PrefBlog

It is the time of year for the annual retraction privilege for BSD.UN Capital Units and the Whole Units:

Concurrent Annual Redemption: A Unitholder who surrenders a Capital Unit together with a Preferred Security will receive an amount equal to the Redemption Proceeds Per Combined Security minus an amount equal to the aggregate of all brokerage fees, commissions and other costs incurred by the Trust in connection with such payment, including, but not limited to, expenses incurred in liquidating underlying Portfolio securities and securities movement charges.

Annual Redemption of Capital Units: A Unitholder who surrenders a Capital Unit for redemption (without surrendering a corresponding Preferred Security for repayment) will receive an amount equal to the Redemption Proceeds Per Combined Security, minus the price paid by the Trust for one Preferred Security in the market or, if the Trust is unable to purchase a Preferred Security in the market, pursuant to the Call Right (as hereinafter defined), and minus an amount equal to the aggregate of all brokerage fees, commissions and other costs incurred by the Trust in connection with such payment, including, but not limited to, expenses incurred in liquidating underlying Portfolio securities, securities movement charges and costs relating to the purchase of one Preferred Security. The price paid by the Trust for Preferred Securities in the market may be higher than the price the Trust would pay if it redeemed Preferred Securities pursuant to the Call Right.

The Preferred Securities don’t get the ‘naked’ privilege – they can only be retracted as part of a Whole Unit.

This means that a surplus of Capital Unit retractions can be expected; the only practical question is the degree of the surplus:

In 2017, unitholders tendered 81,978 combined securities (2016 – 139,491 combined securities) (being one capital unit and a $10.00 principal amount of preferred securities) and 88,614 capital units (2016 – 155,236 capital units) were tendered alone. In accordance with the Declaration of Trust, 88,614 preferred securities (2016 – 155,236 preferred securities) were purchased in the market at a total price of $914,253 (2016 – $1,574,295) to match the capital units tendered alone, and total redemption proceeds of $1,154,257 (2016 – $1,989,918) were paid to settle the capital units and combined securities surrendered through the redemption process.

Performance has long been an issue with this fund, and in the 2017 Annual Report it was stated:

If interest on the preferred securities are included, the return based on NAV of the combined units for the twelve-month period ended December 31, 2017 is positive 1.55%. During the same timeframe the S&P/TSX Composite increased 9.10%.

Sadly, but understandably, the company did not disclose Whole Unit performance for a longer period; only for the components, as required by regulations. But performance is horrible, as illustrated by the following table for the Capital Units:

Amusingly, the above table includes the preceding year, a decidedly non-standard presentation. I can only suppose the Manager wanted to highlight his one good year … but rational investors will look at the longer term periods, which include that run of luck, laugh and move on.

However, it seems likely that there will be quite a few Capital Unit retractions this year. given that the Capital Unit NAV has declined from 1.98 on 2017-12-29 to 0.83 on 2018-11-2, while income on these units is … sporadic:

On October 23, 2008, the Trust announced that it was suspending its distributions on its capital units, in accordance with its Declaration of Trust, as the Trust’s net asset value was below the required 1.4 times coverage ratio. The distribution was suspended for the remainder of 2008 and was suspended for each month from January 2009 to January 2011. On February 17, 2011, when it was anticipated that a distribution could be paid without violating the 1.4 times coverage ratio, a quarterly distribution of $0.01 per capital unit was declared, reflecting a current annualized rate of $0.04 per unit. Subsequent to the June 2011 payment, the Trust suspended the distribution.

So, there might be a lot of naked Capital Unit retractions in the works, which – if true – will give rise to a fair amount of buying pressure for the highly illiquid BSD.PR.A shares. Shareholders who are – quite justifiably – getting nervous about the prospects for default on the scheduled maturity date of 2020-3-31 (there is also a “Preferred Special Repayment Right” in case they get extended again), may wish to watch the market closely for signs that demand forced by Capital Unit retractions is outpacing supply. At the moment the quote is 9.65-84, 200×176, a reasonably rational level but huge size considering the average trading volume on this instrument.

As an aside, I note that the manager charged management fees of 273,655 in 2017, which is nice work if you can get it.

Long time Assiduous Readers will remember that I was outraged when the company decided to suspend retractions; I am pleased to pass on the news that:

On March 16, 2015, the Trust announced that the annual redemption right available to preferred securities (together with an equal number of capital units) in November of each year would no longer be suspended in circumstances where the asset coverage on the preferred securities is less than 1.4 times. Recent changes in applicable securities laws have resulted in the Trust terminating the suspension of the annual redemption right in these circumstances.

A change in applicable securities laws. Sometimes even a blind squirrel can find the nut.

Pembina Pipeline Corporation has announced (on November 1):

that it does not intend to exercise its right to redeem the currently outstanding Cumulative Redeemable Rate Reset Class A Preferred Shares, Series 1 (“Series 1 Shares”) (TSX: PPL.PR.A) on December 1, 2018 (the “Conversion Date”).

As a result, and subject to certain terms of the Series 1 Shares, as described in the prospectus supplement dated July 19, 2013 relating to the issuance of the Series 1 Shares, the holders of the Series 1 Shares will have the right to elect to convert all or any of their Series 1 Shares into Cumulative Redeemable Floating Rate Class A Preferred Shares, Series 2 of Pembina (“Series 2 Shares”) on the basis of one Series 2 Share for each Series 1 Share on the Conversion Date.

With respect to any Series 1 Shares that remain outstanding after December 1, 2018, holders thereof will be entitled to receive quarterly fixed cumulative preferential cash dividends, if, as and when declared by the Board of Directors of Pembina. The annual dividend rate for the Series 1 Shares for the five-year period from and including December 1, 2018 to but excluding December 1, 2023 will be 4.906%, being equal to the five-year Government of Canada bond yield of 2.436% determined as of today plus 2.47%, in accordance with the terms of the Series 1 Shares.

With respect to any Series 2 Shares that may be issued on December 1, 2018, 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 Pembina. The annual dividend rate for the 3-month floating rate period from and including December 1, 2018 but excluding March 1, 2019 will be 4.204%, being equal to the annual rate of interest for the most recent auction of 90-day Government of Canada treasury bills of 1.734% plus 2.47%, in accordance with the terms of the Series 1 Shares (the “Floating Quarterly Dividend Rate”). The Floating Quarterly Dividend Rate will be reset every quarter.

As provided in the terms of the Series 1 Shares: (i) if Pembina determines that there would remain outstanding immediately following the conversion less than 1,000,000 Series 1 Shares, all remaining Series 1 Shares will be converted automatically into Series 2 Shares on a one-for-one basis effective December 1, 2018; or (ii) if Pembina determines that there would remain outstanding immediately following the conversion, less than 1,000,000 Series 2 Shares, holders of Series 1 Shares will not be entitled to convert their Series 1 Shares into Series 2 Shares on the Conversion Date. There are currently 10,000,000 Series 1 Shares outstanding.

The Series 1 Shares are issued in “book entry only” form and, as such, the sole registered holder of the Series 1 Shares is the Canadian Depositary for Securities Limited (CDS). All rights of holders of Series 1 Shares must be exercised through CDS or the CDS participant through which the Series 1 Shares are held. The deadline for the registered shareholder (CDS) to provide notice of exercise of the right to convert Series 1 Shares into Series 2 Shares is 3:00 p.m. (MST) / 5:00 p.m. (EST) on November 16, 2018. Any notices received after this deadline will not be valid. As such, holders of Series 1 Shares who wish to exercise their right to convert their Series 1 Shares into Series 2 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 the time to complete the necessary steps.

If Pembina does not receive an election notice from CDS during the time fixed therefor, then the Series 1 Shares shall be deemed not to have been converted (except in the case of an automatic conversion). Holders of Series 1 Shares and Series 2 Shares will have an opportunity to convert their shares again on December 1, 2023, and every five years thereafter as long as the shares remain outstanding.

As previously announced, the dividend payable on December 3, 2018 to shareholders of record on November 1, 2018 will be $0.265625 per Series 1 share, consistent with the dividend rate in effect since issuance on July 26, 2013.

For more information on the terms of, and risks associated with an investment in, the Series 1 Shares and the Series 2 Shares, please see Pembina’s prospectus supplement dated July 19, 2013, which can be found at www.sedar.com.

PPL.PR.A is a FixedReset, 4.25%+247, that commenced trading 2013-7-26 after being announced 2013-7-17. It is tracked by HIMIPref™ and assigned to the “Scraps – FixedResets (Discount)” subindex, relegated there due to 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., PPL.PR.A 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 be becoming interested in floating rate product; the implied rates until the next interconversion are above the current 3-month bill rate as the averages for investment-grade and junk issues are at +1.96% and +1.78%, 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 PPL.PR.A 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, PPL.PR.A. Therefore, it seems likely that I will recommend that holders of PPL.PR.A continue to hold the issue and not to convert, but I will wait until it’s closer to the November 16 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.

Enbridge Inc. has announced (on November 1):

that it does not intend to exercise its right to redeem its currently outstanding Cumulative Redeemable Preference Shares, Series N (Series N Shares) (TSX: ENB.PR.N) on December 1, 2018. As a result, subject to certain conditions, the holders of the Series N Shares have the right to convert all or part of their Series N Shares on a one-for-one basis into Cumulative Redeemable Preference Shares, Series O of Enbridge (Series O Shares) on December 1, 2018. Holders who do not exercise their right to convert their Series N Shares into Series O Shares will retain their Series N 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 N Shares outstanding after December 1, 2018, then all remaining Series N Shares will automatically be converted into Series O Shares on a one-for-one basis on December 1, 2018; and (ii) alternatively, if Enbridge determines that there would be less than 1,000,000 Series O Shares outstanding after December 1, 2018, no Series N Shares will be converted into Series O Shares. There are currently 18,000,000 Series N Shares outstanding.

With respect to any Series N Shares that remain outstanding after December 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 N Shares for the five-year period commencing on December 1, 2018 to, but excluding, December 1, 2023 will be 5.086 percent, being equal to the five-year Government of Canada bond yield of 2.436 percent determined as of today plus 2.65 percent in accordance with the terms of the Series N Shares.

With respect to any Series O Shares that may be issued on December 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 O Shares for the three-month floating rate period commencing on December 1, 2018 to, but excluding, March 1, 2019 will be 1.08 percent, based on the annual rate on three month Government of Canada treasury bills for the most recent treasury bills auction of 1.73 percent plus 2.65 percent in accordance with the terms of the Series O Shares (the Floating Quarterly Dividend Rate). The Floating Quarterly Dividend Rate will be reset every quarter.

Beneficial holders of Series N Shares who wish to exercise their right of conversion during the conversion period, which runs from November 1, 2018 until 5:00 p.m. (EST) on November 16, 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.N is a FixedReset, 4.00%+265, that commenced trading 2012-7-17 after being announced 2012-7-9. It is tracked by HIMIPref™ and assigned to the “Scraps – FixedResets (Discount)” subindex, relegated there due to 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.N 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 be becoming interested in floating rate product; the implied rates until the next interconversion are above the current 3-month bill rate as the averages for investment-grade and junk issues are at +1.96% and +1.78%, 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.N 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, ENB.PR.N. Therefore, it seems likely that I will recommend that holders of ENB.PR.N continue to hold the issue and not to convert, but I will wait until it’s closer to the November 16 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.

Royal Bank of Canada has announced (on November 2):

it has closed its domestic public offering of Non-Cumulative, 5-Year Rate Reset Preferred Shares Series BO. Royal Bank of Canada issued 14 million Preferred Shares Series BO at a price of $25.00 per share to raise gross proceeds of $350 million.

The offering was underwritten by a syndicate led by RBC Capital Markets. The Preferred Shares Series BO will commence trading on the Toronto Stock Exchange today under the ticker symbol RY.PR.S.

The Preferred Shares Series BO were issued under a prospectus supplement dated October 29, 2018 to the bank’s short form base shelf prospectus dated January 30, 2018.

RY.PR.S is a FixedReset, 4.80+238, announced 2018-10-25. It will be tracked by HIMIPref™ and has been assigned to the Fixed-Resets (Discount) subindex.

RY.PR.S traded 747,100 shares on its November 2 opening date in a range of 24.50-75 before closing at 24.70-75. Vital statistics (on November 2) were:

Given that the FixedReset (Discount) index to which it is assigned lost 2.51% between the October 25 announcement date and the November 2 closing date, the 24.70 bid is actually pretty good!

The new issue is so ridiculously expensive that we don’t even need fancy-pants Implied Volatility Analysis to prove it, but here’s the chart anyway:

Click for Big

According to this analysis, the fair value of the new issue on November 5 is 22.61, down $1.16 from the October 26 estimate of 23.77.

But, as I say, we don’t need this – even though the issue is, amusingly, trading more in line with NVCC non-compliant issues than the compliant ones. Let’s look at RY.PR.H, a FixedReset, 3.90%+226, that commenced trading 2014-6-3 after being announced 2014-5-23. This issue resets 2019-8-24, which is only three dividends away. The total dividend difference between RY.PR.H and RY.PR.S until then is therefore (4.80% – 3.90%) * 25 * 3/4 = $0.17. So for a reasonable comparison, take the actual November 5 bid of 22.20 for RY.PR.H and add seventeen cents to it to reflect the dividend difference. RY.PR.H has a projected dividend of (GOC5 + IRS) * 25 = (2.44% + 2.26%) * 25 = 4.70% * 25 = 1.175 p.a., which, at a notional price of 22.37, gives us an Expected Future Current Yield of 5.25%.

At the current bid of 24.69 and an expected future dividend of 1.205, RY.PR.S has an Expected Future Current Yield of 4.88%. Need I say more?

The ludicrously high figure of Implied Volatility is something I take to mean that the underlying assumption of the Black-Scholes model, that of no directionality of prices, is not accepted by the market; the market seems to be taking the view that since things seem rosy now, they will always be rosy and everything will trade near par in the future.

I balk at ascribing a 100% probability to the ‘all issues will be called, or at least exhibit price stability’ hypothesis. There may still be a few old geezers amongst the Assiduous Readers of this blog who can still (faintly) remember the Great Bear Market of 2014-16, in which quite a few similar assumptions made earlier turned out to be slightly inaccurate. The extra cushion implied by an Issue Reset Spread that is well over the market spread is worth something, even if nothing gets called. Or, to put it another way, one can buy a whole lot of downside protection for very little extra money, relative to this issue.