Investors starved for bond issuance in Canada are gobbling up preferred shares instead as companies, including Enbridge Inc., try to lock in financing in the face of rising borrowing costs.
Issuers offered $2.5-billion of the securities over the past two weeks, with TransCanada Corp. doubling its offering to $1-billion, a record for any Canadian company outside the financial sector. Enbridge and Manulife Financial Corp. also increased their offerings and Brookfield Asset Management Inc. completed a sale.
Canadian issuers have sold about $10.4-billion of preferred shares this year, the most year-to-date since 2014, while Canadian-dollar corporate bond issuance has dropped by about 8 per cent from last year, according to data compiled by Bloomberg.
"Even though the markets are still facing a reasonable amount of volatility and uncertainty, it's much less than it was in the past couple weeks, so both sides got together to put the pin in on some deals," Jason Parker, head of fixed-income research at Bank of Montreal's BMO Capital Markets, said by phone from Toronto. "There was the money on the sidelines and there was the need on the part of the issuers."
Preferred shares, equity instruments that offer a dividend usually linked to government bond yields, have risen in popularity among fixed-income investors after central bank bond-buying programs and market uncertainty drove yields to record lows before the recent spike tied to Donald Trump's election win.
The S&P/TSX Preferred Share Index has returned 16 per cent since its January low, compared with the 2.6-per-ent gain for an index of Canadian corporate bonds.
TransCanada's offering, the largest non-financial preferred share deal ever in Canada according to Bank of Montreal, gives investors a 4.9-per-cent yield until the end of May 2022, at which point the dividend rate resets to the five-year government yield plus 3.85 per cent. The shares offer a guarantee that the rate will be no less than 4.9 per cent. Enbridge's $750-million in shares offer a similar floor of 5.15 per cent. That's a better deal than the 180 basis points, or 1.8 per cent, over government debt that investors are currently earning for a BBB rated five-year corporate bond, or 120 basis points for a A rated credit, Parker said.
Brookfield and Enbridge didn't respond to requests for comment. TransCanada declined to comment.
Manulife took advantage of strong institutional and retail demand to issue its second preferred share offering of the year for $475-million in proceeds, Halina von dem Hagen, executive vice president of treasury and capital management at the Toronto-based firm, said in an e-mail. "The domestic Canadian market currently remains the most attractive market for preferred shares," she said.
Preferred shares carry more risk than debt securities given that only common shares sit below them on the capital structure in the event of a failure. The S&P/TSX Preferred Share Index saw a collapse in late 2015 when shares issued before the Bank of Canada cut rates were reset with yields below their original dividend, said Darcy Briggs, Calgary-based fixed income portfolio manager at Franklin Bissett Investment Management, which has $5-billion in fixed income assets.
"It was definitely a growth part of fixed income," Mr. Briggs said in an interview at Bloomberg's Toronto office. "Higher running yield, protection against rising interest rates and good credit. Unfortunately we didn't anticipate negative rates globally."
Non-financial preferred share issuers responded to the market collapse by adding the minimum yield to the terms, Kris Somers, fixed-income analyst at BMO Capital Markets, said by phone from Toronto. Financial issuers are not allowed to add that protection to their issuance, he said.
As preferred shares have become more attractive to institutional investors, rather than just individual buyers, the ability to trade the securities has improved. That boosts their attractiveness by making the market more developed and efficient, Briggs said. Franklin Bissett owns preferred shares in its balanced fund strategies.
Still, investors may pull back from preferred shares if rates continue to rise, making government and corporate bonds more attractive, Parker said.
"It's definitely a 2016 phenomenon," he said.