BAM.PR.X To Reset At 2.727%

Brookfield Asset Management Inc. has announced:

that it has determined the fixed dividend rate on its Cumulative Class A Preference Shares, Series 28 (“Series 28 Shares”) (TSX: BAM.PR.X) for the five years commencing July 1, 2017 and ending June 30, 2022 …

Series 28 Shares and Series 29 Shares

If declared, the fixed quarterly dividends on the Series 28 Shares during the five years commencing July 1, 2017 will be $0.1704375 per share per quarter, which represents a yield of 4.177% on the most recent trading price, similar to the current yield. The new fixed dividend rate that will apply for the five years commencing July 1, 2017 represents a yield of 2.727% based on the redemption price of $25 per share.

Holders of Series 28 Shares have the right, at their option, exercisable not later than 5:00 p.m. (Toronto time) on June 15, 2017, to convert all or part of their Series 28 Shares, on a one-for-one basis, into Cumulative Class A Preference Shares, Series 29 (the “Series 29 Shares”), effective June 30, 2017.

The quarterly floating rate dividends on the Series 29 Shares will be paid at an annual rate, calculated for each quarter, of 1.80% over the annual yield on three-month Government of Canada treasury bills. The actual quarterly dividend rate in respect of the July 1, 2017 to September 30, 2017 dividend period for the Series 29 Shares will be 0.58704% (2.329% on an annualized basis) and the dividend, if declared, for such dividend period will be $0.14676 per share, payable on September 29, 2017.

Holders of Series 28 Shares are not required to elect to convert all or any part of their Series 28 Shares into Series 29 Shares.

As provided in the share conditions of the Series 28 Shares, (i) if Brookfield determines that there would be fewer than 1,000,000 Series 28 Shares outstanding after June 30, 2017, all remaining Series 28 Shares will be automatically converted into Series 29 Shares on a one-for-one basis effective June 30, 2017; and (ii) if Brookfield determines that there would be fewer than 1,000,000 Series 29 Shares outstanding after June 30, 2017, no Series 28 Shares will be permitted to be converted into Series 29 Shares. There are currently 9,394,373 Series 28 Shares outstanding.

The Toronto Stock Exchange (“TSX”) has conditionally approved the listing of the Series 29 Shares effective upon conversion. Listing of the Series 29 Shares is subject to Brookfield fulfilling all the listing requirements of the TSX and, upon approval, the Series 29 Shares will be listed on the TSX under the trading symbol “BAM.PR.Y”.

BAM.PR.X is a FixedReset 4.60%+180 that commenced trading 2011-2-8 after being announced 2011-1-19. It has been a member of the FixedReset subindex since inception.

Thus, the new rate represents a dividend reduction of 41%. Ouch!

The most logical way to analyze the question of whether or not to convert is through the theory of Preferred Pairs, for which a calculator is available. Briefly, a Strong Pair is defined as a pair of securities that can be interconverted in the future (e.g., BAM.PR.X and the FloatingReset BAM.PR.Y that will exist if enough holders convert). Since they will be interconvertible on this future date, it may be assumed that they will be priced identically on this date (if they aren’t then holders will simply convert en masse to the higher-priced issue). And since they will be priced identically on a given date in the future, any current difference in price must be offset by expectations of an equal and opposite value of dividends to be received in the interim. And since the dividend rate on one element of the pair is both fixed and known, the implied average rate of the other, floating rate, instrument can be determined. Finally, we say, we may compare these average rates and take a view regarding the actual future course of that rate relative to the implied rate, which will provide us with guidance on which element of the pair is likely to outperform the other until the next interconversion date, at which time the process will be repeated.

We can show the break-even rates for each FixedReset / FloatingReset Strong Pair graphically by plotting the implied average 3-month bill rate against the next Exchange Date (which is the date to which the average will be calculated).

Click for Big

The market appears to have a distaste at the moment for floating rate product; most of the implied rates until the next interconversion are lower than the current 3-month bill rate and the averages for investment-grade and junk issues are both well below current market rates, at +0.07% and -0.33%, respectively! Whatever might be the result of the next few Bank of Canada overnight rate decisions, I suggest that it is unlikely that the average rate over the next five years will be lower than current – but if you disagree, of course, you may interpret the data any way you like.

Since credit quality of each element of the pair is equal to the other element, it should not make any difference whether the pair examined is investment-grade or junk, although we might expect greater variation of implied rates between junk issues on grounds of lower liquidity, and this is just what we see.

If we plug in the current bid price of the BAM.PR.X FixedReset, we may construct the following table showing consistent prices for its soon-may-be-issued FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Estimate of FloatingReset BAM.PR.Y (received in exchange for BAM.PR.X) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 0.50% 0.00% -0.50%
BAM.PR.X 16.50 180bp 15.80 15.28 14.76

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to be cheap and trading below the price of their FixedReset counterparts. Therefore, it seems likely that I will recommend that holders of BAM.PR.X continue to hold the issue and not to convert, but I will wait until it’s closer to the June 15 notification deadline before making a final pronouncement. I will note that, given the apparent cheapness of the FloatingResets, it may be a good trade to swap the FixedReset for the FloatingReset in the market once both elements of each pair are trading and you can – presumably, according to this analysis – do it with a reasonably good take-out in price, rather than doing it through the company on a 1:1 basis. But that, of course, will depend on the prices at that time and your forecast for the path of policy rates over the next five years. There are no guarantees – my recommendation is based on the assumption that current market conditions with respect to the pairs will continue until the FloatingResets commence trading and that the relative pricing of the two new pairs will reflect these conditions.

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