EMA.PR.C To Reset At 4.721%

Emera Incorporated has announced:

the applicable dividend rates for its Cumulative Rate Reset First Preferred Shares, Series C (the “Series C Shares”) and Cumulative Floating Rate First Preferred Shares, Series D (the “Series D Shares”), in each case, payable if, as and when declared by the Board of Directors of the Company:
• 4.721% per annum on the Series C Shares ($0.29506 per Series C Share per quarter), being equal to the sum of the Government of Canada bond yield as at July 16, 2018, plus 2.65%, payable quarterly on the 15th of February, May, August and November of each year during the five-year period commencing on August 15, 2018 and ending on (and inclusive of) August 14, 2023; and
• 4.1140% on the Series D Shares of the Company (the “Series D Shares”) for the three-month period commencing on August 15, 2018 and ending on (and inclusive of) November 14, 2018 ($0.25924 per Series D Share for the quarter), being equal to the sum of the three-month Government of Canada treasury bill yield rate as at July 16, 2018, plus 2.65% (calculated on the basis of the actual number of days elapsed during the quarter divided by 365), payable on the 15th of November 2018. The quarterly floating dividend rate will be reset every quarter.

Holders of the Series C Shares have the right, at their option, to convert all or any of their Series C Shares, on a one-for-one basis, into Series D Shares on August 15, 2018 (the “Conversion Date”). On such date, holders who do not exercise their right to convert their Series C Shares into Series D Shares will continue to hold their Series C Shares. The foregoing conversion right is subject to the following:
• if the Company determines that there would be less than 1,000,000 Series D Shares outstanding on the Conversion Date, then holders of Series C Shares will not be entitled to convert their shares into Series D Shares, and
• alternatively, if the Company determines that there would remain outstanding less than 1,000,000 Series C Shares on the Conversion Date, then all remaining Series C Shares will automatically be converted into Series D Shares on a one-for-one basis on the Conversion Date.

Beneficial owners of Series C 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 runs from July 16, 2018 until 5:00 p.m. (EDT) on July 31, 2018.

EMA.PR.C is a FixedReset, 4.10%+265, that commenced trading 2012-6-7 after being announced 2012-5-29. The extension was announced 2018-07-06. DBRS discontinued coverage of Emera in June, 2016. The preferreds are rated P-2(low) by S&P. It is tracked by HIMIPref™ but relegated to the Scraps subindex on credit concerns.

Note that the July 31 notification deadline is that of the company; brokers will normally set their internal deadlines a day or two in advance of this date – so check, well in advance! If you miss the brokers’ deadline, but still have time to make the company deadline, brokers will usually attempt the conversion on a ‘best efforts’ basis, provided you grovel in a sufficiently entertaining fashion.

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., EMA.PR.C 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 appears to be relatively uninterested in floating rate product; the implied rates until the next interconversion are approximately equal to the current 3-month bill rate and the averages for investment-grade and junk issues reflect this, at +1.49% and +1.21%, 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 EMA.PR.C 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 EMA.PR.C) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 2.00% 1.50% 1.00%
EMA.PR.C 23.60 265bp 23.53 23.02 22.51

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to be cheap and trading below the price of their FixedReset counterparts. Therefore, it seems likely that I will recommend that holders of EMA.PR.C continue to hold the issue and not to convert, but I will wait until it’s closer to the July 31 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.

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