CIU.PR.A : Analyze as Junior to Series Second

This post arises from inquiries I made subsequent to their debenture issue.

CU Inc. is a wholly owned subsidiary of Canadian Utilities Limited and in turn controls several operating utilities of its own.

Consolidated financial statements therefore bring with them a certain amount of confusion when considering their two series of preferred shares.

The “Series Preferred Shares” currently have only one series outstanding, which is CIU.PR.A. There also exist the “Series Second Preferred Shares”, of which Series U and Series V are outstanding.

Bearing in mind the language from the CIU.PR.A prospectus (bolding added):

In the event of the liquidation, dissolution or winding up of the Corporation, or other distribution of assets of the Corporation among its shareholders for the purpose of winding-up its affairs, the holders of the Series 1 Preferred Shares shall be entitled to receive the amount paid up on such shares together with all accrued and unpaid cumulative preferential dividends thereon and, if such liquidation, dissolution, winding-up or distribution is voluntary, a premium of $1.00 per share if such event commences prior to June 1, 2009, and, if such event commences thereafter, a premium equivalent to the premium payable on redemption if such shares were to be redeemed at the date of commencement of any such voluntary liquidation, dissolution, winding-up or distribution, before any amount shall be paid or any property or assets of the Corporation shall be distributed to the holders of any Class A non-voting shares or Class B common shares or other shares ranking junior to the Series 1 Preferred Shares. After payment to the holders of the Series 1 Preferred Shares of the amounts so payable to them, they shall not be entitled to share in any further distribution of the property or assets of the Corporation.

It seems reasonable to ask: are the “Series Second Preferred Shares” junior, senior or parri passu with the Series 1 Preferred Shares?

It turns out – as is not made clear in any financial statements or prospectus that I’ve been able to find – that the “Series Second Preferred Shares” are actually issued by CU Inc.’s subsidiaries and are held by Canadian Utilities (the parent). So what happens if disaster strikes? It’s something of a persnicketty question to be asking of a utility holding company, to be sure … but disaster can strike at any time and as fixed income investors, we seek to ensure it strikes somebody else.

I have been unable to determine just which of CU Inc’s subsidiaries have issued the “Series Second”, so let’s analyze this generically – assume that CU Inc holds all the common equity in SubPref and SubPlain. Canadian Utilities (“Parent”) owns all the common of CU Inc, and all the preferreds issued by SubPref. We – public preferred share holders – hold all the preferreds issued by CU Inc. Let’s look at some scenarios.

CU Inc dragged down by bankruptcy of SubPref: All the common equity in SubPref has been lost; there is only enough to cover SubPrefs Preferreds. Parent gets paid off for its preferreds; CU Inc gets nothing; it is conceivable that CIU.PR.A holders get nothing. In this case, we may regard the SubPref Preferreds to be at least parri passu and possibly senior to CIU.PR.A

CU Inc dragged down by bankruptcy of SubPlain: All the common equity in SubPlain is gone; this loss could be enough to wipe out CU Inc’s common and Preferred equity, as the value of the SubPref equity is just enough to cover CU Inc’s senior debt. However, Parent still has an interest in the SubPref preferreds. Again, the Series Second is at least parri passu and possibly senior to CIU.PR.A

Even worse bankruptcy of SubPref: All the common AND all the preferred equity of SubPref is wiped out, but SubPlain has enough equity to pay off CIU.PR.A. In this scenario, anyway, CIU.PR.A is at least parri passu and possibly senior to “Series Second”.

So, we look at this … the first two scenarios, at a glance, look more believable than the third, in the absence of any numbers, anyway. In any event, given the absence of deconsolidated statements, we have to believe that the first two scenarios are possible … and since these are the worst-case scenarios, gloomy fixed income investors such as ourselves will assume they’re likely.

Therefore, I suggest that anybody constructing a table of asset coverage ratios for operating company preferreds should assume that CIU.PR.A is junior to “Series Second” and therefore is protected only by the common equity buffer. Drat! The coverage would have been 10% higher if we had comfort that they were, in fact, senior.

This assumption of Junior status can be contradicted at any time that Atco / Canadian Utilities / CU Inc. chooses to make deconsolidated statements available. However, what puzzles me is the question of why this situation exists in the first place. Why is Canadian Utilities Inc. insisting on holding a claim in ultimate subsidiaries that is senior to the claim of an intermediate subsidiary? It doesn’t show a lot of confidence in the viability of the ultimate subsidiaries, and leaves investors in the intermediate subsidiary with the possibility that they will be left holding the baby.

It may be a regulatory thing … it may be a tax thing. The company does not see fit to address the issue.

Please note! This is Finance Geek stuff! CU Inc is rated Pfd-2(high) by DBRS and P-2(high) by S&P and I have no quarrels with these ratings … although I would like to see some of that material non-public information that the company may selectively disclose to these agencies to assist them to a favourable conclusion.

Update: See also previous post for CIU.PR.A

2 Responses to “CIU.PR.A : Analyze as Junior to Series Second”

  1. […] should be analyzed as junior to the series second showing on their […]

  2. […] am not a big fan of this interlocking preferred share structure – it makes credit analysis more difficult and makes me wonder why they aren’t injecting capital into their operating subs via common […]

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