BIP.PR.F Settles Soft on Modest Volume

The Brookfield Infrastructure new issue closed today without a formal announcement from the company.

BIP.PR.F is a FixedReset, 5.10%+292M510, announced 2018-09-05. It has been assigned to the FixedReset-Discount subindex.

There are two non-standard elements to this issue, as we can specify when examining the prospectus (see SEDAR, “Brookfield Infrastructure Partners L.P. Sep 5 2018 22:59:56 ET Prospectus (non pricing) supplement – English PDF 913 K”). I regret that the Canadian Securities Administrators have made direct links to this public document illegal.

First, distributions are not dividends: they are Return of Capital and (potentially fully taxable) other things:

For Canadian federal income tax purposes, holders of Series 11 Preferred Units and Series 12 Preferred Units will be allocated a portion of the taxable income of the Partnership based on their proportionate share of distributions received on their units. The allocation of taxable income to such holders may be less than the distributions received and this difference is commonly referred to as a tax deferred return of capital (i.e., returns that are initially non-taxable but which reduce the adjusted cost base of the holder’s units). See “Certain Canadian Federal Income Tax Considerations” for further details. The below table reflects certain information regarding the taxable income allocation for the 2013 through 2017 period, with all periods updated to reflect the three-for-two unit split that occurred during September 2016. As shown in the table below, the historical 5 year average per unit return of capital (i.e., excess of distributions over allocated taxable income) expressed as a percentage of the annual distributions in respect of units of the Partnership for the period 2013 through 2017 was approximately 45%. Management anticipates a 6 year average per unit return of capital percentage of 50% for the period 2018 through 2023; however, no assurance can be provided this will occur.

  2017 2016 2015 2014 2013
Total distribution C$2.2320 C$2.0313 C$1.8511 C$1.4252 C$1.1922
Total taxable income C$0.7661 C$1.0552 C$1.0228 C$1.4024 C$0.4638
Return of capital C$1.4660 C$0.9761 C$0.8283 C$0.0228 C$0.7284
Income % 30.77% 51.62% 55.25% 98.40% 38.9%
Return of capital % 69.23% 48.38% 44.75% 1.60% 61.1%

Second, it is likely, although not certain, that conversion of this issue into a FloatingReset when the time comes may be a Deemed Disposition and therefore trigger a capital gain or loss:

The reclassification of a Series 11 Preferred Unit into a Series 12 Preferred Unit or a Series 12 Preferred Unit into a Series 11 Preferred Unit, whether pursuant to an election made by the Resident Holder or pursuant to an automatic reclassification, may be considered to be a disposition of the Series 11 Preferred Unit or Series 12 Preferred Unit by the Resident Holder. The CRA’s position is that the conversion of an interest in a partnership into another interest in the partnership may result in a disposition of the partnership interest by the holder if the conversion results in a significant change in the rights and obligations of the holder in respect of the converted interest, including a significant change in the percentage interest in the profits of the partnership. Whether or not the reclassification of Series 11 Preferred Units into Series 12 Preferred Units or Series 12 Preferred Units into Series 11 Preferred Units would result in a significant change in the percentage interest of a Resident Holder in the profits of the Partnership is a question of fact that depends upon the facts and circumstances that exist at the time of the reclassification.

BIP.PR.F traded 414,753 shares today in a range of 24.70-89 before settling at 24.88-89. Vital statistics are:

Maturity Type : Limit Maturity
Maturity Date : 2048-09-12
Maturity Price : 23.10
Evaluated at bid price : 24.88
Bid-YTW : 5.07 %

The new issue is extremely expensive according to Implied Volatility Analysis:

Click for Big

According to this analysis, the fair value of the new issue on September 12 is 23.30, but note that it appears that the issue would be closer to the regression line if Implied Volatility was permitted to exceed the arbitrary limit of 40%. It is the level of Implied Volatility that is the real problem with this issue, not the distance to the fitted line.

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.

Part of the problem may be that all but one of the BIP FixedReset series have minimum reset guarantees. There are many naifs out there (many of them stockbrokers; many others egged on by their stockbrokers) who consider this to be an effective guarantee that the issues will always trade near par. They have evidently forgotten that spread widening is a very common cause of price declines.

Or, to put it another way, one can buy a whole lot of downside protection for very little extra money, relative to this issue. For instance, BIP.PR.D, FixedReset, 5.00%+378M500, ROC + Interest, is bid at 25.01 (theoretical fair value of 25.25, according to the above analysis, which ignores the interim dividend shortfall). You’re giving up about $0.025 p.a. in dividends until it resets 2022-03-31, sure, but that’s hardly a big deal and you’re getting a significant amount of protection in the event of a market downturn, and a bit more dividend afterwards. Is it worth it? Well, that will depend a lot on your aversion to loss … I’m just saying that buying the same amount of protection costs more in most other series of FixedResets.

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