Category: Issue Comments

Brookfield Renewable Energy Partners L.P. has announced:

that, in connection with its previously announced offer to exchange each issued and outstanding Class A Preference Share, Series 5 of Brookfield Renewable Power Preferred Equity Inc. (TSX:BRF.PR.E) with an annual dividend rate of 5.00% (collectively, the “Series 5 Preferred Shares”) for one newly issued Class A Preferred Limited Partnership Unit, Series 5 of Brookfield Renewable with an annual distribution rate of 5.59% (the “Exchange Offer”), it has extended the expiry date of the Exchange Offer to 5:00 p.m. (Toronto Time) on February 8, 2016 and waived the Exchange Offer’s minimum tender condition (the “Minimum Tender Condition”). As of 5:00 p.m. (Toronto Time) on January 20, 2016, a total of 2,805,911 Series 5 Preferred Shares have been validly tendered to the Exchange Offer, representing approximately 40.08% of the issued and outstanding Series 5 Preferred Shares.

Following expiry of the Exchange Offer, any and all Series 5 Preferred Shares tendered will be taken up, regardless of how many Series 5 Preferred Shares are tendered, provided that the remaining Exchange Offer conditions have been satisfied or waived and the expiry date of the Exchange Offer has not been further extended. The waiver of the Minimum Tender Condition and the extension of the Exchange Offer enable holders of Series 5 Preferred Shares (the “Series 5 Preferred Shareholders”) who have not yet tendered their Series 5 Preferred Shares to accept the Exchange Offer. All other terms and conditions of the Exchange Offer remain the same. Series 5 Preferred Shareholders who have validly tendered (and not withdrawn) their Series 5 Preferred Shares pursuant to the Exchange Offer need take no further action to accept the Exchange Offer.

The Exchange Offer is being extended pursuant to a second amendment and restatement of Brookfield Renewable’s prospectus supplement dated November 9, 2015, as amended and restated on December 23, 2015, to its short form base shelf prospectus dated May 12, 2015 (the “Second Amended and Restated Prospectus Supplement”). Full details of the Exchange Offer are contained in the Second Amended and Restated Prospectus Supplement, which will be filed with securities regulatory authorities in each of the provinces and territories of Canada and mailed to Series 5 Preferred Shareholders as required under applicable Canadian securities laws on or about January 27, 2016. Copies of the Second Amended and Restated Prospectus Supplement will be available on SEDAR at www.sedar.com and on Brookfield Renewable’s website at www.brookfieldrenewable.com at such time. Series 5 Preferred Shareholders are urged to evaluate carefully all information in the Exchange Offer, including risk factors, and to consult their own investment, tax and legal advisors.

Computershare Investor Services Inc. is the Depositary for the Exchange Offer and D.F. King Canada, a division of CST Investor Services Inc., is the Information Agent. Any questions or requests for assistance concerning the Exchange Offer or further information about tendering to the Exchange Offer should be directed to the Depositary at 1-800-564-6253 (toll free in North America) or 1-514-982-7555, or by e-mail at corporateactions@computershare.com; or to the Information Agent at 1-800-332-4904 (toll free in North America) or 1-201-806-7301, or by e-mail at inquiries@dfking.com.

Copies of the Second Amended and Restated Prospectus Supplement may be obtained free of charge upon request to the Depositary or the Information Agent. Series 5 Preferred Shareholders whose Series 5 Preferred Shares are registered in the name of a broker, investment dealer, bank, trust company or other nominee should contact such nominee for assistance in depositing their Series 5 Preferred Shares to the Exchange Offer.

Assiduous Readers will remember that the original offer was announced 2015-11-9, which was extended 2015-12-21 with a filing thereof appearing on SEDAR on 2015-12-23.

TransCanada Corporation has announced:

that 1,284,609 of its 14,000,000 fixed rate Cumulative Redeemable First Preferred Shares, Series 5 (Series 5 Shares) have been elected for conversion on a one-for-one basis, into floating rate Cumulative Redeemable First Preferred Shares, Series 6 (Series 6 Shares) effective on February 1, 2016. As a result, on February 1, 2016, TransCanada will have 12,715,391 Series 5 Shares and 1,284,609 Series 6 Shares issued and outstanding. The Series 5 Shares and Series 6 Shares will be listed on the Toronto Stock Exchange under the symbols TRP.PR.C and TRP.PR.I, respectively.

Assiduous Readers will recall that TRP.PR.C will reset to 2.263%; TRP.PR.I is a FloatingReset paying 154bp over 3-Month Bills, reset quarterly. I recommended against conversion.

Power Financial Corporation has announced:

that 2,234,515 of its outstanding 11,200,000 Non-Cumulative 5-Year Rate Reset First Preferred Shares, Series P (the “Series P shares”) will be converted on February 1, 2016, on a one-for-one basis, into Non-Cumulative Floating Rate First Preferred Shares, Series Q (the “Series Q shares”) of Power Financial.

As a result, on February 1, 2016, Power Financial will have issued and outstanding 8,965,485 Series P shares and 2,234,515 Series Q shares.

The Series P shares are currently listed on the Toronto Stock Exchange under the symbol PWF.PR.P. The Series Q shares will be listed on the Toronto Stock Exchange under the symbol PWF.PR.Q.

Assiduous Readers will remember that PWF.PR.P will reset to 2.306%; PWF.PR.Q is a FloatingReset that will pay 3-Month T-Bills +160bp, reset quarterly. I recommended against conversion.

Pembina Pipeline Corporation has announced:

that it has closed its previously announced public offering of cumulative redeemable minimum rate reset class A preferred shares, Series 11 (the “Series 11 Preferred Shares”) for aggregate gross proceeds of $170 million (the “Offering”).

The Offering was announced on January 6, 2016 when Pembina entered into an agreement with a syndicate of underwriters led by Scotiabank, BMO Capital Markets and RBC Capital Markets. A total of 6,800,000 Series 11 Preferred Shares, which includes 800,000 Series 11 Preferred Shares issued pursuant to the partial exercise of the underwriters’ option, were sold under the Offering.

Proceeds from the Offering will be used to reduce indebtedness under the Company’s credit facilities, as well as for capital expenditures and working capital requirements in connection with the Company’s 2016 capital program.

The Series 11 Preferred Shares will begin trading on the Toronto Stock Exchange today under the symbol PPL.PR.K.

Dividends on the Series 11 Preferred Shares are expected to be $1.4375 per share annually, payable quarterly on the 1st day of March, June, September and December, as and when declared by the Board of Directors of Pembina, for the initial fixed rate period to but excluding March 1, 2021.

Concurrently with the closing of the Offering, Pembina’s Board of Directors has declared the initial quarterly dividend for the Series 11 Preferred Shares in the amount of $0.1812, for the period of January 15, 2016 to March 1, 2016. The dividend will be payable on March 1, 2016, to shareholders of record on February 1, 2016.

All of Pembina’s dividends are designated “eligible dividends” for Canadian income tax purposes.

That’s very good of them to highlight the record date of the short first dividend! I wish more issuers would provide specifics – or at least estimates and intentions – on their announcements of closing.

PPL.PR.K is a FixedReset, 5.75%+500M575, announced January 6. The issue will be tracked by HIMIPref™ and has been assigned to the Scraps index on credit concerns.

The issue traded 333,090 shares today in a range of 23.40-24.70 before closing at 23.20-47, 10×10. VWAP was 24.09. Those who are outraged at the poor performance of this issue are reminded that the market in the last ten days has been horrid; epically horrid, as the kids say. From the close on the day of announcement, January 6, to the close today, January 15, the TXPL Price Index went from 661.34 to 565.59, a drop of 14.5%; the TXPL Total Return index went from 777.32 to 664.90, also a drop of 14.5%. So in context of the market, the drop to a bid of 23.20 from the issue price of 25.00, which is 7.2%, actually looks pretty good. Buyers of the new issue can celebrate!

I have the funny feeling I’m going to be telling this story quite a bit over the next few years, until my Assiduous Readers get fed up to the back teeth with the thing. But really: a market drop of 14.5% between announcement and closing? If I don’t cite the example when I tell the story, nobody will believe me.

In fact, I have a sneaking suspicion that the only person telling this story more often than me will be Scott Burrows, Pembina’s CFO. “Yes, sir”, he’ll say, drawling a little to emphasize his good old-fashioned common sense, “When the dealers approached me about a bought deal, I suddenly realized that my big toe had been hurting all day. Something terrible! And when my big toe hurts that much for so long, it means only one thing: the market’s about to drop by 14.5%. So I didn’t waste any time! I got that puppy out the door as fast as the agreement could be printed! I printed it backwards, so I could sign on the dotted line while waiting for the job to finish!”

And, oh, how I wish I could be a fly on the wall during his next performance and salary review. “Mick”, he’ll say to Michael Dilger, CEO, “Remember that $170-million preferred share issue I pushed out just before the market dropped 14.5%? Well, I’ve been doing some figuring, and I figure that gave the company a trading gain of a little under $25-million, mainly out of the pockets of the Big Banks, right out of the box. I couldn’t believe it when the first headhunter told me that, but when the third one called and casually mentioned it in the course of completely innocent conversation, I just had to check the numbers myself. Interesting, eh?”

Vital Statistics are:

Implied Volatility of the PPL series provides some food for thought:

Click for Big

The Implied Volatility of 7% is dramatically lower than the 22% calculated on the announcement date. This may be ascribed to the following changes in price for the PPL FixedReset series:

So we verify that the drop in Implied Volatility can be ascribed to outperformance of the higher-spread issues. This is a mathematical equivalence, but it’s always good to check!

What surprises me, though is just how different the PPL Implied Volatility is from other series – the TD series, for example, discussed in the post New Issue: NA FixedReset, 5.60%+490, has an Implied Volatility of 29%.

It may have something to do with credit or, more precisely, credit perception. Assiduous Readers will be aware that the BAM series of FixedResets consistently has a lower Implied Volatility than the other series examined regularly; given that unreasonably high levels of Implied Volatility are associated with expectations of directionality in future prices, there might be a connection. Just how this might be explained and proven, however, is another question.

Update, 2016-2-8: It seems to have settled in-line with other issues at 23.50.

Click for Big

Standard & Poor’s has announced:

• •We are removing our ratings on Shaw Communications Inc. from CreditWatch, where they were placed with negative implications Dec. 17, 2015.
• •At the same time, we are affirming our ratings on Shaw, including our ‘BBB-‘ long-term corporate credit rating. The outlook is negative.
• •We expect that Shaw will generate weak free cash flow over the next two years as the company integrates WIND Mobile Corp. and builds out its mobile network to the current industry-standard long-term evolution (LTE).
• •We could lower the rating on Shaw if fully adjusted debt leverage increases toward 3.5x, which could indicate the company is having difficulties achieving profitability expectations in mobile or increasing debt-funded capital to support its competitive position.
• •The negative outlook reflects our expectation of weak free cash flow over the next two years as the company integrates WIND and builds out its mobile network to the current industry-standard LTE.
• •We could revise the outlook to stable if Shaw’s free and discretionary cash flow measures improve enough to keep fully adjusted debt leverage consistently below 3x, which we believe would be characterized by free operating cash flow approaching 10% and sustained positive discretionary cash flow.
  …
  “The affirmation incorporates our expectation that Shaw will maintain fully adjusted debt leverage of about 3x over the next two years, which is consistent with our ‘BBB-‘ rating, after incorporating the WIND acquisition and the recently announced sale of Shaw Media,” said Standard & Poor’s credit analyst Donald Marleau.
  …
  The negative outlook reflects our expectation of weak free cash flow over the next two years as the company integrates WIND and builds out its mobile network to the current industry-standard LTE.

  We could lower the rating if we expect that Shaw’s fully adjusted debt leverage will increase toward 3.5x, which could indicate difficulties achieving profitability expectations in mobile or increased debt-funded capital to support the company’s competitive position.

  We could revise the outlook to stable if Shaw’s free and discretionary cash flow measures improve enough to keep fully adjusted debt leverage consistently below 3x, which we believe would occur if WIND EBITDA maintained a positive trajectory to exceed C$100 million by 2018 along with expectations of steady-to-declining capital expenditures. We believe that such a scenario would be characterized by free operating cash flow approaching 10% and sustained positive discretionary cash flow.

The acquisition of Wind Mobile was greeted with distaste by the Rating Agencies; both DBRS and S&P placed the rating on review-negative. As noted in the Market Action report for January 13, 2016, the acquisition will be financed by the sale of media assets to a related firm (or is it affiliated? I can never get that terminology right); this news was greeted with distinct lack of enthusiasm by DBRS, which is simply waiting for the acquisition to close before (very probably) downgrading the rating by a notch.

IIROC announced:

The following issues have been halted by IIROC:
…
Company: The Toronto-Dominion BankNON-CUMULATIVE 5-YEAR RATE RESET CLASS AFIRST PREFERRED SHARES, SERIES 12

TSX Symbol: TD.PF.G

Reason: Pending Closing

Halt Time (ET): 7:57 AM ET

They later announced:

Trading resumes in:

Company: The Toronto-Dominion Bank NON-CUMULATIVE 5-YEAR RATE RESET CLASS A FIRST PREFERRED SHARES, SERIES 12

TSX Symbol: TD.PF.G

Resumption (ET): 9:30 AM ET

There was no announcement from the company.

TD.PF.G is a FixedReset, 5.50%+466, NVCC-compliant issue, announced January 5. This issue will be tracked by HIMIPref™ and has been assigned to the FixedReset subindex.

The issue traded 2,212,913 shares in a range of 25.27-44 before closing at 25.34-35, 8×8. This enormous volume gains it 19th place in the HIMIPref™ database ranked by one-day volume and the largest since 2006-12-15, when FBS.PR.B was issued. That was only a Split-Share, though, with a $10 par value; if we restrict the list to $25 pv issues, today’s TD.PF.G volume is the greatest since 2005-11-8, when 2,540,400 shares of BCE.PR.A changed hands … PrefBlog didn’t exist then!

So, yeah, that was a lot of trading, as befits an issue size of $700-million!

Vital statistics are:

Yesterday I mentioned GMP Capital’s restructuring:

GMP, proud issuer of GMP.PR.B, has swallowed hard and acknowledged hard times:

GMP Capital Inc.’s radical restructuring, which involves shutting down its United Kingdom and Australian operations as well as eliminating its dividend, is also hitting senior staff at home.

In total, seventy-three jobs are being axed in a new round of cuts announced Wednesday, affecting investment bankers, research analysts and employees in sales and trading. Twenty-nine positions are being eliminated in Canada, 22 in the U.K., 12 in Australia and 10 in the U.S. GMP said 97 positions – a quarter of its work force – have now been eliminated since the end of the third quarter.
…
GMP has lost money in three of the past four quarters. In the third quarter of 2015, revenue from the company’s energy sector investment banking cratered 87 per cent from a year ago.

The brokerage was founded in 1995 and went public in December, 2003. GMP was immensely profitable during the great bull run in resources and some of its proprietary traders, such as Michael Wekerle, were among the best paid people on Bay Street. In mid-2006, GMP’s share price peaked at $28. It closed Tuesday at $3.92 – not far from an all-time low.

I have not seen any reaction from the Credit Rating Agencies yet.

Today, DBRS reacted:

DBRS Limited (DBRS) has today placed the Cumulative Preferred Shares rating of Pfd-3 (low) for GMP Capital Inc. (GMP or the Company) Under Review with Negative Implications. This review follows GMP’s announcement that it is undertaking a series of fundamental organizational changes in its Capital Markets division which have the potential to have an impact on the Company’s franchise positioning and further weaken its earnings generation ability.
…
During the review period, DBRS will also focus on the ongoing weakness in the Company’s earnings. While GMP’s intention is to improve earnings over the longer term by reducing fixed costs in its expense base, the near- to medium-term results will likely be pressured by the very adverse market environment, given the challenges posed by the dramatic decline in oil and gas prices, especially if the Company’s franchise position is weakened during its restructuring. GMP’s Q4 2015 results will be affected by the restructuring charge, and DBRS expects that the Company will report a loss in the quarter and for the full year 2015. DBRS will evaluate the size of the loss and impact on capital following the release of results.

The severity of a downgrade will consider various factors during the review period. These factors include the Company’s vulnerability to the uncertain economic outlook and market conditions, the degree to which its franchise strength has been impaired, the sufficiency and quality of its capital, and the potential for it to return to sustained profitability.

DBRS expects to conclude its review shortly after the release of GMP’s Q4 2015 results.

GMP has been labeled Trend-Negative by DBRS since November, 2012.

GMP has only a single preferred issue outstanding, GMP.PR.B, a FixedReset 5.50%+289, which commenced trading 2011-2-22 after being announced 2011-2-1

It will be recalled that PWF.PR.P will reset to 2.306% effective February 1.

Holders of PWF.PR.P have the option to convert to FloatingResets, which will pay 3-month bills plus 160bp on the par value of $25.00. The deadline for notifying the company of the intent to convert is 5:00 p.m. (EST) on January 18, 2016; but note that this is a company deadline and that brokers will generally set their deadlines a day or two in advance, so there’s not much time to lose if you’re planning to convert! However, if you miss the brokerage deadline they’ll probably do it on a ‘best efforts’ basis if you grovel in a sufficiently entertaining fashion. The ticker for the new FloatingReset is not yet known.

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., PWF.PR.P 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 have a distaste at the moment for floating rate product; almost all of the implied rates until the next interconversion are lower than the current 3-month bill rate and the averages for investment-grade and junk issues are both well below zero, at -0.63% and -0.28%, 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 PWF.PR.P FixedReset, we may construct the following table showing consistent prices for its soon-to-be-issued FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

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, I recommend that holders of PWF.PR.P continue to hold the issue and not to convert. I will note that, given the apparent cheapness of the FloatingResets, 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 future path of policy rates. 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.

Note as well that conversion rights are dependent upon at least one million shares of each series being outstanding after giving effect to holders’ instructions; e.g., if only 100,000 shares of PWF.PR.P are tendered for conversion, then no conversions will be allowed; but if only 100,000 shares of PWF.PR.P will remain after the rest are all tendered, then conversion will be mandatory. However, this is relatively rare: all 38 Strong Pairs currently extant have some version of this condition and all but four have both series outstanding.

Brookfield Renewable is making a big fat acquisition:

Brookfield Renewable Energy Partners L.P. (TSX: BEP.UN; NYSE: BEP) (“Brookfield Renewable”) today announced that with its institutional partners it has committed to acquire 57.6% of the outstanding common shares of Isagen S.A. (“Isagen”) from the Colombian government. Isagen owns and operates a renewable energy portfolio consisting of 3,032 MW of principally hydroelectric generating capacity and a 3,800 MW development portfolio in Colombia.

A Brookfield led consortium will acquire 1,570,490,767 common shares of Isagen for aggregate consideration of COP 6,486 billion1 (approximately US$2.2 billion), payable in cash in US dollars on the expected closing date of January 26, 2016. This reflects a purchase price of COP 4,130 per share (approximately US$1.38). Brookfield Renewable’s equity commitment will be approximately US$243 million giving it an approximate 9% interest in Isagen. Brookfield Renewable currently has $1.2 billion of available liquidity and will fund its commitment with available resources.

DBRS notes:

The Acquisition is expected to close on January 26, 2016. As part of the Acquisition, two mandatory tender offers (MTO) will also be provided to all remaining shareholders of ISAGEN within six months after closing of the initial investment. This could increase BREP’s equity commitment by approximately $517 million if all remaining ISAGEN shares are tendered, which would bring BREP’s interest in ISAGEN to approximately 25%. BREP is expected to initially fund its $243 million equity commitment with $1.2 billion of available liquidity (comprising available credit facilities and cash on hand). The additional MTO commitment is expected to initially be funded with a $500 million acquisition facility and existing liquidity. The rating actions largely reflect the current uncertainty with the final MTO commitment net to BREP and the Company’s permanent financing strategy for the Acquisition. The Acquisition is not expected to have a significant impact on the Company’s business risk profile.
…
BREP’s financial risk profile is based on its deconsolidated key credit metrics. The Acquisition (including the MTO commitment), combined with the 292 MW Pennsylvania hydroelectric portfolio acquisition (the Pennsylvania Acquisition) expected to close in Q1 2016 (see DBRS press release dated October 9, 2015), have increased the funding pressure on the Company’s deconsolidated balance sheet over the near term as the Company finalizes its permanent financing alternatives for these growth initiatives. Pro forma the (1) $243 million initial investment in the Acquisition, (2) $224 million equity commitment for the Pennsylvania Acquisition, (3) CAD 175 million Preferred LP Units issuance in December 2015 and (4) $135 million of incremental proceeds from the Bear Swamp refinancing in October 2015, BREP’s deconsolidated debt-to-capital was approximately 25% as of September 30, 2015. Assuming the MTO is fully tendered, the $517 million equity commitment would result in a pro forma deconsolidated debt-to-capital of approximately 28%. DBRS notes that BREP’s ratings reflect the Company’s history of prudently financing its growth initiatives to maintain its deconsolidated key credit metrics at a level that is commensurate with the BBB (high) rating category, which has included a mix of equity, preferred shares, asset divestitures and debt. In its review, DBRS will assess BREP’s permanent financing plan and the impact on the Company’s deconsolidated key credit metrics. Upon final review, if the Company prudently finances the Acquisition in a way that its deconsolidated debt-to-capital remains around the 20% threshold over time, and other deconsolidated credit metrics, such as cash flow-to-debt and interest coverage ratios, remain supportive of the current rating, DBRS will likely confirm BREP’s ratings. However, if the Company finances the Acquisition in such a way that its non-consolidated debt-to-capital structure exceeds 20% significantly on a sustained basis and its other non-consolidated credit metrics deteriorate significantly without corrective action within a reasonable time frame, then a negative rating action is likely to occur.

DBRS will proceed with its review as more information becomes available and aims to resolve the Under Review status once the equity commitment (pending MTO clarity) and permanent financing details are known.

Brookfield Renewable is the proud issuer of BRF.PR.A, BRF.PR.B, BRF.PR.C, BRF.PR.E and BRF.PR.F. One of these issues, BRF.PR.E, is the subject of an Exchange Offer that will expire January 20.

It will be recalled that BNS.PR.Z will reset to 2.063% effective February 2.

Holders of BNS.PR.Z have the option to convert to FloatingResets, which will pay 3-month bills plus 134bp on the par value of $25.00. The deadline for notifying the company of the intent to convert is 5:00 p.m. (EST) on January 18, 2016; but note that this is a company deadline and that brokers will generally set their deadlines a day or two in advance, so there’s not much time to lose if you’re planning to convert! However, if you miss the brokerage deadline they’ll probably do it on a ‘best efforts’ basis if you grovel in a sufficiently entertaining fashion. The ticker for the new FloatingReset is not yet known.

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., BNS.PR.Z 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 have a distaste at the moment for floating rate product; almost all of the implied rates until the next interconversion are lower than the current 3-month bill rate and the averages for investment-grade and junk issues are both well below zero, at -0.62% and -0.26%, 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.

It should also be noted that although BNS.PR.Z is NVCC non-compliant and therefore subject to a Deemed Maturity 2021-1-31 (according to my analysis!), this has no effect on the analysis: the essential point is that the elements of the Strong Pair will be equivalent on the next Exchange Date, regardless of anything that might or might not happen afterwards.

If we plug in the current bid price of the BNS.PR.Z FixedReset, we may construct the following table showing consistent prices for its soon-to-be-issued FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

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, I recommend that holders of BNS.PR.Z continue to hold the issue and not to convert. I will note that, given the apparent cheapness of the FloatingResets, 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 future path of policy rates. 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.

Note as well that conversion rights are dependent upon at least one million shares of each series being outstanding after giving effect to holders’ instructions; e.g., if only 100,000 shares of BNS.PR.Z are tendered for conversion, then no conversions will be allowed; but if only 100,000 shares of BNS.PR.Z will remain after the rest are all tendered, then conversion will be mandatory. However, this is relatively rare: all 38 Strong Pairs currently extant have some version of this condition and all but four have both series outstanding.