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.

Why blind index investing doesn’t exactly work – or beware the TSX Venture Exchange!

Typical free advice you hear on other channels talk about the virtues of passively investing in indicies. While putting some money in the S&P 500 or TSX Composite (generally speaking, close-to-the-top 500 and 60 capitalized companies in the USA and Canada, respectively) will likely represent a broad proxy for the corporate profitability of those two countries and over the long haul you will make profits in line with the growth of the overall economy, there are also bad indicies one can invest in.

Such as the TSX Venture Exchange.

Right now it has 385 constituents, and they are not doing so well:

cdnx

An investor in the TSX Venture index will have lost roughly 2/3rds of their investment over the past two years, while TSX Composite investors would have lost about 15%.

It goes without saying that if you invest in a basket of junk, it doesn’t matter how much diversification there is in that basket, you will get junk results. And this is indeed the case for the TSX Venture – it is an utterly failed index.

If you do have to dip your toes into the index, I would highly suggest cherry-picking for firms that have nothing to do with the mining sector. This leaves about 15% of the index (capitalization-weighted). Fundamentally, it seems nothing has really changed since the Vancouver Stock Exchange era where seemingly half the companies involved were just simply there to defraud investors.

Preferred shares getting hammered

Investors that are doing the simple “borrow at 2%, invest in a fixed income product at 5%” are getting a lesson on leverage today when they see charts like this:

slf-pb

I just chose Sun Life Preferred Series B for just a complete random example and is no way an endorsement of this security – however, this series of preferred shares gives off a lazy 30 cent per quarter dividend and just one month ago was trading near par value, which would have given its investors a 4.8% yield.

Now, investors are waking up to see they have lost 10% of their capital, which is about two years’ worth of yield if the price doesn’t subsequently appreciate.

The odd thing is that predicting when the bottom ends is a very difficult guessing game of how desperate everybody is to liquidate income products in exchange for capital. If people are still leveraged and their equity is running low to the point where they still need to raise capital to maintain their positions, then we will still see further dumping into the market and lower prices.

We do have a good example of what happens when this occurs – in the depths of the economic crisis in 2008-2009, this preferred share traded as low as $13 – or 52% of par value.

All of this is likely a function of the underlying fixed income instruments (30-year, 10-year treasuries) getting bidded up in a volatile fashion and the subsequent capital losses there are reverberating into the more junior markets in terms of balancing portfolios. In other words, anything with a yield is getting liquified.