Category: Issue Comments

Partners Value Split Corp. has released its Semi-Annual Report to June 30, 2015.

The company has the following issues outstanding: PVS.PR.A, PVS.PR.B, PVS.PR.C and PVS.PR.D.

Figures of interest are:

MER: I suggest it is best to include the amortization of share issue costs in MER – after all, this is a charge against the stated value of the company. Therefore, expenses were $215,000 (regular expenses) + $739,000 (amortization) = $954,000 for six months on assets of $3.301-billion (see below) or 4bp p.a..

Average Net Assets: We need this to calculate portfolio yield and MER. There were negligible capital transactions, so we’ll just take the average of the beginning and end of period assets (including preferred shares) so: [(2.733-billion + 0.761-billion) + (2.348-billion + 0.760-billon)]/2 = $3.301-billion

Underlying Portfolio Yield: Total Income of $23.3-million semi-annually divided by average net assets of $3,301-million is 1.41% p.a..

Income Coverage: Net income of $23.068-million less amortization of $0.739-million is $22.329-million to cover senior preferred dividends and debenture interest of $12.964-million is 172%. However, I consider it prudent to include the $10-million p.a. stated entitlement of the Junior preferreds, even though none of this was actually paid in 2015 to date because the Juniors can be retracted at any time, which could prove embarrassing in times of extreme stress. So I’d say income coverage is 124%.

It will be recalled that

• NPI.PR.A will reset to 3.51% effective September 30. Holders of NPI.PR.A have the option to convert to FloatingResets, which will pay 3-month bills plus 280bp, reset quarterly.
• FFH.PR.G will reset to 3.318% effective September 30. Holders of FFH.PR.G have the option to convert to FloatingResets, which will pay 3-month bills plus 256bbp, reset quarterly.
• ALA.PR.A will reset to 3.38% effective September 30. Holders of ALA.PR.A have the option to convert to FloatingResets, which will pay 3-month bills plus 266bp, reset quarterly.

The deadline for notifying the companies of the intent to convert is September 15 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., NPI.PR.A and the FloatingReset, NPI.PR.?, 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 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 nearly all 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:

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 NPI.PR.A, FFH.PR.G and ALA.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 NPI.PR.A are tendered for conversion, then no conversions will be allowed; but if only 100,000 shares of NPI.PR.A 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.

As mentioned in the post EMA Outlook-Negative by S&P; Review-Developing by DBRS, Emera’s Canadian subsidiary Nova Scotia Power has been put on Outlook-Negative by S&P:

• •On Sept. 4, Emera announced the US$10.4 billion proposed acquisition of TECO Energy, a Florida-based holding company that wholly owns regulated utilities Tampa Electric Co. and New Mexico Gas Co.
• •The proposed acquisition is partly being financed with the issuance of convertible debentures, and the additional debt load pushes Emera’s adjusted funds from operations-to-debt ratio to below 11%, the downgrade trigger.
• •As a result of the financing risk associated with this large acquisition that will double the size of the company, we are revising our outlook on Emera and its Canadian subsidiary Nova Scotia Power Inc. to negative from stable.
• •We are also revising the financial risk profile to “aggressive” from “significant”. The business risk of the consolidated entity post acquisition remains “excellent”.
• •We are affirming all ratings on Emera and NSPI, including our ‘BBB+’ long-term corporate credit ratings.

…
The negative outlooks on Emera and NSPI reflect the financing risk associated with this large acquisition and our expectation that the consolidated pro forma credit metrics will materially weaken due to the C$1.9 billion convertible debenture issuance to finance, in part, the purchase of TECO Energy.

Although we expect that the debentures have a high likelihood of conversion due to several factors including no interest after acquisition close, targeted sale to institutions that would be buyers of Emera equity, not debt), in the meantime credit metrics are expected to be below 11%. If conversion does not occur as expected and metrics remain below 11%, we could lower the ratings on Emera and NSPI.

We could revise our outlook to stable within our two-year outlook period if we expect consolidated AFFO-to-debt to be sustained comfortably above 11%, all else being equal. This could occur if the debentures are successfully converted.

The DBRS announcement regarding Emera made no mention of Nova Scotia Power.

Emera Inc. announced on Friday:

a definitive agreement for Emera to acquire TECO Energy (the “Transaction”), creating a North American energy leader, with over US$20 billion of assets and more than 2.4 million electric and gas customers. Upon closing, TECO Energy will become a wholly owned subsidiary of Emera.

Under the terms of the all-cash deal, which has been unanimously approved by the Board of Directors of both companies, TECO Energy shareholders will receive US$27.55 per common share, a 48 percent premium based on TECO Energy’s unaffected closing stock price on July 15, 2015 (the last trading day prior to news reports regarding TECO Energy’s strategic review) and 25 percent above TECO Energy’s unaffected 52-week high. This represents an aggregate purchase price of approximately US$10.4 billion including assumption of approximately US$3.9 billion of debt.

The closing of the Transaction, which is expected to occur by mid-2016, is subject to TECO Energy common shareholder approval and certain regulatory and government approvals, including approval by the New Mexico Public Regulation Commission, the Federal Energy Regulatory Commission and compliance with any applicable requirements under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the satisfaction of customary closing conditions.

… and announced today:

that its direct wholly-owned subsidiary, Emera Holdings NS Company (the “Selling Debentureholder”), has agreed to sell $1,900,000,000 aggregate principal amount of 4.00% convertible unsecured subordinated debentures (“Debentures”) of Emera in a secondary offering on a “bought deal” basis (the “Offering”). In connection with the Offering, the underwriters have also been granted an over-allotment option to purchase up to an additional $285,000,000 aggregate principal amount of Debentures at the offering price, within 30 days from the date of the closing of the Offering solely to cover over-allotments, if any, and for market stabilization purposes.

All Debentures are being sold on an instalment basis at a price of $1,000 per Debenture, of which $333 is payable on the closing of the Offering and the remaining $667 is payable on a date (the “Final Instalment Date”) to be fixed by the Company following satisfaction of all conditions precedent to the closing of Emera’s acquisition of TECO Energy, Inc. (NYSE:TE).

On September 4, 2015 Emera announced that it had entered into an agreement and plan of merger pursuant to which it will indirectly acquire TECO Energy, Inc. (“TECO Energy”), a Florida and New Mexico regulated electric and gas utilities holding company, for an aggregate purchase price of approximately US$10.4 billion including the assumption of approximately US$3.9 billion of debt.

As a result of this activity, S&P has announced:

• •On Sept. 4, Emera announced the US$10.4 billion proposed acquisition of TECO Energy, a Florida-based holding company that wholly owns regulated utilities Tampa Electric Co. and New Mexico Gas Co.
• •The proposed acquisition is partly being financed with the issuance of convertible debentures, and the additional debt load pushes Emera’s adjusted funds from operations-to-debt ratio to below 11%, the downgrade trigger.
• •As a result of the financing risk associated with this large acquisition that will double the size of the company, we are revising our outlook on Emera and its Canadian subsidiary Nova Scotia Power Inc. to negative from stable.
• •We are also revising the financial risk profile to “aggressive” from “significant”. The business risk of the consolidated entity post acquisition remains “excellent”.
• •We are affirming all ratings on Emera and NSPI, including our ‘BBB+’ long-term corporate credit ratings.

…
The negative outlooks on Emera and NSPI reflect the financing risk associated with this large acquisition and our expectation that the consolidated pro forma credit metrics will materially weaken due to the C$1.9 billion convertible debenture issuance to finance, in part, the purchase of TECO Energy.

Although we expect that the debentures have a high likelihood of conversion due to several factors including no interest after acquisition close, targeted sale to institutions that would be buyers of Emera equity, not debt), in the meantime credit metrics are expected to be below 11%. If conversion does not occur as expected and metrics remain below 11%, we could lower the ratings on Emera and NSPI.

We could revise our outlook to stable within our two-year outlook period if we expect consolidated AFFO-to-debt to be sustained comfortably above 11%, all else being equal. This could occur if the debentures are successfully converted.

Prior to the announcement of the convertible debt issue, DBRS announced:

DBRS Limited (DBRS) has today placed the BBB (high) Issuer Rating, BBB (high) Medium-Term Notes and Pfd-3 (high) Preferred Shares – Cumulative ratings of Emera Inc. (Emera or the Company) Under Review with Developing Implications.
…
The primary focus of DBRS’s FRA [financial risk assessment] analysis is on Emera’ non-consolidated capital structure (parent level) and cash flow from the subsidiaries to the parent to service the parent’s debt and corporate expenses. On a non-consolidated basis, the cash flow-to-interest expense ratio was reasonable at 12.3x in LTM 2015, while debt-to-capital was approximately 19%. DBRS notes that the non-consolidated leverage of 19% is well within the 30% threshold.

Currently, it is uncertain as to how Emera plans to ultimately finance the Acquisition. As a result, DBRS has placed the ratings of Emera Under Review with Developing Implications. DBRS will further review the Company’s financing plan when it is finalized. Upon final review, if the Company finances the Acquisition in such a way that its non-consolidated debt-to-capital structure exceeds 30% 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.

Affected issues are EMA.PR.A, EMA.PR.B, EMA.PR.C, EMA.PR.E and EMA.PR.F. S&P’s announcement also affects NSI.PR.D, which will be posted separately.

Northland Power Inc. has announced:

that pursuant to the share terms in respect of the Cumulative Rate Reset Preferred Shares, Series 1 (“Series 1 Shares”), it has determined the fixed dividend rate for the five years commencing September 30, 2015 and ending September 29, 2020. The fixed quarterly dividends on the Series 1 Shares during that period will be paid at an annual rate of 3.51% (Cdn. $0.22 per share per quarter).

Holders of Series 1 Shares have the right, at their option, exercisable not later than 5:00 pm (Toronto time) on September 15, 2015, to convert all or part of their Series 1 Shares, on a one-for-one basis, into Cumulative Floating Rate Preferred Shares, Series 2 (the “Series 2 Shares”), effective September 30, 2015. The quarterly floating rate dividends on the Series 2 Shares will be paid at an annual rate, calculated for each quarter, of 2.80% over the annual yield on 90-day Government of Canada treasury bills. The actual quarterly dividend rate in respect of the September 30, 2015 to December 30, 2015 dividend period for the Series 2 Shares will be 0.80% (3.18% on an annualized basis) and the dividend, if and when declared, for such dividend period will be Cdn. $0.20 per share, payable on December 31, 2015.

Holders of Series 1 Shares are not required to elect to convert all or any part of their Series 1 Shares into Series 2 Shares.

As provided in the share conditions of the Series 1 Shares, (i) if Northland determines that there would be fewer than 1,000,000 Series 1 Shares outstanding after September 30, 2015, all remaining Series 1 Shares will be automatically converted into Series 2 Shares on a one-for-one basis effective September 30, 2015; or (ii) if Northland determines that there would be fewer than 1,000,000 Series 2 Shares outstanding after September 30, 2015, no Series 1 Shares will be permitted to be converted into Series 2 Shares. There are currently 6,000,000 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 Northland 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 “NPI.PR.B”.

NPI.PR.A is a FixedReset with a spread of 280bp over five-year Canadas, which commenced trading July 28, 2015 under the ticker symbol NPP.PR.A after being announced July 6, 2010. The ticker was changed effective January 1, 2011 after conversion from an Income Trust. The original coupon was 5.25%, so the reset rate of 3.51% represents a decline of 33%. Hey, by recent 40%+ standards, that looks good!

As noted in the press release, holders have the option to convert into NPI.PR.B, a FloatingReset, and this option must be exercised prior to 5pm, September 15 before vanishing until the next reset date in 2020. Recent market conditions have been highly unfavourable for FloatingResets and it is likely that I will recommend against conversion. However, conditions can change dramatically and rapidly and I will wait until September 10 to make a more formal recommendation.

Note that the September 15 notification date is for notification of the company, and brokers will generally have an internal deadline a day or two prior to this … so if you’re planning to wait until the last minute, contact your broker and find out precisely when the last minute will be!

Fairfax Financial Holdings Limited has announced:

that it has determined the fixed dividend rate on its Cumulative 5-Year Rate Reset Preferred Shares, Series G (“Series G Shares”) (TSX:FFH.PR.G) for the five years commencing October 1, 2015 and ending September 30, 2020. The fixed quarterly dividends on the Series G Shares during that period will be paid at an annual rate of 3.318% (Cdn.$0.207375 per share per quarter).

Holders of Series G Shares have the right, at their option, exercisable not later than 5:00pm (Toronto time) on September 15, 2015, to convert all or part of their Series G Shares, on a one-for-one basis, into Cumulative Floating Rate Preferred Shares, Series H (the “Series H Shares”), effective September 30, 2015. The quarterly floating rate dividends on the Series H Shares will be paid at an annual rate, calculated for each quarter, of 2.56% over the annual yield on three month Government of Canada treasury bills. The actual quarterly dividend rate in respect of the October 1, 2015 to December 30, 2015 dividend period for the Series H Shares will be 0.731987% (2.936% on an annualized basis) and the dividend for such dividend period, if and when declared, will be Cdn.$0.18300 per share, payable on December 30, 2015.

Holders of Series G Shares are not required to elect to convert all or any part of their Series G Shares into Series H Shares. A holder of Series G Shares who does not so elect will (subject to the next paragraph) retain their Series G Shares.

As provided in the share conditions of the Series G Shares, (i) if Fairfax determines that there would be fewer than 1,000,000 Series G Shares outstanding after September 30, 2015, all remaining Series G Shares will be automatically converted into Series H Shares on a one-for-one basis effective September 30, 2015; and (ii) if Fairfax determines that there would be fewer than 1,000,000 Series H Shares outstanding after September 30, 2015, no Series G Shares will be permitted to be converted into Series H Shares. There are currently 10,000,000 Series G Shares outstanding.

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

Fairfax is a holding company which, through its subsidiaries, is engaged in property and casualty insurance and reinsurance and investment management.

FFH.PR.G is a FixedReset with a spread of 256bp over five-year Canadas, which commenced trading July 28, 2010 after being announced July 20, 2010. The original coupon was 5.00%, so the reset rate of 3.318% represents a decline of 34%. Hey, by recent 40%+ standards, that looks good!

As noted in the press release, holders have the option to convert into FFH.PR.H, a FloatingReset, and this option must be exercised prior to 5pm, September 15 before vanishing until the next reset date in 2020. Recent market conditions have been highly unfavourable for FloatingResets and it is likely that I will recommend against conversion. However, conditions can change dramatically and rapidly and I will wait until September 10 to make a more formal recommendation.

Note that the September 15 notification date is for notification of the company, and brokers will generally have an internal deadline a day or two prior to this … so if you’re planning to wait until the last minute, contact your broker and find out precisely when the last minute will be!

The National Bank of Canada has announced:

its intention to redeem on November 15, 2015, all of its issued and outstanding Non-Cumulative Fixed Rate First Preferred Shares Series 20 (the “Preferred Shares Series 20”) for total redemption price of approximately $176 million.

Pursuant to the share conditions, on November 15, 2015, the Bank may redeem the Preferred Shares Series 20 at a price equal to $25.50 per share together with all declared and unpaid dividends.

Separately from the payment of the redemption price, the declared quarterly dividend of $0.375, payable on November 15, 2015, will be paid in the usual manner to shareholders of record on October 13, 2015.

Since November 15, 2015 is a non-business day, any payments due to shareholders on such date will be made on the first business day following such date, being Monday, November 16, 2015.

A formal notice will be issued to holders of the Preferred Shares Series 20 in accordance with the share conditions. The redemption is subject to the final approval of the Office of the Superintendent of Financial Institutions (OSFI).

The Bank recommends shareholders consult with their tax advisors to determine the appropriate treatment and impact of the redemption.

Since the redemption is being priced at a premium to par, the Deemed Dividend rules come into account for taxable shareholders. Shareholders who allow their shares to be redeemed will be taxed as if they had sold it for $25.00 and simultaneously received a dividend of $0.50; shareholders who sell on the market (at a price which, unless something goes terribly wrong, should be a few pennies under the total redemption value, which will include the final actual dividend until that goes ex) will be taxed normally. The most favourable course will depend on the investors personal tax situation; please consult your personal tax advisor.