Bank of Canada QT Progression

Another $23 billion of Canadian government bonds matured off the Bank of Canada balance sheet on May 1:

What’s interesting is that the Government of Canada ordinarily will receive a lot of tax remissions by April 30. In the past couple years, between the last April data point and the first May data point, the number spiked up about $10 billion, but this time the amount was up less than a billion dollars. Spend, spend, spend!

The $182 billion in bank reserves remaining continue to earn member institutions a very adequate 4.5% deposit rate – I’m sure the public really loves the annualized $8.2 billion dollars (that’s about $210 per Canadian!) being graciously donated to the big banks, risk-free. Why bother lending money to customers when you can get it so good from the BoC?

The next few slabs of QT are $6 billion on June 1, $9 billion on August 1, and $24 billion on September 1.

Dream Office REIT SIB

An interesting financial gamble just commenced yesterday evening.

Dream Office REIT (TSX: D.UN) owns 28 properties (2 under construction), and currently about 63% of the square feet is lease-able in downtown Toronto. The consolidated portfolio is 80% occupied (84% with commitments), with the Toronto segment at 88%.

Just like other office REITs, D.UN’s unit prices have gotten killed over the past year for well-known reasons.

On D.UN’s balance sheet, their primary assets are $2.39 billion in investment properties, and about 26 million (effective) units of Dream Industrial REIT (TSX: DIR.UN) (fair market value: $383 million at March 31, 2023). There is also about $1.27 billion in debt. Some of the debt is secured with the DIR.UN equity. The net equity is $1.5 billion, and with 52.2 million diluted units outstanding, gives a net asset value of about $29/unit.

They announced they will be selling about half (12.5 million units) of their DIR.un for $14.20 a piece ($177.5 million gross) and then commence a SIB for 12.5 million of their own REIT (24% of diluted units outstanding) for $15.50/unit. This is $194 million gross.

A typical bought deal would cost about 4% of the gross, so D.UN is paying about $7 million for this transaction, plus another amount for the legal fees for the SIB, so let’s round it to a $200 million dollar transaction.

D.UN shot up from $12.61 to around $15.00 per unit today in response – clearly some arbitrage potential being priced in.

The $200 million dollar question is (and this applies to all of these office REITs) whether the $2.4 billion in properties on their balance sheet is actually worth $2.4 billion.

If so, Dream is trying to buy dollars for half-dollars.

If the properties are worth 71% of the stated value, then the proposition is break-even at best (not factoring in the leverage factor and lost income from the ownership of DIR.un).

If the properties are worth less than 71% of the stated value, then this is a value-destroying proposition.

Another interesting factoid is that Artis REIT (TSX: AX.UN) and related entity Sandpiper jointly own about 6.8 million units of Dream Office REIT. Will they tender?

This will be interesting to watch. I have no skin in the game here – in general, I am adverse to deeply leveraged entities in our existing macroeconomic environment.

How not to sell an ETF

If you ever wanted to liquidate $2 million dollars of the CASH.to ETF in the last four seconds of trading, look what happens!

I could not imagine went on in the mind of somebody punching this order into the computer. Reading the tape, those sitting at around $49.75 on the limit would have received a reasonable fill and this is the financial equivalent of picking up the freest half a basis point on the planet.

Office REITs

Those of you that tuned into the last episode of Late Night Finance will know that I took tiny positions in a couple office REITs, which I took the liberty to dump out subsequent to that zoom-cast (no, not a pump-and-dump, I promise).

Traditional valuation methods of real estate can use cash flow methods, capitalized costs of land/building, and gut instinct on where future market demand lies, but there is one universal truth and that is when vacancy rates are high, it is not a good sign of how much cash flow you can dredge out of a property.

We are starting to see downward pressure on various office properties (WSJ article), at least in San Francisco.

While the specific example in this article may be an extreme case (a mark-down of 80% or so from pre-Covid pricing), because mortgage and other secured financing is collateralized by real estate asset values, it stands to reason that many other office REITs are going to face issues with trust covenants of specific debt-to-asset ratios going forward.

Since real estate loans are a slow-moving process, it will take a sustained credit-tight environment to trigger more and more financial stress on these entities, but just like how Silicon Valley Bank and Signature Bank New York were the first canaries in the coal mine, it will be inevitable that we will see the first office REITs start to fall – the trigger will be forced liquidations of office properties.

Processing the entrails of First Republic Bank

In highly anticipated news, First Republic (NYSE: FRC) went bye-bye over the weekend.

As long as the yield curve remains inverted and quantitative easing continues, financial institutions are going to receive continued pressure and the “too big to fail” institutions will be the ones to vacuum up the money.

Think of it this way – behind each bank asset (a customer loan) is a bank liability (a customer deposit). If the asset to liability situation goes out of regulatory proportions (e.g. you took your customer loans and invested in them in high-duration government debt and suddenly your customer wants their deposits back and you can’t pay it), you get FDIC’ed. However, when the FDIC process occurs, it is not as if all of that capital goes away – it has to go somewhere. It doesn’t end up as paper banknotes inside the safe or underneath the couch, but rather it goes to another financial institution. The assets and liabilities go somewhere else within the financial net – they do not vanish!

In this case, it appears destined that the assets in this digital financial world (where assets get transferred with mouse clicks) will bubble up to the systemically important banks.

I’ve been trying to pick away at the entrails of the lesser banks within the USA, but I don’t have a clue how to project who will survive and who will not. So I’ve given up.

I will leave this post with one amusing note. Financial releases go through plenty of review cycles within management, but if they can’t spell the word “average” correctly, it is trouble: