Dividend Tax Rate in 2011?/Bought 50 NPBCO at 23.09/ Bank Director's Magazine Bank Rankings/GS & the SEC/

The ^VIX has closed 40 consecutive days below 20. The DJIA volatility index closed last Friday at 14.63 and has been moving continuously below 20 since a close at 19.35 on 2/16/2010: Djia Volatility Chart I would generally require continuous movement below 20 for 3 months before declaring the start of a Stable VIX Pattern, though this is not a hard and fast rule. Vix Asset Allocation Model Explained Simply With as Few Words as Possible Historically, once the Stable Vix Pattern forms, a bull market in stocks has lasted for several years. The two previous periods, where the Stable Vix Pattern formed out of the Unstable Vix Pattern, were in 1991 and 2003, with the cyclical bull move thereafter lasting six and four years respectively. VIX and S & P Compared 1990 to 1997 & Item # 7 Historical VIX Patterns Of course, this time may be different.

1. The Fabulous Fabrice Tourre: Apparently, the source of some of the Fabulous Fab's emails is a girlfriend, identified in the press as Marine Serres. Some of the new disclosures can be found at the WP and the WSJ which shows Fabulous to be a cad and not a sympathetic individual. In short, about what I would expect him to be working at GS. I am surprised that his attorney is allowing him to testify before the Senate on Tuesday, unless he has a cogent and convincing explanation for some of his emails that contradict the conclusions being drawn by the SEC. He did meet with Senate investigators on Saturday.

The most damaging email is his response to a request from ACA about Paulson's role in Abacus. This email is summarized in paragraph 47 of the Complaint:

"On January 10, 2007, Tourre emailed ACA a “Transaction Summary” that included a description of Paulson as the “Transaction Sponsor” and referenced a “Contemplated Capital Structure” with a “[0]% - [9]%: pre-committed first loss” as part of the Paulson deal structure. The description of this [0]% - [9]% tranche at the bottom of the capital structure was consistent with the description of an equity tranche and ACA reasonably believed it to be a reference to the equity tranche. In fact, GS&Co never intended to market to anyone a “[0]% - [9]%” first loss equity tranche in this transaction. "

www.sec.gov/litigation/complaints/2010/comp-pr2010-59.pdf

I did notice in the FlipBook at page 14 that the "first loss" tranche was "Not Offered". Abacus 2007-Ac1 Flipbook 20070226 Pelligrini told the SEC that there was no equity tranche in Abacus. News Headlines

If Tourre is going to be allowed to testify by his attorney, I will be most interested in hearing his explanation on this particular contention by the SEC. If his excuse is to say that it was a mistake, or something along those lines, he would be better off staying in England.

The SEC does not address in the Complaint other information, possessed by it, that contradicts the main contention in the allegation contained in the foregoing paragraph. These omissions include the testimony of the Paulson point man that he told ACA of Paulson's intent (WSJ), ACA had the legal authority to select the securities and their interest was aligned with the German bank, and the fact that these synthetic CDOs exist for the sole purpose of providing experienced institutional investors the opportunity to go both long and short. The Abacus transactions was just a form of casino gambling. An apt analogy was made by Thomas Donlan in his Barrons column, comparing it to a game of craps.

The NYT has mentioned reports that Tourre received 2 million in compensation in 2007, partly due to his work on the Abacus deal.

I also noted this detail while reviewing the "Transaction Overview" referenced by the SEC in paragraph 47:

"The upward-sloping fee structure increases ACA’s incentives to avoid losses relative to a standard flat fee accrued on the overall reference portfolio notional amount."

Goldman's position paper, apparently for use in Lloyd's testimony this week, can be found at online.wsj.com /goldman pdf This is a harder story to tell than the one that the public will gleam from the FAB's emails.

The SEC is apparently telling the press that none of the revelations last week involving ACA impact the part of its case dealing with the German bank IKB: SEC confident on IKB part The alleged reason for this fall back position is that IKB wanted an independent selection agent, and instead got ACA who took suggestions from Paulson's firm. This argument still overlooks the extremely inconvenient truth that ACA's interests were aligned in a big way with IKB, not with Paulson, and ACA had the sole legal authority to make the final selections.

The basic problem, ignored by the SEC, was that both IKB nor ACA were wrong about the future value of these subprime mortgages, and Paulson turned out to be right. At the time, a lot of "professional" investors would have sided with IKA and ACA's side of the bet. ACA ended up losing for its parent company far more money than IKB. Possibly someone needs to drill that point home to the SEC. Apparently these points about alignment of interests and legal authority go way over the head of the reporters writing about this case. The SEC is trying to sweep inconvenient facts under the rug. As I understand the SEC's enforcement chief, Robert Khuzami, believes that it is okay for the long and short to work together on selecting the securities for the synthetic CDO, since he apparently blessed those transaction when he worked for Deutshe. (WSJ). But if a firm is employed to select securities, whose interest is unquestionably tied to the long side, it is wrong according to Khuzami for that long interest only investor to work with the short side investor to select those securities.

In the last analysis, however, the purpose of Abacus transaction was to provide a vehicle for Paulson to short the subprime mortgage market. The effect was to both magnify and spread the losses from those securities. The European financial institutions that were the patsies suffered close to 1 billion dollars in losses just from this one transaction, and both had to be bailed out by their host governments.

2. What Will be the Tax Rate for Dividends in 2011?: The short answer is that no one knows now. The 15% maximum rate for qualified dividends is set to expire at the end of this year. It is far from clear that Congress will be able to do anything to resolve their differences on this issue. The Republicans would want to extend it and to allow the wealthy the benefit of the current tax rate. The Democrats want to apply a higher rate to taxpayers making what they consider to be a lot of money, usually defined by them to mean a couple with annual income of over $250,000. This is an important issue for those of us who invest in fixed coupon equity preferred stocks that pay qualified dividends. If their favorable tax treatment is taken away, then their appeal would certainly be diminished and it would be reasonable to predict a fall in price to reflect any negative tax change. The same may happen to electric utility stocks. Many pay dividends at their current prices in the 5 to 6% (some pay over 6%) which makes them appealing to conservative investors in high tax brackets now due to their after tax yields. In effect, the after tax yield would in many cases be more attractive than the after tax yield from their bonds, in part due to the differences in tax rates applied to those types of investments. But, if nothing is done, the new top rate for dividends will be the same as interest.

Although I own some fixed coupon equity preferred stocks, I view those securities as a disfavored asset class and consequently keep my total commitment small. If it looked like the favorable tax treatment was about to expire for them, I would consider selling them and moving up the priority chain.

An article in the WSJ highlights the uncertainty now about what will happen in 2011 regarding dividend tax rates.

3. Bank Director's Magazine 2009 Bank Performance Scorecard: A reader let me know that Bank Director's Magazine has released its 2009 bank performance scorecard: bankdirector.com/PDF/ A summary of the results can be found at Bank Director Magazine. Glacier Bancorp (GBCI) is at #3, and is the only bank in the top 20 where I have a common stock position in my regional bank strategy. I do own SIVBO, a TP issued by #17 SVB Financial and an equity preferred from #19 Oriental Financial Group. I also own common shares in #28, #29, # 30, #31, #32, #37, # 42, #43, #53, #56, #58, #69, #71, #88, #89, #90, #94, #97, #114, #122, and #126.

Regional Bank Stocks

4. Red Flags in Bank Accounting: This article in Seeking Alpha highlights some red flags to consider when evaluating whether to purchase a bank stock. One item is the percentage of non-performing loans to total loans. I also focus on the allowance set aside as a percentage of non-performing loans. Many trouble banks will frequently have reserved a low percentage for even their non-performing loans.

The author also mentions the Texas ratio which is another item worth considering. Fortunately, I have a reader who sends me spreadsheets containing calculations of the Texas Ratio. Being a philosopher, I have never prepared a spreadsheet in my life and most likely never will.

The author of the Seeking Alpha article also mentions TCE (Tangible Common Equity"). Tangible common equity is considered more conservative than the tier 1 capital ratio since it excludes preferred stock and intangible assets. An example of an intangible asset would be deferred tax assets, which may have an uncertain value or even no value in cases where the firm is not able to generate future profits. A bank losing a lot of money might have a large deferred tax asset which inflates its other capital ratios. TCE is calculated generally to mean tangible common equity divided by tangible assets.

I have never had an accounting course, but these concepts are fairly easy to understand and worth knowing for individuals investing in bank stocks.

5. Bought 50 NPBCO at $23.09 (See Disclaimer): NPBCO is a Trust Preferred from NPB Capital Trust II, a Delaware Trust, that has as its underlying security a junior bond issued by National Penn Bancshares (NPBC). National Penn is primarily a regional bank operating in Pennsylvania and has 127 offices.

NPBCO is a typical bank TP. The coupon is 7.85%. Par value is $25. The bond matures on 9/30/2032. At a total cost of $23.09, the yield is around 8.5%. I do not believe this TP is rated. The bid/ask spread early this morning was 23/23.09, when I placed the order, so I just placed a limit order to buy 50 shares at $23.09.

A link to the prospectus can be found at www.sec.gov. Provided no cash dividend is being paid on a junior security, the TP's interest payments may be deferred up to 5 years. The interest payments are cumulative and deferred payments earn interest at the coupon rate (see p. 47). The stopper provision is standard.

Since National Penn still has outstanding equity preferred stock issued to the government, the TP interest payments can not be deferred unless National Penn first eliminates its common share dividend and defers the cumulative preferred dividend payable to the government. National Penn is currently paying a quarterly stock dividend of 1 cent. Any cash dividend is sufficient to activate the stopper provision.

I have been reluctant to pay this TP until recently due to the large losses suffered by this bank in 2009. The bank reported a 356.379 million dollar loss shown for 2009. The total net income for the preceding four years was 219.276 (see page 31 Annual Report npb10k.htm) Part of the 2009 loss was a goodwill impairment charge of 275 million. The bank did raise some equity capital in 2009 through a common stock issuance of 31 million shares, raising a net 153.3 million. The bank has not paid back the 150 million in TARP funds received from the government.

The bank did report a small profit of 2 cents per share in the 1st quarter of 2010: ex99-1.htm The total capital ratio was 14.17% as of 3/31/2010. Allowance for loan losses to nonperforming loans was at 127.8%. Net interest margin was 3.44%.

6. Southwest Bancorp (OKSB)(own-Regional Bank Stocks strategy): Southwest announced this morning that it will be offering newly issued common stock to raise gross proceeds of approximately 40 million dollars. exv99

OKSB closed on Friday at $15.37, and I purchased shares at 6.84 in January 2010. I believe that the government still owns 70 million in preferred stock (see annual report at p. 22 and balance sheet at p. 33)