PrefBlog

Standard & Poor’s has announced:

• •S&P Global Ratings lowered its long-term issuer credit rating on Calgary, Alta.-based Husky Energy Inc. to ‘BBB’ from ‘BBB+’, based on the forecast deterioration of its cash flow metrics.
• •We have removed the ratings from CreditWatch Negative, where they were placed Oct. 1, 2018.
• •We are also lowering our senior unsecured debt rating to ‘BBB’ from ‘BBB+’.
• •We also lowered our global scale preferred stock rating to ‘BB+’ from ‘BBB-‘, and lowered our Canada scale preferred stock rating to ‘P-3(High)’ from ‘P-2(Low)’.
• •The stable outlook reflects our expectation that Husky should be able to maintain its cash flow and leverage metrics within the 35%-40% range throughout our 24-month outlook period. Cash flow metrics at these levels would adequately support the ‘BBB’ rating.

…
Our weakened Brent and West Texas Intermediate (WTI) price assumptions, compounded by our decreased Canadian heavy oil and natural gas prices, result in the company’s three-year weighted-average funds from operations (FFO)-to-debt ratio falling into the 35%-40% range. Cash flow metrics in this range, and our expectation of ongoing dividend payments, result in a deteriorated financial risk profile. Despite this deterioration, we believe the company’s overall credit profile, characterized by the scale and breadth of Husky’s upstream operations, and the integration benefits of its midstream assets, and downstream segment, continue to support an investment-grade rating.

Affected issues are HSE.PR.A, HSE.PR.B, HSE.PR.C, HSE.PR.E AND HSE.PR.G.

It will be recalled that I reported the Credit Watch Negative in October (which was concerned with the now-aborted MEG acquisition) and found the experience so enjoyable I reported it again in November.

DBRS confirmed its Pfd-2(low) rating in November and took no rating action when the MEG acquisition was aborted.

It will be recalled that Fortis made selective disclosure of the FTS.PR.K reset rate to its pals in the brokerage industry, but I have obtained a document stating that the quarterly dividend has been reset to $0.2453125, which is $0.98125 p.a., which is 3.925% of the $25.00 par value.

It is of interest to note that the Government of Canada 5-Year yield implied by this rate is 1.875%, whereas the rates of the resets for PPL.PR.C, ENB.PR.P and ENB.PR.J each imply a rate of 1.879%. As far as I can tell, the methodology for getting each of the four rates is identical and specified to be at the same time on the same day. Once Fortis has published the rate officially, I’ll ask them about it. I don’t think it’s just a rounding difference – from the prospectus:

“Annual Fixed Dividend Rate” means, for any Subsequent Fixed Rate Period, the rate of interest (expressed as a percentage rounded to the nearest one hundred-thousandth of one percent (with 0.000005% being rounded up)) equal to the sum of the Government of Canada Bond Yield on the applicable Fixed Rate Calculation Date plus 2.05%.

I remain not just angry about the selective disclosure, but also completely befuddled. What on earth does the company expect to gain by (partial) secrecy? What do they win? They claim to be waiting for “the board of directors approval and declaration” – why? Everybody else in the business is simply careful to state that the quoted rate will actually be paid only as and when declared by the directors, but the rate is the rate. The new rate is calculated in accordance with an extant binding contract embodied by the prospectus – no approval is required for simply announcing the results of the mandated calculation … especially when they are selectively disclosing this rate to their friends in the brokerage business.

The reliance that Fortis has on the brokerage community to communicate this material non-public information is laughable; considering that this was the issue ostensibly at the heart of the ABCP crisis. I am informed by one investor that he received a letter telling him he had conversion rights that did not advise him of the reset rate for FTS.PR.K nor of the calculation methodology for FTS.PR.L (its FloatingReset counterpart). So much for this communication strategy! I will also note that I sent an eMail to TMX DataLinx on the evening of February 4, regarding subscriptions to the CDS Advisory Bulletins, as recommended by Fortis Investor Relations:

What is the cost to subscribe to the captioned service? May these bulletins be purchased individually?

If you suppose that the Exchange can be bothered to respond to inquiries by potential customers on, at worst, a ‘next day’ basis, you clearly haven’t spent a lot of time in the bowels of the Canadian financial industry. No response has been received as yet.

This whole episode is a farce. It will be interesting to see what future screw-ups Fortis can present to the investing public. However, now that we have reached enlightenment, our problem is to decide whether or not investors should convert from FTS.PR.K to FTS.PR.L.

FTS.PR.K is a FixedReset, 4.00%+205, that commenced trading 2013-7-13 after being announced 2013-7-9. It resets to 3.925% effective 2019-3-1, although the company would prefer you didn’t know that. The issue is tracked by HIMIPref™ but relegated to the Scraps – FixedResets (Discount) subindex on credit concerns.

In accordance with the prospectus, holders of FTS.PR.L (if issued; there’s a minimum amount of conversions required):

will be entitled to receive floating rate cumulative preferential cash dividends, if, as and when declared by the Board of Directors, payable quarterly on the first day of March, June, September and December of each year (the initial quarterly dividend period and each subsequent quarterly dividend period referred to as a “Quarterly Floating Rate Period”), in the amount per share determined by multiplying the applicable Floating Quarterly Dividend Rate (as defined herein) by $25.00. The Floating Quarterly Dividend Rate will be equal to the sum of the T-Bill Rate (as defined herein) plus 2.05% (calculated on the basis of the actual number of days elapsed in the applicable Quarterly Floating Rate Period divided by 365) determined by the Corporation on the 30th day prior to the first day of the applicable Quarterly Floating Rate Period.

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., FTS.PR.K and the FloatingReset, FTS.PR.L, 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 lost its fleeting interest 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 +1.10% and +1.44%, 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 FTS.PR.K FixedReset, we may construct the following table showing consistent prices for its soon-may-be-issued FloatingReset counterpart FTS.PR.L given a variety of Implied Breakeven yields consistent with issues currently trading:

Based on current market conditions, I suggest that the FloatingResets, FTS.PR.L, that will result from conversion are likely to be cheap and trading below the price of their FixedReset counterparts, FTS.PR.K. Therefore I recommend that holders of FTS.PR.K continue to hold the issue and not to convert. 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.

Those who wish to convert anyway are advised that the deadline for notifying the company of such a desire is probably February 14 although I do not have that explicitly in writing from the company (surprise, surprise). Brokers and other intermediaries generally set their internal deadlines a day or two in advance of this date, so if you wish to convert there’s no time to waste! Note that brokers will, in general, try to execute the instruction on a ‘best efforts’ basis if received between the two deadlines, provided that the procrastinating shareholder grovels entertainingly enough.

It will be recalled that ENB.PR.J will reset at 4.449% effective March 1, 2019.

ENB.PR.J is a FixedReset, 4.40%+257, that commenced trading 2013-12-12 after being announced 2013-12-3. Notice of the reset to 4.449% was published 2019-1-30. The issue is tracked by HIMIPref™ but relegated to the Scraps – FixedResets (Discount) 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., ENB.PR.P 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 lost its fleeting interest 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 +1.10% and +1.44%, 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.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 be cheap and trading below the price of their FixedReset counterparts, ENB.PR.P. Therefore I recommend that holders of ENB.PR.J continue to hold the issue and not to convert. 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.

Those who wish to convert anyway are advised that the deadline for notifying the company of such a desire is 5:00 p.m. (EST) on February 14, 2019. Brokers and other intermediaries generally set their internal deadlines a day or two in advance of this date, so if you wish to convert there’s no time to waste! Note that brokers will, in general, try to execute the instruction on a ‘best efforts’ basis if received between the two deadlines, provided that the procrastinating shareholder grovels entertainingly enough.