PrefBlog

Fairfax Financial Holdings Limited has announced:

that it has determined the fixed dividend rate on its Cumulative 5-Year Rate Reset Preferred Shares, Series C (the “Series C Shares”) (TSX: FFH.PR.C) for the five years commencing January 1, 2020 and ending December 31, 2024. The fixed quarterly dividends on the Series C Shares during that period, if and when declared, will be paid at an annual rate of 4.709% (C$0.294313 per share per quarter).

Holders of Series C Shares have the right, at their option, exercisable not later than 5:00 p.m. (Toronto time) on December 16, 2019, to convert all or part of their Series C Shares, on a one-for-one basis, into Cumulative Floating Rate Preferred Shares, Series D (the “Series D Shares”) (TSX: FFH.PR.D), effective December 31, 2019. The quarterly floating rate dividends on the Series D Shares will be paid at an annual rate, calculated for each quarter, of 3.15% over the annual yield on three-month Government of Canada treasury bills. The actual quarterly dividend rate in respect of the December 31, 2019 to March 30, 2020 dividend period for the Series D Shares will be 1.19721% (4.80199% on an annualized basis) and the dividend for such dividend period, if and when declared, will be C$0.29930 per share, payable on March 30, 2020.

Holders of Series D Shares also have the right, at their option, exercisable not later than 5:00 p.m. (Toronto time) on December 16, 2019, to convert all or part of their Series D Shares, on a one-for-one basis, into Series C Shares, effective December 31, 2019. Holders of the Series D Shares who elect to convert their shares by the conversion deadline will receive Series C Shares effective December 31, 2019 and will be entitled to receive, if and when declared, the fixed-rate dividend as described above.

Holders of Series C Shares are not required to elect to convert all or any part of their Series C Shares into Series D Shares and holders of Series D Shares are not required to elect to convert all or any part of their Series D Shares into Series C Shares. Holders of the Series C Shares who do not elect to convert their shares by the conversion deadline will retain their Series C Shares and will receive the fixed-rate dividend as described above (subject to the automatic conversion features described below). Holders of the Series D Shares who do not elect to convert their shares by the conversion deadline will retain their Series D Shares and will receive the floating-rate dividend as described above (subject to the automatic conversion features described below).

As provided in the share conditions of the Series C Shares and the Series D Shares: (i) if Fairfax determines that there would be fewer than 1,000,000 Series C Shares outstanding after December 31, 2019, all remaining Series C Shares will be automatically converted into Series D Shares on a one-for-one basis effective December 31, 2019 and Fairfax will cause the return of all Series C Shares tendered for conversion into Series D Shares; and (ii) if Fairfax determines that there would be fewer than 1,000,000 Series D Shares outstanding after December 31, 2019, all remaining Series D Shares will be automatically converted into Series C Shares on a one-for-one basis effective December 31, 2019 and Fairfax will cause the return of all Series D Shares tendered for conversion into Series C Shares.

There are currently 6,016,384 Series C Shares and 3,983,616 Series D Shares outstanding. The Series C Shares and the Series D Shares are listed on the Toronto Stock Exchange under the trading symbols “FFH.PR.C” and “FFH.PR.D”, respectively.

Fairfax also announces that it has declared the following quarterly dividends per share on its preferred shares:

Series of Preferred Shares	Dividend (C$)	Payment Date	Record Date
Series C	0.286125	December 31, 2019	December 13, 2019
Series D	0.30171	December 30, 2019

FFH.PR.C was issued as a cumulative FixedReset issue, 5.75%+315 that commenced trading 2009-10-5 after being announced 2009-9-29. It reset to 4.578% in 2014. I recommended in favour of conversion to FloatingResets. The conversion rate was about 40%.

FFH.PR.D resulted from 40% conversion from FFH.PR.C in 2014 and commenced trading 2014-12-31.

The most logical way to analyze the question of whether or not to convert is through the theory of Preferred Pairs, for which a calculator is available. Briefly, a Strong Pair is defined as a pair of securities that can be interconverted in the future (e.g., FFH.PR.C and the FloatingReset FFH.PR.D that will exist if enough holders convert). Since they will be interconvertible on this future date, it may be assumed that they will be priced identically on this date (if they aren’t then holders will simply convert en masse to the higher-priced issue). And since they will be priced identically on a given date in the future, any current difference in price must be offset by expectations of an equal and opposite value of dividends to be received in the interim. And since the dividend rate on one element of the pair is both fixed and known, the implied average rate of the other, floating rate, instrument can be determined. Finally, we say, we may compare these average rates and take a view regarding the actual future course of that rate relative to the implied rate, which will provide us with guidance on which element of the pair is likely to outperform the other until the next interconversion date, at which time the process will be repeated.

We can show the break-even rates for each FixedReset / FloatingReset Strong Pair graphically by plotting the implied average 3-month bill rate against the next Exchange Date (which is the date to which the average will be calculated). Inspection of the graph and the overall average break-even rates for extant pairs will provide a guide for estimating the break-even rate for the pair now under consideration assuming, of course, that enough conversions occur so that the pair is in fact created.

The market has little enthusiasm for floating rate product; the implied rates until the next interconversion are generally well below the current 3-month bill rate as the averages for investment-grade and junk issues are at +0.89% and +1.20%, respectively. Whatever might be the result of the next few Bank of Canada overnight rate decisions, I suggest that it is unlikely that the average rate over the next five years will be lower than current – but if you disagree, of course, you may interpret the data any way you like.

Since credit quality of each element of the pair is equal to the other element, it should not make any difference whether the pair examined is investment-grade or junk, although we might expect greater variation of implied rates between junk issues on grounds of lower liquidity, and this is just what we see.

If we plug in the current bid price of the FFH.PR.C FixedReset, we may construct the following table showing consistent prices for its soon-may-be-issued FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Before I get eviscerated in the comments, please note that I am well aware that FFH.PR.D is trading and is quoted with a bid of 17.60. Who cares? At the moment, both issues are cum-dividend and are interconvertible effective December 31 and are therefore differ from being the exactly same thing from an investment perspective only by the difference in one dividend payment, less than two cents. We are interested in predicting what might happen after the potential for conversion has passed.

Based on current market conditions, I suggest that the FloatingResets FFH.PR.D that will result from conversion are likely to trade below the price of their FixedReset counterparts, FFH.PR.C. Therefore, it seems likely that I will recommend that holders of FFH.PR.C continue to hold the issue and not to convert, while holders of FFH.PR.D should convert to FFH.PR.C, but I will wait until it’s closer to the December 16 notification deadline before making a final pronouncement. I will note that once the conversion period has passed it may be a good trade to swap one issue for the other in the market once both elements of each pair are trading and you can – hopefully – do it with a reasonably good take-out in price, rather than doing it through the company on a 1:1 basis. But that, of course, will depend on the prices at that time and your forecast for the path of policy rates over the next five years. There are no guarantees – my recommendation is based on the assumption that current market conditions with respect to the pairs will continue until the FloatingResets commence trading and that the relative pricing of the two new pairs will reflect these conditions.

This entry was posted on Tuesday, December 3rd, 2019 at 1:27 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.