CA Bancorp New Issue – Appalling!

Holy smokes, I’m in the wrong business!

CA Bancorp has announced:

that a preliminary prospectus for a newly created mutual fund corporation, C.A. Bancorp Canadian Realty Finance Corporation (the “Corporation”), has been filed with, and a receipt therefor issued by, the securities regulatory authorities in each of the provinces and territories of Canada. The Corporation is offering and will issue preferred shares, Series 1 (the “Preferred Shares”) to the public.

Let’s take a quick look at this … seeing as I was asked so nicely.

The prefs are supposed to pay 6.75% p.a. on a tax-advantaged basis – which is to say, return of capital and capital gains. One should note that capital gains, nowadays, are not as tax-efficient as they used to be compared to dividends … and that return of capital merely defers taxation as a capital gain, it does not eliminated it. The prefs will be redeemed in 2018, making them ten-year paper.

There are a number of things that caught my eye on my first glance at the preliminary prospectus:

  • Salesmen are getting a 5.25% commission to flog the thing
  • All the capital units will be held by the sponsor
  • Asset coverage will probably be about 1.1:1
  • The issue will not be rated

Feeling nervous yet? The underlying investment is Canadian commercial mortgages and the reference portfolio has a yield of about 12%.

Let’s very quickly run through some numbers … say the total size of the vehicle is $100-million, of which 90-million is prefs and 10-million capital units. Gross income is $12-million, the pref distribution will be about 6.1-million, fees will be about $2-million. Gross profit to the capital unit holders will be about $4-million, which is a return of about maybe 40% of their investment per annum.

Now … on the positive side of this investment, we can say that the sponsor is stepping up and taking the first loss. This is a good thing. Mind you, though, there’s not really a whole lot of buffer before the pref holders start taking the second loss! After three-odd years, the sponsor has made back his capital and the rest is gravy.

There is no way I would invest in an unrated issue … not because I worship the ratings agencies, but because that’s the price of admission. If an issuer doesn’t want to pay an agency, open its books, submit to the agency’s questions and endure the agency’s press releases, that’s fine … but they won’t be getting any of my money!

I have nothing against high-yielding commercial mortgages as an asset class. If you know what you’re doing, you can make good money – I have no quibbles at all with the stated rationale of the corporation:

The Corporation was created to obtain exposure to the investment performance of an actively managed portfolio of secured loans and investments in the Canadian commercial real estate sector on a tax efficient basis. The Manager believes that there are excellent opportunities for the Corporation to gain exposure to well-structured commercial mortgage and real estate loans with attractive debt yields. Most large Canadian financial institutions focus on the larger loan and longer term mortgage transactions as the loan underwriting and due diligence time required for any size commercial real estate loan is virtually the same. The Manager believes that the lender market that competes for small value and shorter term loans and mortgages is presently under-serviced and highly fragmented.

… but I’m not prepared to let the general partner of such an arrangement skim off so much of the profit. Offer 10%, get a rating, and we can do lunch.

Update, 2008-1-10: It is worth noting that the Commercial Mortgage Backed Security (CMBS) market in Canada has been vapourized:

The $4-billion market for commercial mortgage-backed securities has been “vaporized” almost overnight and resulted in three major American financial institutions shutting down or scaling back their CMBS businesses in Canada.

Layoff notices went out last week for 25% of employees at Merrill Lynch’s Canadian CMBS operations while competitors Column Canada, a division of Credit Suisse First Boston, and Capmark Canada have shut operations.

The CMBS market accounted for about 25% of all new commercial real estate debt in Canada in 2006 and with it in tatters because of global credit concerns, Canadian banks, life insurance companies and pension funds are expected to pick up the slack and profit from the new business.

“The banks and life insurance companies are going to be able to increase their fees because they won’t have to compete with CMBS to attract loans anymore,” said an insurance industry executive, adding the spreads – the difference between Government of Canada bonds and loan rates – have risen by more than 100 basis points in the past couple of months.

To the extent that this new issue is a CMBS – and it basically is, right? – I wish the sponsors well in their endeavors … but guys, you’ve got to share! More money for the preferred shareholders, or more principal protection, one or the other!

Update, 2008-2-1: A final prospectus has been filed.

Update, 2008-3-20: The company has announced:

that C.A. Bancorp Canadian Realty Finance Corporation (the “Corporation”) (TSX:RF.PR.A) has issued an additional 100,000 Preferred Shares, Series 1 (the “Preferred Shares”) for gross proceeds of $2,500,000 pursuant to the exercise by the agents of their over-allotment option.

Including the over-allotment, the total gross proceeds of the Corporation’s recent initial public offering are $38,500,000.

The Preferred Shares trade on the Toronto Stock Exchange under the symbol RF.PR.A.

RF.PR.A closed on the TSX today at 24.00-25, 1×2.

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