PrefBlog

E-L Financial has announced a new perpetual issue. See CCN Mathews for the press release … the actual press releases cannot be linked, but were timestamped 9:47 & 9:48 am, ET, today.

No prospectus is yet available on SEDAR, but informal information available to me indicates that it can be described as follows:

Dividend: 4.75%, or $1.1875 p.a. per share, non-cumulative

Redemption: $26.00 commencing October 17, 2011, declining by $0.25 p.a. until it’s redeemable at $25.00 at any time on or after October 17, 2015. The company has the right to force conversion into stock, using the applicable redemption price and the greater of $1.00 or 95% of the average common price (as defined) to determine the exchange ratio.

Rating: A preliminary rating of P-2(high) from Standard & Poors has been claimed. I have no information regarding a DBRS rating but, for analytical purposes, have assumed a Pfd-2(low) rating, the same as the existing ELF.PR.F.

It’s a bought deal via RBC-DS.

Preliminary analysis using a taxable yield curve indicates the following:

The “Price due to Liquidity” for the ELF.PR.? is a little fishy. As with all new issues, the analysis assumes maximal liquidity, but on the other hand, the ELF is only a $100-million dollar issue. $1.44 liquidity value seems a little steep!

Another way to say the same thing is: I think the EL new issue should be priced at less than the RY.PR.B by the sum of:

• $0.72 for the credit spread
• Somewhere between $0.00 and $1.44 for the liquidity

Well, I won’t be rushing to pull out my chequebook for this one! Seems to me that, like the Fortis new issue, the underwriters are pricing this deal according to the trading levels of all the Pfd-1(low) bank perps and hoping nobody notices the credit difference.

This new issue has been added to the HIMIPref™ database with the symbol ELF.PR.?.

I was asked by eMail to comment on this new issue.

The issue is featured on the Brompton website and the issue characteristics are:

Pays: 5.25% p.a. as dividends, quarterly, cumulative

Options: None relevant.

Maturity:  2013-11-29  @ 10.000000

Rating: Pfd-2 by DBRS. I can’t find anything about the issue on the DBRS website, but I have no reason to believe the prospectus is inaccurate. The OSC would be inclined to take a rather dim view of such shennanigans – and so would DBRS!

Other: Split Share Corporation.

 I’ve entered the information into HIMIPref™ – normally I wouldn’t bother, but I was specifically asked about this issue, so why not? – and on a TAXABLE basis the issue looks cheap compared to the current yield curve:

When discounted by the Pre-Tax curve they’re even better!

Clearly, one’s views of the “fair” price for this instrument will be influenced by whether one is speaking of “taxable” or “non-taxable” accounts, but it is equally clear that this issue is attractively priced at $10.00 regardless of the tax-status of the speaker!

My correspondent also wondered how a split share corporation could pay 5.25% dividends when the underlying investment only pays 3-3.5%. Well, the best underlying yielder (BMO) pays 3.7%, whereas the two worst (IAG & MFC) only pay 1.9% (both figures from the preliminary prospectus), but it’s a reasonable enough guess none-the-less.

Let’s say the company takes in $100-million, which is 4 million units priced at $25 total. They’re going to have to pay issue expenses – let’s call that $500,000, for the sake of a number, and selling commissions of $4.8-million. So they’re left with $94.7-million to invest, and lets just estimate the average yield of the underlying investments at 3%. So that means the company will be getting dividend income of $2.84-million.

They have 4 million prefs outstanding, and have to pay $0.525 annually on each of them. That comes to $2.1-million. So we can say that the dividends we expect on the prefs are covered quite comfortably by the dividends on the underlying assets – a dividend coverage ratio of about 1.3:1 – which is entirely reasonable. Note that the company has $94.7-million in assets to cover the return of $40-million to the preferred shareholders … an asset coverage ratio of just under 2.37:1, which is great! These calculations help explain why DBRS has put such an attractive credit rating on the issue … the banks and insurance companies in the underlying portfolio would have to go down in price by more than 50% before the company ran out of money to pay the preferred obligations.

All very nice, you say, but what about the class A shares? Well, what about them? I don’t care about them. They’re entitled to the excess dividend income that was estimated above to be about $740,000 … they’re also entitled to all the extra income the company can make from writing options and lending securities. Good for them. And if the price of the shares in the underlying portfolio goes up, they can have all that, too. I don’t care, as long as I get paid on my prefs!

The prospectus states that in order to meet the return projections for the Class A shares (8%), the company will have to produce an annualized return of 9.2%, out of which will come the fees, expenses and, of course, the preferred shareholders slice of the pie. Who knows? Maybe the company will succeed in achieving these gains! 9.2% is certainly a not unheard-of return on financial equities over a 7 year period. However, I look upon most split-share corporations as a vehicle whereby greedy retail investors (who buy the “Class A” residual shares) voluntarily donate money to conservative retail investors (who buy the prefs). The greedy guys are my new best friends!

I wouldn’t buy the Class A shares, but the Prefs look attractively priced and well protected.

Update 2006-10-19 The above calculation of the Dividend Coverage Ratio did not take account of the MER. Oops! If an MER of 0.95% is assumed, then the income available to cover dividends should be reduced by $900,000 in the above example, leaving $1.95-million to cover dividends of $2.1-million, resulting in an estimated DCR of a little over 0.9:1, which is still fine, considering the asset coverage (and the fact that potential income from stock lending and option writing has been ignored. Thanks to Financial Webring for pointing this out.

Update, 2013-10-4: This issue trades as LBS.PR.A.