PrefBlog

The Bank of Montreal has announced (although not yet on their website):

the applicable dividend rates for its Non-Cumulative 5-Year Rate Reset Class B Preferred Shares, Series 16 (the “Preferred Shares Series 16”) and Non-Cumulative Floating Rate Class B Preferred Shares, Series 17 (the “Preferred Shares Series 17”).

With respect to any Preferred Shares Series 16 that remain outstanding after August 26, 2013, commencing as of such date, holders thereof will be entitled to receive fixed rate non-cumulative preferential cash dividends on a quarterly basis, as and when declared by the Board of Directors of the Bank and subject to the provisions of the Bank Act (Canada). The dividend rate for the five-year period commencing on August 26, 2013, and ending on August 25, 2018, will be 3.390%, being equal to the sum of the five-year Government of Canada bond yield as at July 29, 2013, plus 1.65%, as determined in accordance with the terms of the Preferred Shares Series 16.

With respect to any Preferred Shares Series 17 that may be issued on August 26, 2013, holders thereof will be entitled to receive floating rate non-cumulative preferential cash dividends on a quarterly basis, calculated on the basis of actual number of days elapsed in each quarterly floating rate period divided by 365, as and when declared by the Board of Directors of the Bank and subject to the provisions of the Bank Act (Canada). The dividend rate for the three-month period commencing on August 26, 2013, and ending on November 25, 2013, will be 2.669%, being equal to the sum of the three-month Government of Canada Treasury bill yield as at July 29, 2013, plus 1.65%, as determined in accordance with the terms of the Preferred Shares Series 17.

Beneficial owners of Preferred Shares Series 16 who wish to exercise their right of conversion should communicate as soon as possible with their broker or other nominee and ensure that they follow their instructions in order to ensure that they meet the deadline to exercise such right, which is 5:00 p.m. (EDT) on August 12, 2013.

Conversion inquiries should be directed to BMO’s Registrar and Transfer Agent, Computershare Trust Company of Canada, at 1-800-340-5021.

BMO’s intent to allow the issue to reset was reported on PrefBlog.

I recommend holders of BMO.PR.M (series 16) convert to the FloatingReset (series 17).

This recommendation is based on several factors:

• The two series will be interconvertible again in five years, thus they will have identical values in five years (even if they do not have an identical price!)
• Therefore, any difference in value must be due to the dividends paid in the interim.
• For the amounts paid to be equal, three-month T-Bills must average 1.74% throughout the period, 75bp above their current level. This implies that the ending three-month rate for break-even is about 2.50% (assuming rate hikes are evenly spaced). This is not an unreasonable projection.
• In addition, the FloatingReset offers some insurance against short-term government rates skyrocketting, a scenario which I consider to be of low probability, but of higher probability of short-term rates diving.
• The market loves FloatingResets and I expect the new series to trade above the old one.

The last point deserves a bit more explanation: the FixedReset BNS.PR.P is bid today at 24.59, while the FloatingReset BNS.PR.A (the only FloatingReset currently trading) is bid at 26.12. Given an interconversion date of 2018-4-26 and a fixed yield of 3.35% on BNS.PR.P, it is trivial to calculate that the average required coupon on BNS.PR.A must be 4.85% for break-even. Given the Issue Reset Spread of 205bp, this implies that the break-even three-month bill rate is 2.80%, which is very, very high compared to the current rate of 1.00%. Assuming equal spacing of hikes, this means and end-rate of 4.60%; readers may take their own views on the likelihood of that.

If we set the price of the FixedReset BMO.PR.M at 25.00 and perform a similar calculation, we find that in order for the break-even three-month bill rate to be 2.80%, the price of the new FloatingReset will have to be 26.15.

So, according to me conversion is recommended. Note that the above analysis ignores the fact that FloatingResets are callable at any time at 25.50, a risk that does not apply to the FixedResets. I do not consider this to have a material effect on the analysis, but views may differ.

I have updated the Pair Equivalency Calculator to include data for the three FixedReset / FloatingReset strong pairs currently outstanding or announced.

This entry was posted on Tuesday, July 30th, 2013 at 12:27 am and is filed under Issue Comments. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.