PrefBlog

National Bank of Canada has announced:

the dividend rates applicable to the Non-Cumulative 5-Year Rate Reset First Preferred Shares, Series 30 (the “Series 30 Preferred Shares”) and the Non-Cumulative Floating Rate First Preferred Shares, Series 31 (the “Series 31 Preferred Shares”).

Holders of Series 30 Preferred Shares, should any remain outstanding after May 15, 2019, will be entitled to receive fixed rate non-cumulative preferential cash dividends on a quarterly basis, as and when declared by the Board of Directors of the Bank and subject to the provisions of the Bank Act (Canada). The dividend rate for the five-year period commencing on May 16, 2019 and ending on May 15, 2024 will be 4.025%, being equal to the sum of the five-year Government of Canada Bond yield (1.625%) plus 2.40%, as determined in accordance with the terms of the Series 30 Preferred Shares.

Holders of Series 31 Preferred Shares, should any be issued on May 15, 2019, 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 the Bank and subject to the provisions of the Bank Act (Canada). The dividend rate for the three-month period commencing on May 16, 2019 and ending on August 15, 2019, will be 4.060%, being equal to the sum of the 90-day Government of Canada Treasury Bill yield (1.66%) plus 2.40%, calculated on the basis of actual number of days elapsed in such quarterly floating rate period divided by 365, as determined in accordance with the terms of the Series 31 Preferred Shares.

Holders of the Series 30 Preferred Shares have, subject to certain conditions, the right to convert all or part of their Series 30 Preferred Shares on a one-for-one basis into Series 31 Preferred Shares on May 15, 2019.

Beneficial owners of Series 30 shares who wish to exercise their conversion right should communicate as soon as possible with their broker or other nominee and ensure that they follow their instructions in order to meet the deadline to exercise such right, which is April 30, 2019 at 5:00 p.m. (EST).

They previously announced (on March 18):

that it does not intend to exercise its right to redeem all or part of the currently outstanding 14,000,000 Non-Cumulative 5-Year Rate Reset First Preferred Shares, Series 30 (the “Series 30 Preferred Shares”) on May 15, 2019. As a result, subject to certain conditions, the holders of the Series 30 Preferred Shares have the right to convert all or part of their Series 30 Preferred Shares on a one-for-one basis into Non-cumulative Floating Rate First Preferred Shares Series 31 (the “Series 31 Preferred Shares”) on May 15, 2019 in accordance with the terms of the Series 30 Preferred Shares described in the prospectus supplement dated January 31, 2014 to the short form base shelf prospectus dated October 5, 2012.

Holders of Series 30 Preferred Shares who do not exercise their right to convert their Series 30 Preferred Shares into Series 31 Preferred Shares on May 15, 2019 will retain their Series 30 Preferred Shares.

The foregoing conversions are subject to the conditions that: (i) if National Bank determines that there would remain outstanding on May 15, 2019 less than 1,000,000 Series 31 Preferred Shares, after having taken into account all Series 30 Preferred Shares tendered for conversion into Series 31 Preferred Shares, then holders of Series 30 Preferred Shares will not be entitled to convert their shares into Series 31 Preferred Shares, and (ii) alternatively, if National Bank determines that there would remain outstanding on May 15, 2019 less than 1,000,000 Series 30 Preferred Shares, after having taken into account all Series 30 Preferred Shares tendered for conversion into Series 31 Preferred Shares, then all remaining Series 30 Preferred Shares will automatically be converted into Series 31 Preferred Shares without the consent of the holders on May 15, 2019.

In either case, National Bank shall give a notice to that effect to all registered holders of Series 30 Preferred Shares no later than May 8, 2019.

On April 15, 2019, National Bank will give notice of:

i. the annual fixed dividend rate applicable to the Series 30 Preferred Shares to which a holder of Series 30 Preferred Shares will be entitled for the 5-year period from May 16, 2019 up to and including May 15, 2024; and

ii. the floating quarterly dividend rate applicable to the Series 31 Preferred Shares to which a holder of Series 31 Preferred Shares will be entitled for the 3-month period from May 16, 2019 up to and including August 15, 2019.

Beneficial owners of Series 30 shares who wish to exercise their conversion right should communicate with their broker or other nominee to obtain instructions for exercising such right during the conversion period, which will run from April 15, 2019 until April 30, 2019 at 5:00 p.m. (EST).

NA.PR.S is a NVCC-compliant FixedReset, 4.10%+240, that commenced trading 2014-2-7 after being announced 2014-1-29. It is tracked by HIMIPref™ and assigned to the FixedResets-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., NA.PR.S 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 has lost its fleeting enthusiasm for floating rate product; the implied rates until the next interconversion are below the current 3-month bill rate as the averages for investment-grade and junk issues are at +0.68% and +1.42%, 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 NA.PR.S 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 below the price of their FixedReset counterparts, NA.PR.S. Therefore, it seems likely that I will recommend that holders of NA.PR.S continue to hold the issue and not to convert, but I will wait until it’s closer to the April 30 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 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 Wednesday, April 17th, 2019 at 1:01 am 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.