In the last edition of PrefLetter I pointed out a significant inversion in the floating rate sector, with BPO Properties Ltd. Fltg Rate Pr Series “J”, for instance (BPP.PR.J) trading at a higher price than Brookfield Asset Management Inc Cl A Pr Ser 13 (BAM.PR.K), despite the latter’s higher credit rating.
BPO’s debt-to-gross book value could increase to closer to 50% to 55% over the next two years from 44% currently. EBITDA interest coverage is likely to decline prior to Bay-Adelaide coming online in mid-2009, but is expected to remain close to 2.5 times including capitalized interest, which is acceptable for the current rating. Fixed-charges coverage should remain manageable at close to two times. Excluding capitalized interest, EBITDA interest coverage should remain above three times.
Over the short term, BPO should continue to benefit from stronger office markets looking forward which could drive growth in cash flows to support EBITDA interest coverage ratios. Net rental rates in Calgary have experienced unprecedented growth of approximately 50% over the past two years to $35 to $40 per square foot. BPO’s in-place rents are on average 25% to 30% below current market net rents, partly due to long-term leases.
The rating also reflects the following factors: (1) BPO has greater diversification with the addition of new markets in Ottawa and Edmonton in recent years that enhance cash flow stability. (2) BPO’s solid tenant profile and average lease maturity of seven years is expected to support cash flow stability.
It’s a nice little company – and according to note 10 of their 2007 Annual Report, all the debt is secured by individual properties and is non-recourse to the company. This is a nice provision; I like this provision. Each property can hurt them, certainly, in the event of disastrous market conditions, but no single property can take out the company.
The problems are the same as with every other property company … rents can go to zero, or negative (you have to pay the janitor!) for years while the mortgage still needs to be paid … and I would be a lot happier if they weren’t so concentrated in Toronto & Calgary. But they do a good job of mitigating these risks with long leases and well-staggered mortgage maturities.
BPO Properties is 89% controlled by Brookfield Asset Management … this sort of subsidiary action can be a chancy thing. In general, it is better to be close to the money (Loblaws is a better credit – slightly – than Weston; Bell Canada preferred were a much better credit than BCE, until the idiot holders gave up their advantage for trivial consideration), but in some cases it’s better to be diversified.
Regarding BAM’s credit, DBRS noted in 2006:
Brookfield has completed the move from cyclical natural resources-based investments to a diversified portfolio of investments focused on stable real estate, power and infrastructure assets. This strategy is supported by Brookfield’s solid balance sheet and good liquidity. Brookfield also continues to develop relationships with large institutional investors, mitigating some of the risks associated with large investments.
Consistent with this overall strategy, Brookfield, along with three large Canadian institutional investors, recently announced plans to acquire HQI Transelec Chile S.A., the largest electricity-transmission company in Chile, for approximately $1.7 billion, of which Brookfield’s share of the equity is expected to be approximately 30%, or $300 million. Also, Brookfield Properties Corporation (Brookfield Properties), which is 50% owned by Brookfield, and The Blackstone Group recently bid to acquire Trizec Canada Inc. and Trizec Properties, Inc. for total consideration of $9.2 billion. The net effective interest of Brookfield Properties is approximately $400 million in equity ($1.74 billion in total value) after reflecting the interest of other large institutional shareholders. This compliments its growing portfolio of investments in stable assets that generate relatively predictable cash flow.
In 2005, Brookfield continued to generate strong free cash flow of $475 million on a remitted basis (adjusted to reflect actual dividends paid by Brookfield Properties and Brookfield Homes Corporation) and coverage ratios remain solid. Although Brookfield recently increased its common dividend by 50%, its substantially larger asset base and stable cash flows are expected to support higher levels of cash outflows. As a result, Brookfield is expected to continue to generate free cash flow after all dividends in 2006 as acquisitions in the power segment in particular contribute to higher cash flows.
During 2005, Brookfield was successful in reducing its debt levels to 28% on a deconsolidated basis, which is below 2004’s 34%, within its target range of 25% to 30% and acceptable for a holding company. Improved debt levels were largely due to the divestiture of its stake in Falconbridge Limited for net cash proceeds of $1.4 billion (proceeds from the sale were $2.7 billion, including preferred shares and exchangeable debentures). Brookfield remains committed to maintaining a solid credit profile through prudent balance-sheet management. Funds for investment will come from its significant internal free cash flow and liquid investments of more than $2 billion.
Their consolidated debt-to-equity ratio looks scary, but most of this is property-specific; additionally, there is much more diversification than with BPP. If, for instance, the real-estate market in Calgary & Toronto cratered, BAM could simply jettison BPP, taking a large loss, but staying afloat with their timberland and power-generation assets. I have no problem with the idea that BAM is a better credit than BPP.
The market has recently had other ideas, however, with BPP floaters yielding less than BAM floaters. It’s a funny old world. The May edition of PrefLetter included some charts showing the development of this inversion:
- YTW vs time, BAM.PR.B & BPP.PR.J
- YTW Difference vs time, BAM.PR.B less BPP.PR.J
- Bid Prices vs. time, BAM.PR.B & BPP.PR.J
- Price Difference vs. Time, BAM.PR.B less BPP.PR.J
The credit inversion continues and encompasses all the floaters of each issuer: BAM.PR.B & BAM.PR.K vs. BPP.PR.G, BPP.PR.J & BPP.PR.M. It should be noted that the BPP floaters are highly illiquid.