BCE.PR.F To Reset at 239% of GOC-5; Interconvertible with BCE.PR.E

BCE Inc. published their conversion notice for BCE.PR.F on December 18, 2019:

Holders of fixed-rate BCE Inc. Series AF Preferred Shares have the right to convert all or part of their shares, effective on February 1, 2020, on a one-for-one basis into floating-rate Cumulative Redeemable First Preferred Shares, Series AE of BCE Inc. (the “Series AE Preferred Shares”). In order to convert their shares, holders must exercise their right of conversion during the conversion period which runs from December 18, 2019 until 5:00 p.m. (Eastern time) on January 20, 2020.

As of February 1, 2020, the Series AF Preferred Shares will, should they remain outstanding, pay, on a quarterly basis, as and when declared by the Board of Directors of BCE Inc., a fixed cash dividend for the following five years that will be based on a fixed rate equal to the product of: (a) the yield to maturity compounded semi-annually (the “Government of Canada Yield”), computed on January 13, 2020 by two investment dealers appointed by BCE Inc., that would be carried by a non-callable Government of Canada bond with a 5-year maturity, multiplied by (b) the “Selected Percentage Rate”. The “Selected Percentage Rate” determined by BCE Inc. is 239%. The annual dividend rate applicable to the Series AF Preferred Shares will be published on January 16, 2020 in the national edition of The Globe and Mail, the Montreal Gazette and Le Devoir and will be posted on the BCE Inc. website at www.bce.ca.

There is a similar conversion notice for BCE.PR.E.

The Five-Year Canada rate is now 1.60%, if that is the case on the determination date of 2020-1-13, the dividend rate of BCE.PR.F will be 3.824%, or $0.956 p.a.

BCE.PR.F is a FixedFloater which was added to the HIMIPref™ database in December 2008, when it was paying 4.40%. It reset in 2010 to 4.541% and after a net conversion to BCE.PR.F the issue pair was about 90% FixedFloater. It reset in 2015 to 3.110% and after a massive conversion the issue pair was about 60% RatchetRate.

BCE.PR.E is a RatchetRate preferred, interconvertible every five years with BCE.PR.F. It was added to the HIMIPref™ database in May, 2012.

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.F and the RatchetRate BCE.PR.E that will continue to exist if enough holders want it). 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). 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 seems to be doing a pretty good job of arbitraging this series of issues; the seven BCE issues have an average break-even prime rate of 4.15%, close to the current prime of 3.95% although there is more variation than might be expected. 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.

If we plug in the current bid price of the BCE.PR.F FixedFloater, we may construct the following table showing consistent prices for its RatchetRate counterpart BCE.PR.E given a variety of Implied Breakeven yields consistent with issues currently trading:

Estimate of RatchetRate BCE.PR.E (received in exchange for BCE.PR.F) Trading Price In Current Conditions
  Assumed RatchetRate
Price if Implied Prime
is equal to
FixedReset Bid Price 4.50% 4.00% 3.50%
BCE.PR.F 15.60 16.25 15.77 15.29

Based on current market conditions, I suggest that BCE.PR.E will likely to trade roughly equal to the price of their counterparts, BCE.PR.F. Therefore, it seems likely that I will recommend that holders of either issue make their decision based on their own portfolio and other financial circumstances and outlook, but I will wait until it’s closer to the January 20 notification deadline before making a final pronouncement. I will note that once the conversion period has passed 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 after the conversion and that the relative pricing of the two new pairs will reflect these conditions.

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