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Bell Canada Strips

Harry Koza

16:07 EST Thursday, Oct 19, 2006

TORONTO (GlobeinvestorGOLD) -  Last week we talked about BCE Inc. C bonds, the Good Bells and the Hell's Bells. Truth be told, the Hell's Bells aren't really all that Satanic.

Sure, they've widened out a little in yield spread against Canada bonds, but given how starved the corporate bond market is for product, they've tightened in a bit again as bargain hunters scooped them up at the higher yields. As for the Good Bells, well, last week I didn't have room to get into just how really, really good they are.

Look at it this way. Bell is going to redeem $2-billion worth of bonds. The bondholders will get their $2-billion back, plus accrued interest, plus an extra $1.5-billion premium for the early retirement of the debt. Now that's a nice pass! In fact, as one credit analyst pointed out this week, it may be unprecedented in Canadian corporate bond history.

One of my e-mails from the Street this week also argued that, all in all, since most institutional investors owned some of both the Good Bells and the Hell's Bells, they still made out like bandits. While the prices of the medium-term notes (MTNs) went down a bit on the trust announcement, the prices of the bonds being called went through the roof. Net-net, they're still up huge.

There are two more Bell bond issues involved in the trust conversion early debt retirement that are interesting. A number of years back, Bell issued $150-million 9.75-per-cent bonds maturing on May 15, 2053, and $150-million 10-per-cent bonds maturing on Oct. 12, 2054. Both issues were 60-year maturities at the time of issue, which is in itself a pretty unusual thing in the bond market. I mean, there just aren't that many companies that anyone in his right mind would lend money to for 60 years. There aren't many companies that you could look at today and say with any certainty that they will even still be in business 60 years from now. That Bell could issue 60-year debt twice speaks volumes about its stature as a Canadian corporate icon.

By the way, International Business Machines Corp., if memory serves, has actually issued 100-year, or "Century" bonds three times over the years, each time within days of a major market bottom in interest rates. There are few better indicators of the end of a bond bull market than an IBM Century bond issue, so if they ever do another one, run for the exits.

Anyway, back to the Bell 60 years. When they were issued, the entire amounts were immediately stripped. The residuals went mostly to investors needing extra-long duration; for instance, insurance companies looking to match off annuity liabilities. The stripped coupons were sold to a variety of investors, including retail investors.

When the trust conversion was announced, and all us bond geeks were scrambling around trying to figure out what it all meant and looking at all the outstanding Bell bonds, I looked at these two 60-year issues and thought, how in hell are they going to call these? Will the dealers have to buy back all the individual coupons and residuals and reconstitute the parts back into the original bonds? That seemed like an awfully complicated and expensive process. So, in my travels over the past week or so, I've been asking traders and portfolio managers how these bonds would be handled.

Everyone agreed that it was a complicated issue and scratched their heads and said they didn't know either. I decided to go to the source on strips, so I  called up Keith Campbell, who used to be the Canadian Depository Securities' (CDS) resident strip bond guru. He directed me to his excellent website (www.stripbonds.info) where I discovered, among other interesting, things, that Canada is the world leader in strip bonds, with more than double the face value outstanding of stripped underlying bonds per capita than any of the other 14 countries where strip bonds are available. Who knew? Two things that define Canadians: strip bonds and having to get your kids Halloween costumes that fit over a snowsuit.

The site also explains how the 60-year Bell strips will be dealt with. The approach used is based on the concept of "proportionate economic interest." This process normally calculates a value for each individual strip using the yield of a Government of Canada bond of similar maturity for each one. The value of each strip is then divided by the total value of all the strips, to give a percentage of the total value. Each individual holder of the strips then receives their calculated percentage of the total value. In this case, since the bonds are being called at a premium, the value is based on the total that Bell is paying to redeem the underlying bonds.

Since strip bonds are all book-based, that is, there are no physical bonds, no actual pieces of paper that need to be turned in against payment, this is an easy and painless process for CDS to deal with. They have over $3.0 trillion* worth of securities on deposit and handle more than 77 million securities transactions a year. They won't even break a sweat over this one.

* The globe version shows $2.7 trillion. CDS updated its website since I wrote this, but by the time I noticed, it was too late to get the change in the paper.

Harry Koza,

Sr. Market Analyst,

Thomson Financial,

36 Green Meadow Crescent,

Richmond Hill, Ontario,

L4E 3W7




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