PrefBlog

With an eMail headed NXY.PR.U, I was asked:

Can you please comment on how to classify the subject preferred shares ? How would you rate the credit risk ?

NXY.PR.U is more formally referred to as Nexen 7.35% Subordinated Notes due 2043, which were issued pursant to a Prospectus Supplement dated October 28, 2003, which is available on SEDAR.

The prospectus states:

Our unsecured subordinated debentures due November 1, 2043 (the ‘‘Subordinated Notes’’) will bear interest, payable in U.S. dollars, at an annual rate of 7.35%, accruing from November 4, 2003 and payable quarterly in arrears on February 1, May 1, August 1 and November 1 of each year, commencing February 1, 2004.

The Subordinated Notes will be subordinated to all our present and future senior indebtedness and will be effectively subordinated to all liabilities of our subsidiaries, including partnerships.

This deep subordination means that the only thing they are senior to is equity – which will include preferred equity if Nexen ever issues some. However, they are on the right side of the bond/equity line, which means there are events of default. These events of default are specified on page 32 of the Shelf Prospectus, dated October 22, 2003, and are not over-ridden (as they might be) by the Prospectus Supplement for this particular series. This means that in the event of a missed interest payment, the holders of NXY.PR.U may declare the principal immediately due and payable, effectively placing the company in bankruptcy. This is significantly more protection than is available with preferred shares, although in practice holders of the sub-debt might wish to keep the company out of bankruptcy since they’ll be totally out-gunned and subordinated to the Senior Debt Holders in bankruptcy court.

However, if matters were to become sufficiently dire that the company could not meet its obligation to pay interest, they have the option to forestall such a move by redeeming the issue for common shares. This issue is currently redeemable at par:

We may redeem the Subordinated Notes, in whole or in part, at any time and from time to time on or after November 4, 2008 at a redemption price equal to 100% of the principal amount of the Subordinated Notes to be redeemed plus any accrued and unpaid interest to the date of such redemption.
…
We may satisfy our obligation to pay the applicable redemption price (excluding any accrued and unpaid interest) or principal amount of the Subordinated Notes by delivering to the Trustee (as defined herein) Common Shares (as defined herein), in which event the holders of the Subordinated Notes shall be entitled to receive cash payments equal to the applicable redemption price (excluding any accrued and unpaid interest) or principal amount from the proceeds of the sale of the requisite Common Shares by the Trustee.

The noteholders will not actually get the shares; they will be sold by the Trustee and the proceeds deposited in trust (see “Common Shares Payment Election” in the Prospectus Supplement). Another wrinkle is that there is no set number of Common Shares that must be delivered:

Notwithstanding the foregoing, we will not be permitted to satisfy our obligations to pay the redemption price (excluding any accrued and unpaid interest) or principal amount of the Subordinated Notes through the delivery of Common Shares if, on the Common Shares Delivery Date, the Common Shares are not then listed on a significant stock exchange in Canada or the United States. Neither our making of the Common Shares Payment Election nor the consummation of sales of Common Shares on the Common Shares Delivery Date will:

) result in the holders of the Subordinated Notes not being entitled to receive cash in an aggregate amount equal to the redemption price or principal amount of the Subordinated Notes plus, in each case, accrued and unpaid interest and other amounts, if any, thereon on the Maturity Date; or

) entitle or oblige such holders to receive any Common Shares in satisfaction of our obligation to pay the redemption price or principal amount of the Subordinated Notes.

So the Common Share Payment Election is a death-spiral conversion. I suspect the company would, 99 times in a hundred, prefer to go bankrupt.

The income distributions (7.35%, remember) are payable quarterly and are taxed as interest.

As far as credit quality is concerned … well, there’s a limit to what I’m going to do for free! DBRS rates them BBB(low), which maps to about maybe Pfd-2(low) / Pfd-3(high), somewhere around there.

There was something of a craze for issues of this nature back in the old days, when men were men.

Given the preponderance of of utilities in the above list, I suspect that this was a mechanism whereby the companies could gain the advantages of preferred shares (better credit ratios on their senior debt) without running afoul of contemporary regulatory restrictions on the issue of preferreds. But I have no definitive information on that point.

It was a nice market, hopelessly inefficient. Then, unfortunately, they continued to trade at enormous premia even as the first redemption date approached, yields declined to derisory (and even negative) levels and when they were called poor old retail got left holding the bag. I discussed the asset class in an article titled Interest Bearing Preferreds.

NXY.PR.U has not been previously discussed on PrefBlog. It is not tracked by HIMIPref™ since it is USD denominated.