DC.PR.B To Reset At 5.284%

Dundee Corporation has announced (although not yet on its website):

the applicable dividend rates for its Cumulative 5-Year Rate Reset First Preference Shares, Series 2 (“Series 2 Shares”) and its Cumulative Floating Rate First Preference Shares, Series 3 (“Series 3 Shares”).

With respect to any Series 2 Shares that remain outstanding on September 30, 2019, holders thereof will be entitled to receive fixed rate cumulative preferential cash dividends on a quarterly basis, as and when declared by the Board of Directors of the Company and subject to the provisions of the Business Corporations Act (Ontario). The dividend rate for the five-year period commencing on September 30, 2019 to, but excluding September 30, 2024, will be 5.284%, being equal to the sum of the five-year Government of Canada bond yield as at September 3, 2019, plus 4.10%, as determined in accordance with the terms of the Series 2 Shares.

With respect to any Series 3 Shares that remain outstanding on September 30, 2019, holders thereof will be entitled to receive floating rate cumulative preferential cash dividends on a quarterly basis, calculated on the basis of 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 Company and subject to the provisions of the Business Corporations Act (Ontario). The dividend rate for the three-month period commencing on September 30, 2019 to, but excluding, December 31, 2019, will be 5.74%, being equal to the sum of the three-month Government of Canada Treasury bills yield preceding September 3, 2019, plus 4.10%, as determined in accordance with the terms of the Series 3 Shares.

Beneficial owners of Series 2 Shares or Series 3 Shares who wish to exercise their right of conversion should communicate as soon as possible with their broker or other intermediary for more information. It is recommended that this be done well in advance of the deadline in order to provide the broker or other intermediary with time to complete the necessary steps. The deadline for the registered shareholder, CDS & Co., to provide notice of the exercise of its right to convert all or any part of the Series 2 Shares into Series 3 Shares or Series 3 Shares into Series 2 Shares is 5:00 p.m. (Toronto time) on September 16, 2019 and, once received, is irrevocable.

Holders will again have the opportunity to convert their Series 2 Shares into Series 3 or to convert their Series 3 Shares into Series 2 Shares on September 30, 2024, and every five years thereafter as long as the Series 2 Shares and Series 3 Shares remain outstanding.

DC.PR.B is a FixedReset, 5.688%+410, that commenced trading 2009-9-15 with a 6.75% coupon after being announced 2009-8-25. It reset to 5.688% effective 2014-09-30. I made no recommendation regarding conversion. It is tracked by HIMIPref™ but us relegated to the Scraps – FixedReset (Discount) subindex on credit concerns.

DC.PR.D is a FloatingReset, +410, that came into existence via a partial conversion from DC.PR.B. It is tracked by HIMIPref™ but relegated to the Scraps – FloatingReset 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., DC.PR.B and the FloatingReset DC.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 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). Inspection of the graph and the overall average break-even rates for extant pairs will provide a guide for estimating the break-even rate for the pair now under consideration assuming, of course, that enough conversions occur so that the pair is in fact created.

pairs_fr_190903
Click for Big

The market has lost enthusiasm for floating rate product; the implied rates until the next interconversion are generally well below the current 3-month bill rate as the averages for investment-grade and junk issues are at +0.63% and +1.22%, 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 DC.PR.B FixedReset, we may construct the following table showing consistent prices for its DC.PR.D FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Estimate of FloatingReset DC.PR.D (received in exchange for DC.PR.B) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 1.50% 1.00% 0.50%
DC.PR.B 14.60 410bp 14.87 14.44 14.00

Based on current market conditions, I suggest that the FloatingResets, DC.PR.D, that will result from conversion are likely to trade below the price of their FixedReset counterparts, DC.PR.B. Therefore, it seems likely that I will recommend that holders of DC.PR.B continue to hold the issue and not to convert and that holders of DC.PR.D convert to DC.PR.B, but I will wait until it’s closer to the September 16 notification deadline before making a final pronouncement. I will note that once the conversions, if any, have occurred it may be a good trade to swap one issue for the other in the market once both elements of each pair are trading and you can – hopefully – 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 conversion period has passed and that the relative pricing of the two new pairs will reflect these conditions.

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