RE:RE:RE:RE:RE:RE:RE:RE:Preferred share exchange
Lets take an example relatable to this Pref Exchange offer (TA.PRF, C Series). In 2012, your son asks you for $10,000 to build some windfarms. Hell sell you 400 shares worth $10k and will pay you 4.6% for the next 5 years ($460 / year; $1.15 / share). In 5 years, if his business is doing well, he will buy your shares back for $25 and give your $10k back to you. If however, he still requires your capital and being sensitive to inflation fluctuations throughout the world, he will reset the interest rate to GOC5YR + 3.1%
Due to the popularity of these type of financing arrangements, you cant resell the shares your son issued to you on the open market without taking a capital loss as everyone else is issuing at higher yields. Early Dec 2016 and the open market price is $15 / share (Capital loss if sold of $4k, and cumulative dividends of ~$1,840). Effective yield on the open market is 7.7% if someone bought these for $15 while collecting $1.15 / yr.
The reset date is fast approaching in 2017 and you are paying attention to the rapidly increasing GOC5YR as investors around the world are slowly waking up to the fact debt isnt free. ( https://www.bankofcanada.ca/rates/interest-rates/canadian-bonds/). In Dec 2016, the GOC5YR is 1.2%. If the shares were to reset at 1.2% (+3.1%), the effective reset yield is 4.3%, or $1.075 / share. Youve been collecting $1.15 / share / yr on the original debt deal so a small change isnt a big deal. New effective yield on the open market assuming a $15/share would have been 7.17% (1.075/15)
BUT!! Your son gets an idea to save his company $300MM off of his books by recognizing that these shares are significantly undervalued in the open market. He comes up with a great idea to consolidate all of his shares into a new series paying 6.5% or $1.625 / share / yr. Initially you think this is a great deal as youre getting more monthly income, however, you soon realize that you wont have your original 400 shares that he gave you, instead, youll only have 282 shares issued at a new base price of $25 (almost guaranteeing a capital loss).
Your yearly income used to be $460 / yr on 400 shares, with the expectation that they would reset in 2017 for a new yearly income of $430. Instead, he is proposing to issue you only 282 shares for a yearly income of $458 until 2022.
Sounds great until the time comes when interest rates normalize and companies prefer to issue bonds vs pref shares and would rather cancel the issues at $25. Assume in 2022 that your sons company is doing well and decides to pay you back.
Original Deal
Lend $10k in 2012
Collect $460 / yr on 400 shares until 2017
shares reset and yield $430 / yr
Company buys them back in 2022 for $25
-$10,000
+$460 / yr x 5 yrs
+$430 / yr x 5 yrs
+$10,000
= $4,450 profit
New Deal (Pref Exchange)
Lend $10k in 2012
Collect $460 / yr on 400 shares until 2017
Exchange Shares. Now have 282 Shares and yield $458 / yr
Company buys them back in 2022 for $25
-$10,000
+$460 / yr x 5 yrs
+$458 / yr x 5 yrs
+$7,050 (282 shares x $25)
= $1,640 profit
This is a terrible deal and urge everyone to vote NO on the exchange. There is a reason why TA is forecasting a $300MM savings.