Split Shares

[Arby]

I was reading a recent CIBC report on Split Shares, and noticed that many of the split share corporations are based on Canadian financial stocks, with a total market cap of about $2 Billion. Many of these financial split share corps are planned to wind down in 2008, 2009, and 2010. There will be redemptions of around $500 Million per year in 2008, 2009, and 2010 (assuming they wind down and are not extended). Now that's gotta depress the prices of bank stocks starting in 2008 if the financial split corps start cashing out $500M of bank stocks per year.

[Shakespeare]

Wanna bet that more split share offerings make up any difference?

Hint: the offerings are for the benefit of the sellers, not the buyers.

P.S. A million shares a day or more can be traded by a big bank. Say, $50M. $500M is just a couple of days for the Big 5.

[Arby]

Do split share corporations exist in the USA, or are they strictly a Canadian invention? I'm aware of S&P Split, which is a Canadian split share corp based on the US S&P index, but I'm wondering if there are any US-based split share corps.

[gerryf]

I have shares in Allbanc Split Corporation. It had it's IPO in 1998, and my financial advisor thought it was a good investment - it holds shares in the big five Canadian Banks.

The corporation shows a redemption date on March 10, 2008, which I'm guessing means the shares will be cashed in, and the corporation winds itself up.

My (now former) financial advisor has told me that the shares are coming up for rollover. If I don't do anything, will the cash show up in my account? Or do these split corporations roll over into a new incarnation and if I don't specifically sell them, I wind up with shares in the new corporation?

Sorry if it's a dumb question.

Thanks.
Gerry

[Peculiar_Investor]

From http://biz.yahoo.com/cnw/071211/allbanc ... .html?.v=1

Allbanc Split Corp. Announces Reorganization Proposal
Tuesday December 11, 3:33 pm ET

TORONTO, Dec. 11 /CNW/ - Allbanc Split Corp. (the "Company") announced today that its Board of Directors has approved a proposal to reorganize the Company. The reorganization will permit holders of Class A Capital Shares to extend their investment in the Company beyond the redemption date of March 10, 2008 for up to an additional 5 years. The Class A Preferred Shares will be redeemed on the same terms originally contemplated in their share provisions. Holders of Class A Capital Shares who do not wish to extend their investment and all holders of Class A Preferred Shares will have their shares redeemed on March 10, 2008.

The reorganization will involve (i) the extension of the originally scheduled redemption date, (ii) a special retraction right to enable holders of Class A Capital Shares to retract their shares as originally contemplated should they not wish to extend their investment and (iii) the creation of a new class of shares to be known as the Class B Preferred Shares in order to provide continuing leverage for the Class A Capital Shares. The reorganization will be subject to receipt of all necessary regulatory approvals.

A special meeting of holders of Class A Capital Shares has been called and will be held on January 25, 2008 to consider and vote upon the reorganization. Details of the proposed reorganization will be outlined in an information circular to be prepared and delivered to holders of Class A Capital Shares in connection with the special meeting.

For further information

Investor Relations, Allbanc Split Corp., (416) 945-4171, E-mail: mc_allbanc@scotiacapital.com, Web site: www.scotiamanagedcompanies.com

I would expect that you should have already received a mailing from the company detailing your options and soliciting your vote on the matter.

[gerryf]

Thanks for the information. I haven't received any mailing yet, but your post answers my questions.

Regards,

[gossg]

If I don't do anything, will the cash show up in my account? Or do these split corporations roll over into a new incarnation and if I don't specifically sell them, I wind up with shares in the new corporation?

You're the owner. You decide.

Generally these kind of things go to a shareholder vote. The management designs a rollover plan to a new incarnation and tosses it out to the shareholders. The shareholders decide what to do.

I wonder if the dismantling would go to cash, or if you would end up with 34 shares of scotiabank and 41 shares of TD (etc) or something awkward like that?

[gerryf]

Thanks again.

In the back of my mind I was thinking of investing the funds in an ETF - perhaps Ishares Financial sector ETF.

I notice though that the MER for the ETF is 0.55%, while the MER for Allbanc Split Corp is 0.39%.

Not a lot of difference there.

A recent investing author mentioned she didn't like split corporations, but she wasn't specific why.

Are there any pro/con reasons to prefer an ETF over a Split corporation investing in the same sector?

Thanks,

[adrian2]

A recent investing author mentioned she didn't like split corporations, but she wasn't specific why.

Are there any pro/con reasons to prefer an ETF over a Split corporation investing in the same sector?

Split corporations are harder to trade and sometimes misunderstood.

I'll defer to an article by James Hymas, a forum contributor and real pro. The link comes from http://prefblog.com/.
Split Shares

[queerasmoi]

In another thread (about a Mulvihill structured product), someone mentioned Brompton Life & Banc Split Corp. pref shares (LBS.PR.A). I was curious and did some reading on split-shares.

My understanding is that the split-share corporation owns a basket of securities, and effectively, it behaves as if the common shares owned the entire basket on a margin loan (5.25%, it would seem, in most cases) from the preferred side. The preferred shareholders receive dividends equivalent to those interest payments, and their principal is backed by the equity in the common shares (as long as the common shares still have value ).

What should I be aware / afraid of when it comes to pref split shares? Where do they fit on the spectrum of equity-to-fixed income? My instinct is "safer principal than corporate preferreds, still riskier than 'real' fixed-income", while at the same time, pref splits won't participate in gains the way pref corp shares can.

Also it seems that these structured products are issued with fixed dividends based on a "target" share price. Are split-share preferreds less/differently sensitive to interest rate movements than bonds, corp prefs? A 48-month chart of LBS.PR.A shows a -5% drift over those 4 years at the same time that XSB (short bonds) crept up and back to where it started, while CPD (pref shares ETF) dropped 17.5%. It's actually rather impressive it's only dipped a little bit when it's backed up by bank stocks.

Still trying to wrap my head around these instruments. Wondering if they'd be a good complement to the cash and bonds section of my little portfolio.

[twocentsworth]

Go to www.prefblog.com and check the sidebar articles. I'm sure James has an article there about splits.

[queerasmoi]

Prefblog seems to have a lot of detailed technical analysis but I can't easily locate plain-language articles about splits. Nothing jumps out from the sidebar.

I should add... I'm in BC and in the lowest tax bracket, which means my tax rate on eligible dividends is negative 15%. So I suppose that adds to the equation for me.

[jiHymas]

Try Split Shares from the Canadian Moneysaver of November 2006. If it's garbage, please let me know why so I can do better next time.

The current issue of CMS also carries an article by me on Split Shares.

[queerasmoi]

Thanks, good to know. I have no access to the article from this month though.

[Bylo Selhi]

I have no access to the article from this month though.

Hie thee to your public library. Most carry CMS. If for some reason they don't, contact CMS (Dale or Betty Ennis) and tell them who the offending library is. They'll give them a free one-year subscription.

[queerasmoi]

hah, interesting how never in my financial research have I ever resorted to getting out of my chair and seeking out a print publication.

I'll see when I manage to get there. VPL has copies in a few branches. The UBC library doesn't have it though.

[like_to_retire]

It's the only magazine I subscribe to............

[Arby]

I'll take a shot at answering your questions.

My understanding is that the split-share corporation owns a basket of securities

There are many different types of split-share corps. Some own a basket of underlying stocks (e.g. financial stocks), and others owns a single underlying stock (typically a stable dividends payer such as a bank stock).

effectively, it behaves as if the common shares owned the entire basket on a margin loan (5.25%, it would seem, in most cases) from the preferred side. The preferred shareholders receive dividends equivalent to those interest payments, and their principal is backed by the equity in the common shares (as long as the common shares still have value ).

The split corp (which includes the preferred and capital shares) owns the underlying portfolio of stocks. There is no margin loan from the capital shareholders to the preferred shareholders. The spit corp usually obtains it's revenue from i) the dividends generated by the underling stocks, ii) selling covered calls on the underlying stocks, and iii) capital appreciation of the underlying stocks. The split corp revenues are distributed to the preferred and capital shareholders. Preferred shareholders usually receive a fixed dividend (5.25% is a typical amount for recent split corp issues). Preferred shares have priority over the capital shares in receiving dividends, but preferreds don't share in any dividend increases or capital gains from the underlying portfolio.

The principal of the split corp is backed by the equity of the underlying stocks. On the wind-up date of the split corp, the underling portfolio of stocks are sold, and preferred shareholders have first priority to be paid back the original issue price of the preferred shares. The capital shareholders get whatever is left over after the preferred shareholders have been paid out.

What should I be aware / afraid of when it comes to pref split shares?

A few key points:
- Some pref split shares can be redeemed by the split corp prior to the maturity date. You need to read the prospectus to determine if there is the potential for a forced early redemption. You need to understand the concept of Yield To Worst.
- Pref split shares are very thinly traded, so you should never use a market order to buy or sell.
- You need to be aware of the rating (from S&P or DBRS) of the pref split.

Where do they fit on the spectrum of equity-to-fixed income? My instinct is "safer principal than corporate preferreds, still riskier than 'real' fixed-income"

I agree.

Wondering if they'd be a good complement to the cash and bonds section of my little portfolio.

I consider split prefs as fixed income. Split prefs are somewhat similar to short term bonds, in that they have a fixed maturity date and pay a fixed distribution. I thinks split prefs are a good alternative if you need to hold fixed income in a non-registered account.

[queerasmoi]

I hightailed it to the library when I realized I was in the neighbourhood near closing time and managed to photocopy the article just in time. Read it all.

I think most of my questions are answered.

One thing that didn't come up yet was interest rate risk... when rates swing, bond markets lurch the other way. My instinct here is that split prefs do react but not in a totally correlated way. Does that sound about right?

[Arby]

I expect there should be a direct inverse relationship between split pref prices and interest rates. It also depends on which interest rate is used. James Hymas blog provides a good explanation of the relationship between preferred share price and interest rates. Since split prefs typically have a 5 year maturity, the split pref inverse relationship should be with short term corporate bond rates. However, since split prefs are so thinly traded, a few small trades can greatly affect the price, so I don't think the relationship is very solid.

[queerasmoi]

I expect there should be a direct inverse relationship between split pref prices and interest rates. It also depends on which interest rate is used. James Hymas blog provides a good explanation of the relationship between preferred share price and interest rates. Since split prefs typically have a 5 year maturity, the split pref inverse relationship should be with short term corporate bond rates. However, since split prefs are so thinly traded, a few small trades can greatly affect the price, so I don't think the relationship is very solid.

Okay - the linked article suggests actually more of a correlation with long corporate bond rates rather than short. However it doesn't address the different behaviour of split preferred shares.

From looking at 48-month charts, I would conclude that split preferreds aren't bumped by the same factors as "real" corporate preferreds (compare, say, LBS.PR.A with CPD). Comparing the same split with XCB for corporate bonds, I can say it fluctuates within the same range but at uncorrelated times.

Perhaps what it comes down to is that split prefs are using the common stock as a cushion. If rising interest rates would normally push down fixed-income securities, then the preferred shares are stabilized and the common ones drop instead. And vice-versa?

[like_to_retire]

Perhaps what it comes down to is that split prefs are using the common stock as a cushion.

No, the reason is that splits act much like retractable preferred shares that enjoy a retraction date, which is a put option for the holder, at a known price at a known time. The maturity date of a split is a proxy for this feature. Like a bond, if I know that at a certain date I can "get my money back", it tends to support the price from being wildly affected by interest rates, especially if the retraction or maturity date is within sight.

For example, check a graph of MFC.PR.A (retractable) against a perpetual and a high rated split. The retractable and split will track and the perpetual falls off a cliff.

ltr

[SoninlawofGus]

Where do they fit on the spectrum of equity-to-fixed income? My instinct is "safer principal than corporate preferreds, still riskier than 'real' fixed-income"

I agree.

Not sure how you're coming to this conclusion. James' article seems to suggest the opposite, and he provides examples.

[queerasmoi]

No, the reason is that splits act much like retractable preferred shares that enjoy a retraction date, which is a put option for the holder, at a known price at a known time. The maturity date of a split is a proxy for this feature. Like a bond, if I know that at a certain date I can "get my money back", it tends to support the price from being wildly affected by interest rates, especially if the retraction or maturity date is within sight.

For example, check a graph of MFC.PR.A (retractable) against a perpetual and a high rated split. The retractable and split will track and the perpetual falls off a cliff.

ltr

Ahhh... okay. "Retractable" is the key word here.

So split prefs should behave similarly to retractable corporate prefs, whereas perpetuals are a different beast altogether. And CPD clearly contains a good chunk of perpetuals.

[queerasmoi]

Not sure how you're coming to this conclusion. James' article seems to suggest the opposite, and he provides examples.

Which of his articles?