Pembina Pipeline Corporation has announced:
that it has agreed with Kinder Morgan Canada Limited (TSX: KML) (“KML”) to amend and restate the previously announced arrangement agreement dated August 20, 2019 (the “Arrangement Agreement”) to include the preferred shares of KML in the arrangement transaction pursuant to which Pembina will acquire KML (the “Transaction”). If requisite approval by the holders of KML preferred shares is obtained, upon closing of the Transaction, each outstanding KML preferred share of a series will be exchanged for one preferred share of Pembina with the same commercial terms and conditions as that series of KML preferred shares. The inclusion of KML preferred shares in the Transaction is subject to approval by at least 66 2/3 percent of the votes cast by holders of KML preferred shares, voting together as a single class, present in person or represented by proxy at the special meeting of the holders of KML preferred shares to be held to approve the Transaction, but is not a condition to closing of the Transaction. If KML preferred shareholders do not approve the Transaction but all other conditions to closing are satisfied or waived by the applicable party, the KML preferred shares will remain outstanding as shares in the capital of KML, which will be part of the Pembina group following completion of the Transaction.
Further information regarding the Transaction will be contained in a proxy statement of KML that it will prepare, file and mail to its shareholders in due course in connection with KML voting and preferred special shareholders meetings.
A copy of the amended and restated Arrangement Agreement with respect to the Transaction will be filed under Pembina’s profile on SEDAR at www.sedar.com and on the Company’s website at www.pembina.com.
This follows news that PPL To Acquire KML Under Proposed Plan of Arrangement and that the two KML issues were on Review-Developing by DBRS due to uncertainty.
KML.PR.A is a FixedReset 5.25%+365M525 that commenced trading 2017-8-15 after being announced 2017-8-3. It is tracked by HIMIPref™ but relegated to the Scraps-FixedReset Discount subindex on credit concerns.
KML.PR.C is a FixedReset, 5.20%+351M520, that commenced trading 2017-12-15 after being announced 2017-12-6. It is tracked by HIMIPref™ but relegated to the Scraps-FixedReset Discount subindex on credit concerns.
Hat tip to Assiduous Reader CanSiamCyp for ensuring I was aware of this development.
Update, 2019-09-12: The price movement left the PPL and VSN preferreds trading as equivalents:
Click for Big
The results of this Implied Volatility analysis are a little puzzling, if we look solely at those issues with a minimum reset guarantee.
| PPL / KML issues with Minimum Rate Guarantee |
|||||
| Ticker | Terms | GOC-5 Floor | Bid | Fair Value* | Rich (Cheap) |
| PPL.PF.A | +326M490 | 1.64% | 22.15 | 18.52 | 3.63 |
| KML.PR.C | +351M520 | 1.69% | 22.91 | 19.38 | 3.53 |
| KML.PR.A | +365M525 | 1.60% | 23.10 | 19.47 | 3.63 |
| PPL.PR.M | +496M575 | 0.79% | 25.80 | 22.23 | 3.59 |
| PPL.PR.K | +500M575 | 0.75% | 25.90 | 22.31 | 3.59 |
| "Fair Value" is calculated from the Implied Volatility curve derived using the non-floor issues only | |||||
It’s very strange. Each of the five issues has approximately the same unexplained value, which we may conjecture is equal to the market value of the Reset Floor, even though:
- The GOC-5 yields at which these guarantees become applicable varies widely, with three being in-the-money and two out.
- Two issues are trading at a premium to par, three at a discount
I’m not sure what to make of it. But I will say I’m glad I’m not the guy in the PPL treasury department who has to decide whether or not to call the two issues trading at a premium!
Is there any real advantage (or disadvantage) to changing to PPL? Would KML preferred holders be better protected in the event of a major financial problem for PPL?
Not directly related to the above query, but as a long time skeptic, I want to plan for the worst. My personal default probabilities based on nothing but gut feeling are something like this:
P2L and above – 1 loss in about 20 to 25 years. Doesn’t mean you could not get hit twice within 10 years. So there’s a sequence of default risk, so to speak. Periods of extreme financial stress will cause more defaults, as expected.
P3 levels including P3L, P3 and P3H- 1 loss in about 8 to 10 years.
We should have some kind of default probabilities baked into the whole return profile.
There’s the whole scenario of preferreds ranking about common equity etc, but when SHTF and things are taken over by lawyers and regulators, whatever you get back is serendipitous.
Is there any real advantage (or disadvantage) to changing to PPL?
In general, you would rather hold obligations of the Operating Company rather than the Holding Company, as that way you’re ‘closer to the money’ … i.e., OpCo can’t pay dividends to HoldCo unless the preferred share dividends are up to date.
This is referred to as ‘Structural Subordination’ and it’s usually worth a notch of rating – e.g., PWF is rated higher than POW by DBRS due to the structural subordination; but note that PWF is rated equal to GWO, because PWF has diversification that offsets its dependence on GWO.
At the extreme, some elements of the Brookfield empire are rated lower that Brookfield itself, since BAM is so diversified that if things got really bad at the subsidiary it could be cut loose. BAM shareholders and creditors might not be too happy with such an event, but they would survive.
It’s safe to say that if the acquisition proceeds, KML might not be a better credit than PPL, but it almost certainly won’t be worse.
My personal default probabilities based on nothing but gut feeling are something like this:…
There was recently some discussion of default probabilities on the Financial Wisdom Forum preferred share thread about this
We should have some kind of default probabilities baked into the whole return profile.
A lot of people do! For instance, that is an integral element of my approach to SplitShare Credit Quality and its calculator.
However, the beauty of yield calculations is that the number of assumptions is minimal, although there are continual screw-ups over the few assumptions there are. Once you start adjusting for credit quality on an ab initio basis, you automatically have a bunch of new assumptions, each of which is subject to discussion and manipulation.
A more philosophical point is that calculating a default-adjusted yield for various instruments can easily lead to misunderstandings of just what this yield means. Typically, an operating company will have zero recovery (or near as dammit) in the event of default. So when you refer to a ‘default-adjusted yield’ of, say 5.00%, you really mean “5.05% if it doesn’t default and 0.00% if it does”; people might get upset at you if lightning strikes.
Hi James,
Now that the change of KML preferreds to PPL preferreds has been (not-surprisingly) approved, I am very puzzled by the recent price behaviour of the KML preferreds.
In particular, KML.PR.A is trading with a YTM of roughly 10% less than comparable PPL preferreds. Since it will soon have exactly the same credit rating, risks, etc. as the other PPL issues, why doesn’t its price go down significantly to bring its yields into line? In fact, it has been rising quite smartly over the past month or so.
The two KML issues had a floor rate. See Ticker Change On Acquisition: KML to PPL.