PrefBlog

National Bank of Canada has announced:

that it has closed its domestic public offering of non-cumulative 5-year rate reset first preferred shares series 42 (non-viability contingent capital (NVCC)) (the “Series 42 Preferred Shares”). National Bank issued 12 million Series 42 Preferred Shares at a price of $25.00 per share to raise gross proceeds of $300 million.

The offering was underwritten by a syndicate led by National Bank Financial Inc.

The Series 42 Preferred Shares will commence trading on the Toronto Stock Exchange today under the ticker symbol NA.PR.G.

The Series 42 Preferred Shares were issued under a prospectus supplement dated June 4, 2018 to National Bank’s short form base shelf prospectus dated November 21, 2016.

NA.PR.G is a FixedReset, 4.95%+277, NVCC compliant, announced 2018-05-31. It will be tracked by HIMIPref™ and has been assigned to the FixedResets subindex.

The issue traded 711,342 shares today in a range of 24.85-96 before closing at 24.94-95. The slight discount to par isn’t bad, given that TXPR is down about 0.25% from the close immediately prior to the announcement date. Vital statistics are:

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

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According to this analysis, the fair value of the new issue on June 11 is 23.86.

Capital Power Corporation has announced (on May 31):

that it has notified registered shareholders of its Cumulative Rate Reset Preference Shares, Series 5 (Series 5 Shares) (TSX: CPX.PR.E) of the Conversion Privilege and Dividend Rate Notice.

Subject to certain conditions, beginning on May 31, 2018 and ending at 5:00 p.m. (Toronto time) on June 15, 2018, each registered holder of Series 5 Shares will have the right to elect to convert any or all of their Series 5 Shares into an equal number of Cumulative Floating Rate Preference Shares, Series 6 (Series 6 Shares) by delivering an Election Notice to the Corporation.

If Capital Power does not receive an Election Notice from a holder of Series 5 Shares during the time fixed therefor, then the Series 5 Shares shall be deemed not to have been converted (except in the case of an Automatic Conversion, see below). Holders of the Series 5 Shares and the Series 6 Shares will have the opportunity to convert their shares again on June 30, 2023, and every five years thereafter as long as the shares remain outstanding.

Effective June 30, 2018, on May 31, 2018, the Annual Fixed Dividend Rate for the Series 5 Shares was set for the next five-year period at 5.23800%. Effective June 30, 2018, on May 31, 2018, the Floating Quarterly Dividend for the Series 6 Shares was set for the first Quarterly Floating Rate Period (being the period from and including June 30, 2018, to but excluding September 30, 2018) at 1.12164%. The Floating Quarterly Dividend Rate will be reset every quarter.

The Series 5 Shares are issued in “book entry only” form and, as such, the sole registered holder of the Series 5 Shares is CDS Clearing and Depository Services Inc. (CDS). All rights of beneficial holders of Series 5 Shares must be exercised through CDS or the CDS participant through which the Series 5 Shares are held. The deadline for the registered shareholder to provide notice of exercise of the right to convert Series 5 Shares into Series 6 Shares is 3:00 p.m. (MDT) / 5:00 p.m. (EDT) on June 15, 2018. Any Election Notices received after this deadline will not be valid. As such, beneficial holders of Series 5 Shares who wish to exercise their rights to convert their 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 time to complete the necessary steps.

After June 15, 2018, (i) if Capital Power determines that there would remain outstanding on June 30, 2018, less than 1,000,000 Series 5 Shares, all remaining Series 5 Shares will be automatically converted into Series 6 Shares on a one-for one basis effective June 30, 2018 (an Automatic Conversion); or (ii) if Capital Power determines that there would remain outstanding after June 30, 2018, less than 1,000,000 Series 6 Shares, no Series 5 Shares will be permitted to be converted into Series 6 Shares effective June 30, 2018. There are currently 8,000,000 Series 5 Shares outstanding.

The Toronto Stock Exchange (TSX) has conditionally approved the listing of the Series 6 Shares effective upon conversion. Listing of the Series 6 Shares is subject to the Capital Power fulfilling all the listing requirements of the TSX and upon approval, the Series 6 Shares will be listed on the TSX under the trading symbol CPX.PR.F.

CPX.PR.E is a FixedReset, 4.50%+315, that commenced trading 2013-3-14 after being announced 2013-3-5. It is tracked by HIMIPref™ but relegated to the Scraps subindex 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., CPX.PR.E and the FloatingReset, CPX.PR.F, 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).

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The market appears to be relatively uninterested in floating rate product; the implied rates until the next interconversion bracket the current 3-month bill rate as the averages for investment-grade and junk issues are at +1.01% and +1.34%, 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 CPX.PR.E FixedReset, we may construct the following table showing consistent prices for its soon-may-be-issued FloatingReset counterpart, CPX.PR.F, 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. Therefore, it seems likely that I will recommend that holders of CPX.PR.E continue to hold the issue and not to convert, but I will wait until it’s closer to the June 15 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.

Emera Incorporated has announced (on May 31):

that it has completed its bought deal offering of 12,000,000 Cumulative Minimum Rate Reset First Preferred Shares, Series H at a price of $25.00 per share for aggregate gross proceeds of $300 million. The syndicate of underwriters was led by Scotiabank, CIBC Capital Markets, RBC Capital Markets and TD Securities Inc., as joint bookrunners, and also included BMO Capital Markets, National Bank Financial Inc., Industrial Alliance Securities Inc. and Raymond James Ltd. The net proceeds of the offering will be used for general corporate purposes.

EMA.PR.H is a FixedReset, 4.90%+254M490, announced May 17. It will be tracked by HIMIPref™ and has been assigned to the FixedReset subindex.

The issue traded 1,345,583 shares on its May 31 opening day in a range of 24.65-95 before closing at 24.88-92. Vital Statistics are:

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

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According to the analysis above, the fair value is $24.50 … note, however, that complainers will triumphantly point out that this assigns a value of zero to the Floor Rate Guarantee. But as I stated in the February, 2018, edition of PrefLetter:

It is often asserted that a horrific fall of FixedReset prices is a completely logical expectation; that the 2014-16 bear market was completely justified; that similar experiences will happen again; and that floor rates are an excellent way to protect investors from the decline in income.

This assertion does not make a lot of sense to me. Suppose an investor holds a FixedReset with a coupon rate of 5% and that a decline in government yields makes a reduction to 4% seem both likely and imminent. If the bear market scenario is to play out, this investor and many like him will be selling to avoid experiencing the reset.

But where is this money to be deployed? Yields are already down in the government market and all other fixed income markets will be affected to some degree; corporate-government spreads increased during the recent episode (see Chart FR-63 ), but corporate yields did decline – they just didn’t decline as much. I see no reason for an expectation that FixedReset yields should magically remain constant if the face of global interest rate declines.
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However, any increase in the price of the floor-rate issue is capped by the call price. In the simplest scenario, the non-floor issue will remain priced at par and reset to a 4% distribution, while the floored issue will be called; the investor will then have to reinvest his funds … and find that he is reinvesting at contemporary rates and experiencing transaction costs that are not borne by the investor in the non-floored issue. It’s not much of a win!

In order for the floor rate to have value, both issues must be trading at a discount to par; this will give the floored issue room to rise in price on the secondary market. Such a price rise will be determined by the excess yield to be gained over the next five years until the next reset plus, perhaps, an allowance for the possibility that current conditions will persist and give the holder another chance to reset. The benefit will be capped by the distribution rate difference multiplied by the Modified Duration of the issues (which will normally be in the range of 20 to 25), so a price difference of between 20% and 25% for a one percent decline in government yields. However, this potential gain is capped by the potential for a call, so the issues must already be trading at a 20%-25% discount to par for this maximum to be reached … and to work out the value of this scenario, we must then calculate the probability of such a decline in government yields.

Once we see floor-rate issues trading at large discounts in an environment in which a significant decline in government rates has a reasonable probability, I will revisit my opinion of the value of such guarantees. I’m not holding my breath.

Now, against the above we have actual empirical data regarding the prices of the EMA FixedResets since the announcement date:

This has accompanied the fall in the GOC-5 yield from 2.33% on May 17 to 2.10% on May 31 (which, proponents will gleefully point out, has made the floor rate on the new issue a matter of great interest). For now, the situation remains murky.

However, even those unimpressed by all that “Implied Volatility” blather and tiresome pettifogging regarding Floor Guarantees should be, at the very least, tempted by EMA.PR.A in preference to the new issue. Sure, it only pays 2.555% at present … but it will reset on 2020-8-15 at GOC-5 + 184, or – given the May 31 GOC-5 yield of 2.10% – 3.94%. It was quoted May 31 at 19.10-31, an Expected Future Current Yield of 5.16%, which ain’t bad for investment grade!