2 rate-reset preferred shares to buy for income

•12/5/16 •

An income investor’s never-ending hunt for yield in this low-yield market will often lead to a search for preferred shares. The Money Reporter recently looked at two floating rate preferred shares that reset their rates every five years (also known as  ‘fixed floaters’ or ‘rate-resets’) and recommends both as buys for income-seeking investors.

We’ve upgraded the Series 9 preferred shares of Brookfield Asset Management (TSX—BAM.PR.G) to a buy from a hold. We placed these shares on a hold in February. That’s because the dividend on the shares was to be reset on Nov. 1, 2016, and we had little idea what that new rate would be. You see, fixed-floating preferreds give a company considerable discretion over what their new rates will be. When rates on these issues are reset, the new rate will typically be a percentage of the yield of a five-year Government of Canada bond applied to the par value of the preferred share. In the case of Brookfield’s Series 9 shares, that percentage is not less than 80 per cent. Given that the current yield on a five-year GOC bond is about 0.67 per cent, Brookfield could have paid a new dividend of just $0.134 a share when the Series 9 issue reset on November 1 (0.67×80% = 0.536%; $25×0.536% = $0.134). That would have yielded just 0.9 per cent on the Series 9 recent share price. But we thought that Brookfield would opt to pay a higher rate, as it did in November 2011 when the shares last reset. At that time the average GOC bond yield was 1.43 per cent, but Brookfield reset the rate on Series 9 at 3.80 per cent. This time around, on November 1, Brookfield’s Series 9 shares were reset with a rate of 2.75 per cent on the $25 par value. The dividend, therefore, is now $0.6875 a share ($25×2.75%), and the yield on the recent share price is now 4.87 per cent ($0.6875÷$14.12×100). This yield is not quite as high as the straight perpetual preferred shares we list in our ‘Recommended Preferred Shares’ table, but it’s higher than those of the floating-rate preferred shares we recommend. Keep in mind, the current rate will remain in force until November 1, 2021, when it will once again be reset based on the 5-year GOC bond, assuming the shares aren’t redeemed. By that time interest rates should be higher than they are now. If so, the dividend will likely be adjusted upward at that time. Some of the risks to keep in mind when investing in fixed floaters such as this rate-reset issue, then, are interest rate risk and the flexibility the issuer has when resetting a new rate. If you can tolerate these risks and you think interest rates will be higher five years from now, you might want to buy Brookfield Series 9 shares.

Another rate-reset preferred share to buy for income

BCE Inc. Series AC preferred shares (TSX—BCE.PR.C) is the second of two fixed-floaters we follow. At first glance this issue pays an enticing dividend of $0.8875 a share, which currently yields 6.09 per cent on the recent market price. Keep in mind, though, this dividend was last reset on March 1, 2013, at a rate of 3.55 per cent on the par value of $25. At that time, the five-year GOC bond yielded about 1.5 per cent. That means the next reset date, March 1, 2018, is less than a year-and-a-half away. We doubt interest rates will have rebounded strongly by then. The dividend, then, could very well be set at a lower rate. If you can tolerate this risk, we still regard the stock as a buy for income.   Money Reporter, MPL Communications Inc. 133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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