Month: September 2017

Assiduous Reader JB writes in and brings to my attention a nuance in the conversion of Artis preferred units that had previously escaped me:

You have probably dealt with this question, so I apologize if that is the case.
I own a small position in Artis Preferred Series C. It is a $US pref. (I own lots of other preferreds.)
In the prospectus it states (I’m paraphrasing) that the CRA would consider conversion to the D shares a taxable event. I’m at a loss to determine why this is the case, since in another 5 years, I could convert back, should that be my choice.
Is this just an anomaly, or is this really the CRA’s position?

Well! First of all, let’s have a look at the prospectuses (not directly linked because rights are owned by the Canadian Securities Administrators, and why would they allow convenient access to public documents of interest to investors?)

Preferred Units, Series A (AX.PR.A) Prospectus on SEDAR under “Artis Real Estate Investment Trust Jul 25 2012 20:10:04 ET Prospectus supplement – English PDF 288 K”

In general, a disposition or deemed disposition of a Series A or Series B Unit will give rise to a capital gain (or a capital loss) equal to the amount by which the proceeds of disposition, net of any reasonable costs of disposition, exceed (or are exceeded by) the adjusted cost base of the Series A or Series B Unit, as the case may be, to the Preferred Unitholder. In the Ruling, the CRA expresses the preliminary view that the reclassification of Series A Units as Series B Units (or Series B Units as Series A Units) would likely result in a taxable disposition at that time. In such circumstances, a Preferred Unitholder will generally be considered to have disposed of the reclassified Preferred Units for proceeds of disposition equal to the fair market value of the Preferred Units into which such units are reclassified.

Preferred Units, Series C (AX.PR.U) Prospectus on SEDAR under “Artis Real Estate Investment Trust Sep 11 2012 16:24:11 ET Prospectus supplement – English PDF 287 K”

In general, a disposition or deemed disposition of a Series C or Series D Unit will give rise to a capital gain (or a capital loss) equal to the amount by which the proceeds of disposition, net of any reasonable costs of disposition, exceed (or are exceeded by) the adjusted cost base of the Series C or Series D Unit, as the case may be, to the Preferred Unitholder. In the Ruling, the CRA expresses the preliminary view that the reclassification of Series A Units as Series B Units (or Series B Units as Series A Units) would likely result in a taxable disposition at that time and the same consideration will apply on a reclassification of Series C Units as Series D Units (or Series D Units as Series C Units). In such circumstances, a Preferred Unitholder will generally be considered to have disposed of the reclassified Preferred Units for proceeds of disposition equal to the fair market value of the Preferred Units into which such units are reclassified.

Preferred Units, Series E (AX.PR.E) Prospectus on SEDAR under “Artis Real Estate Investment Trust Mar 14 2013 12:50:30 ET Prospectus supplement – English PDF 298 K”

In general, a disposition or deemed disposition of a Series E or Series F Unit will give rise to a capital gain (or a capital loss) equal to the amount by which the proceeds of disposition, net of any reasonable costs of disposition, exceed (or are exceeded by) the adjusted cost base of the Series E or Series F Unit, as the case may be, to the Preferred Unitholder. In the Ruling, the CRA expresses the preliminary view that the reclassification of Series A Units as Series B Units (or Series B Units as Series A Units) would likely result in a taxable disposition at that time and the same consideration will apply on a reclassification of Series E Units as Series F Units (or Series F Units as Series E Units). In such circumstances, a Preferred Unitholder will generally be considered to have disposed of the reclassified Preferred Units for proceeds of disposition equal to the fair market value of the Preferred Units into which such units are reclassified.

Preferred Units, Series G (AX.PR.G) Prospectus on SEDAR under “Artis Real Estate Investment Trust Jul 22 2013 13:34:56 ET Prospectus supplement – English PDF 304 K”

In general, a disposition or deemed disposition of a Series G or Series H Unit will give rise to a capital gain (or a capital loss) equal to the amount by which the proceeds of disposition, net of any reasonable costs of disposition, exceed (or are exceeded by) the adjusted cost base of the Series G or Series H Unit, as the case may be, to the Preferred Unitholder. In the Ruling, the CRA expresses the preliminary view that the reclassification of Series A Units as Series B Units (or Series B Units as Series A Units) would likely result in a taxable disposition at that time and the same consideration will apply on a reclassification of Series G Units as Series H Units (or Series H Units as Series G Units). In such circumstances, a Preferred Unitholder will generally be considered to have disposed of the reclassified Preferred Units for proceeds of disposition equal to the fair market value of the Preferred Units into which such units are reclassified.

So in each case the company has warned of a preliminary view by the CRA that conversion is a taxable event, which all appears to be based on the view they took when examining the first issue. Of course, it’s only preliminary, but to those of us who are unwilling to spend six figures discussing the matter in tax court, that counts as definitive.

As to why this should be the case … I simply don’t know. I suspect it has a lot to do with the idea that (from the AX.PR.G prospectus):

The Canadian federal income tax considerations that may arise in connection with the acquisition, holding, disposition or reclassification of preferred units of a trust are, in some respects, materially different from the acquisition, holding, disposition or exchange of preferred shares of a corporation.
…
“REIT Exception” means the exception from the SIFT Rules available to a SIFT trust which satisfies a series of conditions relating to the nature of a SIFT’s revenue and property, as more particularly described below under “Principal Canadian Federal Income Tax Considerations – SIFT Rules and REIT Exception”;
…
“SIFT Rules” means the amendments to provisions of the Tax Act proclaimed in force on June 22, 2007, as amended, that implement the changes announced as part of the Tax Fairness Plan proposed by the Minister of Finance (Canada) on October 31, 2006 which modify the tax treatment of “specified investment flow-throughs”, including publicly traded income trusts and limited partnerships, and the tax treatment of their unitholders in the manner described below under “Principal Canadian Federal Income Tax Considerations – SIFT Rules and REIT Exception”;
…
The balance of this summary assumes that Artis qualifies as a mutual fund trust and will continue to so qualify at all material times. If Artis were not to qualify as a mutual fund trust, the income tax considerations described below would, in some respects, be materially different.

… but this is getting into arcane interpretations of tax law in which a simple Portfolio Manager such as myself should take the view that anything he says will be wrong. However, I must say that I am surprised that Artis did not highlight this unusual nuance in its notice of extension for AX.PR.A.

Brompton Group has announced (although not yet on their website because they’re … um, well, I’ve sent an eMail to my friend ChrisC Update: Now available here):

Life & Banc Split Corp. (the “Company”) (TSX:LBS)(TSX:LBS.PR.A)is pleased to announce it is undertaking an overnight treasury offering of class A and preferred shares (respectively, the “Class A Shares” and “Preferred Shares”).

The sales period for this overnight offering will end at 9:00 a.m. (ET) on Tuesday September 26, 2017. The offering is expected to close on or about October 4, 2017 and is subject to certain closing conditions including approval by the Toronto Stock Exchange (“TSX”).

The Class A Shares will be offered at a price of $9.90 per Class A Share for a distribution rate of 12.1% on the issue price, and the Preferred Shares will be offered at a price of $10.00 per Preferred Share for a yield to maturity of 4.8%. The closing price on the TSX for each of the Class A and Preferred Shares on September 22, 2017 was $10.10 and $10.20, respectively. The Class A and Preferred Share offering prices were determined so as to be non-dilutive to the most recently calculated net asset value per unit of the Company (calculated as at September 21, 2017), as adjusted for dividends and certain expenses to be accrued prior to or upon settlement of the offering.

The Company invests in a portfolio (the “Portfolio”) consisting of common shares of the six largest Canadian banks and the four major publicly traded Canadian life insurance companies. The Portfolio consists of common shares of the following Canadian banks and Canadian life insurance companies:

The Bank of Nova Scotia	Royal Bank of Canada
National Bank of Canada	Industrial Alliance Insurance and Financial Services Inc.
The Toronto-Dominion Bank	Great-West Lifeco Inc.
Canadian Imperial Bank of Commerce	Manulife Financial Corporation
Bank of Montreal Sun	Life Financial Inc.

The investment objectives for the Class A Shares are to provide holders with regular monthly cash distributions targeted to be $0.10 per Class A Share and to provide the opportunity for growth in the net asset value per Class A Share.

The investment objectives for the Preferred Shares are to provide holders with fixed cumulative preferential quarterly cash distributions, currently in the amount of $0.11875 per Preferred Share, and to return the original issue price to holders of Preferred Shares on November 29, 2018.

The syndicate of agents for the offering is being led by RBC Capital Markets, CIBC Capital Markets and Scotiabank.

The Company is also pleased to announce that its board of directors has approved an extension of the maturity date of the Class A and Preferred Shares of the Company for an additional term to October 30, 2023. The Preferred Share dividend rate for the extended term will be announced at least 60 days prior to the original November 29, 2018 maturity date. The new dividend rate will be determined based on the market yields for Preferred Shares with similar terms.

So the Whole Units are being offered for a total of 19.90, vs a NAV of 19.32 as of September 21 – which at least is not as much a premium as we have recently seen elsewhere.

Update, 2017-09-26: The offering was successful:

Life & Banc Split Corp. (the “Company”) is pleased to announce a successful overnight treasury offering of class A and preferred shares (respectively, the “Class A Shares” and “Preferred Shares”). Gross proceeds of the offering are expected to be approximately $81.6 million. The offering is expected to close on or about October 4, 2017 and is subject to certain closing conditions including approval by the Toronto Stock Exchange (the “TSX”). The Company has granted the Agents (as defined below) an over-allotment option, exercisable for 30 days following the closing date of the offering, to purchase up to an additional 15% of the number of Class A Shares and Preferred Shares issued at the closing of the offering.

It will be recalled that VNR.PR.A will reset to 4.62% (paid on par) effective October 15.

Holders of VNR.PR.A have the option to convert to FloatingResets, VNR.PR.B, which will pay 3-month bills plus 281bp on the par value of $25.00, reset quarterly. The deadline for notifying the company of the intent to convert is 5:00 p.m. (Eastern Standard Time) on September 29, 2017; but note that this is a company deadline and that brokers will generally set their deadlines a day or two in advance, so there’s not much time to lose if you’re planning to convert! However, if you miss the brokerage deadline they’ll probably do it on a ‘best efforts’ basis if you grovel in a sufficiently entertaining fashion. The ticker for the new FloatingReset, if it is issued, will be VNR.PR.B.

VNR.PR.A is a FixedReset, 4.35%+281, that commenced trading 2012-6-6 after being announced 2012-5-15. The issue is tracked by HIMIPref™ and has been assigned to the FixedReset subindex.

The most logical way to analyze the question of whether or not to convert is through the theory of Preferred Pairs, for which a calculator is available. Briefly, a Strong Pair is defined as a pair of securities that can be interconverted in the future (e.g., VNR.PR.A and the FloatingReset, VNR.PR.B, that will exist if enough holders convert). Since they will be interconvertible on this future date, it may be assumed that they will be priced identically on this date (if they aren’t then holders will simply convert en masse to the higher-priced issue). And since they will be priced identically on a given date in the future, any current difference in price must be offset by expectations of an equal and opposite value of dividends to be received in the interim. And since the dividend rate on one element of the pair is both fixed and known, the implied average rate of the other, floating rate, instrument can be determined. Finally, we say, we may compare these average rates and take a view regarding the actual future course of that rate relative to the implied rate, which will provide us with guidance on which element of the pair is likely to outperform the other until the next interconversion date, at which time the process will be repeated.

We can show the break-even rates for each FixedReset / FloatingReset Strong Pair graphically by plotting the implied average 3-month bill rate against the next Exchange Date (which is the date to which the average will be calculated).

Click for Big

The market appears to have a distaste at the moment for floating rate product; most of the implied rates until the next interconversion are lower than the current 3-month bill rate and the averages for investment-grade and junk issues are both well below current market rates, at +0.71% and +0.69%, respectively! Whatever might be the result of the next few Bank of Canada overnight rate decisions, I suggest that it is unlikely that the average rate over the next five years will be lower than current – but if you disagree, of course, you may interpret the data any way you like.

Since credit quality of each element of the pair is equal to the other element, it should not make any difference whether the pair examined is investment-grade or junk, although we might expect greater variation of implied rates between junk issues on grounds of lower liquidity, and this is just what we see.

If we plug in the current bid price of the VNR.PR.A FixedReset, we may construct the following table showing consistent prices for its maybe-soon-to-be-issued FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to be cheap and trading below the price of their FixedReset counterparts. Therefore, I recommend that holders of VNR.PR.A continue to hold the issue and not to convert. I will note that, given the apparent cheapness of the FloatingResets, it may be a good trade to swap the FixedReset for the FloatingReset in the market once both elements of each pair are trading and you can – presumably, according to this analysis – do it with a reasonably good take-out in price, rather than doing it through the company on a 1:1 basis. But that, of course, will depend on the prices at that time and your forecast for the path of policy rates over the next five years. There are no guarantees – my recommendation is based on the assumption that current market conditions with respect to the pairs will continue until the FloatingResets commence trading and that the relative pricing of the new pair will reflect these conditions.