Split Share Preferreds - Opportunity from an Outlier?

Preferred shares issued by Split Share Closed-End Funds (see Wikipedia article for a quick primer) offer another option to the investor who seeks reliable, regular income in the form of quarterly dividends. Usually that will be within a taxable account where the tax advantage of dividends can be put to use.

Apart from the steady income, there are several other beneficial features of such preferreds:

• a fixed maturity date for a defined value, which has become quite uncommon amongst other types of preferred shares, and fixed dividend payments - you know how much money you get and when you get it, much like a GIC
  
• most often five years or less to maturity - this reduces risk from rising interest rates (since the dividend for such preferreds is fixed the market price of the preferred share will fall as it does with bonds when interest rates go up)
• cashable (called retraction) by the investor, though at a discount, directly from the split share corporation, which gives an alternative to selling back in the stock market
  
• yield is often higher than ordinary retractable preferreds
• as with all preferreds, priority of dividends over common shares - the preferreds get paid first and if not paid, get cumulated for future payment, unlike dividends on common shares
  

Of course, there are risks and potential pitfalls too:

• call risk that the issuer will decide to buy back your shares (called redemption) before the maturity date, which could wipe out your profit if you paid far over the redemption maturity price when buying on the market
• illiquidity i.e. shares hard to sell at all, or large bid vs ask price differentials, i.e. at a much lower price, when the shares are not very actively traded, as does happen with many split share preferreds
• interest rate risk, or the decline in capital value when interest rate rise, as happens to all fixed income securities. There is a floor set by the redemption value.
  
• credit risk, aka the risk of not getting paid dividends or losing your capital, which exists for any investment. This is a factor to examine when buying and it arises from the characteristics of the underlying operating companies whose shares the split share corporations hold. That is why the safest split shares hold a lot of stable Canadian banks, insurance companies, utilities and oil companies. Credit ratings from DBRS help a lot for assessing credit risk since there is wide variation amongst split share preferreds. DBRS rates each split preferred share. The DBRS rating Pfd-1 is the highest / most secure and Pfd-2 is also considered Investment Grade. Our comparison below looks only at shares rated Pfd-1 and -2, which gives us eleven split share corporations out of the 54 in total traded on the TSX.

The Investment Grade Preferred Split Shares
Two categories of split share funds exist. The first invests in a basket of shares from multiple companies and provides better diversification than the other type, which invests in the shares of a single company. It is no surprise that there are more multi-company investment grade preferreds. Here below is the current list:

	Ticker	Portfolio	Redemption / Maturity Date	Redemption Price
Multiple Underlying Companies
Allbanc Split Corp.	ABK.PR.B	Banks	10 Mar 2013	$26.75
Brompton Equity Split Corp.	BE.PR.A	similar to TSX 60	31 May 2011	$10.00
Big 8 Split Corp Class B 7.0%	BIG.PR.B	Banks & insurance companies	15 Dec 2013	$12.00
Big Bank Big Oil Split Corp.	BBO.PR.A	Banks, oil & gas companies	30 Dec 2016	$10.00
First Asset CanBanc Split Corp.	CBU.PR.A	Banks	15 Jan 2016	$10.00
CANADIAN Financials & Utilities Split Corp.	CFS.PR.A	Banks, utilities, pipelines, financial companies	31 Jan 2012	$10.00
Newgrowth Corp. Ser 2 6.0%	NEW.PR.C	Banks & utilities	26 Jun 2014	$13.70
Sixty Split Corp.	SXT.PR.A	TSX 60	15 Mar 2011	$25.00
Single Underlying Company
BNS Split Corp. II	BSC.PR.B	Bank of Nova Scotia common	22 Sep 2015	$18.85
BAM Split Corp. 4.95% Class AA Series I	BNA.PR.B	Brookfield Asset Management common	25 Mar 2016	$25.00
BAM Split Corp. 4.35% Class AA Series III	BNA.PR.C	Brookfield Asset Management common	10 Jan 2019	$25.00
BAM Split Corp. 7.25% Class AA Series IV	BNA.PR.D	Brookfield Asset Management common	9 Jul 2014	$26.00
TD Split Inc.	TDS.PR.C	TD Bank common	15 Nov 2015	$10.00

Comparison Measures of Value and Risk
The next table below shows the data for the selected preferreds in terms of:
1) Value - The current dividend yield (dividend over market price) does not tell an adequate story since the change in price between what is paid today for a preferred share and what you get back at maturity must be taken into account. The Yield to Maturity tells a more complete story, factoring in both the dividend and the eventual capital gain or loss if the preferred share is held to maturity. Unfortunately this critical figure is not apparently publicly available online and one must do the calculation oneself. Try Shakespeare's free downloadable spreadsheet (and read James Hymas' instructions here) which has the formulas into which you plug the details for a particular share issue. An additional calculation that can help assess a worst case on the downside (but which we have not done here) with the same spreadsheet is the yield to the earliest possible call date.

CBU.PR.A, CFS.PR.A and BE.PR.A look bad with their minimal or even negative yield to maturity. BBO.PR.A has the best yield amongst the broadly diversified preferreds, while BNA.PR.C and BNA.PR.D have even higher yields.

2) Call/ Early Redemption Factors - The likelihood that the split share fund company will exercise its option to redeem your shares before the maturity date and the possible harm that will cause you depends on several factors. First, if the current market price you pay is much higher than the redemption price, you stand to have a big capital loss, as would be the case most especially now for CBU.PR.A where the last market price is $13.69 while the redemption price is only $10. On the other hand, a BNA.PR.C shareholder would gain 10% over the market price (until January 10, 2012 the redemption price is actually $26, not the $25 maturity price shown in the table, which would be an even better gain).

Second, if the current market price of the capital shares of the split fund are trading far below the Net Asset Value (NAV), there is an incentive for those capital shareholders to turn their shares in for retraction, which then forces the split fund to call and redeem an equal number of preferred shares. (To find current NAV Premiums/Discounts, search for Closed-End Funds on GlobeInvestor). On that measure CBU.PR.A is also at high risk due to the big discount to NAV of 18.9% and CFS.PR.A is not far behind, while NEW.PR.C is at some risk.

3) Liquidity Factors - The more active the trading volume and the tighter the bid-ask spread of market price, the better off is the investor. Based on current data it is hard to make definitive judgements about our crop of preferreds though the three BAM split shares with their higher trading volumes and larger number of shares outstanding look a bit better than the rest.


The Pick of the Crop
Our analysis points to BNA.PR.C and BNA.PR.D as very attractive choices and BBO.PR.A as a solid choice amongst the split preferreds. Preferred share specialist James Hymas of Prefblog seems to share the favourable opinion of BNA.PR.C according to this recent post. The upward momentum of the underlying company Brookfield Asset Management in its latest quarterly report, and the further assurance that provides, strengthens the belief that the two BNA preferreds are a solid choice. There are also many other preferred shares (see this list on PrefInfo.com) on the market. Perhaps there really is a very good deal available for the moment with the two BNA issues but, as ever, the online DIY investor must decide for him or herself whether to buy in.

Disclosure: The blog writer owns shares of BNA.PR.C.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.