Canada – Page 2

Canada Convertible debentures – near maturities

The issuer market for Canadian TSX-traded debentures has been very muted. In past times, issuers would typically roll over debt with 6-12 months remaining in maturity by issuing new debt and calling the soon-to-mature issue. Today, these rollovers have been exceedingly rare, presumably because everybody and their grandmothers have been waiting for lower interest rates!

We have the following issuers that have maturities coming in less than three months, coupled with some point form notes:

AD.DB – Alaris – Likely to mature for cash, paid for with room in the company’s credit facility
AFN.DB.F – Ag Growth – Likely to get rolled over with a new issue – AFN.DB.J (3.7 years out) is 16% away from the money and is trading at 108, it is likely they can get an acceptable coupon price… AFN.DB.G is not further away with a year-end maturity and both might be done with a $150 million or so debt offering (disclosure: I own some shares here).
AI.DB.C – Atrium MIC – will likely mature and be paid by the bank line of credit
ALC.DB.A – Algoma Central – will mature for sure, the question is how much will get converted to equity? (they are 2% in the money at present)
EFN.DB.B – Element Fleet Management – will be converted to equity (conversion is well in the money at present)
TF.DB.C – Timbercreek Financial – will be paid off with the secured credit facility

With the possible exception of Ag Growth, all of these debentures will vanish from the TSX and be absorbed.

When examining the overall debt market (and also the preferred share market), very little strike me as potentially interesting. The price inflation in relation to potential risk is quite unattractive to me at present – the companies trading at low prices are generally doing so for very good reasons. They are also competing against risk-free cash at around 5%, which does not make their relative valuations look good – why aim for a risky 7-8% when you know that the liquidity associated with that 7-8% will be crap when there is a real market crisis, when you can just sit on your rear end with a safe and liquid 5%? I’m not reaching for yield – not being paid enough.

Some quick thoughts at the beginning of 2024

Two data points, I am not adding any value to the universe with this post:

The Nasdaq 100 had a +55% year, while the Nasdaq Composite was +45%.

I don’t think there is any degree of active portfolio management that would match this number.

The correct strategy in 2023 was to put your portfolio into 5 equal-sized chunks, in NVidia, Facebook/Meta, Tesla, Microsoft, Amazon and Apple. (You can sub-in your favourite large-cap darlings here, including Google and the like, but you get the idea).

No sane portfolio manager would do this.

It is very similar to the times in 1999 how if you weren’t in technology stocks (whether large cap, or the trashiest of the trash dot-com companies) in 1999 that you were guaranteed to under-perform.

The question is whether we will see “momentum”, or “regression to the mean” going forward.

I truly don’t know anymore. I note that, separate to the investment world, I have been receiving some email correspondences that are worded like they were generated by ChatGPT. Indeed, when I entered the text of the email and asked for it to form a response, it spit out some language. I then asked ChatGPT to simplify it, and what came out looked like a carbon copy of what said individual emailed to me.

I think from this point forward I’m just going to resort to in-person face-to-face communication.

However, others will opt for the convenience of not having to parse language in their heads, let alone spill it out on a keyboard (or god help those that can use touchscreen phones to do their typing). They will not have to deal with grammar, or even have to think about anything. AI will take care of it.

So perhaps it isn’t too late to buy those deeply out of the money calls on NVidia, it is banking on the intellectual laziness of people – sadly a safe bet.

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In 2024, Canada will have an active stock buyback tax of 2% applied on net share repurchases. While the legislation is more technically worded, essentially “net” in this case means that share buybacks beyond offsetting share issuances (whether through SPOs or option issuances, etc.) will be taxed at 2%. I don’t wish to get into the stupidity of how meddling in capital structure is going to cause perversions (indeed, prior to this, share buybacks are tax-preferential to dividends and this in itself was a perversion), but nothing makes the government more happy to claim to the public they are sticking it to greedy corporations with their share buybacks than applying an additional tax.

While 2% is not a huge penalty to pay, it is one more unnecessary friction impeding the return on and of capital. I am looking at the companies in my existing portfolio and am wondering if the ones voraciously performing share buybacks will be more keen to compensate through the issuance of stock options. Again, 2% is not a huge penalty to pay, but it is yet another annoyance.

No free lunch – CASH ETFs revisited

On October 31, 2023, OSFI gave out a huge “trick or treat” to high-interest savings ETF owners (CASH, PSA, etc.) in the following technical bulletin.

There is a transitional period until January 31, 2024 whereby banks and HISA ETF operators will come to a separate rate structure that will most likely involve another haircut of gross yield – the media quoted one analyst from TD that claimed it would be about 50bps, but my suspicion it will be about half of that.

This will still make cash ETFs competitive, but not the no-brainer compared to alternatives, which include high-credit short-duration corporate bond funds.

In other words – there is no free lunch.

CASH.to right now yields a net 5.18%, while the nearest corporate bond alternative (looking at ZST.to as a reasonable proxy for this – they survived March 2020 fairly intact) is netting 5.47% for half a year duration risk. Government of Canada 6 month debt is at 5.11%. CBIL.to is an average 1.8 month duration government bond ETF that yields a net 4.92%. Another relatively innovative product is target date maturity ETFs (looking at RBC’s RQL.to), which has an average duration of 0.63 years and a 5.16% net yield and by all accounts looks inferior to ZST.

What other proxies for Canadian short-term investment-grade corporate debt are out there? Most of them have duration of 2-4 years which involves a significant interest rate component exposure. The other question is whether half a percentage point is adequate compensation for (albeit very low) credit risk.

The yield curve continues to remain heavily inverted – 1 year to 30 year is roughly a -146bps differential, while the more quoted 2-10yr spread is -80bps.

The glacial speed of quantitative tightening

Bank of Canada bond holdings

Maturity	Coupon rate	ISIN	Par value	Of which on repo
2024-02-01	0.75	CA135087M920	3,566,474,000
2024-03-01	2.25	CA135087J546	6,611,368,000	95,000,000
2024-04-01	0.25	CA135087L690	23,275,739,000	1,775,000,000
2024-05-01	1.5	CA135087N423	1,005,000,000
2024-06-01	2.5	CA135087B451	6,304,081,000	30,000,000
2024-09-01	1.5	CA135087J967	10,042,352,000	1,352,000,000
2024-10-01	0.75	CA135087M508	4,062,206,000	572,000,000
2025-03-01	1.25	CA135087K528	12,055,174,000	643,000,000
2025-04-01	1.5	CA135087N340	600,000,000
2025-06-01	9	CA135087VH40	545,039,000	31,000,000
2025-06-01	2.25	CA135087D507	4,281,933,000
2025-09-01	0.5	CA135087K940	25,819,675,000
2026-03-01	0.25	CA135087L518	20,536,229,000	362,000,000
2026-06-01	1.5	CA135087E679	7,715,229,000	244,000,000
2026-09-01	1	CA135087L930	8,403,101,000	435,000,000
2026-12-01	4.25	CA135087VS05	440,000,000
2027-03-01	1.25	CA135087M847	2,194,445,000
2027-06-01	8	CA135087VW17	2,454,089,000
2027-06-01	1	CA135087F825	8,534,306,000	1,091,000,000
2028-06-01	2	CA135087H235	8,435,363,000
2029-06-01	5.75	CA135087WL43	4,909,719,000
2029-06-01	2.25	CA135087J397	7,890,136,000	169,000,000
2030-06-01	1.25	CA135087K379	17,477,505,000
2030-12-01	0.5	CA135087L443	17,051,478,000
2031-06-01	1.5	CA135087M276	10,856,641,000
2031-12-01	1.5	CA135087N266	3,648,167,000
2031-12-01	4	CA135087WV25	406,000,000
2032-06-01	2	CA135087N597	595,000,000
2033-06-01	5.75	CA135087XG49	5,099,690,000	5,000,000
2036-12-01	3	CA135087XQ21	440,000,000
2037-06-01	5	CA135087XW98	7,740,024,000	880,000,000
2041-06-01	4	CA135087YQ12	6,953,855,000
2041-12-01	2	CA135087YK42	429,000,000
2044-12-01	1.5	CA135087ZH04	424,600,000
2045-12-01	3.5	CA135087ZS68	8,925,652,000
2047-12-01	1.25	CA135087B949	392,700,000
2048-12-01	2.75	CA135087D358	6,371,150,000
2050-12-01	0.5	CA135087G997	76,000,000
2051-12-01	2	CA135087H722	18,006,997,000
2053-12-01	1.75	CA135087M680	2,965,110,000
2064-12-01	2.75	CA135087C939	2,194,182,000
			279,735,409,000	7,684,000,000

In 2024, $55 billion will mature, and in 2025, $43 billion, in addition to a couple billion in mortgage bonds. This is still below the $130 billion that are held in reserves at the bank, but at the rate things are going, coupled with projected deficits of the Government of Canada, means the reserves will be drained out sometime in 2025. Things will indeed get interesting once again, but it will require patience. That said, anticipation of illiquidity may cause it to occur earlier!

Canadian Convertible Debentures – Maturing 2023

I’ve been looking at the Canadian Convertible Debentures that are scheduled to mature between now and December 31, 2023. Some observations:

Medexus (TSX: MDP.DB, October 16, 2023 maturity) – This will mature on Monday for a cash payment at 125 of par (a very unique offering). To be honest, this one surprised me in that I was expecting some sort of distressed debt situation, but the company managed to scrape enough pennies together through a newly minted credit facility in early March 2023, some decent financial results posted on June 2023 and finally a secondary equity offering that concluded a week ago – striking while the equity was hot. Management navigated this whirlpool quite well, and at 24 employees, each person’s individual effort really counts for these types of companies. Before they get delisted I’ll post their chart, again noting that payout at maturity is 125 of par:

The rest are December 31, 2023 maturities:

Aecon Group (TSX: ARE.DB.C) – $184 million due. The company has a $600 million credit facility, of which $188 million was drawn out on June 30, 2023. Conversion is at $24/share and the stock is at $10.59/share, so very likely a cash maturity. Even a mediocre execution in the next six months will not result in these debentures getting in trouble and hence the 99% of par trading price at present. This engineering firm has been kind of lost since the Canadian government shot down its acquisition by a Chinese national firm many years back, but they continue to meander along despite being in a market where there is going to be plenty of demand going forward. The problem is that engineering firms need to retain talented individuals that need enough motivation to stay in such firms, which facilitates both the precise costing and execution of projects. It is one thing to get contract wins, it is another thing entirely to discover that your costing is so out of whack that in order to execute on such projects that you’re going to be losing money. A great example of this is the construction of the North Vancouver sewage plant which appears to be a case of a company being completely out of its depth.

Firm Capital (TSX: FC.DB.G) – $22.5 million due. Conversion is $15.25 with the stock price at $9.80. Firm Capital has many issues of convertible debentures outstanding at various maturities, trading roughly 4-5% above the government yield curve. The company proactively sent out a financial release on September 19, 2023 which attempted to reassure the market that despite their mortgage portfolio outstanding shrinking in size, that they are solvent. In particular, a $180 million credit facility remains untapped and combined with cash, this is comfortably facilitating a cash maturity of this particular issue. However, it is pretty clear that FC is going to have to make some tough choices – they traditionally have funded their loans through convertible debentures at really cheap coupons – the latest ones (FC.DB.K, FC.DB.L) were a combined $90 million out for 5 years with a 5% coupon with a conversion price well out of the money ($17.75 and $17.00/share!) – the last offering was done in January 2022 and this was PERFECT timing by management – there is no chance at all of them doing this again in the current rate environment.

Northwest Healthcare Properties REIT (TSX: NWH.DB.G) – $125 million due. Conversion is $13.35/unit with a current unit price of $4.57. The quick summary here is that the trust is in serious financial trouble. I remember this REIT being one of these “dividend starlings” that the usual retail crowd hyped up on financial twitter and the like, and unless if management is skillful, this one is potentially heading down to a zero. With specific regard to the ability to redeem this debenture, the trust is hitting a financial limit with its term facility (on June 30, 2023 there is $165 million available to be drawn). The minutiae in their last quarterly filing includes distressed paragraphs like this:

On August 2, 2023, the REIT executed an interim non-revolving tranche under its revolving credit facility to increase availability by $50.0 million. The tranche matures in October 2023 and can be extended until January 2024 under certain circumstances. The facility is secured by certain assets in the REIT’s Americas portfolio and it bears interest ranging from 10.6% to 13.8%.

… 10.6% to 13.8%! Ouch!

Subsequent to June 30, 2023, the REIT extended the maturity date of its revolving unsecured credit facility with an outstanding balance of $125.0 million credit facility by one year to November 2024, The facility bears interest ranging from 8.73% to 10.01% (previously 8.23% to 9.51%).

Banks are ratcheting the screws on the trust…

They released a September 22, 2023 financial update trying to assure the market that with some “non-core” asset sales coupled with some other measures they are “fortifying” the balance sheet, but there is indeed a danger that this convertible debenture will be partly redeemed in units by the company. While writing this post, I notice the “fantastic” SEDAR Plus is down for maintenance so I could not confirm directly that the indenture allows for this, but a previous MD&A does allude to this being an option for the company. The two other outstanding convertible debenture issues (maturing roughly in 4 years) are trading at a YTM of 12.5% so refinancing is not going to be in the cards for this REIT. My guess is that they squeeze out a cash maturity but good luck in the future!