FTS.PR.M To Reset At 3.913%

Fortis Inc. has announced that it (on November 1, although only on its share information page, not as a press release):

provides notice to the holders of its Cumulative Redeemable Fixed Rate Reset First Preference Shares, Series M of the Corporation (the “Series M Shares”) of the following dividend rates, in each case payable if, as and when declared by the Board of Directors of the Corporation:

i. $0.2445625 per Series M Share, being the fixed dividend rate payable quarterly on the first day of March, June, September and December of each year during the five-year period from and including December 1, 2019 to but excluding December 1, 2024; and

ii. $0.25816575 per share on the Cumulative Redeemable Floating Rate First Preference Shares, Series N of the Corporation (the “Series N Shares”), being the floating dividend rate applicable to the Series N Shares for the 3-month period from and including December 1, 2019 and ending on and including February 29, 2020, in each case determined in accordance with the corresponding rights, privileges, conditions and restrictions attached to the Series M Shares and Series N Shares, respectively, as a class, as set out in the short form prospectus of the Corporation dated September 11, 2014 relating to the issuance of the Series M Shares.

Beneficial owners of Series M Shares wishing to convert to Series N Shares should communicate with their broker or other nominee to obtain instructions for exercising such right during the conversion period, which runs from November 1, 2019, until 5:00 p.m. (EST) on November 18, 2019.

Inquiries should be directed to Ms. Karen Gosse, Vice President, Treasury and Planning, Fortis at 709.737.2865.

FTS.PR.M is a FixedReset, 4.10%+248, that commenced trading 2014-9-19 after being announced and supersized 2014-9-3. The issue is tracked by HIMIPref™ but is relegated to the Scraps – FixedResets (Discount) subindex.

Note that the reset rate is inconsistent with the rate for ENB.PF.A and the rate for PPL.PR.G; it has been shown on PrefBlog that FixedReset Prospectuses Are Imprecise!

I am pleased to note that Fortis has reconsidered its previous policy of selective disclosure.

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., FTS.PR.M 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). Inspection of the graph and the overall average break-even rates for extant pairs will provide a guide for estimating the break-even rate for the pair now under consideration assuming, of course, that enough conversions occur so that the pair is in fact created.

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The market has lost enthusiasm for floating rate product; the implied rates until the next interconversion are generally well below the current 3-month bill rate as the averages for investment-grade and junk issues are at +0.47% and +1.44%, respectively, after removal of the outlying pair FFH.PR.C / FFH.PR.D from the junk group. 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 FTS.PR.M 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 FTS.PR.M) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 1.50% 1.00% 0.50%
FTS.PR.M 17.31 248bp 17.38 16.88 16.39

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, FTS.PR.M. Therefore, it seems likely that I will recommend that holders of FTS.PR.M continue to hold the issue and not to convert, but I will wait until it’s closer to the November 18 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 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.

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