PrefBlog

Preferred Share buybacks are a perennial topic of interest on PrefBlog and were most recently discussed on the post Split-Share Buy-Backs? WFS.PR.A & FIG.PR.A Examined.

Now, Assiduous Reader PL writes in and says:

Just wondered if companies are allowed to buy back their preferred shares the same way they buy common shares? I am analyzing SLF.PR.A for example. With the redemption at 25 buying as many as you could at around 20 would make sense if you were allowed to and planned to redeem it. Thanks.

There are two items of interest in the prospectus for SLF.PR.A, which may be found on SEDAR, with an issue date of February 17, 2005:

Conversion into a New Series of Preferred Shares

SLF, at any time by resolution of the Board of Directors of SLF, may constitute a separate series of Class A Shares (‘‘New Preferred Shares’’) having rights, privileges, restrictions and conditions attaching to them (other than any option or right to convert into Common Shares) which would qualify such New Preferred Shares as Tier 1 capital of SLF under the then current capital adequacy guidelines established by the Superintendent. In such event, SLF, with any necessary prior consent of the Superintendent, may give registered holders of the Class A Preferred Shares Series 1 notice that they have the right, pursuant to the terms of the Class A Preferred Shares Series 1, at their option, to convert their Class A Preferred Shares Series 1 on the date specified in the notice into fully-paid and non-assessable New Preferred Shares on a share for share basis. SLF will give notice of any option to convert to registered holders not more than 60 days and not less than 30 days prior to the conversion date. See ‘‘Insurance Act Restrictions’’. SLF will ensure that such New Preferred Shares will not, if issued, be or be deemed to be ‘‘short-term preferred shares’’ within the meaning of the Income Tax Act (Canada).

Purchase for Cancellation

Subject to the provisions of the Insurance Act, the prior consent of the Superintendent and the provisions described below under ‘‘Restrictions on Dividends and Retirement of Shares’’, SLF may at any time purchase for cancellation any Class A Preferred Share Series 1 at any price.

So the short answer to AR PL’s question is “yes”.

But under what circumstances would they do this? The funds represent cheap money – cheap Tier 1 money at that. In the ordinary course of business, there would be no reason for them to buy these things back: even if they didn’t need the money now, they’re going to figure that it’s really nice to have it anyway, since it’s cheap and replacing it a few years down the road will not only entail a probably higher coupon, but issuance costs as well.

However, there is the occasional redemption announcement that takes place when the issues are trading below par. The most famous of these announcement was the abortive Teachers’ bid for BCE, in which the preferreds were planned to be redeemed since the take-over was intended to proceed by Plan of Arrangement, to which the Preferred Shareholders voting as a class were allowed veto power under the Corporations Act, which they certainly would have exercised if they hadn’t been given a sweetener under the deal, even considering the dim-bulb nature of many of these holders.

There were a few scattered redemptions of floaters that traded below par in the 1990s (notably TD.PR.D and BNS.PR.A) but these were nowhere near the $20 level at the time of the announcement. While I’m sure holders did not object to the redemption, they didn’t make out like bandits either.

The other extract from the prospectus that I have highlighted is the potential for exchange into a new series of shares … a client asked me about this in connection with TD.PR.O just last week and that prospectus has similar language.

The first thing to note is that the exchange is optional for both parties. SLF doesn’t have to create the new series; holders don’t have to exchange. All I can imagine to justify the clause is a potential smoothing of the way for a redemption and new issue to be done simultaneously.

Say, for instance, straight perpetuals suddenly trade to yield 4% and SLF.PR.A trades at $26 (not the $29.69 implied by the $1.1875 dividend due to the potential for call). What Sun Life could do – for instance – is send preferred shareholders an envelope with two notices in it: the first advises that the issue will be called at par on November 1 and the second advises that they can exchange into a new issue of SLF preferreds paying $1.05 (a nickel in excess of market rates), provided that they do it on October 31.

Presto, SLF achieves its desire of reducing their cost of funds and don’t have to pay $0.75 per share issuance expenses either. I would not consider this a coercive exchange offer, because it has always been understood that the issue could be called at par; it’s not like other offers we’ve seen lately where the company says something like: do this, because we’re going to cancel the dividend.

Having the exchange clause in the prospectus might make this process simpler and less costly should SLF ever wish to do this … but I’m not a securities lawyer. Those among you who ARE securities lawyers – or fancy their legal skills – are invited to come up with better explanations in the comments.

Update: See also Repurchase of Preferred Shares by Issuer, which references the GWO.PR.E / GWO.PR.X Normal Course Issuer Bid.

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