PrefBlog

Bank of Montreal has announced:

the applicable dividend rates for its Non-Cumulative 5-Year Rate Reset Class B Preferred Shares, Series 27 (the “Preferred Shares Series 27”) and Non-Cumulative Floating Rate Class B Preferred Shares, Series 28 (the “Preferred Shares Series 28”).

With respect to any Preferred Shares Series 27 that remain outstanding after May 25, 2019, commencing as of such date, holders thereof will be entitled to receive fixed rate non-cumulative preferential cash dividends on a quarterly basis, as and when declared by the Board of Directors of the Bank and subject to the provisions of the Bank Act (Canada). The dividend rate for the five-year period commencing on May 25, 2019, and ending on May 24, 2024, will be 3.852 per cent, being equal to the sum of the five-year Government of Canada bond yield as at April 25, 2019, plus 2.33 per cent, as determined in accordance with the terms of the Preferred Shares Series 27.

With respect to any Preferred Shares Series 28 that may be issued on May 27, 2019, being the first business day following the conversion date of May 25, 2019, identified in the Preferred Shares Series 27 prospectus, which falls on a Saturday, holders thereof will be entitled to receive floating rate non-cumulative preferential cash dividends on a quarterly basis, calculated on the basis of the actual number of days elapsed in each quarterly floating rate period divided by 365, as and when declared by the Board of Directors of the Bank and subject to the provisions of the Bank Act (Canada). The dividend rate for the three-month period commencing on May 25, 2019, and ending on August 24, 2019, will be 4.002 per cent, being equal to the sum of the three-month Government of Canada Treasury bill yield as at April 25, 2019, plus 2.33 per cent, as determined in accordance with the terms of the Preferred Shares Series 28.

Beneficial owners of Preferred Shares Series 27 who wish to exercise their right of conversion should communicate as soon as possible with their broker or other nominee and ensure that they follow their instructions in order to ensure that they meet the deadline to exercise such right, which is 5:00 p.m. (EDT) on May 10, 2019.

Conversion enquiries should be directed to BMO’s Registrar and Transfer Agent, Computershare Trust Company of Canada, at 1-800-340-5021.

They previously announced:

that it does not intend to exercise its right to redeem the currently outstanding Non-Cumulative 5-Year Rate Reset Class B Preferred Shares, Series 27 of the Bank (the “Preferred Shares Series 27”) on May 25, 2019. As a result, subject to certain conditions, the holders of Preferred Shares Series 27 have the right, at their option, to convert all or part of their Preferred Shares Series 27 on a one-for-one basis into Non-Cumulative Floating Rate Class B Preferred Shares, Series 28 of the Bank (the “Preferred Shares Series 28”) on May 27, 2019. This date is the first business day following the conversion date of May 25, 2019, identified in the Preferred Shares Series 27 prospectus, which falls on a Saturday. Holders who do not exercise their right to convert their Preferred Shares Series 27 into Preferred Shares Series 28 on such date will retain their Preferred Shares Series 27, unless automatically converted in accordance with the conditions below.

The foregoing conversions are subject to the conditions that: (i) if, after May 10, 2019, the Bank determines that there would be less than 1,000,000 Preferred Shares Series 27 outstanding on May 25, 2019, then all remaining Preferred Shares Series 27 will automatically be converted into an equal number of Preferred Shares Series 28 on May 25, 2019; and (ii) alternatively, if the Bank determines that there would be less than 1,000,000 Preferred Shares Series 28 outstanding on May 25, 2019, no Preferred Shares Series 27 will be converted into Preferred Shares Series 28. In either case, the Bank will give written notice to that effect to any registered holders of Preferred Shares Series 27 affected by the preceding minimums on or before May 17, 2019.

The dividend rate applicable to the Preferred Shares Series 27 for the 5-year period commencing on May 25, 2019, and ending on May 24, 2024, and the dividend rate applicable to the Preferred Shares Series 28 for the 3-month period commencing on May 25, 2019, and ending on August 24, 2019, will be determined and announced by way of a news release on April 25, 2019. The Bank will also give written notice of these dividend rates to the registered holders of Preferred Shares Series 27.

Beneficial owners of Preferred Shares Series 27 who, on or after April 25, 2019, wish to exercise their right of conversion should instruct their broker or other nominee to exercise such right before 5:00 p.m. (EDT) on May 10, 2019.

Conversion inquiries should be directed to BMO’s Registrar and Transfer Agent, Computershare Trust Company of Canada, at 1-800-340-5021.

BMO.PR.S is a FixedReset, 4.00%+233, NVCC-compliant issue that commenced trading 2014-4-23 after being announced 2014-4-14. It is tracked by HIMIPref™ and is assigned to the FixedReset-Discount Sub-Index.

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., BMO.PR.S and the FloatingReset 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).

The market has lost its fleeting enthusiasm for floating rate product; the implied rates until the next interconversion are below the current 3-month bill rate as the averages for investment-grade and junk issues are at +0.69% and +1.39%, 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 BMO.PR.S 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:

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to trade below the price of their FixedReset counterparts, BMO.PR.S. Therefore, it seems likely that I will recommend that holders of BMO.PR.S continue to hold the issue and not to convert, but I will wait until it’s closer to the May 10 notification deadline before making a final pronouncement. I will note that once the FloatingResets commence trading (if, in fact, they do) 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.

This entry was posted on Friday, April 26th, 2019 at 12:00 am and is filed under Issue Comments. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.