AQN.PR.A To Reset At 5.162%

Algonquin Power & Utilities Corp. has announced (emphasis added):

the applicable dividend rates for its Cumulative 5-Year Rate Reset Preferred Shares, Series A (the “Series A Preferred Shares”) and Cumulative Floating Rate Preferred Shares, Series B (the “Series B Preferred Shares”).

With respect to any Series A Preferred Shares that remain outstanding after December 31, 2018, holders thereof will be entitled to receive quarterly fixed cumulative preferential cash dividends, if, as and when declared by the board of directors of the Company (the “Board”). The dividend rate for the 5-year period from and including December 31, 2018 to but excluding December 31, 2023 will be 5.162%, being equal to the 5-year Government of Canada bond yield determined as of today plus 2.94%, in accordance with the terms of the Series A Preferred Shares.

With respect to any Series B Preferred Shares that may be issued on December 31, 2018, holders thereof will be entitled to receive quarterly floating rate cumulative preferential cash dividends, if, as and when declared by the Board. The dividend rate for the 3-month floating rate period from and including December 31, 2018 to but excluding March 31, 2019 will be 4.653%, being equal to the 3-month Government of Canada Treasury Bill yield determined as of today plus 2.94%, calculated on the basis of the actual number of days in such quarterly period divided by 365, in accordance with the terms of the Series B Preferred Shares.

Beneficial owners of Series A Preferred Shares who wish to exercise their conversion right should communicate with their broker or other nominee to ensure their instructions are followed so that the registered holder of the Series A Preferred Shares can meet the deadline to exercise such conversion right, which is 5:00 p.m. (EST) on December 17, 2018.

AQN.PR.A is a FixedReset, 4.50%+294, that commenced trading 2012-11-9 after being announced 2012-10-25. The 2018-11-28 notice of extension was reported on PrefBlog. The issue is tracked by HIMIPref™, but relegated to the Scraps – FixedReset Discount index on credit concerns.

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., AQN.PR.A 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 becoming relatively more interested in floating rate product; the implied rates until the next interconversion are above the current 3-month bill rate as the averages for investment-grade and junk issues are at +2.03% and +2.18%, 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 AQN.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 AQN.PR.A) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 2.50% 2.00% 1.50%
AQN.PR.A 20.37 294bp 20.64 20.16 19.68

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, AQN.PR.A. Therefore, it seems likely that I will recommend that holders of AQN.PR.A continue to hold the issue and not to convert, but I will wait until it’s closer to the December 17 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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