Sum or Product? Always Read the Prospectus!

An Assiduous Reader writes in and says:

I am a private investor and have been unable to get a satisfactory answer from any investment advisors/bank personnel on a question about the new flurry of rate re-set preferreds. They all refer to the rate being re-set in 5 years at a level of x% above government of canada bonds (let’s use a 4.5% re-set as an example). If in 2014 the appropriate GoC bond yield is 5%, and assuming the pfd is not called at that time, then everyone I have spoken to says the pfd rate will be re-set to 9.5%. However, a literal application of the description in the prospectus would be 5% GoC plus 4.5%, which would be a re-set rate of 5.225% (5+[5x.045]). The prospectus refers to a percent, not basis points. Could the banks be this misleading? What am I missing? I would greatly appreciate it if you are able to respond to me.

Well … I’m not sure what is meant by “literal application of the descriptions in the prospectus – no quotations were supplied. However, I looked at the TD prospectus supplement for 2009-2-27 and found the following language (emphasis added):

“Annual Fixed Dividend Rate” means, for any Subsequent Fixed Rate Period, the rate of interest (expressed as a percentage rate rounded down to the nearest one hundred–thousandth of one percent (with 0.000005% being rounded up)) equal to the Government of Canada Yield on the applicable Fixed Rate Calculation Date plus 4.15%.

Additionally, the front page of the Supplement states (emphasis added):

The Annual Fixed Dividend Rate for the ensuing Subsequent Fixed Rate Period will be determined by the Bank on the Fixed Rate Calculation Date (as defined herein) and will be equal to the sum of the Government of Canada Yield (as defined herein) on the Fixed Rate Calculation Date plus 4.15%. See “Details of the Offering”.

… and …

During each Subsequent Fixed Rate Period, the holders of the Series AI Shares will be entitled to receive fixed quarterly non-cumulative preferential cash dividends, as and when declared by the Board of Directors, subject to the provisions of the Bank Act, payable on the last day of January, April, July and October in each year, in an amount per share per annum determined by multiplying the Annual Fixed Dividend Rate applicable to such Subsequent Fixed Rate Period by $25.00.

Prospectuses may always be found on SEDAR; usually a few days after the new issue announcement.

I do not think that an argument that “plus 4.15% [full stop]” means “plus 4.15% of the 5-Year GOC rate” can be successful. On balance of probabilities – which would be the test in a civil action – if they wanted to say such a thing, they would have said “Annual Fixed Dividend Rate is … 104.15% of the 5-Year GOC rate”, or similar. This would follow examples such as the BCE fixed floaters, which have such language as:

“Selected Percentage Rate” for each Fixed Dividend Rate Period means the rate of interest, expressed as a percentage of the Government of Canada Yield, determined by the board of directors of BCE as set forth in the notice to the holders of the Series R Preferred Shares, which rate of interest shall be not less than 80% of the Government of Canada Yield.

It is also unclear to me as to whether OSFI would allow an issue paying a multiple of an index yield rather than a spread over the index yield to be a Tier 1 issue. It’s an interesting question, though!

It seems pretty clear to me that in the reader’s example, the applicable reset rate is 9.5%. If the prospectus was, in fact, sloppy enough to say “4.5% above…”, then there would in fact be ambiguity: but I suspect that this language comes from press releases and sales material, not directly from the prospectus.

But if anybody can find a counter-example, let’s hear about it! I’ve certainly seen some sloppy language in prospectuses that doesn’t seem to make a lot of difference … until one day, quite suddenly, it does.

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