Big Picture Synopsis
Stocks:
Stable Vix Pattern:
Short Term: Neutral to Slightly Bullish
Intermediate and Long Term: Bullish
Bonds:
Short Term: Neutral to Slightly Bearish
Intermediate Term: Bearish
Long Term: Extremely Bearish
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Byron Wien is still looking for a 200 point decline in the S & P 500 during the first half of 2013. Some of the reasons given by him include the increase in the payroll tax and other taxes at the beginning of the year, and the ongoing budget battles.
Doug Kass has turned negative on the market. He is in Byron Wien's camp. Kass believes that we face an earnings cliff ahead in light of tax and fiscal policy, and there will be continued weakness in Europe.
The payroll tax increase, which is simply a return to the pre-existing level two years ago, may be a short term negative on GDP growth in the current quarter. I suspect that Kass and Wein are over estimating the tax increase drag on GDP growth after the 2013 first quarter.
Reduced federal spending will be a longer term drag on GDP growth. After all, the economy has been juiced by the federal government borrowing and spending over a trillion dollars per year for several years now. Given the extraordinary amount of fiscal and monetary stimulus, and the less than robust GDP growth so far, there is certainly reason for concern.
The January retail sales were above expectations. Reuters noted that there was little effect traceable to the payroll tax increase.
The International Council of Shopping Centers reported that same store sales for retailers, excluding drugstores, rose 5.1% in January Y-O-Y.
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BNY Mellon issued a report, summarized in a Barrons.com blog, that offered a bleak assessment for bond returns in the coming decade. BNY estimates an annual total return of just 1.25% for the Barclay's Aggregate Bond Index; -.25% for long dated treasuries and 1.75% for investment grade bonds. All of those returns would be lower than the current expected annual inflation rate.
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Doug Kass has turned negative on the market. He is in Byron Wien's camp. Kass believes that we face an earnings cliff ahead in light of tax and fiscal policy, and there will be continued weakness in Europe.
The payroll tax increase, which is simply a return to the pre-existing level two years ago, may be a short term negative on GDP growth in the current quarter. I suspect that Kass and Wein are over estimating the tax increase drag on GDP growth after the 2013 first quarter.
Reduced federal spending will be a longer term drag on GDP growth. After all, the economy has been juiced by the federal government borrowing and spending over a trillion dollars per year for several years now. Given the extraordinary amount of fiscal and monetary stimulus, and the less than robust GDP growth so far, there is certainly reason for concern.
The January retail sales were above expectations. Reuters noted that there was little effect traceable to the payroll tax increase.
The International Council of Shopping Centers reported that same store sales for retailers, excluding drugstores, rose 5.1% in January Y-O-Y.
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BNY Mellon issued a report, summarized in a Barrons.com blog, that offered a bleak assessment for bond returns in the coming decade. BNY estimates an annual total return of just 1.25% for the Barclay's Aggregate Bond Index; -.25% for long dated treasuries and 1.75% for investment grade bonds. All of those returns would be lower than the current expected annual inflation rate.
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Gas Fired Turbines as the New Base Load
I discussed recently an emerging trend where utilities would start using gas fired turbines to meet baseload generating requirements, previously fulfilled by coal and nuclear units. Item # 4 Bought 50 FCG at $15.84 As noted in that post, I am calling this emerging transition as a super cycle for natural gas usage. Using gas turbines to meet baseload demand will burn up a lot of natural gas.
Last week, Duke Energy announced that it would be permanently closing its Crystal River nuclear plant in Florida. The company is reviewing alternatives to replacing the power produced by that nuclear plant with a "state-of-the-art natural gas-fueled plant". Crystal River Nuclear Plant to be retired
Duke also noted that it expects to retire two older coal fired plants, mostly likely between 2015-2018, due to EPA's new emissions regulations.
Duke recently put into service a 620MW combined cycle natural gas generating facility, a process described in this brochure from Duke: Buck-Combined-Cycle-Brochure-.pdf Two other gas fired large stations (H.F. Lee and Dan River) went into commercial operation late in 2012 as part of Duke's plan to retire 7GW of coal capacity. Smart Energy
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Spurt of New Non-Cumulative Equity Preferred Stock Offerings:
This article at SeekingAlpha discusses several recent non-cumulative equity preferred stock offerings primarily by banks. An equity preferred stock sits below all debt in the capital structure and is senior only to common stock Seeking Alpha I left some comments to that article.
A non-cumulative preferred stock simply means that the dividend can be eliminated and is gone forever, just like an eliminated common stock dividend. These equity preferred stocks do not have maturity dates. If interest rates rise, the value will likely go down, and the investor does not have the option to hold until maturity.
The issuer does have the option to call after a future date, usually five years or so after the IPO. That option protects the issuer from a rise in rates by giving it an option to call the security at its par value and to refinance at a lower rate.
It is conceivable, though not very likely, that an issuer would be able to refinance at a lower rate on or after the call option date. The most likely candidate would be a preferred stock with greater than a 6% coupon, rated now as junk, when the issuer's credit rating for such issues improves to investment grade (e.g. BBB from BB) and interest rates are about the same or lower than now.
The call may occur if there was a law change impacting the use of non-cumulative preferred stocks as Tier 1 equity, similar to what happened with trust preferred securities, but I seriously doubt that will happen.
Several financial institutions are taking advantage of the current abnormally low interest rate environment to issue non-cumulative equity preferred stocks with coupons less than 6%.
Anyone investing in these securities has to recognize their disadvantages and likely volatility. The price for equity preferred stocks can become volatile, with a downside bias, when the market is under stress, or investors develop concerns, rational or irrational, about the financial health or viability of the issuer and/or the continuation of the dividend.
The downside risk for an equity preferred stock issued by a leveraged financial institution is zero. I would anticipate that such securities would become worthless in a bankruptcy. The upside is not much based on their current yields and risk. Sill, a number of individuals may want to nibble in this area just to produce income taxed at qualified dividends rates.
Equity and Mortgage REIT preferred stocks do not pay qualified dividends.
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1. Bought 50 RDS-A at $68.93 (see Disclaimer): I bought these shares in a satellite taxable account:
In this particular account, I am simply trying to generate some income until I am able to earn more than 3% in a savings account and short term certificates of deposit. I originally only had an online savings account used to buy certificates of deposit.
Back in late 2008, when it became apparent that the FED was embarking on a long term Jihad Against the Saving Class, I used funds remaining in the online savings account to buy longer term CDs with yields over 4%. I noted some of that activity in my blog. (first paragraph: Stocks, Bonds & Politics: Trust Certificates PJL and XFL: Verizon Bond) As those CDs came due, I elected to open a brokerage account with the same company, rather than to roll them over, and to buy dividend paying stocks until savings rates returned to something resembling normal levels.
I will just highlight some issues relating to this well known company. Some of the positives and negatives are summarized in this recent Seeking Alpha article. The author is more upbeat about the long term future than the analyst community.
Security Description: Royal Dutch Shell PLC ADS Cl A (RDS.A) is a large vertically integrated energy company with worldwide operations.
Royal Dutch Shell profile page at Reuters
Royal Dutch Shell key developments page at Reuters.
RDS-A is an ADS and each RDS-A share represents two ordinary shares. The "A" series have a Dutch source of dividend income and will be subject to a 15% withholding tax for payments made in cash. The "B" series have a U.K. source.
2011 SEC Filed Annual Report
At the closing price of $67.33 on 2/11/13, and using other financial data as of 12/31/12, price to book is 1.13 and price to sales is .44. RDS-A Key Statistics
Prior Trades: None since starting this blog in October 2008.
Last Earnings Report: Rather than typing the results, I just took a snapshot from the press release:
Form 6-K
Net capital investment in the 2012 4th quarter was $10.9B and $29.8B for the full year. Net capital investments would be total capital investments less the proceeds from divestments.
Capex is expected to be $33B in 2013 with about $18B going to develop new projects.
Rationale (1) Large Financially Stable Company with a Decent Dividend: As I have become older, dividends have become more important with each passing year. Except for stocks bought in my Lottery Ticket basket strategy, virtually all of my individual security positions pay dividends.
RDS recently declared a quarterly dividend of $.86 per ADS share that went ex dividend today (2/13/13): Royal Dutch Shell plc - Form 6-K The company states in that announcement that joining the "Scrip Dividend Programme" will offer a tax advantage in several countries since dividends paid out in shares will not be subject to the Dutch 15% withholding tax. This is considered by the company to be the dividend for the 2012 4th quarter.
As stated in its 4th quarter earnings release, RDS expects the 2013 first quarter dividend to be $.90 per ADS.
While the dividend yield is good, there is not much dividend growth over the past several years: 2009: $3.12 per share; 2010: $3.36 per share; 2011: $3.36 per share; and 2012: $3.44 per share.
(2) Reasonable Valuation: The stock is trading at less than 10 times earnings, but that has been normal for the past several years, except for 2009 according to the Morningstar and S & P data.
For 2012, Shell earned $8.04 per share per ADS share, excluding items, up from $7.94 per share in 2011. Basic CCS earnings were $8.64 in 2012 and $9.22 in 2011 (CCS=Current cost of supplies adjustment for downstream operations)(CCS for 2010=$6.08 per share-Form 6-K)
(3) Hard to See Much Downside at the Current Price: The stock has slid some since my purchase, but I would not expect it to go below $60 per share other than for a brief period.
(4) The Large Bets on North American Natural Gas Plays May Prove Worthwhile Long Term (See risk section under (2) below: This point is related to my super cycle in natural gas demand thesis, explained in more detail in Item # 4 Bought 50 FCG at $15.84 (under Rationale section in that Item)
(5) Shell is a Leader in Liquified Natural Gas: Countries without plentiful natural gas will be supplied by liquified natural gas transported by ships rather than pipelines. Natural gas is stripped of its impurities, including water, and then cooled to -162°C which turns the gas into liquid and shrinks its volume by 600 times. Turning natural gas into liquid - watch the animation - Shell Global
Shell has also developed a process to liquify natural gas at sea that will enable the shipment from the production site without having to build pipelines to shore and LNG processing plants on land. Floating liquefied natural gas (FLNG) - Shell Global
Given the extreme level of pollution already present in China and other countries, I doubt that building hundreds of coal plants to meet future power needs will be a desirable option. Those who are bullish on American coal companies are clinging to that hope. Instead, I would anticipate for fewer coal plants will be constructed in China than currently anticipated, replaced with more gas fired and solar power generation.
Risks: (1) Hard to See Much Upside Near Term: For the past two years, the stock has been stuck in a narrow channel mostly between $60 to $70, with some brief spurts above $70. RDS-A Interactive Chart
(2) Shell's North American Production Has a Lot of Natural Gas: Shell has placed large bets on dry gas shale plays. This is a negative now given relatively low natural gas prices. I suspect that increasing use of natural gas to fuel baseload electric generation, running 24/7, will improve pricing over time, but I am not predicting the timing of the crossover point, where that demand starts to tilt price in favor of the suppliers. It would make a big difference to have an average price in the $6 to $9 range rather than $2.5 to $3.7 for example.
(3) S & P Downgrade To Sell: After the 4th quarter earnings report, S & P downgraded Shell to two stars, a sell rating, noting that production growth has been difficult and that aggressive capex will result in negative free cash flow until 2015, but would then ramp up to double-digit free cash flow growth as production ramps up and capex declines. I am not sure how S & P is defining free cash flow in that assessment. In 2012, operating cash flow was at $46.1B; and free cash flow was at $13.5B.
(4) Shell Spends a Lot of Money on Capex on Increasingly Risky Projects: While this is understood as being necessary, the trend has been that the prospects are more risky and the returns on capital will be less. It is not like sticking a drill down in the ground and hitting a gusher like Spindletop anymore. An example is the approximately $4.5B spent so far in Alaska's Arctic waters. One of the drill ships grounded off the Kodiak Island on 12/31/12. And, after I purchased the shares, Shell reported that it was sending two of its offshore rigs from those waters to Asia for repairs and upgrades. NYT
2. Bought 50 PNTA at $24.70 (see Disclaimer):
Security Description: PennantPark Investment Corp. 6.25% Senior Notes due 2025 (PNTA) is a new exchange traded baby bond issued by the Business Development Corporation PennantPark Investment.
This is a senior unsecured note that makes quarterly interest payments at 6.25% on a $25 par value. The note matures on 2/21/25. The notes may be redeemed at PennantPark's option at par value plus accrued interest on or after 2/1/16. Final Prospectus Supplement I would not be concerned about this note being redeemed by the company given its low coupon and my future forecast for bond prices. The risk is not that the company will exercise its option to redeem, but that interest rates will rise and the price of this bond will fall significantly at some point prior to maturity.
In the prospectus, the note is described as PennantPark's "direct senior unsecured obligations and rank pari passu with future unsecured unsubordinated indebtedness by PennantPark Investment Corporation.
PennantPark Investment profile page at Reuters
PennantPark Investment key developments page
2012 Annual Report for the F/Y ending 9/30/12 Form 10-K
Prior Trades: PNTA is a new exchange traded bond. This is my initial purchase, and most probably my last given the low coupon. I do own 50 shares of the common PNNT bought in the ROTH IRA. Item # 6 Bought 50 PNNT at $10.2-ROTH IRA I may buy more of the common which has a higher yield than the senior bond which is typical for BDC securities.
Recent Earnings Release: As of 12/31/12, the company reported net assets of $688.5B and a net asset value per share of $10.38. The yield on its debt investments was reported at 13.3%. Net investment income for the quarter was $18.2M or 28 cents per share. The company paid out 28 cents per share in dividends to the common shareholders. SEC Filed Press Release
So, I have just highlighted one of the risks for bond owners. The income is flying out the door every quarter to the common shareholders.
Out of the total investments of $1.064B, the company had $411M of subordinated debt and $127.9M in preferred and equity investments. That highlights another risk. Only $291.7M was invested in senior secured loans. As of 12/31/12, the company estimated that it had $10M in unrealized appreciation on its investments.
As of 12/31/12, the company owed $211.5M under its credit facility with a weighted average interest cost of 3%, exclusive of a .5% fee for undrawn commitments. The company has also borrowed money from the SBA, fully drawn at $150M with a weighted average interest cost of 4.04% with upfront fees.
The senior unsecured notes were issued in January 2013 with net proceeds to PNNT of $65.2M. The proceeds are going to be used to repay indebtedness under the credit facility, to invest in new or existing portfolio companies and for general corporate purposes. This debt would be subordinate to the SBA loan and the borrowings under the credit facility, see page S-2 of the Prospectus.
Roughly speaking, the debt is less than 50% of the current estimated value of PNNT's investments.
Earnings Call Transcript - Seeking Alpha
Rationale: (1) My Key and Most Basic Strategy is to Generate Income: I own a very large number of securities that throw off dividend and interest income. I use that income to buy more of the same. This purchase plays a very small role in that overall strategy.
The yield at a total cost of $24.7 is about 6.32% with the YTM a smidgen higher due to the small discount to par value.
Risks: Interest Rate and Credit Risks: The interest rate risk is mitigated by the 13 year term. I have the option to hold this security until maturity in the event rates start to rise. If that option is exercised due to a rise in rates and a decline in this bond's value, I will nonetheless lose the opportunity to earn more on a similarly rated bond or even this bond bought at a lower price. Opportunity losses are important and need to be kept in mind when making bond investments. I limited myself to just 50 shares given these risks.
I view the credit risk over a 13 year period to be the greater risk. This company invests in higher risk borrowers and has a large exposure to subordinated debt and equity securities that face a greater likelihood of being wiped out in the event of a borrower's bankruptcy. The average yield as of 12/31/12 was over 13% which is a red light flashing on the risk issue.
Still, with over 50% equity a lot will have to go wrong for the bond owners to lose their principal. A more likely result would be an elimination of the common dividend and/or PNNT's acquisition by another BDC in the event of large scale losses in the investment portfolio. The risk of loss is nonetheless present.
3. Added 50 FMER at $15.09 (REGIONAL BANK BASKET STRATEGY)(see Disclaimer):
Security Description: FirstMerit (FMER) is a bank holding company headquartered in Akron, Ohio, with 196 branches in Ohio, Western Pennsylvania, and the Chicago metropolitan area.
FirstMerit is in the process of acquiring Citizens Republic in a stock exchange. Each Citizen's share would be exchanged for 1.37 FMER shares. FirstMerit Corporation
FMER recently sold 4 million equity preferred stock shares, with a $25 par value and a 5.875% coupon. Prospectus FMER intends to use those proceeds, along with the sale of subordinated notes, to repay Citizens' TARP preferred stock issued to the government. Citizens issued $300M in cumulative preferred stock to the government (page 114, Form 10-K) The subordinated notes have a principal amount of $250M, mature in 2023, and make quarterly interest payments at 4.35% per annum. Prospectus This is a link to FMER's presentation, filed with the SEC, made to the fixed income investors.
Citizens has 219 branches, primary in Michigan and Wisconsin, with 85% of its revenues originating from Michigan. (Map at page 4: Citizens Investor Presentation). It is the 58th largest U.S. bank holding company ranked by assets.
The merger is discussed in this Seeking Alpha article.
Prior Trades: I am close to break-even on my FMER position.
Bought 50 FMER at 16.96 (May 2011)-Sold 50 FMER at $17.3 (March 2012); Added 50 FMER at 16.18 (May 2011); Bought 30 FMER at $11.35 (August 2011); Added 50 FMER at $15.2 (Sept 2012)
Last Earnings Report:
FMER
SEC Filed Press Release
2012 4th Quarter vs. 2011 4th Quarter
Net Income: $38.2M, up from $30.5M
E.P.S.: $.35 (estimate $.33), up from $.28
Net Interest Margin= 3.58%/3.85%
Efficiency Ratio= 62.65%
NPA Ratio= .57%
Coverage Ratio for non-covered loans= 269.69%
Charge offs to average loans= .34%
Tangible Equity to Tangible Assets= 8.16%
Return on Average Assets= 1.03%
Return on Average Common Equity= 9.3%
Quarterly Dividend Per share= $.16
Given the importance of Citizens to FMER's future, I wanted to summarize briefly some data points from Citizens' last earnings report.
Citizens Republic
SEC Filed Press Release
Earnings Call Transcript - Seeking Alpha
2012 4th Quarter vs. 2011 4th Quarter
Net Income= $17M, up from $12.3M
E.P.S.= $.42 vs. $.31
Net Interest Margin=3.5%
Efficiency Ratio= 66.65%
NPL Ratio= 1.12%
Coverage Ratio=187.15%
NPA Ratio= .71%
Tier 1 Common Equity Ratio=9.24%
Tier 1 Capital Ratio=15.67%
Total Capital Ratio= 16.93%
Tangible Equity to Tangible Assets= 11.3%
Return on Average Assets=.96%
Citizens did not fare well during the recent Near Depression, but it appears that it has righted the ship.
The bank deferred both its dividends payable to the government and the interest payable on its trust preferred security, Citizens Funding Trust I 7.5% Enhanced Trust Pfd. Secs (CTZ.PA). The bank mentioned in January that the bank is in the "midst of paying our accrued trust preferred dividends". FMER, as noted above, is repaying Citizen's TARP obligation.
There was a 1 for 10 stock split in 2011. Adjusted for that split, the shares hit a high of over $350 in November 2004. CRBC Interactive Chart Without even looking at the historical earnings data, I know from this chart that the owners of this bank suffered greatly. When I looked at the results, the word awful does not do it justice. The bank lost $43.2 per share in 2008 and $27.11 in 2009. Form 10-K I assume those figures have been adjusted for the 1 for 10 reverse split.
Rational: (1) FMER is a Well Capitalized Bank with a Good Dividend: FMER did participate in TARP, FORM 8-K, but quickly repaid the government in April 2009. FORM 8-K It has been over the years a competently managed bank. The current quarterly dividend is 16 cents per share which results in a 4.24% dividend yield at a total cost of $15.09.
(2) Citizens Acquisition Appears to be A Good One to Me: The market has not reacted positively to this merger. In my gut, I am more optimistic. The merger will significantly expand the size of FMER at an overall favorable price including the baggage that comes with Citizens. FMER expands into Michigan and Wisconsin with the acquisition of 219 branches, some of which are in northern Ohio.
Risks: (1) Most of the Risks are Typical for Regional Banks: The main risk for the near term applicable to all regional banks is net interest margin compression caused by the Federal Reserve's monetary policy. The banks have generally already received most of the benefits relating to lower rates paid to depositors, as higher yielding certificates of deposit mature. Higher yielding investments are being lost to repayments. This is the same type of problem that I face as an individual investor who buys bonds and is similar to the one currently negatively impacting Mortgage REITs.
One typical recession is just the increased in bad loans that are inevitable during recessions. The key for me is that NPLs remain below 2% of total loans during a garden variety recession (or 3% for really nasty recessions), which indicates relatively good management. NPAs are now .71% for FMER.
(2) Integration Risk: FirstMerit also has integration risks associated with the Citizens' acquisition. This is a very large acquisition for FMER.
(3) Citizens' Baggage: I mentioned above that Citizens comes with a lot of baggage. The recent capital raises by FMER, represented by the subordinated note and equity preferred stock sales, were done to raise capital in order to pay off Citizen's TARP obligations.
Future Buys and Sells: I am more likely to sell my highest cost FMER shares remaining, bought first at $16.18, rather than to buy more, unless the price drops below $14 again. If that happens, I may add another 50 shares. I am reinvesting the dividend to buy more shares. My average cost is $14.96 for almost 189 shares.
4. Sold 50 of 230 SANPRB at $20.77 (see Disclaimer): I sold my highest cost shares held in the main taxable account:
The trade resulted in a long term capital gain of $124.58:
Security Description: Santander Finance Preferred S.A. Unipersonal Floating Rate Gtd. Pfd. Series 6, (SAN.PB) is an equity preferred stock that pays non-cumulative qualified dividends at the greater of 4% or .52% above the 3 month LIBOR rate on a $25 par value. www.sec.gov There is no maturity date. The issuer is Santander Finance with Banco Santander providing a guarantee as provided in the prospectus. The security may be redeemed, at the option of the issuer, on or after March 5, 2017 at the $25 par value plus accrued dividends.
The symbol was changed last year from STDPRB to SANPRB.
Prior Trades: I still own SANPRB shares in two Vanguard brokerage accounts.
I own 50 shares bought last October in the Roth IRA at $16.93:
I also own 130 in a Vanguard taxable account, one of my satellite taxable accounts:
My prior realized gains from 2010 and 2011 were as follows (symbol was then STDPRB)
Total Realized Gains 2010-To Date: $569.78 plus dividends
Bought 100 STDPRB at $15.3; Sold 100 STDPRB at 18.11; Added to STDPRB at 18.6; Added 50 STDPRD at $18.54; Bought 50 STDPRB @ 17.96; Sold 50 STDPRB at $19.64 in the Roth IRA; Sold 50 STDPRB at 20.2; Sold 50 STDPRD at 20.34; Bought: STDPRB at $13; Added 50 STDPRB at $15.44; Bought 50 SANPRB at $16.93-Roth IRA
Rationale: (1) Solely Profit Taking: This security can be volatile. As shown in the trade links above, I bought 50 shares in an IRA at $16.93 last October. I bought 30 shares in August 2011at $13, when there was a severe downdraft in all equity preferred stocks and European hybrids. Whenever there is some significant negative news about Spain, Santander's home market, this security has a tendency to decline.
Equity preferred floaters have interested me for several years since they combine in one security some deflation/low inflation and problematic inflation protection.
The deflation/low inflation protection is provided by the minimum coupon. And, that protection is provided in times such as the present and the past four years when the Federal Reserve and other central banks have kept interest rates artificially low; when the market rates, based on actual and anticipated inflation, would be higher. The inflation protection component is the LIBOR float provision.
Risks (1) I have discussed the risks inherent in equity preferred stocks throughout this blog. A general discussion can be found in a 2009 Gateway Post on this subject: Stocks, Bonds & Politics: Advantages and Disadvantages of Equity Preferred Floating Rate Securities.
They can be quite volatile in price. The volatility is frequently due to fear. The fear in this case is losing all your money, the kind of fear that can feed on itself and consume the investor; or losing the dividend which is not cumulative and can be eliminated, provided the common dividend is eliminated first (typical stopper clause). After all, the dividend is reason for buying these securities.
It has to be kept in mind that those issued by leveraged financial institutions will go to zero in the event of a bankruptcy which actually happened to an equity preferred floater issued by Lehman. During the financial crisis, I was able to buy equity preferred stocks issued by banks in the single digits. The downside risk is substantial.
Of the ones that I have owned, none of them have failed to pay their quarterly dividends. When the banks get around to blowing themselves up again, I would not be surprising to see several of them eliminate both their common and equity preferred dividends to preserve capital.
5. Added 50 GAL at $31.79 (see Disclaimer): I bought these shares in a taxable account.
My prior buy was 50 shares in a ROTH IRA. Item # 4 Pared Trade Roth IRA: Bought 50 GAL at $31.89 and Sold 50 IYLD at $26.58 Since I recently discussed that purchase, I have nothing to add to that discussion.
SPDR SSgA Global Allocation ETF (GAL)
GAL - SPDR SSgA Global Allocation ETF | State Street Global Advisors (SSgA)
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Spurt of New Non-Cumulative Equity Preferred Stock Offerings:
This article at SeekingAlpha discusses several recent non-cumulative equity preferred stock offerings primarily by banks. An equity preferred stock sits below all debt in the capital structure and is senior only to common stock Seeking Alpha I left some comments to that article.
A non-cumulative preferred stock simply means that the dividend can be eliminated and is gone forever, just like an eliminated common stock dividend. These equity preferred stocks do not have maturity dates. If interest rates rise, the value will likely go down, and the investor does not have the option to hold until maturity.
The issuer does have the option to call after a future date, usually five years or so after the IPO. That option protects the issuer from a rise in rates by giving it an option to call the security at its par value and to refinance at a lower rate.
It is conceivable, though not very likely, that an issuer would be able to refinance at a lower rate on or after the call option date. The most likely candidate would be a preferred stock with greater than a 6% coupon, rated now as junk, when the issuer's credit rating for such issues improves to investment grade (e.g. BBB from BB) and interest rates are about the same or lower than now.
The call may occur if there was a law change impacting the use of non-cumulative preferred stocks as Tier 1 equity, similar to what happened with trust preferred securities, but I seriously doubt that will happen.
Several financial institutions are taking advantage of the current abnormally low interest rate environment to issue non-cumulative equity preferred stocks with coupons less than 6%.
Anyone investing in these securities has to recognize their disadvantages and likely volatility. The price for equity preferred stocks can become volatile, with a downside bias, when the market is under stress, or investors develop concerns, rational or irrational, about the financial health or viability of the issuer and/or the continuation of the dividend.
The downside risk for an equity preferred stock issued by a leveraged financial institution is zero. I would anticipate that such securities would become worthless in a bankruptcy. The upside is not much based on their current yields and risk. Sill, a number of individuals may want to nibble in this area just to produce income taxed at qualified dividends rates.
Equity and Mortgage REIT preferred stocks do not pay qualified dividends.
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1. Bought 50 RDS-A at $68.93 (see Disclaimer): I bought these shares in a satellite taxable account:
 |
| 2013 Bought 50 RDS-A at $68.93 |
Back in late 2008, when it became apparent that the FED was embarking on a long term Jihad Against the Saving Class, I used funds remaining in the online savings account to buy longer term CDs with yields over 4%. I noted some of that activity in my blog. (first paragraph: Stocks, Bonds & Politics: Trust Certificates PJL and XFL: Verizon Bond) As those CDs came due, I elected to open a brokerage account with the same company, rather than to roll them over, and to buy dividend paying stocks until savings rates returned to something resembling normal levels.
I will just highlight some issues relating to this well known company. Some of the positives and negatives are summarized in this recent Seeking Alpha article. The author is more upbeat about the long term future than the analyst community.
Security Description: Royal Dutch Shell PLC ADS Cl A (RDS.A) is a large vertically integrated energy company with worldwide operations.
Royal Dutch Shell profile page at Reuters
Royal Dutch Shell key developments page at Reuters.
RDS-A is an ADS and each RDS-A share represents two ordinary shares. The "A" series have a Dutch source of dividend income and will be subject to a 15% withholding tax for payments made in cash. The "B" series have a U.K. source.
2011 SEC Filed Annual Report
At the closing price of $67.33 on 2/11/13, and using other financial data as of 12/31/12, price to book is 1.13 and price to sales is .44. RDS-A Key Statistics
Prior Trades: None since starting this blog in October 2008.
Last Earnings Report: Rather than typing the results, I just took a snapshot from the press release:
Net capital investment in the 2012 4th quarter was $10.9B and $29.8B for the full year. Net capital investments would be total capital investments less the proceeds from divestments.
Capex is expected to be $33B in 2013 with about $18B going to develop new projects.
Rationale (1) Large Financially Stable Company with a Decent Dividend: As I have become older, dividends have become more important with each passing year. Except for stocks bought in my Lottery Ticket basket strategy, virtually all of my individual security positions pay dividends.
RDS recently declared a quarterly dividend of $.86 per ADS share that went ex dividend today (2/13/13): Royal Dutch Shell plc - Form 6-K The company states in that announcement that joining the "Scrip Dividend Programme" will offer a tax advantage in several countries since dividends paid out in shares will not be subject to the Dutch 15% withholding tax. This is considered by the company to be the dividend for the 2012 4th quarter.
As stated in its 4th quarter earnings release, RDS expects the 2013 first quarter dividend to be $.90 per ADS.
While the dividend yield is good, there is not much dividend growth over the past several years: 2009: $3.12 per share; 2010: $3.36 per share; 2011: $3.36 per share; and 2012: $3.44 per share.
(2) Reasonable Valuation: The stock is trading at less than 10 times earnings, but that has been normal for the past several years, except for 2009 according to the Morningstar and S & P data.
For 2012, Shell earned $8.04 per share per ADS share, excluding items, up from $7.94 per share in 2011. Basic CCS earnings were $8.64 in 2012 and $9.22 in 2011 (CCS=Current cost of supplies adjustment for downstream operations)(CCS for 2010=$6.08 per share-Form 6-K)
(3) Hard to See Much Downside at the Current Price: The stock has slid some since my purchase, but I would not expect it to go below $60 per share other than for a brief period.
(4) The Large Bets on North American Natural Gas Plays May Prove Worthwhile Long Term (See risk section under (2) below: This point is related to my super cycle in natural gas demand thesis, explained in more detail in Item # 4 Bought 50 FCG at $15.84 (under Rationale section in that Item)
(5) Shell is a Leader in Liquified Natural Gas: Countries without plentiful natural gas will be supplied by liquified natural gas transported by ships rather than pipelines. Natural gas is stripped of its impurities, including water, and then cooled to -162°C which turns the gas into liquid and shrinks its volume by 600 times. Turning natural gas into liquid - watch the animation - Shell Global
Shell has also developed a process to liquify natural gas at sea that will enable the shipment from the production site without having to build pipelines to shore and LNG processing plants on land. Floating liquefied natural gas (FLNG) - Shell Global
Given the extreme level of pollution already present in China and other countries, I doubt that building hundreds of coal plants to meet future power needs will be a desirable option. Those who are bullish on American coal companies are clinging to that hope. Instead, I would anticipate for fewer coal plants will be constructed in China than currently anticipated, replaced with more gas fired and solar power generation.
Risks: (1) Hard to See Much Upside Near Term: For the past two years, the stock has been stuck in a narrow channel mostly between $60 to $70, with some brief spurts above $70. RDS-A Interactive Chart
(2) Shell's North American Production Has a Lot of Natural Gas: Shell has placed large bets on dry gas shale plays. This is a negative now given relatively low natural gas prices. I suspect that increasing use of natural gas to fuel baseload electric generation, running 24/7, will improve pricing over time, but I am not predicting the timing of the crossover point, where that demand starts to tilt price in favor of the suppliers. It would make a big difference to have an average price in the $6 to $9 range rather than $2.5 to $3.7 for example.
(3) S & P Downgrade To Sell: After the 4th quarter earnings report, S & P downgraded Shell to two stars, a sell rating, noting that production growth has been difficult and that aggressive capex will result in negative free cash flow until 2015, but would then ramp up to double-digit free cash flow growth as production ramps up and capex declines. I am not sure how S & P is defining free cash flow in that assessment. In 2012, operating cash flow was at $46.1B; and free cash flow was at $13.5B.
(4) Shell Spends a Lot of Money on Capex on Increasingly Risky Projects: While this is understood as being necessary, the trend has been that the prospects are more risky and the returns on capital will be less. It is not like sticking a drill down in the ground and hitting a gusher like Spindletop anymore. An example is the approximately $4.5B spent so far in Alaska's Arctic waters. One of the drill ships grounded off the Kodiak Island on 12/31/12. And, after I purchased the shares, Shell reported that it was sending two of its offshore rigs from those waters to Asia for repairs and upgrades. NYT
2. Bought 50 PNTA at $24.70 (see Disclaimer):
Security Description: PennantPark Investment Corp. 6.25% Senior Notes due 2025 (PNTA) is a new exchange traded baby bond issued by the Business Development Corporation PennantPark Investment.
This is a senior unsecured note that makes quarterly interest payments at 6.25% on a $25 par value. The note matures on 2/21/25. The notes may be redeemed at PennantPark's option at par value plus accrued interest on or after 2/1/16. Final Prospectus Supplement I would not be concerned about this note being redeemed by the company given its low coupon and my future forecast for bond prices. The risk is not that the company will exercise its option to redeem, but that interest rates will rise and the price of this bond will fall significantly at some point prior to maturity.
In the prospectus, the note is described as PennantPark's "direct senior unsecured obligations and rank pari passu with future unsecured unsubordinated indebtedness by PennantPark Investment Corporation.
PennantPark Investment profile page at Reuters
PennantPark Investment key developments page
2012 Annual Report for the F/Y ending 9/30/12 Form 10-K
Prior Trades: PNTA is a new exchange traded bond. This is my initial purchase, and most probably my last given the low coupon. I do own 50 shares of the common PNNT bought in the ROTH IRA. Item # 6 Bought 50 PNNT at $10.2-ROTH IRA I may buy more of the common which has a higher yield than the senior bond which is typical for BDC securities.
Recent Earnings Release: As of 12/31/12, the company reported net assets of $688.5B and a net asset value per share of $10.38. The yield on its debt investments was reported at 13.3%. Net investment income for the quarter was $18.2M or 28 cents per share. The company paid out 28 cents per share in dividends to the common shareholders. SEC Filed Press Release
So, I have just highlighted one of the risks for bond owners. The income is flying out the door every quarter to the common shareholders.
Out of the total investments of $1.064B, the company had $411M of subordinated debt and $127.9M in preferred and equity investments. That highlights another risk. Only $291.7M was invested in senior secured loans. As of 12/31/12, the company estimated that it had $10M in unrealized appreciation on its investments.
As of 12/31/12, the company owed $211.5M under its credit facility with a weighted average interest cost of 3%, exclusive of a .5% fee for undrawn commitments. The company has also borrowed money from the SBA, fully drawn at $150M with a weighted average interest cost of 4.04% with upfront fees.
The senior unsecured notes were issued in January 2013 with net proceeds to PNNT of $65.2M. The proceeds are going to be used to repay indebtedness under the credit facility, to invest in new or existing portfolio companies and for general corporate purposes. This debt would be subordinate to the SBA loan and the borrowings under the credit facility, see page S-2 of the Prospectus.
Roughly speaking, the debt is less than 50% of the current estimated value of PNNT's investments.
Earnings Call Transcript - Seeking Alpha
Rationale: (1) My Key and Most Basic Strategy is to Generate Income: I own a very large number of securities that throw off dividend and interest income. I use that income to buy more of the same. This purchase plays a very small role in that overall strategy.
The yield at a total cost of $24.7 is about 6.32% with the YTM a smidgen higher due to the small discount to par value.
Risks: Interest Rate and Credit Risks: The interest rate risk is mitigated by the 13 year term. I have the option to hold this security until maturity in the event rates start to rise. If that option is exercised due to a rise in rates and a decline in this bond's value, I will nonetheless lose the opportunity to earn more on a similarly rated bond or even this bond bought at a lower price. Opportunity losses are important and need to be kept in mind when making bond investments. I limited myself to just 50 shares given these risks.
I view the credit risk over a 13 year period to be the greater risk. This company invests in higher risk borrowers and has a large exposure to subordinated debt and equity securities that face a greater likelihood of being wiped out in the event of a borrower's bankruptcy. The average yield as of 12/31/12 was over 13% which is a red light flashing on the risk issue.
Still, with over 50% equity a lot will have to go wrong for the bond owners to lose their principal. A more likely result would be an elimination of the common dividend and/or PNNT's acquisition by another BDC in the event of large scale losses in the investment portfolio. The risk of loss is nonetheless present.
3. Added 50 FMER at $15.09 (REGIONAL BANK BASKET STRATEGY)(see Disclaimer):
Security Description: FirstMerit (FMER) is a bank holding company headquartered in Akron, Ohio, with 196 branches in Ohio, Western Pennsylvania, and the Chicago metropolitan area.
FirstMerit is in the process of acquiring Citizens Republic in a stock exchange. Each Citizen's share would be exchanged for 1.37 FMER shares. FirstMerit Corporation
FMER recently sold 4 million equity preferred stock shares, with a $25 par value and a 5.875% coupon. Prospectus FMER intends to use those proceeds, along with the sale of subordinated notes, to repay Citizens' TARP preferred stock issued to the government. Citizens issued $300M in cumulative preferred stock to the government (page 114, Form 10-K) The subordinated notes have a principal amount of $250M, mature in 2023, and make quarterly interest payments at 4.35% per annum. Prospectus This is a link to FMER's presentation, filed with the SEC, made to the fixed income investors.
Citizens has 219 branches, primary in Michigan and Wisconsin, with 85% of its revenues originating from Michigan. (Map at page 4: Citizens Investor Presentation). It is the 58th largest U.S. bank holding company ranked by assets.
The merger is discussed in this Seeking Alpha article.
Prior Trades: I am close to break-even on my FMER position.
Bought 50 FMER at 16.96 (May 2011)-Sold 50 FMER at $17.3 (March 2012); Added 50 FMER at 16.18 (May 2011); Bought 30 FMER at $11.35 (August 2011); Added 50 FMER at $15.2 (Sept 2012)
Last Earnings Report:
FMER
SEC Filed Press Release
2012 4th Quarter vs. 2011 4th Quarter
Net Income: $38.2M, up from $30.5M
E.P.S.: $.35 (estimate $.33), up from $.28
Net Interest Margin= 3.58%/3.85%
Efficiency Ratio= 62.65%
NPA Ratio= .57%
Coverage Ratio for non-covered loans= 269.69%
Charge offs to average loans= .34%
Tangible Equity to Tangible Assets= 8.16%
Return on Average Assets= 1.03%
Return on Average Common Equity= 9.3%
Quarterly Dividend Per share= $.16
Given the importance of Citizens to FMER's future, I wanted to summarize briefly some data points from Citizens' last earnings report.
Citizens Republic
SEC Filed Press Release
Earnings Call Transcript - Seeking Alpha
2012 4th Quarter vs. 2011 4th Quarter
Net Income= $17M, up from $12.3M
E.P.S.= $.42 vs. $.31
Net Interest Margin=3.5%
Efficiency Ratio= 66.65%
NPL Ratio= 1.12%
Coverage Ratio=187.15%
NPA Ratio= .71%
Tier 1 Common Equity Ratio=9.24%
Tier 1 Capital Ratio=15.67%
Total Capital Ratio= 16.93%
Tangible Equity to Tangible Assets= 11.3%
Return on Average Assets=.96%
Citizens did not fare well during the recent Near Depression, but it appears that it has righted the ship.
The bank deferred both its dividends payable to the government and the interest payable on its trust preferred security, Citizens Funding Trust I 7.5% Enhanced Trust Pfd. Secs (CTZ.PA). The bank mentioned in January that the bank is in the "midst of paying our accrued trust preferred dividends". FMER, as noted above, is repaying Citizen's TARP obligation.
There was a 1 for 10 stock split in 2011. Adjusted for that split, the shares hit a high of over $350 in November 2004. CRBC Interactive Chart Without even looking at the historical earnings data, I know from this chart that the owners of this bank suffered greatly. When I looked at the results, the word awful does not do it justice. The bank lost $43.2 per share in 2008 and $27.11 in 2009. Form 10-K I assume those figures have been adjusted for the 1 for 10 reverse split.
Rational: (1) FMER is a Well Capitalized Bank with a Good Dividend: FMER did participate in TARP, FORM 8-K, but quickly repaid the government in April 2009. FORM 8-K It has been over the years a competently managed bank. The current quarterly dividend is 16 cents per share which results in a 4.24% dividend yield at a total cost of $15.09.
(2) Citizens Acquisition Appears to be A Good One to Me: The market has not reacted positively to this merger. In my gut, I am more optimistic. The merger will significantly expand the size of FMER at an overall favorable price including the baggage that comes with Citizens. FMER expands into Michigan and Wisconsin with the acquisition of 219 branches, some of which are in northern Ohio.
Risks: (1) Most of the Risks are Typical for Regional Banks: The main risk for the near term applicable to all regional banks is net interest margin compression caused by the Federal Reserve's monetary policy. The banks have generally already received most of the benefits relating to lower rates paid to depositors, as higher yielding certificates of deposit mature. Higher yielding investments are being lost to repayments. This is the same type of problem that I face as an individual investor who buys bonds and is similar to the one currently negatively impacting Mortgage REITs.
One typical recession is just the increased in bad loans that are inevitable during recessions. The key for me is that NPLs remain below 2% of total loans during a garden variety recession (or 3% for really nasty recessions), which indicates relatively good management. NPAs are now .71% for FMER.
(2) Integration Risk: FirstMerit also has integration risks associated with the Citizens' acquisition. This is a very large acquisition for FMER.
(3) Citizens' Baggage: I mentioned above that Citizens comes with a lot of baggage. The recent capital raises by FMER, represented by the subordinated note and equity preferred stock sales, were done to raise capital in order to pay off Citizen's TARP obligations.
Future Buys and Sells: I am more likely to sell my highest cost FMER shares remaining, bought first at $16.18, rather than to buy more, unless the price drops below $14 again. If that happens, I may add another 50 shares. I am reinvesting the dividend to buy more shares. My average cost is $14.96 for almost 189 shares.
4. Sold 50 of 230 SANPRB at $20.77 (see Disclaimer): I sold my highest cost shares held in the main taxable account:
The trade resulted in a long term capital gain of $124.58:
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| 2013 50 Shares SANPRB +$124.58 |
The symbol was changed last year from STDPRB to SANPRB.
Prior Trades: I still own SANPRB shares in two Vanguard brokerage accounts.
I own 50 shares bought last October in the Roth IRA at $16.93:
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| Snapshot 2/12/13 |
I also own 130 in a Vanguard taxable account, one of my satellite taxable accounts:
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| Snapshot 2/12/13 |
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| 2010 STDPRB 100 Shares $265.01 |
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| 2011 STDPRB 100 Shares (50 Share lots) +$143.16 |
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| 2011 STDPRB 50 Shares +$37.03 |
Bought 100 STDPRB at $15.3; Sold 100 STDPRB at 18.11; Added to STDPRB at 18.6; Added 50 STDPRD at $18.54; Bought 50 STDPRB @ 17.96; Sold 50 STDPRB at $19.64 in the Roth IRA; Sold 50 STDPRB at 20.2; Sold 50 STDPRD at 20.34; Bought: STDPRB at $13; Added 50 STDPRB at $15.44; Bought 50 SANPRB at $16.93-Roth IRA
Rationale: (1) Solely Profit Taking: This security can be volatile. As shown in the trade links above, I bought 50 shares in an IRA at $16.93 last October. I bought 30 shares in August 2011at $13, when there was a severe downdraft in all equity preferred stocks and European hybrids. Whenever there is some significant negative news about Spain, Santander's home market, this security has a tendency to decline.
Equity preferred floaters have interested me for several years since they combine in one security some deflation/low inflation and problematic inflation protection.
The deflation/low inflation protection is provided by the minimum coupon. And, that protection is provided in times such as the present and the past four years when the Federal Reserve and other central banks have kept interest rates artificially low; when the market rates, based on actual and anticipated inflation, would be higher. The inflation protection component is the LIBOR float provision.
Risks (1) I have discussed the risks inherent in equity preferred stocks throughout this blog. A general discussion can be found in a 2009 Gateway Post on this subject: Stocks, Bonds & Politics: Advantages and Disadvantages of Equity Preferred Floating Rate Securities.
They can be quite volatile in price. The volatility is frequently due to fear. The fear in this case is losing all your money, the kind of fear that can feed on itself and consume the investor; or losing the dividend which is not cumulative and can be eliminated, provided the common dividend is eliminated first (typical stopper clause). After all, the dividend is reason for buying these securities.
It has to be kept in mind that those issued by leveraged financial institutions will go to zero in the event of a bankruptcy which actually happened to an equity preferred floater issued by Lehman. During the financial crisis, I was able to buy equity preferred stocks issued by banks in the single digits. The downside risk is substantial.
Of the ones that I have owned, none of them have failed to pay their quarterly dividends. When the banks get around to blowing themselves up again, I would not be surprising to see several of them eliminate both their common and equity preferred dividends to preserve capital.
5. Added 50 GAL at $31.79 (see Disclaimer): I bought these shares in a taxable account.
My prior buy was 50 shares in a ROTH IRA. Item # 4 Pared Trade Roth IRA: Bought 50 GAL at $31.89 and Sold 50 IYLD at $26.58 Since I recently discussed that purchase, I have nothing to add to that discussion.
SPDR SSgA Global Allocation ETF (GAL)
GAL - SPDR SSgA Global Allocation ETF | State Street Global Advisors (SSgA)
I wanted to see if you have commented on a particular preferred, but the search window in the blog is not appearing, so I am posting this.
ReplyDeleteI don't know if you have
commented about JFTTL.
It is a JPM preferred, fixed 7.9% until 2018 and then variable LIBOR+3.47%, trading at $116, which still gives about 7.5% yield to call. To good to be true?
The problem: it is in the pink sheets, so maybe it is
impossible to trade it well?
What are your thoughts?
Thanks!
correction: the yield to call would be about 4.7%... sorry for the typo in my previous post.
ReplyDeleteI would view it as more probable than not that JPM will call JFTTL on 4/30/2018 at par value plus accrued dividends. A buyer at $116 would lose then $16 per share. If your YTM calculation of 4.7% is correct, then that will likely be the total return per annum before taxes. I do not find that YTM enticing.
ReplyDeleteIf the security is not called, then there would be only one reason. It would be in the interest of JPM to stick the owners with the 3 month LIBOR rate plus 3.47%. This kind of security is in that respect is heads JPM wins and tails the owner of this security loses. I would not evaluate it based on ever securing that floating rate unless it was to JPM's advantage to pay it.
I discuss a benefit of this kind of security in a comment at SA today, in reference to ZBPRG which is a fixed to floating rate non-cumulative equity preferred stock. Unlike the owner of a fixed coupon perpetual equity preferred, the owner of this coupon can at least get paid par value by JPM on or after 4/30/18 if JPM finds it advantageous to do so, either due to being able to refinance at a lower rate or just getting rid of an open ended LIBOR float security when short term interest rates are rising.
The owner of a fixed coupon preferred would not have that option when interest rates are rising. The issuer would just stick it to that owner so that the only remedy would be to sell at a loss or just watch the security slide in price to who knows how low.
JFTTL trades in the Grey Market which is a dark market. Generally, bids and ask prices are not displayed, so limit orders have to be used and an investor can only guess about the best price to place an order based on the then existing trades.