Enbridge Inc. has announced (on January 30):
that it does not intend to exercise its right to redeem its currently outstanding Cumulative Redeemable Preference Shares, Series D (Series D Shares) (TSX: ENB.PR.D) on March 1, 2018. As a result, subject to certain conditions, the holders of the Series D Shares have the right to convert all or part of their Series D Shares on a one-for-one basis into Cumulative Redeemable Preference Shares, Series E of Enbridge (Series E Shares) on March 1, 2018. Holders who do not exercise their right to convert their Series D Shares into Series E Shares will retain their Series D Shares.
The foregoing conversion right is subject to the conditions that: (i) if Enbridge determines that there would be less than 1,000,000 Series D Shares outstanding after March 1, 2018, then all remaining Series D Shares will automatically be converted into Series E Shares on a one-for-one basis on March 1, 2018; and (ii) alternatively, if Enbridge determines that there would be less than 1,000,000 Series E Shares outstanding after March 1, 2018, no Series D Shares will be converted into Series E Shares. There are currently 18,000,000 Series D Shares outstanding.
With respect to any Series D Shares that remain outstanding after March 1, 2018, holders thereof will be entitled to receive quarterly fixed cumulative preferential cash dividends, as and when declared by the Board of Directors of Enbridge. The new annual dividend rate applicable to the Series D Shares for the five-year period commencing on March 1, 2018 to, but excluding, March 1, 2023 will be 4.46 percent, being equal to the five-year Government of Canada bond yield of 2.09 percent determined as of today plus 2.37 percent in accordance with the terms of the Series D Shares.
With respect to any Series E Shares that may be issued on March 1, 2018, holders thereof will be entitled to receive quarterly floating rate cumulative preferential cash dividends, as and when declared by the Board of Directors of Enbridge. The dividend rate applicable to the Series E Shares for the three-month floating rate period commencing on March 1, 2018 to, but excluding, June 1, 2018 will be 0.89984 percent, based on the annual rate on three month Government of Canada treasury bills for the most recent treasury bills auction of 1.20 percent plus 2.37 percent in accordance with the terms of the Series E Shares (the Floating Quarterly Dividend Rate). The Floating Quarterly Dividend Rate will be reset every quarter.
Beneficial holders of Series D Shares who wish to exercise their right of conversion during the conversion period, which runs from January 30, 2018 until 5:00 p.m. (EST) on February 14, 2018, should communicate as soon as possible with their broker or other intermediary for more information. It is recommended that this be done well in advance of the deadline in order to provide the broker or other intermediary time to complete the necessary steps. Any notices received after this deadline will not be valid.
ENB.PR.D is a FixedReset, 4.00%+237, that commenced trading 2011-11-23 after being announced 2011-11-14. It is tracked by HIMIPref™ but relegated to the Scraps subindex on credit concerns.
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., BAM.PR.Z and the FloatingReset BAM.PF.K 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 BigThe market appears to be relatively uninterested in 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 slightly below current market rates, at +1.10% and +1.12%, respectively – although these break-even rates are much closer to the market rate than has been case for recent resets! 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.D 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:
| Estimate of FloatingReset (received in exchange for ENB.PR.D) Trading Price In Current Conditions |
| |
Assumed FloatingReset
Price if Implied Bill
is equal to |
| FixedReset |
Bid Price |
Spread |
1.50% |
1.00% |
0.50% |
| ENB.PR.D |
20.86 |
237bp |
20.27 |
19.77 |
19.27 |
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, it seems likely that I will recommend that holders of ENB.PR.D continue to hold the issue and not to convert, but I will wait until it’s closer to the February 14 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 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.
