Category Archives: Debt

Canadian yield scan

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The market for high-yielding products continues to dwindle as anything with a yield has been bidded up to the roof, and the products remaining with a yield have qualities that warrant them trading as such. The following is a comprehensive list of convertible debentures that have a yield to maturity of 8% or above:

Company Ticker Coupon Date Term Price YieldToMaturity
Yellow Media Inc YLO.DB.A 6.25% 1-Oct-17          5.6 12.1 70.00%
Perpetual Energy PMT.DB.D 7.25% 31-Jan-15          2.9 75.75 18.40%
Perpetual Energy PMT.DB.E 7.00% 31-Dec-15          3.8 73.75 16.54%
Armtec Infrastructure ARF.DB 6.50% 30-Jun-17          5.3 70 14.85%
Boyuan Construction BOY.DB.A 10.00% 31-Oct-15          3.7 87 14.72%
Tree Island Wire TIL.DB 10.00% 26-Nov-14          2.7 90 14.57%
Perpetual Energy PMT.DB.C 6.50% 30-Jun-12          0.3 98 12.99%
Royal Host REIT RYL.DB.B 6.00% 31-Oct-15          3.7 81.5 12.46%
Royal Host REIT RYL.DB.D 5.90% 30-Jun-14          2.3 88.1 11.93%
Ivanhoe Energy IE.DB 5.75% 30-Jun-16          4.3 80.5 11.62%
Lanesbourough REIT LRT.DB.G 9.50% 28-Feb-15          3.0 95 11.53%
Royal Host REIT RYL.DB.C 6.25% 30-Sep-13          1.6 92.64 11.52%
Data Group DGI.DB.A 6.00% 30-Jun-17          5.3 82.5 10.36%
Altus Group AIF.DB 5.75% 31-Dec-17          5.8 81.25 10.09%
Gen Donlee Income GDI.DB 7.00% 30-Jun-14          2.3 94 9.96%
Brigus Gold Corp. BRD.DB.U 6.50% 31-Mar-16          4.1 90.01 9.52%
Clearwater Seafoods CLR.DB.B 10.50% 31-Dec-13          1.8 102 9.26%
Discovery Air DA.DB.A 8.38% 30-Jun-16          4.3 98.5 8.79%
Superior Plus SPB.DB.E 5.75% 30-Jun-17          5.3 88 8.61%
GreatBasin Gold GBG.DB 8.00% 30-Nov-14          2.7 98.85 8.47%
Superior Plus SPB.DB.F 6.00% 30-Jun-18          6.3 88.55 8.37%
Anderson Energy AXL.DB.B 7.25% 30-Jun-17          5.3 97 8.07%

Suffice to say, most of these companies have “issues” pertaining to the solvency of the underlying entity. They were also trading much lower during the mini-credit crisis back in October-November; for example, Data Group and Superior Plus, which are both cash-producing entities, were trading 25 cents on the dollar lower.

I don’t need to say anything about Yellow Media, which also makes money. Perpetual Energy has positive cash flow, but being in the oil and gas industry, has tremendous capital investment requirements and has debt ratios that is not terribly favourable to the subordinated debt holders.

30-year treasury bonds

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I am so tempted to short 30-year bonds right now. I might soon.

There are a few ways to represent this position:

1. Short bond futures (CME) – this is the world’s most liquid proxy to treasury bonds (other than dealing with the underlying product directly!). It has the advantages of liquidity and dealing strictly with the capital and not income component of the bond.

2. Purchase/short a liquid ETF that deals with long-term treasuries. There are a few to choose from:

- iShares 20-year+ government bond fund (TLT) – MER is 0.15%; average term of bond is 27.8 years – fund is highly liquid and shortable;
- Proshares Ultra/short (2x) 20-year+ (UBT/TBT) – MER is 0.95%; linked to TLT performance above as basis index. UBT is not very liquid, while TBT is very liquid.

ETFs have the advantage of being tradable in smaller amounts than futures (Future contracts are for $100,000 face value of product, which currently trade around 142% of par for the June contract). Futures typically have a spread advantage ($31.25 per $142,000 notional value), but liquid ETFs such as TLT have typically had penny spreads, resulting in comparable slippage. As previously mentioned the futures have an advantage with stripping the income-related aspects of the bond, and also tax advantages (both in the USA and Canada).

Slight tightening of mortgage credit

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I notice that the local credit union, which used to offer prime minus 0.9% (equating to 2.1%) floating rate is now at prime minus 0.3% (2.7%).

The only conclusion that one can make is that retail credit is somewhat tightening and/or banks are getting concerned about their leverage linked to the real estate market. You wouldn’t see this in government debt rates – 1 year treasuries in Canada yield 0.90%. Five-year government bonds yield 1.35% and the best five-year mortgage rate you can find in Canada is about 3.19%.

Given the difference between the two (prime minus 0.3% versus 3.19% fixed), combined with the (albeit unlikely) potential for an interest rate spike would suggest that paying the half-percent spread for a five-year lock would be well-spent insurance money.

That said, anything around the 3% range is historically very, very, very low and would explain the high prices in the real estate market.

Credit coming to a crunch

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It is quite evident looking at bond trading that credit is coming to a halt, very quickly.

First of all, I notice debentures on various firms are plummeting – most of the underlying companies have lots of refinancings ahead in order to make it through. An example of this is Data Group (TSX: DGI.UN), which has had its debentures trade down to 60 cents on the dollar.

Sterling Shoes (TSX: SSI) announced they will not be making their interest payments on their debentures, effectively putting them in default – their interest payment is due on October 31, 2011 and will subsequently lead to a potential default sometime in November according to their prospectus (if enough debenture holders are able to declare a default).

Superior Plus (TSX: SPB) was lucky to get off a $75M debenture financing (with a 5-year term at 7.5%) in the middle of September before their common shares started to fall off a cliff – and took the debentures (series C, D, E, F) with them. Superior Plus is no stranger to this website, having predicted a dividend cut in the past.

Yellow Media is no stranger to this site either, but since I am still licking my wounds on this one, I will leave it at that with this company. Similar to Superior Plus, however, both companies are still free cash flow positive.

First Uranium (TSX: FIU) has had some serious issues regarding their operations and financing, and also some political risk thrown into the mix. As a result, its secured notes have traded down. Indeed, when looking at the management projections for the July to September quarter, management has projected they will be left with about $9 million cash on their balance sheet before they can make a (what they think) turnaround – instead, they just might be ready to default since they also have a CAD$150M debt payment on their unsecured debentures due June 2012. First Uranium is also no stranger to our site, having had the misfortune of investing in their notes and debentures in the past.

Finally, Connacher Oil and Gas (TSX: CLL) has had their common shares annihilated over the past couple months – their unsecured debentures are due on June 30, 2012 and are now trading at 85 cents on the dollar. This is quite interesting in light of the fact that the rest of the company’s debt is structured out until 2018 and they have set up a credit facility to be able to pay off these debentures. The risk is that the company will simply convert the debentures into equity and you end up with another Arctic Glacier (TSX: AG.UN) which underwent a lot of dysfunction after they did the same thing with a very low stock price. Those debenture holders would have been lucky to realize half the value of their debt, or if you timed it perfectly and had a small amount of debt to work with, about two-thirds.

A lot of credit-sensitive companies are trading lower. It is difficult to tell when it will end, but an investor picking up the scraps of companies that will, through organic business performance, be able to bounce back will be very rich – similar to how anybody investing in the corporate debt market in early 2009 made out very well.

Timing indeed is everything.

Connacher – Short term yield

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Connacher Oil and Gas (TSX: CLL) is a small oil sands producer. Like OPTI (TSX: OPC), it is heavily in debt. Unlike OPTI, there is a valid business case to be made that would suggest that it could actually pay its debt without bankrupting its shareholders. The forecast does depend on the price of oil (and specifically bitumen) continuing to be high. The bulk of the capital expenditures on its two primary oil sands projects (Pod One and Algar) has been completed and so the cash requirements have been primarily maintenance and additional exploration.

The company is capitalized with roughly $500 million in equity and $1 billion in debt. The company was able to perform a term extension on its first lien and second lien notes, pushing the maturity away from 2014/2015 to 2018/2019 and incurring less of an interest rate bite (in exchange for some capital – the loan went up from roughly $800M to $900M).

There is also a $100M senior unsecured debenture (TSX: CLL.DB.A) which is due to mature on June 30, 2012. Given the company’s cash flow situation and available credit (having extended a credit facility for $100M for three years, a facility currently not used) it is quite probable that the debentures will be redeemed at maturity.

At a 98 cent price that would imply a yield to maturity of about 6.8%. The primary risk to the successful maturity of this issue would be if the price of bitumen dropped significantly beyond existing levels. Closer to the maturity date, it is likely the company will float another convertible debt offering to refinance.

My assessment is that there are probably worse places to put short term investment money than the debenture issue.

Disclaimer: I own some of these debentures from the economic crisis (early 2009) when they were trading under 40 cents.

Treasury yields creeping up again

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I know a few days of trading don’t make a market, but the spike up in yield seemed a bit unusual:

If long term interest rates continue to use, it will have a dampening effect on the rest of the marketplace. Inflation expectations are also baked into this chart.

If somebody asked me to receive 3.55% over the next 10 years, versus dumping that money into selected equities, one would think that equities would outperform.

Priszm Income Fund declares bankruptcy

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Priszm Income Fund (TSX: QSR.UN) has finally bit the bullet and gone into creditor protection. They will be liquidating the assets of their business.

Units of the trust and debentures (TSX: QSR.DB) have been suspended and will be delisted out of the TSX. They were last trading at around 9 cents on the dollar and as you might glean, does not anticipate much, if any recovery whatsoever.

I had written on the episode of my quick trade in and out of the debentures in earlier posts on this site; I retained the minimum face value ($1,000) of debentures as a “lottery ticket” ($90 market value) that evidently will not be winning. I eagerly anticipate the huge stack of documents in the mail that will politely inform me that my debentures are worthless.

Holloway Lodging REIT – Default on radar screen

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The last time I wrote about Holloway Lodging REIT (TSX: HLR.UN) was back in December when there was a corporate governance spat between a significant shareholder and management. That conflict resolved differently than what I had expected, with the significant shareholder being given a minority slate of trustees.

I have been continuing to dump my debentures in Holloway (the 2012 issue, TSX: HLR.DB.A) at around the 65 cent range and got rid of my last piece today at 62, leaving $1,000 in par value of debt just so I can see how this train wreck ends.

Holloway released their 2010 annual results yesterday, and reading it contains two not-so-subtle inclusions on their financial statements and management discussion that warrants further analysis:

The REIT is also subject to financial covenants on its mortgages and loans payable, which are measured on an annual basis and include customary terms and conditions for borrowings of this nature. These include the Debt Service ratio presented above. The REIT is in compliance with, or has obtained waivers for all of its financial covenants except one. One lender has not provided a waiver however, as a result of discussions with this lender, management believes the loans will not be called prior to maturity. The two mortgages with this lender, on hotels in Fort McMurray and Drayton Valley, are included in current liabilities and mature in October 2011 and January 2012.

Notably, the company has $153M of mortgages outstanding which are secured by the property and buildings within those mortgages. If the company does not abide by their debt covenants, in theory, the lender can call the debt unless if the company can cure the breach. If this occurs it would likely result in the company being pushed into creditor protection as their line of credit is not large enough to cover the difference.

The REIT has $25.4 million of mortgages maturing in 2011. The REIT expects to refinance its maturing mortgages at similar or better terms with existing or other lenders.

The REIT also has $20.2 million in convertible debentures that mature on August 1, 2011. The REIT has a signed term sheet to finance the repayment of the debentures. The Board and management continue to explore other alternatives to raise funds to repay the debenture holders which may include other debt financing, the sale of certain properties or some combination, thereof.

HLR has $45 million in debt in 2011 that they must be able to roll over in order to avoid creditor protection. The mortgage debt they should be able to renew at acceptable rates (they did so in 2010 for about 6.6% for a 5-year term). The August 1, 2011 debenture is an interesting issue ($20M) in that it is trading near par (TSX: HLR.DB, 93.5/97 bid/ask presently, albeit very illiquid) which suggests the company can refinance that, but the June 30, 2012 debenture (a $45M issue) is down to 62/63. This suggests the market is betting on the company being able to rollover the 2011 debt but not the 2012 debt. Both debentures are equal in seniority to each other.

It would be a logical and low-risk paired trade to short the 2011 debenture and long the 2012 debenture, but I could not short the 2011 debenture.

The business is not generating a sufficient amount of cash and this is in large part due to the interest bite that comes out of operating income. In 2010, the business pulled in about $19.3M in operating income, but the interest expense was $15.8M. This does not leave much room for other incidental expenses, such as general and administration, and future capital expenditures. Capital expenditures in 2010 I am presuming were of a maintenance-type nature, totaling $3.6 million.

There is nothing to suggest that they will be able to improve their revenue per room or capacity utilization rates over the next couple years.

There is probably residual value left in the operations, but I don’t want to be around to find out what low-ball offer management will be offering to the convertible debenture holders when maturity comes around. I’ve exited the 2012 debentures, short of $1k par value. My basis was about 44 cents on the dollar, so this is a nice gain for nearly 2 years of holding, but as I pointed out earlier, one of my largest mistakes during the 2008/2009 economic crisis was putting money in the debentures of this company compared to Innvest (TSX: INN.DB.B) at the same time period.

First Uranium – Raising equity financing

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First Uranium (TSX: FIU) announced they closed a $52 million equity financing at $1/share. They had originally had $46 million subscribed with a $6M greenshoe embedded.

This is about a 22% dilution of equity interests in the company, but they need this money to bridge their future operations and implement their capital plan:

----------------------------------------------------------------------------
FIU CONSOLIDATED                 end       end       end       end       end
(000's)                      Mar '11  June '11  Sept '11   Dec '11   Mar '12
----------------------------------------------------------------------------
MWS: Cash generated from
 operations                   12,032    16,295     7,444     8,619    13,873
MWS capital expenditures    (17,816)  (12,649)   (7,093)     (337)     (143)
Ezulwini: Cash (utilized
 in) generated from
 operations(1)               (9,449)   (3,823)     (411)     4,964    10,098
Ezulwini capital
 expenditures                (5,236)   (6,580)   (6,677)   (5,938)   (4,927)
FIU corporate expenditures   (2,875)   (2,726)   (3,726)   (2,726)   (2,726)
Interest on convertible
 debentures                  (7,301)   (3,156)   (7,301)   (3,156)   (7,147)
----------------------------------------------------------------------------
Cash movement for the
 quarter                    (30,646)  (12,639)  (17,765)     1,427     9,027
Minimum proceeds from
 financing raise(2)           46,000
Less: estimated financing
 transaction costs           (2,675)
Opening balance               29,979    42,658    30,019    12,254    13,681
----------------------------------------------------------------------------
Closing Balance               42,658    30,019    12,254    13,681    22,708
----------------------------------------------------------------------------

----------------------------------------------------------------------------
COMMODITY AND EXCHANGE RATE
 ASSUMPTIONS
----------------------------------------------------------------------------
Gold price US$/oz               1380      1390      1390      1390      1390
Uranium price US$/lb              65        65        65        65        65
Gold price ZAR/kg            301,703   303,889   303,889   303,889   303,889
ZAR/US$ exchange rate           6.80      6.80      6.80      6.80      6.80
----------------------------------------------------------------------------

What this means is that if the company did not raise money by the end of the month, they would be out of cash – but they need about $42M in capital expenditures in order to buy themselves enough time to build the Ezulwini mine to the point where it can start generating free cash flow.

Assuming they have the operational side covered (which is never a given considering the sketchy history of the company), their next looming financial issue is how to pay off the subordinated convertible debentures, of which $150M is outstanding and due to mature on June 30, 2012. It is low cost debt (4.25% coupon), but if the company is generating free cash flow at this time, it is likely they will be able to rollover the debt at a higher coupon and extend the term out another five years. This will not happen until the first half of 2012.

If the company gets to this point of being free cash flow positive, the equity will be worth well more than a dollar a share. But this is a very risky play – if it works, investors will likely get a very handsome return on investment over a two year period. If it blows up, the common shares will go to zero.

The other embedded risk is commodity pricing – both currency and gold pricing.

The subordinated debt has traded at around 82-83 cents today, which is the highest it has been since early 2008. Disclosure: I do have a position in First Uranium’s notes.

Learning to read statements faster than others

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First Uranium posted a production report for their last quarter. In the Thursday morning very long release contained the words that all equity investors dread:

The Company’s current cash resources may be insufficient to address its medium-term working capital needs. Accordingly, the Company has retained RBC Capital Markets as its financial advisor to review all funding alternatives.

Nobody appeared to read this paragraph until the opening of trading on Friday when presumably all the analysts released negative reports on the company.

The company’s common stock declined significantly Friday – from about $1.17/share to about $1.05/share presently. What is interesting is that this is purely from the news contained in the Thursday release – so institutional investors and analysts could not interpret the statement until given an evening to doing so.

I sold all the debentures (TSX: FIU.DB) out of my TFSA on Thursday for 80 cents on the dollar, but this was strongly instigated by the report. Most people on Thursday mis-interpreted the report as “steady as she goes” for the company operationally when they likely missed the critical part concerning the future capital requirements.

I also had some debentures in my non-registered account that I jettisoned, but still have some position.

First Uranium will likely have to raise further equity or debt capital to bridge their capital expenditure requirements. After that, presumably their existing Ezulwini mining operation could be cash flow positive. The equity is a high risk, high reward situation that I have not invested in. Depending on how such financing is structured it could be positive for debenture holders (e.g. a straight equity raise), but the company is otherwise restricted in terms of raising secured debt because of an existing agreement with noteholders (of which I own some as well).