Category: Equity

TD Bank raises $612M in equity offering

A few days ago, TD Bank (TSX: TD) raised $612M in gross proceeds in an equity offering of 8 million shares at $76.50 a share. This was in conjunction of them acquiring MBNA’s credit card portfolio in Canada, announced in the middle of August.

I have stated in the past that when financial companies raise capital it generally is a yellow flag event that suggests something else negative is going on. However, this intuitively (without seeing anything but basic numbers) seems to be a wise decision by TD.

I find it interesting that the exact amount has not been disclosed. It would be interesting to see how much capital in excess of the MBNA purchase has been raised by the bank. TD Bank has 890 million shares outstanding and so thus this equity offering would be less than 1% dilutive to existing shareholders. At the existing dividend rate, TD will also experience a cash outflow of $21.8M more a year in after-tax dividends.

Bank of America / Berkshire Hathaway

The decision to purchase $5 billion of preferred shares (with an under-market value of a 6% coupon, albeit with bonus provisions) in conjunction with the 10-year warrants to purchase BAC shares for $7.142857 (7 and 1/7th for those that do not recognize the string of numbers after the decimal point) has been analyzed to death by others.

The warrants are the golden part of this agreement – it is essentially a binary bet on the bank – if Bank of America does not go belly-up, it should be able to produce sufficient cash after a ten year period to justify a stock valuation significantly higher than $7 1/7 per share. If the company does go belly-up, Berkshire should be able to retain some residual interest in the preferred shares while the common shareholders get wiped out.

There is about $150 billion in tangible equity on the balance sheet to clear through before this would occur, which is why I suspect that this deal is a very good one for Berkshire and Warren Buffett.

I generally do not like it when financial companies raise capital – this is no exception. It makes you wonder how well JP Morgan is doing in terms of their solvency and liquidity situation. Analyzing big banks such as BAC or JPM is essentially a leap of faith more than an informed investment decision.

Payment for liquidity – anatomy of a margin call

When you go to a bank and ask for their rates on 1-year GICs, you usually get two responses – the rate for the cashable GIC and the rate for a locked-in GIC. You will receive a larger rate if you are willing to commit your money for a longer time period, at the penalty of having no interest if you want early access to your cash. The rate differences can be considered a payment for liquidity.

In the stock markets today, people are paying heavily for liquidity.

As an example, one of my top holdings, Rogers Sugar (TSX: RSI), tanked in trading because somebody needed liquidity, fast:

At 9:56 (eastern), the bid/ask was already being pushed down. It was at bid/ask 4.90/4.92 and then somebody wanted to get rid of about 100,000 shares quickly. In the span of five seconds, they took down the asking price 44 cents to $4.50 and then in the course of ten seconds there were 58,190 shares traded between 4.46 and 4.90. The bulk of the trade was done at the price of $4.50 where 35,400 shares changed hands.

This is the type of trading activity that occurs when somebody is undergoing a margin liquidation. They are paying a 40 cent per share premium for the privilege of wanting cash right now.

Generally speaking if you were on the opposite ends of these types of liqudiations you will receive a very, very good price. However, the window of opportunity you actually have to react to such liquidations is very, very tiny – you had about 1 second to hit somebody’s ask at 4.50 before somebody else picked it up. This is why computer trading is so prevalent in the marketplace – they are out there looking for such prospects.

When the market needs liquidity it does not matter what the fair value of the underlying security is – it will go at whatever price others want to pay for it. This can be much lower than the existing market value or what would be a rational valuation for the underlying company.

Markets getting slammed – how to trade in a downturn

The equity markets have been getting slammed (down about 3% currently) and bond yields have correspondingly dived as people search for safety. Most notably, this is the the second spike in volatility in the year – the first one was in March (which was caused by the Japanese earthquake).

When the bottom is in will be when the least number of people think so, but the tone of the markets at present are quite panicky – even the commodity markets are dropping in price. My guess is that this will occur when volatility reaches around 30-35.

Suffice to say when prices drop, equities become more attractive. The trade that makes money is moving from low risk to high risk when others are running away from high risk. Risk is being discarded quite actively.

Zarlink hostile takeover

Zarlink Semiconductor (TSX: ZL) is facing a hostile takeover bid. I have no idea whether investors should sell the equity or wait for something sweeter, but the relevance of this for me was that when I was looking at companies to invest in during the peak of the economic crisis, Zarlink debentures came on my radar screen. The debentures were trading at about 40 cents on the dollar back then, while the underlying company was not terribly profitable and seemed to be going along the wrong trajectory.

I was also concerned back then that you had a company which had a market capitalization that was a low fraction of the debt outstanding which would have made capitalizing the debt more difficult if the company went down that route (like Arctic Glacier, which will be condemning its unitholders to dilution purgatory at the end of July).

In retrospect, the decision to not invest was bad compared to some entities I did put my money in, but back in the middle of the economic crisis, capital was scarce and I made other investment decisions. Zarlink was a close candidate but barely did not make the cut.

Now when you look at various investments, the potential returns for risk is depressingly low. Back then you didn’t need to take much risk to get a very handsome potential reward. Today those risks are much, much higher.