PrefBlog

Intact Financial Corporation has announced:

that it does not intend to exercise its right to redeem all or any part of the currently outstanding Non-cumulative Rate Reset Class A Shares Series 1 of IFC (the “Series 1 Preferred Shares”) (TSX: IFC.PR.A) on December 31, 2017. As a result, subject to certain conditions set out in the prospectus dated July 5, 2011 relating to the issuance of the Series 1 Preferred Shares (the “Prospectus”), the holders thereof will have the right, at their option, to elect to convert all or any of their Series 1 Preferred Shares into Non-cumulative Floating Rate Class A Shares Series 2 of IFC (the “Series 2 Preferred Shares”) on a one-for-one basis on December 31, 2017. Holders who do not exercise their right to convert their Series 1 Preferred Shares into Series 2 Preferred Shares on such date will retain their Series 1 Preferred Shares, unless automatically converted in accordance with the conditions below.

With respect to any Series 1 Preferred Shares that remain outstanding after December 31, 2017, commencing as of such date, holders thereof will be entitled to receive fixed non-cumulative preferential cash dividends on a quarterly basis, as and when declared by the Board of Directors of IFC. The annual dividend rate for the Series 1 Preferred Shares for the five-year period from and including December 31, 2017 to but excluding December 31, 2022 will be 3.396%, as determined in accordance with the terms of the Series 1 Preferred Shares.

With respect to any Series 2 Preferred Shares that may be issued on December 31, 2017, holders thereof will be entitled to receive floating rate non-cumulative preferential cash dividends on a quarterly basis, as and when declared by the Board of Directors of IFC. The dividend rate for the Series 2 Preferred Shares for the 3-month floating rate period from and including December 31, 2017 to but excluding March 31, 2018 will be 0.63912% (2.592% on an annualized basis), as determined in accordance with the terms of the Series 2 Preferred Shares (the “Floating Quarterly Dividend Rate”). The Floating Quarterly Dividend Rate will be reset every quarter.

The foregoing conversion right is subject to the conditions that: (i) if IFC determines that there would be less than 1,000,000 Series 1 Preferred Shares outstanding on December 31, 2017, then all remaining Series 1 Preferred Shares will automatically be converted into an equal number of Series 2 Preferred Shares on December 31, 2017, and (ii) alternatively, if IFC determines that there would be less than 1,000,000 Series 2 Preferred Shares outstanding on December 31, 2017, then no Series 1 Preferred Shares will be converted into Series 2 Preferred Shares. In either case, IFC will give written notice to that effect to any registered holders of Series 1 Preferred Shares on or before December 24, 2017.

The Series 1 Preferred Shares are issued in “book entry only” form and must be purchased or transferred through a participant in the CDS depository service (“CDS Participant”). All rights of holders of Series 1 Preferred Shares must be exercised through CDS or the CDS Participant through which the Series 1 Preferred Shares are held. As such, beneficial holders of Series 1 Preferred Shares who wish to exercise their right to convert their shares during the conversion period, which will run from Friday, December 1, 2017 until 5:00 p.m. (Toronto time) on Friday, December 15, 2017, should contact their broker or other intermediary for more information and it is recommended that this be done well in advance of the deadline in order to provide the broker or other intermediary with time to complete the necessary steps. Any notices received after the deadline will not be valid.

Holders of the Series 1 Preferred Shares and the Series 2 Preferred Shares will have the opportunity to convert their shares again on December 31, 2022, and every five years thereafter as long as the shares remain outstanding. Subject to certain conditions described in the Prospectus, IFC may redeem the Series 1 Preferred Shares, in whole or in part, on December 31, 2022 and on December 31 every five years thereafter and may redeem the Series 2 Preferred Shares, in whole or in part, after December 31, 2017.

The Toronto Stock Exchange (“TSX”) has conditionally approved the listing of the Series 2 Preferred Shares effective on conversion. Listing of the Series 2 Preferred Shares is subject to IFC fulfilling all of the listing requirements of the TSX.

For more information on the terms of, and risks associated with an investment in, the Series 1 Preferred Shares and the Series 2 Preferred Shares, please see IFC’s prospectus dated July 5, 2011 which is available on www.sedar.com.

IFC.PR.A is a FixedReset, 4.20%+172, that commenced trading 2011-7-12 after being announced 2011-6-22. The issue is tracked by HIMIPref™ and has been assigned to the FixedReset subindex.

As this issue is not NVCC compliant and it is an insurance issue, it is analyzed as having a Deemed Retraction. Note that I am less certain with respect to this decision than I am with life insurers – it is by no means assured that property and casualty insurers will be treated the same as life insurers once all the regulatory dust settles.

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., IFC.PR.A and the FloatingReset that will exist 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).

The market appears to have a distaste at the moment for floating rate product; most of the implied rates until the next interconversion are lower than the current 3-month bill rate and the averages for investment-grade and junk issues are both well below current market rates, at +0.38% and +0.49%, respectively! Whatever might be the result of the next few Bank of Canada overnight rate decisions, I suggest that it is unlikely that the average rate over the next five years will be lower than current – but if you disagree, of course, you may interpret the data any way you like.

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 IFC.PR.A 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 be cheap and trading below the price of their FixedReset counterparts. Therefore, it seems likely that I will recommend that holders of IFC.PR.A continue to hold the issue and not to convert, but I will wait until it’s closer to the December 15 notification deadline before making a final pronouncement. I will note that, given the apparent cheapness of the FloatingResets, it may be a good trade to swap the FixedReset for the FloatingReset in the market once both elements of each pair are trading and you can – presumably, according to this analysis – 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.

This entry was posted on Friday, December 1st, 2017 at 11:43 pm 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.