Debt – Page 11 – Divestor

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.

Bond prices – inflation, deflation

Yields are finally rising. Canadian yields on the 10-year bond:

Yield on the 10-year US treasury note:

While this may look dramatic, it should also be noted that yields on the 10-year note in the middle of 2011 was hovering around the 3.2% level, so the current yield of 2.5% isn’t not that high – indeed, it makes the 1.7% range that things were trading at before the spike up appear to be that much more low.

That said, the question remains on how this is going to impact the rest of the credit market, especially the corporate debt market. Spreads between treasuries and BBB-rated type issues are still at relative historic lows and I wonder if we will start to see a pricing of higher spreads once more.

If this is the onset of a market panic to get out of any assets (fixed income, equity, commodity, real estate) then the only safe haven will continue to be zero-yielding cash. The beneficiary in such an instance would be the US dollar.

We have the last three years of trading on the Canadian dollar and could this mean a weakening of Canadian currency, relative to the US dollar? Time will tell. I have been more or less positioned 2/3rds in US currency since 2012 so this tells you how I think this is going to be resolving itself.

It appears interest rates are headed higher

Despite the federal reserve opening up the monetary spigots again and vowing to bring down the long part of the yield curve, markets had the opposite reaction lately:

While present rates are low from a historical perspective, the trend indeed is now up. If this continues it will have more visible financial consequences. Essentially, those structured with long durations will take valuation losses. Conversely, those that financed their debt with long durations will do favourably (as long as the market believes they are able to pay back or refinance the debt!).

My quarterly performance so far today is absurdly good and this actually frightens me somewhat. Higher interest rates eventually will affect the valuation of the equity markets.

Raising cheap debt capital

Cenovus Energy (TSX: CVE) raised $1.25 billion in debt financing today. Here were the relevant terms:

TRANCHE 1
AMT $500 MLN    COUPON 3 PCT       MATURITY     8/15/2022
TYPE NTS        ISS PRICE 99.129   FIRST PAY    2/15/2013
MOODY'S Baa2    YIELD 3.102 PCT    SETTLEMENT   8/17/2012   
S&P BBB-PLUS    SPREAD 137.5 BPS   PAY FREQ    SEMI-ANNUAL
FITCH N/A       MORE THAN TREAS    MAKE-WHOLE CALL 20 BPS
    
TRANCHE 2
AMT $750 MLN    COUPON 4.45 PCT    MATURITY     9/15/2042
TYPE NTS        ISS PRICE 99.782   FIRST PAY    3/15/2013
MOODY'S Baa2    YIELD 4.463 PCT    SETTLEMENT   8/17/2012   
S&P BBB-PLUS    SPREAD 165 BPS     PAY FREQ    SEMI-ANNUAL
FITCH N/A       MORE THAN TREAS    MAKE-WHOLE CALL 25 BPS

So they can raise 10-year money at 3.1% and 30-year money at 4.46%. After taxes (assume 26%) this is about 2.3% and 3.3%, respectively. At these rates, I’d be raising as much 30-year capital as I can and figure out what to do with it later – there has to be a way to deploy it at a better pre-tax return rate of 4.46%.