Fixed Income   |   Sep 2, 2020

Limited Recourse Capital Notes: a present for preferred share investors

Preferred shares, contrary to the other traditional fixed-income asset classes, are appealing for their upside potential in rising rate environments. But with the odds of the Bank of Canada hiking its benchmark rate in the short-term virtually null, the market isn’t counting on rising benchmark rates to help drive preferred share returns in the near-term.

Nicolas Normandeau
Vice President and Portfolio Manager, Fixed Income

However, Christmas came early for preferred share investors when, on July 21, RBC issued Limited Recourse Capital Notes (LRCNs), a first-of-a-kind hybrid product that, while technically a debt security, count as Additional Tier-1 (AT-1) capital and will lead to important structural changes for the preferred share market over the coming years. Despite the market’s prompt response and preferred share indices having gained about 6% since RBC’s roadshow on July 15,¹ we believe that the asset class still provides an attractive opportunity for Canadian investors.

A game changer for the preferred share market

The preferred share market has rallied, as investors priced-in that all banks’ preferred shares with reset spreads of 380 basis points or more will be redeemed.² Yet we believe the market is still not taking into account the full redemption story, which in our opinion will be supportive for the asset class for years to come.

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