Category: Issue Comments

Hard on the heels of the S&P downgrade, DBRS has announced that it:

has today downgraded its long-term debt and preferred share ratings on Manulife Financial Corporation (MFC or the Company) and its affiliates, including the Issuer Rating of its major operating subsidiary, The Manufacturers Life Insurance Company (MLI), to AA (low) from AA. The Claims Paying Ability and Commercial Paper ratings of MLI have been confirmed at IC-1 and R-1 (middle), respectively. All the trends are Stable. With earnings volatility expected to continue at elevated levels, notwithstanding the best efforts of management to contain market exposures, DBRS recognizes that the Company’s heightened risk profile and the associated adverse impact on regulatory capital and financial flexibility can no longer support the pre-existing ratings and have resulted in the negative rating action.
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The Company has indicated that during the third quarter of 2010, it is expecting to complete its annual actuarial review of the morbidity assumptions embedded in the reserves held against its Long-Term Care policy liabilities. The Company expects to incur a charge of between $700 million and $800 million related to this change in assumptions, although this could be offset somewhat by in-force price adjustments.

I hadn’t seen that number before. As I noted when reporting their quarterly results in MFC Warns of Increased Capital Requirements, last week they had no idea what the number was going to be, except ‘Maybe big’.

the degree of the drop in the minimum continuing capital and surplus requirements (MCCSR) – from 250% at the end of March 2010 to 221% at the end of June 2010 – suggests that another negative quarter will force the Company to raise additional capital. In the meantime, it is DBRS’s view that the Company’s financial flexibility has become increasingly constrained, as the most readily available sources of capital have already been tapped. In addition to two major common equity issues totaling close to $5 billion in 2008 and 2009, a 50% cut in the common dividend and a corporate re-organization designed to free up regulatory capital, the Company has raised close to $1.5 billion in debt and preferred share financings, which increased its financial leverage ratios to the point where DBRS was no longer comfortable with the Company’s pre-existing ratings. At the new rating categories, the Company has at least some additional room to issue debt capital instruments.

MFC has the following preferred shares outstanding: MFC.PR.A (OpRet); MFC.PR.B & MFC.PR.C (PerpetualDiscount); MFC.PR.D & MFC.PR.E (FixedReset). All are tracked by HIMIPref™ and all are included in the noted indices.

And who knows? Perhaps DBRS mention of the “additional room to issue debt capital instruments” means that MFC has said ‘Please sir, I want some more!’

Standard & Poor’s has announced:

• The earnings volatility of the Manulife group of companies exceeds our expectations for higher ratings, and the group has significant variable annuity and segregated fund guarantee values that remain unhedged.
• In addition, Manulife Financial Corp. reported a C$2.4 billion net loss for the quarter ended June 30, 2010, and there could be material charges in the next quarter arising from its annual review of all actuarial methods and assumptions.
• As a result, we have lowered our counterparty credit rating on Manulife Financial Corp. to ‘A’ from ‘A+’ and our counterparty credit and financial strength ratings on its core and guaranteed insurance operating subsidiaries to ‘AA’ from ‘AA+’.
• The outlook is negative because of the continuing earnings volatility and the associated pressure on fixed-charge coverage and capitalization levels.

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We could lower the ratings again if 2011 earnings continue to be highly volatile (whether because of unhedged variable annuity guarantee values or risk exposures), if fixed-charge coverage is less than the 6x-8x expected for similarly rated holding companies in 2011, or if capitalization is not solidly redundant at the ‘AA’ confidence level. Alternatively, if the group meets these conditions on a sustained basis and the group maintains its broad competitive advantages and relatively conservative investment risk profile, we would likely affirm the ratings.

MFC has the following preferred shares outstanding: MFC.PR.A (OpRet); MFC.PR.B & MFC.PR.C (PerpetualDiscount); MFC.PR.D & MFC.PR.E (FixedReset). All are tracked by HIMIPref™ and all are included in the noted indices.

This follows a similar cut in the SLF credit rating in April, although that one was on the basis of sustainable earnings rather than volatility.

Moody’s doesn’t rate MFC, but it does rate the subsidiaries … and it’s not too happy:

Moody’s Investors Service has placed on review for possible downgrade the Aa3 insurance financial strength (IFS) ratings of the life insurance subsidiaries of Manulife Financial Corporation (Manulife; TSX: MFC, unrated) – including The Manufacturers Life Insurance Company (MLI), and John Hancock Life Insurance Company (U.S.A). Other affiliated ratings were also placed on review for possible downgrade (see complete list, below). The rating action follows Manulife’s announcement of a C$2.4 billion net loss in 2Q10, as well as the likelihood of a sizeable charge in 3Q10 for unfavorable long-term care morbidity experience.

Commenting on the review for possible downgrade, Moody’s said that the poor experience of MFC’s U.S. long-term care (LTC) block was not anticipated in its 2009 rating downgrades of MFC’s life insurance subsidiaries. In addition, MFC’s 2Q10 results were materially worse than peers’, due to its more sizeable unhedged exposure to variable annuity/segregated funds and its greater sensitivity to low interest rates on its long-tailed, guaranteed insurance liabilities (i.e., LTC and universal life insurance with secondary guarantees).

2Q10 Shareholders’ Report:

OSFI continues to update and amend the MCCSR guideline in response to emerging issues. The capital requirements for segregated fund guarantees were amended in 2008 and the Company expects that the requirements will increase for new business issued after December 31, 2010. The extent of the increase in requirements has not been finalized and discussions with OSFI are on-going. The Company expects further changes in segregated fund guarantee requirements, likely in 2013, that will impact its existing business. The impact of these future changes is uncertain.

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Allbanc Split Corp. II has announced:

The Company announced today that its Board of Directors has retained Scotia Capital to advise the Company on a possible extension and reorganization of the Company. There is no guarantee that after such review an extension will be proposed or if proposed, will be approved by shareholders.

It will be convenient for the company to work with Scotia Capital, seeing as how they’re the sponsor!

ALB.PR.A is scheduled to mature 2011-2-28. In a reorganization it could be refunded or extended – it could go either way, but given that the issue yield is only 4.25% – and it’s trading above par! – I suggest that an attempt to extend is likely. But we will see!

ALB.PR.A was last mentioned on PrefBlog when there was a partial call for redemption. ALB.PR.A is tracked by HIMIPref™ but is relegated to the Scraps index on credit concerns.

These are total returns, with dividends presumed to have been reinvested at the bid price on the ex-date. The list has been restricted to issues in the HIMIPref™ indices.

It’s interesting to see the BAM OpRet issues dominating the lower end of the monthly returns …. one is tempted to think that BAM.PR.J declined due to the TXPR rebalancing, and the other OpRets went down due to swaps triggered by the initial decline.

Brookfield Properties has announced:

a strategic repositioning plan to transform itself into a global pure-play office property company. The plan includes the acquisition of an interest in a significant portfolio of premier office properties in Australia from Brookfield Asset Management (BAM: NYSE, TSX, Euronext) as well as the divestment of Brookfield Properties’ residential land and housing business.
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Brookfield Properties has agreed to enter into a transaction with Brookfield Asset Management whereby Brookfield Properties will pay Brookfield Asset Management A$1.6 billion (US$1.4 billion) for an interest in 16 premier Australian office properties comprising 8 million square feet in Sydney, Melbourne and Perth which are 99% leased. The properties have a total value of A$3.8 billion (US$3.4 billion).
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Brookfield Properties will fund the transaction from available liquidity of US$1.3 billion and from a US$750 million subordinate bridge acquisition facility from Brookfield Asset Management, which will be repaid from the completion of some or all of the following: asset sales, including a sell down of Brookfield Properties’ equity interest in its publicly-listed company Brookfield Office Properties Canada (TSX: BOX.UN), or other financing or capital activities.

A supplemental information package relating to this transaction is available on Brookfield Properties’ website at www.brookfieldproperties.com.

As a further step in the strategy of converting Brookfield Properties into a global pure play office company, the company announced that it intends to divest of its residential land and housing division. To this end, Brookfield Properties intends to commence discussions with Brookfield Homes Corporation (NYSE: BHS) regarding the possible merger of these operations with Brookfield Homes. Should the merger proceed, Brookfield Properties’ equity interest in the residential business would be converted into a listed security in the merged entity which Brookfield Properties would then dispose of through an offering to its shareholders. Brookfield Asset Management would commit to acquire any shares of the merged entity that are not otherwise subscribed for in the offering, thereby ensuring that Brookfield Properties will successfully dispose of its residential interests and receive full proceeds.

The pricing supplement is titled Australia Office Portfolio Transaction and is of great interest:

BPO’s interest in the Portfolio will be acquired through a Total Return Swap entitling BPO to the net cash flows and any changes in the value of the properties

• This structure preserves the benefit of property-level financing and will allow for efficient transfer of this Portfolio at a future date into a different ownership entity, e.g. public vehicle or private fund in order to continue BPO’s asset management strategy
• BPO will be property manager for the portfolio and will make or approve all significant decisions relating to the properties, including refinancingsand other decisions relating to the property debt
• BPO will be responsible for additional capital requirements and will be entitled to any proceeds from refinancings from the properties
• BPO will have an option to acquire the properties at anytime

The total return swap concept is fascinating, but I haven’t yet thought through all the implications, particularly since the contract is with the parent.

On the whole, the deal seems to me to be a continuation of the basic Brookfield philosophy of accumulating assets at the parent level and then pushing them into subsidiaries; attracting co-investors and increasing (non-recourse!) leverage along the way. It hasn’t been too long since they last did this, with the BPP conversion to a REIT.

BPO has several series of preferreds outstandng: BPO.PR.F, BPO.PR.H, BPO.PR.I, BPO.PR.J, BPO.PR.K, BPO.PR.L and BPO.PR.N.

Update: This is credit-neutral, according to DBRS:

The rating confirmation also takes into consideration that, from a financial risk perspective, the Acquisition is expected to have a neutral impact on the Company’s balance sheet ratios. DBRS expects Brookfield to fund the Acquisition with available liquidity, including un-drawn bank facilities ($788 million) and a cash balance ($475 million) totalling approximately $1.3 billion and from a $750 million bridge facility provided by BAM. Over the next several quarters, DBRS expects Brookfield to repay this bridge facility with a combination of proceeds from the following: a sell-down of the Company’s interest in Brookfield Office Properties Canada (the REIT; of which the Company currently owns a 91% interest), asset sales and other capital activities. As a result, DBRS estimates that the Company’s debt-to-capital ratio will remain close to 55% (including preferred shares) and EBITDA interest coverage should modestly improve to the 2.35 times range (including capitalized interest). This level of interest coverage remains at the low end of the range for the current rating category. However, DBRS takes comfort in the fact that Brookfield has made good progress in improving its overall financial flexibility position and that office fundamentals in the Company’s core markets are showing signs of improvement.

Overall, DBRS believes that the Acquisition complements Brookfield’s existing high-quality office portfolio and offers an immediate and sizeable presence in a new market. Over time, DBRS expects Brookfield to grow this platform, which should further benefit leasing initiatives and tenant retention rates.

Financial 15 Split Corp. II has released its semi-annual statements to May 31, 2010.

Dividend receipts declined to about $1.3-million in 1H10 from about $2.1-million in 1H09, while expenses rose to $461,000 from $390,000 due to higher valuations and a small expense for Service Fees. Accordingly, Income Coverage for the Preferred Shares dropped to 0.6-:1 in 1H10 from 1.0+:1 in 1H09.

FFN.PR.A was last mentioned on PrefBlog when the Capital Unit Distribution was suspended in June (hah! No Service Fees to pay this quarter!). FFN.PR.A is tracked by HIMIPref™, but is relegated to the Scraps index on credit concerns.

Financial 15 Split Corp. has announced:

that its semi-annual financial statements and management report of fund performance for the period ended May 31, 2010 are now available at www.sedar.com and the Company’s website at www.financial15.com.

The Report (to 2010-5-31) states:

During April 2010, the Company issued 1,980,000 Class A and Preferred shares at a unit price of $20 for total net proceeds after the payment of agents fees of $37.5 million. As a result of this offering, one time issue costs and agents fees in connection with the offering increased the expense ratio during the period. The Company did not immediately invest the proceeds into the financial services stocks as reflected by the higher cash position as at May 31,2010 thus benefiting from the opportunity to purchase the core stocks at lower levels than those in April.

Net investment income was $1.1-million, while distributions on preferred shares amounted to $2.1-million, so income coverage for the six months to May 31, 2010, was 0.5+:1, a huge reduction from the 1.2+:1 recorded in 1H09.

Cash on the balance sheet represented 17% of total assets, but this does not explain the sharp decline in income coverage – the secondary offering closed in mid-April, so the cash was only there for about six weeks.

Instead, it appears that several other factors had dominance:

• Dividend receipts declined from about $3-million to about $2-million
• Management and Service fees increased to about $670,000 in 1H10 from about $340,000 (net) in 1H09

Note 6 to the financials reads in part:

The Company is responsible for all expenses incurred in connection with the operation and administration of the Company, including, but not limited to, ongoing custodian, transfer agent, legal and audit expenses.

Pursuant to the administration agreement, the Manager is entitled to an administration fee payable monthly in arrears at an annual rate of 0.10% of the transactional net assets of the Company, which includes the outstanding Preferred shares, calculated as at each monthly valuation date and an amount equal to the service fee payable to dealers on the Class A shares at a rate of 0.50% per annum. No service fee will be paid in any calendar quarter if regular dividends are not paid to holders of Class A shares in respect of each month in such calendar quarter.

Pursuant to the terms of the investment management agreement, Quadravest is entitled to a base management fee payable in arrears at an annual rate equal to 0.65% of the transactional net assets of the Company, which include the outstanding Preferred shares, calculated as at each monthly valuation date. In addition, Quadravest is entitled to receive a performance fee subject to the achievement of certain pre-established total return thresholds.

Total management fees of $519,631 (May 31, 2009-$373,315), incurred during the period, include the administration fee and base management fee. No performance fees were paid in 2010 or 2009.

Clearly, the Service Fee increased because the capital unitholders received all their dividends in the first half so all Service Fees were payable. In 1H09, no service fees were payable – there was even a rather odd recovery!

Management fees increased due to the increase in assets of the fund.

So it looks like the expenses are probably here to stay – provided the NAV holds up above $15.00 and the capital unit distributions are made – but it is rather odd that dividend receipts have declined so precipituously despite the increase in assets. At some point it will be most interesting to attempt to reconcile these data with the disclosed holdings – how much of this is the result of actual dividend cuts for the common shares held, and how much due to selection of lower yielding securities?

However, the income coverage should improve to some extent in the second half as the cash on the balance sheet is invested.

This should have been posted yesterday, July 28. Sorry!

Fairfax Financial Holdings Ltd. has announced that it:

has completed its previously announced public offering of Preferred Shares, Series G (the “Series G Shares”) in Canada. As a result of the underwriters’ exercising in full their option to purchase an additional 2,000,000 Series G Shares, Fairfax has issued 10,000,000 Series G Shares for gross proceeds of $250 million. Net proceeds of the issue, after commissions and expenses, are approximately $242 million.

Fairfax intends to use the net proceeds of the offering to augment its cash position, to increase short term investments and marketable securities held at the holding company level, to retire outstanding debt and other corporate obligations from time to time, and for general corporate purposes.

The Series G Shares were sold through a syndicate of Canadian underwriters led by BMO Capital Markets, CIBC, RBC Capital Markets and Scotia Capital, and that also included TD Securities, National Bank Financial, Cormark Securities, GMP Securities, Canaccord Genuity, Desjardins Securities and HSBC Securities (Canada).

FFH.PR.G is a FixedReset, 5.00%+256, announced July 20.

Vital statistics are:

FFH.PR.G will be tracked by HIMIPref™, but is relegated to the Scraps index on credit concerns.