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Financial advice suggested on Fidelity’s CBL share financing offer

Commonwealth Brewery Limited’s(CBL)much talked about initial public offering(IPO)may get a boost from a plan that offers 100 percent financing at interest rates up to 16 percent.

Fidelity Bank is offering the loan as a part of its existing loan consolidation program. At 100 percent financing for an equity security–usually at the very bottom of the pecking order should a company go bust–investors considering the loan option with interest rates far beyond CBL’s recent dividend yields should give the loan careful consideration.

“When individuals are investing in any offer of securities, they should take investment advice from a licenced security investment advisor,”Gregory Bethel, president of Fidelity Bank toldGuardian Businessyesterday.”After they take that advice and decide that they want to take the risk and invest, then they look for the funds, either from savings, selling some other investment, or in certain circumstances, borrowing.”

Based on the prospective borrower’s financial profile, the least risky prospects for the salary deduction plan could bring the rate down to 14 percent. Prospective borrowers who have any outstanding loans would have to complete a full consolidation, including credit card balances, with Fidelity Bank. The minimum amount of the loan is$5,000, and borrowing for up to 1000 shares to qualified lenders is available.

It is a plan that has raised some eyebrows in the investment and banking sectors.

In a previousGuardian Businessarticle,”Would you leverage to buy into IPOs”, Ken Kerr, CEO of Providence Advisors, toldGuardian Businessthatleverage to make an investment or to buy shares was not necessarily a bad thing.

“The critical point is the carrying cost of investments when you use leverage or borrow money,”he said.

What the carrying cost breaks down to is how much an investor anticipates receiving from the shares in dividends and the increase expected in the price of the shares, less how much it will cost to borrow funds for the investment.

For example, an investor borrowing at 16 percent but anticipating a 7.7 percent dividend yield might expect a share’s price to increase 8.3 percent during the first year to have a neutral carrying cost. 7.7 percent is the dividend that CBL shares would have yielded for 2010 under the company’s current dividend policy. An 8.3 percent capital appreciation would result in a$9.02 share price after the first year.

From a pure cash-flow perspective, the individual in the scenario above would have to fund the difference between the dividends and the loan interest himself. The investor would incur about$800 in interest on a$5,000 loan at 16%, and would earn$385 in dividends if the$5,000 investment had a 7.7 percent dividend yield–the annual difference of$415 comes out of his cash flow.

Under the bank’s program, there is mandatory financial planning and a mandatory savings account attached to any debt consolidation loan. When a salary deduction is set up, the amount of the deduction covers the new, single loan payment and an amount that automatically goes to the savings account.

Asked if the bank had checks in place to ensure that prospective clients seeking to take advantage of the leverage opportunity understood the risks inherent in equities–perhaps amplified in a capital market with an illiquid history–Bethel said that clients had to sign a subscription form and offering memorandum which clearly advises them to seek investment advice, and read the offering memorandum before they subscribe. He also sought to clarify the distinction between Royal Fidelity’s investment advisor role and Fidelity Bank’s lending role in this scenario.

Fidelity Bank, a retail bank, is a part of the Fidelity Group of Companies, along with Royal Fidelity, which is a 50 percent-owned joint venture with Royal Bank of Canada.

The caveat Bethel offered to take investment advice may be twice as important when considering borrowing at around twice the rate of the dividend yield. For the professional investor, it would likely require great faith in the ultimate appreciation of the share price, or a certainty that he could pay off the borrowed money fairly quickly and bring his carrying costs into positive territory.

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