BCE Inc. has announced:

that 7,904,105 of its 14,577,100 fixed-rate Cumulative Redeemable First Preferred Shares, Series AF (“Series AF Preferred Shares”) have been tendered for conversion on February 1, 2015, on a one-for-one basis, into floating-rate Cumulative Redeemable First Preferred Shares, Series AE (“Series AE Preferred Shares”). In addition, 34,872 of its 1,422,900 Series AE Preferred Shares have been tendered for conversion on February 1, 2015, on a one-for-one basis, into Series AF Preferred Shares. Consequently, on February 1, 2015, BCE will have 6,707,867 Series AF Preferred Shares and 9,292,133 Series AE Preferred Shares issued and outstanding. The Series AF Preferred Shares and the Series AE Preferred Shares will continue to be listed on the Toronto Stock Exchange under the symbols BCE.PR.F and BCE.PR.E, respectively.The Series AF Preferred Shares will pay on a quarterly basis, for the five-year period beginning on February 1, 2015, as and when declared by the Board of Directors of BCE, a fixed cash dividend based on an annual dividend rate of 3.110%.

The Series AE Preferred Shares will continue to pay a monthly floating adjustable cash dividend for the five-year period beginning on February 1, 2015, as and when declared by the Board of Directors of BCE. The monthly floating adjustable dividend for any particular month will continue to be calculated based on the prime rate for such month and using the Designated Percentage for such month representing the sum of an adjustment factor (based on the market price of the Series AE Preferred Shares in the preceding month) and the Designated Percentage for the preceding month.

BCE.PR.E closed at 20.50-65 today, while BCE.PR.F closed at 19.64-71, which means that those who took my advice and converted F to E have made a very profitable switch! According to the Pairs Equivalency Calculator, the breakeven Prime Rate for the next five years at these prices is 3.93%, which is more or less in line with the breakeven rates for other FixedFloater / Ratchet Rate Strong Pairs.

I have looked everywhere and I can’t seem to understand how this “Selected Percentage Rate” is set by the issuer. Can you educate me?

According to the prospectus:

So they can set it to anything they want, which could be as low as 80% of the GOC-5 yield. So, for instance, if we assume that five-year Canadas are yielding 0.80%, they could set the yield on BCE.PR.F as low as 0.64%, if they wished.

Abuse of this privilege is prevented by the fact that they may only change the rate on an Exchange Date and must provide notice of the new dividend rate well in advance of the deadline for shareholder exercise of the conversion privilege (to BCE.PR.E; holders may also elect to convert in the other direction). BCE.PR.E is a RatchetRate preferred; it pays anywhere between 50% and 100% of Canada Prime, with this percentage of prime varying depending on the trading price of the issue:

For more information see Calculation of RatchetRate Dividend Yield.

The price of BCE.PR.E has been well below par and has been since the Credit Crunch and the worry and subsequent collapse of the Teachers’ buyout deal. The percentage of prime paid has therefore climbed to 100% and, given the relationship between prime and 3-month bill rates (you can basically say that prime is bills+200bp, although it varies) and the competition that these issues face from FloatingResets of comparable credit quality, one may assume that they will remain below par for the foreseeable future and therefore continue to pay 100% of Prime.

So, if BCE’s Board sets the dividend rate on BCE.PR.F ridiculously low, all they will achieve is a mass conversion into BCE.PR.E. In practice, they tend to set the five-year fixed yield at a level determined by the 5-Year Interest Rate Swap rate. The availability of this hedging derivative means they don’t care what people choose – they can pay either 100% fixed or 100% floating or anything in between, at market rates, regardless of what holders of the shares are paid.