PrefBlog

It will be recalled that ENB.PR.B will reset to 3.415% effective June 1.

Holders of ENB.PR.B have the option to convert to FloatingResets, which will pay 3-month bills plus 240bp on the par value of $25.00, reset quarterly. The deadline for notifying the company of the intent to convert is 5:00 p.m. (Toronto time) on May 17, 2017; 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, if it is issued, is not yet known.

ENB.PR.B is a FixedReset, 4.00%+240, that commenced trading 2011-9-30 after being announced 2011-9-21.

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., ENB.PR.B 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; most 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 current market rates, at +0.02% and -0.15%, 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 ENB.PR.B 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 ENB.PR.B 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 path of policy rates over the next five years. 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.

It will be recalled that CU.PR.C will reset to 3.40% (paid on par) effective June 1.

Holders of CU.PR.C have the option to convert to FloatingResets, which will pay 3-month bills plus 240bp on the par value of $25.00, reset quarterly. The deadline for notifying the company of the intent to convert is 3 p.m. (Calgary time) / 5 p.m. (Toronto time) on May 17, 2017; 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, if it is issued, is not yet known.

CU.PR.C is a FixedReset, 4.00%+240, that commenced trading 2011-9-21 after being announced 2011-9-13.

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., CU.PR.C 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; most 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 current market rates, at +0.02% and -0.15%, 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 CU.PR.C 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 CU.PR.C 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 path of policy rates over the next five years. 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.

S&P has announced:

• •We are lowering our long-term corporate credit rating on Montreal-based Aimia Inc. to ‘BB+’ from ‘BBB-‘, reflecting our view of the risks to the company’s business and cash flow prospects following Air Canada’s notice to not renew its contract with Aimia when the current agreement expires June 30, 2020.
• •We are also lowering our global scale rating to ‘B+’ from ‘BB’ and our Canada scale rating to ‘P-4(High)’ from ‘P-3’ on the company’s preferred shares.
• •The ‘BBB-‘ issue-level rating on the company’s C$450 million senior secured debt outstanding is unchanged, reflecting our expectation of substantial recovery (70%-90%, rounded estimate 80%) in a default scenario. As such, we are assigning a ‘2’ recovery rating to the secured notes.
• •At the same time, we are placing all our ratings on Aimia on CreditWatch with negative implications.
• •The CreditWatch listing reflects the potential that we could lower the ratings on the company by one or more notches. We expect to resolve the CreditWatch placement within the next couple of months following our review of Aimia’s plans.

…
The Aeroplan program drives a significant portion of Aimia’s EBITDA and cash flow, and we believe the announcement increases the risk that gross billings will decline and redemptions increase through 2020. We believe this structural change could materially weaken the company’s medium-term cash flow and growth, and raise significant uncertainty about the company’s long-term outlook for sustained growth and profitability, factors that do not support an investment-grade rating, in our opinion.

The CreditWatch listing reflects the risk that we could lower our ratings on Aimia by one or more notches. We expect to resolve the CreditWatch placement within the next couple of months following our review of Aimia’s plans to manage potentially rising reward redemptions; mitigate potentially lower attractiveness of the Aeroplan program to its members; and, more important, demonstrate sufficient liquidity, financial flexibility, and capital market access to support Aimia’s debt obligations and address investments required to transition the business.

On May 11, DBRS announced that it:

has today placed Aimia Inc.’s (Aimia or the Company) Issuer Rating and Senior Secured Debt rating of BBB (low) as well as its Preferred Shares rating of Pfd-3 (low) Under Review with Negative Implications. The action follows the Company’s announcement that it has received a notice of contract non-renewal from Air Canada after the agreement’s expiration in June 2020. DBRS notes that the existing agreement and Air Canada’s purchasing commitments to Aimia remain in place until June 2020.
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The Under Review with Negative Implications status reflects Air Canada’s importance to Aimia as a coalition partner and DBRS’s previous expectation that the agreement with Air Canada would be renewed, albeit on less favourable terms to Aimia. Furthermore, consumers’ reaction to this announcement, including the potential for lower engagement in the Aeroplan program and accelerated reward redemption, creates additional uncertainty going forward regarding the Company’s revenue, adjusted EBITDA and free cash flow profile (particularly with a lack of clarity on future dividend payments). Consequently, there is an increased risk in the ability to repay and/or refinance the $250 million of Senior Secured Notes due May 2019 as well as amounts outstanding on the revolving credit facility, which matures in April 2020. As such, DBRS believes that Aimia’s credit risk profile may no longer be consistent with an investment-grade rating, even if current credit metrics are maintained.

While a negative rating action is likely required, the degree of such an action will follow DBRS’s ongoing review with management, which will focus on (1) the potential impact on the business risk profile following the loss of Air Canada as a coalition partner; (2) the Company’s longer-term business strategy, including plans to maintain customer engagement and find a new airline partner(s), (3) the Company’s liquidity, including refinancing of upcoming 2019 and 2020 maturities; and (4) Aimia’s financial management intentions and dividend policy going forward. DBRS notes that in today’s release Aimia stated that going forward dividends would be linked to free cash flow. DBRS will seek greater insight on these issues to resolve the Under Review status of the ratings as soon as possible.

Affected issues are AIM.PR.A, AIM.PR.B and AIM.PR.C.

Standard & Poor’s has announced:

•We believe Montreal-based Laurentian Bank of Canada’s funding metrics have weakened, as reliance on unsecured wholesale funding has increased because loan growth has accelerated in the past couple of years more than for peers.
• •We are revising our outlook on Laurentian Bank to negative from stable, to account for the bank’s higher dependence on short-term wholesale funding (as we define it), which we view as a riskier and less-reliable funding source.
• •The negative outlook also reflects the potential risks we believe could materialize from the bank’s aggressive business growth (both organic and acquisitive), particularly in Business Services, which includes specialty lending to commercial segments such as equipment finance as well as lending to small- and medium-size enterprises (SMEs) and B2B Bank, its broker and third-party advisor channel, in the next two years.
• •We are also affirming our ‘BBB/A-2’ long- and short-term issuer credit ratings on Laurentian Bank.

…
“The outlook revision reflects our assessment of the bank’s weakening funding metrics due to management’s increased appetite for unsecured wholesale funding, with a higher emphasis on short-term wholesale funding (as we define it), which we view as a riskier and less reliable funding source” said Michael Leizerovich S&P Global Ratings credit analyst. By our calculation, Laurentian Bank’s short-term wholesale percentage of funding base has meaningfully risen from 14.6% at year-end 2012 to 25.4% at first-quarter 2017 (versus the peer average of 23.8%). As of first-quarter 2017, the bank’s stable funding ratio (which measures the company’s ability to fund long-term assets with long-term funding) was about 87.8%, which is below the Canadian bank peer average of 98.0%. By our estimate, this ratio, which was 95.4% at year-end 2013, has steadily declined for several years as the company has sought to diversify its funding sources to fund its loan growth.

The outlook is negative, reflecting the bank’s weakening funding profile and heightened risks associated with aggressive business growth. We will continue monitoring the bank’s progress against its ambitious seven-year transformation plan and remain vigilant regarding any changes in asset performance.

Affected issues are LB.PR.F, LB.PR.H and LB.PR.J.

Moody’s Investors Service has announced that it:

has today downgraded the Baseline Credit Assessments (BCAs), the long-term ratings and the Counterparty Risk Assessments (CRAs) of six Canadian banks and their affiliates, reflecting Moody’s expectation of a more challenging operating environment for banks in Canada for the remainder of 2017 and beyond, that could lead to a deterioration in the banks’ asset quality, and increase their sensitivity to external shocks.

The banks affected are: Toronto-Dominion Bank, Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Canada, National Bank of Canada, and Royal Bank of Canada.

The BCAs, long-term debt and deposit ratings and CRAs of the banks and their affiliates were downgraded by 1 notch, excepting only Toronto-Dominion Bank’s CRA, which was affirmed. The short term Prime-1 ratings of the Canadian banks were affirmed. All relevant ratings for these banks continue to have negative outlooks, reflecting the expected introduction of an operational resolution regime in Canada.

“Today’s downgrade of the Canadian banks reflects our ongoing concerns that expanding levels of private-sector debt could weaken asset quality in the future. Continued growth in Canadian consumer debt and elevated housing prices leaves consumers, and Canadian banks, more vulnerable to downside risks facing the Canadian economy than in the past.” said David Beattie, a Moody’s Senior Vice President.
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Moody’s considers that weakening credit conditions in Canada — including an increase in private-sector debt to GDP to 185.0% as of the end of 2016, up from 179.3% for 2015 — present increasing risk to Canadian banks’ asset quality and profitability. This increase has been led by household debt, which is now at a record high of 167.3% of disposable income (as at Q4 2016) and accompanying house price appreciation. Despite macro-prudential measures put into place by Canadian policymakers in recent years — which have had some success in moderating the rate of housing price growth — house prices and consumer debt levels remain historically high. Business credit, the other component of private-sector debt, has also grown rapidly, at a 6.2% CAGR over the past 3 years. We do note that the Canadian banks maintain strong buffers in terms of capital and liquidity. However, the resilience of household balance sheets, and consequently bank portfolios, to a serious economic downturn has not been tested at these levels of private sector indebtedness.

Specifically:

Toronto-Dominion Bank (TD, Aa2/Aa2 negative, a1); TD’s strong ratings are attributable to its very strong domestic retail franchise — which generates stable and recurring profitability and its business mix. This strength is due to leading market share positions in many personal & commercial financial services products, where TD typically has market shares in the high teens and holds first or second positions.

TD is the most retail oriented of its Canadian peers, with approximately 90% of earnings coming from retail (combined Canadian personal & commercial, wealth management and US personal & commercial, excluding corporate). While CM income has increased over recent quarters and capital allocated to the wholesale business is rising, we expect that reliance on this inherently volatile source of income will remain relatively modest.

Through acquisition and organic growth, TD has increased its exposure to unsecured Canadian consumer credit risk in recent years. In our view, however, the strength and stability of the earnings from TD’s Canadian personal and commercial banking franchise remain the primary credit strength supporting its ratings. The ratings of TD’s US affiliates benefit from support from the parent, and as such are also affected by this action.

TD’s preferred shares have been downgraded to Baa1(hyb). Issues affected are: TD.PF.A, TD.PF.C, TD.PF.D, TD.PF.E, TD.PF.F, TD.PF.G, TD.PF.H, TD.PR.S, TD.PR.T, TD.PR.Y, TD.PR.Z

BMO:

Bank of Montreal (BMO A1/A1 negative, a3); BMO is one of the six major banks in Canada which benefit from the protection of significant barriers to entry and the stability of a prudent regulatory environment. Although its Canadian retail market shares are towards the lower end of the Canadian peer group, BMO has double digit market shares across all significant retail financial services and products, providing scale and recurring earnings power in its home market. In our view, however, the strength and stability of the earnings from BMO’s Canadian personal and commercial (P&C) banking franchise remain the primary credit strength supporting its ratings. BMO has a strong and improving US regional banking presence through BMO Harris, which adds important diversification away from reliance on Canadian P&C earnings. However, BMO does not enjoy the same franchise strength and pricing power in the more competitive US market that it does in Canada. The ratings of BMO Harris and affiliates benefit from support from the parent, and as such are also affected by this action.

BMO’s preferred shares have been downgraded to Baa3(hyb). Issues affected are: BMO.PR.A, BMO.PR.B, BMO.PR.C, 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, BMO.PR.Z.

BNS:

Bank of Nova Scotia (BNS A1/A1 negative, a3); BNS is the most internationally active of the Canadian banks with approximately half of its earnings generated outside of Canada. BNS has taken significant measures to increase its profitability that signal a fundamental shift away from the bank’s traditionally low risk appetite. While the bank’s strategic actions are intended to enhance current profitability — in 2016, BNS reported domestic net interest margin lower than the six largest Canadian banks’ average- in our view, they increase the prospect of future incremental credit losses.

While BNS had strategically grown its credit card and auto finance portfolios – both of which are particularly prone to deterioration during an economic downturn and exhibit higher defaults and loss severities than mortgage portfolios — in recent years, growth in 2016 was flat. In addition, the bank has made a series of acquisitions away from its strong domestic franchise towards higher-growth but less stable international markets. BNS has aspirations to continue to grow its international earnings, which in Moody’s view adds to bondholder risk.

BNS’ preferreds have been downgraded to Baa3(hyb). Issues affected are: BNS.PR.A, BNS.PR.B, BNS.PR.C, BNS.PR.D, BNS.PR.E, BNS.PR.F, BNS.PR.G, BNS.PR.H, BNS.PR.O, BNS.PR.P, BNS.PR.Q, BNS.PR.R, BNS.PR.Y and BNS.PR.Z.

CM:

Canadian Imperial Bank of Commerce (CIBC A1/A1 negative, a3); CIBC is the most reliant of the Canadian banks on domestic P&C earnings, which generate approximately 65% of total earnings, excluding Corporate. In our view, however, the strength and stability of the earnings from CIBC’s Canadian personal and commercial banking franchise remain the primary credit strength supporting its ratings. CIBC has the second lowest proportionate exposure to unsecured and non-real estate secured consumer debt as a percentage of domestic consumer assets (roughly 11.5%), reflective of its very large book of insured mortgages.

CIBC is one of the six major banks in Canada that benefit from the protection of significant barriers to entry and the stability of a prudent regulatory environment. Although its Canadian retail market shares are mid-range relative to its Canadian peers, CIBC has solid double digit market shares across all significant retail financial services and products, providing scale and recurring earnings.

CM’s preferreds have been downgraded to Baa3(hyb). Affected issues are CM.PR.O, CM.PR.P and CM.PR.Q.

NA:

National Bank of Canada (NBC A1/A1 negative, baa1); NBC’s dominant position in commercial banking and strong second place share of market in retail banking in Québec are the primary credit strengths supporting its high ratings. The stability of the recurring earnings power of NBC’s regional retail franchise is, in Moody’s view, highly unlikely to be challenged. That being said, NBC’s asset base (CAD234 billion as of Q1 2017) and national deposit share (roughly 4%) are small relative to the other large Canadian banks whose branch systems are more national in scale. In our view, however, the strength and stability of the earnings from NBC’s Canadian personal and commercial banking franchise remain the primary credit strength supporting its ratings.

While each of the major Canadian banks enjoys the benefits of superior pricing power due to sustainable large market shares in many significant retail and commercial products and services, this is true for NBC only in the context of its regional market, the province of Québec. As such, the challenges in geographic diversification and earnings stability and the Québec credit concentrations offset partially the strength in local market share and sustainability. NBC is the Canadian bank most reliant upon inherently less stable capital markets earnings, which generated 38% of total earnings, excluding Corporate for 2016 (38% for 2015.)

NA’s preferreds have been downgraded to Ba1(hyb). Affected issues are NA.PR.A, NA.PR.Q, NA.PR.S, NA.PR.W and NA.PR.X

RY:

Royal Bank of Canada (RBC A1/A1 negative, a3 ); RBC’s ratings reflect its profile as a strong and diversified universal bank with sustainable leading market shares across many retail products and services in its home market. The stable earnings from RBC’s domestic Personal and Commercial franchise are a key credit strength. RBC has had very low earnings volatility, supported by the stabilizing effect of the recurring profitability of RBC’s solid domestic retail banking franchise.

However, over the past four years RBC has demonstrated rapid growth in its Capital Markets business, led by growth in its US corporate loan book and the repo and securities finance business. We believe that RBC’s US-focused Capital Markets growth strategy increases its exposure to risks that could more rapidly erode its creditworthiness in volatile or adverse market conditions, and is therefore negative for the credit. To date, this risk has been well managed and its performance has been very stable. Maintaining this performance through more volatile markets will be key to RBC’s longer term risk management track record. We do not expect that this business will continue on this growth trajectory, and, in fact, that capital committed to the Capital Markets business will be more constrained.

Management plans to substantially grow the earnings of its recently acquired, California-based private and commercial bank, City National Bank, (deposits Aa3 stable, a2) both organically and through targeted acquisitions. Growth in the City National business presents less credit risk than continued growth in the Capital Markets area, in our view.

RY’s preferreds have been downgraded to Baa3(hyb). Affected issues are 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.Q, RY.PR.R, RY.PR.W and RY.PR.Z.

RioCan Real Estate Investment Trust has announced:

that it will exercise its right to redeem all of its 5,980,000 outstanding Cumulative Rate Reset Preferred Trust Units, Series C (the “Series C Units”) on June 30, 2017 at the cash redemption price of $25.00 per Series C Unit, for total redemption proceeds of $149.5 million.

The regular quarterly distribution of $0.29375 per Series C Unit for the quarter ending June 30, 2017 (the “Final Distribution”) will be payable to holders of the Series C Units of record on June 30, 2017. Payment of the redemption proceeds and the Final Distribution will be made to CDS & Co., as sole registered holder, on or prior to June 30, 2017. Payment to beneficial holders will be made through the facilities of CDS & Co. on or about July 4, 2017 in respect of the redemption proceeds and July 6, 2017 in respect of the Final Distribution, respectively.

From and after June 30, 2017, the Series C Units will cease to be entitled to distributions and the only remaining rights of holders of such units will be to receive payment of the cash redemption price.

Beneficial holders who are not directly the registered holder of Series C Units should contact the financial institution, broker or other intermediary through which they hold these units to confirm how they will receive their redemption proceeds. Instructions with respect to receipt of the redemption amount will be set out in the redemption notice to be mailed to the registered holder of the Series C Units shortly. Inquiries should be directed to our Registrar and Transfer Agent, CST Trust Company, at 1-800-387-0825 (or in Toronto 416-682-3860).

REI.PR.C is an interest-bearing FixedReset, 4.70%+318, that commenced trading 2011-11-30 after being announced 2011-11-17. It has been a member of the Scraps subindex throughout its existence due to credit concerns.

The spread is very low for a redeemed issue, particularly since it is paying interest rather than dividends, but the company’s intent to redeem has been clear since the shocking redemption of REI.PR.A, which boosted the price of that share by 50%+ on announcement day. While the CFO made a case that the funding was not cost-effective in current conditions (even when having to redeem at par) no case was ever made as to why a tender offering and Normal Course Issuer Bid was ever pursued.