Emera Incorporated has announced:
that it will issue 12,000,000 Cumulative Minimum Rate Reset First Preferred Shares, Series H (the “Series H Preferred Shares”) at a price of $25.00 per share and at an initial annual dividend rate of 4.90 per cent, for aggregate gross proceeds of $300 million on a bought deal basis to a syndicate of underwriters in Canada led by Scotiabank, CIBC Capital Markets, RBC Capital Markets and TD Securities Inc. Emera has granted to the underwriters an option, exercisable at any time up to 48 hours prior to the closing of the offering, to purchase up to an additional 2,000,000 Series H Preferred Shares at a price of $25.00 per share (the “Underwriters Option”). If the Underwriters Option is exercised in full, the aggregate gross proceeds to Emera will be $350 million.
The holders of the Series H Preferred Shares will be entitled to receive fixed cumulative preferential cash dividends at an annual rate of $1.225 per share, payable quarterly, as and when declared by the board of directors of Emera, yielding 4.90 per cent per annum, for the initial period ending on August 15, 2023. The first of such dividends, if declared, shall be payable on August 15, 2018, and shall be $0.25507 per Series H Preferred Share, based on the anticipated closing of the offering on May 31, 2018. The dividend rate will be reset on August 15, 2023 and every five years thereafter at a rate equal to the sum of the then five-year Government of Canada bond yield plus 2.54 per cent, provided that, in any event, such rate shall not be less than 4.90 per cent per annum. The Series H Preferred Shares are redeemable by Emera, at its option, on August 15, 2023 and on August 15 of every fifth year thereafter.
The holders of Series H Preferred Shares will have the right to convert their shares into Cumulative Floating Rate First Preferred Shares, Series I (the “Series I Preferred Shares”), subject to certain conditions, on August 15, 2023 and on August 15 of every fifth year thereafter. The holders of the Series I Preferred Shares will be entitled to receive quarterly floating rate cumulative preferential cash dividends, as and when declared by the board of directors of Emera, at a rate equal to the sum of the then 90-day Government of Canada treasury bill rate plus 2.54 per cent.
The offering is subject to the receipt of all necessary regulatory and stock exchange approvals. The net proceeds of the offering will be used for general corporate purposes.
This issue was announced almost simultaneously with a new issue from Intact Financial Corporation, a FixedReset 4.90%+255. Barry Critchley remarks:
While the two deals shared similar terms, investors treated them differently. By early afternoon only Intact’s order was completely filled. But sources indicated investors could still post expressions of interest for the Emera offering. On TD Investing’s website, the offering is indicated as open.
This seems quite rational, since the new issue is ridiculously expensive.
according to Implied Volatility Analysis:
Click for Big
According to the analysis above, the fair value is a bit under $24.00 … note, however, that complainers will triumphantly point out that this assigns a value of zero to the Floor Rate Guarantee. But as I stated in the February, 2018, edition of PrefLetter:
It is often asserted that a horrific fall of FixedReset prices is a completely logical expectation; that the 2014-16 bear market was completely justified; that similar experiences will happen again; and that floor rates are an excellent way to protect investors from the decline in income.
This assertion does not make a lot of sense to me. Suppose an investor holds a FixedReset with a coupon rate of 5% and that a decline in government yields makes a reduction to 4% seem both likely and imminent. If the bear market scenario is to play out, this investor and many like him will be selling to avoid experiencing the reset.
But where is this money to be deployed? Yields are already down in the government market and all other fixed income markets will be affected to some degree; corporate-government spreads increased during the recent episode (see Chart FR-63 ), but corporate yields did decline – they just didn’t decline as much. I see no reason for an expectation that FixedReset yields should magically remain constant if the face of global interest rate declines.
…
However, any increase in the price of the floor-rate issue is capped by the call price. In the simplest scenario, the non-floor issue will remain priced at par and reset to a 4% distribution, while the floored issue will be called; the investor will then have to reinvest his funds … and find that he is reinvesting at contemporary rates and experiencing transaction costs that are not borne by the investor in the non-floored issue. It’s not much of a win!In order for the floor rate to have value, both issues must be trading at a discount to par; this will give the floored issue room to rise in price on the secondary market. Such a price rise will be determined by the excess yield to be gained over the next five years until the next reset plus, perhaps, an allowance for the possibility that current conditions will persist and give the holder another chance to reset. The benefit will be capped by the distribution rate difference multiplied by the Modified Duration of the issues (which will normally be in the range of 20 to 25), so a price difference of between 20% and 25% for a one percent decline in government yields. However, this potential gain is capped by the potential for a call, so the issues must already be trading at a 20%-25% discount to par for this maximum to be reached … and to work out the value of this scenario, we must then calculate the probability of such a decline in government yields.
Once we see floor-rate issues trading at large discounts in an environment in which a significant decline in government rates has a reasonable probability, I will revisit my opinion of the value of such guarantees. I’m not holding my breath.
However, even those unimpressed by all that “Implied Volatility” blather and tiresome pettifogging regarding Floor Guarantees should be, at the very least, tempted by EMA.PR.A in preference to the new issue. Sure, it only pays 2.555% at present … but it will reset on 2020-8-15 at GOC-5 + 184, or – given today’s GOC-5 yield of 2.33% – 4.17%. It was quoted today at 19.09-25, an Expected Future Current Yield of 5.46%, which ain’t bad for investment grade!
ENB.PR.F : Convert or Hold?
May 12th, 2018It will be recalled that ENB.PR.F will reset at 4.689% effective June 1.
ENB.PR.F is a FixedReset, 4.00%+251, that commenced trading 2012-1-18 after being announced 2012-1-9. 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., ENB.PR.F 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 relatively uninterested in floating rate product; most of the implied rates until the next interconversion are scattered around the current 3-month bill rate and the averages for investment-grade and junk issues are quite different, at +1.13% and +0.72%, respectively – although these break-even rates are much closer to the market rate than has often been the case! 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.F 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:
Price if Implied Bill
is equal to
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, I recommend that holders of ENB.PR.F continue to hold the issue and not to convert.
If you do wish to convert, note that the deadline for notifying the company is 5:00 p.m. (EST) on May 17, 2018.. Brokerages and other intermediaries will normally set their internal deadlines a few days prior to this, so if you want to convert don’t waste any time! Such intermediaries may accept instructions after their internal deadline (but prior to the company deadline, of course) if you grovel in a sufficiently entertaining fashion, but this will only be done on a ‘best efforts’ basis.
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.
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