PrefBlog

TransAlta Corporation has announced:

that it does not intend to exercise its right to redeem all or any portion of the currently outstanding Cumulative Redeemable Rate Reset First Preferred Shares, Series G (“Series G Shares”) (TSX: TA.PR.J) on September 30, 2019 (the “Conversion Date”).

As a result, and subject to certain conditions, the holders of the Series G Shares will have the right to elect to convert all or any of their Series G Shares into Cumulative Redeemable Floating Rate First Preferred Shares, Series H of the Company (“Series H Shares”) on the basis of one Series H Share for each Series G Share on the Conversion Date.

As provided in the share terms of the Series G Shares, the foregoing conversion right is subject to the conditions that: (i) if TransAlta determines that there would remain outstanding immediately following the conversion, less than 1,000,000 Series G Shares, all remaining Series G Shares shall be converted automatically into Series H Shares on a one-for one basis effective September 30, 2019; or (ii) if TransAlta determines that there would remain outstanding immediately after the conversion, less than 1,000,000 Series H Shares, holders of Series G Shares shall not be entitled to convert their shares into Series H Shares on the Conversion Date. There are currently 6,000,000 Series G Shares outstanding.

With respect to any Series G Shares that remain outstanding after September 30, 2019, holders thereof will be entitled to receive quarterly fixed cumulative preferential cash dividends, if, as and when declared by the Board of Directors of TransAlta. The annual dividend rate for the Series G Shares for the five-year period from and including September 30, 2019 to but excluding September 30, 2024, will be 4.988%, being equal to the five-year Government of Canada bond yield of 1.188% determined as of today plus 3.80%, in accordance with the terms of the Series G Shares.

With respect to any Series H Shares that may be issued on September 30, 2019, holders thereof will be entitled to receive quarterly floating rate cumulative preferential cash dividends, if, as and when declared by the Board of Directors of TransAlta. The annual dividend rate for the 3-month floating rate period from and including September 30, 2019 to but excluding December 31, 2019 will be 5.438%, being equal to the annual rate for the most recent auction of 90-day Government of Canada Treasury Bills of 1.638% plus 3.80%, in accordance with the terms of the Series H Shares (the “Floating Quarterly Dividend Rate”). The Floating Quarterly Dividend Rate will be reset every quarter.

The Series G Shares are issued in “book entry only” form and must be purchased or transferred through a participant in the CDS depository service (“CDS Participant”). All rights of holders of Series G Shares must be exercised through CDS or the CDS Participant through which the Series G Shares are held. The deadline for the registered shareholder to provide notice of exercise of the right to convert Series G Shares into Series H Shares is 3:00 p.m. (MST) / 5:00 p.m. (EST) on September 15, 2019. Any notices received after this deadline will not be valid. As such, holders of Series G 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.

If TransAlta does not receive an election notice from a holder of Series G Shares during the time fixed therefor, then the Series G Shares shall be deemed not to have been converted (except in the case of an automatic conversion). Holders of the Series G Shares and the Series H Shares will have the opportunity to convert their shares again on September 30, 2024, and every five years thereafter as long as the shares remain outstanding. For more information on the terms of the Series G Shares and the Series H Shares, please see TransAlta’s articles of amalgamation, including the share terms and shares in series schedule attached thereto as Schedule “A”, which are available on the Company’s website under the Investor Centre (Governance).

TA.PR.J is a FixedReset, 5.30%+380, that commenced trading 2014-8-14 after being announced 2014-8-6. It is tracked by HIMIPref™ and has been assigned to the Scraps index on credit concerns. It was recently downgraded to P-4(high by S&P but remains at Pfd-3(low) with DBRS.

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., TA.PR.J 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). Inspection of the graph and the overall average break-even rates for extant pairs will provide a guide for estimating the break-even rate for the pair now under consideration assuming, of course, that enough conversions occur so that the pair is in fact created.

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The market has lost enthusiasm for floating rate product; the implied rates until the next interconversion are generally well below the current 3-month bill rate as the averages for investment-grade and junk issues are at +0.60% and +0.95%, 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 TA.PR.J FixedReset, we may construct the following table showing consistent prices for its soon-may-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 trade below the price of their FixedReset counterparts, TA.PR.J. Therefore, it seems likely that I will recommend that holders of TA.PR.J continue to hold the issue and not to convert, but I will wait until it’s closer to the September 15 notification deadline before making a final pronouncement. I will note that once the FloatingResets commence trading (if, in fact, they do) it may be a good trade to swap one issue for the other in the market once both elements of each pair are trading and you can – hopefully – 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.

Enbridge Inc. has announced (on August 19):

that none of its outstanding Cumulative Redeemable Preference Shares, Series 3 (Series 3 Shares) will be converted into Cumulative Redeemable Preference Shares, Series 4 of Enbridge (Series 4 Shares) on September 1, 2019.

After taking into account all conversion notices received from holders of its outstanding Series 3 Shares by the August 19, 2019 deadline for the conversion of the Series 3 Shares into Series 4 Shares, less than the 1,000,000 Series 3 Shares required to give effect to conversions into Series 4 Shares were tendered for conversion.

ENB.PR.Y is a FixedReset, 4.00%+238, that commenced trading 2013-6-6 after being announced 2013-5-28. The issue will reset at 3.737% effective September 1, 2019. I recommended against conversion. ENB.PR.Y is tracked by HIMIPref™ but relegated to the Scraps – FixedReset (Discount) subindex on credit concerns.

Element Fleet Management Corp. has announced (although not yet on their website):

that, pursuant to the rights, privileges, restrictions and conditions attaching to the Cumulative 5-Year Rate Reset Preferred Shares, Series E of the Corporation (the “Series E shares”), as provided in the Corporation’s restated articles of incorporation dated October 4, 2016, the holders of Series E shares have the right, at their option, on September 30, 2019 (the “Series E Conversion Date”) to convert all, or any part, of the then outstanding Series E shares into Cumulative Floating Rate Preferred Shares, Series F of the Corporation (the “Series F shares”) on the basis of one Series F share for each Series E share converted (the “Series E Conversion Privilege”).

The dividend rate applicable to the Series E shares for the period from and including September 30, 2019 up to, but excluding, September 30, 2024, and the dividend rate applicable to the Series F shares for the period from and including September 30, 2019 up to, but excluding, December 31, 2019, will be determined by the Corporation and announced by way of a news release on September 3, 2019.

Beneficial owners of Series E shares who wish to exercise their Series E Conversion Privilege should communicate with their broker or other nominee to obtain instructions for exercising such Series E Conversion Privilege during the notice period, which will run from September 3, 2019 until 5:00 p.m. (Toronto time) on September 16, 2019.

The foregoing Series E Conversion Privilege is subject to the following: (i) holders of Series E shares shall not be entitled to convert their Series E shares into Series F shares on the Series E Conversion Date if the Corporation determines that there would remain outstanding on the Series E Conversion Date less than 500,000 Series F shares, after taking into account all Series E shares tendered for conversion into Series F shares, and (ii) alternatively, if the Corporation determines that there would remain outstanding on the Series E Conversion Date less than 500,000 Series E shares after taking into account all Series E shares tendered for conversion into Series F shares, then all, but not part, of the remaining Series E shares shall automatically be converted into Series F shares on the basis of one Series F share for each Series E share on the Series E Conversion Date. In either case, the Corporation will give written notice to that effect to the sole registered holder of the Series E shares at least seven days prior to the Series E Conversion Date.

EFN.PR.E is a FixedReset, 6.40%+472, that was announced 2014-6-2 but not immediately tracked by HIMIPref™ as it was unrated. Coverage commenced in September, 2015 after the company’s preferreds were rated Pfd-3 by DBRS.

I will have more to say once the reset rate is announced on September 3.

Assiduous Reader coolmesh asked on the August 20 post:

I’ve been watching TD.PF.M getting hammered the last four weeks. Good rate, good reset rate and good quality company. Any thoughts on what’s going there?

TD.PF.M is a FixedReset 5.10%+356, NVCC, that commenced trading 2019-6-4 after being announced 2019-5-24. It is tracked by HIMIPref™ and is assigned to the FixedReset (Discount) subindex.

CM.PR.Y is a FixedReset, 5.15%+362, NVCC, that commenced trading 2019-6-4 after announced May 24. It is tracked by HIMIPref™ and is assigned to the FixedReset (Discount) subindex.

June 4 was the last date we saw a new issue start to trade, as the new issue market is currently ‘closed for re-pricing’, we might say. We might normally expect a bank issue or two to be announced once the banks have gotten their 19Q3 earnings announcements out of the way, but given the tone of the market it won’t be surprising if they just give this opportunity a miss. On the other hand, the grossly foreshortened 5-year call-lockout period for FixedResets means that issuers have relatively little at risk in offering so-called perpetual product in times of elevated yields (this has always been a crucial point with this structure) so who knows?

It will be recalled that with respect to the issue-date pricing of TD.PF.M, I concluded:

According to this [Implied Volatility] analysis, the fair price of the new issue is 23.58, down 0.69 from the announcement day fair value of 24.27.

… while the conclusion for CM.PR.Y was:

According to this analysis, the fair price of the new issue is 23.71, down from the announcement day fair-value of 24.85, but alert Assiduous Readers will have noticed that the Implied Volatility plot is very peculiar, having three expensive issues and four cheap ones, with nothing in between.

So let’s update the Implied Volatility Analyses:

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According to these analyses, TD.PF.M continues to be very expensive, bid at 23.86 with a fair price of 22.54; the same applies to CM.PR.Y, bid at 23.50 with a fair value of 22.44.

And now we can turn to relative performance for the month-to-date:

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So neither TD.PF.M (Spread +356bp, Performance -4.71%) nor CM.PR.Y (+362bp, -5.81%) are too far out of line with either the series for their issuers or with the general “Pfd-2 Group” (which includes Pfd-2(high) and Pfd-2(low) issues). In fact, they’ve done relatively well due to their relatively high Issue Reset Spreads, although correlation is poor.

There are three obvious outliers that are ruining the correlation analysis: CIU.PR.C (+136bp, -1.55%); BAM.PF.J (+310bp, -0.76%); and VNR.PR.A (+281bp, +0.40%); the last of which is inching towards acquisition at par. If we perform the correlation analysis without these three, we find a correlation of 19% – which isn’t bad, given three weeks of chaos – and it is this correlation that is shown on the chart.

So the short answer to the question:

Any thoughts on what’s going there?

is … the market’s blown up and these issues are not immune. Note that both of these recent new issues remain expensive relative to their peers and I expect this premium pricing to decay over the next twelve months or so, which is equivalent to saying that I expect them both to underperform.