“Soft” Retractable Preferred Shares

“Soft” retractable preferred shares are the largest category of preferred shares. Canadian banks account for the bulk. Unlike conventional preferreds, softs have a maturity date (the “retraction date”) and carry retraction options for holder and issuer. They are also callable – redeemable at the issuer’s option before maturity. In some cases, the prospectus provides a premium over par to compensate holders for redemption. The retraction option gives the issuer the choice of redeeming the shares in stock or in cash, whence the term “soft.” In other words, the holder may force conversion but the issuer has the choice of paying in stock or in cash. This gives the issuer a great deal of flexibility. An issuer in a tight cash position or seeking to improve its credit with the rating agencies can opt for payment in shares. Issuers with strong balance sheets, such as Canadian banks, conglomerates or multinationals, can opt for cash redemption to avoid a deterioration of their financial ratios (e.g. earnings per share). Soft retractables are less affected by interest-rate movements than conventional preferreds because of their shorter duration. However, they carry an inherent credit risk. As with bonds, changes in credit quality have a significant impact on price. Investors will therefore prefer issuers with credit rating P2 or higher.

“Hard” Retractable Preferred Shares

This type of preferred share has a term (generally 5 to 10 years) and a right of cash redemption at par at the holder’s option on the retraction dates set out in the prospectus. At the retraction date, the holder can oblige the issuer to redeem the preferred shares in cash. This option has the disadvantage of reducing liquidity in the secondary market, since holders will be little inclined to part with positions of assured value at maturity (short of issuer dissolution or bankruptcy). Since the risk to the holder is that of issuer failure to redeem the shares at the retraction date, investors will prefer issuers with credit rating P2 or higher. The fixed retraction date and cash repayment provisions of hard retractable preferreds make them less sensitive to interest-rate movements.

Mounir R. El-Ayari, CIM, FCSI, C.h. P. Strategic Wealth
Investment Advisor
Associate Portfolio Manager
e-mail: mounir.el-ayari@nbf.ca