NPI.PR.C To Reset At 5.08%

Northland Power Inc. has announced:

the fixed dividend rate on its Cumulative Rate Reset Preferred Shares, Series 3 (“Series 3 Shares”) for the five years commencing December 31, 2017 and ending December 30, 2022. The fixed quarterly dividends on the Series 3 Shares during that period will be paid at an annual rate of 5.08% (Cdn. $0.3132 per share per quarter).

Holders of Series 3 Shares have the right, at their option, exercisable not later than 5:00 pm (Toronto time) on December 18, 2017, to elect to convert all or part of their Series 3 Shares, on a one-for-one basis, into Cumulative Floating Rate Preferred Shares, Series 4 (the “Series 4 Shares”), effective December 31, 2017. Holders of Series 3 Shares are not required to elect to convert all or any part of their Series 3 Shares into Series 4 Shares.

The quarterly floating rate dividends on the Series 4 Shares will be paid at an annual rate, calculated for each quarter, of 3.46% over the annual yield on 90-day Government of Canada treasury bills. The actual quarterly dividend rate in respect of the December 31, 2017 to March 30, 2018 dividend period for the Series 4 Shares will be 1.07% (4.33% on an annualized basis) and the dividend, if and when declared, for such dividend period will be Cdn. $0.2669 per share, payable on March 31, 2018.

As provided in the share conditions of the Series 3 Shares, if Northland determines that, after giving effect to the election notices received to convert Series 3 Shares, there would be fewer than 1,000,000 (i) Series 3 Shares outstanding after December 31, 2017, all remaining Series 3 Shares will be automatically converted into Series 4 Shares on a one-for-one basis effective December 31, 2017; and (ii) Series 4 Shares outstanding after December 31, 2017, no Series 3 Shares will be permitted to be converted into Series 4 Shares. There are currently 4,800,000 Series 3 Shares outstanding.

Northland intends to apply to the Toronto Stock Exchange (“TSX”) to list the Series 4 Shares effective upon conversion. Listing of the Series 4 Shares will be subject to Northland fulfilling all the listing requirements of the TSX and, upon approval, the Series 4 Shares will be listed on the TSX under the trading symbol “NPI.PR.D.”

NPI.PR.C is a FixedReset, 5.00%+346, that commenced trading 2012-5-24 after being announced 2012-5-14. It 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., IFC.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 have a distaste at the moment for 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 both well below current market rates, at +0.38% and +0.49%, 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 NPI.PR.C FixedReset, we may construct the following table showing consistent prices for its soon-may-be-issued FloatingReset NPI.PR.D counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Estimate of FloatingReset NPI.PR.D (received in exchange for NPI.PR.C) Trading Price In Current Conditions
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread 1.00% 0.50% 0.00%
NPI.PR.C 24.52 346bp 23.90 23.39 22.89

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 NPI.PR.C continue to hold the issue and not to convert, but I will wait until it’s closer to the December 18 notification deadline before making a final pronouncement. I will note that, given the apparent cheapness of the FloatingResets, 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.

Leave a Reply

You must be logged in to post a comment.