LBS.PR.A : Dividends on Capital Units Suspended

Brompton Group has announced:

In accordance with its prospectus and the Class A Share Provisions, the regular, non-cumulative, monthly distribution for the month of December will not be paid on the class A shares of Life & Banc Split Corp. Under the prospectus, no cash distribution may be paid on the class A shares, if after payment of the distribution by the Fund, the net asset value per unit (consisting of one class A share and one preferred share) would be less than $15.00. The net asset value per unit as at December 11, 2008 was $12.86. The Fund will re-evaluate the payment of class A share distributions in each subsequent month with the expectation that normal monthly distributions will resume and a press release will be issued if the net asset value per unit is in excess of $15.00 prior to declaration.

LBS.PR.A has been placed on Review-Negative by DBRS … and Assiduous Reader lystgl asked the question:

LBS.PR.A is on the list of “about to be or may be” downgraded. I was just wanting, in terms I can understand, to know why.

My response is:

LBS.PR.A is backed by a portfolio of the Big 6 Banks and Big 4 Insurers. This is better than being backed by a single financial issuer, but is worse than the backing of a fully diversified portfolio.

Equity market declines have eroded the asset coverage of the portfolio to a mere 1.279:1 as of December 18. In DBRS terminology, thats “Downside Protection” of about 22% … in other words, if the portfolio declines by another 22%, then the Capital Units will have no intrinsic value (they will have option value) and the Preferred Shares will be fully exposed to further declines in portfolio value. Worse … when the NAV per Unit is $10, they have full downside exposure but no upside, as increases in the portfolio above that point will belong to the Capital Units.

The DBRS guideline (which is influenced by other factors, such as the nature of the underlying portfolio and income coverage) for a Pfd-2/Pfd-2(low) rating is downside protection of 40-50%. Since LBS.PR.A is currently below that figure, they’re reviewing it … and if there are no extenuating factors, they’ll cut the rating.

When we look at their most recent financial statements, we find that all the declared income looks sustainable – it’s nearly all dividends, with minor contributions from securities lending and interest income. There’s no one-off stuff in there, and no games-playing with “option income” or other crap. So we can estimate sustainable income going forward as $4.838-million per six-month period … dependent, of course, on none of their underlying holdings cutting the dividend.

Expenses were $1.189-million, which looks sustainable. Distributions on preferred shares were $2.980-million.

Thus, income coverage is 4.838/(1.189 + 2.980) = 1.16:1. This is a good number. They can cover their expenses and preferred share distribution with sustainable income (assuming no cuts in dividend receipts), which is a Good Thing and not the case for all split-shares (see Split Shares and the Credit Crunch).

There is a major drag on NAV of the Capital Unit distribution, which amounted to $6.818-million in the financial statements. Given that there were 11.363-million units outstanding, this amounts to a drag on NAV of $0.60 per unit per half, or $1.20 per year – which ties in admirably with the “8.0% targeted yield based on $15.00 issue price, paid monthly”. However, this drag has been eliminated due to:

No distributions will be paid on Class A shares if (i) distributions payable on the Preferred shares are in arrears or (ii) after the payment of the distributions by the Fund, the Published NAV per unit is less than $15.


So income and asset coverage both look reasonable especially when compared to the market price rather than to the obligation of $10. But to me, it doesn’t look good enough to warrant a Pfd-2/Pfd-2(low) rating and I expect a cut to maybe Pfd-3 / Pfd-3(high).

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