PrefBlog

Assiduous Reader TS writes in and says:

James, first of all I do want to say that I check your prefblog regularly and do enjoy your content.

Attaboy, TS! That’s how you get your eMails answered!

With DC.A trading at 1.30 now I get a current value of 16.4125 for the series 5 prefs (DC.PR.E)

Thats assuming that Dundee would actually trigger the conversion option at $2.

From what I calculate they can trigger that option anytime prior to jun 30, 2019 at a pref price of

25.25/2 = 12.625 shares of DC.A per DC.PR.E pref

There are 3.29mil prefs outstanding so if they exercised that option they would issue

3.29×12.625=41.5mil shares of DC.A

There are 55.9mil shares of DC.A outstanding so my real question is…

Would they dilute themselves that much???

So let’s back up a little …

Dundee made an initial proposal in November 2015 to exchange its DC.PR.C shares for DC.PR.E, which would pay a little higher dividend and defer the soft-retraction privilege for three years; the proposal attracted some press coverage and an exhortation to consider exercising dissent rights. This led to reconsideration by Dundee despite a rather peculiar endorsement from a proxy advisor and led to a sweeter offer that attracted further commentary.

… and finally, the company announced a ringing endorsement from the shareholders … or perhaps it would be better to say “the shareholders’ advisors”, since the proxy solicitation fee was so high!

The proposal succeeded and DC.PR.E commenced trading on 2016-2-12. Some investors retracted on 2016-6-30, after filing the paperwork. A further 300,000-odd shares were redeemed on 2018-1-31 which comprised only about 8.4% of the total outstanding:

Dundee Corporation (TSX: DC.A and DC.PR.E) today completed the redemption of 303,265 first preference shares, series 5 (the “Series 5 Preferred Shares”), being all such shares tendered for redemption in accordance with the previously announced mandatory redemption provisions of the Series 5 Preferred Shares. The Series 5 Preferred Shares were redeemed at a price of $25.00 per share, or $7,581,625 in aggregate, plus accrued and unpaid dividends of $48,965. Following completion of the partial redemption, a total of 3,294,938 Series 5 Preferred Shares with a par value of $82.4 million remain issued and outstanding.

On August 14, the company announced some pretty awful operating results:

During the second quarter of 2018, the Corporation incurred a net loss attributable to owners of Dundee Corporation of $76.9 million, or a loss of $1.34 per share, compared to a net loss of $24.5 million or $0.45 per share generated in the second quarter of the prior year. Operating results in the second quarter of 2018 include losses from discontinued operations of $1.9 million, compared with earnings from discontinued operations of $4.3 million during the same quarter of the prior year.
…
• During the second quarter of 2018, loss from investments was $16.1 million, compared with loss from investments of $24.8 million in the same period of the prior year.
• Consolidated revenues were $43.5 million during the second quarter of 2018, compared with revenues of $51.4 million in the same quarter of the prior year.
• During the current quarter, the Corporation recognized a loss from its equity accounted investments of $38.6 million, compared with a gain of $0.1 million in the second quarter of 2017.
• On a year-to-date basis, the Corporation incurred a loss attributable to owners of the Corporation of $101.7 million, compared with net earnings attributable to owners of the Corporation of $5.0 million in the same period of 2017.
…
As previously disclosed, and as a result of a transfer out of $134.0 million of AUM to an external manager in May 2018, Goodman & Company, Investment Counsel Inc. (“GCIC”) reported its AUM of $66.9 million at June 30, 2018, compared with $194.1 million at December 31, 2017.

This news was not met with applause by holders of the Subordinate Voting Shares, DC.A:

Click for Big

… with holders of DC.PR.E being rather disapproving:

Click for Big

At today’s DC.A close of 1.23, the 12.5 DC.A shares to be received on shareholder-initiated conversion next June will be worth $15.375, and there will (maybe!) be four dividend payments in the interim totalling (maybe!) 1.875, for a total Future Value of $17.25, so the ratio is out of whack, given that the VWAP today was 20.46 on volume of 10,660.

So, basically, the company has three options:

• Pull a miracle out of its hat – ideally, of course, this miracle would be something along the lines of “earning a boat-load of money” or “attracting a takeover bid made of gold”, but they could always try to get another extension on their commitment and maybe get another rather peculiar endorsement from a proxy advisor, or
• Redeem DC.PR.E for cash – I suppose this is technically a separate option, but realistically I think it’s a detail of the ‘miracle’ option, above, or
• Allow DC.PR.E shareholders to convert to DC.A and thereby suffer enormous dilution of their subordinated shares.

In connection with the last option, we can review their 2017 Annual Information Form, which states in part:

The Company’s business and affairs are controlled by Mr. Ned Goodman, who directly or indirectly, owns shares representing approximately 99% of the votes attached to the Class B Common Shares and approximately 85% of the votes attached to all of the Company’s shares in aggregate. Accordingly, Mr. Goodman may be able to control the board of directors or to cause or prevent a change of control of the Company. Under Canadian law, an offer to purchase the Common Shares, depending on the offered price, would not necessarily result in an offer to purchase the Subordinate Voting Shares.

So he doesn’t care. Ned Goodman will continue to control the corporation and preside over important personnel decisions, such as whether Jonathan Goodman should continue as Executive Chairman and Director, whether David Goodman should continue as Chief Executive Officer and Director, whether Mark Goodman should continue as President and, perhaps most importantly, how to convince the market that the published book value per share of the company of $8.70 is entirely reasonable.

We shall see! However, I suspect that one very important scenario is that this plays out much along the lines of the saga of Quebecor World … in which repeated heavy conversions of the preferreds into common ultimately ended with a devastating restructuring.

Standard & Poor’s has announced:

•In the past few years, Bank of Montreal (BMO) has demonstrated good risk management with historically low loan losses and increased diversity in revenue streams and loan exposures, and has followed a conservative organic growth strategy.
•We are revising our stand-alone credit profile (SACP) on BMO to ‘a’ from ‘a-‘, to reflect improvements in its risk position. We are also revising our SACP on BMO Financial Corp. (BFC) to ‘bbb+’ from ‘bbb’, to reflect the substantial improvement in non-accruals and modest credit loss experience over the past several years.
•Given the improved stand-alone creditworthiness, we are raising our issue-level ratings on BMO’s non-viability contingent capital (NVCC) and non-NVCC subordinated and hybrid securities. We are affirming our ‘A+/A-1’ long- and short-term issuer credit ratings on BMO and its operating subsidiaries, including BFC.
•The stable outlook on BMO and its operating subsidiaries reflects our expectations that the bank’s financial performance and capitalization will remain stable, and its risk position will remain conservative with measured loan growth, stable credit metrics, and limited acquisition activity.

…
Our stable outlook on BMO and its operating subsidiaries reflects our assumption that, over the next two years financial performance and capitalization will remain stable, and asset quality will remain relatively good, reflecting conservative risk management, measured loan growth, and limited acquisition activity. In addition, we expect that BMO will continue to demonstrate conservative underwriting and improving operating efficiency. We expect the bank’s capital ratios will remain stable with no outsize capital-intensive acquisitions. We expect our S&P Global Ratings RAC ratio for BMO will remain in the middle of the 7%-10% capital range, which we deem adequate.

We could lower our assessment of BMO’s stand-alone creditworthiness if we were to see signs of an elevated risk appetite (for example, double-digit loan growth in the U.S.). We would also lower our SACP on BMO if credit quality weakens materially (particularly in mid-market U.S. commercial lending), or if the bank were to undertake aggressive capital actions (such that the RAC ratio declined below 7% on a sustained basis). Nevertheless, given BMO’s high systemic importance in Canada, we would lower our ratings only if its stand-alone creditworthiness were to decline by more than two notches. An upgrade is unlikely over our two-year outlook horizon because our current ratings already factor in an expectation of continued improvement in operating expenses, consistently strong asset quality, and stable operating performance in BMO’s P&C and capital market segments.

Affected issues are:
NVCC-compliant (to P-2(low)): BMO.PR.B, BMO.PR.C, BMO.PR.D, BMO.PR.S, BMO.PR.T, BMO.PR.W, BMO.PR.Y, BMO.PR.Z

NVCC-non-compliant (to P-2): BMO.PR.A*, BMO.PR.M (called for redemption), BMO.PR.Q, BMO.PR.R* (called for redemption)

BMO.PR.A and BMO.PR.R, both FloatingResets that came into existence through partial exchange from BMO.PR.Q and BMO.PR.M, respectively, are not explicitly listed by S&P on their rating list. This is almost certainly merely sloppiness on S&P’s part.

Fortis Inc. has declared:

NOTICE OF ANNUAL FIXED DIVIDEND RATE

CUMULATIVE REDEEMABLE FIVE-YEAR FIXED RATE RESET

FIRST PREFERENCE SHARES, SERIES G

NOTICE IS HEREBY GIVEN that Fortis Inc. (the “Corporation”) has calculated the annual fixed dividend rate (the “Annual Fixed Dividend Rate”) for the five-year period from and including September 1, 2018 to but excluding September 1, 2023 (the “Subsequent Fixed Rate Period”) for the Corporation’s Cumulative Redeemable Five-Year Fixed Rate Reset First Preference Shares, Series G (the “Series G First Preference Shares”) in accordance with the terms of the Series G First Preference Shares incorporated in the provisions of its articles.

The Annual Fixed Dividend Rate for the Subsequent Fixed Rate Period shall be equal to 4.393% per annum, being equal to the 2.263% yield to maturity of a Canadian dollar denominated non-callable Government of Canada bond with a term to maturity of five years as quoted as of 10:00 a.m. (Toronto time) on August 2, 2018 on the display designated as page “GCAN5YR Index” on the Bloomberg Financial L.P. service, plus 2.13%.

During the Subsequent Fixed Rate Period, dividends on the Series G First Preference Shares shall, if, as and when declared by the directors of the Corporation, be payable quarterly at the Annual Fixed Dividend Rate.
Dated the 2nd day of August, 2018.

BY ORDER OF THE BOARD OF DIRECTORS
[signed]
James R. Reid
Executive Vice President, Chief Legal Officer and Corporate Secretary

This information is not on the Fortis website, nor is it on SEDAR. I obtained the document from Investor Relations. Presumably the company sent the notice to its only registered shareholder, CDS, with the hope that CDS would notify the brokerages and the brokerages would notify their clients. Ha-ha! We all know how careful the brokerages are to pass on every scrap of relevant information, don’t we?

FTS.PR.G commenced trading 2008-5-23 after being announced 2008-5-6 as a FixedReset, 5.25%+213. It reset to 3.883% in 2013.

Note that this issue does not have an option to convert into FloatingResets – the structure was very new at the time of issue and provisions had not yet standardized although, of course, there is nothing stopping a new issuer from coming out with an equivalent issue.

Financial 15 Split Corp has released its Semi-Annual Report to May 31, 2018.

Figures of interest are:

MER: 1.17% of the whole unit value, “presented to reflect the normal operating expenses of the Company excluding any one time offering expenses.”

Average Net Assets: We need this to calculate portfolio yield. The Total Assets of the fund at year end was $610.1-million, compared to $700.9-million on May 31, so call it an average of $655.5-million. Preferred share dividends of $9,579,729 were paid over the half year at 0.55 p.a. (a temporary boost from the required 0.525), implying average units outstanding 34.836-million, at an average NAVPU of (17.31 + 18.32)/2 = 17.815, implies net assets of $620.6-million. Say the Average Net Assets are the average of the two estimates, $660.8-million.

Underlying Portfolio Yield: Income received of $8,304,005 divided by average net assets of $660.8-million, multiplied by two because it’s semiannual is 2.51%.

Income Coverage: Net investment income of $4,279,848 (before capital gains) divided by preferred share dividends of $9,579,729 is a very low 45%.

The income coverage calculated is fairly close to the 0.4 times calculated by DBRS in December 2017.

Enbridge Inc. has announced (on August 2):

that it does not intend to exercise its right to redeem its currently outstanding Cumulative Redeemable Preference Shares, Series H (Series H Shares) (TSX: ENB.PR.H) on September 1, 2018. As a result, subject to certain conditions, the holders of the Series H Shares have the right to convert all or part of their Series H Shares on a one-for-one basis into Cumulative Redeemable Preference Shares, Series I of Enbridge (Series I Shares) on September 1, 2018. Holders who do not exercise their right to convert their Series H Shares into Series I Shares will retain their Series H 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 H Shares outstanding after September 1, 2018, then all remaining Series H Shares will automatically be converted into Series I Shares on a one-for-one basis on September 1, 2018; and (ii) alternatively, if Enbridge determines that there would be less than 1,000,000 Series I Shares outstanding after September 1, 2018, no Series H Shares will be converted into Series I Shares. There are currently 14,000,000 Series H Shares outstanding.

With respect to any Series H Shares that remain outstanding after September 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 H Shares for the five-year period commencing on September 1, 2018 to, but excluding, September 1, 2023 will be 4.376 percent, being equal to the five-year Government of Canada bond yield of 2.256% percent determined as of today plus 2.12 percent in accordance with the terms of the Series H Shares.

With respect to any Series I Shares that may be issued on September 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 I Shares for the three-month floating rate period commencing on September 1, 2018 to, but excluding, December 1, 2018 will be 0.88756 percent, based on the annual rate on three month Government of Canada treasury bills for the most recent treasury bills auction of 1.44 percent plus 2.12 percent in accordance with the terms of the Series I Shares (the Floating Quarterly Dividend Rate). The Floating Quarterly Dividend Rate will be reset every quarter.

Beneficial holders of Series H Shares who wish to exercise their right of conversion during the conversion period, which runs from August 2, 2018 until 5:00 p.m. (EST) on August 17, 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.H is a FixedReset, 4.00%+212, that commenced trading 2012-3-29 after being announced 2012-3-20. The issue is tracked by HIMIPref™ but relegated to the Scraps index 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., ENB.PR.H 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).

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The market appears to be relatively uninterested in floating rate product; the implied rates until the next interconversion bracket the current 3-month bill rate as the averages for investment-grade and junk issues are at +1.49% and +1.22%, 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.H 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 be cheap and trading below the price of their FixedReset counterparts. Therefore, it seems likely that I will recommend that holders of ENB.PR.H continue to hold the issue and not to convert, but I will wait until it’s closer to the August 17 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.