I am back from my break, only to come into a nice heat wave which does a good job of impairing my thinking. Nonetheless, I’m going to catch up on a couple weeks’ worth of reading, and get back into the swing of things after the long weekend. There was a 2 week stretch where I didn’t touch a computer and I can visibly feel my typing is slower, and my ability to parse information has slowed as well!
Posting will likely be very light until the beginning of August. Bon Voyage!
Just yesterday I wrote about True Energy Trust debentures, and today they announced:
CALGARY, July 8 /CNW/ – True Energy Trust (“True” or the “Trust”) announces that it has entered into an agreement for the divestiture of the majority of its oil and natural gas assets in Saskatchewan for gross proceeds of $93 million, subject to closing adjustments, effective May 01, 2009. Closing is anticipated to occur on or before July 30, 2009 and is subject to customary conditions, including required regulatory and True’s bank syndicate approvals.
… so they are realizing about $93 million out of an asset sale. As a result, we have the following situation:
True’s total net debt, excluding an unrealized commodity contract asset of $12.7 million, future income taxes and asset retirement obligations, upon completion of these dispositions is anticipated to be approximately $110 million, being approximately $28 million in net debt outstanding on the credit facility including working capital adjustments and $82 million in convertible debentures (liability component).
The bank has $28 million in line (first in line), and then the debt holders (including myself) have dibs on the rest of it. Whatever is left goes to the equity holders. The important part that this point is that the remaining operations have enough cash flow production capability to pay off the debt, and in the event they don’t, they will have the ability to be sold to pay off debt.
The point here is that while the shareholders are going to take it on the chin (they will be owning a company with a reduced amount of operations), the debtholders will make out like gangbusters – they will receive semi-annual interest payments, plus they will receive the proceeds of debt maturity when the debt matures in June of 2011. The market has already marked up the debt from 70 cents to 78 cents today, and this will continue to rise to 100 cents as it closes to the maturity date. The equity is down 5%.
The last event to take place before this will happen is the announcement of a renewal of the credit facility past the maturity date of the convertible debt, and/or another debt offering that has a maturity past June 2011. Either way, I will get my money. The question is whether it is now, or in June 2011. If it is June 2011, I get compensated for this with interest payments. At the price I paid, that would be over 11%.
There is no way I could get this risk-reward profile with equity – the risk would be a lot higher.
The market for the fed funds futures for the end of 2010 is now around 1.45%; this is significantly lower than a month ago, when it peaked around 2.1%. I am relatively happy I closed my short-term interest rate bet when rates were higher.
My line of thought would suggest that 1% is a realistic short term rate, but this would only come in the form of quarter-point increases starting around the summer of 2010. 2% is pie-in-the-sky now, unless if there is some sort of collapse in confidence in the US bond market (which could happen, it is very difficult to tell these days if they are going to fall off a cliff financially).
I have been swinging back and forth on this issue like a pendulum simply because the economic variables coming in are incredibly fuzzy, but all lead to the conclusion that if the economy does recover, it will be a mediocre recovery at best.
This would suggest that inflation will not be a concern for the next year, plus rates should still be kept low. It is a very 1990′s Japan-like scenario. The only question is what will happen with commodity pricing and currencies – I still think oil consumption will rise over time, and this would suggest that oil prices would buck the overall trend economically. This would suggest a favorable lean toward Canadian-denominated issues, but again, the data is very fuzzy at this moment. The Canadian dollar might touch 80 cents again, although 83 cents seems a little more likely.
I have been on the record in thinking that short term crude prices have been somewhat high, and is likely due for some sort of correction around the US$50-60 range (from highs of $72.50 a month ago). When it has played out (which will be very difficult to determine at the time), it would likely be a good time to get back into crude-denominated debt issues. I’ve noticed some of my exchange-traded debt favorites have also been trading somewhat lower, and I still believe that the superior returns are to be obtained through debt, not equity investments, at least with smaller issues. I’m still not confident that over-leveraged companies will be able to deliver returns to shareholders in this environment.
One of my favorites, Harvest Energy Debt (not equity!), is trading around 68 cents, which would give it a yield to maturity of 20.7%. I highly suspect that an investment in the equity would return less than this – they had a secondary offering where they raised $115 million, but this will be hugely dilutive to equity holders. I suspect issues like these will drop in price as crude drops. If we see a 20% price compression or so in those debt issues, I would take it as a good time to continue loading up.
True Energy Trust has a bond issue that trades at 70 cents on the dollar, which looks tempting – yield to maturity of 28%. It has a short maturity (June 2011), and the risk is that their credit facility will not get renewed. Given the awful first quarter they had (which crude selling at an average of US$43/barrel), it only gets better for them, which means it is likely they will be able to renew their facility and refinance their debt. The equity holders will lose in this transaction.
With all of these debt issues trading at rather high yields (Sprint is still at 14.4% for a 19 year maturity), it is very difficult to justify the risk of equity at this moment. Equity prices are still far too high for my liking. The place to be, for the moment, continues to be the corporate debt market. They will not be immune to price shocks, but investors will be well compensated for this risk. They also have the advantage of having a maturity date.
Stories like these are economically significant:
In a clear indication that Canada is starting to be considered a low-tax place to do business, Tim Hortons Inc. announced yesterday plans to shift its base of operations from Delaware to Canada for tax purposes.
Further, analysts indicate this is also a sign of unease among corporations regarding the U.S. business environment, where taxes are likely heading upward to deal with trillion-dollar deficits and proposed health-care reforms and the White House is looking to crack down on companies that invest abroad.
The move by Tim Hortons makes good on a promise contained in the company’s filing with U.S. securities regulators earlier this year, in which it said it was exploring such a reorganization because it could potentially drive down its effective tax rate closer to Canadian statutory levels.
Finn Poschmann, VP of research at the C. D. Howe Institute, said the retail chain’s reorganization is a sign that policy-makers’ efforts to lower corporate taxes are starting to work, and could be the start of a trend.
Let’s take a simple comparison of tax rates between Canada and the USA, for large corporations (BC provincial rate in brackets):
19% (+11%) effective January 1, 2009
18% (+10.5%) effective January 1, 2010
16.5% (+10%) effective January 1, 2011
15% (+10%) effective January 1, 2012
In the USA, the federal tax rate is 35%. State taxes in California is 8.84% and New York 7.5%, although it varies by state, and the state corporate tax is deductible from the federal corporate tax. Note for the most part the average cost of doing business in the USA as a corporation is about 40% of income, needless to say is huge.
The point is that Canada, amazingly enough, is starting to have a huge advantage over the USA in terms of corporate taxation. This will only encourage corporate capital to move into the country, which means that it will get this country out of the recession first.
15 years ago, the story was completely different. You’d move to the USA to get a break on taxation in both the personal and corporate level. Now the tables have completely turned. With the US fiscal situation turning into more of a basket case, corporations are rightfully antsy about future increases in the tax rates – which is why they’re going to come over to Canada. It will start with businesses that already have significant presences here (like Tim Hortons), but others should follow.
Air Canada currently is offering what I consider to be very well priced flights domestically in Canada via their “Explore Canada” flight pass.
If you are in Western Canada, you can purchase 4 one-way trips (or 2 round trips) for $900 (plus 5% GST) that will allow you to fly anywhere between Western Canada to the rest of Canada, provided that you travel on a Tuesday or Saturday. If you wish to travel on any weekday, then it would be $1020 plus GST.
Anyhow, I’ve booked a trip to Newfoundland and will be leaving the following weekend. Normally a round trip flight domestically to Newfoundland and back would set you back around $900 alone, especially during the peak summer season. The ultimate destination is Gros Morne National Park, but there will be plenty of time for supplemental exploration, including getting up to Labrador (an area of Canada which is truly desolate, and probably contaminated with mosquitoes).
One logistical issue is that the closest airport to Gros Morne is Deer Lake, which is a short distance from Gros Morne, but sourcing a car to rent in Deer Lake was impossible. So I will be flying to Gander instead, which is most famously known for doubling its population during 9/11 when they had to shut down US airspace.
I’ve also got Prince Edward Island on the itinerary.
I’ve never visited the Atlantic provinces, so it will be the first time I’ve been to that part of the country.
Alternative itineraries that I considered was exploring the Northwest Territories (Yellowknife) and the Yukon (Whitehorse), as the Western Canada-only pass was $600 plus GST. Typically a round trip between Vancouver and Yellowknife is about $600.
When I looked at the pricing, I was saying to myself that Air Canada won’t ever do this again, as it enables you to travel domestically for about half the price that you could normally do it at. The flight passes essentially represent a sale of excess seat capacity at Air Canada.
Two stories have the same shred of financial wisdom attached to it: Don’t put all your eggs in a single basket.
Via Nelson‘s twitter feed, some victim statements of Bernie Madoff’s multi-billion pyramid scheme. A lot of these statements say things such as “I invested my entire life savings in his fund”, and such.
Concentrating your entire net worth in a single person’s fund is taking risk that is unfathomable. At the very minimum, diversify into two separate entities. If you lose 100% of a fortune, you have nothing left at the end of the day. If you lose 50% of a fortune, at least you will have something left. In Canada, it also helps if the money is invested in a location that is covered by CIPF which will ensure your accounts up to a million dollars in case if the underlying company goes insolvent. I do not believe, however, that this includes fraud.
My knowledge of the legalities of Madoff’s fund is limited, but I believe because it was privately run it wasn’t covered by the US equivalent of CIPF, thus, the investors lost everything.
I guess the moral of the story here is that whenever I get around to launching my own private fund (something I have been planning on doing for the last three years now), please don’t invest more than 20% of your networth in it. I don’t plan on being fraudulent, but rather I’d want to know that I was investing money from people that could afford to lose it. A lot of the victim impact statements clearly showed that they were depending on the money.
The second article is from the Georgia Straight, describing how some couple used current record low mortgage rates (2.75% for a 1 year mortgage) to purchase a property worth over $425,000. They moved from their apartment which they rented for $1,800/mo. They made a 5% down payment. The classic quote was the following:
“But we don’t have a lot of [wiggle] room,” Morettie said. “We can go up to four percent, but then we’re done.”
While I wish this couple the best of luck, they have likely committed financial suicide with a bet that has a huge risk of ruin. Having a buffer of 1.25% is very slim, especially when it comes time to renew their mortgage – short term rates have reached their maximum low limit.
I’m going to guess that they bought a place for $600k (roughly what you can get a small house in Vancouver that isn’t a complete trash heap), put a $30k down payment on it, and are left with a $570k mortgage at 2.75%. Using a standard 25-year amortization, this results in $2625/mo ($31,500 yearly, interest ~$15,400) payments. Financially speaking, they are “up” because they are building about $6,000 equity a year more than what they are currently doing with rent payments. This is because their interest payments are so low.
Pretending that interest rates stay this low for 3 years (it will be at least until mid-2010), their balance on the mortgage will be about $520k. If 1-year interest rates in 3 years goes up to 5% (something that is plausible and was the typical rate offered in mid-2008), their mortgage payments will go up to $3236/mo ($38,800 yearly, interest ~$25,400). The extra interest will financially kill them and they will likely be forced to liquidate the house.
Forced liquidations will result in capital losses, not to mention an extra commission incurred to dispose of the property.
There is absolutely no way anybody should be this leveraged financially in a single asset class. It might work out for them if interest rates continue to be low for a prolonged period of time (the longer the better), and if their cash flow situation improves. But then again, it might not. I’d never take that kind of risk – there are so many events that could cause future trouble, such as losing a source of income (employment), having kids (who will take care of them?), etc.
A simple ground rule would be that if you can’t pay the minimum 25% down payment required to purchase the place, I wouldn’t even bother looking. A 25% down payment is the minimum necessary to get two major benefits – one is that you have to pay significantly less (or no) mortgage insurance, and two is that you can get a floating rate mortgage.
I also still think house valuations are incredibly high in Vancouver.
Posting volume has been light lately, mainly due to the summer. I haven’t been in a writing mood.
On Thursday, I provided some economic stimulus into the US economy. I still can’t believe how much cheaper they sell cheese in the US than they do in Canada.
Happy Canada Day. It feels weird to have the statutory holiday on a Wednesday.
I usually get hesitant to upgrade to new versions of software when the old ones tend to work so well, but both Firefox 3.5 from 3.0 and WordPress 2.8 from 2.7.1 are significantly faster versions, with no negative attributes that I can find.