Category: Issue Comments

Assiduous readers of this blog may remember my my previous post on this issue and be having trouble sleeping at night due to curiosity regarding my current views.

For the benefit of these readers, and of a FWF member who asked about forward rate agreements in general, let’s have another look.

The June 30, 2006 Annual Report isn’t on the manager’s website yet, so you have to get it from SEDAR. Once you do, the previously shown simplified balance sheet can be revised to:

Note the balance sheet value of the Junior Prefs. 18,237 (thousand). This has been reduced from the 2005-12-31 value of 19,445 BECAUSE THEY DON’T HAVE THE MONEY.

The reason they don’t have the money is best understood through the Statement of Operations, which may be simplified as:

The net loss wiped out the share-holders equity.

Now, maybe to you and me this looks appalling. The Junior Prefs are supposed to mature  2012-06-29  and pay holders $14.70. There are 1,322,726 outstanding, so that’s a total amount due on maturity of $19,444,072 and the company only has about $18,237,000 in the kitty. To you and me, maybe, that means the asset coverage ratio is about 0.94:1 and it’s time to exit, stage left.

But!

 On the most recent fact sheet the manager trumpets asset coverage on the Juniors of 1.29:1.

On their listing of NAVs the manager says the $14.70 is covered by the “managed portfolio”, which has a value of $20.16 as of June 30, and the coverage is 1.37:1.

Mind you, though, they also say the NAV of the Juniors is $13.74, not $14.70, so that should at least ring some alarm bells for some holders.

The difference between $20.16 & $13.74, when multiplied by 1,322,726 shares is $8,491,900.90, and the difference between the Series 1 Repayment Portfolio and the redemption value of the Series 1 Shares is … $8,425,407. However, their “Coverage ratio” publication shows a June 30 NAV of $13.77 for the Junior prefs, which is not in agreement with their financials, so let’s assume that we’ve found the explanation – their published coverage ratio includes an allowance for the forward contract.

As I asserted in my prior post, this is absurd. If you want to defease the principal for coverage calculation purposes, you’ve also got to defease the related payments, and this hasn’t been done. Let’s not count too much on investment gains in the future … in the year prior to 2006-6-30, the S&P/TSX 60 Index was up 17.6% and the company did not cover its dividends.

 Even more excitingly, the Managed Portfolio was about 1/3 invested in income trusts at June 30, 2006. The manager claims a Series 2 (Junior Pref) NAV of $13.66 on November 3, 2006, so we’ll just have to see how that goes.

I would dearly love to see an explicit calculation of how the company calculates a coverage ratio of 1.29:1 on 2006-11-3. I would also dearly love to see an explanation of how the company intends to maintain distributions of $3.3-Million p.a. from gross Dividends and Interest of $782,538 (which basically, in 2006, covered the Management Fee and the Forward Agreement Fee, full stop.).

In the meantime, though, I’ll just concentrate on being grateful I don’t own any of these things … and wondering why DBRS still has them at Pfd-2(low).

The HPF.PR.B closed today on the TSX at $15.00-69, 17×4. We’ll just have to see how long that lasts.

All good things must come to an end.

BAM.PR.S has been a wonderful issue, paying $2.0875 interest every year but it’s time to wave farewell to the old friend.

Brookfield called it for redemption:

Brookfield Asset Management Inc. (NYSE/TSX: BAM) announced today that it intends to redeem its 8.35% Preferred Securities (“Securities”) on January 2, 2007 for C$25.00 per Security plus accrued interest of C$0.01144, representing a total Redemption Price of C$25.01144 per Security.

Enjoy the company of BAM.PR.T while you can, because it’s going to get called shortly as well (or, at least, so I predict). These were all issued during a small craze for interest-bearing prefs … they were a bit expensive compared to regular bonds, but these things had a stated term of 50-years. Not only could Brookfield not issue 50-year regular bonds (at least, I don’t think they could) but still get away with offering the preferred securities, but I believe there is some accounting convention whereby a 50-year bond is considered equity for at least some capital adequacy purposes.

Update 2007-01-05 : This post has been singled out for spamming for some odd reason; I have therefore disabled the comment function.

DBRS announced on November 8 that they will be reviewing the ratings of Income-trust based split shares:

This recent announcement has placed downward pressure on the net-asset value of portfolios containing income trusts and consequently the downside protection available to the Split Shares. Income trusts that plan to reduce the level of distributions to unitholders to reflect the additional tax burden may influence the ability for static and managed portfolios to generate sufficient yields to meet distributions to the Split Shares. In addition to the risk that this announcement may represent for distributions from any single trusts, the risk of a number of income trusts reverting back to corporate status may limit the number of eligible names for certain portfolios with a defined investment criteria and thereby increasing concentration risk.

Issues affected by this announcement are:

Two Income-trust-based split share corporations tracked by HIMIPref™ and included in the “InterestBearing” index are BSD.PR.A and MST.PR.A. Presumably their omission from the review list is a simple oversight.

BSD.PR.A is interesting: according to the manager the NAV of BSD.UN was $8.061 on November 10 (compared with $11.479 on October 31! Ouch!). It is currently quoted at $7.66-99 on the TSX – some have traded as low as $7.62 today (the 52-week low is $6.71! We can assume that’s recent!). According to their prospectus (available on the manager’s site! Good for them!):

Concurrent Annual Redemption. A Unitholder who surrenders Capital Units together with Preferred Securities for redemption in the month of November of each year at least 15 Business Days prior to a Redemption Date will receive payment for each Combined Security equal to the Combined Value determined as of the Redemption Date, less redemption costs.

Annual Redemption of Capital Units. A Unitholder who surrenders Capital Units alone for redemption at least 15 Business Days prior to a Redemption Date will receive an amount equal to Combined Value determined as of the Redemption Date, less redemption costs and the costs incurred by the Trust in purchasing a Preferred Security either in the market or pursuant to the Call Right.

 The interesting part comes when we look at the BSD.PR.A redemption schedule:

There were spikes in BSD.PR.A volume on November 1 (wonder why!) and yesterday, November 16. BSD.PR.A is currently quoted at $9.60-80 3×5 with no shares traded today. It will be most (most, most!) interesting to see if there’s a price spike towards month-end, as the manager seeks to match capital units submitted bare for redemption, scrambling to purchase the prefs in order to avoid the punitive redemption price.

Yes, yes, I know that we are now 15 days prior to the Redemption Date and all capital unit redemption requests have been made. But the November 16 volume spike was only 50,000 shares, out of 6,842,341 outstanding. Somehow, I suspect that there were more redemption requests than that … but we will see!

Well, I promised in a previous post that I’d write a few words about this issue: and the time has come!

According to the prospectus dated May 13, 1997, available on Bombardier’s website (good for them!), these issues are convertable into each other on August 1, 2007 and on the first of August every five years thereafter. In certain circumstances, conversion may be forced and there will be only one series outstanding.

BBD.PR.B is the “Series 2” and currently pays 100% of the Canadian Prime Rate, according to Bombardier’s website – there’s no direct link, so you have to poke around a little … what you want is Bombardier > Investor Relations > Share Information > Dividend Information > BBD.PR.B. Since the Canadian Prime Rate is now 6%, this translates to $1.50 on the face value of $25.00.

BBD.PR.D is the Series 3, and pays $1.369 p.a., which was set in 2002 and will be reset in 2007 to take effect August 1.

THEREFORE, according to Mr. Calculator, the Bs will pay about 13.1 cents p.a. more than the Ds, provided prime stays put, until the next reset date which is now less than 10 months away. Being more precise and taking account of ex-Dates, we find that the Bs have their next dividend ex-date on or about Nov 28, and at the end of each month until the end of next July, which is a total of 9 more payments of $0.125, total $1.125. The Ds will pay in January, March and July, $0.34225 a time, total $1.02675.

All the above assumes no default and no change in prime, of course! But we can basically say that from now until conversion, the Bs will pay about $0.10 more than the Ds, so, in full accordance with the Holy Efficient Market Hypowhatsit, should be priced about maybe approximately $0.10 higher, as adjusted for liquidity and discounting effects, not to mention the phase of the moon.

So let’s take a look at the quotes: BBD.PR.B was quoted at the close of business November 13 at $18.21-35. BBD.PR.D was quoted at the close of business November 13 at $16.80-84.

This is an absurd price spread. Clearly, a strategy that will work very well on paper, at the very least, is to short the BBD.PR.B and long the BBD.PR.D for a gross take-out of about maybe $1.40. What’s the profit?

OK, so it looks like there’s a $0.345 / share profit out there, just waiting to be grabbed, for anyone who wants to take it. The only constraint is how much you can get done without moving the price too much – a constraint I won’t attempt to play down! However, so far today, November 14, the Bs have traded 4,610 shares in a range of $18.31-35, while the Ds have traded 8,350 shares in a range of $16.75-81. So it would seem that there’s enough money available to be worth a ‘phone call.

 This strategy is credit neutral – if Bombardier goes bust in the next 9 months, then both your long and short are worthless, which is fine. And you don’t have to rely on the market to recognize the equality either – you can just convert one to the other next summer and your position will flatten out. All in all, it seems like a pretty good play for those who can short. Especially if you have a facility where you get paid interest on your cash collateral for the borrow!

 The major risk is of a short squeeze on the Bs, where you could be forced to buy back the short, perhaps at a greater spread to the Ds than that at which you entered the position. This is the risk of any short strategy – make up your own mind as to the likelihood of that. And never bet the house on ANYTHING. There’s lots of good ideas out there … do enough of them and the one’s that turn out well will pay for the ones that turn out badly, hopefully with a little bit extra tacked on.

I’m not doing this for clients at the moment: shorting is not currently something I “do”. Which, of course, is why I’m publishing the idea! Have a look, maybe it makes sense for your.

I’ve attached two graphs:

• Flat Bid Prices
• Difference in Flat Bid Prices

Have fun!

Update re short squeezes: According to the prospectus, conversion is effected by surrender of an actual certificate in the period 14-45 days prior to the actual conversion date. This could give rise to a short squeeze – IF a sufficient number of shareholders choose to convert from the higher priced issue shorted into the lower priced issue held … which doesn’t seem too likely, but worth mentioning.

Erk! Update re taxation: It was noted on Financial Webring Forum Financial Wisdom Forum [edited 2015-3-31] that there are tax effects on shorting dividend paying stocks in Canada … according to Blakes

Payments made to compensate a securities lender for dividends on a borrowed share of a Canadian issuer will generally not be deductible unless the securities borrower is a registered securities dealer in which case two thirds of the payment will generally be deductible;

Therefore, tax will be owing on the dividends received, but nothing may be deducted with respect to the dividends paid … at a marginal tax rate of 21% on the $1.12 received on the Bs, the tax loss due to dividends will be $0.235, which nearly wipes out the pre-tax profit all by itself.

The only hope for this strategy, then (in the absence of very fancy trading arrangements to skip over the dividends … and I will NOT opine on the admissability of such a strategy for tax purposes!) is to get paid on the cash collateral for the short, or to simply hope that the spread decreases faster than the nine-month maximum.

*Sigh* Tripped up by tax effects! That’s what happens when I step outside my specialty … but really, these things are Pfd-4 by DBRS so I wouldn’t want to go long … still, anybody who for any reason owns the Bs should give serious consideration to swapping into Ds … assuming they really want to own the name.

Further update re Tax: The relevent section of the Income Tax Act is 260(6)(a):

(6) In computing a taxpayer’s income under Part I from a business or property

(a) where the taxpayer is not a registered securities dealer, no deduction shall be made in respect of an amount that, if paid, would be deemed by subsection 260(5) to have been received by another person as a taxable dividend; and

(b) where the taxpayer is a registered securities dealer, no deduction shall be made in respect of more than 2/3 of that amount.

And please note that I am not a tax specialist! Consult your own tax advisor before making or not making any decision based on the above!

This member of the premiumPerpetual index slid into negative YTW territory, so let’s have a look at it.

The listing date was 1998-12-01 and it pays $1.375 annually on a par value of $25: 5.5%. The option schedule (as shown on the embeddedOptionsBox) is:

• Redemption      2003-12-02      2004-12-01  26.000000
• Redemption      2004-12-02      2005-12-01  25.750000
• Redemption      2005-12-02      2006-12-01  25.500000
• Redemption      2006-12-02      2007-12-01  25.250000
• Redemption      2007-12-02   INFINITE DATE  25.000000

which at the 2006-11-09 quotation of $25.72-95 leads to the following call scenarios, reported on the pseudoPortfolioReportBox:

• Call  2006-12-09 YTM: 7.42 % [Restricted: 0.61 %] (Prob: 25.91 %)
• Call  2007-01-01 YTM: -0.26 % [Restricted: -0.04 %] (Prob: 13.07 %)
• Call  2007-10-05 YTM: 4.53 % [Restricted: 4.09 %] (Prob: 5.00 %)
• Call  2008-01-01 YTM: 3.87 % [Restricted: 3.87 %] (Prob: 5.43 %)
• Limit Maturity  2036-11-09 YTM: 5.44 % [Restricted: 5.44 %] (Prob: 50.59 %)

One feature of the calculations is the fact that the issue goes ex-Dividend TODAY, November 10, and at time of writing is quoted at 25.46-57 on volume of 2,100 shares. It doesn’t look as if anybody got caught on the ex-Dividend, with the odd skip-day of November 13 (odd because the TSX is open, but banks are closed): the day’s range is 25.46-55. So it’s lost $0.26 (bid/bid) on the day, having gone ex a dividend of $0.34375. Which means it’s actually up!

I’ve attached some graphs, prepared by the graphDocument:

• Yield-to-Worst : Definition, Graph
• Flat Bid Price : Definition, Graph
• Average Volume : Definition, Graph

We’ve looked at BMO.PR.G (YTW at the 11/7 closing bid of $25.48 is -9.24%) and at RY.PR.K (YTW at the 11/7 closing bid of $25.52 is -10.64%), but there is another member of the OperatingRetractible Index that has a negative Yield-to-Worst.

The option schedule for BMO.PR.I is:

• Redemption      2005-11-25      2006-11-24  25.500000
• Redemption      2006-11-25      2007-11-24  25.250000
• Redemption      2007-11-25   INFINITE DATE  25.000000
• Retraction      2008-11-25   INFINITE DATE  26.040000

which, at the 11/7 closing bid of $25.51, gives rise to the optionCalculationList:

• Call  2006-12-07 YTM: 1.08 % [Restricted: 0.09 %] (Prob: 16.76 %)
• Call  2006-12-25 YTM: -4.99 % [Restricted: -0.66 %] (Prob: 11.55 %)
• Call  2007-12-25 YTM: 2.69 % [Restricted: 2.69 %] (Prob: 0.44 %)
• Soft Maturity  2008-11-24 YTM: 3.60 % [Restricted: 3.60 %] (Prob: 71.25 %)

So: YTW = -4.99%. If it makes it to the softMaturity, then the yield will be considerably greater (one might even call it respectable: 3.60% in dividends net of capital loss converts to 5.04% interest-equivalent for Ontario Investors who don’t need the money anyway, which is a lot better than you can get at the bank for a two-year deposit … or in the bond market.

There are clearly at least some people who are willing to slap some money on the table and bet that it won’t be called as soon as the call price declines to $25.25!

There may be some validity to this view: BMO.PR.I pays $1.1875 p.a. as a dividend and BMO can save $0.25 by waiting an extra year before calling, giving the shares a net cash cost of $0.9375 for that year, which is simple interest of 3.71% on the $25.25 that they’d have to pony up for the shares, interest-equivalent of 5.20% using the shareholders’ conversion factor … I’m not sure what factor the bank would use.

I’d call it a tossup, really: the answer will be somewhat dependent upon BMO’s balance sheet objectives (since these are retractible, they get counted as long-term debt for capital calculation purposes … perpetuals with non-cumulative dividends get counted as equity) and their ability to refinance. Against that is the consideration that a new issue of prefs would come with issuance costs attached of perhaps 3% of face value (which is a major reason why immediate calls are not calculated to have a larger probability).

 Tossups, feh. Paying $25.51 for this issue is taking too much risk for not enough return, according to me. HIMIPref™ won’t recommend it, firstly because the eligibleForPurchase function doesn’t like the short-term nature of the instrument and secondly because the totalRewardAsk is so low, which is largely due to the negative YTW.

Attached to this post for your delectation and amusement are graphs of this issue’s Yield-to-Worst and flatBidPrice for the past year.

BMO.PR.I has had a total return of 2.97% since 2005-11-30, based on the following data reported by the performanceBox:

which just goes to show that you usually shouldn’t put money into issues with lousy YTWs, because you usually get burned!

CIBC has announced that CM.PR.B (Non-cumulative Class A
Preferred Shares Series 24) will be redeemed at $26.00 on January 31, 2007. [Note: the link is to a cgi script. If not accessible, try here.]

 Not a surprise, really … perpetuals paying $1.50 are an endangered species, but the idea that they might have saved $0.25 p.a. on the redemption price (due to a declining call price) added a little piquancy to the speculation.

 What will be interesting is the resolution of the question: will they replace them with a new issue?

Update, 2007-5-10: For some odd reason this post has become the target of spambots. I am therefore disabling comments on this post.