Category: Issue Comments

Issue Comments

GWO.PR.N, FFH.PR.I, CPX.PR.A: Convert or Hold?

It will be recalled that

The deadline for notifying the companies of the intent to convert is December 16 at 5pm; but note that these are company deadlines 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 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., CPX.PR.A and the FloatingReset, CPX.PR.B, 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).

pairs_FR_151211A
Click for Big

The market appears to have a marked distaste at the moment for floating rate product; every single one of the implied rates until the next interconversion are lower than the current 3-month bill rate and most pairs have a break-even yield significantly below zero! 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 three FixedResets, we may construct the following table showing consistent prices for their soon-to-be-issued FloatingReset counterparts given a variety of Implied Breakeven yields consistent with issues currently trading:

Estimate of FloatingReset Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread -1.00% -0.50% 0.00%
GWO.PR.N. 13.50 130bp 11.53 12.05 12.58
FFH.PR.I 15.28 285bp 13.48 13.97 14.45
CPX.PR.A 9.80 217bp 8.09 8.54 8.99

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to be cheap and trading well below the price of their FixedReset counterparts. Therefore, I recommend that holders of GWO.PR.N, FFH.PR.I and CPX.PR.A continue to hold these issues and not to convert. I will note that current conditions make extant FloatingResets so cheap (in general) that 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 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 GWO.PR.N are tendered for conversion, then no conversions will be allowed; but if only 100,000 shares of GWO.PR.N will remain after the rest are all tendered, then conversion will be mandatory. However, this is relatively rare: all 30 Strong Pairs currently extant have some version of this condition and all but two have both series outstanding.

Contingent Capital

S&P Revises Bank Outlook to Stable on Federal Complacency

Standard & Poor’s has announced:

  • •We continue to evaluate the likelihood, degree, and timeframe with respect to which the default risk of systemically important Canadian banks may change as a result of the government’s progress toward introducing a bank bail-in framework.
  • •We now expect that the timeframe could be substantially longer than we had previously assumed. We see the absence of the topic from the new government’s Dec. 4 Speech from the Throne as recent, incremental evidence in this regard.
  • •We now do not expect to consider the removal of rating uplift for our expectation of the likelihood of extraordinary government support from the issuer credit ratings (ICRs) on systemically important Canadian banks until a point beyond our standard two-year outlook horizon for investment-grade ratings, if at all.
  • •When and if we remove such uplift, the potential ratings impact will also consider uplift for additional loss-absorbing capacity, as well as any changes to our stand-alone credit profiles on these banks.
  • •As a result, we are revising our outlooks on all systemically important Canadian banks to stable from negative.

RATING ACTION
On Dec. 11, 2015, Standard & Poor’s Ratings Services revised its outlooks on the Canadian banks that it views as having either “high” (Bank of Montreal, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada, The Toronto-Dominion Bank), or “moderate” (Caisse centrale Desjardins and National Bank of Canada) systemic importance, to stable from negative (see ratings list). The issuer credit ratings (ICRs) on the banks are unchanged.

RATIONALE
We believe that the potential negative ratings impact of a declining likelihood of extraordinary government support, at least within our standard two-year outlook horizon, has subsided. This reflects our updated view that there could be an extended implementation timetable–2018 or later–for the proposed Canadian bail-in framework. Importantly, at the point we would consider removing any uplift from the likelihood of extraordinary government support from our ratings, we would also consider the potential ratings impact of any uplift for additional loss-absorbing capacity (ALAC), as well as any
changes to our stand-alone credit profiles (SACPs) on these banks. In our view, the extended timetable introduces some potential that either the presence of ALAC or fundamental changes in credit quality at individual banks might come into play more than under the previously contemplated timetable.

We had revised our outlooks on systemically important Canadian banks to negative chiefly in reaction to the former government’s “Taxpayer Protection and Bank Recapitalization Regime” consultation paper of Aug. 1, 2014, as we then expected a bail-in regime could be fully implemented by 2016 (see “Outlook On Six Big Canadian Banks Revised To Negative Following Review Of Bail-In Policy Proposal,” published Aug. 8, 2014, on RatingsDirect). A number of subsequent developments have caused us to re-evaluate this expectation:

  • •In its April 2015 budget proposal, the former government affirmed its intention to introduce a bank bail-in regime in Canada, but it provided only very limited additional information relative to what it had outlined in its 2014 consultation paper; nor did the government make substantial subsequent public statement on the topic; nor did it specify timing for the announcement of its fully-developed (post-consultation) legislative proposal.
  • •The Oct. 19 federal election changed the party in government to Liberal (center-left), from Conservative (center-right). The former government’s proposed bail-in regime did not feature prominently in election debates.
  • •The new government’s Dec. 4 Speech from the Throne made no mention of the proposed bail-in framework, nor were any of the legislative priorities enumerated therein closely related, in our opinion. We believe this indicates the introduction of a bail-in framework is not among the immediate priorities of the new government.

Moreover, with Canada experiencing no government bank bail-outs, nor large bank failures, for decades, we believe the political incentive to rapidly end “too-big-to-fail” is less in Canada than in the U.S. and several EU countries, which are jurisdictions under which we have already removed uplift for our expectation of the likelihood of extraordinary government support from our ratings (see “U.S. Global Systemically Important Bank Holding Companies Downgraded Based On Uncertain Likelihood Of Government Support,” and “Most European Bank Ratings Affirmed Following Government Support And ALAC Review,” both published Dec. 2, on RatingsDirect). We will take this factor into consideration as we continue to evaluate our view on the likelihood of extraordinary government support in Canada relative to not only the U.S. and Europe, but also other jurisdictions where we maintain a government support assessment of “supportive” or “highly supportive” under our criteria (such as for many countries in Latin America and Asia-Pacific; see “Banking Industry Country Risk Assessment Update: November 2015,” published Nov. 27).

We now believe the procedural hurdles to passing legislation and related regulations (the latter after passage of the former) for a bail-in regime will alone require a minimum of one-to-two years, after the new government decides on a final legislative framework to propose to Parliament. Considering all of this, we now expect the eventual date for initial implementation of the bail-in regime (that is, banks issuing bail-inable debt) could be in 2018 or later.

In addition, and in contrast to bail-in frameworks outlined by U.S. authorities or in European countries like Germany, Canadian officials’ statements have made clear that only debt issued or renegotiated after an initial implementation date would be subject to conversion. It will take some time for the banks to issue or renegotiate bail-inable debt. We believe this means it could take several years after the initial implementation date before we would consider a Canadian bail-in regime effective, so as to provide a viable alternative to the direct provision of extraordinary government support.

As well, and again in contrast to the U.S. and EU jurisdictions, Canadian governments have made no attempt to limit their ability to provide direct extraordinary support to their banks, if needed. We expect bailing in senior creditors to be the first Canadian policy response in the face of a crisis. At the same time, we believe Canadian governments would be likely to consider all policy options, in such a circumstance. It is therefore not certain that the introduction of a bail-in regime would of itself result in our revising our government support assessment on Canada to “uncertain” from the current “supportive” and the removal of rating uplift for our view on the likelihood of extraordinary government support from our ICRs on systemically important Canadian banks. Rather, our decision would depend, among other factors, on the details of the eventual bail-in regime, including the extent to which bail-inable and unbail-inable senior debt is distinguishable.

Partly to honor G-20 and other international commitments, the Canadian government will, we expect, present a finalized legislative proposal for the bail-in framework in 2016 or 2017. However, we expect an implementation date that could be in 2018 or later, and we think it could take at least one and possibly several years more for substantial bail-in eligible debt to be in place. With a runway that long, the potential ratings impact from removing uplift for the likelihood of extraordinary government support is beyond our standard two-year outlook horizon for investment-grade ratings, and could by then be more meaningfully affected by either ALAC uplift (from the bail-inable debt, assuming our related criteria are met) or SACP changes, than under the previously contemplated timetable.

When the government presents the detailed provisions of the framework, along with a more specific timeframe, we will review the applicable notching for various bank liabilities, taking into account the framework’s implications on different instruments. We expect that issue ratings on new bail-inable instruments will be at a level that is notched in reference to banks’ SACPs, while ratings on non-bailinable senior debt may continue to incorporate rating uplift above the banks’ SACPs, based on our expectation of the likelihood of extraordinary government support, or ALAC.

OUTLOOK
Our outlooks on the systemically important Canadian banks are stable, based on our reassessment of the likelihood, degree, and timeframe with respect to which the default risk of systemically important Canadian banks may change as a result of the government’s progress toward introducing a bank bail-in framework. We believe that the likelihood of extraordinary government support will continue to be a factor in systemically important Canadian bank ratings throughout the current outlook period.

Moreover, we believe these banks will continue to exhibit broad revenue diversification, conservative underwriting standards, and strong overall asset quality. Our current view is that the impact of low oil prices on their profitability and credit quality will be contained, given the modest direct exposure of the banks to the oil and gas sector, and the limited knock-on impact so far on consumer credit in regional economies affected by low oil prices.

On the other hand, we continue to monitor a number of key downside risks to our ratings on these banks, including low margins, high Canadian consumer leverage, residential real estate prices we believe are at least somewhat inflated in some parts of Canada, a Canadian macroeconomic outlook that is very tentative, and the higher-risk nature of certain recent foreign acquisitions.

The August 2014 imposition of Outlook-Negative was reported on PrefBlog, as was the federal consultation on the recapitalization regime. As far as I can tell, the comments received on the consultation paper have not been published; I believe this is because Canadians are too stupid to understand smart stuff like legislation and parliament and all that – if given a pile of comments to work through, we’d probably try to eat them.

Issues affected are:

BMO.PR.K, BMO.PR.L, BMO.PR.M, BMO.PR.Q, BMO.PR.R, BMO.PR.S, BMO.PR.T, BMO.PR.W, BMO.PR.Y and BMO.PR.Z

BNS.PR.A, BNS.PR.B, BNS.PR.C, BNS.PR.D, BNS.PR.L, BNS.PR.M, BNS.PR.N, BNS.PR.O, BNS.PR.P, BNS.PR.Q, BNS.PR.R, BNS.PR.Y and BNS.PR.Z

CM.PR.O, CM.PR.P and CM.PR.Q

NA.PR.Q, NA.PR.S and NA.PR.W

RY.PR.A, RY.PR.B, RY.PR.C, RY.PR.D, RY.PR.E, RY.PR.F, RY.PR.G, RY.PR.H, RY.PR.I, RY.PR.J, RY.PR.K, RY.PR.L, RY.PR.M, RY.PR.N, RY.PR.O, RY.PR.P RY.PR.W and RY.PR.Z

TD.PF.A, TD.PF.B, TD.PF.C, TD.PF.D, TD.PF.E, TD.PF.F, TD.PR.S, TD.PR.T, TD.PR.Y and TD.PR.Z

Issue Comments

BIP.PR.B Settles Better than Expected On Anemic Volume

Brookfield Infrastructure has announced:

the completion of its previously announced issue of Cumulative Class A Preferred Limited Partnership Units, Series 3 (“Series 3 Preferred Units”) in the amount of $125,000,000. The offering was underwritten by a syndicate led by RBC Capital Markets, CIBC, Scotiabank, and TD Securities Inc.

Brookfield Infrastructure issued 5,000,000 Series 3 Preferred Units at a price of $25.00 per unit, for total gross proceeds of $125,000,000. Holders of the Series 3 Preferred Units will be entitled to receive a cumulative quarterly fixed distribution yielding 5.50% annually for the initial period ending December 31, 2020. 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 4.53%, and (ii) 5.50%. The Series 3 Preferred Units will commence trading on the Toronto Stock Exchange this morning under the ticker symbol BIP.PR.B.

BIP.PR.B is a FixedReset, 5.50%+453M550 (Interest + ROC), announced December 1. The issue traded 113,268 shares today (consolidated exchanges) in a range of 24.35-58 before closing at 24.35-40, 8×40.

Given that the TXPL index is down 6.37% to December 8 from its December 1 level, the issue actually performed a little better than expected; but it remains to be seen how much of that is due to underwriter support. I’d have more confidence in the level if the volume was higher.

With some trepidation I am including this issue in the HIMIPref™ FixedReset subindex rather than the Interest-Bearing subindex, since I feel that the defining characteristic of the issue is its dividend formula rather than its dividend taxation status. I might change my mind later!

Vital statistics are:

BIP.PR.B FixedReset YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-12-08
Maturity Price : 22.92
Evaluated at bid price : 24.35
Bid-YTW : 5.61 %
Issue Comments

PWF.PR.P To Be Extended

Power Financial Corporation has announced:

that it does not intend to exercise its right to redeem all or part of the currently outstanding 11,200,000 Non-Cumulative 5-Year Rate Reset First Preferred Shares, Series P (the “Series P shares”) on January 31, 2016. As a result, subject to certain conditions, the holders of the Series P shares have the right to convert all or part of their Series P shares, on a one-for-one basis, into Non-Cumulative Floating Rate First Preferred Shares, Series Q (the “Series Q shares”) on February 1, 2016 (the “Conversion Date”) in accordance with the prospectus supplement dated June 18, 2010.

Holders of Series P shares who do not exercise their right to convert their Series P shares into Series Q shares on the Conversion Date will retain their Series P shares.

The dividend rate applicable to the Series P shares for the 5-year period from February 1, 2016 to January 31, 2021, and the dividend rate applicable to the Series Q shares for the 3-month period from February 1, 2016 to April 30, 2016, will be determined and announced by way of a news release on January 4, 2016.

Beneficial owners of Series P shares who wish to exercise their conversion right should communicate with their broker or other nominee to obtain instructions for exercising such right during the conversion period, which runs from January 4, 2016 until January 18, 2016 at 5:00 p.m. (EST).

The foregoing conversion rights are subject to the conditions that: (i) if Power Financial determines that there would remain outstanding on the Conversion Date less than 1,000,000 Series Q shares, after having taken into account all Series P shares tendered for conversion into Series Q shares, then holders of Series P shares will not be entitled to convert their shares into Series Q shares, and (ii) alternatively, if Power Financial determines that there would remain outstanding on the Conversion Date less than 1,000,000 Series P shares, after having taken into account all Series P shares tendered for conversion into Series Q shares, then all remaining Series P shares will automatically be converted into Series Q shares without the consent of the holders on a one-for-one basis on the Conversion Date.

In either case, Power Financial will give written notice to that effect to the registered holder of Series P shares no later than January 25, 2016.

No surprises here! PWF.PR.P is a FixedReset, 4.40%+160, that commenced trading 2010-6-29 after being announced 2010-6-17.

Issue Comments

DC.PR.C: Coercive Offer Attracts Wider Notice

Assiduous Readers will recall that I harshly criticized Dundee’s recent proposal in the post DC.PR.C: Coercive Exchange Offer.

Now Niall McGee of the Globe has penned a piece titled Dundee faces backlash over new share-exchange plan:

Dundee’s share-exchange plan has raised the ire of a prominent fund manager, a high-profile shareholder rights group and – according to multiple sources – has caused consternation among the company’s institutional shareholder base.

Dundee is under financial pressure, having lost more than $400-million in the year to date, primarily due to heavy exposure to the cratering resource sector. Last week, the company unveiled a proposal designed to take pressure off its balance sheet.

Mr. McGee was kind enough to quote me in the article:

James Hymas, president of Hymas Investment Management Inc., says these payments, which are roughly eight times higher than average, represent “a huge conflict of interest” for brokers and are “coercive” to shareholders.

“You get money for voting yes. But if you vote no and the offer goes through anyway, then you get squat. That makes it coercive,” Mr. Hymas said. He runs a preferred share mutual fund and publishes a daily commentary on preferred shares. Neither he nor his clients have any position in Dundee’s preferred shares.

And a regulators’ puppet group has joined the fray:

“These types of payments are deeply troubling,” said Neil Gross, executive director of FAIR Canada, an independent shareholder rights advocacy firm.

“It’s not just that they give advisers a financial incentive to bias their advice. It’s that they do it so overtly – revealing that the financial industry still hasn’t internalized the principle that conflicts of interest are incompatible with investment professionalism.”

It always makes me laugh to hear those guys talk about conflicts of interest!

You can make up your own minds about Dundee’s defence:

Dundee chief executive officer David Goodman defended the proposal.

“I believe our structure is fair. It’s transparent. It’s in the best interest of Dundee Corporation and it’s consistent with industry custom,” he said in an interview.
…
Mr. Goodman says one of the reasons the payments are necessary is that Dundee needs brokers to get the word out about the vote. He also said he has no concerns about advisers giving biased advice in this instance.

“I have a very high appreciation for the integrity and value that the financial advisers provide and I don’t believe that the receipt of a solicitation fee for their services is going to compromise their ability to properly advise their clients.”

We’ll see how it goes!

Issue Comments

FFH.PR.I To Reset At 3.708%; Potential Conversion to FFH.PR.J

Fairfax Financial Holdings Limited has announced:

that it has determined the fixed dividend rate on its Cumulative 5-Year Rate Reset Preferred Shares, Series I (“Series I Shares”) (TSX:FFH.PR.I) for the five years commencing January 1, 2016 and ending December 31, 2020 . The fixed quarterly dividends on the Series I Shares during that period, if and when declared, will be paid at an annual rate of 3.708% (Cdn. $0.23175 per share per quarter).

Holders of Series I Shares have the right, at their option, exercisable not later than 5:00pm ( Toronto time) on December 16, 2015 , to convert all or part of their Series I Shares, on a one-for-one basis, into Cumulative Floating Rate Preferred Shares, Series J (the “Series J Shares”), effective December 31, 2015 . The quarterly floating rate dividends on the Series J Shares will be paid at an annual rate, calculated for each quarter, of 2.85% over the annual yield on three month Government of Canada treasury bills. The actual quarterly dividend rate in respect of the January 1, 2016 to March 30, 2016 dividend period for the Series J Shares will be 0.82587% (3.34936% on an annualized basis) and the dividend for such dividend period, if and when declared, will be Cdn. $0.20647 per share, payable on March 30, 2016 .

Holders of Series I Shares are not required to elect to convert all or any part of their Series I Shares into Series J Shares.

As provided in the share conditions of the Series I Shares, (i) if Fairfax determines that there would be fewer than 1,000,000 Series I Shares outstanding after December 31, 2015 , all remaining Series I Shares will be automatically converted into Series J Shares on a one-for-one basis effective December 31, 2015 ; and (ii) if Fairfax determines that there would be fewer than 1,000,000 Series J Shares outstanding after December 31, 2015 , no Series I Shares will be permitted to be converted into Series J Shares. There are currently 12,000,000 Series I Shares outstanding.

The Toronto Stock Exchange (“TSX”) has conditionally approved the listing of the Series J Shares effective upon conversion. Listing of the Series J Shares is subject to Fairfax fulfilling all the listing requirements of the TSX and, upon approval, the Series J Shares will be listed on the TSX under the trading symbol “FFH.PR.J”.

The extension of FFH.PR.I is not a surprise, given that it’s trading at about 13.00.

FFH.PR.I commenced trading 2010-10-5 as a FixedReset, 5.00%+285, after being announced 2010-9-27. The issue was not only upsized shortly after the announcement, but the greenshoe was fully exercised.

The new rate of 3.708% is therefore a dividend reduction of about 26%.

As noted in the release, the deadline for notifying the company of a desire to convert to FFH.PR.J is 5:00 p.m. (EST) on December 16, 2015, (a Wednesday) but brokerages will normally have an internal deadline a day or two prior to that. If you miss the brokerage deadline, they’ll probably submit the request for you if you grovel, but if you miss the company deadline, that’s it.

At this point, market conditions are such that I expect FFH.PR.J to trade significantly below FFH.PR.I. FFH.PR.I closed today at a bid of 16.60 and the average implied 3-month bill rate of other junk issues is -0.48%. Assuming this relationship holds, the estimated trading price for the FFH.PR.J is 15.28, about 8% lower. Rather than convert and thereby get 1.00 shares of the FFH.PR.J, it seems likely (but by no means guaranteed!) that it will be better to execute trades in the marketplace after FFH.PR.J commences trading and thereby get (maybe!) 1.09 shares of the new FFH.PR.J.

So, I expect to recommend that holders of GWO.PR.N hang on to them, but I will make a formal recommendation on December 11, just in time for PrefLetter.

Issue Comments

GWO.PR.N To Reset To 2.176%

Great-West Lifeco has announced:

the dividend rates for its Non-Cumulative 5-Year Rate Reset First Preferred Shares, Series N (the “Series N Shares”) and for its Non-Cumulative Floating Rate First Preferred Shares, Series O (the “Series O Shares”).

The annual fixed dividend rate for the five-year period commencing on December 31, 2015 and ending on December 30, 2020 applicable to any Series N Shares that remain outstanding on December 31, 2015 will be 2.176% per annum (or $0.136 per Series N Share per quarter), which rate is equal to the sum of the Government of Canada Yield (as defined in the Series N Share Conditions) on December 1, 2015 plus 1.30%.

The floating dividend rate for the period commencing on December 31, 2015 and ending on March 30, 2016 applicable to any Series O Shares issued on December 31, 2015 will be 1.742% per annum (or $0.108578 per Series O Share). The 1.742% annual rate is equal to the sum of the T-Bill Rate (as defined in the Series O Share Conditions) on December 1, 2015 plus 1.30%.

Beneficial owners of Series N Shares who wish to exercise their right to convert their Series N Shares into Series O Shares on a one-for-one basis should communicate as soon as possible with their brokers or other intermediaries through whom they hold their Series N Shares and ensure that they follow their instructions so as to meet the 5:00 p.m. (eastern time) December 16, 2015 deadline for exercising such right. The news release announcing such conversion right was issued on November 5, 2015 and can be viewed on Great-West Lifeco’s website.

The Series N Shares and the Series O Shares have not been and will not be registered under the United States Securities Act of 1933, as amended, or any state securities laws. The Series N Shares and the Series O Shares may not be offered, sold or delivered in the United States and this release does not constitute an offer to sell or a solicitation of an offer to buy any Series N Shares or Series O Shares within the United States.

The extension of GWO.PR.N was announced on November 6.

GWO.PR.N commenced trading 2010-11-23 as a FixedReset, 3.65%+130, after being announced 2010-11-15. The issue was met with disfavour and there was an inventory clearance sale closing 2010-12-3.

The new rate of 2.176% is therefore a dividend reduction of just over 40%. Ouch!

As noted in the release, the deadline for notifying the company of a desire to convert to the FloatingReset Series O is 5:00 p.m. (EST) on December 16, 2015, (a Wednesday) but brokerages will normally have an internal deadline a day or two prior to that. If you miss the brokerage deadline, they’ll probably submit the request for you if you grovel, but if you miss the company deadline, that’s it.

At this point, market conditions are such that I expect the FloatingReset to trade significantly below GWO.PR.N. GWO.PR.N closed today at a bid of 13.35 (!) and the average implied 3-month bill rate of other investment-grade issues is -0.58%. Assuming this relationship holds, the estimated trading price for the new FloatingReset is 11.82, about 11% lower. Rather than convert and thereby get 1.00 shares of the new FloatingReset, it seems likely (but by no means guaranteed!) that it will be better to execute trades in the marketplace after the new FloatingReset commences trading and thereby get (maybe!) 1.13 shares of the new FloatingReset

So, I expect to recommend that holders of GWO.PR.N hang on to them, but I will make a formal recommendation on December 11, just in time for PrefLetter.

Note that since the issue is issued by an insurance holding company and is not convertible into common at the option of the issuer, I consider it to have a “Deemed Maturity” 2025-1-31 (this date may change in the future). This is due to my belief that OSFI will eventually extend the Non-Viability Contingent Capital (NVCC) rules to insurers and insurance holding companies. There is a brief explanation of this on the PrefLetter website (under the heading “DeemedRetractibles”) and with more detailed argument and progress reports on international negotiations in every edition of PrefLetter.

I will note that the market does not share my views regarding future application of the NVCC rules insurers and insurance issues trade very similarly to perpetuals.

Issue Comments

CPX.PR.A To Reset At 3.06%; Optional Conversion to CPX.PR.B

Capital Power Corporation has announced:

that it has notified the registered shareholder of its Cumulative 5-Year Rate Reset Preference Shares, Series 1 (Series 1 Shares) (TSX: CPX.PR.A) of the Conversion Privilege and Dividend Rate Notice.

Beginning on December 1, 2015 and ending on December 16, 2015 holders of the Series 1 Shares will have the right to elect to convert any or all of their Series 1 Shares into an equal number of Cumulative Floating Rate Preference Shares, Series 2 (Series 2 Shares).

If Capital Power does not receive an Election Notice from a holder of Series 1 Shares during the time fixed therefor, then the Series 1 Shares shall be deemed not to have been converted (except in the case of an Automatic Conversion). Holders of the Series 1 Shares and the Series 2 Shares will have the opportunity to convert their shares again on December 31, 2020, and every five years thereafter as long as the shares remain outstanding.

Effective December 31, 2015, the Annual Fixed Dividend Rate for the Series 1 Shares was set for the next five year period at 3.06%. Effective December 31, 2015, the Floating Quarterly Dividend for the Series 2 Shares was set for the first Quarterly Floating Rate Period (being the period from and including December 31, 2015, to but excluding March 31, 2016) at 2.67%. The Floating Quarterly Dividend Rate will be reset every quarter.

The Series 1 Shares are issued in “book entry only” form and, as such, the sole registered holder of the Series 1 Shares is the Canadian Depository for Securities Limited (CDS). All rights of beneficial holders of Series 1 Shares must be exercised through CDS or the CDS participant through which the Series 1 Shares are held. The deadline for the registered shareholder to provide notice of exercise of the right to convert Series 1 Shares into Series 2 Shares is 3:00 p.m. (MST) / 5:00 p.m. (EST) on December 16, 2015. Any notices received after this deadline will not be valid. As such, holders of Series 1 Shares who wish to exercise their right to convert their shares should contact their broker or other intermediary for more information and it is recommended that this be done well in advance of the deadline in order to provide the broker or other intermediary with time to complete the necessary steps.

After December 16, 2015, (i) if Capital Power determines that there would remain outstanding on December 31, 2015, less than 1,000,000 Series 1 Shares, all remaining Series 1 Shares will be automatically converted into Series 2 Shares on a one-for one basis effective December 31, 2015; or (ii) if Capital Power determines that there would remain outstanding after December 31, 2015, less than 1,000,000 Series 2 Shares, no Series 1 Shares will be permitted to be converted into Series 2 Shares effective December 31, 2015. There are currently 5,000,000 Series 1 Shares outstanding.

The Toronto Stock Exchange (TSX) has conditionally approved the listing of the Series 2 Shares effective upon conversion. Listing of the Series 2 Shares is subject to the Capital Power fulfilling all the listing requirements of the TSX and upon approval, the Series 2 Shares will be listed on the TSX under the trading symbol CPX.PR.B.

CPX.PR.A is a FixedReset, originally 4.60%+217, that commenced trading 2010-12-16 after being announced 2010-12-1. Thus, we observe a 33% reduction of the dividend.

As noted in the release, the deadline for notifying the company of a desire to convert to the FloatingReset CPX.PR.B is 5:00 p.m. (EST) on December 16, 2015, (a Wednesday) but brokerages will normally have an internal deadline a day or two prior to that. If you miss the brokerage deadline, they’ll probably submit the request for you if you grovel, but if you miss the company deadline, that’s it.

At this point, market conditions are such that I expect CPX.PR.B to trade significantly below CPX.PR.A. CPX.PR.A closed today at 10.15 (!) and the average implied 3-month bill rate of other junk issues is -0.70%. Assuming this relationship holds, the estimated trading price for CPX.PR.B is 8.69, about 15% lower. Rather than convert and thereby get 1.00 shares of CPX.PR.B, it seems likely (but by no means guaranteed!) that it will be better to execute trades in the marketplace after CPX.PR.B commences trading and thereby get (maybe!) 1.16 shares of CPX.PR.B.

So, I expect to recommend that holders of CPX.PR.A hang on to them, but I will make a formal recommendation on December 11, just in time for PrefLetter.

Issue Comments

BEP.PR.G Soft On Decent Volume

Brookfield Renewable Energy Partners L.P. has announced:

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

Brookfield Renewable issued 7,000,000 Series 7 Preferred Units at a price of $25.00 per unit, for total gross proceeds of $175,000,000.

The Series 7 Preferred Units will commence trading on the Toronto Stock Exchange this morning under the ticker symbol BEP.PR.G.

BEP.PR.G is Preferred Units FixedReset 5.50%+447M550, announced November 17. It will be tracked by HIMIPref™ but relegated to the Scraps index on credit concerns. Note that the distribution will be a mixture of dividends, income and return of capital for tax purposes; calculating the after-tax return is complex and will require numerous assumptions!

The issue is rated Pfd-3(high) by DBRS:

DBRS Limited (DBRS) has today finalized its provisional rating of Pfd-3 (high) with a Stable trend on Brookfield Renewable Energy Partners L.P.’s (BREP) issuance of Class A Preferred Limited Partnership Units, Series 7 (Preferred LP Units).
…
DBRS notes that the Preferred LP Units will rank on parity with every other series of Class A Preferred Limited Partnership Units and will be fully and unconditionally guaranteed by BREP’s key holding subsidiaries (the Guarantors). The Preferred LP Units will rank pari passu at the Guarantor level with the outstanding Preference Shares (rated Pfd-3 (high) by DBRS) of Brookfield Renewable Power Preferred Equity Inc., which are also guaranteed by BREP.

The issue traded 339,999 shares (consolidated exchanges) in a range of 24.60-94 today before closing at 24.70-75, 57×28. Vital statistics are:

BEP.PR.G FixedReset YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2045-11-25
Maturity Price : 23.05
Evaluated at bid price : 24.70
Bid-YTW : 5.52 %

According to the prospectus:

Management anticipates the 5 year average per unit Canadian dividend, ordinary income and return of capital will be 50%, 25%, and 25%, respectively, for the period between 2015 and 2020; however, no assurance can be provided this will occur.

This is the same estimate as was used for the coercive BRF.PR.E exchange offer, so we can recycle some analysis!

According to Ernst & Young, marginal tax rates for an Ontario resident with taxable income of $150,000 p.a. were 46.41% on income, 23.20% on capital gains and 29.52% on eligible dividends. Since the Return of Capital on the new units will eventually be taxed as a capital gain but only when the gain or loss is crystallized, let’s apply a 25% discount to the capital gain marginal rate to reflect the time value of the money; hence, we will assume that the Return of Capital is subject to tax at a rate of 23.20% * 75% = 17.4%:

Taxation of distributions
  BEP.PR.G
Distribution
Type		 Pre Tax Amount Tax Net
Eligible
Dividend		 0.6875 0.20295 0.48455
Ordinary
Income		 0.34375 0.1595 0.18425
Return
of
Capital		 0.34375 0.0598 0.28395
Total 1.375 0.42225 0.95275

So if we accept the given figures as a good enough guess – the after-tax income per share will be 0.95275, equivalent to a dividend of 1.352, a rate of slightly over 5.40%, which is in agreement with the figure Louisprefs supplied as the Scotia estimate in the comments to the announcement post. However, note that there are no guarantees offered by the company! If it should come to pass that 100% of the distributions are ordinary income, then tax at 46.41% will come to 0.6381 and the net after-tax amount will be 0.7369, which is 23% less than the estimate above. So there’s a certain amount of tax-risk here, depending on the nature of the company’s distributions.

Update, 2015-11-26: S&P has rated the issue P-3(high). On November 4 they degraded the outlook on BREP to stable from positive:

Standard & Poor’s Ratings Services today said it revised its outlook on Brookfield Renewable Energy Partners L.P. (BREP) to stable from positive. At the same time Standard & Poor’s affirmed its ratings on BREP and subsidiaries Brookfield Renewable Power Preferred Equity Inc. and BRP Finance ULC, including its ‘BBB’ long-term corporate credit rating on BREP.

The outlook revision reflects our view of the company’s ability to generate strong remittable cash flows from its holdings and its increased level of holding company (holdco) recourse debt. The company has articulated a policy of maintaining relatively low levels of leverage at the holdco level with leverage at the holdco used opportunistically for acquisitions with equity as market conditions allow. However, during the course of the year, the company has made a number of acquisitions that, although partially funded with new equity issuance, maintained a higher level of debt at the holdco. This has resulted in lower credit metrics. “Although the metrics are still comfortably within the range for the rating, we believe that the increased debt will remain at the holdco level for the foreseeable future,” said Standard & Poor’s credit analyst Stephen Goltz.

Issue Comments

DC.PR.C: Coercive Exchange Offer

Dundee Corporation has announced [although not yet on their website]:

that it is proposing a preferred share exchange transaction pursuant to which each of its First Preference Shares, Series 4 par value $17.84 (the “Series 4 Preferred Shares”) would be exchanged for 0.7136 of a First Preference Share, Series 5 par value $25.00 (the “Series 5 Preferred Shares”) pursuant to a statutory plan of arrangement under the Business Corporations Act (Ontario) (the “Arrangement” or the “Transaction”).

The Company has called a special meeting (the “Meeting”) of the holders of Series 4 Preferred Shares (the “Series 4 Preferred Shareholders”) to consider the Arrangement for 9:00 a.m. (Toronto time) on January 7, 2016, at the offices of Dundee Corporation, 1 Adelaide St. East, Suite 2100, Toronto, Ontario, Canada, M5C 2V9. The Management Information Circular of the Company (the “Circular”) for the Meeting will be mailed to the Series 4 Preferred Shareholders and filed on SEDAR in due course.

The Company has engaged GMP Securities L.P. (“GMP”) as its financial advisor and dealer manager, and Shorecrest Group Ltd. as its proxy advisor and paying agent in connection with the Transaction.

The board of directors of Dundee (the “Board of Directors”) has unanimously determined that the Arrangement is fair to the Series 4 Preferred Shareholders (as well as to the holders of all other classes and series of shares) and is in the best interests of Dundee, and unanimously recommends that the Series 4 Preferred Shareholders vote FOR the Arrangement Resolution (as defined below). The determination of the Board of Directors is based on various factors, including a fairness opinion of GMP.

The Company has received substantial support for the Arrangement based on confidential consultations with representatives of significant holders of the Series 4 Preferred Shares. To be effective, the Arrangement must be approved by a resolution (the “Arrangement Resolution”) passed at the Meeting by not less than two-thirds (66 2/3%) of the votes validly cast by the Series 4 Preferred Shareholders present in person or represented by proxy.

The completion of the Arrangement is conditional on, among other things, the holders of the Series 4 Preferred Shares approving the Arrangement, the approval of the Toronto Stock Exchange, dissent rights not having been exercised with respect to more than 10% of the issued and outstanding Series 4 Preferred Shares, any required lender approvals and other customary conditions.

Series 4 Preferred Shareholders who vote in favour of the Arrangement and their brokers may be entitled to certain consent payments, depending on when their vote is received among other things. See “Consent Payments” below. Series 4 Preferred Shareholders are encouraged to vote regardless of how many Series 4 Preferred Shares they own. Series 4 Preferred Shareholders should follow the instructions provided on the voting instruction form to be provided by their broker, investment dealer, bank, trust company or other intermediary to ensure their vote is counted at the Meeting.

Details of the Transaction

Reasons for the Arrangement

By recommending the Arrangement Resolution to the Series 4 Preferred Shareholders, the Board of Directors believes the Arrangement Resolution provides a number of anticipated benefits to the Series 4 Preferred Shareholders, including, without limitation, the following:

(a) the Series 5 Preferred Shares will have a dividend rate of 6% per annum, which is greater than the current dividend rate on the Series 4 Preferred Shares of 5% per annum;

(b) each Series 4 Preferred Share (each having a par value and redemption price of $17.84 per Series 4 Preferred Share) will be exchanged for 0.7136 of a Series 5 Preferred Share, which will adjust the par value and redemption price to $25.00 per Series 5 Preferred Share, aligning with standard market convention;

(c) the Series 5 Preferred Shares will be redeemable by the Company at its option by the payment of an amount in cash for each Series 5 Preferred Share so redeemed as outlined below. Currently, the Series 4 Preferred Shares are redeemable by the Company at its option at par, together with any accrued and unpaid dividends to but excluding the redemption date. As a result, until June 30, 2019, the Company will not be able to redeem the Series 5 Preferred Shares at its option unless it pays a redemption premium over par, and the Series 5 Preferred Shares will not be callable at the par value of $25.00 per share until the date at which the holder of a Series 5 Preferred Share may require the Company to redeem such share at $25.00 per share; and

(d) the Series 4 Preferred Shareholders will have the opportunity to receive the Consent Payments outlined below.

The Board of Directors also believes that the Arrangement Resolution provides a number of anticipated benefits to the Company and indirect benefits to the holders of the other classes (and series) of shares of the Company as follows:

(a) by extending the retraction date of the Series 4 Preferred Shares through the issuance of the Series 5 Preferred Shares from June 30, 2016 to June 30, 2019, the Company can repurpose up to $107,040,000 that would have been needed should the holders have required the Company to redeem the Series 4 Preferred Shares on or after June 30, 2016 at the par price of $17.84 per Series 4 Preferred Share;

(b) the Company will maintain financial flexibility for future opportunistic business developments; and

(c) the Series 5 Preferred Shares will continue to be serviceable at an attractive cost of capital.

Series 5 Preferred Shares

The rights, privileges, restrictions and conditions of the Series 5 Preferred Shares will be similar to those of the Series 4 Preferred Shares, except that:
•the cumulative dividend rate will be 6% per annum, being an annual dividend of $1.50 per Series 5 Preferred Share, or a quarterly dividend of $0.3750 per Series 5 Preferred Share. This is greater than the current cumulative dividend rate on the Series 4 Preferred Shares of 5% per annum;
•the Series 5 Preferred Shares will be redeemable by Dundee by the payment of an amount in cash for each Series 5 Preferred Share so redeemed of (i) $25.75 per share if redeemed prior to June 30, 2017, (ii) $25.50 per share if redeemed on or after June 30, 2017 and prior to June 30, 2018, (iii) $25.25 per share if redeemed on or after June 30, 2018 and prior to June 30, 2019, and (iv) $25.00 per share if redeemed on or after June 30, 2019, plus, in each case, an amount equal to all accrued and unpaid dividends thereon to but excluding the date fixed for redemption. Currently, the Series 4 Preferred Shares are redeemable by Dundee at par, together with any accrued and unpaid dividends to but excluding the redemption date; and
•the date after which holders may require Dundee to redeem the Series 5 Preferred Shares for cash and before which Dundee may convert the Series 5 Preferred Shares into Dundee’s Class A Subordinate Voting Shares will be June 30, 2019, as opposed to June 30, 2016, which is the date after which holders of Series 4 Preferred Shares may require Dundee to redeem the Series 4 Preferred Shares for cash or before which Dundee may convert the Series 4 Preferred Shares into Dundee’s Class A Subordinate Voting Shares.

Dividends

Series 4 Preferred Shareholders as at the close of business on the anticipated dividend record date of December 17, 2015 are expected to receive a final dividend in respect of their Series 4 Preferred Shares in the amount of $0.2230 per share, which is expected to be paid on the dividend payment date of December 31, 2015. After that, if the Arrangement is completed, holders of Series 5 Preferred Shares will be entitled to receive a quarterly dividend of $0.3750 per Series 5 Preferred Share in accordance with the terms of the Series 5 Preferred Shares.

Series 4 Preferred Shareholders are urged to carefully review the Circular once it is available as it will contain further details on the terms and conditions of the Arrangement, including the Series 5 Preferred Shares.

Consent Payments

If the Arrangement is completed, Dundee will make certain payments (“Consent Payments”) to the Series 4 Preferred Shareholders and their brokers, investment dealers, banks, trust companies or other intermediaries (collectively, “Intermediaries”), subject to certain procedures and conditions which will be outlined in the Circular:
•a Consent Payment of an aggregate of $0.4014 per Series 4 Preferred Share (the “Early Consent Payment”) (representing 2.25% of the par value of the Series 4 Preferred Shares) will be paid by Dundee in respect of each Series 4 Preferred Share that is voted FOR the Arrangement Resolution on or prior to December 31, 2015 (the “Early Deadline”), provided such vote is valid and is not subsequently withdrawn. The Intermediary will be entitled to receive and retain $0.1784 of such amount (representing 1.00% of the par value of the Series 4 Preferred Shares) and the holder of the Series 4 Preferred Share will be entitled to receive $0.2230 of such amount from its Intermediary (representing 1.25% of the par value of the Series 4 Preferred Shares); and
•a Consent Payment of $0.2676 per Series 4 Preferred Share (the “Later Consent Payment”) (representing 1.50% of the par value of the Series 4 Preferred Shares) will be paid by Dundee in respect of each Series 4 Preferred Share that is voted FOR the Arrangement Resolution after the Early Deadline but on or prior to the proxy cut off of 9:00 a.m. (Toronto time) on January 5, 2016, provided such vote is valid and is not subsequently withdrawn. The Intermediary will be entitled to receive and retain $0.0892 of such amount (representing 0.50% of the par value of the Series 4 Preferred Shares) and the holder of the Series 4 Preferred Share will be entitled to receive $0.1784 of such amount from its Intermediary (representing 1.00% of the par value of the Series 4 Preferred Shares).

DC.PR.C was last mentioned on PrefBlog when it was created through conversion of DC.PR.A. It is tracked by HIMIPref™ but relegated to the Scraps index on credit concerns.

Woo-hoo, how about them consent payments, eh? I’m sure glad that the regulators are considering eliminating mutual fund trailers, thus ensuring complete objectivity by advisors! Consent payments to advisors are always suspect, and when they reach the proportions of this offer (1% of par to the advisor, for early tender) become disgraceful and coercive. In addition, the 1.25% of par to holders voting in favour is yet another disgrace. Yes, it’s legal. That doesn’t mean I have to approve.

It will be recalled that Dundee discontinued its credit rating in 2012 [prior to the DC.PR.A conversion to DC.PR.C]. I do not generally track unrated preferred issues, but the issue that I presume will result from this conversion will be tracked, as I consider it to be grandfathered.

I expect the conversion offer will succeed due to the high consent payments and increased dividend; although some [such as myself] might say that a mere 100bp increase to go from a retractible issue to a perpetual would be pretty skinny for investment-grade and is basically laughable considering that Dundee isn’t just junk, it’s unrated junk. As support for my expectation, I will point out that the issue traded 39,456 shares today in a range of 16.90-19 before closing at 17.13-20, 98×36. The volume is very good for this issue; the price is well above recent averages.

The touted 6% yield isn’t really all that hot. Junk Straight Perpetuals are rare, but the Weston issues trade at a significant [but not huge] discount to par [which is good, remember! Calls are Bad!] to yield in the 5.60-70% range, so you’re only getting 30-40bp of spread for an unrated issue from a lesser credit. In addition, the par call commences June 30, 2019, which isn’t much of a lock-out period.

I don’t like this. I think holders should sell; perhaps not immediately, but wait for the news of the consent payments to get out, together with the headline coupon number. There was a bump in price today; maybe there will be more once the proceeds from tax-loss selling need to find a home.

Update, 2015-11-25: As pointed out in the comments by Assiduous (and Careful!) Readers SafetyInNumbers and prefman, the issue is actually retractible in about three-and-a-half years; it is not a perpetual, as I originally mistakenly said.

So what’s the yield? For every DC.PR.C share converted, the holder will get 0.7136 new shares, which will pay 6% quarterly; there will also be a Consent Payment of $0.4014 (if tendered early), of which $0.1784 will go to the advisor as a trailer solicitation fee and $0.2230 will be retained by the rightful owner. $25.00 * 0.7136 = $17.84, so assuming that fair value of DC.PR.C is its retraction price of $17.84 means that

Plugging in the numbers on the Yield-to-Call Calculator results in a conclusion that the company is paying 6.53% for funds, of which the holder gets 6.21%. These humbers are dependent upon the current price we use for DC.PR.C, of course; I have used its pare value of $17.84, but this does not account for accumulated dividend, which it should since I have also used the current date as the purchase date.

Using 2015-12-31 as the purchase date (when payments for DC.PR.C will stop and payments for the new issue will commence accumulating, assuming the deal goes through) result in the holder getting 6.40% compared to the company’s cost of 6.73%.

This is the equivalent of 8.32% interest for three-and-a-half year money! Rich indeed, but the question is – how much should the company be paying given its credit quality? I will note that DC.PR.B, FixedReset, 5.688%+410 was bid yesterday at 17.75 to yield 7.50%, while its Strong Pair DC.PR.D, FloatingReset+410 was bid at 13.61 to yield 8.50%.