I mentioned one half of this pairing in the January 17, 2007 report and I’ll just make things more explicit here.
This pair is very similar to the BBD.PR.B / BBD.PR.D pair that has been discussed previously. They are convertable into each other on December 1, 2007, just over ten months off, but are trading at prices that are very different.
At the moment, for instance, BCE.PR.Z is quoted at 26.38-75, 1×9, and BCE.PR.Y is quoted at 24.86-90, 4×9. Between now and December 1, 2007, when they can convert into each other, the former issue may be expected to pay dividends at a fixed rate totalling $1.3298, while the Ys, paying a ratchetFloatingRate based on Canadian Prime will pay somewhere around 0.92125. Therefore, the price differential, in the absence of liquidity premia, should be in the neighborhood of $0.40 … but it ain’t. The differential bid/bid is more like $1.50, implying (in this very simple analysis) that there is $1.10 just lying around waiting to be scooped up.
I recognize that the BCE.PR.Y (the cheap ones) are relatively illiquid, due to their float of only 1.1-million-odd shares. The Zs (the expensive ones) have a float of 8.8-million-odd shares. So, there will be problems exploiting this inefficiency for those who care to try it.
But … what I can’t understand is: why would anybody hold the Zs? Even if they’re unable to buy sufficient Ys to replace them? BCE can put an extremely low rate on the “Z” dividend payout commencing December 1, 2007, all but forcing conversion. Surely nobody seriously believes that BCE will leave the rate as it was set five years ago, at 5.319%. In BCE’s last ratchet/reset, the BCE.PR.S / BCE.PR.T the rate was reset to 4.502% … and I certainly wouldn’t bet on this very generous payout being offered again on the Y/Z reset date.
Update: The Zs actually went up in price today (2007-1-18) (bid/bid), closing at 26.39-75, 3×8. Why? Surely there will be few who disagree that the projected price as of the Dec. 1 conversion date is $25.00 … and if you do disagree, please leave a comment, because I’m interest. So the projected capital loss (from the bid price) exceeds the intervening dividends – expected total return over the next 10 months is negative. I don’t understand ….
As an investor in the BBD.PR.B/D arbitrage several times over the past few years (including now), I am always interested in new opportunities that eliminate credit risk (more important for BBD than BCE) and diversify my fixed income holdings. I looked at the BCE.PR.Y/Z arbitrage scenario and did not like it for two main reasons:
1. Liquidity in the BCE prefs (3 mo average daily volume) is 1/10 to 1/20 that of the BBD prefs. The BBD trades were hard enough to execute at the 1000-1500 share volumes that make the trade worthwhile, so I wouldn’t touch the BCE.
2. Give the 40 cent unfavorable dividend bias in the BCE trade and the 4 month longer time frame, one needs at least a $2.50 difference in price to earn an annualized arbitrage profit of about 10% before tax.
That said, I thank James for his devotion to managing the complex data needed to value Canadian Prefs. Keep up the good work!
PrefHound
Yes liquidity is, as ever, a problem when trying to execute arbitrage on prefs. Which is one reason why the market is as inefficient as it is, so my complaints are somewhat muted!
As of the January 19, HIMIPref™ calculates the following averageTradingValues for the four issues referenced here:
Note that AverageTradingValue is a defined term and is subject to a number of constraints; when designing the system, I wanted a measure of liquidity that would not be hopelessly distorted by the occasional enormous block trade.
So, yes, the paired arbitrage is difficult to pull off. On the other hand, it seems clear to me that
Some might conclude that it is not necessary to go long on the BCE.PR.Y!
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[…] Closed at $25.88-00, 2×17. Looks like the BCE.PR.Y / BCE.PR.Z mis-match is beginning to unravel … especially as BCE.PR.Y closed at 25.06-40, 3×20. Or, should I say, my recommendation is paying off? The pre-tax bid-YTW on BCE.PR.Z is now 2.04%, based on a bid of $25.88 and a call 2007-12-31 at $25.00, so at least it’s moved to the right side of zero. […]
[…] As recently discussed, this becomes exchangeable with BCE.PR.Y in December […]
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