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Fiera HPR Commentary – July 2020

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The TSX Preferred Share Index rallied hard on July 8 and 9, 2020, up 6.7% over the two days combined, though it was down about 70 basis points (“bps”) as at July 17, 2020, with news of RBC issuing $1 billion worth of new Limited Recourse Capital Notes (“LRCNs”).

We will provide more details on this new structure in an upcoming update, but the basics are: the new note is legally a bond, so it’s considered to be debt by OSFI; its coupon resets and is redeemable every five years at the five-year Government of Canada yield, plus the initial credit spread, with a 60-year final maturity; it has recourse only to equivalent preferred shares that are concurrently issued to a special purpose vehicle, and is converted into those preferred shares upon any missed interest/principal payment, upon an event of default or if the bank does not pay the redemption price at maturity.

The notes are issued only to institutional investors, meaning retail investors won’t have access to them. They rank pari-passu to preferred shares; lower in the capital structure than bonds, but higher than common equity. The LRCN market is likely to be fairly liquid going forward, as institutional interest in the asset class should be strong (institutions are not huge holders of preferred shares).

Why the rally? As is not uncommon in the preferred share market, the story comes back to liquidity. With its consideration as debt, the payments from LRCNs become tax-deductible for the issuer, and thus, more attractive than issuing preferred shares in certain cases. Considering that, it’s safe to assume that, going forward, we may see reduced preferred share issuance by banks, so a scarcity premium is now being baked into the existing preferred share market.

Moreover, there will likely be redemptions on reset dates; any bank/insurer issues with resets over approximately 350 have a fairly high probability of being redeemed, so we’ve seen those issues rally particularly hard. With its interest income as opposed to tax-advantaged dividends, LRCNs are not quite as attractive for the retail crowd, but as mentioned, it’s not available to them anyway.

The views/opinions expressed herein may not necessarily be the views of Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.

Certain statements may constitute a forward-looking statement, including those identified by the expression “expect” and similar expressions (including grammatical variations thereof). The forward-looking statements are not historical facts but reflect the author’s current expectations regarding future results or events. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These and other factors should be considered carefully and readers should not place undue reliance on such forward looking statements. These forward-looking statements are made as of the date hereof and the authors do not undertake to update any forward-looking statement that is contained herein, whether as a result of new information, future events or otherwise, unless required by applicable law.

This document is intended only to provide general information and is not intended to be and should not be construed or relied upon as legal or other professional advice. Fiera Capital Corporation assumes no liability by providing this guidance to its clients or any other person or entity. The information provided herein may or may not apply in any particular situation. Users should carefully review the guidance included here to determine applicability. The information and opinions herein are provided for informational purposes only and are subject to change. The information provided herein does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any funds managed by Fiera Capital Corporation.

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