Category: Canada

Interest rates not going up anytime soon

The Bank of Canada announced they were leaving interest rates unchanged. The salient paragraph was the last one:

Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at 1 per cent. While some modest withdrawal of monetary policy stimulus will likely be required over time, consistent with achieving the 2 per cent inflation target, the more muted inflation outlook and the beginnings of a more constructive evolution of imbalances in the household sector suggest that the timing of any such withdrawal is less imminent than previously anticipated.

This basically means that short term rates are not going to increase for at least half a year, but likely for the rest of 2013. BAX quotes reflect a slight expectation of higher rates approaching the end of 2013:

Month / Strike Bid price Ask price Settl. price Net change Open int. Vol.
Open interest: 543,666 Volume: 171,501
13 FEB 0 0 98.745 0 0 0
13 MAR 98.710 98.715 98.710 0 101,834 14,761
13 APR 0 0 98.695 0 0 0
13 JUN 98.710 98.720 98.720 -0.010 119,478 45,715
13 SEP 98.680 98.690 98.690 -0.010 113,065 42,119
13 DEC 98.640 98.650 98.660 -0.010 90,020 34,371
14 MAR 98.590 98.600 98.610 -0.010 56,655 19,399
14 JUN 98.540 98.550 98.550 -0.010 31,336 9,242
14 SEP 98.480 98.490 98.490 0 14,456 3,892
14 DEC 98.410 98.430 98.430 -0.010 9,608 1,602
15 MAR 98.350 98.370 98.370 0.070 4,925 94
15 JUN 98.280 98.300 98.300 0.080 1,185 17
15 SEP 98.220 98.240 98.240 0.070 754 182
15 DEC 98.150 98.170 98.170 0.060 350 107

The important figure is the 10-year government bond and its yield has not gone anywhere over the past year:

bond-yields_STATIC_V39055_en

The implications here is that if there are going to be disruptive changes in asset prices, it is unlikely to result from interest rate changes. This would suggest that the REIT market and other yield-driven markets will continue to receive demand as investors clamour for yield. I also suspect that real estate asset prices will continue to exhibit a slow deflation rather than a bubble popping.

Canadian short-term interest rate projections

BAX Futures are as follows:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 12 OC 0.000 0.000 98.820 0.000 0
+ 12 NO 0.000 0.000 98.780 0.000 0
+ 12 DE 98.730 98.735 98.745 -0.015 10452
+ 13 MR 98.710 98.720 98.750 -0.030 27000
+ 13 JN 98.680 98.690 98.730 -0.050 32803
+ 13 SE 98.650 98.660 98.690 -0.040 19232
+ 13 DE 98.610 98.620 98.660 -0.040 11758
+ 14 MR 98.570 98.580 98.610 -0.030 1998
+ 14 JN 98.520 98.540 98.560 -0.020 1257
+ 14 SE 98.470 98.480 98.500 -0.020 613
+ 14 DE 98.410 98.430 98.430 -0.010 525
+ 15 MR 98.340 98.360 98.370 -0.010 123
+ 15 JN 98.280 98.300 98.310 -0.010 50
+ 15 SE 98.210 98.230 98.240 -0.020 50

The market is pricing in the anticipation that rates may increase a quarter point in 2013 but nothing yet substantive.  In particular, the September 2015 projection of a 1.5% target rate is an interesting bet from a risk/reward perspective.  Three-month corporate paper is at 1.16% and has been this for quite some time.

Holloway Lodging REIT – debt conversion

Following up from my previous post on Holloway Lodging’s (TSX: HLR.UN) debt situation, I notice on December 22, 2011 they gave a conversion notice of their debentures to units:

Holloway Lodging Real Estate Investment Trust (TSX: HLR.UN HLR.DB.A) (“Holloway” or the “REIT”) announces that it has today given notice to the holders (the “Debentureholders”) of its 6.5% convertible unsecured subordinated debentures (the “Debentures”) that it will redeem the Debentures in full on January 23, 2012 and that it will satisfy the redemption price of the Debentures on the redemption date by issuing trust units (“Units”) of the REIT in lieu of cash, in accordance with the terms of the trust indenture for the Debentures (the “Indenture”). Any accrued and unpaid interest on the Debentures will be paid in cash on the redemption date.

…

The number of Units to be issued to Debentureholders will be determined by dividing the aggregate principal amount of Debentures outstanding by 95% of the weighted average trading price per Unit for the 20 consecutive trading days ending on the fifth trading day preceding the redemption date (the “Current Market Price”). Based on the redemption date of January 23, 2012, the 20-trading day period commenced on and included December 15, 2011 and will end on and include January 16, 2012.

…

Holloway also announces that it will not make the interest payment on its Debentures when such payment is due on December 31, 2011. Holloway intends to make such payment by January 13, 2012, as permitted by the terms of the Indenture.

This is a significant development for unitholders in that the roughly $51.8M face value of debentures outstanding (at least as reported by the TSX; this may be slightly lower due to buybacks) will be converted at the rate of approximately 7-8 cents per share, at least given existing trading patterns to date. Unit prices cratered from 20 cents to as low as 4 cents upon the announcement (currently trading at 10 cents), while debenture prices dropped from 58 cents to as low as 40 cents and is currently at 53 cents on the dollar.

Assuming an 8 cent per unit conversion price, this would mean dilution of about 94% for existing unitholders. Somebody holding $1,000 face value of debentures would receive 12,500 units, implying a unit price of about 4.25 cents post-conversion. The remaining entity will have about 670 million units outstanding and at 4.25 cents per unit it would imply a market capitalization of about 28 million.

Using the 2010 cash flow statement as a very blunt proxy for future performance, the entity without the convertible debentures will be able to pull in about $5.9 million in operating cash flow, which would put it on sounder financial footing. It could suggest that the post-conversion trading price of the units will be around 7-8 cents.

Finally, the company has decided to consolidate the remainder of its non-mortgage debt on the chairman’s company Geosam:

Holloway also announces that it has entered into a second amendment to its credit agreement dated as of June 15, 2011 among Holloway, Geosam Capital Inc. (“Geosam”), as administrative agent, and Geosam, together with such other persons from time to time party to the credit agreement, as lenders, (the “Credit Agreement”) to increase the amount of funds available for drawdown by $3.6mn for certain limited purposes. Holloway has increased the amount outstanding under the Credit Agreement by $1.8mn in order to purchase from the holders of its interest-bearing promissory notes approximately $2.8mn of such notes, representing all of Holloway’s interest-bearing promissory notes outstanding.

This is presumably linked to the resignation of the CEO (Squires) that lasted in the company longer than I expected him to after the takeover of the company by George Aryoman and Geosam.

My conclusion here is that the market is valuing the debentures and units as slightly expensive, but it is within an order of magnitude of a fair valuation. Finally, my continuing thesis is that the only entity that will make any money from Holloway will be Aryoman and Geosam by virtue of their control of the company and the secured credit facility which will continue to hive off interest income from Holloway unitholders. This will continue as the assets are stripped and sold from the trust.

In other words, this is a fun one to watch, but not to invest in. I feel fortunate to dump my debentures at the price that I got for them (roughly 60-65 cents) and get out of dodge. If unit prices go down to the 4 cent level again, the trust may be worth putting a few pennies in, but this would be one of those typical “pick up the cigar butt off the street for one last puff” type value plays.

Back from holidays

I am back from my 6-week vacation outside the country (where the weather was much, much warmer) and will hopefully get back into mental shape to post about some projections for 2012, the performance in 2011 (not good!) and other such worldly things.

One thing I do know, however, is that unwinding from an extended stay out of the country takes a long time, and recovering from a 16 hour time change is not pleasant!

Government Bond yields have dropped significantly

The one impact of the US debt ceiling extension has been that government bond yields have dropped significantly over the past week. For instance, the 10-year Canadian government bond benchmark has lost about 25 basis points which is a huge drop:

10-year bond yields are now lower now than they have been since January 2009 (the depths of the financial crisis). The bond markets are highly pessimistic about any form of economic recovery and are trading as such.

Short term rates are no longer pricing in a sure chance of a rate increase – BAX futures are as follows:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 AU 0.000 0.000 98.670 0.000 0
+ 11 SE 98.685 98.690 98.685 0.000 23202
+ 11 OC 0.000 0.000 98.655 0.000 0
+ 11 DE 98.660 98.670 98.660 0.010 42832
+ 12 MR 98.630 98.640 98.610 0.020 35992
+ 12 JN 98.590 98.610 98.560 0.040 16408
+ 12 SE 98.550 98.570 98.510 0.050 7649
+ 12 DE 98.500 98.510 98.450 0.060 2729

The December BAX Futures are at 98.66 (1.34%) compared to 98.46 (1.54%) when the Bank of Canada made its last pronouncement on short term rates.  It no longer appears that short term rates will be rising at all.  Three month corporate paper is still at 1.17%.  If there is any hint of economic recovery, it is not seen in the bond market.