Fresh from releasing their 4Q08 Financials, BMO has announced:
a domestic public offering of $150 million of Non-Cumulative 5-year Rate Reset Class B Preferred Shares Series 18 (the “Preferred Shares”). The offering will be underwritten on a bought deal basis by a syndicate led by BMO Capital Markets. The Bank has granted to the underwriters an option to purchase up to an additional $100 million of the Preferred Shares exercisable at any time up to two days before closing.
The Preferred Shares will be issued to the public at a price of $25.00 per Preferred Share and holders will be entitled to receive non-cumulative preferential fixed quarterly dividends for an initial five years, as and when declared by the board of directors of the Bank, payable in the amount of $0.40625 per Preferred Share, to yield 6.50 per cent annually.
Thereafter, the dividend rate will reset every five years to be equal to the 5-Year Government of Canada Bond Yield plus 3.83 per cent. Subject to certain conditions, holders may elect to convert any or all of their Preferred Shares into an equal number of Non-Cumulative Floating Rate Class B Preferred Shares Series 19 on February 25, 2014 and on February 25th of every fifth year thereafter. Holders of the Preferred Shares Series 19 will be entitled to receive non-cumulative preferential floating rate quarterly dividends, as and when declared by the board of directors of the Bank, equal to the then 3-month Government of Canada Treasury Bill yield plus 3.83 per cent.
The anticipated closing date is December 11, 2008. The net proceeds from the offering will be used by the Bank for general corporate purposes.
The first dividend will be $0.73459 payable 2009-5-25 based on a December 11 closing.
BMO PerpetualDiscounts are currently yielding about 8.50% (it depends on which one you look at, the market is very sloppy) AND will provide a rather impressive capital gain should long rates decline substantiall and they get called away. This new issue has zero potential for capital gain, the same credit exposure and yields 200bp less. I simply cannot believe that the reset feature is worth that much! I thought the Fear Du Jour was deflation! I thought … a lot of things!
So what is so interesting about this issue?? Why bother getting this at $25 while you can purchase it in the mkt for a discount??
Series 16 for example.. based on the price at closing Today is $22.40 providing a dividend yield of 5.80% plus capital gain potential. I would much rather purchase this issue instead.
“I thought … a lot of things!”
Do you think perpetuals might someday make a comeback?
It makes no sense to me. Why buy a 6.5% that in a few years resets to 5 yr.bond +380 or so when it looks very much like the US and Canada are going to look like Japan in the foreseeable future. Interest rates are going to be low, low, low. If you bought the perpetual at a yield of 8.5% or so, you’re protecting yourself from the low interest environment, more so than with a reset, aren’t you?
I’ve commented before that I see value in the reset. The issue is how much that reset is worth. The market is currently saying that it’s worth 200 basis points or so. Mr. Hymas has posited that it’s actually worth somewhere in the range of 60-80 basis points. I don’t have any quibble with that analysis, but I think there’s another way to think about the issue.
A typical person who’s account is being serviced by a broker has trouble understand the difference between duration and maturity date, or cash yield vs. yield to maturity, never mind risk premium between a variable rate and a fixed rate security. These are an easy sell: “You’re protected if interest rates rise. If rates fall it will be called and you’ll get your money back so you’re protected there too. It’s way less risky than a perpetual, and you earn more after tax than you would on a bond.” I’m guessing that this is the story being told by the average advisor to the average personal account holder.
I don’t think it’s the fixed resets that are trading at irrational valuations, I think it’s the perpetuals. Canadian perps are pricing in armageddon. The value proposition I see in the bank and lifeco perps is:
-After tax equivalent cash yield north of 11%
-75 to 100% capital gain if it gets called away
-Very little risk of default.
The only argument for the fixed resets, at least until valuations normalize between the two types of issue, is limiting asset allocation to the ultra-long end of the yield curve. Irrespective of the value I see, there’s only so much of my portfolio that I’m going to put into a fixed income instrument with no maturity date. A small allocation to the fixed resets, at their current valuations makes sense to me, if it allows me to move more money into preferred shares than I otherwise would.. i.e. I don’t think I’d move money from perpetuals to fixed resets, but I might move some money from medium term bonds into fixed resets.
Am I completely out to lunch on this?
I don’t think it’s the fixed resets that are trading at irrational valuations, I think it’s the perpetuals.
Tom-AY-toes, Tom-AH-toes. I have no idea what the level of the market should be … I’m just looking at the spread.
The only argument for the fixed resets, at least until valuations normalize between the two types of issue, is limiting asset allocation to the ultra-long end of the yield curve.
Well, that’s just it. From a credit perspective, these things are perpetuals. Given sufficient downgrades, the spread to five year Canadas will look awfully skimpy.
The spread to fives will also look skimpy if we go through a long period with a very steep yield curve; or one with very high corporate risk premia. All of which is to say … the RETURN is based on five-years. The RISK is based on perps.
I might move some money from medium term bonds into fixed resets.
Well, a lot of that is dependent on your individual circumstances and portfolio goals. I will suggest though, that there is an awful lot of liquidity give-up in such a trade, at the very least.
Am I completely out to lunch on this?
Heavens, no. Despite my quibbles above, I’ll agree with you 100% on the mechanics of how they’re sold!
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