Looking for USD income? Perhaps a USD paying Preferred Share can meet your needs.

Published by on

Preferred Shares have long occupied a niche segment of the capital structure of a company.  They rank senior to common shares but below that of secured debt.  More recently, rate reset preferred share issues that are getting close to their maturity date have seen their prices punished as investors anticipate a cut to the dividend as well as their extension rather than redemption at par value.  Remember,held in a non-registered account allows you to utilize the dividend tax credit benefit that preferred shares pay. 


Compared to interest income, (such as what a GIC or corporate bond might pay), dividends are taxed at a lower rate.  Thus, if your Alberta based income is $150,000 your marginal tax rate is 42%.  The tax on eligible dividend income is only 23.43%.  Therefore, to generate $1000 of after-tax income per year, ($1,724.14 before tax), you would need alot more money invested in a bond or GIC compared to a preferred or common share, (only $1305.99).


Here are a couple examples of how much capital you would need to generate the same $1000 annually on an after-tax basis:


Bond: 4% yielding, 5 year maturity, BBB rated corporate bond: $43,103.45  

GIC: 2.2% 5 year GIC: $78,369.91

Preferred Share: 6% dividend yield: $21,766.57


As you can see, generating reasonable levels of income in a low interest rate environment is hard to do!  However, a preferred share might be the answer if you take the longer view.  Further, in the examples above, you might be challenged to find a bond yielding that much or have to accept locking into a GIC for 5 years to earn that yield, but you could easily find that 6% or higher dividend.   


Given some people are looking for USD income the ideas are real examples below.  Whether they are appropriate or you depends on suitability that must be considered first.   


For a benchmark, this is what US Government bonds are yielding:

2 year: 0.8%

5 year: 1.4%

10 year: 2.0%

30 year: 2.8%


USD bonds provide little yield across the board.  However, high yield bond yields, (ie. non-investment grade), have recently spiked upwards and a lot of that is due to the high amount of leverage in the US energy sector.  You don’t want to be there which is why an ETF or bond fund isn’t a very good idea.  You don’t know what you own and from a tax perspective you could be subject to full taxation on any distributions so there is no tax efficiency for you.


There are very few USD denominated and USD paying preferred shares that also allow you to benefit from the Canadian Dividend Tax credit.  Reviewing issues for quality led me to 2 issues by E Corp and A Corp. 


Both are Investment Grade rated although E Corp is rated a slight bit higher.  Here are their details:


A Corp Preferred: Price: $18.30.  Yield: 6%, Dividend: $1.10/year, Reset: Sept. 30, 2017 Par Value: $25, maturity spread: 3.58% over the 5 year US Government bond yield, (1.4%).  If all else stays the same and A Corp does not redeem the preferred share the dividend would go to $1.245/share meaning there would be a dividend increase and the yield would rise to 6.8% on your cost.  A Corp is a large infrastructure company with operations split a third each to power generation, mid-stream, and utilities. 


E Corp Preferred: Price: $15.  Yield: 6.7%, Dividend: $1/year, reset: June 1, 2018, Par Value: $25, maturity spread: 3.14% over the 5 year US Government bond yield.  If all else stays the same and E Corp does not redeem the preferred share in 2018 the dividend would go to $1.135/share meaning the dividend would increase and the yield would rise to 7.6% on your cost. E Corp is a large pipeline and to a lesser extent power generation company.


Give me a call if you believe this is of interest to you!  

Chasing Dividends

Investors are challenged to find sufficient income as bond yields are historically low.  Many strategists are projecting an initial US interest rate hike this year which might lead to higher interest rates in the US.  In Canada it appears most analysts expect the Bank of Canada on hold well into 2016.  As a result, investors turn to dividends as they seek income.  However, not all dividends are safe!  Some companies pay out dividends that exceed their cash flow which can be a temporary or more permanent condition.  When you factor in virtually all businesses require some amount of reinvestment to maintain and/or grow their business it becomes clear that a dividend should be less than what total cash flow is minus maintenance capital and a bit of a cushion.  Financial Statements don't make this very easy to identify which requires deep analysis.  For example, consider the oil and gas company that in 2014 received $100/bbl for their oil and in 2015 received $45/bbl.  They might have had a hedging program to soften the decline in revenue but has it now expired?  One must determine is the cash flow from production at $40/bbl enough to fund any dividend without incurring significant amounts of debt?  What are your alternatives for income?  Give me a call and we can discuss some options that are appropriate for you.

Shareholder Yield

Investors are constantly bombarded by a multitude of investment strategies and a combination of using each of them.  One strategy that has proven effective over time is that of Shareholder Yield.  It consists of 3 components: Dividend Yield, Share Buybacks, and Debt Repayment.  Focusing on securities with these characterisitics outperform relative to using just one of these strategies.  Simplistically, the combined Shareholder Yield return often indicates companies that have a strong focus on capital discipline.  It also tends to indicate companies will be less volatile in stressed markets.

I am a strong believer in this as an investment strategy.  I view this as foundational to achieving long term investment goals as its' a strategy that works in all markets.  When you consider an Index holds securities that are not focused on these fundamentals and many investment strategists and managers attempt to capture the investment trend with the most momentum of the day it can quickly lead an investor to wonder about the quality of their portfolio.