BCE.PR.C To Reset at 4.38%

BCE Inc. has announced:

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The new rate of 4.38% is a nice improvement over the past five years’ rate of 3.55% and significantly better than the November, 2017, reset of BCE.PR.Z to 3.904%.

Assiduous Readers will recall that conversion notices were recently sent to holders of BCE.PR.C and BCE.PR.D.

In my terminology, BCE.PR.D is a Ratchet Rate preferred, currently paying 100% of Prime, reset quarterly. BCE.PR.C is a FixedFloater currently paying $0.8875 p.a., or 3.55% of its $25 par value. The latter rate resets every Exchange Date; the next exchange date is imminent – 2018-3-1. Both issues have been relegated to the Scraps subindex on credit concerns.

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., BCE.PR.C and BCE.PR.D). 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 FixedFloater / RatchetRate Strong Pair graphically by plotting the implied average Prime rate against the next Exchange Date (which is the date to which the average will be calculated).

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The average break-even rate for the BCE pairs is 4.67%, while the average for all FixedFloater – RatchetRate pairs is 4.60%.

Predictions are difficult, particularly when they are about the future! It will be remembered that Prime is currently at 3.45%; therefore, if we assume that future hikes are evenly sized and spaced, an average of 4.70% implies an end-value in five years of about 5.95%. I’m inclined to believe that it will turn out to be a little less than that, but if you disagree I won’t put up much of an argument!

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 BCE.PR.C FixedFloater, we may construct the following table showing consistent prices for its BCE.PR.D FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Estimate of BCE.PR.D (received in exchange for BCE.PR.C) Trading Price In Current Conditions
  Assumed RatchetRate
Price if Implied Prime
is equal to
FixedFloater Bid Price Fixed Rate +4.25% 4.75% 5.25%
BCE.PR.C 21.25 4.38% 21.12 21.62 22.12

Based on current market conditions and the 4.38% reset rate for the BCE.PR.C FixedFloater, I will make a preliminary prediction that BCE.PR.C will likely trade at somewhat less than the price of BCE.PR.D, its RatchetRate counterpart. Therefore, it appears probable that I will recommend holders retain, or switch to, BCE.PR.D, when the time comes to make a prediction. Those with strong convictions regarding future movements in Prime will, of course, have an equally strong preference for one of the two issues; other investors may wish to select which of the pair they wish to hold for the next five years based on their personal circumstances (e.g., if you’re hedging a prime-linked mortgage with this issue [not a wise move], you will want to hold BCE.PR.D). Holders have until 5:00 p.m. (Eastern time) on February 19, 2018 to communicate a desire to exchange to the company (brokerages will want to know a day or two in advance so they can communicate on your behalf), so there’s still a little time to wait and see if the market changes dramatically at the last minute.

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