BCE.PR.A To Reset At 3.61%

BCE Inc. has announced (although not yet on their website):

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The new rate of 3.61% is a little higher than the current rate of 3.45%.

As previously noted in the report of the BCE.PR.A / BCE.PR.B Conversion Notice:

These issues constitute a Strong Pair.

The effective date of the interconversion is 2017-9-1. The deadline for instructing the company to convert shares is 2017-8-22 – but note that brokers serving the public will probably have internal deadlines a day or two in advance of this.

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.A and BCE.PR.B). 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 Prime rate against the next Exchange Date (which is the date to which the average will be calculated).

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Predictions are difficult, particularly when they are about the future! It will be remembered that Prime is currently at 2.95%; therefore, if we assume that future hikes are evenly sized and spaced, an average of 4.00% implies an end-value in five years of about 5.00%. I’m inclined to believe that it will turn out to be less than that, but if you disagree I won’t put up much of an argument!

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 BCE.PR.A FixedFloater, we may construct the following table showing consistent prices for its soon-to-be-issued FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Estimate of BCE.PR.B (received in exchange for BCE.PR.A) Trading Price In Current Conditions
  Assumed RatchetRate
Price if Implied Prime
is equal to
FixedFloater Bid Price Fixed Rate +3.50% 4.00% 4.50%
BCE.PR.A 18.46 3.61% 18.35 18.86 19.37

Based on current market conditions, I suggest that the RatchetRate issue, BCE.PR.B, should be trading somewhat above the price of BCE.PR.A, its FixedFloater counterpart. Therefore, it is likely that when the time comes I will recommend that holders of BCE.PR.A convert into BCE.PR.B, while current holders of the latter issue stand pat. However, a formal recommendation will not be made until closer to the notification date of August 22. Those with strong convictions regarding future movements in Prime will, of course, have an equally strong preference for one of the two issues; other investors may wish to select which of the pair they wish to hold for the next five years based on their personal circumstances (e.g., if you’re hedging a prime-linked mortgage with this issue [not a wise move], you will want to hold BBD.PR.B).

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