds are in the same vicinity.
Indeed, after adjusting for the dividend tax credit, yields on perpetual preferred shares, like the Bank of Nova Scotias series 12, currently surpass long-term corporate bonds by a huge 320 basis points. This spread has been exceeded in the past 16-plus years only at the depths of the credit crunch in November/December 2008, says preferred-share expert James Hymas. The long-term spread ranges from 100 to 150 basis points.
I believe that the phenomenon is due, continues Mr. Hymas, to retail investors understanding of the facts that the Bank of Canada rate has nowhere to go but up and that a portion of these increases will be reflected in the 5-Year Canada yield and hence to mortgages. However, the reasoning becomes suspect when, as I believe, it is extended to apply to long corporate bond yields and [perpetual] yields.
In other words, not all interest rates are alike and subject to the same forces. Notably, when the economy is recovering andsolvency risk becomes less of a concern, yields on corporate bonds can stay the same or fall — even if interest rates elsewhere are rising. In fact, this is currently happening.
One would expect perpetual preferred shares to follow corporate yields down since they are subject to similar forces. However, the preferred-share market has a bigger retail presence than the corporate bond market and many issues are relatively illiquid. This, in turn, can make preferred-share prices more volatile, especially when retail investors get nervous, like now, about inflation and interest rates.
So I am prepared,adds Mr. Hymas, to go so far as to say that the attractiveness of PerpetualDiscounts versus long corporate bonds is currently enhanced relative to other times. In his April PrefLetter (published April 9), he recommended CIU.PR.A, BAM.PR.M, SLF.PR.A and PWF.PR.E as the best options in the perpetual class.