PrefBlog

Intact Financial Corporation has announced:

that it has closed its previously announced bought deal offering (the “Offering”) of Non-Cumulative Class A Shares, Series 11 (the “Series 11 Preferred Shares”) underwritten by a syndicate of underwriters led by TD Securities Inc. together with BMO Capital Markets, CIBC Capital Markets, National Bank Financial, RBC Capital Markets and Scotiabank, resulting in aggregate gross proceeds (including the proceeds resulting from the exercise of their option) to Intact of $150 million. The net proceeds are expected to be used by Intact to fund a portion of the redemption price of all of the outstanding floating rate restricted notes (approximately $445 million, based on the exchange rate as of March 4, 2022) of the Company’s subsidiary, RSA Insurance Group Limited (formerly RSA Insurance Group plc) and/or for general corporate purposes.

Each Series 11 Preferred Share entitles the holder thereof to receive quarterly non-cumulative preferential cash dividends, if, as and when declared by the Board of Directors, on the last day of March, June, September and December in each year at a rate equal to $0.328125 per share. The initial dividend, if declared, will be paid on June 30, 2022 and will be $0.3848 per share.

The Series 11 Preferred Shares will commence trading today on the Toronto Stock Exchange under the symbol IFC.PR.K.

IFC.PR.K is a Straight Perpetual, 5.25%, announced 2022-03-07.

The issue traded 818,601 shares today in a range of 25.00-14 before closing at 25.08-12. Vital statistics are:

It will be recalled that BAM.PF.I will reset at 5.386% effective April 1, 2022.

BAM.PF.I was issued as a FixedReset, 4.80%+385M480 that commenced trading 2016-11-18 after being announced 2016-11-10.

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. BAM.PF.I and the FloatingReset that will arise 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).

Click for Big

It is somewhat surprising to note that the market is not pricing in a particularly aggressive or lengthy policy tightening cycle by the BoC: the implied rates until the next interconversion are not far above the current 3-month bill rate of 0.53%, with the averages for investment-grade and junk issues at +0.64% and +1.16%, respectively.

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 BAM.PF.I 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:

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to trade below the price of their FixedReset counterparts, BAM.PF.I. Therefore, I recommend that holders of BAM.PF.I continue to hold the issue and not to convert. I will note that once the FloatingResets commence trading (if, in fact, they do) 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.

Readers who are not as Assiduous as they should be occasionally get upset at my conversion recommendations because I make no attempt whatsoever to make my own estimate of the average 3-month bill rate for the next five years and tailor a recommendation accordingly. I do not do this because it cannot be done with any degree of conviction whatsoever; anybody who tells you that they can reliably predict market yields five years in advance is a charlatan. Market Timing is a snare and delusion; financial markets form a chaotic system in which things that have no rational relevance today can be the driving forces tomorrow. I did not predict the market effects of the COVID pandemic six months before it happened; I did not predict the market effects of the Russian invasion of Ukraine six months before it happened, either; I don’t know anybody who did. All we can ever do is compare similar instruments and attempt an educated guess about relative value; for example BAM.PF.I vs. its possible Floating Rate counterpart. Comparing either one of them with cash or equity over the short term is an exercise in futility.

So what to do? Construct your portfolio to meet your needs and your risks, based on the long-term characteristics of the various alternatives. If, for instance, you are financing your position with a variable rate mortgage based on prime (not a wise move, but some people do it), your lower risk (higher certainty) option is the FloatingReset, as it will reset every three months in accordance with the three month bill rate, which is closely related to prime. Prime and the three month bill rate are similar instruments; prime and the five-year bond rate are less similar; prime and equity prices are highly dissimilar. My purpose in making these ‘convert or hold’ recommendations is to show the potential for short term trading gains between the FixedReset and its FloatingReset counterpart which are, as previously noted, similar instruments. Thus, for instance, if your portfolio requirements indicate that the FloatingRate instrument is better suited for you, you might wish to elect to hold the FixedReset anyway; this would be reasonable (but not guaranteed!) to the extent that you have a reasonable (but not guaranteed!) expectation that the FloatingReset will be trading lower than the FixedReset for a long enough period to allow you to swap the issues on the market and maybe take out $0.25/share on the swap. The same action is indicated if you take a strong view that the average bill rate over the next five years will be far higher than that currently priced by the market – in this case, you want to hold the FloatingReset, but attempting to perform the conversion on better terms than the 1:1 exchange offered by the company is still a good risk.

That’s how you make money in the market, taking out small profits as many times as opportunity permits. That’s what proprietary traders (and properly operated hedge funds, deserving of the name) do – and proprietary trades, backed with sufficient capital, are the only group of market participants that consistently make profits.

Those who wish to convert are advised that the deadline for notifying the company of such a desire is 5:00 p.m. (Toronto time) on March 16, 2022. Brokers and other intermediaries generally set their internal deadlines a day or two in advance of this date, so if you wish to convert there’s no time to waste! Note that brokers will, in general, try to execute the instruction on a ‘best efforts’ basis if received between the two deadlines, provided that the procrastinating shareholder grovels entertainingly enough.