In the new weekly format, random political and non-investment related events will be haphazardly discussed at the end.
Big Picture Opinion-A Brief Synopsis
Stable Vix Pattern-A Bullish Cyclical Cycle
Stocks: Short Term Cautious-Slightly Bearish/Intermediate and Long Term Bullish
Bonds: Short Term Neutral/Intermediate Term-Slightly Bearish /Long Term Extremely Bearish
The most positive long term economic factor in the U.S. is the ability to refinance debt at abnormally low rates. For homeowners, the savings will improve consumer purchasing power, the main driver of the U.S. economy for a very long time.
The impact is showing up in a variety of data, including the rapidly declining debt service payments as a percentage of disposable income. The household debt service ratio (DSR) for the 2012 second quarter was 10.69%, the lowest since 1993. Household Debt Service and Financial Obligations Ratios
The Federal Reserve has another ratio, called the financial obligation ratio (FOR) which adds to the DSR automobile lease payments, rental payments on tenant-occupied property, homeowners insurance and property tax payments. The FOR ratio was 13.97 in the 2012 second quarter, down from 17.63 in the 2007 third quarter, and at the lowest level since the third quarter of 1984.
Consumer spending is a main driver of U.S. GDP. The re-emergence of the American consumer is being confirmed by both hard and soft data. Among the soft data, the Conference Board reported yesterday that its consumer confidence index increased to 72.2 in September, the highest level since February 2008 and up from 68.4 in September. Does that confidence translate into actual spending? The TJX Companies reported yesterday a 7% increase in same store sales over the 4 week period ending 10/27/12. Macy’s reported a 4.1% increase in comparable store sales. Costco Wholesale's same store sales were up 7%. Retail Report on October 2012 Retail Sales Figures Macy’s, TJX, Kohl’s Rise on Sales Reports
Publicly traded corporations have been able to refinance their debt at even lower rates in many cases. Lower interest payments will improve profitability for many years to come.
The ultimate losers from this process will be those holding the abnormally low interest rate paper when the worm turns. And the worm will turn, most likely with a vengeance given the current abnormally low yields as a starting point. The long term bull market in bonds kicked off in 1981-1982 when a thirty year treasury bond was yielding over 14%. That bond is now yielding less than 3%. The bond bulls will be gored. Timing is the only issue.
The ongoing rise in home prices will make it easier for more Americans to refinance.
The Case Shiller indices for home prices, both the 10 and 20 metropolitan areas, increased by .9% in August versus July 2012. The 10 and 20 city recorded annual returns of 1.3% and 2% respectively in August 2012. The largest percentage increases in August, compared to July, were Atlanta (1.8%); Detroit (2.3%); Las Vegas (1.6%); Los Angeles (1.3%); Miami (1%); Minneapolis (1.2%) and Washington (1.1%).
On 10/24/12, the government reported that new residential sales rose 5.7% in September and the average sales price was $292,400 (median at $242,400 vs. $217,000 a year ago). census.govpdf
The foregoing positive trends are viewed by me as far more important than the result's of next Tuesday's election; and even more critical than a resolution of the upcoming fiscal cliff.
On a worldwide basis, the most positive long term trend is the growth of middle class consumers in emerging markets, most of whom have not yet discovered the credit card. The size of that class will dwarf the numbers of U.S. consumers, gradually demoting the U.S. to a far less important driver of worldwide economic growth over the coming years and decades.
*****
Brett Arends noted in his WSJ column that bond CEFs are "showing ominous signs of a bubble", as many of them are now selling at significant premiums to their respective net asset values. Arends also notes that several stock CEFs, including Adams Express (owned), are selling at greater than 10% discounts to their net asset value.
My most significant bond CEF position is Wells Fargo Advantage Multi-Sector Income Fund (ERC) which is selling at a negligible discount to its net asset value. I own 550 shares. (ERC page at the CEFA) At the moment, given my unrealized profit and concerns about bond prices, I am at best a weak holder of those shares.
1. Sold Remaining ISM at $23.84 (see Disclaimer): I waited until these shares were held for more than a year before selling them. This lot was purchased on 10/5/11. I realized a LT gain of $201.07:
Bought 50 ISM at 19.5 (October 2011). The foregoing snapshot also captures the 50 shares sold earlier this year that were bought at $20.62.
Quote: SLM CPI-Linked Medium Term Notes Series A 2018
Security Description: ISM is a senior unsecured bond issued by SLM, generally known as Sallie Mae, that matures in 2018 at $25. Interest is paid monthly based on a 2.05% spread to CPI (Consumer Price Inflation), calculated in the manner described in the prospectus and my earlier posts. Prospectus; Item # 1 Stocks & Politics: OSM
ISM and OSM are functionally equivalent securities from the same issuer, differing slightly on the CPI spreads and the maturity dates.
Most Recent Earnings Release: SEC Filed Press Release for the Q/E 9/30/12
Trading History Synopsis: SLM has two exchange traded senior unsecured notes (OSM and ISM) that make monthly interest payments tied to a spread over a CPI calculation. Both have $25 par values. When I first started to discuss these notes in 2008, both were trading near $10. CPI and CPI Floaters-OSM (December 2008-discussing a buy near $10); Item # 2 CPI FLOATER: OSM; CPI FLoaters PFK AND OSM. I have bought ISM shares as low as $11.85 (8/3/2009)
I have flipped ISM and OSM repeatedly for the reasons discussed in the Rationale section of this post, while I have kept my shares of the Prudential CPI floater PFK. Bought 100 PFK at 18.47, Bought 90 PFK in IRA $18.94, Added 50 PFK at $17.83, Added 50 PFK in Roth at 20.88-Averaged UP. The difference in trading history for these similar securities is solely based on my assessment of credit risk.
Rationale: There are several considerations that led me to sell this security.
(1) Credit Risk, Time to Maturity, and Potential Upside from $23.84: I do not believe that it would be reasonable to forecast a price above par value prior to maturity, based upon what is known now about SLM's credit risk and the likely inflation rate reflected in the five year TIP break-even number. This would limit my potential upside to the $25 par value or about a 4.8% increase from $23.84.
SLM senior unsecured bonds are currently rated junk by Moody's at Ba1 and the lowest investment grade level by S & P at BBB-. (summarized at New Issue-SLM Corp) The firm is highly leveraged, and has a constant need to refinance maturing debt. When assessing future risks, it is important to keep in mind that a lot of things can go wrong. One major recent event, occurring after this note was issued by SLM, was the withdrawal of the government's guarantee for future SLM issued student loans. That event was a significant adverse development. Other unforeseeable events may also occur that will increase the credit risk for these notes before maturity. Are the known and unknown risks worth an extra 5% in appreciation? Maybe it would for some investors, but not for me.
(2) Realized Gain in Relation to Interest Payments Foregone: When I recently sold three TIP bonds, I noted that the interest payments until maturity would be less than the realized gain. And, I would forego a good chunk of the realized gain by holding those bonds to maturity. Item # 3 Sold 3 TIP Bonds Maturing in 2019 at 120.45 In this kind of analysis, it is not relevant whether I could have waited and sold those bonds at 122.
What was my last interest monthly interest payment on ISM?
While that amount will fluctuate depending on the CPI calculation, I am not currently anticipating a material jump in that amount. At a $4 per month payment, the annual take would be $48.
What was my long term capital gain on the shares with no further exposure to the credit risk? Answer=$201.37
With $48 in annual interest payments taxed at my highest marginal rate, it would take over 4 years for me to equal the LT realized gain, and there are a lot of bad things that can happen in four years. The note matures in a little over five years.
Some investors believe that risks decrease by holding a security long term. I am not one of them. As the period of ownership increases, measured in years, so do the risks resulting from some change, usually one that can not be predicted except possibly as a guess. Duality of Long Term Risks Those risks would be far more pronounced with an individual security selection, compared to a total stock or bond market ETF. Yet, even if the individual investor bought the iShares Trust Dow Jones U.S. Index Fund (IYY), with the widest exposure to U.S. stocks, the investor has not eliminated the long term risk.
Instead, even with a security like IYY, the investor has only eliminated the long term risk associated with an individual security selection. Due to situational risks, involving the individuals particular need for the cash tied up in stocks, there may be extended blocks of time when even the broadest ETF exposure to stocks loses value to inflation even after reinvestment of dividends. The Roller Coaster Ride of the Long Term Secular Bear Market; To Professor Siegel: Time for a Re-Think.
While many new investors do not yet fully appreciate it, there are long term secular bear markets in bonds too, and the next one is likely to be extremely nasty in my opinion given the starting point in yields.
Lastly, it is also possible that the LT tax rate will change to my detriment on 1/1/13.
3. Right Brain's Contrary Point of View For Holding ISM-Have Your Cake and Eat It Too: For those willing to shoulder the credit risk, holding this bond until maturity could produce both a steady flow of monthly income, protected in part from interest rate risk caused by inflation, given the built in spread to CPI, plus some additional profit on the security. If SLM survives to pay par value, and I had held the 50 ISM shares, I would have realized more profit on the shares as well as the income. In this sense, ISM is different from the three 2019 TIPs that were sold. ISM would increase slightly in value in to maturity, whereas those three TIPs would have a principal value significantly less at maturity than my sales price of 120.45.
I could use the proceeds received from the bond sale and invest them in a higher yielding security likely to generate 3%-4% more per annum than ISM, assuming current inflation estimates prove to be near the mark. An example would be CYSPRA, mentioned below.
RB would have held ISM until maturity, whereas the Old Geezer decided to sell it after balancing all factors including the reinvestment options for the proceeds. LB sided with the OG. "The Nerd Machine is way too cautious, and the OG is way past his prime and needs to retire to the Old Folks Home to play checkers and listen to Frank Sinatra all day", the RB retorted.
Yesterday's Close: ISM: 24.40 +0.55 (+2.31%) Volume is typically light with a large bid/ask spread.
Future Buy?: While it may never be mentioned in a weekly post, I would consider repurchasing either OSM or ISM shares below $20 after reviewing recent SLM news and earnings reports first, in order to make a judgment about the credit risk and the reasons behind the decline in price. After this last transactions, I have no position in SLM securities.
*************************************************************
2. Bought 50 CYSPRA at $25.2-ROTH IRA (see Disclaimer)
Security and Company Description: CYS Investments is a Mortgage REIT.
CYS Investments Profile Page at Reuters
I bought this REIT's recently issued equity preferred stock. CYS Investments Inc. Cum. Redeem. Pfd. Series A (CYS.PA)
CYSPRA has a 7.75% coupon on a $25 par value. Dividends are cumulative and are paid quarterly. Given the REIT's tax status, distributions will not be characterized as qualified dividend.Prospectus Supplement This security just went ex dividend for its 4th quarter distribution. Dividend payments are scheduled on 1/15; 4/15; 7/15 and 10/15.
While dividends are cumulative, no interest accumulates on the deferred amount.
The equity preferred dividend can not be deferred for as long as the company pays a common share cash dividend. I refer to that provision in the prospectus as the "stopper clause". It stops the issuer from deferring the preferred dividend while making any payment to the common shareholders. Once the common share cash dividend is eliminated, however, the preferred dividend can be deferred by the issuer. (Prospectus as page 25)
With limited exceptions, the security can not be called prior to 8/4/17. Given the large number of redemptions now occurring, it is important to check the optional call date provision when purchasing the preferred stock at more than its par value. One of the exceptions involves a "change in control" (see page S-2 to S-3).
Individual investors who invest in bonds and preferred stocks need to become familiar with "change of control" provisions. The presence of such a provision can become quite important when there is a leveraged buyout (LBO). The buyer in LBO's will load the company up with senior secured debt in order to finance the deal, thereby making all junior securities more risky. It is not unusual to see investment grade senior debt downgraded deep into junk status after an LBO.
Who would want a "change of control" provision in an equity preferred prospectus? As a buyer of that security, I would want one. One example will suffice to explain why. Many years ago, there was a leveraged buyout of a REIT called Innkeeper's Trust. The common shareholders received a nice premium for their common stock. The REIT also had a publicly traded cumulative equity preferred stock, and the owners of that security could not force a buyout of their security. So what happens next? The end of the story is that the preferred stock was delisted, then the dividend was deferred, and eventually the over leveraged REIT declared bankruptcy. Innkeepers Usa Trust News - Bloomberg
Recent Earnings Release: Like many Mortgage REITs, CYS has been reducing its common share dividend. The general problem is a narrowing spread between the cost of borrowed funds and the yield on mortgage securities.Big Picture Opinion-A Brief Synopsis
Stable Vix Pattern-A Bullish Cyclical Cycle
Stocks: Short Term Cautious-Slightly Bearish/Intermediate and Long Term Bullish
Bonds: Short Term Neutral/Intermediate Term-Slightly Bearish /Long Term Extremely Bearish
The most positive long term economic factor in the U.S. is the ability to refinance debt at abnormally low rates. For homeowners, the savings will improve consumer purchasing power, the main driver of the U.S. economy for a very long time.
The impact is showing up in a variety of data, including the rapidly declining debt service payments as a percentage of disposable income. The household debt service ratio (DSR) for the 2012 second quarter was 10.69%, the lowest since 1993. Household Debt Service and Financial Obligations Ratios
The Federal Reserve has another ratio, called the financial obligation ratio (FOR) which adds to the DSR automobile lease payments, rental payments on tenant-occupied property, homeowners insurance and property tax payments. The FOR ratio was 13.97 in the 2012 second quarter, down from 17.63 in the 2007 third quarter, and at the lowest level since the third quarter of 1984.
Consumer spending is a main driver of U.S. GDP. The re-emergence of the American consumer is being confirmed by both hard and soft data. Among the soft data, the Conference Board reported yesterday that its consumer confidence index increased to 72.2 in September, the highest level since February 2008 and up from 68.4 in September. Does that confidence translate into actual spending? The TJX Companies reported yesterday a 7% increase in same store sales over the 4 week period ending 10/27/12. Macy’s reported a 4.1% increase in comparable store sales. Costco Wholesale's same store sales were up 7%. Retail Report on October 2012 Retail Sales Figures Macy’s, TJX, Kohl’s Rise on Sales Reports
Publicly traded corporations have been able to refinance their debt at even lower rates in many cases. Lower interest payments will improve profitability for many years to come.
The ultimate losers from this process will be those holding the abnormally low interest rate paper when the worm turns. And the worm will turn, most likely with a vengeance given the current abnormally low yields as a starting point. The long term bull market in bonds kicked off in 1981-1982 when a thirty year treasury bond was yielding over 14%. That bond is now yielding less than 3%. The bond bulls will be gored. Timing is the only issue.
The ongoing rise in home prices will make it easier for more Americans to refinance.
The Case Shiller indices for home prices, both the 10 and 20 metropolitan areas, increased by .9% in August versus July 2012. The 10 and 20 city recorded annual returns of 1.3% and 2% respectively in August 2012. The largest percentage increases in August, compared to July, were Atlanta (1.8%); Detroit (2.3%); Las Vegas (1.6%); Los Angeles (1.3%); Miami (1%); Minneapolis (1.2%) and Washington (1.1%).
On 10/24/12, the government reported that new residential sales rose 5.7% in September and the average sales price was $292,400 (median at $242,400 vs. $217,000 a year ago). census.govpdf
The foregoing positive trends are viewed by me as far more important than the result's of next Tuesday's election; and even more critical than a resolution of the upcoming fiscal cliff.
On a worldwide basis, the most positive long term trend is the growth of middle class consumers in emerging markets, most of whom have not yet discovered the credit card. The size of that class will dwarf the numbers of U.S. consumers, gradually demoting the U.S. to a far less important driver of worldwide economic growth over the coming years and decades.
*****
Brett Arends noted in his WSJ column that bond CEFs are "showing ominous signs of a bubble", as many of them are now selling at significant premiums to their respective net asset values. Arends also notes that several stock CEFs, including Adams Express (owned), are selling at greater than 10% discounts to their net asset value.
My most significant bond CEF position is Wells Fargo Advantage Multi-Sector Income Fund (ERC) which is selling at a negligible discount to its net asset value. I own 550 shares. (ERC page at the CEFA) At the moment, given my unrealized profit and concerns about bond prices, I am at best a weak holder of those shares.
1. Sold Remaining ISM at $23.84 (see Disclaimer): I waited until these shares were held for more than a year before selling them. This lot was purchased on 10/5/11. I realized a LT gain of $201.07:
++$201.27.jpg){kind=small} |
| 2012 ISM 50 Shares (10/24) +$201.07 |
Quote: SLM CPI-Linked Medium Term Notes Series A 2018
Security Description: ISM is a senior unsecured bond issued by SLM, generally known as Sallie Mae, that matures in 2018 at $25. Interest is paid monthly based on a 2.05% spread to CPI (Consumer Price Inflation), calculated in the manner described in the prospectus and my earlier posts. Prospectus; Item # 1 Stocks & Politics: OSM
ISM and OSM are functionally equivalent securities from the same issuer, differing slightly on the CPI spreads and the maturity dates.
Most Recent Earnings Release: SEC Filed Press Release for the Q/E 9/30/12
Trading History Synopsis: SLM has two exchange traded senior unsecured notes (OSM and ISM) that make monthly interest payments tied to a spread over a CPI calculation. Both have $25 par values. When I first started to discuss these notes in 2008, both were trading near $10. CPI and CPI Floaters-OSM (December 2008-discussing a buy near $10); Item # 2 CPI FLOATER: OSM; CPI FLoaters PFK AND OSM. I have bought ISM shares as low as $11.85 (8/3/2009)
I have flipped ISM and OSM repeatedly for the reasons discussed in the Rationale section of this post, while I have kept my shares of the Prudential CPI floater PFK. Bought 100 PFK at 18.47, Bought 90 PFK in IRA $18.94, Added 50 PFK at $17.83, Added 50 PFK in Roth at 20.88-Averaged UP. The difference in trading history for these similar securities is solely based on my assessment of credit risk.
Rationale: There are several considerations that led me to sell this security.
(1) Credit Risk, Time to Maturity, and Potential Upside from $23.84: I do not believe that it would be reasonable to forecast a price above par value prior to maturity, based upon what is known now about SLM's credit risk and the likely inflation rate reflected in the five year TIP break-even number. This would limit my potential upside to the $25 par value or about a 4.8% increase from $23.84.
SLM senior unsecured bonds are currently rated junk by Moody's at Ba1 and the lowest investment grade level by S & P at BBB-. (summarized at New Issue-SLM Corp) The firm is highly leveraged, and has a constant need to refinance maturing debt. When assessing future risks, it is important to keep in mind that a lot of things can go wrong. One major recent event, occurring after this note was issued by SLM, was the withdrawal of the government's guarantee for future SLM issued student loans. That event was a significant adverse development. Other unforeseeable events may also occur that will increase the credit risk for these notes before maturity. Are the known and unknown risks worth an extra 5% in appreciation? Maybe it would for some investors, but not for me.
(2) Realized Gain in Relation to Interest Payments Foregone: When I recently sold three TIP bonds, I noted that the interest payments until maturity would be less than the realized gain. And, I would forego a good chunk of the realized gain by holding those bonds to maturity. Item # 3 Sold 3 TIP Bonds Maturing in 2019 at 120.45 In this kind of analysis, it is not relevant whether I could have waited and sold those bonds at 122.
What was my last interest monthly interest payment on ISM?
 |
| $3.81 |
What was my long term capital gain on the shares with no further exposure to the credit risk? Answer=$201.37
With $48 in annual interest payments taxed at my highest marginal rate, it would take over 4 years for me to equal the LT realized gain, and there are a lot of bad things that can happen in four years. The note matures in a little over five years.
Some investors believe that risks decrease by holding a security long term. I am not one of them. As the period of ownership increases, measured in years, so do the risks resulting from some change, usually one that can not be predicted except possibly as a guess. Duality of Long Term Risks Those risks would be far more pronounced with an individual security selection, compared to a total stock or bond market ETF. Yet, even if the individual investor bought the iShares Trust Dow Jones U.S. Index Fund (IYY), with the widest exposure to U.S. stocks, the investor has not eliminated the long term risk.
Instead, even with a security like IYY, the investor has only eliminated the long term risk associated with an individual security selection. Due to situational risks, involving the individuals particular need for the cash tied up in stocks, there may be extended blocks of time when even the broadest ETF exposure to stocks loses value to inflation even after reinvestment of dividends. The Roller Coaster Ride of the Long Term Secular Bear Market; To Professor Siegel: Time for a Re-Think.
While many new investors do not yet fully appreciate it, there are long term secular bear markets in bonds too, and the next one is likely to be extremely nasty in my opinion given the starting point in yields.
Lastly, it is also possible that the LT tax rate will change to my detriment on 1/1/13.
3. Right Brain's Contrary Point of View For Holding ISM-Have Your Cake and Eat It Too: For those willing to shoulder the credit risk, holding this bond until maturity could produce both a steady flow of monthly income, protected in part from interest rate risk caused by inflation, given the built in spread to CPI, plus some additional profit on the security. If SLM survives to pay par value, and I had held the 50 ISM shares, I would have realized more profit on the shares as well as the income. In this sense, ISM is different from the three 2019 TIPs that were sold. ISM would increase slightly in value in to maturity, whereas those three TIPs would have a principal value significantly less at maturity than my sales price of 120.45.
I could use the proceeds received from the bond sale and invest them in a higher yielding security likely to generate 3%-4% more per annum than ISM, assuming current inflation estimates prove to be near the mark. An example would be CYSPRA, mentioned below.
RB would have held ISM until maturity, whereas the Old Geezer decided to sell it after balancing all factors including the reinvestment options for the proceeds. LB sided with the OG. "The Nerd Machine is way too cautious, and the OG is way past his prime and needs to retire to the Old Folks Home to play checkers and listen to Frank Sinatra all day", the RB retorted.
Yesterday's Close: ISM: 24.40 +0.55 (+2.31%) Volume is typically light with a large bid/ask spread.
Future Buy?: While it may never be mentioned in a weekly post, I would consider repurchasing either OSM or ISM shares below $20 after reviewing recent SLM news and earnings reports first, in order to make a judgment about the credit risk and the reasons behind the decline in price. After this last transactions, I have no position in SLM securities.
*************************************************************
2. Bought 50 CYSPRA at $25.2-ROTH IRA (see Disclaimer)
Security and Company Description: CYS Investments is a Mortgage REIT.
CYS Investments Profile Page at Reuters
I bought this REIT's recently issued equity preferred stock. CYS Investments Inc. Cum. Redeem. Pfd. Series A (CYS.PA)
CYSPRA has a 7.75% coupon on a $25 par value. Dividends are cumulative and are paid quarterly. Given the REIT's tax status, distributions will not be characterized as qualified dividend.Prospectus Supplement This security just went ex dividend for its 4th quarter distribution. Dividend payments are scheduled on 1/15; 4/15; 7/15 and 10/15.
While dividends are cumulative, no interest accumulates on the deferred amount.
The equity preferred dividend can not be deferred for as long as the company pays a common share cash dividend. I refer to that provision in the prospectus as the "stopper clause". It stops the issuer from deferring the preferred dividend while making any payment to the common shareholders. Once the common share cash dividend is eliminated, however, the preferred dividend can be deferred by the issuer. (Prospectus as page 25)
With limited exceptions, the security can not be called prior to 8/4/17. Given the large number of redemptions now occurring, it is important to check the optional call date provision when purchasing the preferred stock at more than its par value. One of the exceptions involves a "change in control" (see page S-2 to S-3).
Individual investors who invest in bonds and preferred stocks need to become familiar with "change of control" provisions. The presence of such a provision can become quite important when there is a leveraged buyout (LBO). The buyer in LBO's will load the company up with senior secured debt in order to finance the deal, thereby making all junior securities more risky. It is not unusual to see investment grade senior debt downgraded deep into junk status after an LBO.
Who would want a "change of control" provision in an equity preferred prospectus? As a buyer of that security, I would want one. One example will suffice to explain why. Many years ago, there was a leveraged buyout of a REIT called Innkeeper's Trust. The common shareholders received a nice premium for their common stock. The REIT also had a publicly traded cumulative equity preferred stock, and the owners of that security could not force a buyout of their security. So what happens next? The end of the story is that the preferred stock was delisted, then the dividend was deferred, and eventually the over leveraged REIT declared bankruptcy. Innkeepers Usa Trust News - Bloomberg
CYS Investments reported third quarter GAAP net income of $241.9M or $1.49 per share for the third quarter. The company had core income of $41.2M or 25 cents per share, down from 38 cents in the 2012 second quarter.
CYS paid a third quarter common dividend of 45 cents per share, down from 50 cents in the 2012 second quarter.
In addition to its "core earnings", which is substantially below the common share dividend, CYS has what it calls "drop income". For the third quarter, drop income was reported at $36.9M or 23 cents per share. This component is "appreciation on forward settling purchases". Those purchases permit the company to obtain assets at a discount (or "drop") to their current market value. That income is explained further in the press release. Further details can be found in the CYS 10Q 2012 Q3 at pp. 13-14, 31-32. Is that a reliable source of income?
Net asset value per share was reported at $14.46 after declaring the 45 cent per share dividend.
The leverage ratio was 7.7:1 as of 9/30/12.
The interest rate spread, net of hedging, fell to 1.24% from 1.71% in the second quarter.
Total Liabilities as of 9/30/12= $20.259+B
Total Assets as of 9/30/12= $22.864+ B
CYS 10Q 2012 Q3
During the quarter, the company recorded $745.3M in scheduled and unscheduled repayments and prepayments, which "equated to a constant prepayment rate ("CPR") of approximately 17.3%...". The company expects the 4th quarter CPR to increase due to the most recently announced Federal Reserve policy.
 |
| CPR Definition |
Trading History: CYSPRA is a new issue. I briefly owned the common stock in an IRA. Sold 50 CYS at $13.33
Rationale:
1. It is All About Income: During the Near Depression period, anyone could have bought equity preferred stocks at steep discounts to their $25 par values. My steepest discount was the purchase of GRTPRF at $2.9 which had a 8.7% coupon on a $25 par value. The issuer never missed a payment and recently redeemed this preferred stock at its $25 par value plus the accrued dividend.
Those days are gone, at least for now. The REITs which own real property are redeeming their higher cost preferred stocks and issuing lower yielding preferred securities.
A buyer today of equity preferred stocks will generally have to pay a price near par value, and frequently above par value.
The potential appreciation will therefore be negligible, given the purchase slightly below or above par value.
The downside is a zero price. It is always important to look down first, before gazing up at the stars. The purchaser of GRTPRF and other REIT preferred stocks, when those securities were trading near par value before the onset of the Near Depression, found out the hard way about the downside risk.
The owner of an equity preferred stock does not have an ownership interest in the business. The preferred stock owner really only has the dividend.
The yield at a total cost of $25.2 is about 7.69%. The will be a tax free return in the ROTH IRA. I had managed to build the cash in that account to $30,000, earning nothing in a money market account, and that money market return is one reason for this small investment in this security.
2. Risks and Disadvantages: The general risks associated with equity preferred stocks are discussed in Advantages and Disadvantages of Equity Preferred Floating Rate Securities A post that focuses on REIT preferred stocks is the Gateway Post REIT CUMULATIVE PREFERRED LINKS IN ONE POST/Advantages & disadvantages. That post deals with preferred stocks issued by traditional REITs, i.e., the ones that own real property rather than pieces of paper.
While other investors may differ with my opinion on the matter, I am more nervous about preferred stocks issued by Mortgage REITs than by traditional REITs.
Both suffer from the risk associated with the absence of a cash cushion. After all, money is flying out the door every quarter to the common shareholders. To maintain the REIT tax status, at least 90% of the net income has to be paid out to the common shareholders. For an owner of an equity preferred stock, I would obviously prefer having most of that money retained by the corporation.
Both types of REITs are leveraged with debt, but there is a huge difference in debt to equity. A traditional REIT may be carrying both senior unsecured debt and/or mortgages, but the amount of debt will not exceed the fair market value of the assets owned by the traditional REIT. Generally, the value of the property will be greater than the total amount of debt, i.e. debt will be significantly less than equity.
Mortgage REITs will have debt at 7 to 10 times equity. While the mortgages owned by the REIT are more liquid than the property owned by the traditional REIT, the possibility of a downward spiral leading to a liquidation is far greater with the Mortgage REIT than the far less leveraged traditional REIT.
The Mortgage REIT will have a much greater dependency on short term debt. In a credit crisis, similar to the one recently experienced, liquidity can dry up pretty quickly, leading to a liquidity driven adverse event.
I would also have a concern about a quick and unforeseen spike in short term interest rates, particularly one occurring at the same time as a decline in value of the paper bought by the Mortgage REIT with borrowed money.
Taking the potential downside risks and the upside which will likely involve almost exclusively the receipt of income, I will only invest small amounts in preferred stocks issued by Mortgage REITs.
I previously bought 50 shares of ARRPRA, which pays monthly. Bought 50 ARRPRA at $25.50
At most, I will buy 50 preferred shares issued by another Mortgage REIT (MR). My maximum exposure to any MR's preferred stock is 50 shares.
Given the risks, the goal is simply to harvest several dividends and to sell the security at any profit whatsoever. I would not buy this security if money market yields were 4% or higher.
Some investors attempt to compare the common and preferred stocks issued by these REITs. I will invest very small amounts in both. At the moment, the CYS common has a higher yield than the preferred. Depending on the price of the securities, the current spread may fluctuate between 5% to 6%. The last quarter dividend on the common shares was $.45. CYS Stock Quote If that rate was continued for one year, the yield would be about 13.5% at yesterday's closing price: CYS: 13.33 -0.09 (-0.67%).
However, there is likely to be more common share dividend cuts, which will narrow the spread in the coming quarters, and it would not be inconceivable to see the spread even disappear due to reductions in the common share dividend, while the preferred dividend remains at 7.7% on a $25 par value. The preferred shareholder has a higher claim on income and the preferred dividend, unlike the common dividend, is cumulative. Neither the common or preferred stocks are "safe", but the preferred stock is less risky than the common shares when the issue is dividend reliability.
Yesterday's Close: CYS-PA: 25.20 -0.08 (-0.32%)
3. Bought 50 BDN at $11.70 (see Disclaimer):
Security and Company Description: Common Stock. Brandywine Realty Trust is a Real Estate Investment Trust that owns office properties.
Brandywine owns, leases and manges an office portfolio of 295 properties comprising 34 million square feet. Of that amount, 57 properties were owned through unconsolidated real estate ventures.
After depreciation, the company reported real estate investments of $3.908+B as of 6/30/12, and total assets of $4.669+B. Total liabilities were reported at $2.775B which included mortgage notes at $505+M and unsecured debt at $2.004+B. BDN 06.30.2012 10-Q (see pp. 27-28)
There was no a significant change in those number for the Q/E 9/30/12. (assets $4.666+B-liabilities at 2.782+B=Total Equity $1.853+B) There was no outstanding borrowings under the $600M credit facility.
As of 9/30, the company had cash and cash equivalents of $241.6M and a net debt to to gross assets ratio of 42.4%.
Link to Company Website: Brandywine Realty Trust
Brandywine Realty Trust Profile Page at Reuters
Brandywine Realty Trust Key Developments Page at Reuters
Trading History: I have not traded this common stock in a taxable account and currently own 100 shares in my main taxable account. As a result of this last transaction, I now own 150 shares in that account and have changed my dividend distribution to reinvestment from payment in cash.
After collecting one quarterly dividend, I did flip 100 shares in the ROTH IRA earlier this year. Bought Roth IRA: 100 BDN at $11.24 (June 2012)- Item # 2 Sold 100 BDN at $12.38-ROTH IRA (snapshot)(August 2012)
I have also bought and sold a cumulative preferred stock issue, BDNPRC. The largest realized gain was $234.48 on a 50 share lot sold in 2009, held for slightly over 2 months. Another gain was realized in 2008 on just a 30 share flip, with the position held slightly over one month, which shows extreme caution at that time.
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| 2009 BDNPRC 50 Shares +$234.48 |
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| 2008 BDNPRC 30 Shares +$162.99 |
Recent Earnings Release: Brandywine Realty Trust reported third quarter Funds from Operations of $.39 in line with the consensus estimate. The company reported cash available for distribution (CAD) of $30.2M or 21 cents per share, up from seven cents in the 2011 third quarter. Many REITs will provide the CAD calculation in a supplementary filing to its earnings release. I took a snapshot of the BDN calculation:
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| BDN CAD Calculation |
Brandywine is currently paying a 15 cent quarterly dividend, and the CAD was 21 cents for the 2012 third quarter. A continuation of that spread, or its enhancement, would suggest to me that a dividend raise is more likely than a dividend cut.
As of 9/30/12, the core properties were 88.6% leased, including leases signed after the end of the quarter.
Rationale: The common shares, unlike the preferred shares, have some appreciation potential. After the release of BDN's third quarter results on 10/24/12, which I view as satisfactory, the shares slid from a a $12.01 close on 10/24, and closed at $12.66 on 10/18/12. BDN Historical Prices
A longer term chart reveals significant moves up and down. BDN Interactive Chart There was a 1 for 3 reverse split in November 1996. Adjusting for that split, the price moved from $1.11 in December 1992 to a top over $35 in February 2007, and then careened down during the Near Depression before bottoming out near $2.85 in March 2009.
The quarterly dividend was raised from 41 cents per share to 44 cents in the 2001 third quarter. The rate remained at 44 cents until it was cut to $.30 in the 2009 first quarter and then to 10 cents in the next quarter. The quarterly dividend was raised from 10 to 15 cents in 2010 first quarter and has remained at that level since that time. Investor Details: Brandywine Realty Trust: Dividends
BBN was ex dividend for its quarterly distribution on 10/3/12: BDN Stock Quote
The general goal for this type of investment is a 10% annualized total return. Even with an increase in the dividend, the dividend can provide me with about 1/2 of that annualized return at the current quarterly rate of $.15 per share.
Yesterday's Close: BDN: 11.62 +0.01 (+0.09%)
4. Bought 100 WBCO at $13.46 (Regional Bank Basket Strategy)(see Disclaimer): This stock was bought in a satellite taxable brokerage account.
Security And Company Description: Common Stock. Washington Banking is the holding company for the Whidbey Island Bank which has 30 branches in six Northwest Washington counties. Whidbey Island is the largest of nine islands in Island County Washington.
Map of Locations: Whidbey Island Bank
WBCO Profile at Reuters
The bank did participate in TARP, 8-k, receiving $26.38M of government money in exchange for cumulative equity preferred stock. The company repurchased that preferred stock, and bought back the stock warrants, in early 2011. Form 10-K at p. 43.
Whidbey Island Bank acquired City Bank of Lynnwood in a FDIC assisted acquisition in 2010. FDIC: Press Release; SEC Form 8-K8 City Bank had 8 branches and 4 loan offices. Those branches were south of the Whidbey Island bank branches, and there was no geographic overlap.
In another FDIC assisted acquisition of certain assets and liabilities of North County Bank, WBCO picked up four branches in Snohomish County, Washington.
Both of these acquisitions seem to be prudent extensions of Whidbey's geographic territory into continuous areas in the larger Seattle metropolitan area. Using the Near Depression to expand with the FDIC's help is viewed positively. REGIONAL BANK BASKET STRATEGY GATEWAY POST
Recent Earnings Release: Washington Banking reported the following results for the 2012 third quarter:
Net Income: $4.6M-E.P.S. 30, up from 24 cents 2011 third quarter
Net Interest Margin: 5.48% (highest in my Regional Bank Basket)
Efficiency Ratio: 61.53%
NPL Ratio: 2.14% (non-covered)
Coverage Ratio: 93.92%
NPA Ratio: 1.29 (non-covered by FDIC loss sharing)
Return on Average Assets: 1.1%
Tangible Book Value Per Share=$11.31
Tangible Equity to Tangible Assets=10.44%
Total Risk-Based Capital Ratio=19.65% (consolidated)
Tier 1 Risk-Based Capital Ratio=18.4% (consolidated)
Tier 1 Leverage Raio=11.67% (consolidated)
Total Risk Based Capital Ratio=19.02% (Whitbey Island Bank, operating bank)
Several hedge funds, specializing in regional bank stocks, own a good chunk of the stock. WBCO Major Holders
This release is discussed in a Zach's report published at Seeking Alpha.
Rationale: (1) Numbers Speak Volumes: The preceding numbers are good. The capital ratios are excellent. The net interest margin is high. My purchase price is only 1.19 to 1 of tangible book value per share. The coverage ratio is comforting. While non-performing loans to total loans at 2.14% (non-covered) is a little high, it is still okay and has decreased from 3.27% in the 2011 third quarter.
(2): Good Dividend with a Variable Component: Washington Banking declared a basic quarterly dividend of 6 cents per share and a variable quarterly dividend "to equate to a total dividend payout not to exceed 50% of quarterly earnings". The total payout for the next payment will be $.15 per share. In this approach, the dividend can go up with increases in earnings.
Assuming a continuation of the 15 cent quarterly dividend rate, which could go up or down depending on future earnings, the dividend yield would be about 4.46% at a total cost of $13.46 per share.
WBCO was ex dividend yesterday. WBCO Stock Quote
On the negative side, the bank did cut its quarterly dividend from $.0625 per share to $.025 in the 2009 third quarter and had raised it back up to $.06 by 2012 when it started the the fixed and variable distribution policy. Whidbey Island BanK Dividend History
(3) Reasonable Valuation: The consensus forecast is for a 2012 E.P.S. of $1.02 and $1.12 for 2013. WBCO Analyst Estimates The forward P/E is about 12.02 at a total cost per share of $13.46. And, as mentioned above, the price is only a slight premium to tangible book, with good dividend support particularly in the current low interest rate environment.
Another reason is that I am below my minimum $40,000 allocation to this strategy.
Yesterday's Close: WBCO: 13.63 +0.11 (+0.81%)
5. Sold 1 Telefonica Emisones 6.421% Senior Bond Maturing 6/20/16 at 108.254-ROTH IRA (see Disclaimer):
Security Description: Senior Unsecured Bond.
Trading History: I bought this bond back in July. Bought 1 Telefonica Emisiones 6.421% Senior Bond Maturing in 2016 at 95.178. I realized over a 10% gain on the bond plus interest:
++$121.36.jpg){kind=small} |
| 2012 Telefonica Emisiones 2016 Bond (1) +$121.36 |
Rationale: I am satisfied with the 15% Annualized Return in 4 Months. If I held the bond to maturity, another 3 years and eight months, I would have lost $80 of that $121.36 in profit. I give up $64.21 in annual interest payments for the remaining term.
For such a maturity, the interest rate risk is negligible.
The credit risk is not particularly worrisome, based on what I know now, but that risk does exist given Telefonica's large debt load, the depressionary conditions in Spain, and a constant need to refinance maturing debt. Shortly after buying these three bonds, a reader questioned whether I was being realistic about the credit risk. Given the rise in prices of all of those bonds since my purchase, the market has come around to my perception, but that may change based on future developments. As a result of this last sale, I no longer have a position in any Telefonica security.
For this bond, I view the interest rate risk connected to holding this bond until maturity (2016) as having three components.
The first is the risk of lost opportunity. Rates rise and I could have used the funds tied up in this bond to buy another one yielding more, possibly even with a better credit risk profile.
The second interest rate risk is not related to my ownership of the bond, but instead involves the bond issuer. A rise in rates may place so more strain on the borrower that its ability to refinance is placed in jeopardy, possibly leading to a default and bankruptcy. That risk is more pronounced for a corporation already creaking under a heavy debt load where the refinance rates could be the final nail in the coffin, particularly when the rise in rates occurs during a major downturn in the business.
The third component is not applicable to me, since I have the financial means to hold the bond to maturity. If I had to sell it due to some situational risk coming to fruition, then I would face what is normally characterized as interest rate risk, selling the bond at a loss due to a rise in interest rates since my purchase. This kind of risk will generally increase with the length of maturity, unless the situational risk is known to have a time certain. If I had to sell the 2016 bond in two years to meet a college tuition payment, for example, then that situational risk would create a type of interest rate risk that otherwise would not exist for me.
Politics and Etc.
1. Rapists as Having Parental Rights?: I noted in Maureen Dowd's NYT column an interesting fact, assuming it is true, that a rapist can assert parental rights in 31 states. She also mentioned that republicans are geniuses at convincing people to vote against their own best interest.
2. Rape, Pregnancy and God's Will: There was someone who left a comment to one of my posts, agreeing with Richard Mourdock's assertion that a pregnancy resulting from rape was God's will. With support from the Tea Party and assorted True Believers, Mr. Mourdock defeated the former GOP senator from Indiana Richard Lugar in Indiana's GOP primary.
The spam filter for Blogger treated the comment as spam, and I was inclined to agree and consequently deleted it. The author claimed to be a student of Western philosophy, having read profusely in that area. After much study, he concluded that cholera and the Black Death were also God's will and no one disagreed with that contention. Therefore, the reasoning was that a pregnancy resulting from a rape was God's Will too since the Black Death was without question God's Will. Reduced to its essence, the argument becomes "God wants the rapist to rape". Needless to say, the American legal system does not accept that argument. If someone wishes to post a comment like that, they will need to use their real name before I will publish it.
Possibly, the alleged student of Western Philosophy had missed the discussions about "free will". If GOD caused everything to happen, which was the commenters's argument when reduced to its essence, then there could be no free will, and a person's afterlife would be predetermined at birth. Historically, some Christians have believed in predestination and the non-existence of free will. The non-existence of free will was the premise of the recent romantic comedy, The Adjustment Bureau.
It is and always has been a tremendous leap to move from GOD knowing the result before it happens (assuming that is true) to God causing the result or the result being the product of God's Will rather than Man's Will. (see generally, Foreknowledge and Free Will -Internet Encyclopedia of Philosophy)
I would add that it is entirely a separate argument or belief as to when life begins. If one believes that life begins at conception, for example, then it would logically follow that they would be opposed to an abortion for any reason.
3. Counting Ships and Planes To Determine Adequacy of U.S. Defense: I thought the most preposterous contention made in the last Presidential debate originated from Malleable Mitt. Romney claimed that the U.S. was losing its military superiority because our "Navy is smaller than it's been since 1917", and the "Air Force is smaller and older than any time since 1947". PolitiFact gave that statement a "Pants on Fire" rating. (see also FactCheck.org : Romney All Wet on Ships)
Well, as one commentator noted, our horse calvary is not what it used to be either.
Romney had to know that this argument could only work on the ignorant, stupid and weak-minded. If Romney actually believed in this line of reasoning, it would just be plain scary that he could very possibly be our next Commander-in-Chief.
Romney is measuring defense capability by counting the number of ships and planes rather than the capabilities of each ship or plane. There were no aircraft carriers in 1917. According to Romney, the defense capabilities of a nuclear powered aircraft carrier is no different than say the coal powered USS Texas. A 1917 cruiser is no different really than the modern Ticonderoga class cruiser with 122 missile launching tubes capable of firing cruise missiles, surface-to-air missiles, and anti-submarine warfare rockets (pictures of 1917 era ships: United States Navy, USN, World War 1) A stealth bomber, the B-2 Spirit, counts the same as a propeller driven B-52. A propeller driven P-51 Mustang counts the same as a Lockheed Martin F-35 Lightning II. Perhaps, Romney will build a few hundred P-51 Mustangs to bring the numbers up to snuff, which may even impress some small African nation with their firepower. Building 1000 of the P-51 Mustangs would certainly cost a lot less than the current generation of fighters and the number of planes is the true measure of defense capability anyway, at least for gullible idiots and politicians that seek to lead them.
List of current ships of the United States Navy - Wikipedia
List of active United States military aircraft - Wikipedia
And, as noted by the fact checkers, the number of navy ships have increased under Obama compared to his republican predecessor. So if counting the number of ships has any bearing on anything, then Obama is stronger on defense than the republicans under Bush.
If Romney becomes President, I would anticipate that he will surpass 100 "Pants on Fire" ratings from Politifact after 4 years. He currently has 19 of those ratings, 33 Mostly False and 32 False ratings. PolitiFact | Mitt Romney's file
4. The latest flagrantly dishonest Romney ad is the one claiming that Obama sold Chrysler to the Italians so that they could build jeeps in China at the cost of American jobs. PolitiFact GM said that Romney must be living in a parallel universe, Detroit Free Press, and Chrysler asserted that the ad had no validity. The Detroit News
5. Vietnam jailed two musicians for composing songs critical of the government.
6. The NYT published a lengthy investigative article claiming that several family members of the China's Prime Minister, Wen Jiaboa, have accumulated great wealth. China in response blocked access to the NYT. Lawyers representing Wen hinted at legal action and disputed the NYT claims. NYT
7. A Family Values Politician: Another woman has come forward claiming to have had an affair with the family values GOP Congressman Scott DesJariais from Tennessee. timesfreepress.com This lady claims that the affair started when she was in a Doctor-Patient relationship with DesJariais who allegedly smoked marijuana with her and gave her prescription for pain pills. Scott claims that this lady is lying. He did not make the same claim about another lady, where he was caught on tape urging her to have an abortion. (citizensforethics.org Complaint.pdf)
It is difficult for the OG to decide whether he would prefer Scott to his current GOP representative, a Sarah Palin soul sister and a Michelle Bachmann clone, incapable of learning anything due to her rigid ideology.
The Democrats do not have a candidate running in Tennessee's 7th congressional district, where HQ is located. Why bother? The district was gerrymandered to insure an election of a "conservative" GOP politician.
8. VOTER ID Laws: There are southerners still living who started voting for FDR and never quit voting for Democrats. My mother cast her first vote in 1944. and has voted in every Presidential election since FDR ran against Thomas Dewey. United States presidential election, 1944 She early voted yesterday in the 2012 election.
When asked whether Romney or Obama got her vote, she replied "republicans are for the rich people". When my parents were married, my father had to borrow $2 to buy the wedding ring and there was no honeymoon, unless you count going down to the airport in another's couple's care and having a coke a honeymoon. My mother's politics were formed in that era. A large number of southerners were never peeled away from the Democrats by the GOP's Southern strategy since they already believed in civil rights for everyone.
For the first time in her life, she had to show her driver's license and her voting card in order to cast a ballot. The voting card has her signature. In prior elections, the election official would compare the signature on the card with the signature made in front of the official on an election form, Possibly, an expert forger could make a passable imitation on the spot, but even that is doubtful.
{it has been a long time since I first registered to vote. I do recall having to show a driver's license at that time, but other proof may have sufficed such as a birth certificate which I could have produced by going back home and retrieving it)
The GOP in Tennessee and a number of other states passed laws, allegedly aimed at preventing voter fraud, that required the voter to produce a government issued ID (driver's license) and the voter card in order to exercise their constitutional right. VOTER ID Law In Tennessee No proof of voter fraud was offered in support of these laws.
While I am in the minority in Tennessee, I believe that the GOP's transparent and obvious purpose is to cut down on voting by poor people, primarily poor blacks, and the elderly. In short, the new Voter ID laws are a modern version of the poll tax, passed with the purpose and intent of interfering with the exercise of an important constitutional right by large segments of registered voters who normally vote for Democrats. If that purpose was ever stated in public, then even a "conservative" court would have difficulty upholding the law.
Hopefully, the civil rights lawyers will have a huge number of registered voters (500 minimum), with no driver's license, appear at the polling places on election day with their voter's cards, maybe even their birth certificates and prior election records showing the casting of votes, and then have them attempt to cast a vote in Tennessee, taking pictures and filming wherever permitted and with witnesses.
See Jon Stewart's take on the GOP Voter ID laws: Cockblock the Vote.
7. Republicans Snuff Out a Non-Partisan Report: After being pressured by the republicans, the Congressional Research Service withdrew a report that concluded there was no correlation between top tax rates and economic growth. NYT I referenced this report in an earlier post. Stocks, Bonds & Politics: Romney: Half of Americans Are Moochers and Hopeless Losers, CNBC (report: online.wsj.com/public documents.pdf) The economic team that prepared the non-partisan report stood by it. Mitch McConnell, the GOP Senate leader, led the charge to snuff out the report. It was McConnell who stated that there was no evidence that the Bush tax cuts diminished the government's revenues. The evidence is overwhelming that those cuts did diminish revenue by a substantial amount. See, e.g.: The Atlantic; Tax Cuts Don't Boost Revenues - TIME; CBO Data Show Tax Cuts Have Played Much Larger Role than Domestic Spending Increases in Fueling the Deficit; Testimony of Mark Zandi .pdf; Critics Still Wrong on What’s Driving Deficits in Coming Years — Center on Budget and Policy Priorities; New Joint Tax Committee Estimates Raise Cost of Bush Tax Plan Cost Now Well Over $2 Trillion - Rev. 3/6/01 It is really hard to reach a compromise when one side turns everything upside down-and for a reason that has nothing whatsoever to do with evidence. The Koch brothers and the other billionaires financing the GOP campaigns and related Super Pacs want their taxes lowered from existing levels, and that explains why the GOP was so vociferous in snuffing out the Congressional Research Service report.
