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:
| Curve Price : Taxable Curve |
| Price due to base-rate |
10.21 |
| Price due to short-term |
0.10 |
| Price due to long-term |
0.38 |
| Price due to SplitShareCorp |
-0.22 |
| Price due to Retractibility |
0.34 |
| Price due to Credit Spread (2) |
-0.11 |
| Total |
$10.70 |
When discounted by the Pre-Tax curve they’re even better!
| Curve Price : Non-Taxable Curve |
| Price due to base-rate |
10.25 |
| Price due to short-term |
0.50 |
| Price due to long-term |
0.01 |
| Price due to SplitShareCorp |
-0.30 |
| Price due to Retractibility |
0.48 |
| Price due to Credit Spread (2) |
-0.17 |
| Price due to error |
0.02 |
| Total |
$10.80 |
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.
BAM.PR.B / Floating-rate Index
Wednesday, September 27th, 2006“You say you dislike floating rate issues. Why then does the system love BAM.PR.B?”
Well! That was a lovely eMail to receive! Don’t I have enough problems spouting my opinions without having to worry about consistency?
HIMIPref™ does love BAM.PR.B. It is ranked as the best single preferred share in the marketplace, so let’s dig into the numbers a little and see what’s what. Very briefly, the issue is currently callable at $25.00 and pays 70% of Canada prime, so the annual dividend is currently $1.05. It’s a member of the “Floaters” index, so let’s compare it with those issues:
The key figure here is the Price Disparity which is a major influence on valuation. “Price Disparity is high” implies “HIMIPref™ loves”.
In tracing the source of the price disparity, we find two table rows of note: the Liquidity adjustment and the Floating Rate adjustment – these are both elements of the Yield Curve Calculation. Briefly: the market is now placing a huge premium on liquidity. When the entire HIMIPref™ universe is analyzed, it is found that there is a very definite liquidity effect: issues with high Average Trading Values are generally a lot more expensive than a straightforward analysis of their expected cashflows would indicate. Similarly, Floating Rate issues are far more expensive than their expected cash flows would indicate (which is why I don’t like ’em!). Note that cash flow expectations for floating rate issues are calculated with the view that Prime is what it is and ever shall be, world without end.
So … that’s why HIMIPref™ loves BAM.PR.B! It’s not due to any particular factor – it is based on the idea that, should the market come to value its characteristics in the same manner as the market values those characteristics for all the other preferreds analyzed, then it will go up in price – big time!
Is this guaranteed? Of course not. There may be elements that the market is pricing that are ignored by HIMIPref™, most obviously “Company Specific Effects”, i.e., maybe the market just doesn’t like BAM. I have not been able to define, parameterize and test a formulation of such an effect that leads to better results, but that doesn’t mean that it doesn’t exist, and certainly doesn’t mean that it doesn’t exist right now at this moment for BAM only!
HIMIPref™ is a statistical system. The market is a sometimes illogical beast. All one can do is make lots of small “bets” when the odds are in your favour (rather than making one big bet!) to give the statistics a chance to work. Some trades will work out nicely, others won’t … the idea is to accept that and to keep rolling the slightly-loaded dice!
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