CBW.PR.A Downgraded to Pfd-3(low) by DBRS

DBRS has announced that it:

has today downgraded the Preferred Shares issued by Copernican World Banks Split Corp. (the Company) to Pfd-3 (low) from Pfd-2 (low) with a Stable trend. The rating had been placed Under Review with Developing Implications on March 19, 2008.

In November 2007, the Company raised gross proceeds of $96.1 million by issuing 4.805 million Preferred Shares (at $10 each) and an equal amount of Class A Shares (at $10 each). The initial structure provided downside protection of 50% to the Preferred Shares as all issuance costs were paid by AIC Investment Services Inc. (the Manager).

The net proceeds from the offering were used to invest in a portfolio of common shares (the Portfolio) issued by bank-based financial institutions with strong credit quality (World Banks). The Portfolio is actively managed by the Manager to invest in World Banks that have at least a US$1 billion market capitalization and exhibit the potential for attractive dividend yields and strong earnings growth momentum. It is expected that a minimum of 80% of all foreign content will be hedged back to the Canadian dollar at all times to mitigate net asset value (NAV) volatility relating to foreign currency exchange fluctuation.

Holders of the Preferred Shares receive fixed cumulative quarterly dividends yielding 5.25% per annum. The Company aims to provide holders of the Class A Shares with monthly distributions targeted at 8.0% per annum.

There is an asset coverage test in place that does not permit the Company to make monthly distributions to the Class A Shares if the dividends on the Preferred Shares are in arrears or if the NAV of the Portfolio is less than $15 after giving effect to such distributions. Since the Company’s NAV has decreased below $15, distributions to the Class A Shares are currently suspended, which greatly reduces the grind on the Portfolio going forward.
The credit quality of the Portfolio is strong and globally diversified, but the NAV of the Portfolio has experienced downward pressure due to its concentration in the financial industry. Since inception, the NAV has dropped from $20 per share to $13.06 (as of April 11, 2008), a decline of about 35%. As a result, the current downside protection available to the Preferred Shareholders is approximately 23%.

The downgrade of the Preferred Shares is based on the greatly reduced asset coverage available to cover repayment of principal.

The redemption date for both classes of shares issued is December 2, 2013.

CBW.PR.A is not tracked by HIMIPref™. The DBRS mass review of financial split shares has been previously discussed.

Update: Financial statements and other information is available on the fund’s website.

5 Responses to “CBW.PR.A Downgraded to Pfd-3(low) by DBRS”

  1. jiHymas says:

    Assiduous Reader prefhound posted the following on another thread, then realized it should have been posted here. JH

    This is a real beauty! Way worse than old FTU.PR.A discussed a couple of days ago, and using the same futile option writing strategy — though with a much fatter MER (1.95% plus 0.40% on the total unit, plus GST, costs, etc; withholding taxes are not considered an expense, but an adjustment to investment income; I sure hope this isn’t held in an RRSP!).

    Dec 31/07 NAV for the capital units was $5.03 (vs $10 issue price only a year earlier). The 2007 revenue was $0.71 per unit, but expenses were $1.09 (includes 0.525 of pref share dividends). Yup, that’s an expense ratio of 10.9% of the initial value and 21.7% of the 2007 ending capital unit value. Recall the capital units bear all the costs until run down to NAV=zero. No wonder the CBW units trade at a huge discount to NAV.

    If these units continue to have a net burn rate of $0.38 per unit per year, the NAV is likely to be a lot lower at maturity in 2013, so the prefs may be challenged to realize $10 par –even with frozen distributions on the capital units. If the pref were a subprime AAA-rated mortgage tranche (the closest parallel), it might not have an investment grade rating. Can’t DBRS see this?

    Expense Ratios of 20%+. I love it! Only in Canada you say? Gotta love those regulators.

    Meanwhile, please keep these things out of the HimiPref universe.

  2. jiHymas says:

    Well, let’s see how much I agree!

    The fund reports a MER of 2.57% on the unit value.

    The review of performance notes that:

    To meet all of its investment objectives, the Company needs to generate an average annual return of approximately 9.7%.

    Note that the investment objective with respect to the Capital Unitholders was to make 8.0% … so really, as far as they’re concerned, it was a leveraged mutual fund.

    The portfolio’s trailing 12-month weighted average dividend yield is approximately 5.1%, and its trailing 12-month weighted average return on equity is 19.0% – in our view these are all particularly robust credentials.

    Hmm…. trailing 12-month weighted average dividend yield … I wonder what relevance that has? I could, given a little time, work out what the dividend yield is NOW based on announced dividend cuts in the underlying portfolio, but frankly … I can’t be bothered. Let’s just assume that the dividend yield is 4% on the underlying portfolio.

    That leaves about 1.5% income after expenses but before preferred share dividends. The preferred shares pay 5.25% on what is now 10/13 (= about 75%) of the total portfolio, so let’s say that’s a drag of about 3.9% on the total portfolio.

    So … the drag on the NAV is now about 2.6% MER + 3.9% Preferred Dividends = 6.5%. They’ve got a little over 4.5 years to go to maturity, so that’s 4.5*6.5% = about 29%. Downside protection is only 23%. The underlying portfolio must make a total return of 6% cumulative over 4.5 years to avoid default on the prefs … and, holy smokes, the prefs are only paying 5.25% of par value! And if the underlying portfolio should suddenly triple (when all the subprime guys pay their bills) the upside is capped!

    I could do a lot more work … how much upside do I want? … but it’s not “my thing”. For now, I’ll content myself with saying that whatever these things are, they’re not investment grade prefs.

    Expense Ratios of 20%+. I love it! Only in Canada you say? Gotta love those regulators.

    I have to take issue with this. It’s not the regulators’ job to tell people what fees they should pay, or what constitutes a good investment. As long as the investment is fully described in the prospectus, the regulators should butt out.

  3. prefhound says:

    One thing you may have forgotten is the 5.1% dividend yield is most likely pre-tax and subject to 15% withholding.

    It’s not the quality of the investment the regulators should be responsible for but (a) the clarity of the fee (and expense) structure disclosure and (b) the misleading prospectus that equates gross option premiums written to some kind of profit. The way these things are marketed and reported now, even investment professionals and advisers would be hard pressed to quickly find the single relevant number that would allow them to compare with other investments.

    My contention is, that if regulators removed the deliberate obfuscations, demand would be 10X lower and crappy investments would not be IPO’d in the first place.

    Meanwhile, as pref share investors, we have to realize that the analysis of these involves different factors than it does for operating companies –and those differences are usually unfavorable.

  4. jiHymas says:

    even investment professionals and advisers would be hard pressed to quickly find the single relevant number that would allow them to compare with other investments.

    The prospectus does disclose the rate of return required on the underlying portfolio in order for the investment to meet its stated objectives. That’s good enough for me.

    It doesn’t really matter to me that the option revenue is quoted gross. It’s disclosed. The calculation is all laid out. If you don’t like the assumption, there’s no rule that disallows you from substituting your own.

    I disagree that the prospectus has anything to do with demand. Nobody reads these things anyway.

  5. […] follows a downgrade to Pfd-3(low) on April 17. CBW.PR.A is not tracked by […]

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