Wednesday, December 17, 2014

Bought 1 Extremely High Risk Sandridge Energy 8.75% Senior Bond Maturing 1/15/2020 at 65/Added 50 FSC at $7.86/Bought 50 TCRD at $11.38 Regular IRA

I am going to gradually discuss some small junk bond purchases over the next week or so. I have focused on several smashed junk bonds issued by highly leveraged E & P companies. Under the current circumstances, those purchases are HIGH RISK, and I have consequently kept my exposure small. The riskiest one is the one bond purchase discussed below.


Big Picture: No Change

Stable Vix Pattern (Bullish):


Recent Developments:

With three dissents (2 from hawks and 1 from a dove), the Federal Reserve approved a statement indicating that it "can be patient in beginning to normalize the stance of monetary policy". The Fed deleted the statement made in prior releases that it expected to keep rates low for a considerable time. The FED insisted that the patience language effectively meant the same thing. FRB: Press Release--Federal Reserve issues FOMC statement--December 17, 2014

It is my current opinion that economic conditions will improve next year compared to 2014 and that job growth will accelerate some from current levels. Capacity utilization will increase above historic levels. I am therefore anticipating two .25% increases in the federal funds rate next year, with the first being in the summer and the second late in the year. The FED will then assess for several months the impact of those increases and whether further small increases spaced out over time is warranted under the then existing economic conditions.

Jeff Gundlach has a slide presentation that is worth viewing. Chart 24 highlights a major problem. The annualized percent change in real hourly wages between 2007 and 2014 is negative for most wage earners, with only the very 20% showing any growth. Another problem is that the minimum wage for a full time worker has declined substantially since the early 1980s. I highlighted these strong structural problems in an old blog. Introduction "Labor Productivity and Wages" (9/28/13 Post)

The German two year government bond has a negative yield. Inflation expectations are trending down.

The flash HSBC/Markit manufacturing PMI fell into contraction territory, falling to 49.5 in December. The new orders sub-index declined to 49.6. markiteconomics.com

U.S. industrial production increased 1.3% in November. Capacity utilization for the industrial sector increased .8% to 80.1%, a rate equal to the long term average. It has been a long slog back to that average:



Capacity Utilization: Total Industry-St. Louis Fed

Capacity utilization to the current level is associated with business spending increasing at 8%: Bloomberg


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1. Bought 1 Extremely High Risk Sandridge Energy 8.75% Senior Bond Maturing on 1/15/2020 at 65 (see Disclaimer): 

Snapshot of Trade Information: This bond was bought at Fidelity which charges an $8 commission. 

I was not able to buy just 1 bond online at Vanguard, when I decided to make this purchase, where the commission would have been $2 for that 1 bond purchase. 

Fidelity will add its $8 commission to the price paid, so the following snapshot shows a $65.8 price, which includes the $8 commission, bumping the price shown in the confirmation to $65. 

For those unfamiliar with the bond market, this is a $1,000 par value bond that I bought for $650, plus an $8 commission. 

I also had to pay the seller accrued interest in the amount of $36.94. That number is not added to my cost basis which will be $694.94. 

Instead, when I receive the semi-annual interest payment on 1/15/2015, I will receive the entire month's interest payment, even though I did not own the bond for the first five months or so of that six month period.  

I will then deduct that $36.94 interest payment made to the seller when I prepare my tax return for 2015. I will have a deduct accrued interest paid to seller line in my schedule B. That assumes that my 1099 includes the full six month's interest payment which has always been the case for me so far. 


I am gambling with this purchase. 

I am placing a small bet that SD will make all interest payments when due and will survive to pay me $1,000 on 1/15/2020, which will create a large total return somewhat commensurate with the huge risk.

The broker calculates my current yield at 13.297% and the yield to maturity at 19.699% at my cost. That is a locked in 19.7% annualized yield to maturity provided all interest payments are made when due and the principal amount is paid in full on 1/15/2020. That is one important caveat.


The sentiment being expressed in both the Sandridge common and bond prices has been overwhelmingly and relentlessly bearish for several weeks, though the pricing improved for both last Wednesday with the robust stock market rally and a rise in energy prices. 

Bond investor fears were nowhere to be found a few months ago. On 5/2/14, I sold a 7.5% Sandridge senior unsecured bond maturing in 2021 for $106.375:


That 2021 senior unsecured bond closed at $57.25 on 12/15/14, almost cut in half in just 7+ months. FINRA

Another possible favorable result would be for SD to be acquired before a BK filing by a larger company with a rock solid investment grade rating. 

Company Description: SandRidge Energy (SD) is a relatively small E & P company that has recently sold off  assets to focus on the Mississippi Lime area. oilindependents.org. One problem with production in the Mississippian Lime area generates huge amounts of saltwater and costs have to be incurred to dispose of that waste product properly. The primary operators in this area are Chesapeake, MidStates Petroleum and Sandridge. Midstates Petroleum's stock closed at $1.6 on 12/17/14, and its high yield bond closed with a YTM just south of 27%. FINRA

The company is currently unable to file a third quarter 10-Q with the SEC due to an accounting problem that some investors view as minor. (e.g. Seeking Alpha). The company discussed the reasons for the delay in an early November 2014 press release, which generated the usual number of class action lawsuits filed by the usual assortment of attorneys: SandRidge Energy I would not hazard an opinion on the impact, but will simply note its existence here.

Sandridge did release a press release describing third quarter results. The company made the following statements. It claims to have a substantial majority of production through 2015 hedged over $90 per barrel. No borrowings then existed on its $1.2B credit facility. Total company production was 80MBoe per day which was a 14% quarter-over-quarter increase. Sandridge estimated that over 90% of its liquids production was hedged at over above $93/Bbl.  SEC Filed Press Release

The company has a lot of senior unsecured debt but none of it matures before 2020:

Cash and Long Term Debt as of 9/30/14

I do not trade future's contracts and simply have to accept whatever the company says about its hedge book:

Derivative Contracts
SandRidge Energy has filed a registration statement for an IPO for MidCon Midstream L.P. that was formed by SD to own, operate, acquire and develop assets to gather, process and dispose of saltwater produced alongside oil and gas. There has been no activity after that filing on 10/24/14: SEC Filings for MidCon

Rationale: This is a speculative purchase. I would call it a gamble, sort of like playing a hand of blackjack for $650. If Sandridge survives to pay this bond off at maturity, I have locked in a total annualized return  of 19.699% with the usual highly material caveat. Sandridge has to survive until it pays off that bond at maturity. And that is the rub.

Risks: The bond market has some really serious questions about SD surviving to the 2020 maturity date. A close to 20% annualized yield from a senior bond carries with it a substantial default risk. 

How long will oil prices remain low? How will SD finance production in 2015 to 2020 without having to borrow more money, probably by drawing down its credit facilities. Selling senior unsecured bonds is not an option now.

In a S & P report that I read, which was prepared in July 2014, the analyst opined that SD would outspend its cash flow by $900 million this year and that deficit would be financed with a draw on the credit facility and an asset sale which has already occurred.

Bond investors are probably anticipating that SD will start to heavily lean on its credit facility which will have priority over the senior unsecured bonds.

Expenditures in 2015 need to be brought in line with cash flow generated by production and hedges, and that may not happen.

The bond market is not predicting a default in 2015 at a 65 price in my opinion.

But that price is not consistent with anywhere near a 100% likelihood of survival to the bond's maturity date.

The 65 price is, in my opinion, predicting a significant possibility of a default in the 2017-2020 time period with the recovery in a BK hampered by significant draws on the credit facility to finance production.

The market's opinion, expressed in the price, will change based on subsequent developments.

If crude oil is at $50 next winter, and has stayed below $70 in the interim, then that is an adverse scenario for the bond, whereas a $80 price which is rising that allows for hedges to be secured at favorable prices for 2016 and beyond is another.

Hard to say now what will happen, but it will most likely be very dicey with some drama before there is a clear resolution.

2. Bought 50 TCRD at $11.38-Regular IRA (see Disclaimer): 

Snapshot of Trade: 



I recently discussed this BDC here and have nothing material to add to that discussion. Stocks, Bonds & Politics: Bought 100 TCRD at $12.83/Sold 433+ RMT at $12.76-Average Cost Per Share $7.91

I also have an article at SA that is an excerpt from that blog post and I have made some comments linked to that article. Nibbling At BDCs During The Current Downdraft: Bought 100 TCRD At $12.83 - South Gent | Seeking Alpha

Since my purchase, this stock has gone ex dividend for its $.34 per share quarterly dividend and has fallen significantly after adjusting for that payment. The entire BDC sector has been in a substantial downtrend for weeks, a topic discussed in more detail in the next item.

At a total cost of $11.38 per share, and assuming a continuing of that quarterly dividend rate, the yield is about 11.98%.

3. Added 50 FSC at $7.86 (see Disclaimer): I have small positions in this BDC in two IRAs and in a taxable account. This buy was made in a taxable account to generate cash flow for reinvestment in other securities and to reduce my average cost to $9.04 per share, with just a 150 share position.

Snapshot of Trade: 


Security Description: Fifth Street Finance (FSC) is a business development corporation ( hereinafter BDC) that invests primarily in small and mid-sized private companies, primarily in connection with investments made by private equity sponsors.

Website: Individual Investor | Fifth Street

Fifth Street Finance Profile Page at Reuters

Fifth Street Finance Key Developments Page at Reuters

The portfolio is weighted in secured loans:

Portfolio Composition as of 9/30/14

A description of the FSC's investments can be found starting at page 90 of its recently filed 10-K.

The oil and gas sector exposure appears to be relatively light at 3.71% as of 9/30/14 and is described as "oil & gas equipment services" rather than a loan to a production company. (page 55) That exposure is to three companies and two of them are in the "process of sold for a fairly substantial multiple". Page 4 Earnings Call Transcript | Seeking Alpha

One of the comments to that SA transcript reproduces some comments, both negative and hopeful, about FSC from the BDC Reporter that are worth reading.

This BDC has what is called an ATM program where KeyBank capital markets can sell FSC's stock in the open market. In a Prospectus filed 12/9/14, FSC mentions that it sold through its ATM program 841,456 shares of stock between 8/22/14 and 9/30/14 at an average price per share of $9.86 or $8.3M The $100M authorization under the ATM program is consequently reduced to $91.7+M. There is a statement in the prospectus that the sale's price can not be "less than the net asset value per share of our common stock at the time of such sale" (page S-10).

After the share price finally worked its way back over $10 per share, FSC Interactive Chart, FSC announced after the close on 7/10/14 that it was going to sell stock, one of the well known and perpetually annoying risks associated with BDCs. Fifth Street Finance Corp. Commences Public Offering of Common Stock FSC priced 13.25M shares at $9.95 per share to the public. There was the usual over allotment option granted to the underwriters. Fifth Street Finance Corp. Prices Public Offering of Common Stock


When looking at a stock offering, it is important to keep in mind that the $9.95 per share offering price to the public is not what FSC receives per share. The underwriters bought the stock at $9.81. FSC also incurred about 2 cents per share in expenses relating to the offering. So the net proceeds after the underwriting discount and FSC's expenses was about $9.79 per share. The net asset value per share was $9.71 as of 6/30/14.

Other stock offerings since December 2012 are detailed at page 71:


This BDC has sold two exchange traded baby bonds with a $25 par values: Fifth Street Finance Corp. 6.125% Senior Notes due 2028 (FSCFL);  Fifth Street Finance Corp. 5.875% Senior Notes due 2024 (FSCE)

This is a link to a press release discussing one large recent investment: Metalogix Acquisition by Permira Funds

Dividend History: Fifth Street Finance raised its monthly dividend from .0833 per share to $.0917 effective with the September 2014 distribution.

FSC has cut its monthly rate twice since the 2010 4th quarter. The first cut was a small decline from $.11 to $.1066. The next cut was to $.0958 in January 2012 and then to $.0833. Fifth Street Finance Dividend History

I would not call the increase to $.0917 a dividend raise. When the dividend is increased to over $.11 per month, the rate from November 2010, then that increase will be a raise. The last increase just restored some of the previous cuts.

Assuming a continuation of the current monthly rate and a total cost per share of $7.86, the dividend yield is about 14%.

When the ten year treasury is yielding just over 2%, a 14% yield obviously carries a lot of risk. The problem with BDCs is how to harvest the yield without giving some or all of it back in share losses.

Recent Earnings Report: For the Q/E 9/30/14, FSC reported $.25 of net investment income per share. The weighted average yield on FSC's income producing investments was 11.1% with the cash component of that yield making up 9.9%. At fair value, 79% of FSC's portfolio consisted of senior secured loans.

Fifth Street Finance Corp. Announces Fourth Quarter and Fiscal Year Ended September 30, 2014 Financial Results

An article discussing this report is authored by Scott Kennedy and published earlier this month at Seeking Alpha.

Rationale: There is only one reason to invest in this company. In today's abnormally low interest rate environment, a prudent saver has no real options for generating a satisfactory real rate of return without taking risks. I could buy a 10 year treasury yielding slightly over 2%. Before taxes and inflation, it will take about 35 years for money to double at a 2% rate. Estimate Compound Interest  Investing at a 2% rate of return is in my opinion a huge risk for most investors to take, since it enhances the risk that assets will not grow sufficiently to meet expenses.

So, I have no choice but to take risks. I would prefer to avoid companies like FSC altogether.

I can suffer a loss in the shares that generate a 14% yield and still receive an acceptable real rate of return, particularly with inflation trending down.

The discount to the last reported net asset value per share of $9.64 is historically abnormal at 18.46+% based on the purchase price of $7.86. That historically high discount at least suggests a reasonable possibility of price appreciation to more normal levels, assuming the market price decline is primarily due to temporary factors.

Management has stated that it will not sell stock below net asset value per share, which is a positive.

Risks: The risks are substantial, as one would expect for a 14% yield.

1. Net Asset Value Per Share Destruction: Most of the time, the market price for an externally managed BDC will hug net asset value per share within a few percent either higher or lower. If the external managers are destroying net asset value over time, the market price will be declining too.

What is FSC's long term record? Fortunately, this BDC had an IPO in 2008 rather than in 2006 with the investments made just in time for the Near Depression.

6/30/08: $13.2 per share (page 5 10-Q)
6/30/09: $11.95 per share (page 5 10-Q)
6/30/10: $10.43 per share   (")
6/30/14  $ 9.71 per share (page 3 10-Q
9/30/14: $ 9.64 Fifth Street Finance

Does that history show a trend yet, or is the decline some kind of aberration that will not repeat itself in the future?

2. Unsatisfactory Long Term Total Returns: The Longrundata calculator goes back to 6/12/2008 for FSC and will reinvest the dividends to buy more shares. Starting then and calculating the total return through 12/16/2014, FSC has produced only a 4.56% annualized total return, significantly below its average dividend yield. Calculator That poor annualized total return highlights an issue. An investor should not become mesmerized by the dividend yield when the long term total return performance screams trade.  

3. Serial Stock Issuer: Stock offerings cost money and raise significantly less per share after the underwriting discount and the BDC's expenses relating to the offering than the public price per share. The continuous offering of shares whenever the price creeps above net asset value per share has a tendency to cap price gains to small premiums.

If there is a prolonged period where stock can not be sold above NAV per share, the coffers will not be replenished after loan losses, and net assets producing income will decline. The company would also lose the asset value accretion due to stock offerings where the proceeds to the BDC per share exceed the then existing book value per share.

4. The dividend is not safe or secure. The dividend history proves this point. In case anyone needs to be reminded, the next recession will provide a refresher course about the sustainability of the payouts.

5. Dividends Drain Cash: To maintain its tax status, the BDC must pay 90%+ of its taxable net income to its shareholders. The avoidance of double taxation increases the amount available for distribution, but the dark side to that high dividend is that funds are not being retained to grow the business.

6 The company discusses the abundant risks incident to its operations, including conflict issues inherent in the external management arrangement, starting at page 24 of its recently filed annual report, FSC 10-K F/Y Ending 09/30/2014

7. The significant costs of external management are also a major negative. Net expenses for the year rose to $151.4M from $106.7M for the prior fiscal year.

How did net asset value increase between 9/30/13 and 9/30/14?

Page 47-FSC 10-K
9/30/14: $9.64 Net Asset Value Per Share
9/30/13: $9.85 Net Asset Value Per Share

What can you say about that? In a generally favorable economic environment, net asset value per share decreased by $.21 per share as expenses rose $44.7M. Are FSC's external managers justifying their pay packages? Each investor can answer that question for themselves. I view the answer as both obvious and certain.

8. The chart looks awful: FSC Interactive Stock Chart


I believe that it is important to have a handle on the downside risks.

When I look at the preceding summary, one rational and understandable response is just to say no. Another, which I follow, is to recognize those downside risks and then try to adapt.

Future Buys and Sells: I will consider averaging down at a lower price. I will consider selling shares when the market price exceeds net asset value per share or possibly as soon as I have a net profit in the shares after harvesting dividends. My preference is to harvest 1 to 2 years and then escape with a profit on the shares while I still have one.

Closing Price 12/17/14: FSC: $7.92 +0.10 (+1.28%)

The next ex dividend date is 1/13/15. FSC 

Saturday, December 13, 2014

Bought 2 LINN Energy LLC 8.625% Senior Unsecured Bonds at $81 (4/15/2020 Maturity)/Bought 50 ARESF at $12-REIT Basket Strategy

Big Picture: No Change

Stable Vix Pattern (Bullish):


Recent Developments:


GE's Board of Directors increased the quarterly dividend by 5%. The new quarterly rate will be $.23 per share, up just one cent. The ex dividend date will be 12/18/14. I am not reinvesting the dividend. Based on my total average total cost per of $20.13, the new penny rate raises my dividend yield to 4.57%. I currently own 531+ shares.

Crude oil futures fell to the lowest level since May 2009 last week. The decline accelerated last Friday after the IEA cuts its 2015 global growth number by 230,000 barrels per day to 900,000 barrels a day. December:- IEA releases Oil Market Report for December That forecast would result in consumption of 93.3 million barrels per day, up from the 2014 current estimate of 92.4M barrels per day. The market is oversupplied with 94.1Mb/d in production during November.  I am estimating that supply will not match demand until early next summer at the earliest, unless OPEC agrees to cut production which does not appear likely.

WTI and Brent have lost about 45% of their values since peaking in early summer. The January 2015 future's contract for WTI Crude dropped $8.03 per barrel or 12.2% last week to close at $57.81. Energy & Oil Prices

The DJIA declined 678 points or 3.8% last week. The S & P 500 lost 73 points or 3.5%.


Recently Received Year End Fund Distributions: I really do not appreciate large year end distributions. Does a fund distribution add to my net worth? The net asset value is adjusted down to reflect the distribution amount. The distribution creates a tax obligation. Short term capital gains are taxed at the highest marginal rate. A long term capital gain still generates a 15% tax payment, assuming the taxpayer qualifies for that rate as I do.

I recently sold out of the Royce Micro Cap Fund (RMT), when its discount narrowed to just 3% and in advance of a $2.19 per share distribution. Item 2 Sold 433+ RMT at $12.76-Average Cost Per Share $7.91 (12/9/2014 Post) After going ex dividend on 12/11/14, the shares closed last Friday at $9.79. I may start buying back small lots when the discount expands to over 12% again. The discount last Friday had expanded to -8.85%.  

The only way for me to come out ahead is that the reinvested dividend generates a return after tax in excess of the tax liability associated with that payment. In a bull market, that can and often will occur. A bear market will simply cause a loss in value of the original dividend used to buy more shares that later go down in value.

I may own a fund in two different accounts, reinvesting the dividend in one account and taking cash payment in the other.

I have taken the capital gains distributions for the Matthews Pacific Tiger (MAPTX) fund in cash, since I first acquired shares over a decade ago. I view that approach as a way to harvest gains without having to sell shares. As shown in the snapshot below, I received a $256.53 cash distribution from that fund.

The Permanent Portfolio (PRPFX) is another long term holding that is mostly out-of-sight, out-of-mind. That fund is sort of my disaster hedge, with its large and relatively constant allocations to gold and silver bullion, treasuries, investment grade corporate bonds, Swiss government bonds, natural resource stocks and REITs, and what it calls an "aggressive growth" portfolio that is more accurately called a value tilt. This is the second year in a row where PRPFX has paid a large capital gain distribution. The 2014 long term capital gain dividend was $2.9 per share.

At least these funds only classified a small amount as short term capital gains. Most of the ordinary income dividends will probably be classified as qualified.


Permanent Portfolio Fund (PRPFX)





Matthews Pacific Tiger Fund  (MAPTX)-Taken IN CASH




Matthews Asian Growth & Income Fund MACSX)




Matthews China Dividend Fund (MCDFX)



Total 4 Funds:
Long Term Capital Gains: $1,132.27
Short Term Capital Gains: $13.42
Ordinary Income: $226.51
Total: $1,372.2

I have elected to keep my China Fund (CHN) shares notwithstanding the 4th $3+ per share annual distribution. I am reinvesting the dividend.

Adams Express has already gone ex dividend for its year end distribution and I will receive that dividend in cash. Adams Express ($1.03 per share)

The Swiss Helvetia has a big one that has not yet gone ex dividend. I am reinvesting SWZ dividends, and this distribution will take me over a 1000 shares. The Swiss Helvetia Fund ($2.195 per share on 900+ shares)

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Canadian REITs have taken a bad tumble over the past few weeks, with several of them hitting new 52 week or all time lows.

As far as I can surmise, some investors have concluded in typical group think fashion that Canada is about to fall into an abyss, never again to see daylight or prosperity, due to the most recent sharp decline in crude prices. All is lost, bad now and will never get any better.

Tenants will abandon their leases in droves, just prior to jumping off tall buildings en masse. That is a really scary thought.

My unrealized losses in the Canadian REIT sector now exceed my realized gains in 2014. I thought that I was doing pretty good until the herd decided that Canada was going kaput. I am exaggerating just a little bit here.

Many of the Canadian REITs are now yielding over 9%, and some are now over 10% yields, based on their recent share prices. All of them pay monthly distributions.

The carnage inflicted in the Canadian REIT sector has caused the Old Geezer to become more timid with his purchases.

When I last bought Artis, discussed below, I used my CADs to buy 300 units on the Toronto exchange.

Having sold that lot 300 unit lot at C$15.71 on 9/12/14, I managed to generate only enough courage to buy 50 ordinary shares traded on the U.S. pink sheet exchange and priced in USDs for the reasons discussed hereafter.

1. Bought 50 ARESF at $12 (Equity REIT Common and Preferred Stock Basket)(see Disclaimer):

Snapshot of Trade: I bought the ordinary shares priced in USDs that are traded on the U.S. pink sheet exchange: Artis Real Estate Investment Trust (ARESF)


Closing Prices Day of Trade: Friday 12/12/14

ARESF: $12.02 -0.28 (-2.28%)-Ordinary Shares Priced in USDs
AX-UN.TO: C$13.92 -0.24 (-1.69%)-Ordinary Shares Priced in CADs

Currency Conversion on Day of Trade:


Security Description: Artis Real Estate Investment Trust (AX.UN:TOR) is a diversified Canadian REIT that owns office, retail and industrial properties in Canada and the U.S., with a focus on Western Canada. 

As of 9/30/14, Artis had 244 properties in its portfolio with 25.6M square feet of leasable space. Portfolio occupancy stood at 96%.

On a net operating income basis, Artis had a 51.9% weighting in office buildings, 23.8% in industrial properties and 24.3% in retail properties.The U.S. properties provided 22.6% of net operating income. (page 4 Third Quarter Earnings Report)

Property Map: Portfolio Map

U.S. properties are concentrated primarily in Minneapolis and Phoenix and Denver to a lesser extent.

It owns 40 properties in Minneapolis consisting of 4 office, 6 retail and 30 industrial properties Pictures Those properties accounted for 13.4% of net operating income YTD through 9/30/14.

The company owns 6 office and 1 industrial property in Phoenix. Pictures

Three office buildings were owned in Denver.

For assets owned in the U.S., the U.S. funds are converted back into Canadian Dollars which produces "largely unpredictable foreign exchange gains and losses on our income statement" which impacts "results from operations, as well as the other comprehensive income".  For the three months ending 9/30/14, Artis booked an unrealized gain in "other comprehensive income of $32.5 million, a large number due to the size of our U.S. portfolio". Page 3 Q3 2014 Results-Earnings Call Transcript | Seeking Alpha

A list of properties, with occupancy rates can be found at page 5 of the last earnings report.

As of 9/30/14, the weighted average interest rate was 4.09%. The weighted average term was 4 years. Total debt to gross book value stood at 48.6%. The interest coverage ratio was 2.8 times. Page 12 Investor-Presentation

AFFO per unit has risen steadily, though slowly, from C$1.15 per unit in 2012 to an estimated C$1.22 in the 2013 third quarter. The AFFO payout ratio was 87% in the last quarter, which is high, but still within the high end of my comfort range. (page 14) The consensus 2015 estimate is for AFFO C$1.28 per unit.

Based on the closing price of C$13.92 last Friday, the P/AFFO based on the C$1.28 estimate would be 10.875 which I view favorably.

As of 11/6/14, the consensus estimates were as follows: net asset value per share was C$16.51; implied capitalization rate of 6.7%; and consensus target price of C$17.16 (page 18)

Distributions: The monthly distribution rate is currently C$0.09 per share. 

The distribution will be converted from CADs to USDs after a 15% Canadian withholding tax. At the exchange rate from last Friday,  C$.09 would buy $.0777 before the adjustment for the Canadian tax.

For owners of ARESF, and assuming the distribution rate remains constant at C$.09, it is important to keep in mind that a decline in the CAD after a purchase results in a dividend cut, while an increase in the CAD's value operates as a dividend increase.

Given the currency fluctuations, it is impossible to compute a dividend yield. The dividend yield would be about 7.77% at a total cost per share of $12, assuming no dividend change and a constant currency exchange rate that produces a $.0777 monthly rate for ARESF unit holders. The actual annualized yield will depend on the conversion rate for each monthly dividend payment.

Link to Distribution History

Prior Trades: My prior trades were made on the Toronto exchange which requires an explanation of how profits are reported by my broker, an issue that is avoided when the investor buys the ordinary shares using USDs on the U.S. pink sheet exchange.

For a U.S. taxpayer, the taxable profit reportable on a 1099 by the broker will not be determined by the investor's profits in CADs. Instead, both the cost basis and the proceeds will be converted from CADs into USDs. If the CAD declines in value against the USD during the period of ownership, the U.S. taxpayer will realize a lower taxable profit than the amount actually realized in CADs. Different permutations of that scenario could also apply. The investor might have a profit in CADs and a loss in USDs, for example, or a loss in CADs and a profit in USDs.

Since I sold a number of Canadian REITs earlier this year, my reportable tax profit was less than my CAD profit due to the decline in the CAD during my ownership period.

One example is provided by my disposition of 300 Artis shares bought on the Toronto exchange using my CADs. I sold those shares in Toronto and received C$397 more than I used in CADs to make that purchase. My reportable USD profit was $6.92. The accounting related to currency conversion for tax reporting purposes eliminated about C$390 in profits.

Snapshots at Item # 1 SOLD 300 AX-UN:CA at C$15.71 (9/26/14 Post)-Item # 1 Bought 300 of Artis REIT at C$14.36 (9/28/13 Post)

Last Friday, I could have bought the ordinary shares in Toronto at a lower price than that previous September 2013 purchase.

Prior to the foregoing round trip, I had flipped two 100 share units back in 2011, realizing a total gain of $281.27 (snapshot in both prior linked posts).

Recent Earnings Report: All amounts are in Canadian Dollars. For the quarter ending 9/30/14, Artis reported revenues of $125.425M and AFFO of $42.128M or $.31 per shares:


The AFFO calculation can be found at page 24. The AFFO number subtracts from FFO reserves for capital expenditures, reserves for leasing costs and straight-line rent adjustments.


Page 9 Third Quarter Report.pdf

Third Quarter Financial Statement.pdf

Q3 2014 Results - Earnings Call Transcript | Seeking Alpha

I will use the AFFO numbers, rather than FFO, when making a valuation judgment.

Rationale: Both the dividend yield and valuations are good in my opinion. I noted the consensus P/AFFO was 10.875. The P/FFO would be lower. The average P/FFO for American REITs was 17.8 in November 2014, page 3 Lazard_US RealEstate Indicators Report

I can never predict how long irrational pricing will continue. I thought that investors had lost their collective minds in 1998 and had gone berserk. Yet, prices continued to rise through 1999 and into 2000. The same kind of mindset was prevalent in March 2009, when investors were pricing securities based on an economic scenario that had already been eliminated through the collective actions of central banks and governments. Common Valuation in Bear Markets: It is Bad and Will Never Get Better (3/22/09 Post)

Risks:

(1) Currency Conversion Issues: The following discussion is fairly typical whenever I buy a foreign security.

The ARESF price is linked to the ordinary share price priced in CADs as converted into USDs. If the CAD continues to decline against the USD, the ARESF shares will underperform the ordinary shares traded in Toronto and priced in CADs. The CAD has been declining in value, so I would expect to see ARESF underperforming the Toronto listed shares priced in CADs which is the case as shown by this two year chart:



That chart looks like the stock decided all of a sudden to jump off a cliff.

The USD priced ordinary shares will outperform the ordinary shares priced in CADs when the CAD has gained value. To show how this works, I looked at a five year chart for the CAD/USD. I noted that the CAD was rising in value between 7/1/2010 to 7/29/12. I then entered those dates as the time period for another comparison chart:



Putting side all other currency conversion issues, the buyer of ARESF would want the CAD to rise against the USD after purchasing shares.

The worst scenario for the ARESF owner, which I simply call the double whammy, is for the CAD to continue declining against the USD and for the ordinary shares priced in CADs to decline in price at the same time.

The best scenario is for the CAD to increase in value after the purchase and for the ordinary shares priced in CADs to increase in price at the same time.

In my opinion, I prefer to buy foreign securities when the USD has significantly risen in value against the relevant foreign currency and the ordinary shares have declined significantly in local currency terms for non-fundamental reasons.  Both of those conditions have now occurred with ARESF, unless one believes that Canada is in for a long term economic decline. The current declines in the CAD and the ordinary shares priced in CADs may be far from over too. I can not predict the future. When and if I believe that I can, I would hope my family appoints a conservator to manage the money.

Stocks, Bonds & Politics: Strong U.S. Dollar + Weak Market=Time to Start Looking Overseas (6/1/2010 Post)

Stocks, Bonds & Politics: International Trading and Currency Risks (7/11/2010 Post)

(2) Investor Perception about the Canadian Economy: As noted earlier, the Canadian REIT sector decline gathered momentum as energy prices accelerated their decline. A persistent long term decline in crude oil prices will have a negative impact on Canada's GDP. I suspect more of that negative impact would be felt in the Alberta and Saskatchewan provinces.

Canadian banks may be negatively impacted by increased credit risks. Several western Canadian governments will have less revenues.

For the Ontario and Quebec provinces, the overall impact would probably be positive as consumers have more money to spend due to lower heating and gasoline costs. Investors have already overreacted in a major and irrational way when pricing Canadian REITs, in my opinion. When the herd starts engaging in group think that assumes Armageddon is near, fear has gained control over the rational Left Brain decision making process.

Recessions will take a toll on REITs. It remains to be seen whether Canada will slip into a recession. Recent economic numbers are generally positive. Gross domestic product, expenditure-based (quarterly);  GDP growing at 2.8% pace-CBC News (11/28/14 dated article)

3. Company Description of Risks: Every company that I buy regularly produces a summary of risk incident to its operations. Generally, an investor can find those risks in an Annual Report. Artis describes those risks starting at page 22 of its 2013 annual report: Artis-REIT-2013-Financial-Report.pdf

Future Buys/Sells: Sometimes, when I purchase foreign ordinary shares on the pink sheets, my broker converts the shares to the ordinary shares priced in the local currency. That ends up being a cheaper way to buy the foreign security, since the commission is more than 50% lower than the cost applicable for Toronto trades. This will not happen until I own 100 shares and may not happen at all. I have to trade round 100 share lots in Toronto.

When and if the ARESF price sinks below $11.5, I will consider buying 50 more shares and another 50 below $11.

I do not have a target price. Most likely, I would sell the highest cost lost first to lower my average cost per share, and then buy that lot back whenever it would reduce my average cost per share. If my shares are converted to the symbol used in Canada, then I would only average down with a 200 share lot, using my existing CAD stash to fund the purchase, given the C$19 commission rate.


2. Bought 2 LINN Energy L.L.C. 8.625% Senior Unsecured Bonds at 81 (Maturing on 4/15/20) (see Disclaimer)

I have started up again my junk bond basket strategy. I have been explaining my reasoning in comments made at SA in Land of Milk and Honey Instablog #51 | Seeking Alpha.

I will be focusing on junk E & P bonds that have been smashed in price. I have non-energy names on my monitor list, but want lower prices before buying. This is an EXTREMELY HIGH RISK STRATEGY. I EXPECT DEFAULTS. The goal is to cover the losses caused by defaults with profits on bonds issued by companies who survive to pay off the bond at maturity or earlier.


Snapshot of Trade:

Bought 2 LINN $1,000 Par Value 8.625% Senior Unsecured Bonds at $81 
Company and Security Description: Linn Energy LLC (LINE) is well known to income oriented investors. A large number of articles, pro and con, are written about the common shares. Linn Energy, LLC | Seeking Alpha One authored published an article at Seeking Alpha claiming that LINN would have "strong cash flow for years" in order to pay distributions to the common unit owners. I am going to refer to those "units" as "shares" hereafter.

LINN Energy, LLC-Homepage

LINN Operations-Homepage

Q3 2014 Earnings Release

LINE 10-Q for the Q/E 9/30/2014

I have not owned the LINN common shares since 2010: Sold 100 LINE at 25.90 (6/26/2010 Post)(profit snapshot=$971.97) As an owner of the senior bond, the payments being made to the common shareholders are a negative.

The common shares have been smashed pretty good in response to the crude oil price decline: LINE Interactive Stock Chart When I bought the common shares, the price had already been smashed for the same reason.

Since I own a senior bond, I only care about receiving my interest payments when due and par value at maturity. I am consequently uninterested in the debates about whether the common shares have hit bottom or whether the distribution will be maintained or cut to those common share owners.


The following snapshot explains the basic terms:



The bond is currently rated well into junk territory: B1 by Moody's and B by S & P. This bond was originally issued in a private placement back in March 2010. LINN Press Release

I would anticipate ratings' downgrades before the current down cycle runs its course.

This bond is listed in LINN's last SEC Filed 10-Q at page 11. Total long term debt, less current maturities stood at $11.010+B as of 9/30/14. Three billion of senior notes are scheduled to mature before 2020, with the first being a 6.5% senior unsecured note maturing in May 2019 with an outstanding principal amount of $1.2B. Another note in the principal amount of $1.8B matures in November 2019. LINE 9/30/2014 10Q

I view it as more likely than not that this bond will become cheaper, unless there is a major reduction soon in OPEC's production limits. The future is however not knowable with any certainty. I certainly do not know now how much cheaper.

What was knowable last Friday? I could buy just 2 bonds in my Vanguard brokerage account, which is unusual. Fidelity's order book required a minimum 5 bond purchase and at a slightly higher price than 81. I do not want to buy more than 2 bonds from a single E & P issuer, so I can not be too picky when I buy when the best price allows for a 1 or 2 bond buy. I also know that I will have almost a $400 profit provided LINN survives to pay off this bond. I would even appreciate an optional early redemption at a premium price.  I also know that this bond was trading at over 115 last May, and that the 81 price is about 30% lower than that high price last May. FINRA Chart

What is not known and is ultimately unknowable now? I can only guess how long oil prices will remain low and how LINN will adapt to potentially unfavorable future scenarios. Consequently, I could lose some or even most of my principal that would be offset to some degree by interest payments received prior to a default.

Rationale and Risks: I hope to buy a number of E & P junk bonds at deep discounts to par value over the next several weeks. The timing will in part depend on when I am able to buy a 1 or 2 bond lot. I will be checking the order books at least twice a day.

The rationale is that yields have become enticing.

The YTM of the LINN 2020 is 13.703%. Yield to maturity assumes that the bond will be paid off at maturity.

The current yield is about 10.65% ($8.625 dividend by $81)

My best estimate is that a 10%+ annualized yield will beat the S & P 500 return over the next five years, possibly by a wide margin. If I can harvest a 10% or higher annualized yield, and have a net profit on the junk E & P bonds, no matter how small, then I am reasonably confident that this high risk junk bond strategy will outperform SPY over the next five years. I could even afford to have a small net loss on the bonds, since all of them will have greater than 10% current yields, and still exceed a 10% total annualized return.

The risk is a default. Credit risk is the risk. The risk is heightened by two events occurring at the same time: a decline in crude prices and money flying out the door to the common share owners. Hopefully, if distributable cash flow turns negative, LINN will cease making distributions to the common share owners in order to avoid a default on its senior debt obligations that would probably quickly lead to a bankruptcy filing. After a BK, interest payments on debt obligations cease of course, and it becomes a question of how many cents on the dollars are available for the unsecured senior creditors.

I am not concerned about interest rate risk for a bond maturing in April 2020, particularly given the low inflation forecasts embodied in the 5 year treasury TIP. The break-even spread for the 5 year TIP closed last Friday (12/12/14) at 1.2%:

Subtract Yield on the 5 Year TIP= .33%
Daily Treasury Real Yield Curve Rates

From the Yield of the 5 Year Non-Inflation Protected Treasury= 1.53%
Daily Treasury Yield Curve Rates

The average annual CPI increase would need to be 1.2% over the next five years for the 5 year TIP buyer to break-even with the buyer of the non-inflation protected 5 year treasury.

Thursday, December 11, 2014

Sold 206+ IRC at $10.945/Bought 50 BKSC at $14.6 Regional Bank Basket

Big Picture: No Change

Stable Vix Pattern (Bullish):


Recent Developments:

China's consumer price index rose 1.4% Y-O-Y in November, a five year low.

For 2015, Citigroup anticipates a "9% total return on global equities and a 1.5% return on fixed income."  Barron's

OPEC forecasted that the demand for its oil in 2015 would decline to 28.9M barrels per day, down from an estimated 29.5M barrels per day this year. That forecast, along with a surprise rise in oil inventory for the week ending 12/5, sent crude prices tumbling down last Wednesday. Spot Prices for Crude Oil and Petroleum Products Perhaps their motive for making this prediction is not pure.

Oil inventory rose 1.5M barrels to 380.5M barrels while the consensus estimate was for a decline of 2.7M barrels.

EIA Petroleum Status Report 12/5/14.pdf

U.S. oil reserves continue rising, surpass 36 billion barrels for first time since 1975-EIA (12/5/2014)

Household net worth decreased slightly in the third quarter according to the Federal Reserve's Z.1 Flow of Funds report. Net worth was reported at $81.3 trillion. The value of stocks declined by $700B while the value of real estate increased by $245B. Household debt increased at an annualized rate of 2.7%.

Retail sales increased by .7% in November, compared to October, and were up 5.1% over November 2013. census.govpdf  Retail sales ex-autos rose .5%. The consensus forecast was for a .4% gain and .1% ex autos.


***********************

1. Sold 206+ IRC at $10.945-Satellite Taxable Account (Equity REIT Common and Preferred Stock Basket)(see Disclaimer): Before the FED's Jihad Against the Savings Class was underway, I had a savings account at an online bank that was used to fund CD purchases.

When the FED announced its ZIRP policy late in 2008, I went online and purchased several longer term CDs, with the longest being 2 years as I recall. All of them paid more than 4%. It did not occur to me at that time that the Jihad Against the Savings Class would last at least 6 years. My best guess in November 2008 was 2 to 3 years.

As those CDs and others came due, I refused to accept the rates then being offered, which produced a negative real rate of return before taxes.

I set up a brokerage account instead and started to buy dividend paying stocks. I have a strong emphasis on capital preservation for those funds. I would be content to buy 1 year, FDIC insured CDs, with a 4% coupon, that pay interest monthly. Maybe I will be able to do that before I meet the Great Stock Jock in the Sky. It may be a close call however. Maybe it will happen when Congress decides to repeal the tax on my SS benefits, a tax on a tax.

Snapshot of Trade:

Snapshot of Profit:

2014 IRC 206+ SHARES +$122.33
Dividends: $67.68

Item # 3 Added 50 IRC at $9.93  (10/11/14 Post)Item # 6 Bought 150 IRC at $10.35 (3/3/14 Post)

Total Return: $189.91 (or 8.91% based on total cost of $2,130.58)


Security Description: The Inland Real Estate Corp. (IRC) is a self-advised and managed small REIT that owns retail centers, primarily in the Chicago and Minneapolis MSAs. IRC owned interests in 136 properties with 15M square feet of leasable space as of 9/30/14. The company is expanding into the Southeast. Corporate Profile

Pictures of Recent Acquisitions

Company Website: Inland Real Estate

Inland Real Estate Profile Page at Reuters

Inland Real Estate Key Developments Page at Reuters

I view this REIT's dividend history extremely negatively for two reasons. First, there was a monthly dividend slash from $.08167 to $.0475, effective for the May 2009 payment. Second, the dividend has not been raised since that slash. Inland Real Estate Corporation (IRC) Dividend History

The long term chart shows a rise from $9.5 (May 2004) to $20.83 (February 2007), followed by a downward sloping plunge to $6+ in March 2009.

The last investor presentation was made in October 2014: IRC (map showing concentration in Chicago and Minneapolis at page 8)

SEC Filings for IRC

Inland Real Estate sold 4M shares of a 6.95% series B cumulative preferred stock in October. The offering price to the public was $25, raising an estimated $96.45M net of the underwriting discount and before IRC's expenses related to the offering. Inland Real Estate Corp. 6.95% Cumulative Preferred Series B (IRC.PB )

Inland Real Estate announced on 10/6/14 that it had completed the acquisition of Prairie Crossings cash consideration of $24.7M. That retail development is in "an affluent southwest suburb of Chicago" and consists of approximately 109,000 square feet of leasable space. The anchor tenants are Office Depot, Bed Bath & Beyond, Kohl's and Sports Authority. Other tenants include Panera Bread, Game Stop and Chipotle. The press release has a picture.

Inland Real Estate also announced in October a joint venture to develop a 158,000 square foot retail power center in Elizabeth City, N.C. that is approximately 70% pre-leased to several retail firms including TJ Maxx, Dollar Tree and Hobby Lobby.

Last Quarterly Report: IRC- Q/E 9/30/14 SEC Form 10-Q

Earnings Press Release 11/4/14

Rationale: I am going to transfer ownership of this REIT to the Roth IRA.

The dividend slash in 2009, going from $.08167 to $.0475, and the lack of any raises since that slash, takes the air out of meaningful capital appreciation possibilities in my opinion. The best near or intermediate term option for IRC shareholders would be an acquisition at a premium price (20% to 30% above the current market price). It is hard for me see the current management generating material upside share appreciation given this REIT's history.

As mentioned above, I had a strong capital preservation emphasis in this satellite taxable account.

Future Buys: I will postpone my next purchase until I can buy shares at below $10.25.

Closing Price Today:  IRC: $10.95 +0.03 (+0.27%)

2. Bought 50 BKSC at $14.6 (REGIONAL BANK BASKET STRATEGY)(see Disclaimer): The last update for this basket strategy was published on 12/3/14. With this purchase, I am using some of the proceeds realized from selling Susquehanna Bancshares after it agreed to be acquired by BB & T. Sold SUSQ: 100 at $13.2 and 30 at $13.10-Being Acquired by BBT

Snapshot of Trade: This stock is a micro cap and is lightly traded. The average three month volume at the time of my trade was 3,128. The total market capitalization is about $65+M at a $14.6 market price.


I used a limit order to buy this odd lot. A bid-ask spread of $.10 to $.2 is fairly normal. My first two efforts to buy using limit orders were unsuccessful.

Prior Trades: None

Company Description: The Bank of South Carolina (BKSC) is the holding company for the Bank of South Carolina which has four banking offices in the Charleston, S.C. area.

Pictures of Main Office and 3 Branches: Locations

The main office is located at 256 Meeting Street, Charleston, S.C. (256 Meeting St - Google Maps).

The bank's South Carolina market share for deposits was just .46% and at 3.35% in Charleston country.    

The Bank of South Carolina did not participate in TARP, which I view positively.

Dividends: I would give this bank a "C" for its dividend history described below. While this history is understandable under the circumstances, I still view it negatively.

The company paid a 10% stock dividend in 2010 (page 9) and several others prior to then. BKSC Historical Prices

The current quarterly dividend is $.13 per share. Dividends A $.10 special dividend was paid in October 2014. Prior special dividends were paid in 2006 ($.0929 per share), 2003, 2002, 2000,  and 1997 ($.1365)

The Bank omitted the 2009 third quarter dividend in order to increase loan loss reserves. It appears that the 2010 dividends for the first and second quarters were likewise omitted.

The bank then resumed its dividend payments after slashing the quarterly rate from the prior $.1455 per share to $.0909 (both penny rates are adjusted for the 10% stock dividend paid in 2010).

At the current quarterly rate of $.13 per share, the dividend yield is about 3.56% at a total cost of $14.6 per share.

Chart: The long term chart, which starts in September 1986, looks good to me but I am easier to please than most. BKSC Interactive Stock Chart

There has been some drama along the way.

After a parabolic spike from $2.85 (April 2005) to $13.82 (April 1998), there was a price adjustment to that parabola that took the price down to $6.75 (April 2000), a period that coincided with a recession and the infamous savings and loan crisis that ended up costing taxpayers an estimated $124B to clean up.

The stock thereafter went into a channel pattern trade, mostly churning in the $6 to $9 range, before taking off again. The apex, near $15.65, was hit in August 2006, whereupon the stock started to roll over again. Regional bank stocks started to roll over at various times throughout 2006, giving an early warning signal of problems that the overall market was ignoring until 2008.

A lower channel was then formed, starting in October 2008 and lasting until March 2013, where the stock price churned largely between $9 to $12. By September 2013, the stock had reached an all time high over $16 before retreating to its current level. Regional bank stocks have been churning in price throughout 2014 after having robust gains in 2013.

The regional bank ETF KRE, which I own, had a 2013 total return of 47.5% based on price. KRE's total return was -1.75% in 2014 through 12/10/14.

Last Earnings Report: The earnings reports during 2014 has not been inspiring, but contain many positive qualities that justified a nibble at this time. BKSC reported diluted earnings per share of $.25, up from $.24 reported in the 2013 third quarter. That is the uninspiring part.

The following informing is sourced from the last 10-Q filing: Q/E 9/30/14 SEC Form 10-Q

The returns on average assets and average equity were 1.23% and 11.52% respectively (page 40).

Deposits increased 10.31% or $31.774+M to $329.275+M compared to the 2013 third quarter (page 39) Non-interest bearing demand deposits constituted 33.21% of the total. The average yield on interest bearing deposits was .19% (page 40)

Average loans increased by $6.257M.  Outstanding loans equaled 69.75 of total deposits at quarter's end.

The risk-based capital ratio was good at 14.81% as of 9/30/14 (page 48)

For the third quarter, the bank had charge-offs of $18,038 and recoveries of $12,206. The allowance for loan losses to total loans stood at 1.47% as of 9/30/14.

Bank of South Carolina Corporation Announces Third Quarter Earnings

I took the following information from a fact sheet prepared by the bank that compiled data for the trailing 4 quarters: BKSC.pdf

ROAA:  1.19%
ROAE: 11.66%
Net Interest Margin 3.69%
Efficiency Ratio: 60.24
Loans/Deposit Ratio: 69.75
NPA Ratio: .33% (non-performing assets to total assets)
Allowance of Loan Losses to NPAs: 275.28%

The NPA ratio is excellent.

The coverage ratio of 275.28% is comforting for a new owner.

BKSC's returns on average assets and average equity are well above BKSC's peer group numbers. Generally, I like to see ROA at over 1% and ROE over 10%.

Rationale: On balance, this small micro cap bank appears to be competently managed, as reflected in the  preceding data.

Prior to the recent Near Depression, the bank was steadily raising its dividend, going from a quarterly rate of $.0063 in 1989 to $.1455 in 2007. Those numbers appear to be adjusted for the several stock dividends paid by the bank.

Hopefully, the bank can return to a similar growth path in the coming years. The dividend rate doubled from $.0727 (first paid in the 2005 first quarter) to $.1455 (first paid in the 2007 second quarter).

Recessions and bank profits do not go together well. The last recession was a particularly bad for the banking industry. The FDIC has a long list of banking failures:  FDIC: Failed Bank List

Needless to say, when the FDIC seizes the operating subsidiary of a bank holding company, the bank holding company has lost its principal asset. The liabilities at the holding company level will most likely exceed the market value of any remaining assets. In other words, the common and any preferred stocks become worthless.

Knowing that the downside risk is a zero stock price after an FDIC seizure of a failed bank, I place some emphasis on banks that successfully navigated the last Near Depression, continuing to earn profits and paying dividends.

I can look a 10-K filing and find that pertinent historical data that tells me how the bank performed during the last major banking crisis.

BKSC remained profitable in 2008-2013, and I view that as important. Annual E.P.S. did decline Y-O-Y in 2009 but then increased in each year thereafter:



Historical Data 2013 10-K at page 11

I would describe the Charleston area as a vibrant economy. Forbes (tied for 7th in projected 2015 job growth); Charleston SC Employer Statistics Population grew 7.2% to 712,200 between 2010-2013.

Given its small size, this bank would be a mere morsel for a large banking institution who wants to expand in the Charleston, S.C. geographic area. I would not base an investment decision based on that possible outcome.  

Risks: Bank stocks will be poor performers during a recession. Hopefully, investors do not need to be reminded of that fact.

BKSC is a small fish even in its home market. It has several large and well known competitors. Many banking customers prefer to avoid those large institutions whenever possible that allows for a small bank like BKSC to find a niche.

Net interest margin compression is an ongoing problem for banks. Deposits have already repriced to abnormally low levels and have no meaningful downside left. With the decline in interest rates, the spread between the cost of funds and the yields on investments and loans contracts, and the net interest margin spread is a major source of bank earnings and earnings growth.



Net Interest Margin for all U.S. Banks-St. Louis Fed

Rightly or wrongly, investors believe that a rise in intermediate and long term rates will help banks by improving their net interest margins. Regional banks had an exceptional year in 2013 when intermediate and longer term interest rates rose significantly. I would note that it takes time for a positive impact to occur and the rise in rates can hurt profits too. A number of regional banks saw their mortgage origination business decline significantly during that rate spike last year. The bank's investment portfolio will also be declining in value and there will be less profits available from selling available for sale securities.

In part, I view the regional bank basket as an interest rate hedge of sorts for my somewhat larger REIT basket: REIT and Regional Bank Baskets

Banks have been faced with increases in regulatory costs since the recent Near Depression.

Future Buys: Whenever I buy 50 shares, I am most likely contemplating a possible average down at a lower price and have simply chopped a potential 100 share order into two pieces. While I do not have a downside target price set, I would consider buying the other 50 shares near $14. If there is no material adverse change, I will buy the next 50 shares at below $14.