BPO.PR.A To Reset At 4.709%

Brookfield Office Properties Inc., a subsidiary of Brookfield Property Partners L.P. has announced:

the reset dividend rate on its Class AAA Preference Shares, Series AA (“Series AA Shares”) (TSX: BPO.PR.A)

Series AA Shares

If declared, the fixed quarterly dividends on the Series AA Shares for the five years commencing January 1, 2020 and ending December 31, 2024 will be paid at an annual rate of 4.709% ($0.294313 per share per quarter).

Holders of Series AA Shares have the right, at their option, exercisable not later than 5:00 p.m. (Toronto time) on December 16, 2019, to convert all or part of their Series AA Shares, on a one-for-one basis, into Class AAA Preference Shares, Series BB (the “Series BB Shares”), effective December 31, 2019.

The quarterly floating rate dividends on the Series BB Shares have an annual rate, calculated for each quarter, of 3.15% over the annual yield on three-month Government of Canada treasury bills. The actual quarterly dividend rate for the January 1, 2020 to March 31, 2020 dividend period for the Series BB Shares will be 1.196710% (4.80% on an annualized basis) and the dividend, if declared, for such dividend period will be $0.299178 per share, payable on March 31, 2020.

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

As provided in the share conditions of the Series AA Shares, (i) if Brookfield determines that there would be fewer than 1,000,000 Series AA Shares outstanding after December 31, 2019, all remaining Series AA Shares will be automatically converted into Series BB Shares on a one-for-one basis effective December 31, 2019; and (ii) if Brookfield determines that there would be fewer than 1,000,000 Series BB Shares outstanding after December 31, 2019, no Series AA Shares will be permitted to be converted into Series BB Shares. There are currently 12,000,000 Series AA Shares outstanding.

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

BPO.PR.A is a FixedReset, 4.75%+315, that commenced trading 2014-10-23 after being announced 2014-10-7. The issue is tracked by HIMIPref™ but relegated to the Scraps index 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., BPO.PR.A 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.

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The market has little 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 +0.89% and +1.20%, 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 BPO.PR.A 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 BPO.PR.A) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 1.50% 1.00% 0.50%
BPO.PR.A 17.81 315bp 17.75 17.28 16.80

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, BPO.PR.A. Therefore, it seems likely that I will recommend that holders of BPO.PR.A continue to hold the issue and not to convert, but I will wait until it’s closer to the December 16 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.

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