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Toronto-Dominion Bank (TD) logos are seen outside of a branch in Ottawa.

© Chris Wattie / Reuters

Anyone who looked longingly at the big yields attached to bank-issued preferred shares earlier this year may be disappointed by the latest issues: Yields are falling.

Toronto-Dominion Bank announced on Monday that it will issue preferred shares yielding 4.85 per cent.

While that looks attractive relative to the slim yields on government bonds, it is down from a much higher yield on the previous round of TD preferred shares. For shares issued in January, yields were 5.5 per cent – meaning that the yield on the new issue is 0.65 percentage points lower.

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It is likely that other large Canadian banks will respond with similar-looking preferred shares in the months ahead as they bolster their capital levels, which raises the question: Have we seen peak yield?

Preferred shares are fixed-income securities that are issued and redeemed at a set price, usually $25 each. Like bonds, they distribute regular income. Like stocks, you can buy them in small quantities on stock exchanges, but you don't get any benefit from rising corporate profits.

The market for preferred shares has been volatile over the past two years. Preferred shares whose yields are reset periodically, often at a predetermined rate above bond yields, were hit particularly hard as bond yields fell.

Exchange-traded funds that track preferred shares reflected the turbulence. For example, the iShares S&P/TSX Canadian Preferred Share Index ETF fell nearly 20 per cent in 2015 and touched multiyear lows in January.

Amid this roller coaster, the banks added one more wrinkle: New regulations dictate that investors, rather than taxpayers, must bail out struggling banks during a severe financial crisis. The process is called bail-in: New bonds and preferred shares – now classified as non-viability contingent capital (NVCC) – will automatically convert to common shares.

If these conditions and caveats are making your head spin, you're not alone. That's why the banks needed to lure investors earlier this year with preferred shares that had dazzling terms.

Besides TD, Royal Bank of Canada, Bank of Nova Scotia, Bank of Montreal and Canadian Imperial Bank of Commerce also issued shares with yields in the 5.5-per-cent ballpark earlier this year.

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The issues came with a sweetener, too: After five years, the yields would be reset well above the yield on the Government of Canada five-year bond – 4.8 percentage points above, in the case of RBC-issued preferred shares; 4.66 percentage points in the case of TD shares.

Now, TD is offering considerably less. After five years, the yield on the new preferred shares will be 4.12 percentage points above the five-year bond yield, down more than half a percentage point.

For investors who love the idea of generating regular income in an environment where income is hard to find, the lower yields and reset rates are disappointing.

But TD is merely responding to market conditions. While preferred shares were a tough sell at the start of the year, the market appears more receptive today.

The iShares S&P/TSX Canadian Preferred Share Index ETF has rebounded 16 per cent from its lows in January, while the price of recently issued bank preferred shares have risen well above $25.

Peter Routledge, an analyst at National Bank Financial, added that risk aversion toward the Canadian banks appears to be easing, reflected in contracting spreads on other bank instruments such as senior and subordinated debt.

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"And despite a much lower coupon, the yield on these instruments looks quite attractive in the current interest rate environment," Mr. Routledge said.

If the reception to the new shares is any indication, TD appears to have made the right move. The lender initially announced that it had issued 12 million preferred shares for total proceeds of $300-million. Within hours, the issue had expanded to 40 million shares valued at $1-billion.

Yields may be down. But investor interest is heating up.

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