BMO.PR.W To Reset At 3.851%

Bank of Montreal has announced (on October 28):

the applicable dividend rates for its Non-Cumulative 5-Year Rate Reset Class B Preferred Shares, Series 31 (the “Preferred Shares Series 31”) and Non-Cumulative Floating Rate Class B Preferred Shares, Series 32 (the “Preferred Shares Series 32”).

With respect to any Preferred Shares Series 31 that remain outstanding after November 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 November 25, 2019, and ending on November 24, 2024, will be 3.851 per cent, being equal to the sum of the five-year Government of Canada bond yield as at October 28, 2019, plus 2.22 per cent, as determined in accordance with the terms of the Preferred Shares Series 31.

With respect to any Preferred Shares Series 32 that may be issued on November 25, 2019, 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 November 25, 2019, and ending on February 24, 2020, will be 3.856 per cent, being equal to the sum of the three-month Government of Canada Treasury bill yield as at October 28, 2019, plus 2.22 per cent, as determined in accordance with the terms of the Preferred Shares Series 32.

Beneficial owners of Preferred Shares Series 31 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.ET on November 12, 2019.

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

BMO.PR.W is a FixedReset, 3.80%+222, that commenced trading 2014-7-30 after being announced 2014-7-22. Notice of extension was given 2019-9-27. It is tracked by HIMIPref™ and has been assigned to the FixedReset – Discount subindex.

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.W 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). 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_191030
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 +0.46% and +0.67%, respectively, after removal of the outlying pair TRP.PR.A / TRP.PR.F from the investment grade universe and the pairs FFH.PR.C / FFH.PR.D and NPI.PR.A / NPI.PR.B from the junk group. 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.W 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 (received in exchange for BMO.PR.W) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 1.00% 0.50% 0.00%
BMO.PR.W 17.24 222bp 16.62 16.12 15.63

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.W. Therefore, it seems likely that I will recommend that holders of BMO.PR.W continue to hold the issue and not to convert, but I will wait until it’s closer to the November 12 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 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 FloatingResets commence trading and that the relative pricing of the two new pairs will reflect these conditions.

One Response to “BMO.PR.W To Reset At 3.851%”

  1. Tim says:

    Hey, a tiny reset higher!

    Here’s hoping for more upward resets throughout 2020-21 based on what the 5 year GoC was at during 2015-16 (0.7% to 1.0% range).

    Some upticks in the current rate by the end of 2019 would be very nice to see!

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