Category: Issue Comments

DBRS has announced that it:

has today placed the BBB Issuer Rating and the Medium-Term Notes (MTNs) rating and the Pfd-3 Preferred Shares – Cumulative rating of AltaGas Ltd. (AltaGas or the Company) Under Review with Developing Implications. These rating actions follow the announcement that the Company has agreed to acquire WGL Holdings Inc. (WGL) for a total consideration of CAD 8.4 billion, including assumption of CAD 2.4 billion of debt (the Acquisition). The Acquisition is subject to WGL shareholders and certain regulatory and government approvals. The Acquisition is expected to close by the end of the second quarter of 2018.
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DBRS notes that there is execution risk associated with the Acquisition. In addition to a shifting political climate in the United States, there is execution risk associated with regulatory, government hurdles and the financing plan. The expectation of the Acquisition closing in approximately 18 months considers the regulatory and political risks. Regulatory approvals are required from three separate public utility commissions in Virginia, Maryland and District of Columbia, the Federal Energy Regulatory Commission (FERC), the Committee on Foreign Investment in the United States (CFIUS), and expiration or termination of any applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the satisfaction of customary closing conditions. There is also execution risk with respect to generating expected proceeds from the proposed sale of AltaGas assets to finance the acquisition.

WGL has a reasonably healthy financial profile supported largely by its diverse and growing regulated utility operations. On a pro forma basis, DBRS expects initial pressure on AltaGas consolidated credit metrics at the close of the Acquisition in 2018 as a result of higher debt levels, including debt at WGL. Ratings could be pressured should the timing and amount of asset sales envisaged in the preliminary financing plan not materialize, as this could result in higher leverage. There is also currency risk associated with the USD 4.95 billion bridge credit facility. As the financing plan at closing of the Acquisition could change based on the timing, amounts and execution of the planned asset sales, the impact on the Company’s financial risk assessment (FRA) is uncertain at this time.

DBRS has placed the ratings of AltaGas Under Review with Developing Implications, considering the execution risks and uncertainties surrounding the financing plan. As noted in the latest DBRS rating report dated November 14, 2016, DBRS expects AltaGas to fund its growth projects and acquisitions with a prudent mix of debt and equity in order to maintain the company’s debt-to-capital ratio in the low 50% range. DBRS will further review the Company’s ratings as more information becomes available and aims to resolve the Under Review status of the ratings once financing details are known and the Acquisition has closed.

AltaGas has several issues of preferred shares outstanding, the most recently issued being ALA.PR.I, which commenced trading in November, 2015. Affected issues are ALA.PR.A, ALA.PR.B, ALA.PR.E, ALA.PR.G and ALA.PR.I.

Implied Volatility analysis yields the following chart:

Brookfield Infrastructure has announced:

the completion of its previously announced issue of Cumulative Class A Preferred Limited Partnership Units, Series 7 (“Series 7 Preferred Units”) in the amount of $300,000,000. The offering was underwritten by a syndicate led by CIBC Capital Markets, RBC Capital Markets, Scotiabank, and TD Securities Inc.

Brookfield Infrastructure issued 12,000,000 Series 7 Preferred Units at a price of $25.00 per unit, for total gross proceeds of $300,000,000. Holders of the Series 7 Preferred Units will be entitled to receive a cumulative quarterly fixed distribution yielding 5.00% annually for the initial period ending March 31, 2022. Thereafter, the distribution rate will be reset every five years at a rate equal to the greater of: (i) the 5-year Government of Canada bond yield plus 3.78%, and (ii) 5.00%. The Series 7 Preferred Units will commence trading on the Toronto Stock Exchange this morning under the ticker symbol BIP.PR.D.

BIP.PR.D is a FixedReset, 5.00%+378M500, ROC + Interest, announced January 19. It will be tracked by HIMIPref™ and has been assigned to the FixedReset subindex.

The issue traded 1,272,999 shares today in a range of 25.05-19 before closing at 25.15-17, 10×30. Vital statistics are:

Implied Volatility analysis yields the following chart:

Update, 2017-10-11: Note that according to the prospectus, available on SEDAR under “Brookfield Infrastructure Partners L.P. Jan 19 2017 19:48:49 ET Prospectus (non pricing) supplement – English PDF 525 K”:

The reclassification of a Series 7 Preferred Unit into a Series 8 Preferred Unit or a Series 8 Preferred Unit into a Series 7 Preferred Unit, whether pursuant to an election made by the Resident Holder or pursuant to an automatic reclassification, may be considered to be a disposition of the Series 7 Preferred Unit or Series 8 Preferred Unit by the Resident Holder. The CRA’s position is that the conversion of an interest in a partnership into another interest in the partnership may result in a disposition of the partnership interest by the holder if the conversion results in a significant change in the rights and obligations of the holder in respect of the converted interest, including a significant change in the
percentage interest in the profits of the partnership. Whether or not the reclassification of Series 7 Preferred Units into Series 8 Preferred Units or Series 8 Preferred Units into Series 7 Preferred Units would result in a significant change in the percentage interest of a Resident Holder in the profits of the Partnership is a question of fact that depends upon the facts and circumstances that exist at the time of the reclassification.

TransAlta Corporation has announced:

that it has filed a Management Information Circular (the “Information Circular”) with respect to the previously announced transaction pursuant to which all the currently outstanding first preferred shares in the capital of the Corporation (the “Existing Preferred Shares”) are proposed to be exchanged (the “Preferred Share Exchange”) for shares in a single new series of cumulative redeemable minimum rate reset first preferred shares, Series 1, in the capital of the Corporation (the “New Preferred Shares” or “Series 1 Preferred Shares”) pursuant to a plan of arrangement (the “Arrangement”).

Following the announcement of the proposed Arrangement, the Corporation decided to increase the premium on the Series A preferred shares resulting in an increase in the exchange ratio for the Series A preferred shares to 0.530 which represents an implied offer premium of 10.9% relative to the December 16, 2016 closing price for the Series A preferred shares on the Toronto Stock Exchange (the “TSX”). This increase more appropriately aligns the premium offered to Series A preferred shareholders to the premium offered to holders of other series of Existing Preferred Shares. The Corporation believes this adjustment will increase preferred shareholder support of the proposed Arrangement while maintaining fairness for holders of all other series of Existing Preferred Shares.

The exchange ratios of the Series B preferred shares, Series C preferred shares, Series E preferred shares and Series G preferred shares remain unchanged at 0.550, 0.705, 0.790 and 0.820, respectively. These ratios provide premiums in the range of 13% to 17%.

In a breathtaking display of disinformation, they claim:

Implied Offer Premia Ranges from 11% to 17%. In addition to the minimum floor protection, the Arrangement also offers a premium of 11% to 17% depending on the series of Existing Preferred Shares held (based on their respective trading values on December 16, 2016, the last trading day on the TSX prior to the announcement of the Arrangement). The premia reflect the percentage increase of the deemed value of the Series 1 Preferred Shares over the trading price of the applicable series of Existing Preferred Shares after adjusting for the applicable exchange ratio. Please refer to the table at the bottom of this section for details of the calculations.

Part of the “table at the bottom of this section” is:

	Series A	Series B	Series C	Series E	Series G
Number of Shares Outstanding	10,175,380	1,824,620	11,000,000	9,000,000	6,600,000
Pre-Announcement Closing Price (December 16, 2016)	$11.95	$11.75	$15.57	$16.99	$18.07
Exchange Ratio	0.530	0.550	0.705	0.790	0.820
Equivalent Exchanged Price(1)	$22.55	$21.36	$22.09	$21.51	$22.04
Series 1 Issue Price	$25.00	$25.00	$25.00	$25.00	$25.00
Offer Premium(2)	10.9%	17.0%	13.2%	16.2%	13.4%

… with the notes, inter alia:

(1) “Equivalent Exchanged Price” is calculated by dividing the trading price of each series of Preferred Shares on December 16, 2016 by the applicable exchange ratio.

(2) Premia calculated by multiplying the $25.00 issue price of Series 1 Preferred Shares by the applicable exchange ratio for each series of Existing Preferred Shares and dividing this total by the trading price of the applicable series of Existing Preferred Share on December 16, 2016.

So their touted “Offer Premium” is dependent upon a trading price for the new shares of $25.00, a dubious proposition; this is besides the fact that – according to me – the TransAlta preferreds have been undervalued given their extant terms by far more than their “Offer Premium” and I’m perfectly happy waiting for the market to agree with me.

However, what attracted my ire about the Information Circular was on page 28 of this 203 page monstrosity:

TransAlta has engaged CIBC to form and manage a group (“Soliciting Dealer Group”) consisting of members of the Investment Industry Regulatory Organization of Canada for the purpose of soliciting votes in favour of the Arrangement. TransAlta has agreed to pay each member of the Soliciting Dealer Group (a “Soliciting Dealer”) who has entered into an agreement with CIBC, a fee of $0.13 per Preferred Share for each Preferred Share that is: (a) solicited by such member of the Soliciting Dealer Group and (i) whose name appears in the appropriate place on the proxy form or the voting instruction form, or (ii) described in the solicitation claim form or electronic file submitted by such member provided that such form or file contains adequate detail with respect to the beneficial ownership of such Preferred Share; (b) voted in favour of the applicable Arrangement Resolution; and (c) exchanged pursuant to the Arrangement, provided that the solicitation fee in respect of any beneficial owner of Preferred Shares shall not be less than $52 or more than $1,500 in respect of each beneficial owner who has voted in favour of the Arrangement. The Corporation will not pay any fee with respect to Preferred Shares held for a Soliciting Dealer’s own account as principal, and solicitation fees will not be payable in respect to votes received from an applicable series of Preferred Shares if (a) the Arrangement Resolution applicable to such series is withdrawn; (b) approval of the Arrangement Resolution is not obtained; or (c) the Arrangement is not completed with respect to such series of Preferred Shares. The solicitation fee is only payable to brokers or dealers with a Canadian address and is not payable to (a) any United States broker or dealer in respect of votes received in favour of the Arrangement Resolution from forms of proxy bearing a United States address; or (b) where the registered or beneficial owner of the Preferred Shares to which such fee applies is an institutional investor. In cases where a single beneficial owner of Preferred Shares holds such Preferred Shares in the accounts of more than one broker or dealer, the $52 minimum and $1,500 maximum amounts will be applied separately in respect of such broker or dealer.

Additionally, TransAlta may use Broadridge’s QuickVote™ service to assist beneficial Preferred Shareholders with voting their Preferred Shares. Beneficial Preferred Shareholders may be contacted by Kingsdale to conveniently obtain a vote directly over the telephone. Members of the Soliciting Dealer Group can direct shareholders to Kingsdale for assistance with voting. Broadridge then tabulates the results of all instructions received and provides the appropriate instructions respecting the Preferred Shares to be represented at the Meetings.

Thirteen cents a share for a favourable vote and nothing for an unfavourable one! It’s an absolute disgrace and a disgrace that’s been obvious for years, but that’s life in Canada. At least it removes any uncertainty regarding what the banks’ employees are going to tell their clients.

TransAlta does not appear to have put the Information Circular on their website and, of course, the Canadian Securities Administrators do not allow stinking investor scum to link directly to the public documents that are filed on their website in accordance with the law. Go to SEDAR and find the document “TransAlta Corporation Jan 16 2017 22:20:08 ET Management information circular – English PDF 1585 K”.

I’ll have more to say about this on the weekend. In a nutshell, as I wrote in PrefLetter:

TransAlta has proposed a Plan of Arrangement whereby its extant preferred shares will be converted into fractional shares of a new series of FixedReset preferreds with an initial rate of 6.50% paid until December 31, 2021, which will then reset to GOC-5 + 529bp if not called (with a minimum of 6.50%). This is an appalling, abusive offer. TransAlta’s extant preferred shares are trading well below their call price, which gives them a lot of room to make impressive capital gains should market conditions improve (e.g., narrowing FixedReset spreads to GOC-5, increases in the GOC-5 yield, and improvements in the perceived credit quality of the company). The plan effectively lowers the redemption price of the preferred shares outstanding, which will allow any such gains to be scooped up by the company instead of its preferred shareholders. The pathetic amount of extra income offered by the company (which will disappear on reset with even a small increase in the GOC-5 yield) does not even begin to compensate for the huge asymmetry in investment outcomes that will be imposed if the Plan is approved.

For more commentary regarding the Plan, see https://prefblog.com/?p=34082 and https://prefblog.com/?p=34114. The table below shows the effective change in redemption price for each outstanding issue; this is determined by multiplying the new issue’s redemption price of $25.00 by the fractional consideration of these shares offered for each extant series.

Ticker	Current Dividend	Spread on Reset	Next Reset Date	Fractional Consideration	Effective Redemption Price if Plan Approved
TA.PR.D	0.67725	203	2021-3-31	0.503	12.58
TA.PR.E	Floating	203	2021-3-31	0.550	13.75
TA.PR.F	1.15	310	2017-6-30	0.705	17.62
TA.PR.H	1.25	365	2017-9-30	0.790	19.75
TA.PR.J	1.325	380	2019-9-30	0.820	20.50

The shareholder meeting to vote on the Plan is currently scheduled for February 16. I recommend that shareholders vote “No” to this appalling plan.

Note that the table above now needs an adjustment: the proposed Fractional Consideration for TA.PR.D is now 0.530 and the Effective Redemption Price is therefore 13.25.

Affected issues are TA.PR.D, TA.PR.E, TA.PR.F, TA.PR.H and TA.PR.J.

Standard & Poor’s has announced:

• •IGM Financial Inc. today announced that its subsidiary, Mackenzie Financial Corporation, has entered into an agreement to acquire a 10% interest in China Asset Management Co., Ltd. for approximately CAD$468 million.
• •In our view, given that IGM may finance a significant portion of the acquisition through the issuance of debt and/or preferred shares, we would expect the company to operate with debt to EBITDA levels closer to 1.5x compared with our previous projections of 1.0x.
• •We are placing our ‘A+/A-1+’ issuer credit ratings on IGM on CreditWatch with negative implications.
• •The CreditWatch negative indicates that we could lower the ratings of IGM upon the close of the transaction due to higher leverage. We expect to resolve the CreditWatch once the transaction is consummated, or in the event the minority acquisition plans are called off.

S&P Global Ratings said today it placed its ‘A+/A-1+’ issuer credit ratings on IGM Financial Inc. on CreditWatch with negative implications. We also placed our ‘A+’ issue-level rating on IGM’s senior unsecured debt, ‘A-‘ issue-level rating on IGM’s preferred stock, and ‘P-1 (Low)’ Canadian national scale preferred share rating on CreditWatch negative.
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As we believe, IGM intends to finance a significant portion of the acquisition through the issuance of debt and/or preferred shares, we would expect the company to operate with debt to EBITDA levels closer to 1.5x compared with our previous projections of 1.0x, and EBITDA coverage metrics between 9x and 10x compared with our previous assessment of 10x to 11x. As a result of the modest deterioration of credit protection measures, we would assess IGM’s financial risk profile to be more in line with the “modest” category compared with our previous assessment of “minimal” upon the close of the transaction. IGM does have a sizeable portfolio of investments on its balance sheet to provide additional credit protection measures beyond these metrics.

The IGM Press Release notes:

Mackenzie Investments’ interest in China AMC leverages Power Corporation of Canada’s long term presence and investment record in China which includes a 10% ownership in China AMC acquired in 2011.

The proposed transaction is expected to be accretive to IGM Financial’s earnings in the first full year of ownership. IGM Financial expects to finance the transaction with a combination of existing cash and the issuance of debt and/or preferred shares in the first half of 2017.

The transaction is expected to close in the first half of 2017, and is subject to customary closing conditions, including Chinese regulatory approvals.

Update, 2016-12-30: DBRS is more sanguine, but they’ve already got IGM a notch lower!

DBRS Limited (DBRS) today notes that it does not expect to be taking any action on IGM Financial Inc.’s (IGM) ratings following the December 29, 2016, announcement of an agreement by IGM’s subsidiary, Mackenzie Financial Corporation, to acquire a 10% interest in China Asset Management Co. Ltd (China AMC) and potentially acquire an additional 3.9% interest. The value of the acquired 10% share will be approximately $468 million.

Currently, IGM’s Issuer Rating and Unsecured Debentures rating are both A (high) and its First Preferred Shares rating is Pfd-2 (high). All trends are Stable.

p>Quadravest has announced:

Canadian Banc Corp. (the “Company”) is pleased to announce it has filed a preliminary short form prospectus with respect to an additional offering of its Preferred Shares. This offering is being led by National Bank Financial Inc.

The Preferred Shares are listed and posted for trading on the Toronto Stock Exchange (the “TSX”) under the symbol “BK.PR.A”. On December 21, 2016 the closing price of the Preferred Shares on the TSX was $10.56.

The authorized capital of the Company also consists of Class A Shares (the “Class A Shares”). On December 12, 2016 the Company declared a special capital gains dividend, payable partially in cash and partially in Class A Shares, to holders of Class A Shares of record on January 5, 2017. The special dividend will be payable on January 9, 2017, the same date the Preferred Shares will be issued under the short form prospectus. The number of Class A Shares being issued as a result of this special dividend will be equal to the number of Preferred Shares expected to be issued in the offering.

A copy of the preliminary short form prospectus will be available from National Bank Financial Inc.

BK.PR.A is tracked by HIMIPref™ but is relegated to the Scraps subindex on both volume and credit concerns.

Update, 2017-1-15: Just a few more shares:

Canadian Banc Corp. (the “Company”) is pleased to announce it has completed its Offering of 393,602 Preferred Shares at $10.35 per share for aggregate gross proceeds of $4,073,781. The Preferred Shares will trade on the Toronto Stock Exchange under the symbol BK.PR.A.

The authorized capital of the Company also consists of Class A Shares (the “Class A Shares”). The Company declared a special capital gains dividend, payable partially in cash and partially in Class A Shares, to holders of Class A Shares of record on January 5, 2017. The number of Class A Shares being issued as a result of this special dividend will be equal to the number of Preferred Shares issued in this offering.

BCE Inc. has announced:

that 2,254,079 of its 25,000,000 fixed-rate Cumulative Redeemable First Preferred Shares, Series AK (Series AK Preferred Shares) have been tendered for conversion on December 31, 2016, on a one-for-one basis, into floating-rate Cumulative Redeemable First Preferred Shares, Series AL (Series AL Preferred Shares). Consequently, BCE will issue 2,254,079 new Series AL Preferred Shares as of December 31, 2016.

The remaining Series AK Preferred Shares will continue to be listed on the Toronto Stock Exchange under the symbol BCE.PR.K. The Series AK Preferred Shares will pay on a quarterly basis, for the five-year period beginning on December 31, 2016, as and when declared by the Board of Directors of BCE, a fixed quarterly cash dividend based on an annual dividend rate of 2.954%.

The Series AL Preferred Shares will pay for each quarterly period beginning with the quarterly period from and including December 31, 2016 up to but excluding March 31, 2017, as and when declared by the Board of Directors of BCE, a quarterly floating cash dividend based on the T-Bill Rate for such quarterly period plus 1.88%, calculated in accordance with the articles of BCE. The floating dividend rate applicable to the Series AL Preferred Shares for the quarterly period beginning on December 31, 2016 is 0.58907% (annual rate of 2.389% based on an initial T-Bill Rate of 0.509%). The Series AL Preferred Shares will be listed on the Toronto Stock Exchange under the symbol BCE.PR.L and will start trading on January 3, 2017.

It will be recalled that the rate reset to 2.954% for BCE.PR.K was announced on December 1 and that I recommended that holders of BCE.PR.K not convert.

Sun Life Financial Inc. has announced

that after having taken into account all election notices received by the December 16, 2016 deadline for the conversion of its Class A Non-Cumulative Rate Reset Preferred Shares Series 12R (the “Series 12R Shares”) into Class A Non-Cumulative Floating Rate Preferred Shares Series 13QR (the “Series 13QR Shares”), there were 832,321 Series 12R Shares tendered for conversion, which is less than the one million shares required to give effect to conversions into Series 13QR Shares, meaning there will be no conversion of Series 12R Shares into Series 13QR Shares.

For the five-year period commencing on December 31, 2016 to but excluding December 31, 2021, holders of the Series 12R Shares will be entitled to receive non-cumulative preferential cash dividends on a quarterly basis, as and when declared by the Board of Directors of Sun Life Financial and subject to the Insurance Companies Act (Canada), based on an annual dividend rate of 3.806% per annum or $0.237875 per share per quarter, being equal to the sum of the 5-year Government of Canada Yield, as defined in the terms of the Series 12R Shares, on Thursday, December 1, 2016 plus 2.73%, as determined in accordance with the terms of those shares.

Subject to regulatory approval, Sun Life Financial may redeem the Series 12R Shares in whole or in part on December 31, 2021 and on the 31st of December every five years thereafter by the payment of an amount for each share so redeemed of $25.00, together with all declared and unpaid dividends to the date fixed for such redemption.

It will be recalled that the extension of SLF.PR.I was announced in November; the rate reset to 3.806% was announced on December 1 and I recommended holders not convert on December 9.

TransAlta Corporation has announced:

that its Board of Directors has approved a transaction pursuant to which all the currently outstanding first preferred shares in the capital of the Corporation are proposed to be exchanged for shares in a single new series of cumulative redeemable minimum rate reset first preferred shares, series 1, in the capital of the Corporation (the “New Preferred Shares”) pursuant to a plan of arrangement (the “Arrangement”). The terms of the New Preferred Shares will be substantially the same as the terms of the existing first preferred shares with the exception of an adjustment to the reset spread to 5.29%, a change to December 31, 2021 for the next reset date, and the addition of a minimum reset coupon rate of 6.5%.

The Corporation currently has four series of cumulative redeemable rate reset first preferred shares outstanding, being the series A shares, series C shares, series E shares and series G shares, and one series of cumulative redeemable floating rate first preferred shares outstanding, being the series B shares (collectively, the “Existing Preferred Shares”). Pursuant to the Arrangement, the outstanding Existing Preferred Shares will be exchanged for New Preferred Shares at an exchange ratio specific to each series of Existing Preferred Shares.

The Arrangement is expected to provide several benefits to holders of Existing Preferred Shares including:

• dividend volatility will be minimized as a result of the downside protection provided under the terms of the New Preferred Shares, which will include a “minimum floor” mechanism pursuant to which holders of the New Preferred Shares will have certainty that the reset coupon rate will be no lower than 6.50%;
• the dividends to be paid to holders of the New Preferred Shares are expected to be greater than the current dividends received by holders of the Existing Preferred Shares over the initial five-year reset period based on current interest rate levels;
• trading liquidity is expected to be enhanced, as the consolidation of the Existing Preferred Shares into one series of New Preferred Shares is expected to provide holders of New Preferred Shares with more flexibility and depth in the market to buy and sell such New Preferred Shares; and
• the exchange of Existing Preferred Shares for New Preferred Shares will constitute an automatic tax deferred exchange for Canadian income tax purposes. The Arrangement will, however, provide holders of Existing Preferred Shares with an option, at their election, to have the exchange occur in a manner which may allow a shareholder to realize a capital gain or a capital loss for Canadian income tax purposes.

The Arrangement is also expected to benefit TransAlta by:

reducing the Corporation’s notional capital balance of preferred shares by approximately $300 million, which strengthens the balance sheet and improves certain financial ratios; and
• providing future preferred share issuance capacity based on the equity treatment guidelines of the Corporation’s credit rating agencies.

Pursuant to the Arrangement, (i) holders of series A shares will receive 0.503 of a New Preferred Share; (ii) holders of series B shares will receive 0.550 of a New Preferred Share; (iii) holders of series C shares will receive 0.705 of a New Preferred Share; (iv) holders of series E shares will receive 0.790 of a New Preferred Share; and (v) holders of series G shares will receive 0.820 of a New Preferred Share. The New Preferred Shares will pay fixed cumulative dividends of $1.625 per share per annum, yielding 6.5% per annum, payable on the last business day of March, June, September and December of each year, as and when declared by the Board of Directors of TransAlta. The dividend rate will be reset on December 31, 2021 and every five years thereafter at a rate equal to the sum of the then five-year Government of Canada bond yield and 5.29%, provided that, in any event, such calculated rate shall not be less than 6.50%. The New Preferred Shares will be redeemable by TransAlta, at its option, on December 31, 2021 and on December 31 in every fifth year thereafter.

The Corporation will deliver an information circular, describing the proposed Arrangement in greater detail, to holders of Existing Preferred Shares entitled to vote in connection with the Arrangement, with a view to completing the Arrangement in the first quarter of 2017. Holders of Existing Preferred Shares are encouraged to review the information circular as it includes important information pertaining to the Arrangement.

The closing of the Arrangement will be subject to various conditions to be set out in the information circular, including: (i) the approval of not less than two-thirds of the votes cast in person or by proxy at a special meeting of holders of each series of Existing Preferred Shares; (ii) approval of the Arrangement by the Court of Queen’s Bench of Alberta; and (iii) any required regulatory approvals, including the listing of the New Preferred Shares on the Toronto Stock Exchange.

PricewaterhouseCoopers LLP has provided its fairness opinion that the Arrangement is fair, from a financial point of view, to holders of each series of Existing Preferred Shares. Based on the fairness opinion and after consulting with its financial and legal advisors, among other considerations, the Board of Directors of the Corporation (i) has unanimously determined that the Arrangement is in the best interests of the Corporation; (ii) has unanimously determined that the Arrangement is fair to the holders of each series of Existing Preferred Shares; and (iii) recommends that holders of each series of Existing Preferred Shares vote in favour of the Arrangement. In connection with the Arrangement, CIBC World Markets Inc. acted as the financial advisor to the Corporation and Norton Rose Fulbright Canada LLP acted as legal counsel to the Corporation.

DBRS has assigned the new issue a provisional Pfd-3 Trend-Negative rating.

The market seemed to like the proposed exchange, with TA preferred issues jumping in price:

So it looks as if prices instantly adjusted on the day to reflect a $25 trading price for the new issue, less a deal-risk discount of about 4%. So far, this is normal and unobjectionable.

The objectionable part of this plan becomes clear once we start looking at the Implied Volatility of the FixedResets. One thing is very clear: given the higher coupon on the new issue, it may be expected to trade at a much higher price than the issues it replaces – regardless of the exact level, it will also be clear that there is therefore much less potential upside (if spreads narrow), if any, before the issue gets called, while the downside (if spreads should widen) is more or less the same. Normally, as is formally explained by the theory of Implied Volatility, the reduced chance of an upside win is offset by a higher yield, which will result in increased income if spreads remain stagnant.

This deal takes away that upside, without compensation.

For instance lets look at the Implied Volatility of the TA series of FixedResets as of last Friday:

The curve has been fit using the four extant FixedReset issues only (TA.PR.E is a FloatingReset). We can see that in order to be consistent with four extant issues, the new issue should yield about 7.5%, whereas in fact it only yields about 6.5%. In this model, the fair price for the new issue is about 21.69 and purchasers of the TA shares at the new level are going to be awfully disappointed.

It may certainly be objected that the derived level of Implied Volatility in the above analysis is unwarrantably high at 25% and I have certainly not been shy about stating in the past that I consider a reasonable value to be in the high single digits. So let’s re-run the analysis, constraining Implied Volatility to be 10%. We get:

Even with this constraint, we see that in order to be consistent with Friday’s closing bids for the extant issues the new issue should offer a yield of just under 7.0% – compared to the 6.5% actually offered – which in turn implies that the free trading price of the new issue is predicted to be about 23.30 … again, purchasers of the TA shares at the new level are going to be disappointed.

Finally, we can look at the Implied Volatility analysis with end of day prices. Obviously, as shown in the table above, there was a very large move in the prices of these issues. This happened very quickly as illustrated in the day’s chart for TA.PR.H:

… and the day’s action has changed the Implied Volatility analysis to:

It is only in this analysis that we may conclude that the new issue is well-priced, as the theoretical yield for consistency is only 6.35% compared to the actual offer of 6.50%.

All of this analysis leads to the conclusion that this is a rotten deal for the preferred shareholders, so rotten that we may call it a sleazy attempt by the company to pull the wool over the eyes of unsophisticated retail investors. As the company admits, they look forward to:

reducing the Corporation’s notional capital balance of preferred shares by approximately $300 million

That $300-million is money that currently can potentially be earned by the current shareholders with price increases on the extant issues; price increases that could result from an increase in the GOC-5 yield, or from straightforward spread narrowing. The company is giving up nothing – NOTHING! – in order to capture this entire amount for themselves.

But, whimpers the incompetent dork from PriceWaterhouseCoopers who signed his name to the fairness opinion, we are giving up something!

the dividends to be paid to holders of the New Preferred Shares are expected to be greater than the current dividends received by holders of the Existing Preferred Shares over the initial five-year reset period based on current interest rate levels.

Sure, based on current interest rate levels. But my vast experience in fixed income has led me to the arcane knowledge that interest rate levels do not always remain constant – however convenient it might be for analysis to assume that they do – and that we should at least be aware of what happens in various scenarios. So with the aid of a handy xlsx MS-Excel spreadsheet we can draw a graph of what will happen if the GOC-5 yield changes:

Yes, that’s right: preferred shareholders will get a little extra income after the Exchange for as long as the GOC-5 yield is under 2%. Once they rise above that, though, the Exchange makes them worse off. There is no compensation in this deal for the reduction of potential income in the event that yields rise. Whether yields rise in the future is a matter of opinion, snivel the directors who claim this is fair to shareholders … but with the North American economy beginning to show signs of life, it will be very hard to find takers for bets they’ll remain constant when these bets are presented straightforwardly and honestly.

So, to put things in a nutshell, Transalta wants to eliminate (more or less) potential capital gains should spreads narrow in the future, and reduce potential income increases should GOC-5 yields increase in the future; all this for a very, very tiny increase in current income. Hell, why not send them the deed to your house and car, while you’re at it?

This is a shitty deal for shareholders. Vote No. I will note that as a matter of practicalities, the idea of selling into this stupidly inflated market and becoming indifferent to how this abusive deal turns out is also quite attractive.

Update, 2016-12-24 I was perplexed by a comment on Financial Wisdom Forum:

More on the TransAlta exchange.

http://business.financialpost.com/news/ … picks=true

FWIW, I am quite satisfied with the offer because I’m a trader and am more than happy to bail on these PF-3 issues because I really believe that one would have to be wearing super sized rose coloured glasses to think that they would someday trade or be redeemed at par, especially with a company like TA that has slashed the dividend on the common to 4 cents/quarter.

The case for the “No” vote does not depend on the hope that the shares will “someday trade or be redeemed at par”, and demonstrating this should actually make the argument more clear for those who have difficulty with the concept of Implied Volatility.

Let us examine the specific case of TA.PR.D; the following analysis framework may be applied to the other series with changes in numbers.

TA.PR.D:

• pays $0.67725 p.a. until the next Exchange Date
• will reset to GOC-5 + 203bp (paid on par value of $25) on each Exchange Date
  • This is equal to (25 * GOC-5) + (25 * 203bp)
  • which is equal to (25 * GOC-5) + $0.5075
• may be redeemed at $25 on each Exchange Date
• Exchange Dates are 2021-3-31 and every five years thereafter

The company proposes to exchange each share of this for 0.503 of a New Preferred Share; each New Preferred Share will

• Pay 6.50% of $25.00 = 1.625 until the next Exchange Date
• will reset to GOC-5 + 529bp (paid on par value of $25) on each Exchange Date
• may be redeemed at $25 on each Exchange Date
• Exchange Dates are 2021-12-31 and every five years thereafter

The fact that holders will be getting only 0.503 New Preferred Shares for each share of TA.PR.D makes the changes a little more complex for many investors, so as a thought experiment, let’s design a Notional Share which we will assume will be offered 1 for 1 for TA.PR.D, with the new holdings, in total, having exactly the same characteristics as the proposed new holdings of the New Preferred Shares.

A Notional Preferred Share:

• pays $0.817375 until the next Exchange Date
• will reset to 0.503 (GOC-5 + 529bp) * 25 on each Exchange Date
  • This is equal to (0.503 * 25 * GOC-5) + (0.503 * 25 * 529bp)
  • which is equal to 12.575 * GOC-5 + $0.6652175
  • subject to a minimum rate of $0.817375
• may be redeemed at $12.575 on each Exchange Date
• Exchange Dates are 2021-12-31 and every five years thereafter

So when we compare the currently held TA.PR.D to the Notional Share we see that:

• The Notional Share will pay an extra $0.14 annually for each of the next five years (approximately), for a total of $0.70.
• The redemption price will drop from $25 to $12.575
• The dividends after the next Exchange Date (if it is left outstanding) will depend on the GOC-5 yield, as indicated on the following chart

The big problem, of course, is the change in redemption price – holders lose out on a lot of potential capital gains if the market improves, either through increases in the GOC-5 yield (which should increase the trading price of the preferreds) or through a narrowing of spreads (which may occur because the market improves, or TA’s credit improves, or both). In addition, we see that increases in the GOC-5 rate greatly improve the dividend payout from TA.PR.D and the much higher redemption price means these potential increases will not be called away unless for a gigantic premium over the current price.