Fixed income purchase

As alluded to in my last quarterly report, I have been looking for some fixed income securities that have relatively short durations, marginability, and with a credit risk profile of next to nothing, yet maximizing yield.

Late last month I purchased a secured corporate bond. The debt is the only issue outstanding of the issuer and it was purchased at a mild discount to par. The underlying issuer obtained a credit rating for the debt and it is in the B’s. The issuer itself has a cash balance that is about 40% higher than the amount of debt outstanding. It is also profitable, generating cash flows, and has been doing so for quite some time. There is no good reason to believe that these cash flows will materially change between now and maturity. The debt is covenant restricted, only enabling the issuer to repurchase equity linked to the amount of income it produces. Not surprisingly, the company in question has been repurchasing their debt on the open market at a discount to par.

Yield to maturity that I received on my purchase: 10.0%.

I am not sure who was asleep at the switch as I did get the bonds at the bid, in a size that was sufficient to make me happy. Quite frankly I was surprised to see the trade executing.

The funny thing here is that the capital that I am required to lock up for the next few years (the maintenance margin is approximately 50%) will actually decrease my long-term performance figures, but in terms of the risk/reward ratio, this investment is a slam dunk. I am not aiming for the best returns, I am aiming for the best risk/return ratio.

Teekay Corporation – Debt

Over the past couple months I have accumulated a substantial position in Teekay Corporation’s (NYSE: TK) unsecured debt, maturing January 15, 2020. The coupon is 8.5% and is paid semi-annually. I am expecting this debt to be paid out at or above par value well before the maturity date. The yield to maturity at my cost I will be receiving for this investment will be north of 20% (and obviously this number goes up if there is an earlier redemption).


I was really looking into the common shares and was asleep at the switch for these, especially around the US$7-8 level a month ago. Everything told me to pull the trigger on the commons as well, and this mistake of non-performance cost me a few percentage points of portfolio performance considering that the common shares are 50% above where I was considering to purchase them. This would have not been a trivial purchase – my weight at cost would have been between 5-10%.

However, offsetting this inaction was that I also bought common shares (technically, they are limited partnership units) of Teekay Offshore (NYSE: TOO) in mid-February. There is a very good case that these units will be selling at US$15-20 by the end of 2017, in addition to giving out generous distributions that will most likely increase in 2018 and beyond.

The short story with Teekay Corporation debt is that they control three daughter entities (Teekay Offshore, Tankers, and LNG). They own minority stakes in all three (roughly 30% for eachUpdate on April 26, 2016: I will be more specific. They have a 26% economic interest and 54% voting right in Teekay Tankers, a 35% limited partner interest in Teekay Offshore, and 31% limited partnership interest in Teekay LNG), but own controlling interests via general partner rights and in the case of Tankers, a dual-class share structure. There are also incentive distribution rights for Offshore and LNG (both of which are nowhere close to being achieved by virtue of distributions being completely slashed and burned at the end of 2015). If there was a liquidation, Teekay would be able to cover the debt with a (painful) sale of their daughter entities.

Teekay Corporation itself is controlled – with a 39% equity stake by Resolute Investments, Ltd. (Latest SC 13D filing here shows they accumulated more shares in December 2015, timed a little early.) They have a gigantic incentive to see this debt get paid off as now do I!

The mis-pricing of the common shares and debt of the issuers in question revolve around a classic financing trap (similar to Kinder Morgan’s crisis a few months ago). The material difference that the market appears to have forgotten about is that Teekay Offshore (and thus Teekay Corporation’s) business is less reliant on the price of crude oil than most other oil and gas entities. The material financial item is that Teekay Offshore faces a significant cash bridge in 2016 and 2017, but it is very probable they will be able to plug the gap and after this they will be “home-free” with a gigantic amount of free cash flow in 2018 and beyond – some of this will go to reduce leverage, but the rest of it is going to be sent into unitholder distributions assuming the capital markets will allow for an easy refinancing of Teekay Offshore’s 2019 unsecured debt.

At US$3/share, Teekay Offshore was an easy speculative purchase. Even at present prices of US$7/share, they are still a very good value even though they do have large amounts of debt (still trading at 16% yield to maturity, but this will not last long).

The absolute debt of Teekay Corporation is not too burdensome in relation to their assets, and one can make an easy guess that given a bit of cash flow through their daughter entities, they will be in a much better position in a couple years to refinance than they are at present. They did manage to get another US$200 million of this 2020 debt off at a mild discount in mid-November 2015, which was crucial to bridging some cash requirements in 2016 and 2017. The US$593 million face value of unsecured debt maturing January 2020 is the majority of the corporation’s debt (noting the last US$200 million sold is not fungible with the present $393 million until a bureaucratic process to exchange them with original notes) – I’d expect sometime in 2017 to 2018 this debt will be trading above par value.

The debt can be redeemed anytime at the price of the sum of the present values of the remaining scheduled payments of principal and interest, discounted to the redemption date on a semi-annual basis, at the treasury yield plus 50 basis points, plus accrued and unpaid interest to the redemption date.

This is a very complex entity to analyze as there is a parent and three daughter units to go through (and realizing that Teekay Corporation’s consolidated statements are useless to read without dissecting the daughter entities – this took a lot of time to perform properly). I believe I’ve cherry-picked the best of it and have found a happy place to park some US currency. I still think it is trading at a very good value if you care to tag along.

Pinetree Capital – Redeeming debentures

Pinetree Capital (TSX: PNP) today has announced it is redeeming $10 million of its debentures, at par value plus accrued interest, effective April 30, 2015.

As readers are aware by my previous rantings about Pinetree, their debt has been a remarkably good deal, especially around the 70 cent range, but they are still a reasonable risk/reward at 80 cents. The extra security that was arm-wrestled from management once they blew the covenants is icing on the cake.

Debenture holders will be cashed out pro-rata, which works out to an 18% redemption of debt. I’ll be hard-pressed to find a better alternative for the cash, but I’ll be happy to have it sitting in the bank account until such a time.

The market value of the debentures was bid/ask 80/83 cents and considering the cash-out is at par, this will likely result in an increase in the quoted price for the remaining debentures.

Notable to this announcement is that this is going to be funded by cash on hand, which implies that the company has been doing some liquidation of its non-disclosed holdings (these would be less than 10% ownership stakes in various firms). There has only been a minor trace of activity on SEDI on their 10%+ ownership stakes (the two largest that are publicly known is POET Technologies (TSXV: PTK) and Sphere 3D (Nasdaq: ANY)).

Also notable is that this is the first $10 million of the $20 million that is required to be redeemed by July 31, 2015. Up to half of the remaining amount can be done through open market transactions and also the company has the option of redeeming 1/3rd of its debentures in the form of equity, which has not been the case to date.

Finally, Pinetree has not released its 2014 year-end audited financial statements, but one can assume that they will be able to with this redemption notice. The annual statements are due on March 31, 2015 otherwise very bad things happen to reporting issuers that do not report.

Pinetree must have a debt-to-assets ratio of 50% up until October 31, 2015 and then after that it must be below 33% otherwise it will be in default of its debt covenants (once again). We should get a better view of what may occur once they file their 1st quarter report. Achieving 33% is going to be made much easier once they complete $20 million in redemptions and the question is whether debenture holders are going to receive equity or not (which would likely give debtholders control of the firm).

I’m expecting there will be a reasonably decent chance that investors in the senior secured convertible debentures will be made whole and also be able to collect a 10% coupon between now and the May 31, 2016 maturity date.

Pinetree Capital Debentures – Buying a dollar for 80 cents

The ongoing saga of Pinetree Capital (TSX: PNP) continues.

After coming to an agreement (after what functionally amounted to a financial game of chicken when management “blinked”) with over 2/3rds of the debenture holders in a very private setting, management has been ousted, and a new agreement has been put in place that grants debt holders security over the assets of the entire company.

There is also a provision to repurchase debentures as follows:

On or prior to July 31, 2015, the Company shall reduce the aggregate principal amount of the outstanding Debentures by at least $20,000,000 by redeeming outstanding Debentures and, at the Company’s discretion, repurchasing outstanding Debentures up to a maximum principal amount of $5,000,000 pursuant to a normal course issuer bid.

There will likely be some market action in the upcoming months as the company attempts to repurchase its debt. Of course by doing so the price will get closer to par value. There is also a redemption to equity feature which has been opened by the debtholders, as the following language was inserted into the indenture agreement:

The Initial Debentures will be redeemable prior to the Maturity Date in accordance with the terms of Article 4, at the option of the Company, in whole or in part from time to time, on notice as provided for in Section 4.3 for the Redemption Price. The Redemption Notice for the Initial Debentures shall be substantially in the form of Schedule B. In connection with the redemption of the Initial Debentures, the Company may, at its option, and subject to the provisions of Section 4.6 and subject to regulatory approval, elect to satisfy its obligation to pay up to one-third of the aggregate principal amount of the Initial Debentures to be redeemed by issuing and delivering to the holders of such Initial Debentures, such number of Freely Tradeable Common Shares as is obtained by dividing such amount by 95% of the Current Market Price in effect on the Redemption Date. If the Company

The company will have the choice of either paying out the debtholders in cash, or by issuing equity, or a combination of both up to a one-third allocation of equity, depending on what the market price is.

Management will be compelled to dispose of securities from the newly constructed investment committee, which consists of two directors that were nominated by the debenture consortium:

The Company shall adhere to the decisions of the Investment Oversight Committee, except in cases where the Company’s board of directors has overruled a decision of the Investment Oversight Committee. For greater certainty, the Investment Oversight Committee has the power to override a decision of the Company’s management to purchase or dispose of any securities and to make a binding decision to dispose of any security now held or that may be held by the Company in the future, provided that such decisions are subject to the approval of the board of directors of the Company.

In addition to having a net asset value above the market value, in addition to an anticipation of an equity conversion, the equity of Pinetree has risen. It will likely rise to a point that reflects a modest discount to NAV, and the company is required to disclose its audited financial statements by the end of March.

Pinetree’s two largest holdings, Sphere3D (Nasdaq: ANY), and POET Technologies (TSXV: PTK), have done quite well and will likely provide cash for paying off debtholders.

Finally, lest the company gets its balance sheet out of position, it is required to have a debt-to-assets ratio of 50% up until October 31, 2015 and then afterwards it will go down to 33% as per the original covenant. This will assure the debtholders will be in the driving seat until they are paid off in full. If the company defaults on these provisions, the debtholders will set terms of forbearance and will likely be in a position to be paid off no matter what, as at this point there will only be $35 million outstanding and being first in line to collect.

The conclusion is obvious: barring a collapse in Pinetree’s (admitting they are less than AAA quality) holdings, the original thesis as presented holds true. Debtholders will very likely get the chance to get out at par and collect a very happy 10% coupon in the meantime. The fact that debtholders now have a general pledge of asset security over the entire company is icing on the cake – it does not give Pinetree any maneuvering room until they are paid off first (i.e. by pillaging debtholders by putting somebody ahead of line with them – see Armtech Infrastructure for the end of that sad saga).

I will discount the fraud scenario as it is perfectly obvious by the February 19, 2015 SEDAR disclosures that debentureholders got a very good look at the corporation as they made their negotiations. I would expect the audited financial statements to be published in mid-month. The only accounting decision of any substance would likely involve a valuation allowance offsetting their currently existing tax asset of $13 million (this would have an impact on their NAV, but this can get unlocked in some other transaction of substance).

The maturity date for the debentures are May 31, 2016, but effectively debtholders will know the game is over by October 31, 2015 and the market will treat the debt at that time as more or less being a done deal (i.e. at least 95 cents on the dollar, if not more for the 10% interest accrual).

With the conservative assumption that debtholders will get 95 cents on the dollar, it looks like from existing market prices (roughly 80 cents), an investor will achieve a 20% capital gain and another 10% interest coupon between now and whenever they get cashed out. I’ll call that a 30% reward for little risk at this stage of the game.

It is really a sad story for me as I cannot think of any other place where capital could be allocated for such a good risk/reward situation. I am riding the coattails of some financial institutions that have their vested interests in total alignment with mine – i.e. taking the reins of the underlying company to ensure we are paid back. Backing up this claim is the following clause inserted into the indenture:

The Initial Debentures are direct secured obligations of the Company, and rank senior to all other indebtedness for borrowed money of the Company. In accordance with Section 2.12, the Initial Debentures rank pari passu with each other. Notwithstanding anything else to the contrary in this Indenture, no additional Initial Debentures and no additional series of Debentures shall be issued under this Indenture or under indentures supplemental to this Indenture.

I have little opinion on the equity other than that it should trade a shade below net asset value, plus some amount for the implied value of the future capital loss carryforwards for an inspiring acquirer of Pinetree. Unlike Aberdeen International (TSX: AAB), new management at least has the ability to show they pretend to care about shareholders instead of using the publicly traded vehicle as a personal enrichment device.

This might be my last post on Pinetree Capital as the story appears to have come to a close, but “never say never” in these very strange and weird capital markets we live with.

Disclosure – Long on a non-trivial position of Pinetree Capital debentures.

Pinetree Capital Re-visited: Another debt opportunity

Please read my prior article, Pinetree Capital: Possibly the worst closed end fund ever, for a good backgrounder on what I am writing about here.

How would you like it if you bought an equity interest in 70 cents per share for the market price of 20 cents?

Normally most people would snap up on the opportunity. Every dollar you invested is backed by over 3 dollars of real net financial assets! What could be the catch?

The catch, of course, is that the assets you are purchasing are illiquid, of dubious value beyond a thin market quotation, and is managed by somebody that has an impressive track record of losing money.

Otherwise the market would not be giving such a steep discount to the whole consolidated operation.

What is interesting is that the capital fund continues to be hampered by debentures that have a 33% ceiling on the debt-to-asset ratio. Last year the fund breached this and had to pay handsomely for the privilege of obtaining more time.

Management has a huge incentive to not let the debtholders take over – surely the big players in the debenture space would liquidate the fund piece by piece and would not be hamstrung by pesky management or their insanely huge salaries.

The debentures, by virtue of the debt-to-asset covenant, are functionally secured, first-in-line debt, next in line to the margin loans the fund has been taking to fund its incredibly speculative investment portfolio.

They also mature in 1 year and 7 months time.

Now that the whole world stock market has tanked over the past month, speculative issues get hammered the most. Pinetree has been suffering, and its equity has thus gone down to the huge discount over stated asset value that you see today.

There is probably some value in the equity, but it will take time to realize the value due to liquidity issues.

However, the real value is in the debentures mainly because they have the noose over management at the moment, who have shown every indication they will dilute and use every trick in the book to maintain control of their lucrative salaries.

Who wants to invest in this train wreck? I don’t know, but if you have a very thick stomach wall for scraping the bottom of the investment barrel, consider purchasing some Pinetree Capital Debentures (TSX: PNP.DB) if you feel brave. There is a reasonable chance that you will be made whole.

Disclosure: I own the debentures.

Short term investments

A friend of mine asked me one day… I’ve got $X to invest, over the next two years, and I was wondering what is out there where I can get a better than 3% return with liquidity and relatively little risk.

I asked them if they were interested in investing in 30-year government bonds, which yield a tad over 3%, and certainly fits the liquidity criterion. They were strict on the 2 year limit.

So I pulled up a list of Canadian debentures that were maturing over the next couple years. I couldn’t find anything acceptable. I did do some research on Ag Growth International (TSX: AFN.DB) which would give roughly 5.6% or so, but was strongly conditional upon them obtaining refinancing. With their equity prices as high as they were, this should not pose much challenge at present, but who knows what it will be like in half a year?

Every institutional manager on this planet is trying to squeeze a few more basis points out of their short term portfolios and this competition is quite evident in the public marketplaces.

I also looked at split share preferred shares, but those equally have risks that I won’t bother getting to in this post.

I face the same dilemma myself – there is relatively little that is striking my attention in the marketplace at present. The only purchases I have made are really special situations that would otherwise be very difficult to pick up on a typical screen.

Junk debt is being accumulated

It is very evident that money is once again flowing into junk debt. I am finding every piece of junk debt securities being bidded up over the past week. Amazing what happens when the Federal Reserve talks about not wanting to ease up on quantitative easing – liquidity and party-time again for everybody! Back to the strategy of borrowing at 1%, and buy up those 8% junk debt securities and skim the spread… until the music stops.

Of course, I do not endorse or condemn this strategy – it will work, until it stops working. Such are the markets we are currently in.

Finding financial needles in haystacks – an investment opportunity

During the great fixed income purge over the past month, there have been a few babies thrown out with the bathwater. I am still working on accumulation since these securities are not that highly traded. It is my general belief that hedge funds and other institutional managers are still on auto-liquidation mode with their algorithms with respect to these securities and they are being relatively indiscriminate on price – they are just hitting sizable bids at opportune moments. Whenever this selling pressure subsides, prices should rise again.

Anyhow, the next candidate for investment is a debt security that has an embedded debt-to-assets covenant that is well below 1:1 and is currently the most senior debt structure in the corporation. The corporation has tangible equity to more than cover double its outstanding debt, yet the market is worried that there is a solvency risk to the point where the debt product is deeply discounted despite the fact that such investors clearly will get a full recovery if it goes into creditor protection (and it will not unless if management is clearly insane, since their own vested economic interests will take over and pay the debtors).

This is a type of situation where an investor can make a capital gain of roughly 50% over a year time frame, plus interest payments. The risk is that the corporation’s assets are misstated, or cannot be liquidated at book value. The risk/reward, however, seems to be disproportionately positive and there is a very clear reason why the market is actively dumping the product at present. The company’s economic condition is partially the reason but I believe a further factor is the indiscriminate selling by existing holders.

I can’t give more specific figures without giving away the name of the company. I also generally have a belief that the selling pressure will be met with more demand sometime after August 9-12, so investors will have about three weeks left to capitalize on what will likely be the rock bottom for this security.

First Capital Realty – Cheap capital

First Capital Realty (TSX: FCR) owns and operates shopping centres. They do so quite profitably, and while not technically an REIT, it does have REIT-type characteristics, including a policy of distributing most of its cash flows through dividends.

When doing some research on this company, I did notice they were able to raise the following debt offering a couple months ago:

First Capital Realty Inc. (TSX:FCR) (the “Company”), Canada’s leading owner, developer and operator of supermarket and drugstore anchored neighbourhood and community shopping centres, located predominantly in growing urban markets, announced today that as a result of investor demand for its public offering of Series Q senior unsecured debentures which was announced earlier today, the size of the offering has been increased by C$75 million to C$175 million. These debentures will bear interest at a rate of 3.90% per annum and will mature on October 30, 2023. The $175 million of debentures were sold at a price of $100.952 per $100 principal amount plus accrued interest, with an effective yield of 3.788% if held to maturity. An aggregate of $300 million of such debentures will be outstanding after giving effect to the offering. The offering is being underwritten by a syndicate co-led by TD Securities, CIBC World Markets Inc. and RBC Capital Markets. Subject to customary closing conditions, the offering will close on May 15, 2013. It is a condition of closing to the offering that the debentures be rated at least BBB (high) with a stable trend by DBRS and at least Baa2 (stable) by Moody’s Investors Service.

This is giving the company 10-year money at 3.8%, which is an amazingly low rate for unsecured debt. If they could raise even more money at this rate, they should – indeed the original offering was for quite less volume. This was at the peak of the market’s thirst for yield.

Something also very different about this company is they have a series of convertible debentures, and a prominent policy of the company states:

It is the current intention of First Capital Realty to satisfy its obligations to pay principal and interest on all of its Convertible Debentures by the issuance of Common Shares.

This is the only corporation I can think of that has this policy.

This leads to some very interesting financial results in terms of shareholder dilution, but it has not impacted the net return to shareholders in the meantime. Glossing through some historical reports, shares outstanding on March 31, 2003 was (split adjusted to present levels) 64.5 million shares, while shares outstanding on March 31, 2013 was 207.3 million. Still, a shareholder on March 31, 2003 would have paid about $7.60 and received at March 31, 2013: a $19 share plus $7.56 in cash dividends. Working the math, that is about 13%/year compounded annually, not a bad haul at all.

The only time I can see this strategy failing is if there is some transient condition where the equity falls below a certain threshold level. Even during the depths of the 2008-2009 economic crisis, the company was fairly resolute in keeping this policy despite the 40% haircut shareholders took from the previous peak.

I won’t be buying into this company (or its debt), but I have to commend their finance crew for a very unconventional policy that does seem to deliver results for shareholders.

Some opportunities hitting the radar

There are a few opportunities that are emerging on the fixed income side. These deal with somewhat distressed entities (but not by any means mortally wounded) and on the fixed income side. Unfortunately these securities are not very liquid (typical volumes are around $10k/day) so I can’t get into any further detail. But suffice to say, there have been some items hitting my radar lately and I’ve been stretched to do some further proper research.