Understanding Rate Reset Preferreds: A Guide for Income Investors

What Are Rate Reset Preferreds?

Rate reset preferreds are the dominant structure in the Canadian preferred share market, representing approximately 55% of all outstanding issues. Unlike traditional perpetual preferreds with fixed dividends forever, rate resets offer a mechanism to adjust yields based on interest rate changes.

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How They Work

Initial Period (5 Years)
- Fixed dividend for the first 5 years from issue date
- Known yield at purchase
- Predictable income stream

Reset Date
- Dividend recalculates based on: Government of Canada 5-year bond yield + spread
- New rate fixed for another 5 years
- Issuer has option to call (redeem) at par ($25)

Example:
If a preferred has a +3.00% spread and the GoC 5-year yield is 3.25% at reset:
New yield = 3.25% + 3.00% = 6.25%

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Key Terms to Understand

| Term | Definition | Importance |
|------|-----------|------------|
| Reset Spread | Fixed margin added to GoC 5-year yield | Higher = better protection |
| Reset Date | When dividend recalculates | Plan your holding period |
| Call Date | When issuer can redeem | Usually same as reset |
| Yield to Worst | Lowest possible return | Conservative estimate |

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Pros and Cons

Advantages:
- Protection against rising interest rates (upside)
- Known reset formula provides transparency
- Typically higher yields than perpetuals
- Call feature can benefit investors if rates fall

Disadvantages:
- "Negative convexity" - limited upside if rates rise
- Reset risk if GoC yields are low at reset date
- More complex than perpetuals
- Price volatility around reset dates

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Current Opportunities (February 2026)

With reset spreads averaging +3.00% or higher, the current environment favors rate reset preferreds:

Attractive Spreads:
- NA.PR.K: +3.40% spread, 6.55% yield
- MFC.PR.J: +3.50% spread, 7.00% yield
- BMO.PR.Q: +3.25% spread, 6.20% yield

These spreads are historically wide, providing good value.

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Who Should Own Rate Resets?

Rate reset preferreds are suitable for:
- Income investors comfortable with moderate complexity
- Those seeking protection against rising rates
- Investors with 3+ year time horizons
- Taxable accounts (eligible for dividend tax credit)

They may not be suitable for:
- Investors needing guaranteed income levels
- Those uncomfortable with reset date uncertainty
- Short-term investors (under 2 years)

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Bottom Line

Rate reset preferreds offer a compelling middle ground between fixed-rate bonds (rate risk) and perpetuals (duration risk). In the current environment with wide spreads, they represent good value for patient income investors.

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*This educational content is for informational purposes only. Consult a financial advisor before making investment decisions.*