PrefBlog

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.

This entry was posted on Monday, November 5th, 2018 at 11:45 pm and is filed under Issue Comments. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.