BMO Issues Cumulative Tier 1 Capital

BMO has announced:

that BMO Capital Trust II (the “Trust”), a closed-end trust wholly-owned by the Bank, will issue $450 million of BMO Tier 1 Notes – Series A due December 31, 2107 (the “Notes”). The Notes are expected to qualify as Tier 1 capital of the Bank for regulatory purposes. The Trust intends to file a final prospectus with the Canadian securities regulators today, and anticipates that a receipt for the prospectus will be issued on Monday, December 15, 2008.

Interest on the Notes is payable semi-annually. From the date of issue to but excluding December 31, 2018, the rate of interest on the Notes will be fixed at 10.221% per annum. Starting on December 31, 2018, and on every fifth anniversary after such date, the rate of interest on the Notes will be reset as described in the prospectus filed by the Trust and the Bank.

On or after December 31, 2013, the Trust may, at its option and subject to certain conditions, redeem the Notes, in whole or in part.

In certain circumstances, the Notes or interest thereon may be automatically exchanged or paid by the issuance of Class B non-cumulative preferred shares of the Bank.

The transaction is expected to close on December 18, 2008 and the net proceeds will be used by the Bank for general corporate purposes.

This is the first issue I know of that takes advantage of OSFI’s recent reckless rule change to allow Tier 1 Capital with a stated maturity and cumulative income payments.

Existence of these notes will not directly affect the critical Equity/RWA ratio that was most recent review of BMO’s capital on PrefBlog. They do, however, represent a method of bumping up the Tier 1 Capital ratio with issues effectively senior to the preferreds, which certainly shouldn’t give preferred shareholders any cause for celebration.

Update, 2008-12-15: Preferred shareholders can, however, take heart from a $1-billion equity issue:

Bank of Montreal (TSX, NYSE: BMO) today announced an offering of 33,340,000 common shares at CDN$30.00 per share for total gross proceeds of approximately CDN$1.0 billion. The offering will be underwritten on a bought deal basis by a syndicate of underwriters. The Bank has granted to the underwriters an over-allotment option to purchase, on the same terms, up to a further 3,334,000 common shares. The option is exercisable, in whole or in part, up to 30 days after closing. The maximum gross proceeds raised under the offering will be approximately CDN$1.1 billion if the option is exercised in full.

The anticipated closing date of the offering is December 24, 2008. The net proceeds from the offering will be used by the Bank for general corporate purposes. The issue will qualify as Tier 1 capital.

The Bank’s Tier 1 capital ratio was 9.77% as of October 31, 2008. On a pro-forma basis, adjusting for the issuance of CDN$1.0 billion of common equity, the issuance of the CDN$150MM Series 18 Preferred Shares, the issuance of the CDN$450MM BMO Tier 1 Notes – Series A, the redemption of the CDN$250MM Series 6 Preferred Shares and the November 1, 2008 implementation of a new Basel II requirement, the Tier 1 ratio would be approximately 10.4%.

Update, 2008-12-16: The prospectus is now available on SEDAR – Issuer is BMO Capital Trust II, date is December 12:

Starting on December 31, 2018 and on every fifth anniversary of such date thereafter until December 31, 2103 (each such date, an ‘‘Interest Reset Date’’), the interest rate on the BMO Tier 1 Notes—Series A will be reset at an interest rate per annum equal to the Government of Canada Yield (as defined herein) plus 10.50%.

Government of Canada Yield means, on any Interest Reset Date, the average of the annual yields as at 12:00 p.m. (Eastern time) on the third Business Day prior to the applicable Interest Reset Date as determined by two Canadian registered investment dealers, each of which will be selected by, and must be independent of, the Bank and the Trust, as being the annual yield to maturity on such date which a non-callable Government of Canada bond would carry, assuming semi-annual compounding, if issued in Canadian dollars in Canada at 100% of its principal amount on such date with a term to maturity of five years.

On or after December 31, 2013, the Trust may, at its option, with the prior approval of the Superintendent, on giving not more than 60 nor less than 30 days’ notice to the holders of the BMO Tier 1 Notes — Series A, redeem the BMO Tier 1 Notes — Series A, in whole or in part. The redemption price per $1,000 principal amount of BMO Tier 1 Notes — Series A redeemed on any day that is not an Interest Reset Date will be equal to the greater of par and the Canada Yield Price, and the redemption price per $1,000 principal amount of BMO Tier 1 Notes — Series A redeemed on any Interest Reset Date will be par, together in either case with accrued and unpaid interest to but excluding the date fixed for redemption, subject to any applicable withholding taxes.

The Class B Preferred Shares Series 20 will pay fixed quarterly Shares Series 20: non-cumulative preferential cash dividends, as and when declared by the Board of Directors, subject to the provisions of the Bank Act, at the applicable Perpetual Preferred Share Rate on each quarterly dividend payment date, subject to any applicable withholding taxes.

Perpetual Preferred Share Rate means the rate per annum equal to the Thirty Year Canada Yield prevailing: (i) in the case of the Class B Preferred Shares Series 20, at the time of the Automatic Exchange; or (ii) in the case of the Class B Deferral Preferred Shares, on the date of issuance of each series of Class B Deferral Preferred Shares, plus, in each case, 3.49%.

20 Responses to “BMO Issues Cumulative Tier 1 Capital”

  1. Louis says:

    I do hope you will one day explain us what makes a Bank elect for one type rather than another type of Tier 1 capital. If I understand correctly, this is as if the BMO had issued straight prefs giving a dividend of 7% at par with the added “bonus” of these having priority over all ordiary and pref shares. So, do I have to take it that the existing perp prefs of BMO should lose value to yield a dividend of more that 8 or 9%? When will this stop? Why haven’t they issued ordinary shares instead?

  2. Louis says:

    Addendum: And the income of this new beast is not subject to the Bank’s discretion of declaring a dividend… They must be desperate to do that! Will those be tradeable on a public market after their issuance?

  3. jiHymas says:

    I do hope you will one day explain us what makes a Bank elect for one type rather than another type of Tier 1 capital.

    They want to have as many different funding sources as possible, while maximizing returns to shareholders (which implies minimizing cost of funds).

    If I understand correctly, this is as if the BMO had issued straight prefs giving a dividend of 7% at par with the added “bonus” of these having priority over all ordiary and pref shares.

    The real bonus is that they can pretend they are actual bonds and sell them to the institutional bond market. Depending on the size of the step-up that will occur on 2018-12-31, they will probably also be able to sell them based on a spread against 10-year Canadas.

    So, do I have to take it that the existing perp prefs of BMO should lose value to yield a dividend of more that 8 or 9%?

    This is a rather tricky question, but I don’t think that the spread between Preferreds and Innovative Tier 1 Capital should be as great as all that. Given that the preferreds have a potential for capital gain, it is possible that they should even trade through these notes.

    And the income of this new beast is not subject to the Bank’s discretion of declaring a dividend

    The prospectus will contain various clauses that will (a) force the cessation of interest payments in certain circumstances and (b) ensure that dividends on common and preferred issues are halted before this happens. In distinction to an actual bond, however, non-payment of interest will not be an event of default.

  4. Louis says:

    Thks alot but I don’t understand what you mean by the last part of your: “Given that the preferreds have a potential for capital gain, it is possible that they should even trade through these notes” I would think that the market value of the notes will increase as well with equivalent capital gain to the existing perps if the high spreads between Canadas and perps/notes was to go down.

  5. jiHymas says:

    I would think that the market value of the notes will increase as well with equivalent capital gain to the existing perps if the high spreads between Canadas and perps/notes was to go down.

    Increase, yes; equivalent, no. Capital gains on the notes will be limited by the fact that they are callable at their current price. The lowest priced BMO perp is priced at 14.66, indicating a potential capital gain of 70%.

  6. lystgl says:

    This scares me to no end. A bank offering over 10% right outta the gate!
    When the overnight is 1.5%? We are in deep do do.

  7. jiHymas says:

    A bank offering over 10% right outta the gate! When the overnight is 1.5%?

    Yeah, it’s wild, isn’t it? Still, it may go some way towards explaining to the public why they didn’t fully pass on the last cut in the overnight rate to prime.

  8. Annette says:

    Scary indeed. I haven’t found the prospectus yet. Hopefully, the reset formula will provide for some very low reset rate. Could it simply be a typo in the press release (10.221%!!!). And it is a sizeable issue (450 millions)! This is another insult to the buyers of earlier issues not even a month old.

  9. jiHymas says:

    it is a sizeable issue (450 millions)!

    Sizeable indeed compared to preferred share issues but maybe even a little on the small side for a bond issue.

  10. Louis says:

    Nothing on Sedar yet concerning this new issue. On BMO discount trading site, they have this strange entry when I made a search for something looking like this new issue on their “fixed income” product search engine:

    BMO BOATS C’18 10.221%31DEC07 31 décembre 2018 977 000 103,170 $ CAN 9,718% 9,954%

    Is this that new issuance? The interest rate at par as well as the first redemption date are the same as the new issue while the issuance date doesn’t fit but this could be a typo.

  11. jiHymas says:

    BMO BOATS C’18 10.221%31DEC07 31 décembre 2018 977 000 103,170 $ CAN 9,718% 9,954%

    That’s it! There’s no prospectus yet on SEDAR (well … the red herring is there, but no meat). Remember when you look for it that the issuer is BMO Capital Trust II.

    Is this that new issuance? The interest rate at par as well as the first redemption date are the same as the new issue while the issuance date doesn’t fit but this could be a typo.

    Heh-heh.

    Take another look.

    BMO BOATS C’18 10.221%31DEC07 31 décembre 2018 977 000 103,170 $ CAN 9,718% 9,954%

    Is the bolded bit what you are looking at as the issuance date? Not if I’m right about this … recall that the maturity date is December 31, 2107.

    Step up date is 2018-12-31, so that explains that part.

    I’ll admit I’m puzzled about price & yield. I think they’re quoting a market of 97.70 – 103.17 , but I don’t see how that turns into a yield-quote of 9.718% – 9.954% … which is a backwards quote anyway.

  12. Louis says:

    Thks alot again. With your precious help, I’ve now found and am printing the draft prospectus full of bullets in lieu of the important info which had been filed since October 1st, 2008. the “977 000” digit is under the colomn of quantity left (humm! I assume it is only the quantity which can be sold via BMO Investors Line) while the two percentage figures are the annual and semi annual compounded yields. The last part of the enigma for me is the single price they state of $103.17 for something which has yet to be issued (it just shows you how little I know on corporate bonds). Is the $3.17 mark up the “profit” either BMO Capital Trust II or BMO Investors Line (or both) are taking right from the start? I wish I could have a full final prospectus in front of me as I otherwise see this as a good investment for a RSP / REER unless I am missing something bearing in mind that I have so far a perfect 100% record losing money with new issues.

  13. jiHymas says:

    Is the $3.17 mark up the “profit” either BMO Capital Trust II or BMO Investors Line (or both) are taking right from the start?

    We won’t know for sure until we see a full prospectus, but it is entirely possible that the issue gets sold at a different price from par.

    I wish I could have a full final prospectus in front of me as I otherwise see this as a good investment for a RSP / REER

    You could well be right. Just remember that these things ARE NOT BONDS! The best way to think of them is RSP-friendly perpetual preferred shares.

  14. max1234 says:

    Is possible for individual investors to buy some of these notes or you need to be an “institutional investor” to do that?

    Maxime

  15. Louis says:

    You don’t need to be an institutional investor. You may buy some right now from BMO Investors Line and, presumably, from BMO Nesbitt Burns. Having read the bulletted prospectus (not very professionnal) on Sedar with James’ precious help to find it, I am currently of the opinion that such product is overcomplicated with a lot of unswanred question marks on possible scenarios. I take it to be even less liquid than prefs but I have since them found “similar” product (TD Cats) listed on the TSX (see for instance TDD.M). My understanding after the painful exercise is that, in case of liquidation or insolvency, what you get are reset pref shares such that you are not better off with those than with pref shares unless you buy them for a RSP. A big concern on which James might be able to help is the provision whereby TD cannot declare dividends on its ordinary and prefs if the “interest” on the notes is not paid for a certain period of time but such can (or is then) paid by way of pref shares. It is not clear to me what you get exactly in case of a suspension of dividend as preferred shares amongst many other questions the reading of an incomplete & tedious prospectus raised in one’s mind while watching an as boring football game of the Cleveland Browns.

  16. jiHymas says:

    Is possible for individual investors to buy some of these notes or you need to be an “institutional investor” to do that?

    I would expect that most dealers will offer these to retail. Since there is a prospectus, there are no legal problems with this – it will simply be a policy decision by each dealer.

    I take it to be even less liquid than prefs

    For retail investors, you’re probably right. For institutional investors however, the liquidity will be much greater for this issue of pseudo-bonds.

    It is not clear to me what you get exactly in case of a suspension of dividend as preferred shares

    Until the final prospectus is out, we won’t know.

  17. max1234 says:

    Here is what BMO investors relations sent me:

    ———————
    These notes have been sold to institutional investors, the news release
    done to serve as notification of the Bank’s actions and not as an offer
    to sell.

    However, starting December 18th, the institutional investor has the
    right to sell them on the secondary market if they choose to do so.
    These will be sold as over the counter securities.

    ———————

    These institutional investors are named in their prospectus. It is basically the big five + National Bank, Desjardins and HSBC securities. There will probably be a markup on monday to buy these notes I guess. The only thing that surprise me is why BMO is so hurried for cash such that it cannot take more time to get a better rate from the market.

  18. jiHymas says:

    These notes have been sold to institutional investors

    Rather a strange thing for BMO-IR to say!

    The prospectus states:

    Pursuant to an agreement (the ‘‘Underwriting Agreement’’) dated December 12, 2008 between the Trust, the Bank and BMO Nesbitt Burns Inc., Scotia Capital Inc., CIBC World Markets Inc., RBC Dominion Securities Inc., TD Securities Inc., HSBC Securities (Canada) Inc., National Bank Financial Inc., Desjardins
    Securities Inc. and Laurentian Bank Securities Inc. (collectively, the ‘‘Underwriters’’), the Trust has agreed to sell, and the Underwriters have agreed to purchase, on December 18, 2008 or on such other date not later than December 31, 2008 as may be agreed upon all but not less than all of the $450,000,000 BMO Tier 1 Notes — Series A at a price of $1,000 per $1,000 principal amount of BMO Tier 1 Notes — Series A, subject to the terms and conditions set forth therein. The Trust has agreed to pay to the Underwriters a fee per $1,000 principal amount of BMO Tier 1 Notes — Series A equal to $10.00 with respect to BMO Tier 1 Notes — Series A sold for an aggregate Underwriters’ fee of $4,500,000.

    The underwriting agreement available on SEDAR.

    The only thing that surprise me is why BMO is so hurried for cash such that it cannot take more time to get a better rate from the market.

    Pricing new securities is more are than science – what can I say? And it is the first time with this new structure.

    Given that the FixedReset market appears to have become saturated, it is possible that BMO simply made a strategic decision that it was willing to pay up for the funds simply to ensure that it hit the markets fustest with the mostest.

  19. jiHymas says:

    I will also note that the new issue concession on this thing is huge.

    Perimeter provides the following quotation:

    BMO Cap Tr 4.633 2015Dec31 79.16 8.65

    These are similar; the step up on Dec 31, 2015 to BAs + 150bp is presumed to trigger a call, although that assumption looks increasingly dubious given the current environment.

    So anyway, extant securites with a pretend-maturity of 2015-12-31 have a pretend-yield of 8.65% (yield to perpetuity is much less) and these things have a coupon of 10.122%!

  20. […] I discussed the new issue of TD CATS earlier today; it is similar to December’s BMO issue. […]

Leave a Reply

You must be logged in to post a comment.