We're going to open a disaster relief centre at my office. It's for the victims of an unnatural calamity that struck the investment business in September. The federal Finance Department fired an Exocet missile at the income trust gravy train by, in effect, halting the creation of income trusts until it decides whether or not to clamp down on the tax treatment of them. The missile hit Bay Street with full force, and some victims are just starting to talk.
The analysts in our disaster centre say the Street should have seen it coming. Back in August, the analysts met with an investment banker. Things were too good to be true. "Thank the stars for income trusts," the banker said. "Without them, we'd be dead." He then described, in the most lurid of terms, the process of selling income trust product to institutions.
Now, follow this closely. First, he agreed there are just a handful of hungry-hippo institutional buyers, mainly income funds that repackage the stuff for retail investors. The hungriest include Sentry Select, Middlefield and funds run by the big banks. "There is so much demand for packaged income trust product that these guys have to buy almost anything. By comparison, to sell a regular new issue of stock in chunks of $10 million to anyone is almost impossible." This guy has been doing that for about 15 years, so he should know. "To sell $10 million of an income trust," he said sarcastically, "all you need to know is who to phone, what its stock trading symbol will be and the payout ratio [the percentage of yearly cash flow the trust will pay out as distributions to investors]."
He went on: "To sell $15 million worth, the CEO making the presentation to investors needs to have a tie and polished shoes, and just know enough about the company to seem like he's done his homework. To sell $20 million, maybe take someone from your firm who can answer some basic questions. It's that easy."
As the initial shock of Finance's announcement wears off, investment bankers will arrive at our disaster centre bawling uncontrollably. Some salaries and bonuses at the bank-owned firms could decline by as much as 50% next year.
Our trained staff will gently suggest that selling debt might be an okay tax alternative for companies that had considered turning themselves into trusts. The issuing company can deduct the interest payments from taxable income, and the result is a lower effective tax rate. "But bonds only have a 1% commission," the victims will cry, "versus 5% commission on income trusts." You see, investment bankers are now hooked on 5% commissions. Many of them have been selling trusts as income alternatives to bonds for almost a decade. Even with those fat commissions, investors have been earning annual returns of close to 10% on many trusts--way better than bonds or GICs.
Our staff will be sensitive to investment bankers who have BMW payments to make. And we know they still have to send their kids to Muskoka Woods Sports Resort (a.k.a. Camp Gucci Loafer) next summer, or wine tasting camp in the Okanagan Valley. Our toughest job will be getting them ready to go back into battle.
We'll set up a role-playing exercise. We'll make each investment banker practise a speech--over and over again--to the CEO of a cash-flow-positive carpet cleaning business, telling him he's only going to get half as much from his IPO as he was promised a few months ago. (We'll spare the banker the more likely scenario: Now, when investors look at a company as potential shareholders, rather than as renters of its cash flow, they'll likely walk, leaving the banker with nothing. No IPO. No business. No commission.)
In true Bay Street style, our disaster centre will also work the other side of the fence. We'll try to help the federal Finance team tease out the difference between paid-lobbyist moaners and investor victims who really have been hurt by the eighth-inning trust halt.
And there is a silver lining for the industry. If there is excess demand for income trust units, and Ottawa has cut off the supply of new ones, what will happen to the price of existing units? Yes, our counsellors will say, the feds have done Canadian retirees the biggest favour since the Canada Pension Plan. Limiting the supply of the income-producing instruments that so many of those retirees now depend on will make the units they already hold much more valuable. It's the ultimate payoff for bad investors who jumped on a dubious fad early.
Investment bankers will realize they still can't make better money doing anything else. Then we'll be able to close our centre and help someone else.
© The Globe and Mail
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