TD CaTS and Scotia BaTS behave like bonds: new A-rated capital trust units are suitable for fixed income investors

Money Digest, May, 2000 by Chuck Chakrapani

There is a new kind of investment vehicle in the Canadian capital market. It is called the capital trust unit.

Capital trust units will be of interest to fixed income investors who currently invest in securities such as bonds and mortgage-backed securities and seek a higher return.

There are currently two major capital trust units in Canada -- CaTS and BaTS- and more are sure to follow.

TD Capital Shares (CaTS)

The first major one to hit the market was TD Capital Trust (TSE: TDD.M; recent price $102; Yield: 7.45%). TD Capital Trust is a subsidiary of TD Bank and holds mortgage-related assets. As a result, the trust has a yield attached to it.

The difference between CaTS and a fixed income investment is that CaTS are "securitized." They are structured like closed-end funds. In some ways CaTS are more like preferred shares which trade like stocks but are bought mainly for their yield.

Another interesting feature of CaTS is that they are redeemable. They can be redeemed after five years or possibly be exchanged for Class A first preferred shares of TD Bank after 10 years.

Because CaTS are likely to be bought by the cautious income investor, they come with the `dividend stopper' undertaking: if CaTS fail to pay the stated yield, dividends on all other classes of shares -- preferred and common -- will also be stopped. Since stopping dividends on all classes of shares will be a drastic measure for a major bank like the Toronto-Dominion Bank, this can be seen as an assurance of continued yield payments.

When issued, TD CaTS were priced at $1,000, with a yield of 7.6%. Like bonds, they are quoted at one-tenth their actual value. (For example, they are now trading at around $1,020 and are therefore quoted as $102.) Again, like bonds, payments are made twice a year.

BNS Capital Trust (BATS)

BNS Capital Trust or BaTS (TSE: SBA.M; Recent price: $100; Yield: 7.31%) are similar to CaTS and are issued by the Bank of Nova Scotia. Scotia BaTS are being offered through BNS Capital Trust, a closed-end unit trust, which will purchase a co-ownership interest in a pool of CMHC-insured mortgages from Scotiabank.

Scotia BaTS have no maturity date, but are redeemable at par at the option of BNS Capital Trust subject to regulatory approval on or after December 31, 2010. Subject to BNS Capital Trusts right to redeem or acquire the Scotia BaTS, investors have the right to exchange their Scotia BaTS for Scotiabank preferred shares, convertible to common shares of the Bank on or after June 30, 2011.

The Scotia BaTS is priced at $1,000 each to yield 7.31%, which will be paid semi-annually in an amount of $36.55 per Scotia BaTS on the last day of June and December. The initial payment will be on December 31, 2000 in the amount of $54.27.

The investor advantage

The main attraction of capital shares is their higher yield. Compared to 10-year Government of Canada bonds, the yields on these capital trusts are about 1.5 percentage points (150 basis points) higher. (The benefit to the issuing banks is that the interest they pay is pre-tax.)

How safe are they?

Both these capital trusts have received an A rating from S&P. So they can be considered safe investments.

What else you should know

Because capital trusts offer a specified yield, their price will vary depending on the prevailing interest rates. Their price will fall when the long-term interest rates rise and will rise when the long-term interest rates fall.

DID YOU KNOW ...

* March, 2000, was the first month Nasdaq closed above 5,000?

* April, 1999, was the first month the Dow Jones Industrial Average closed above 10,000?

* March, 2000, was the first month the Toronto Stock Exchange to closed above 10,000?

* April, 2000, saw Nasdaq's three worst point-loss days ever?

* April, 1999, was the first month the Dow gained more than 1,000 points?