BCE.PR.G Dividend to Reset to 4.50%

BCE Inc. has announced:

BCE Inc. will, on May 1, 2011, continue to have Cumulative Redeemable First Preferred Shares, Series AG outstanding if, following the end of the conversion period on April 21, 2011, BCE Inc. determines that at least two million Series AG Preferred Shares would remain outstanding. In such a case, as of May 1, 2011, the Series AG Preferred Shares will pay, on a quarterly basis, as and when declared by the Board of Directors of BCE Inc., a fixed cash dividend for the following five years that will be based on an annual fixed dividend rate equal to 4.50%.

BCE.PR.G forms a Strong Pair with BCE.PR.H. BCE has announced previously that the date for providing notice of conversion is April 21. Most brokers will have an internal deadline a few days in advance of this date.

A Pairs Equivalency Calculator for determining the break-even Prime Rate when choosing between these two (and other) issues has been published on PrefBlog.

While the pundits have been tireless in warning us that Prime is set to increase, they are less voluble on the matter of how much and how fast. There is also the question of how corporate paper will react to the increase – I suggest there will be some effect, but it won’t be one-to-one.

BCE Ratchet Rate issues such as BCE.PR.H are trading in the $23-24 range and have been paying 100% of prime for quite some time. As noted in the prospectus:

From May 1, 2006, Öoating adjustable cumulative preferred cash dividends, if declared, will be payable monthly on the twelfth day of each month following the month of May 2006, with the annual Öoating dividend rate for the Ñrst month equal to 80% of Prime. The dividend rate will Öoat in relation to changes in Prime and will be adjusted upwards or downwards on a monthly basis whenever the Calculated Trading Price of the Series 18 Preferred Shares is $24.875 or less or $25.125 or more respectively. The maximum monthly adjustment for changes related to the Calculated Trading Price will be 4.00% of Prime. However, the annual Öoating dividend rate applicable in a month will in no event be less than 50% of Prime or greater than Prime.

Thus, if prime should increase dramatically, there is every possibility that the proportion paid on Prim will decline equally dramatically.

The break-even rate for the Ratchet Rate is equal to the new Fixed-Floater rate of 4.5% over the next five years, given that the prices are identical (if not, you can currently buy the cheaper and convert to the more expensive issue). To achieve this breakeven rate, Prime would have to increase by 300bp over the next five years, or 60bp per year. I consider that not only such an increase to be a bit on the high side but, as mentioned, the calculation of the break-even is dependent upon BCE.PR.H continuing to pay 100% of Prime, which is by no means assured in such a scenario.

Thus, I recommend that holders of BCE.PR.G hold on to their issue, and that holders of BCE.PR.H exercise their conversion rights. If I’m wrong and hyperinflation comes to Canada … fear not! You’ll get another chance to convert in 2016.

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