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Trust mania spurs quality concerns

Financiers worry demand outstripping supply of good companies for securities

Investor demand for income trusts now outstrips the supply of good companies to put in these high-yield securities, prompting financiers to fear that low-quality assets may start coming to market.

An estimated $3-billion or more in trust financings have hit the market in each of the past three quarters--with more than 10 companies selling units every month --and the pipeline is running dry. In the first three months of this year, brokerage house executives are calling for about $2-billion of new offerings, with a heavy weighting toward energy trusts and real estate investment trusts, or REITS.

"The easy trusts have been done. There's just not that many Yellow Pages [Income Fund] out there," said one financier who specializes in the sector, referring to the successful $935-milion debut of the phone directories trust last year. He added: "We're hearing that with some of the REITs, you're moving into lower-quality assets."

In the oil patch, several veteran financiers say there aren't enough oil and gas properties for sale to meet the appetite of energy trusts. George Gosbee, managing director of Tristone Capital Inc. in Calgary, said: "In the past, the trusts would have used their superior valuations to buy junior and intermediate oil companies, and pump up their reserves. But all those target companies have now converted themselves into trusts."

The gap between supply and demand stems from the fact that $2-billion worth of trust offerings are coming this quarter, while the mutual fund companies are collecting more than $1.2-billion a month in their income and dividend funds, money that must be put to work. With bond yields near historic lows and the Bank of Canada cutting interest rates, much of this new cash is earmarked for trusts.

Financiers expect more cash to flow into mutual funds during the first part of the year, as investors rush to make their RRSP contributions.

Last year, there were a total of 22 income trust initial public offerings, which raised $4.3-billion. In addition, 85 existing trusts tapped the market for more money, pulling in more than $9.2-billion. The S&P/TSX trust index was up 38.3 per cent last year, easily outstripping a 26.7-per-cent rise in the broader S&P/TSX composite benchmark.

If demand is overwhelming, existing trusts are likely to come to the table with opportunistic financings. Both energy trusts and REITs have been active in recent weeks, selling units in a series of deals that run to the $150-million range. Last year, the ratio of trust IPOs to secondary offerings was about 40-60, a number that's influenced by the record-setting Yellow Pages debut. This year, IPOs are expected to account for only 25 per cent of total trust financing.

The demand for trusts helps explain why Manitoba Telecom Services Inc. stock rose 9 per cent last week on news that the phone company will consider a shareholder proposal to convert to a trust at this spring's annual meeting. By raising the possibility that it may become a $4-billion trust, Manitoba Tel struck a chord with a whole new class of income-hungry investors.

There are at least half-a-dozen trust IPOs under consideration, with the newcomers expected to include at least two apartment building-based REITs that are currently under construction.

Last Thursday, a labour-sponsored investment fund was the first out of the gate, looking to raise $100-million with a portfolio of 29 mostly retail properties spread across the country. The new REIT, from Mississauga-based Retrocom Investment Management Inc., features four Wal-Mart-anchored centres, but also includes some older properties with bingo halls and thrift stores as main tenants.

Some of the key leases also are nearing their expiration date.

A source knowledgeable in the retail property market said the owners of the properties were shopping at least some properties before they decided to try a trust offering, but did not get the interest they were after. "Now apparently the right thing for them is to do a REIT," he said.

Another company eyeing the market owns shopping malls. Sources in the investment banking community said the mall owner is a foreign company that offered its package of properties to strategic buyers, but found no interest, then turned to the REIT market.

Two power companies are also expected to go public in the first three months of this year.

One company is already out marketing, with a new twist on the trust theme.

The Algonquin Power Venture Fund, the latest concept from a company that's already launched utility trusts, will offer both cash distributions, gleaned from buying the debt of independent power companies, plus tax credits. The fund is structured to give Ontario investors a tax break equal to 30 per cent of their investment, to a maximum of $1,500.

© 2007 The Globe and Mail. All rights reserved.

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