CM.PR.P To Reset At 3.909%

Canadian Imperial Bank of Commerce has announced (on December 31):

the dividend rates applicable to its Non-cumulative Rate Reset Class A Preferred Shares Series 41 (Non-Viability Contingent Capital (NVCC)) (the “Series 41 Shares”) and Non-cumulative Floating Rate Class A Preferred Shares Series 42 (Non-Viability Contingent Capital (NVCC)) (the “Series 42 Shares”).

The fixed dividend rate applicable to the Series 41 Shares, should any remain outstanding after January 31, 2020, for the five-year period from and including January 31, 2020 to but excluding January 31, 2025 is 3.909%, payable quarterly as and when declared by the Board of Directors of CIBC.

The floating dividend rate applicable to the Series 42 Shares, should any be issued, for the three-month period from and including January 31, 2020 to but excluding April 30, 2020 is 3.911%, payable for the period as defined as and when declared by the Board of Directors of CIBC. CIBC has designated the Series 42 Shares as eligible to participate in the CIBC Shareholder Investment Plan.

Beneficial owners of Series 41 Shares who wish to exercise their conversion right should instruct their broker or other nominee to exercise such right during the conversion period, which runs from January 1, 2020 until 5:00 p.m. (Eastern Standard Time) on January 16, 2020. Any notices received after this deadline will not be valid.

CM.PR.P is a FixedReset, 3.75%+224, that commenced trading 2014-12-16 after being announced 2014-12-8. In December, notice of extension was published. CM.PR.P 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., CM.PR.P 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). Inspection of the graph and the overall average break-even rates for extant pairs will provide a guide for estimating the break-even rate for the pair now under consideration assuming, of course, that enough conversions occur so that the pair is in fact created.

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The market has little 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 +0.75% and +1.41%, respectively, ignoring the outliers FTS.PR.H/FTS.PR.I and SLF.PR.G/SLF.PR.J for investment grade (due to a very short term until the next reset) and AIM.PR.A/AIM.PR.B for junk (due to a ludicrous quotation spread on AIM.PR.B). 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 CM.PR.P 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:

Estimate of FloatingReset (received in exchange for CM.PR.P) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 1.50% 1.00% 0.50%
CM.PR.P 16.87 224bp 16.7 16.21 15.72

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to trade below the price of their FixedReset counterparts, TD.PF.C. Therefore, it seems likely that I will recommend that holders of CM.PR.P continue to hold the issue and not to convert, but I will wait until it’s closer to the January 16 notification deadline before making a final pronouncement. I will note that once the conversion period has passed 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.

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