PrefBlog

The Toronto-Dominion Bank has announced (although not yet on their website):

the applicable dividend rates for its Non-Cumulative 5-Year Rate Reset Preferred Shares, Series 3 (Non-Viability Contingent Capital (NVCC)) (the “Series 3 Shares”) and Non-Cumulative Floating Rate Preferred Shares, Series 4 (NVCC) (the “Series 4 Shares”).

With respect to any Series 3 Shares that remain outstanding after July 31, 2019, holders of the Series 3 Shares will be entitled to receive quarterly fixed non-cumulative preferential cash dividends, as and when declared by the Board of Directors of TD, subject to the provisions of the Bank Act (Canada). The dividend rate for the 5-year period from and including July 31, 2019 to but excluding July 31, 2024 will be 3.681%, being equal to the 5-Year Government of Canada bond yield determined as at July 2, 2019 plus 2.27%, as determined in accordance with the terms of the Series 3 Shares.

With respect to any Series 4 Shares that may be issued on July 31, 2019, holders of the Series 4 Shares will be entitled to receive quarterly floating rate non-cumulative preferential cash dividends, calculated on the basis of the actual number of days elapsed in such quarterly period divided by 365, as and when declared by the Board of Directors of TD, subject to the provisions of the Bank Act (Canada). The dividend rate for the floating rate period from and including July 31, 2019 to but excluding October 31, 2019, will be 3.931%, being equal to the 90-day Government of Canada Treasury Bill yield determined as of July 2, 2019 plus 2.27%, as determined in accordance with the terms of the Series 4 Shares.

Beneficial owners of Series 3 Shares who wish to exercise their conversion right should communicate as soon as possible with their broker or other nominee to obtain instructions for exercising such right on or prior to the deadline for exercise, which is 5:00 p.m. (Toronto time) on July 16, 2019.

Inquiries should be directed to TD’s Registrar and Transfer Agent, AST Trust Company (Canada), at 1-800-387-0825 (or in Toronto 416-682-3860).

TD.PF.B is a FixedReset 3.80%+227, NVCC-compliant, issue that commenced trading 2014-7-31 after being announced 2014-7-22. TD provided notice of extension on 2019-6-25. The issue is tracked by HIMIPref™ and is assigned to the FixedReset (Discount) subindex.

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., TD.PF.B 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).

Click for Big

The market has lost enthusiasm for floating rate product; the implied rates until the next interconversion are generally well below the current 3-month bill rate as the averages for investment-grade and junk issues are at +0.63% and +0.67%, 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 TD.PF.B 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 well below the price of their FixedReset counterparts, TD.PF.B. Therefore, it seems likely that I will recommend that holders of TD.PF.B continue to hold the issue and not to convert, but I will wait until it’s closer to the July 16 notification deadline before making a final pronouncement. 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.

This entry was posted on Tuesday, July 2nd, 2019 at 10:24 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.