PrefBlog

I was asked recently to comment on Brompton Lifeco Split Corp., a split share issue that commenced trading yesterday, April 18.

From the first page of the prospectus we learn that:

The Preferred Shares and the Class A Shares are offered separately but will be issued only on the basis that an equal number of each class of shares will be issued and outstanding.

Then, from page 2 we see that the preferreds are being offered at $10.00, with the company paying the agents $0.30 for each one sold, while the capital units are being offered at $15.00 with a commission of $0.90.

Hence, for each matched-pair sold, the company will receive $23.80 net after commission. We also note that:

Before deducting the expenses of issue estimated at $675,000 in the case of the minimum offering and $725,000 in the case of the maximum offering (but not to exceed 1.5% of the gross proceeds of the Offering) which, together with the Agents’ fees, will be paid out of the proceeds of the offering.

. So, for the sake of analysis, let’s assume that the expenses will be $700,000, charged over 3-million units.

Hindsight helps when guessing issue size on this sort of issue, obviously. When you don’t have a precise number, make a conservative guess. In this case, the approximations in the above paragraph lead to an estimate of issue expenses of $0.23 / unit. Round it to $0.25, to be conservative.

Hence, we are estimated that the company will receive a net total of $23.80 – 0.25 = $23.55 after fees and expenses, as assets which will cover the preferred share obligation of $10.00. That’s an Asset Coverage Ratio of 2.3:1 (being conservative!). To compare this with some other issues, look at the posts regarding LBS.PR.A and SXT.PR.A.

When looking at the Asset Coverage Ratio you also have to look at the nature of the assets! In this particular case, the company informs us that the investment portfolio will be four major, equally weighted, life insurance companies. As preferred share investors, we would prefer a more diversified portfolio … but then, perhaps, nobody would want to buy the capital units and therefore not want to borrow our money at all – we can’t have everything! Still, the assets are fairly solid. These aren’t junior uranium explorers who are risking everything on one throw of the dice!

Now we turn to the Income Coverage Ratio. Page one of the prospectus advises that the portfolio generates 2.3% annual dividends. We want to be conservative, so we’ll assume they make no money at all on their options strategy (but we’ll be optimistic and assume that it won’t actually cost them anything!).

When we look for expenses, we find on page 42 of the prospectus that management fees will be 0.60% of portfolio value. Page 43 advises that they are paying a trailer fee of 0.40% on the value of the capital units; since the capital units will have an initial value of $23.55 – $10.00 = $13.55, we can estimate the initially payable trailer as 0.40% * (13.55 / 23.55) = 0.23% of portfolio value … let’s round it to 0.25%, just so we can continue to brag about how conservative we are!

And, finally, the fund will have expenses … for things like audit, filing, reporting and other good things. Page 43 of the prospectus estimates this as $235,000 p.a., based on an issue size of $100-million. We estimated, earlier, an issue size of $75-million. The expenses will be a bit smaller with a $75-million portfolio, but not a lot smaller and certainly not proportionately smaller. To maintain our conservative attitude, we’ll assume that $235,000 will be the actual expenses … which comes to 0.31% on the portfolio.

So: The portfolio as a whole will have income of 2.3%. From this we subtract 0.60% Management Fees, 0.25% Trailer Fees and 0.31% expenses, which comes to a net income of 1.14% on the portfolio.

On a per-unit basis, the portfolio has an initial value of $23.55, so net income per unit will be roughly $0.27. And each unit has one preferred share, paying 5.25% of par, so the income required to cover the dividend is $0.525.

Need $0.525 per year, estimate will get $0.27 per year, income coverage is just over 50%, which is a little scary. It means that to meet their obligations, in the absence of capital gains and options winnings, they’ll have to dip into capital. Which is not the end of the world in and of itself, but it’s not as nice as an income coverage of 200%, for instance!

More Later ….

Well, that didn’t take long!

When CU announced their new issue (which is trading as CIU.PR.A, by the way – I have no idea why it’s not in the “CU” ticker family) I predicted that the CU.PR.T & CU.PR.V would be redeemed (missed the D! But it wasn’t in the HIMIPref™ universe anyway) and, lo and behold, as soon as the new issue settles, CU is announcing:

that, as a result of the successful closing of the CU Inc. issue of $115,000,000 4.60% Cumulative Redeemable Preferred Shares Series 1, it will redeem on May 18, 2007 all of its outstanding Cumulative Redeemable Second Preferred Shares Series Q, R and S at a price of $25.00 per share plus accrued and unpaid dividends per share.

That’s a total of 5,050,105 shares, so it’s a net paydown of debt for them … and a massive decrease in coupon! The average dividend rate on the redeemed shares is just a hair under 5.75% … so payback time on issuance costs won’t come to much.

Boy, BCE and its credit problems is just taking over this blog, aren’t they?

With the confusion and losses, though, comes volatility. And volatility is your friend. I have previously noted the BCE.PR.Y / BCE.PR.Z pair … let’s make a list of all of them!

A number of BCE issues are not listed here because only one member of the pair is trading.

These pairs are interesting because, in theory, the prices of the elements of the pair should move in lockstep, given that they are exchangeable into each other on the Exchange Date. There will be some degree of uncertainty due to the fact that changes in prime – and changes in percentage of prime paid – will change … but it’s fun to watch.

There would be a fair amount of risk involved in putting on a long/short position to arbitrage the differences for the three longer-dated pairs, due to these uncertainties. If a debt-holder-unfriendly deal goes through, we can assume (or, at least, I will) that retail will panic and all the issues will trade not just below par, but below a reasonable valuation that takes account of the actual risk. This will imply that the Floating-Rate issues will quickly ratchet up to pay 100% of prime … a very different kettle of fish from the other major alternative, that nothing happens. So playing the arbitrage game on the three longer issues could just possibly be a little risky … at least until the uncertainty clears up a little.

But the BCE.PR.Y / BCE.PR.Z pair … that’s more interesting.

So, based on this very brief analysis, it looks as if the BCE.PR.Z are very cheap compared to BCE.PR.Y. Of course, putting a position on could be a major exercise in frustration, given the volume-average of the BCE.PR.Y … but never-the-less, if I was the owner of some Y right now AND if I still liked the BCE name, I know what I’d be doing!