IFC.PR.A, BAM.PF.J, BAM.PR.Z, BPO.PR.I : Convert or Hold?

BAM.PF.J will reset at 6.229% effective 2023-1-1. BAM.PF.J was issued as a FixedReset, 4.75%+310M475, that commenced trading 2017-9-13 after being announced 2017-09-06.

BAM.PR.Z will reset at 6.089% effective 2023-1-1. BAM.PR.Z was issued as a FixedReset, 4.80%+296, that commenced trading 2011-11-2 after being announced 2011-10-24. BAM.PR.Z reset to 4.685% effective 2018-1-1; I recommended against conversion; and there was no conversion.

BPO.PR.I will reset at 6.359% effective 2023-1-1. BPO.PR.I was issued as a FixedReset, 4.85%+323M485, that commenced trading 2017-12-7 after being announced 2017-11-29.

IFC.PR.A will reset at 4.841% effective 2022-12-31. IFC.PR.A was issued as a FixedReset, 4.20%+172, that commenced trading 2011-7-12 after being announced 2011-6-22. IFC.PR.A reset at 3.396% effective December 31, 2017, and I recommended against conversion. There was no conversion.

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 arise 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

It is somewhat surprising to note that the market is pricing in a lengthy policy tightening cycle by the BoC: the implied rates until the next interconversion are not much different from the current 3-month bill rate of 4.26%, with the averages for investment-grade and junk issues at +4.08% and +4.25%, respectively. Some may conclude that investors are making no attempt to forecast the duration of this tightening cycle!

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.

It should be noted that the data is not of particularly good quality, since of the InvestmentGrade pairs, only SLF.PR.G / SLF.PR.J and TRP.PR.A / TRP.PR.F have FloatingResets of any appreciable liquidity. These two pairs are plotted with the coordinates (2.89 years, 3.62%) and (2.39 years, 4.22%) respectively. So there’s a certain amount of danger that plots could change appreciably if the upcoming conversion options result in FloatingResets that are highly liquid. Be warned!

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:

Estimate of FloatingReset (received in exchange for IFC.PR.A) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 3.50% 4.00% 4.50%
IFC.PR.A 17.50 172bp 17.87 18.36 18.85

Similarly, for BAM.PF.J:

Estimate of FloatingReset (received in exchange for BAM.PF.J) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 3.50% 4.00% 4.50%
BAM.PF.J 24.10 310bp 24.47 24.97 25.47

Similarly, for BAM.PR.Z:

Estimate of FloatingReset (received in exchange for BAM.PR.Z) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 3.50% 4.00% 4.50%
BAM.PR.Z 21.82 296bp 22.16 22.67 23.16

Similarly, for BPO.PR.I:

Estimate of FloatingReset (received in exchange for BPO.PR.I) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 3.50% 4.00% 4.50%
BPO.PR.I 19.67 323bp 20.02 20.49 20.96

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to trade above the price of their FixedReset counterparts. Therefore, I recommend that holders of IFC.PR.A, BAM.PF.J, BAM.PR.Z and BPO.PR.I convert their holdings to the corresponding FloatingResets. 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.

Readers who are not as Assiduous as they should be occasionally get upset at my conversion recommendations because I make no attempt whatsoever to make my own estimate of the average 3-month bill rate for the next five years and tailor a recommendation accordingly. I do not do this because it cannot be done with any degree of conviction whatsoever; anybody who tells you that they can reliably predict market yields five years in advance is a charlatan. Market Timing is a snare and delusion; financial markets form a chaotic system in which things that have no rational relevance today can be the driving forces tomorrow. I did not predict the market effects of the COVID pandemic six months before it happened; I did not predict the market effects of the Russian invasion of Ukraine six months before it happened, either; I don’t know anybody who did. All we can ever do is compare similar instruments and attempt an educated guess about relative value; for example IFC.PR.A vs. its possible Floating Rate counterpart. Comparing either one of them with cash or equity over the short term is an exercise in futility.

So what to do? Construct your portfolio to meet your needs and your risks, based on the long-term characteristics of the various alternatives. If, for instance, you are financing your position with a variable rate mortgage based on prime (not a wise move, but some people do it), your lower risk (higher certainty) option is the FloatingReset, as it will reset every three months in accordance with the three month bill rate, which is closely related to prime. Prime and the three month bill rate are similar instruments; prime and the five-year bond rate are less similar; prime and equity prices are highly dissimilar. My purpose in making these ‘convert or hold’ recommendations is to show the potential for short term trading gains between the FixedReset and its FloatingReset counterpart which are, as previously noted, similar instruments. Thus, for instance, if your portfolio requirements indicate that the FixedReset instrument is better suited for you, you might wish to elect to convert to the FloatingReset anyway; this would be reasonable (but not guaranteed!) to the extent that you have a reasonable (but not guaranteed!) expectation that the FloatingReset will be trading higher than the FixedReset for a long enough period to allow you to swap the issues on the market and maybe take out $0.25/share on the swap.

That’s how you make money in the market, taking out small profits as many times as opportunity permits. That’s what proprietary traders (and properly operated hedge funds, deserving of the name) do – and proprietary trades, backed with sufficient capital, are the only group of market participants that consistently make profits.

Those who wish to convert are advised that the deadline for notifying the company of such a desire is 5:00 p.m. (Toronto time) on December 16, 2022 for each of these issues. Brokers and other intermediaries generally set their internal deadlines a day or two in advance of this date, so if you wish to convert there’s no time to waste! Note that brokers will, in general, try to execute the instruction on a ‘best efforts’ basis if received between the two deadlines, provided that the procrastinating shareholder grovels entertainingly enough.

8 Responses to “IFC.PR.A, BAM.PF.J, BAM.PR.Z, BPO.PR.I : Convert or Hold?”

  1. Prefhound says:

    Thank you for this James. Thoughtful as always. I’m an owner of BPO.PR.I $19.74 close Dec 9) so I’m wondering whether to take my 8% fixed yield for 5 years or something based on a floating rate. I agree that you and I can’t forecast the future of interest rates, but, if the market is attempting to, then we had better factor that into where we expect the floater from BPO.PR.I to trade.

    Our next exchange date is in 5 years – the right hand side of your figure on Breakeven 3 month bill rates where there is no market data. The question really boils down to whether this figure has a slope significantly different from zero. I’m sure that under normal conditions and your experience with doing these analyses for a decade, the slope is usually not significantly different from zero.

    If one interprets the data to say the market expects zero slope then use the current average market rate of around 4.25% for 2027 and BPO.PR.I could be exchanged for the floater for a handsome $1 gain.

    On the other hand, if the slope is significantly different from zero, it seems to be pointing downward, with a eyeballed Dec 2027 Breakeven rate of maybe 2.5 to 3% – call it 2.75%. Plug that into the forecast immediate trading price of the floater and one gets $19.32, which is BELOW the BPO.PR.I Price, so the swap into floater would not be helpful.

    For interest, a linear regression through all the data in the BreakEven Plot gives BreakEven Yield = 2.5 +/- 0.5% in 5 years with a slope of -0.77% per year +/- 0.23%. (to get these error estimates, set the data up so the intercept is 2027 and standard excel functions will generate the error estimates. Since the ratio Slope/StDev of Slope is Z= -3.36 Which means the probability the Slope is actually zero is <1%. 2.5% implied Breakeven corresponds to a floater price of $19.08.

    Market participants have a variety of ways of expressing their views of future interest rates and their averages over time. In the current inverted GOC curve, GOC-5 around 3% may be a decent indicator of the market expectations of the average 3 month yield until the next reset date. That might push the floater price up to $19.55.

    All three of these simplistic methods to assess the future market price of the floater from BPO.PR.I lead to potential losses on a swap from fixed to floating. So, wouldn't a betting person place his bet on the market being consistent (ONLY in the short term) and conclude that the BPO.PR.I floater might not be appealing nor even get the requisite 1M Share minimum conversion, so the question of its trading price might not get answered?

  2. Fuzzybear says:

    Interesting analysis from both. I also hold the BPO.PR.I, recently purchased (and disappointed by the effects of Powell’s dovish turn, which probably cost 15bps on the rate-setting date).

    When you look at the price of other floating rate offerings, they do not entirely seem to reflect the current high interest rates, though comparing against other offerors is challenging, and the reset rates on matched pairs – e.g., FFH.PR C/D – may be affected by an old reset rate vs. the recent move in interest rates. In fact, for most of the period (affected, of course, by really low rates, particularly on the front end of the curve) the floating rate FFH product did worse. It has since come into its own and is now doing better than its fixed rate cousin. The spread is 315 on both (vs. 5 yr. for C and 3-month T-bills on D), so not much different than BPO.

    For BPO, the reset rate, based on current prices, produces a healthy 8.0%+ dividend. If you’ve purchased in this current market (trading between ~19.25 – 20.00), that’s pretty good; the share has the added value of a 4.85% floor. (As an aside, pref shares seem unbelievably out of favour – locking up an 8% dividend, with the potential for some capital appreciation, why don’t pref shares form something of a base in more portfolios?)

    If you successfully convert, the effective dividend yield for the first quarter will be north of 9% (YOC) – but you then wear the risk of interest rate fluctuations noted by Prefhound. If interest rates are “higher for longer”, then you might do very well. And, you can always transition back in 2027 if rates move solidly against you (which would wipe out any notional capital loss, if that occurs).

    Alternatively – and I think this is suggested in the post – if the floating rate issue moves up, you can always trade out of the floating rate stock, pocket the profit, and move into the fixed rate product. Assuming you are trading through a discount broker, the friction is minimal (in some platforms – NatBank and WealthSimple, it’s zero).

    It’s not clear that the chance to do this will emerge – there’s no existing body of JJ shares, so holders representing at least 1,000,000 shares will need to elect to do the switch. This will be interesting to watch. It also will be interesting to track if conversion occurs, to see how theory plays out in the markets.

  3. Prefhound says:

    Thanks for your thoughts Fuzzy. I would only note that “friction” is much much higher than trading commission as bid-ask spreads are substantial and there isn’t much trading volume (and will be less in a small floater issue).

  4. stusclues says:

    “Assuming you are trading through a discount broker, the friction is minimal (in some platforms – NatBank and WealthSimple, it’s zero).”

    My kids use WealthSimple. They cannot buy preferred shares or many less-liquid commons.

  5. Fuzzybear says:

    Agreed that the lack of liquidity in the pref share world can be a problem. “At the market” bids are for these shares could be dangerous…and the spreads can be big.

    Interesting that Wealthsimple does not permit trading in pref shares – not sure the rationale there, but it may have to do with their actual funding model (i.e., how the service is really paid for).

    Does NatBank’s site have a similar restriction?

  6. […] IFC.PR.A will reset at 4.841% effective 2022-12-31. IFC.PR.A was issued as a FixedReset, 4.20%+172, that commenced trading 2011-7-12 after being announced 2011-6-22. IFC.PR.A reset at 3.396% effective December 31, 2017, and I recommended against conversion. There was no conversion. In 2022 I recommended conversion. […]

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