Only 99 cents to go

Recognizing the writing on the wall is a gift. Particularly when it involves investments. So I applauded Coventree (COF:TSX) yesterday for cutting expenses in the face of a very uncertain business environment. Although they put 25 people out on the streets as they cut their workforce by 30%, including the entire Denver office, the board seems to be on the job. Why a Canadian asset backed issuer ever had an office in Denver is an altogether fair question for you to ask, but it matters not now.

The dream is in tatters. Funding long term obligations with short term paper can have that impact.

For weeks I’ve been amazed that the stock has held in as well as it has (see prior posts “DBRS puts the bullet in Coventree“, September 13-07 and “More Coventree details“, August 15-07). Even after the credit world started to go into convulsions, and the money market buyers went on strike, Coventree’s shares were trading north of $4. Yesterday they finally fell below a buck, to 99 cents.

And the fallout in the leasing world, for example, is reverberating across the country. Funding sources for the small and mid size ticket leases (under $2 million) are drying up. Major global institutions are exiting the Canadian leasing market, and there don’t appear to be too many firms around to pick up the billions of annual business they were carrying.

The lessons for firms in the domestic specialty finance business are pretty clear:

1. Own your own funding source. Whether it be publicly-traded share capital (such as Quest Capital {QC:TSX}) or long term commitments from some of Canada’s largest institutions (8 years in our case), specialty finance firms need to be structured to succeed. Raising overnight and 30 day paper to finance 48 month leases is, well, umm, insane.
2. See above.

And for companies borrowing from firms in the specialty finance arena, ask your prospective partner shere their capital comes from before you do a deal. If they mumble something about a using multiples of leverage from a standby facility with a foreign bank or hedge fund, you’ve got to recognize that any structure that relies on an ultimate capital provider that you can’t meet face-to-face can suffer the same consequences as Coventree.

Xceed’s (XMC:TSX; year high $7.99, year low $2.54) mortgage clients thought they were borrowing from Xceed. They were, but only in part. It turned out they relied on Coventree. And Coventree relied on the overnight money market universe. Whoops.

If a firm as knowledgeable in lending as General Electric can change their strategy and dump a US$4.5 billion subprime division, every provider in the 2nd hand leverage finance business will be circumspect these days about the risk/reward profile of their own lines of business.

MRM