It will be recalled that BCE.PR.I will reset to 2.75% effective August 1.
Holders of BCE.PR.I have the option to convert to the RatchetRate issue, BCE.PR.J, which pays a percentage of Canada Prime on the par value of $25.00. The percentage is currently 100% and will not decline unless the trading price of BCE.PR.J rises above $25, which seems rather unlikely in the current environment. The deadline for notifying the company of the intent to convert is July 22, 2016; but note that this is a company deadline and that brokers will generally set their deadlines a day or two in advance, so there’s not much time to lose if you’re planning to convert! However, if you miss the brokerage deadline they’ll probably do it on a ‘best efforts’ basis if you grovel in a sufficiently entertaining fashion.
It will also be noted that holders of BCE.PR.J have the option of converting to BCE.PR.I. After the dust settled following the last Exchange Date five years ago, about 25% of the total was BCE.PR.J.
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., BCE.PR.I and BCE.PR.J, which will have another Exchange Date in five years). 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 FixedFloater / RatchetRate Strong Pair graphically by plotting the implied average Canada Prime rate against the next Exchange Date (which is the date to which the average will be calculated).
Click for BigThere’s a fair bit of scatter, but most pairs are within shouting distance of a 2.70% breakeven rate – that is, most pairs are priced such that the total return of the component issues will be equal if Canada Prime remains at 2.70% until the relevant Exchange Date.
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.
And, of course, since BCE.PR.I will reset to 2.75%, this is equivalent to saying the prices currently and the prices expected to be effective following the Exchange Date are roughly equal. I do not believe that any gains can be expected to be made, or losses expected to be avoided, by holding either issue.
However, on a looking forward basis, I find it more believable that the average Canada Prime over the next five years will exceed 2.70% than I find it to believe that the rate will average lower than current.
Therefore, I recommend that holders of BCE.PR.I convert to BCE.PR.J and that holders of BCE.PR.J continue to hold their shares.
Note that conversion rights are dependent upon at least one million shares of each series being outstanding after giving effect to holders’ instructions; e.g., if only 100,000 shares of BCE.PR.I will remain after all instructions are executed, then all BCE.PR.I will be converted and no BCE.PR.J will convert to BCE.PR.I. And the other way ’round, of course, if practically everybody wants to hold BCE.PR.I. However, this is relatively rare: all 51 Strong Pairs currently extant have some version of this condition and all but six have both series outstanding.
This entry was posted on Wednesday, July 20th, 2016 at 1:13 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.
BCE.PR.I / BCE.PR.J : Convert Or Hold?
It will be recalled that BCE.PR.I will reset to 2.75% effective August 1.
Holders of BCE.PR.I have the option to convert to the RatchetRate issue, BCE.PR.J, which pays a percentage of Canada Prime on the par value of $25.00. The percentage is currently 100% and will not decline unless the trading price of BCE.PR.J rises above $25, which seems rather unlikely in the current environment. The deadline for notifying the company of the intent to convert is July 22, 2016; but note that this is a company deadline and that brokers will generally set their deadlines a day or two in advance, so there’s not much time to lose if you’re planning to convert! However, if you miss the brokerage deadline they’ll probably do it on a ‘best efforts’ basis if you grovel in a sufficiently entertaining fashion.
It will also be noted that holders of BCE.PR.J have the option of converting to BCE.PR.I. After the dust settled following the last Exchange Date five years ago, about 25% of the total was BCE.PR.J.
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., BCE.PR.I and BCE.PR.J, which will have another Exchange Date in five years). 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 FixedFloater / RatchetRate Strong Pair graphically by plotting the implied average Canada Prime rate against the next Exchange Date (which is the date to which the average will be calculated).
Click for Big
There’s a fair bit of scatter, but most pairs are within shouting distance of a 2.70% breakeven rate – that is, most pairs are priced such that the total return of the component issues will be equal if Canada Prime remains at 2.70% until the relevant Exchange Date.
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.
And, of course, since BCE.PR.I will reset to 2.75%, this is equivalent to saying the prices currently and the prices expected to be effective following the Exchange Date are roughly equal. I do not believe that any gains can be expected to be made, or losses expected to be avoided, by holding either issue.
However, on a looking forward basis, I find it more believable that the average Canada Prime over the next five years will exceed 2.70% than I find it to believe that the rate will average lower than current.
Therefore, I recommend that holders of BCE.PR.I convert to BCE.PR.J and that holders of BCE.PR.J continue to hold their shares.
Note that conversion rights are dependent upon at least one million shares of each series being outstanding after giving effect to holders’ instructions; e.g., if only 100,000 shares of BCE.PR.I will remain after all instructions are executed, then all BCE.PR.I will be converted and no BCE.PR.J will convert to BCE.PR.I. And the other way ’round, of course, if practically everybody wants to hold BCE.PR.I. However, this is relatively rare: all 51 Strong Pairs currently extant have some version of this condition and all but six have both series outstanding.
This entry was posted on Wednesday, July 20th, 2016 at 1:13 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.