I will start publishing my weekly post whenever I finish writing it, but no later than Saturday morning.
There was another problem in the font size for this post that required me to increase the size to large from normal. Apparently, the problem is caused by dragging and dropping some material into this post regarding GSPRC, which I will avoid doing in the future.
Big Picture Synopsis:
There was another problem in the font size for this post that required me to increase the size to large from normal. Apparently, the problem is caused by dragging and dropping some material into this post regarding GSPRC, which I will avoid doing in the future.
Big Picture Synopsis:
Stocks:
Stable Vix Pattern (bullish)
Closing Prices 11/6/13: VIX: 12.67 -0.60 (-4.52%)
S & P 500: 1,770.49 +7.52 (+0.43%)
DJIA: 15,746.88 +128.66 (+0.82%)
Vix Asset Allocation Model Explained Simply
Stable Vix Pattern (bullish)
Closing Prices 11/6/13: VIX: 12.67 -0.60 (-4.52%)
S & P 500: 1,770.49 +7.52 (+0.43%)
DJIA: 15,746.88 +128.66 (+0.82%)
Vix Asset Allocation Model Explained Simply
Short Term: Expecting a 10+% Correction (market not cooperating)
Intermediate and Long Term: Bullish
Bonds:
Short Term: Neutral
Intermediate and Long Term: Slightly Bearish Based on Interest Rate Normalization (The Difficult Path to Interest Rate Normalization
I downgraded my short term rating from slightly bullish to neutral based on the rally in bonds. Investors will start obsessing about the taper again later this year or early in 2014.
Intermediate and Long Term: Bullish
Bonds:
Short Term: Neutral
Intermediate and Long Term: Slightly Bearish Based on Interest Rate Normalization (The Difficult Path to Interest Rate Normalization
I downgraded my short term rating from slightly bullish to neutral based on the rally in bonds. Investors will start obsessing about the taper again later this year or early in 2014.
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Recent Developments:
Recent Developments:
The ISM October PMI for manufacturing was reported at 56.4, solidly in expansion territory. The new orders index inched up to 60.6 from the 60.5 reading in September. Exports grew to 57 from 52.
The Fed reported that domestic banks "on balance" reported an easing of their lending standards but experienced "little change in loan demand". FRB: Senior Loan Officer Opinion Survey: October 2013
The EC decreased its estimate for 2014 eurozone GDP growth from 1.2% to 1.1% and increased its unemployment projection to 12.2% from 12.1%.
CoreLogic reported that U.S. home prices increased 12% Y-O-Y in September.
The Goldman Sachs top economist, Jan Hatzius, believes the FED will lower the unemployment threshold for raising the federal funds rate from 6.5% to 6%. He predicts that this change will occur at the March 2014 meeting and will be based on these two recent FED papers: "The Federal Reserve's Framework for Monetary Policy-Recent Changes and New Question". pdf; Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy .pdf
The ISM services PMI for October was reported at 55.4, up from 54.4 in September. The Business Activity index jumped to 59.7 from 55.1, but the new orders component declined from 59.6 to 56.8. Employment rose to 56.2 from 52.7
The Fed reported that domestic banks "on balance" reported an easing of their lending standards but experienced "little change in loan demand". FRB: Senior Loan Officer Opinion Survey: October 2013
The EC decreased its estimate for 2014 eurozone GDP growth from 1.2% to 1.1% and increased its unemployment projection to 12.2% from 12.1%.
CoreLogic reported that U.S. home prices increased 12% Y-O-Y in September.
The Goldman Sachs top economist, Jan Hatzius, believes the FED will lower the unemployment threshold for raising the federal funds rate from 6.5% to 6%. He predicts that this change will occur at the March 2014 meeting and will be based on these two recent FED papers: "The Federal Reserve's Framework for Monetary Policy-Recent Changes and New Question". pdf; Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy .pdf
The ISM services PMI for October was reported at 55.4, up from 54.4 in September. The Business Activity index jumped to 59.7 from 55.1, but the new orders component declined from 59.6 to 56.8. Employment rose to 56.2 from 52.7
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Ares Capital (own common & bond): Ares Capital Corporation declared its regular 4th quarter dividend of $.38 per share and two special dividends of $.05 per share.
For the 2013 third quarter, Ares reported core E.P.S. of $.48, up from $.42 in the 2012 third quarter. Net investment income was reported at $.47 per share with another $.03 per share in net realized gains. Net asset value per share stood at $16.35 as of 9/30/13, up from $15.74 as of 9/30/12.
I last discussed Ares when I bought one of its exchange traded senior unsecured bonds. Item # 2 Stocks, Bonds & Politics: Bought 50 ARU at $24.5 (10/31/13 Post)
I will frequently own securities throughout the capital structure from the same issuer.
I do have a $10,000 limit on my total out-of-pocket exposure to each company. This is one of many risk mitigation techniques that I utilize in my turtle approach to investing. That limit is calculated by adding up the out-of-pocket costs for all securities-throughout the capital structure-issued by one company.
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For the 2013 third quarter, Ares reported core E.P.S. of $.48, up from $.42 in the 2012 third quarter. Net investment income was reported at $.47 per share with another $.03 per share in net realized gains. Net asset value per share stood at $16.35 as of 9/30/13, up from $15.74 as of 9/30/12.
I last discussed Ares when I bought one of its exchange traded senior unsecured bonds. Item # 2 Stocks, Bonds & Politics: Bought 50 ARU at $24.5 (10/31/13 Post)
I will frequently own securities throughout the capital structure from the same issuer.
I do have a $10,000 limit on my total out-of-pocket exposure to each company. This is one of many risk mitigation techniques that I utilize in my turtle approach to investing. That limit is calculated by adding up the out-of-pocket costs for all securities-throughout the capital structure-issued by one company.
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1. Bought 100 ENF:CA at C$23 (see disclaimer):
Snapshot of Trade:
 |
| 2013 Bought 100 Enbridge Income Fund Holdings at C$23 |
Security Description: As of 12/31/12, the Enbridge Income Fund Holdings (ENF:TOR) owned 84.5% of the outstanding trust units issued by the Enbridge Income Fund, representing a 40.3% economic interest in that fund with Enbridge Inc. (ENB:NYSE) owning the remainder.
The Fund's operations include the generation, transportation, and storage of energy "through its interests in 524 megawatts (MW) of renewable and alternative power generation capacity (Green Power), its liquids transportation and storage business in Western Canada (Liquids, Transportation and Storage) and natural gas transmission through its 50% interest in the Canadian segment of Alliance Pipeline (Alliance Canada)". 2012 Annual Report.pdf
For 2012, ENF reported net income of C$1.48 per share and paid out $1.244 in dividends.
Company Website: Enbridge Income Fund Holdings
In February, ENF sold 3.82M shares to the public and 948,000 to Enbridge Ince at C$25.- Enbridge Income Fund Holdings
Prior Trades: None
Recent Earnings Report: For the 2013 second quarter, ENF reported earnings of $21.8M or $.39 per share. Funds available for distribution increased 30% during the first six months of 2013 compared to 2012 "primarily as a result of contributions from a portfolio of crude oil storage assets and renewable power generation assets acquired in December 2012". Enbridge Income Fund Holdings Inc. Announces Second Quarter Results; Declares Monthly Dividend Those renewable generation assets are described at page 2 of the 2012 Annual Report (bottom paragraph)
After my purchase, Enbridge Income Fund Holdings reported earnings for the third quarter of $21.5M or $.38 per share. For the first nine months, cash available for distribution totaled C$198.2M or a 31% increase compared to the first nine months of 2012.
Rationale: I added this security to generate income on my Canadian dollar stash. ENF was paying a C$.11125 per share monthly dividend and recently raised the distribution to C$.1146 effective for the December 2013 dividend. Enbridge Income Fund Holdings - Dividends
At a total cost of C$23, the dividend yield at that rate is about 5.8%.
The shares hit a 52 week high at C26.5 back in May and a low at $22.81 (9/4/13). ENF Stock Chart There is at least a decent chance that the price will work higher provided interest rates remain stable or continue to move down.
Taking into account the dividend, which gives me 5.8% before tax, my goal is a total return of 10%, annualized, before tax.
Risks: For investors buying any foreign security, currency risk is very important. Once an investor buys a foreign stock or bond, the overall total return will be impacted, possibly significantly, by the currency conversion rates thereafter. I mitigate that risk by buying and selling in Canadian dollars that I have held and will continue to hold for a long time. Consequently, I am less concerned about currency exchange rates over any period of time.
{However, based on informations supplied by my broker, tax reporting for a U.S. citizen is impacted by the exchange value of the foreign currency into USDs at both the time of purchase and sale. I could have a gain in Canadian dollars but a loss for tax reporting purposes, or a loss in Canadian dollars reported as a gain in USDs. The broker handles the cost issue}
2. Roth IRA Paired Trade: Sold 50 EMQ at $26.49 and Bought 50 EFM at $24.9 (see Disclaimer):
Snapshot of Trades:
Snapshot of EMQ Profit:
Item # 5 Roth IRA: Bought 50 EMQ at $24.83 (8/3/13)
Security Descriptions: Both EMQ and EFM pay interest quarterly and have $25 par values. Both bonds are issued under separate indentures to a Mortgage and Deed of Trust dated 1/1/1988. The amount of bonds issued under the mortgage is determined by property additions, cash deposits with the trustee, and first lien bond retirements. There is also an earnings test. This snapshot was taken from the EFM prospectus at page 6:
The security will also be the same:
The Entergy Mississippi Inc. 6.00% Series First Mortgage Bonds 2032 (EMQ) is a first lien bond issued by Entergy Mississippi, a wholly owned subsidiary of Entergy Corp. (ETR). EMQ matures on 11/1/32 and may be redeemed now at par plus accrued interest.
EMQ Prospectus
EFM matures on 4/15/40 and may be redeemed on or after 4/15/15.
EFM Preliminary Prospectus Supplement
Closing Prices 10/25/13:
EMQ: $26.22 +0.51 (+1.98%)
EFM: 24.89 -0.06 (-0.24%)
The 2012 results for Entergy Mississippi are discussed in Entergy's 2012 Annual Report starting at page 342: 10-k Net revenue was reported at $1.120+B. Net income was $43.940M. Total assets were reported at $3.354+B. Long term debt was $1.069+B (pages 355-357)
For the quarter ending 6/30/13, Entergy Mississippi's results can be found in its parent's quarterly report starting at page 134: 10-Q Net income available to common shareholders was reported at $18.247M.
EFM went ex interest for its quarterly distribution on 10/9/2013. EMQ was ex interest on 10/29.
Rationale: This paired trade was mostly a no brainer. EFM and EMQ are functionally equivalent securities. Both are first mortgage bonds issued by Entergy Mississippi.
EFM has a 6.2% coupon while EMQ has a 6% coupon. Both securities have a $25 par value. Yet, I sold the lower yielding EMQ at $26.49 and bought the higher yielding EFM at $24.9.
The pricing of EMQ in relation to EFM made no sense. If EFM was priced correctly at $24.9, then EMQ was clearly priced incorrectly at $26.49. In this kind of paired trade, I am not saying the security purchased is a good buy in general but is simply a better buy than a functionally equivalent security from the same issuer. During the Near Depression period, and its aftermath, I did a number of similar paired trades primarily involving trust certificates that contained the same bond as their underlying security. The same type of analysis would also apply to equity preferred stocks and European hybrids from the same issuer. Stocks, Bonds & Politics: Functional Equivalence in Bond Trading (1/8/2009 Post)
There is a difference in maturity dates that would give EFM slightly more interest rate risk given its longer duration.
By buying EFM in the Roth IRA, I have in effect converted that investment grade bond into a tax free one.
Risks: From my viewpoint, interest rate risk is more important than credit risk. EFM matures in 2040. While I may be rescued from interest rate risk by an early redemption, it is also possible that this bond will never be redeemed due to a rise in rates.
A small rise in interest rates can have a major impact on bonds with long durations. The general rule of thumb is to multiply the duration by the percentage rise in rates. A bond with a 20 year duration could lose approximately 20% of its value with a 1% rise in rates.
Using a calculator available at SIFMA, Bond Calculator, the duration of EFM was shown as 13.1 years. Duration is not the same as maturity for bonds that pay current interest. Bond Duration-Charles Schwab A zero coupon bond will have the same duration and maturity.
The recent rise in long term rates starting in May highlights the impact on EFM's price. This bond closed at $27.58 on 5/16/13 and at $29.25 on 10/24/12. EFM Interactive Chart
The parent company discusses risks in its 2012 Annual Report, starting at page 247: 10-k
Closing Prices 11/6/13:
EFM: $24.58 -0.32 (-1.29%)
EMQ: 25.26 -0.27 (-1.06%)
TLT: 105.07 +0.05 (+0.05%) : iShares 20+ Year Treasury Bond ETF
3. Bought 50 THGA at $21.58-Roth IRA (see Disclaimer):
Snapshot of Trade:
Security Description: The Hanover Insurance Group Inc. 6.35% Subordinated Debenture due 2053 (THGA) is an Exchange Traded junior bond issued by the Hanover Insurance Group (THG). Hanover is one of the top 25 property and casualty insurers in the U.S.
THGA will make quarterly interest payments at the fixed coupon rate of 6.35% on a $25 par value. This security may be redeemed by the issuer on or after 3/30/18. As provided in the prospectus, the bond may be redeemed prior to 3/3/0/18 after a "tax event" or a "rating agency event". Those terms are described at S-17. A early redemption for a "rating agency event" is subject to a modified make whole provision.
Hanover may defer interest payments for up to 5 years. However, during any such deferral, Hanover can not make cash dividend payments on its junior securities. The stopper clause can be found starting at page S-15. PROSPECTUS
This bond was issued last March, traded briefly in the $25 to $26 range, before doing a swan dive when interest rates started to rise in May. This exchange traded bond traded briefly below $21 in August before stabilizing mostly in the $21 to $22.5 price range starting in September when interest rates quit going up and headed back down after the Fed decided to continue QE full throttle, pedal to the metal. THGA Interactive Chart
Hanover Insurance Group Profile Page at Reuters
Hanover Insurance Group Key Developments Page at Reuters
2012 Annual Report Form 10-K (annual net income is erratic-see page 39)
Prior Trades: None
Related Trades: There were two trust certificates (PKM and KRH) containing a junior Hanover Insurance bond. PKM had a 8% coupon, while KRH was .25% lower. Both had the same junior bond with a 8.207% coupon maturing in 2027 as their respective underlying security. Both were called by their call warrant owners. That bond is still outstanding, Finra. A purchase near par would be a better deal than THGA, given the higher current yield, identical credit rating for the two bonds since both are junior bonds, and an earlier maturity. I had forgotten about the bond altogether and will look for an opportunity to buy it.
Realized Gains PKM AND KRH:
Item # 3 Bought 150 TC PKM at 17.8 & 17.5 June 2009; Item # 3 Pared PKM-Sold 50 at $20.11 July 2009; Bought 50 PKM at $24.84 September 2010; PKM Called; Item # 4 Sold 100 of 150 PKM at $25.93 January 2011
Bought: KRH at $24.85 Bought 50 of the TC KRH at $19 November 2009- KRH-Exercise of Call Warrant December 2010
Bought 50 KRH at $18.62 in IRA-Sold 50 KRH at 24.6 (October 2010)
Total Realized Gains PKM and KRH: $1,151.6
Recent Earnings Report: For the second quarter, Hanover reported net income of $53.4M or $1.19 per share, up from $.46 in the 2012 quarter. Operating income was $46.8M. SEC Filed News Release
Form 10-Q
Rationale: This one became at best slightly attractive after plunging in price. At a total cost of $21.58, the current yield will be around 7.36% which is okay in today's low interest rate environment. At least that is a tax free yield when this bond is bought in a Roth IRA. Before taxes and inflation, money will double in about 9.76 years at 7.36%: Estimate Compound Interest.
I do not view it likely that this bond will be called by the issuer, at least for the foreseeable future.
There is at least a possibility that the bond may recover some in price provided interest rates remain at, or fall from, current levels. The bond simply quit going down in value when interest rates quit going up and headed back down some.
Risks: The risks relating to Hanover are discussed by the company starting at page 21 in its 2012 Annual Report: Form 10-K The bond's prospectus contains a discussion of risk factors starting at page S-6
Interest rate risk is huge which is why I decided to buy only 50 shares. If I am caught holding this one during an interest rate spike, I at least have the option of buying another 50 shares at a much lower price that will generate a higher yield.
Future Buys/Sells: When buying a 50 share lot, I am placing some odds on a continued decline in price that will enable me to average down. I would consider buying another 50 shares provided the current yield was 8%+, a typical marker that I am currently using in making those decisions.
If there was a spurt back up toward par value, I would consider selling this security and then wait for another opportunity to buy it back.
Closing Price 11/6/13: THGA: $22.06 +0.04 (+0.18%)
4. Bought 50 SLGPRI at $22.69 (see Disclaimer):
Snapshot of Trade:
Security Description: The SL Green Realty Corp. Preferred Series I (SLG.PI) is an equity preferred stock that will pay quarterly dividends at the fixed coupon rate of 6.5% on a $25 par value. Dividends are cumulative and may be deferred legally once the issuer ceases to pay cash dividends on its common stock (stopper clause). The stopper clause is typical and can be found at page S-15 of the prospectus. SL Green has the option to redeem at par, plus accrued dividends, on or 8/10/17.
Prospectus
This security is currently rated Ba2 by Moody's and B+ by S & P.
SL Green is "New York City's largest office landlord", with interests in 58 Manhattan properties totaling 35M square feet. Company Profile for SL Green Realty
SL Green Realty recently sold 2.6M shares at $98.15.
Stocks, Bonds & Politics: REIT CUMULATIVE PREFERRED LINKS IN ONE POST/Advantages & Disadvantages
Prior Trades: None
Related Trades: During the Near Depression period, I traded both the common stock and other SLG equity preferred shares.
While it is hard to believe now, I included SLG's common in what I call a scatter buy with cash flow. LATE DAY TRADES: GCI, CBL, FR, SLG, NYT, NWSA (11/18/08 Post). I bought 25 shares of SLG at $23.35. While that seems like an absurd price now, I later averaged down by buying another 25 shares at around $15. Needless to say, the LB sold the shares too soon. The RB was proud to own -indirectly-less than a square inch of one of those really expensive Manhattan office towers.
That is the full extent of my trading in the common shares.
I also did some nibbling during the Dark Period in SLGPRC and SLGPRD. Both of those preferred stocks have been redeemed at par value by SLG. While I traded SLGPRD profitably, I was more fortunate with SLGPRC:
Bought SLGPRC at $10.5 (March 2009)-Sold 50 SLGPRC at $24.76 (August 2010)
Sold Remaining SLGPRC at $25.01 (August 2010)-Bought SLGPRC (February 2009)
Recent Earnings Report: SL Green Realty reported third quarter FFO of $1.34 per share compared with the prior year third quarter of $1.12. The company raised its full year FFO guidance to $5.12 to $5.16 from $4.9 to $5. The company also raised its FAD (funds available for distribution) to $3.51 to $3.55 per share from $3.1 to $3.2.
Rationale: Given the significant price decline, I decided to at least initiate a position in this equity preferred stock primarily for its income generation. At a total cost of $22.69, the current yield is about 7.16%.
Unless interest rates are lower than now when SL Green has the option to redeem, and its credit rating is at least a notch or two higher, I doubt that this issue will be redeemed, but that judgment will need to be made based on the facts in existence starting in August 2017. I am assuming now that this security will be perpetual and can only hope that the issuer will redeem at par in August 2017.
Risks: The risks are summarized by the company starting at page S-7 of the prospectus.
I discuss the disadvantages of equity REIT preferred stocks in this post: Stocks, Bonds & Politics: REIT CUMULATIVE PREFERRED LINKS IN ONE POST/Advantages & Disadvantages
I would highlight again the interest rate and volatility risks inherent in all perpetual equity preferred stocks.
This stock was sold to the public back in August 2012 at $25. A high closing price was hit in May at $26.19 and a low at $21.96 during October. SLG.PI Stock Chart That decline of 16.14% was due to interest rate and volatility risks.
The credit risk issue, real and imagined, will rear its head from time to time. The clearest recent example was the pricing of SLGPRC and SLBPRD during the Near Depression. Those preferred stocks dived into the single digits and SL Green never missed a dividend payment. The credit risk issue can be fueled by fear, rational or irrational, and is stoked by the realization that an equity preferred stock issued by a heavily leveraged firm may have no value in a BK.
A zero value in a BK would be virtually certain for an equity preferred stock issued an investment bank (e.g. Lehman) or a bank holding company. A equity REIT preferred stock may have some value depending on the value of the properties and the amount of debt.
Closing Price 11/6/13: SLG-PI: 22.32 -0.12 (-0.54%)
The price has continued to decline after my purchase.
5. Sold 301+ WIW at $11.7243 (see Disclaimer): I am in a trading mode for this low yielding bond CEF. I held the security long enough to collect two monthly dividends. The snapshot of the profit does not include fractional shares which will be liquidated by the broker:
Snapshot of Trade:
Snapshot of Profit:
Item # 6 Bought 300 WIW at $11.44 (8/31/13 Post)
Total Realized Trading Gains on WIW Shares= $656.15 ($70.61 + $585.54 cumulative shown in snapshots in the prior linked post)
Closing Price 11/6/13: WIW: 11.76 +0.01 (+0.08%)
6. Bought 50 GSPRC at $19.95 (see Disclaimer):
Snapshot of Trade:
Security Description: Tht Goldman Sachs Group Inc. Preferred Series C (GS.PC) is an equity preferred stock issued by Goldman Sachs Group Inc. (GS ) that pays non-cumulative and qualified dividends at the greater of 4% or .75% above the 3 month Libor rate on a $25 par value: Prospectus
The prospectus contains a typical stopper clause:
The stopper clause is the legal means used to give the preferred shareholder their preference right to dividends compared to the more junior common shares.
Historical Charts 3 month Libor and Federal Funds:
Effective Federal Funds Rate
3-Month London Interbank Offered Rate (LIBOR)
In comments to a Seeking Alpha article, I recently discussed the advantages and disadvantages of floating rate preferred stocks. The gist of the discussion was the current yield differential between a fixed coupon and floating rate preferred stocks from the same issuer. The author of that article reproduced a chart of the market's current forecast for short term rates until 2022 (second chart).
He then bases an argument for certain floaters based on that chart being an accurate prediction about the future. What can you say? When did humans start being able to accurately predict what will happen with interest rates over the next seven years?
I can not develop a portfolio based on that projection being 100% accurate. I have to account for various scenarios including one where short term rates turn out to be far lower or higher than this projection.
If this chart proves prescient, the coupon for GSPRC would not be equal to the 6.2% fixed rate coupon of GSPRB even in December 2022 with the 3 month Libor rate projected to be near 4.7%. Adding the .75% float to 4.7%, I would have a 5.45% coupon on GSPRC.
In a perfect market, with no other rational factors influencing price, the price of GSPRC would then be converging on GSPRB, assuming that the market was pricing both securities based solely on their respective coupons which would not be the case under those circumstances involving persistently rising short term interest rates.
In that scenario (i.e. 3 month Libor accelerating to 4.7%), I would expect the GSPRC price to be at or near its par value while GSPRB would likely be declining in price. A lot would depend on the market's future forecast (up or down) for short term rates at that time.
Theoretically, GSPRC would make up in capital gains what it lost in income generation under the market's current short term rate forecast but it would take several years to do so. The market could easily be way off about its future interest rate forecast, either up or down.
As of 2:00 P.M. CST 11/5/13:
Floater: GS-PC: $19.98 +0.05 (+0.25%)
Fixed Coupon: GS-PB: $24.30 -0.11 (-0.44%)
When constructing the bond and bond like part of my portfolio, I am playing a variety of scenarios. I will use the floaters to offset the interest rate risk of long maturity bonds.
Prior Trades: None
Related Trades-GS Equity Preferred Stocks: I have bought and sold the functionally equivalent GSPRA and GSPRD. I currently own 100 shares of GSPRD: Item # 6 Bought Roth IRA: 50 GSPRD at $21.65; Item # 1 Bought 50 GSPRD at $20.6 (December 2012). I will sell the lot bought in the ROTH IRA at over $22.
Snapshots of trades can be found at the end of this Gateway Post: Stocks, Bonds & Politics: Advantages and Disadvantages of Equity Preferred Floating Rate Securities That post also contains a general discussion of the advantages and disadvantages of floating rate equity preferred stocks.
Except for one trade involving 100 shares of GSPRD, which netted a $257.24 profit, the realized gains for GS equity preferred floaters (GSPRA, GSPRC, and GSPRD) have been between $40 to $100.
Rationale and Risks: I am just dragging and dropping the recent discussion made in connections with GSPRD and making a few changes to conform to the GSPRC purchase.
Floaters: Links in One Post
Rationale: (1) Income is Better Than Cash Earning Nothing/Some appreciation Potential Possibly to $22-23.5 with Risks (see below)/Deflation-Low Inflation-Problematic Inflation Scenarios Embodied in One Security.
At a total cost of $19.95, the dividend yield at the 4% coupon is about 5.01% which is satisfactory at the moment. The LIBOR float provision will activate when the 3 month LIBOR rate is over 3.25% during the relevant computation period. At a 5% LIBOR, the coupon rate would be 5.75% or approximately 7.21% at a total cost of $19.95 per share.
This type of security also balances the interest rate risk of longer term fixed coupon senior bonds held in the taxable account.
Another way of looking at it is to compare the current yield differential with GSPRB at today's closing price and then assigning your personal value to the inflation protection afforded by the floater and the greater capital appreciation potential. Of course, the mere fact that GSPRC is attractively priced in relation to GSPRB, based on the values that I assign to those two issues, does not mean that GSPRB is being priced correctly.
Current Yield Differential Based on 11/5/13 Closing Prices: Data From Marketwatch
GS.PB at $24.4 Current Yield of 6.35%
GS.PC at $19.99 Current Yield of 5.11%
Another way to look at this comparison is to compare income generation by investing the same amount of money in each security, and then evaluating the income generation under different LIBOR scenarios.
For example, assume I invested $10,000 in both GSPRB and GSPRC at today's closing prices:
GSPRB Prospectus (6.2% fixed coupon on a $25 par value)
410 Shares of GSPRB Annual Income is Constant at $635.5.
500 Shares of GSPRC: Current Annual Income of $500
Current Income Differential for 3 years= $406.5 plus income on that income differential
Assume a 4% 3 month Libor for 1 year:
GSPRB Remains at $635.5
GSPRC is now at a 4.75% coupon= $593.75
Assume a 4.4% 3 month Libor for 1 year (5.15% coupon for GSPRC):
GSPRB remains at $635.5
GSPRC up to $643.75
GSPRC now generating more income.
Assume a 5% 3 Month Libor for 1 year:
GSPRB Still at $635.5
GSPRC is up to $712.5
Assume a 7% 3 month Libor for 1 year:
GSPRB still at $635.5
GSPRC moves up to $968.75
Assume a 10% 3 month Libor for 1 Year:
GSPRB still at $635.5
GSPRC at $1,343.75
Without question, the investor sacrifices current income going with the floater versus the fixed rate coupon from the same issuer. To be rescued from that lost income, the floater will need to rise in price creating a capital gain sufficient to offset that lost income or rates will need to move up faster than currently expected by the market to narrow the time period for the ongoing income generation differential, or some combination of the two.
Risks: (1) Highly Volatile/Heightened Risk/Non-Cumulative: I started to invest in some of these securities during the Near Depression when they could be purchased at greater than 50% discounts to their $25 par values. The downside risk is zero as shown by what happened to those unfortunate souls who owned LEHPRG, a Lehman equity preferred floater, that is now worthless of course.
An equity preferred stock is only superior to common stock. It will be junior in the capital structure to all bonds. Given that low priority, the non-cumulative dividends paid by most of them, and the highly leveraged balance sheets of financial institutions issuing them, there will be no recovery in a bankruptcy for an owner of an equity preferred stock. Investors realized that would be the likely outcome and will behave irrationally when there is a whiff of a possible financial collapse. (a 75% chance of bankruptcy when a rational number would be less than 10%).
BAC equity preferred stocks, for example, could have been bought for less than $10 even in 2009. I bought ZBPRA, a Zions equity preferred floater for $7.8. Bought 100 ZBPRA at $7.8 (May 2009)(see snapshot in Gateway Post on this topic) None of those equity preferred floaters missed a dividend payment. (METPRA for less than $8, rational or irrational?, AEB for less than $5, rational or irrational?)
Periodically, these stocks will hit an air pocket and just fall as if a bankruptcy filing was imminent. I am just used to it.
I discuss an example from August 2011: Item # 1 Fear and Enhanced Volatility in Certain Classes of Income Securities I was able to buy Santander's floater at $13 during that one. A few weeks later, yet another downdraft, and I picked up HBAPRG at $16.18 (HSBC's US operation). Bought 50 HBAPRG at $16.8
One of my earlier discussions about embracing their volatility in a trading strategy is discussed in a May 2009 post. Embracing Volatility as A Risk Management Tool In the Sub-Asset Class of Equity Preferred Stock
So, volatility and risk are just known hazards. Know what you are buying, its history and characteristics.
Equity preferred stocks were hit harder in many cases than fixed income preferred stocks from the same issuer when rates spiked up starting in early May.
GS.PC declined from a closing high of $24.97 in May 2013 to a $19.47 low during October.
GS has two fixed coupon equity preferred stock that pays non-cumulative and qualified dividends. GSPRB has a 6.2% fixed rate coupon on a $25 par value. Prospectus That one closed at $25.81 on 5/7 and at $23.46 on 8/19. GS.PB Stock Chart
GS has recently issued one 5.85% fixed coupon equity preferred stock: Goldman Sachs Group Inc. 5.95% Non-Cum. Pfd. Series I) (GS.PI ) That one traded at over $26 in May, GS.PI Stock Chart.
Another recent one from GS is a fixed to floating rate equity preferred stock: Goldman Sachs Group Fixed-to-Floating Rate Stock (GS.PJ). That one has a 5.5% fixed coupon until 5/10/23 and three month Libor plus 3.64% thereafter. PROSPECTUS SUPPLEMENT If the Libor rate is high, I would expect a redemption by GS on or after 5/10/23. I recently bought that one and will discuss that purchase in my next post.
2. No Coupon Bump Likely for Several Years: The likely continuation of ZIRP for two more years and the likely slow pace of the subsequent tightening cycle after ZIRP's end will combine to keep the 4% minimum coupon as the applicable rate for several years. It would take a rise in the 3 month LIBOR rate to over 3.25% during the relevant computation period to trigger any increase in the coupon. I do not currently see that happening before 2017.
On the flip side, GSPRC at least produces a current real rate of return of close to 3%, before taxes, based on the currently forecasted inflation rate embodied in the ten year TIP price which is 2.19% as of today's closing prices.
Closing Price 11/6/13: GS-PC: $19.99 +0.06 (+0.30%)
Politics and Etc.
1. Obama's Lack of Involvement: I first noticed that Obama was going to be a Bystander in Chief when he allowed the Democrats in Congress to piece together the 2009 stimulus bill known as the American Recovery and Reinvestment Act of 2009.
I regarded that $787B stimulus bill to be poorly designed and woefully inadequate in infrastructure spending that the nation needed to do anyway.
Can you point to any structure built with those funds? I can only point to a $787B in more debt that the government will be paying interest to finance and refinance, most likely for as long as the U.S. exists.
The stimulus bill did soften the impact of the recession and probably provided a significant and temporary lift to the economy. However, if the nation is going to spend that kind of money, then the benefits need to be long term too.
In Nashville, I can point to several structures still in use, including the Tennessee Supreme Court Building and the Nashville Courthouse that were built during FDR's stimulus programs during the Great Depression.
This is a link to a map of structures still in use throughout the U.S. built during that earlier time. New Deal Project Map | Living New Deal
Another stark contrast between a competent President and Obama is that the competent President realizes when executives and experts in private businesses need to be brought into government to run certain projects. FDR frequently relied on business executives to get things done. There are legions of examples, such as the appointment of William S. Knudsen, the President of GM, to help lead the nation's war material production efforts during WWII.
Obama relied on a clearly unqualified politician from Kansas and a bureaucrat way above her head to coordinate the launch of Healthcare.gov
Obama knows how to win elections, but does not have a clue how to govern effectively. I would agree with John Dickerson's observations on that point. CBS News
Obama is a better President than his predecessor, but that is not a compliment.
2. Substantial Health Insurance Premium Increases for Small Employers Due to Obamacare: An article published in USATODAY last Monday claimed that small businesses with less than 50 employees, who provided health insurance, will be experiencing "30% to even 100%" increases in premiums upon renewal due to Obamacare. Businesses with a preponderance of young employees will be hit the hardest since the Affordable Care Act "ACA" prohibits insurance companies from charging older persons more than 3 times their premiums for younger individuals.
3. Linda Ronstadt: I only recently became aware that Linda had to retire due to the onset of Parkinson's disease. YouTube
I was reading a WSJ article about the song 'Different Drum' that was released in 1967 when Linda was the lead singer for a group known at the Stone Ponys. I watched the YouTube Video of her live performance of "Different Drum" that is embedded in the WSJ article which started me on a tour down memory lane.
I was always partial to her rendition of Heat Wave (1976) Offenbach, Germany, originally performed by Martha & the Vandellas - Heatwave - YouTube
There really is no comparison with Miley Cyrus and Lady Gaga.
It is a travesty that Linda has not been inducted into the Rock Hall of Fame. She does not care. latimes.com Don Henley referred to that omission as a travesty. Did you know that the Eagles started out as her backup band, and she helped them get started on their own? "The Eagles talk about Linda Ronstadt and The Rock and Roll Hall of Fame" - YouTube
I care, so I took the time to cast a vote on her behalf. Online Fan Poll | The Rock and Roll Hall of Fame and Museum
The Fund's operations include the generation, transportation, and storage of energy "through its interests in 524 megawatts (MW) of renewable and alternative power generation capacity (Green Power), its liquids transportation and storage business in Western Canada (Liquids, Transportation and Storage) and natural gas transmission through its 50% interest in the Canadian segment of Alliance Pipeline (Alliance Canada)". 2012 Annual Report.pdf
For 2012, ENF reported net income of C$1.48 per share and paid out $1.244 in dividends.
Company Website: Enbridge Income Fund Holdings
In February, ENF sold 3.82M shares to the public and 948,000 to Enbridge Ince at C$25.- Enbridge Income Fund Holdings
Prior Trades: None
Recent Earnings Report: For the 2013 second quarter, ENF reported earnings of $21.8M or $.39 per share. Funds available for distribution increased 30% during the first six months of 2013 compared to 2012 "primarily as a result of contributions from a portfolio of crude oil storage assets and renewable power generation assets acquired in December 2012". Enbridge Income Fund Holdings Inc. Announces Second Quarter Results; Declares Monthly Dividend Those renewable generation assets are described at page 2 of the 2012 Annual Report (bottom paragraph)
After my purchase, Enbridge Income Fund Holdings reported earnings for the third quarter of $21.5M or $.38 per share. For the first nine months, cash available for distribution totaled C$198.2M or a 31% increase compared to the first nine months of 2012.
Rationale: I added this security to generate income on my Canadian dollar stash. ENF was paying a C$.11125 per share monthly dividend and recently raised the distribution to C$.1146 effective for the December 2013 dividend. Enbridge Income Fund Holdings - Dividends
At a total cost of C$23, the dividend yield at that rate is about 5.8%.
The shares hit a 52 week high at C26.5 back in May and a low at $22.81 (9/4/13). ENF Stock Chart There is at least a decent chance that the price will work higher provided interest rates remain stable or continue to move down.
Taking into account the dividend, which gives me 5.8% before tax, my goal is a total return of 10%, annualized, before tax.
Risks: For investors buying any foreign security, currency risk is very important. Once an investor buys a foreign stock or bond, the overall total return will be impacted, possibly significantly, by the currency conversion rates thereafter. I mitigate that risk by buying and selling in Canadian dollars that I have held and will continue to hold for a long time. Consequently, I am less concerned about currency exchange rates over any period of time.
{However, based on informations supplied by my broker, tax reporting for a U.S. citizen is impacted by the exchange value of the foreign currency into USDs at both the time of purchase and sale. I could have a gain in Canadian dollars but a loss for tax reporting purposes, or a loss in Canadian dollars reported as a gain in USDs. The broker handles the cost issue}
2. Roth IRA Paired Trade: Sold 50 EMQ at $26.49 and Bought 50 EFM at $24.9 (see Disclaimer):
Snapshot of Trades:
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| 2013 ROTH IRA Sold 50 EMQ at $26.49 |
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| 2013 ROTH IRA Bought 50 EFM at $24.9 |
Snapshot of EMQ Profit:
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| 2013 Roth IRA EMQ 50 Shares +$68.97 |
Security Descriptions: Both EMQ and EFM pay interest quarterly and have $25 par values. Both bonds are issued under separate indentures to a Mortgage and Deed of Trust dated 1/1/1988. The amount of bonds issued under the mortgage is determined by property additions, cash deposits with the trustee, and first lien bond retirements. There is also an earnings test. This snapshot was taken from the EFM prospectus at page 6:
 |
| Criteria for Issuing More First Lien Bonds |
 |
| Security |
EMQ Prospectus
EFM matures on 4/15/40 and may be redeemed on or after 4/15/15.
EFM Preliminary Prospectus Supplement
Closing Prices 10/25/13:
EMQ: $26.22 +0.51 (+1.98%)
EFM: 24.89 -0.06 (-0.24%)
The 2012 results for Entergy Mississippi are discussed in Entergy's 2012 Annual Report starting at page 342: 10-k Net revenue was reported at $1.120+B. Net income was $43.940M. Total assets were reported at $3.354+B. Long term debt was $1.069+B (pages 355-357)
For the quarter ending 6/30/13, Entergy Mississippi's results can be found in its parent's quarterly report starting at page 134: 10-Q Net income available to common shareholders was reported at $18.247M.
EFM went ex interest for its quarterly distribution on 10/9/2013. EMQ was ex interest on 10/29.
Rationale: This paired trade was mostly a no brainer. EFM and EMQ are functionally equivalent securities. Both are first mortgage bonds issued by Entergy Mississippi.
EFM has a 6.2% coupon while EMQ has a 6% coupon. Both securities have a $25 par value. Yet, I sold the lower yielding EMQ at $26.49 and bought the higher yielding EFM at $24.9.
The pricing of EMQ in relation to EFM made no sense. If EFM was priced correctly at $24.9, then EMQ was clearly priced incorrectly at $26.49. In this kind of paired trade, I am not saying the security purchased is a good buy in general but is simply a better buy than a functionally equivalent security from the same issuer. During the Near Depression period, and its aftermath, I did a number of similar paired trades primarily involving trust certificates that contained the same bond as their underlying security. The same type of analysis would also apply to equity preferred stocks and European hybrids from the same issuer. Stocks, Bonds & Politics: Functional Equivalence in Bond Trading (1/8/2009 Post)
There is a difference in maturity dates that would give EFM slightly more interest rate risk given its longer duration.
By buying EFM in the Roth IRA, I have in effect converted that investment grade bond into a tax free one.
Risks: From my viewpoint, interest rate risk is more important than credit risk. EFM matures in 2040. While I may be rescued from interest rate risk by an early redemption, it is also possible that this bond will never be redeemed due to a rise in rates.
A small rise in interest rates can have a major impact on bonds with long durations. The general rule of thumb is to multiply the duration by the percentage rise in rates. A bond with a 20 year duration could lose approximately 20% of its value with a 1% rise in rates.
Using a calculator available at SIFMA, Bond Calculator, the duration of EFM was shown as 13.1 years. Duration is not the same as maturity for bonds that pay current interest. Bond Duration-Charles Schwab A zero coupon bond will have the same duration and maturity.
The recent rise in long term rates starting in May highlights the impact on EFM's price. This bond closed at $27.58 on 5/16/13 and at $29.25 on 10/24/12. EFM Interactive Chart
The parent company discusses risks in its 2012 Annual Report, starting at page 247: 10-k
Closing Prices 11/6/13:
EFM: $24.58 -0.32 (-1.29%)
EMQ: 25.26 -0.27 (-1.06%)
TLT: 105.07 +0.05 (+0.05%) : iShares 20+ Year Treasury Bond ETF
3. Bought 50 THGA at $21.58-Roth IRA (see Disclaimer):
Snapshot of Trade:
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| 2013 Roth IRA Bought 50 THGA at $21.58 |
THGA will make quarterly interest payments at the fixed coupon rate of 6.35% on a $25 par value. This security may be redeemed by the issuer on or after 3/30/18. As provided in the prospectus, the bond may be redeemed prior to 3/3/0/18 after a "tax event" or a "rating agency event". Those terms are described at S-17. A early redemption for a "rating agency event" is subject to a modified make whole provision.
Hanover may defer interest payments for up to 5 years. However, during any such deferral, Hanover can not make cash dividend payments on its junior securities. The stopper clause can be found starting at page S-15. PROSPECTUS
This bond was issued last March, traded briefly in the $25 to $26 range, before doing a swan dive when interest rates started to rise in May. This exchange traded bond traded briefly below $21 in August before stabilizing mostly in the $21 to $22.5 price range starting in September when interest rates quit going up and headed back down after the Fed decided to continue QE full throttle, pedal to the metal. THGA Interactive Chart
Hanover Insurance Group Profile Page at Reuters
Hanover Insurance Group Key Developments Page at Reuters
2012 Annual Report Form 10-K (annual net income is erratic-see page 39)
Prior Trades: None
Related Trades: There were two trust certificates (PKM and KRH) containing a junior Hanover Insurance bond. PKM had a 8% coupon, while KRH was .25% lower. Both had the same junior bond with a 8.207% coupon maturing in 2027 as their respective underlying security. Both were called by their call warrant owners. That bond is still outstanding, Finra. A purchase near par would be a better deal than THGA, given the higher current yield, identical credit rating for the two bonds since both are junior bonds, and an earlier maturity. I had forgotten about the bond altogether and will look for an opportunity to buy it.
Realized Gains PKM AND KRH:
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| 2011 PKM 50 Shares Tendered to Warrant Call $356 (6/18/09-2/15/11) |
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| 2011 Regular IRA 50 Shares +$400.58 (6/18/2009-1/28/11) |
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| 2009 PKM 50 Shares +103.47 (6/18/09-7/27/09) |
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| 2010 KRH 100 Shares Tendered to Warrant Call (12/22/10) + $291.55 (11/4/10 & 11/11/09) |
Bought: KRH at $24.85 Bought 50 of the TC KRH at $19 November 2009- KRH-Exercise of Call Warrant December 2010
Bought 50 KRH at $18.62 in IRA-Sold 50 KRH at 24.6 (October 2010)
Total Realized Gains PKM and KRH: $1,151.6
Recent Earnings Report: For the second quarter, Hanover reported net income of $53.4M or $1.19 per share, up from $.46 in the 2012 quarter. Operating income was $46.8M. SEC Filed News Release
Form 10-Q
Rationale: This one became at best slightly attractive after plunging in price. At a total cost of $21.58, the current yield will be around 7.36% which is okay in today's low interest rate environment. At least that is a tax free yield when this bond is bought in a Roth IRA. Before taxes and inflation, money will double in about 9.76 years at 7.36%: Estimate Compound Interest.
I do not view it likely that this bond will be called by the issuer, at least for the foreseeable future.
There is at least a possibility that the bond may recover some in price provided interest rates remain at, or fall from, current levels. The bond simply quit going down in value when interest rates quit going up and headed back down some.
Risks: The risks relating to Hanover are discussed by the company starting at page 21 in its 2012 Annual Report: Form 10-K The bond's prospectus contains a discussion of risk factors starting at page S-6
Interest rate risk is huge which is why I decided to buy only 50 shares. If I am caught holding this one during an interest rate spike, I at least have the option of buying another 50 shares at a much lower price that will generate a higher yield.
Future Buys/Sells: When buying a 50 share lot, I am placing some odds on a continued decline in price that will enable me to average down. I would consider buying another 50 shares provided the current yield was 8%+, a typical marker that I am currently using in making those decisions.
If there was a spurt back up toward par value, I would consider selling this security and then wait for another opportunity to buy it back.
Closing Price 11/6/13: THGA: $22.06 +0.04 (+0.18%)
4. Bought 50 SLGPRI at $22.69 (see Disclaimer):
Snapshot of Trade:
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| 2013 Bought 50 SLGPRI at $22.69 |
Security Description: The SL Green Realty Corp. Preferred Series I (SLG.PI) is an equity preferred stock that will pay quarterly dividends at the fixed coupon rate of 6.5% on a $25 par value. Dividends are cumulative and may be deferred legally once the issuer ceases to pay cash dividends on its common stock (stopper clause). The stopper clause is typical and can be found at page S-15 of the prospectus. SL Green has the option to redeem at par, plus accrued dividends, on or 8/10/17.
Prospectus
This security is currently rated Ba2 by Moody's and B+ by S & P.
SL Green is "New York City's largest office landlord", with interests in 58 Manhattan properties totaling 35M square feet. Company Profile for SL Green Realty
SL Green Realty recently sold 2.6M shares at $98.15.
Stocks, Bonds & Politics: REIT CUMULATIVE PREFERRED LINKS IN ONE POST/Advantages & Disadvantages
Prior Trades: None
Related Trades: During the Near Depression period, I traded both the common stock and other SLG equity preferred shares.
While it is hard to believe now, I included SLG's common in what I call a scatter buy with cash flow. LATE DAY TRADES: GCI, CBL, FR, SLG, NYT, NWSA (11/18/08 Post). I bought 25 shares of SLG at $23.35. While that seems like an absurd price now, I later averaged down by buying another 25 shares at around $15. Needless to say, the LB sold the shares too soon. The RB was proud to own -indirectly-less than a square inch of one of those really expensive Manhattan office towers.
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| 2009 SLG 25 Shares +$306.47 |
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| 2010 SLG 25 Shares +$793.98 |
I also did some nibbling during the Dark Period in SLGPRC and SLGPRD. Both of those preferred stocks have been redeemed at par value by SLG. While I traded SLGPRD profitably, I was more fortunate with SLGPRC:
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| 2010 Regular IRA SLGPRC 30 Shares +$377.63 |
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| 2010 ROTH IRA 50 Shares +$697.02 |
Sold Remaining SLGPRC at $25.01 (August 2010)-Bought SLGPRC (February 2009)
Recent Earnings Report: SL Green Realty reported third quarter FFO of $1.34 per share compared with the prior year third quarter of $1.12. The company raised its full year FFO guidance to $5.12 to $5.16 from $4.9 to $5. The company also raised its FAD (funds available for distribution) to $3.51 to $3.55 per share from $3.1 to $3.2.
Rationale: Given the significant price decline, I decided to at least initiate a position in this equity preferred stock primarily for its income generation. At a total cost of $22.69, the current yield is about 7.16%.
Unless interest rates are lower than now when SL Green has the option to redeem, and its credit rating is at least a notch or two higher, I doubt that this issue will be redeemed, but that judgment will need to be made based on the facts in existence starting in August 2017. I am assuming now that this security will be perpetual and can only hope that the issuer will redeem at par in August 2017.
Risks: The risks are summarized by the company starting at page S-7 of the prospectus.
I discuss the disadvantages of equity REIT preferred stocks in this post: Stocks, Bonds & Politics: REIT CUMULATIVE PREFERRED LINKS IN ONE POST/Advantages & Disadvantages
I would highlight again the interest rate and volatility risks inherent in all perpetual equity preferred stocks.
This stock was sold to the public back in August 2012 at $25. A high closing price was hit in May at $26.19 and a low at $21.96 during October. SLG.PI Stock Chart That decline of 16.14% was due to interest rate and volatility risks.
The credit risk issue, real and imagined, will rear its head from time to time. The clearest recent example was the pricing of SLGPRC and SLBPRD during the Near Depression. Those preferred stocks dived into the single digits and SL Green never missed a dividend payment. The credit risk issue can be fueled by fear, rational or irrational, and is stoked by the realization that an equity preferred stock issued by a heavily leveraged firm may have no value in a BK.
A zero value in a BK would be virtually certain for an equity preferred stock issued an investment bank (e.g. Lehman) or a bank holding company. A equity REIT preferred stock may have some value depending on the value of the properties and the amount of debt.
Closing Price 11/6/13: SLG-PI: 22.32 -0.12 (-0.54%)
The price has continued to decline after my purchase.
5. Sold 301+ WIW at $11.7243 (see Disclaimer): I am in a trading mode for this low yielding bond CEF. I held the security long enough to collect two monthly dividends. The snapshot of the profit does not include fractional shares which will be liquidated by the broker:
Snapshot of Trade:
Snapshot of Profit:
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| 2013 WIW 301+ Shares +$70.61 |
Total Realized Trading Gains on WIW Shares= $656.15 ($70.61 + $585.54 cumulative shown in snapshots in the prior linked post)
Closing Price 11/6/13: WIW: 11.76 +0.01 (+0.08%)
6. Bought 50 GSPRC at $19.95 (see Disclaimer):
Snapshot of Trade:
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| Bought 50 GSPRC at $19.95 |
Security Description: Tht Goldman Sachs Group Inc. Preferred Series C (GS.PC) is an equity preferred stock issued by Goldman Sachs Group Inc. (GS ) that pays non-cumulative and qualified dividends at the greater of 4% or .75% above the 3 month Libor rate on a $25 par value: Prospectus
The prospectus contains a typical stopper clause:
The stopper clause is the legal means used to give the preferred shareholder their preference right to dividends compared to the more junior common shares.
Historical Charts 3 month Libor and Federal Funds:
Effective Federal Funds Rate
3-Month London Interbank Offered Rate (LIBOR)
In comments to a Seeking Alpha article, I recently discussed the advantages and disadvantages of floating rate preferred stocks. The gist of the discussion was the current yield differential between a fixed coupon and floating rate preferred stocks from the same issuer. The author of that article reproduced a chart of the market's current forecast for short term rates until 2022 (second chart).
He then bases an argument for certain floaters based on that chart being an accurate prediction about the future. What can you say? When did humans start being able to accurately predict what will happen with interest rates over the next seven years?
I can not develop a portfolio based on that projection being 100% accurate. I have to account for various scenarios including one where short term rates turn out to be far lower or higher than this projection.
If this chart proves prescient, the coupon for GSPRC would not be equal to the 6.2% fixed rate coupon of GSPRB even in December 2022 with the 3 month Libor rate projected to be near 4.7%. Adding the .75% float to 4.7%, I would have a 5.45% coupon on GSPRC.
In a perfect market, with no other rational factors influencing price, the price of GSPRC would then be converging on GSPRB, assuming that the market was pricing both securities based solely on their respective coupons which would not be the case under those circumstances involving persistently rising short term interest rates.
In that scenario (i.e. 3 month Libor accelerating to 4.7%), I would expect the GSPRC price to be at or near its par value while GSPRB would likely be declining in price. A lot would depend on the market's future forecast (up or down) for short term rates at that time.
Theoretically, GSPRC would make up in capital gains what it lost in income generation under the market's current short term rate forecast but it would take several years to do so. The market could easily be way off about its future interest rate forecast, either up or down.
As of 2:00 P.M. CST 11/5/13:
Floater: GS-PC: $19.98 +0.05 (+0.25%)
Fixed Coupon: GS-PB: $24.30 -0.11 (-0.44%)
When constructing the bond and bond like part of my portfolio, I am playing a variety of scenarios. I will use the floaters to offset the interest rate risk of long maturity bonds.
Prior Trades: None
Related Trades-GS Equity Preferred Stocks: I have bought and sold the functionally equivalent GSPRA and GSPRD. I currently own 100 shares of GSPRD: Item # 6 Bought Roth IRA: 50 GSPRD at $21.65; Item # 1 Bought 50 GSPRD at $20.6 (December 2012). I will sell the lot bought in the ROTH IRA at over $22.
Snapshots of trades can be found at the end of this Gateway Post: Stocks, Bonds & Politics: Advantages and Disadvantages of Equity Preferred Floating Rate Securities That post also contains a general discussion of the advantages and disadvantages of floating rate equity preferred stocks.
Except for one trade involving 100 shares of GSPRD, which netted a $257.24 profit, the realized gains for GS equity preferred floaters (GSPRA, GSPRC, and GSPRD) have been between $40 to $100.
Rationale and Risks: I am just dragging and dropping the recent discussion made in connections with GSPRD and making a few changes to conform to the GSPRC purchase.
Floaters: Links in One Post
Rationale: (1) Income is Better Than Cash Earning Nothing/Some appreciation Potential Possibly to $22-23.5 with Risks (see below)/Deflation-Low Inflation-Problematic Inflation Scenarios Embodied in One Security.
At a total cost of $19.95, the dividend yield at the 4% coupon is about 5.01% which is satisfactory at the moment. The LIBOR float provision will activate when the 3 month LIBOR rate is over 3.25% during the relevant computation period. At a 5% LIBOR, the coupon rate would be 5.75% or approximately 7.21% at a total cost of $19.95 per share.
This type of security also balances the interest rate risk of longer term fixed coupon senior bonds held in the taxable account.
Another way of looking at it is to compare the current yield differential with GSPRB at today's closing price and then assigning your personal value to the inflation protection afforded by the floater and the greater capital appreciation potential. Of course, the mere fact that GSPRC is attractively priced in relation to GSPRB, based on the values that I assign to those two issues, does not mean that GSPRB is being priced correctly.
Current Yield Differential Based on 11/5/13 Closing Prices: Data From Marketwatch
GS.PB at $24.4 Current Yield of 6.35%
GS.PC at $19.99 Current Yield of 5.11%
Another way to look at this comparison is to compare income generation by investing the same amount of money in each security, and then evaluating the income generation under different LIBOR scenarios.
For example, assume I invested $10,000 in both GSPRB and GSPRC at today's closing prices:
GSPRB Prospectus (6.2% fixed coupon on a $25 par value)
410 Shares of GSPRB Annual Income is Constant at $635.5.
500 Shares of GSPRC: Current Annual Income of $500
Current Income Differential for 3 years= $406.5 plus income on that income differential
Assume a 4% 3 month Libor for 1 year:
GSPRB Remains at $635.5
GSPRC is now at a 4.75% coupon= $593.75
Assume a 4.4% 3 month Libor for 1 year (5.15% coupon for GSPRC):
GSPRB remains at $635.5
GSPRC up to $643.75
GSPRC now generating more income.
Assume a 5% 3 Month Libor for 1 year:
GSPRB Still at $635.5
GSPRC is up to $712.5
Assume a 7% 3 month Libor for 1 year:
GSPRB still at $635.5
GSPRC moves up to $968.75
Assume a 10% 3 month Libor for 1 Year:
GSPRB still at $635.5
GSPRC at $1,343.75
Without question, the investor sacrifices current income going with the floater versus the fixed rate coupon from the same issuer. To be rescued from that lost income, the floater will need to rise in price creating a capital gain sufficient to offset that lost income or rates will need to move up faster than currently expected by the market to narrow the time period for the ongoing income generation differential, or some combination of the two.
Risks: (1) Highly Volatile/Heightened Risk/Non-Cumulative: I started to invest in some of these securities during the Near Depression when they could be purchased at greater than 50% discounts to their $25 par values. The downside risk is zero as shown by what happened to those unfortunate souls who owned LEHPRG, a Lehman equity preferred floater, that is now worthless of course.
An equity preferred stock is only superior to common stock. It will be junior in the capital structure to all bonds. Given that low priority, the non-cumulative dividends paid by most of them, and the highly leveraged balance sheets of financial institutions issuing them, there will be no recovery in a bankruptcy for an owner of an equity preferred stock. Investors realized that would be the likely outcome and will behave irrationally when there is a whiff of a possible financial collapse. (a 75% chance of bankruptcy when a rational number would be less than 10%).
BAC equity preferred stocks, for example, could have been bought for less than $10 even in 2009. I bought ZBPRA, a Zions equity preferred floater for $7.8. Bought 100 ZBPRA at $7.8 (May 2009)(see snapshot in Gateway Post on this topic) None of those equity preferred floaters missed a dividend payment. (METPRA for less than $8, rational or irrational?, AEB for less than $5, rational or irrational?)
Periodically, these stocks will hit an air pocket and just fall as if a bankruptcy filing was imminent. I am just used to it.
I discuss an example from August 2011: Item # 1 Fear and Enhanced Volatility in Certain Classes of Income Securities I was able to buy Santander's floater at $13 during that one. A few weeks later, yet another downdraft, and I picked up HBAPRG at $16.18 (HSBC's US operation). Bought 50 HBAPRG at $16.8
One of my earlier discussions about embracing their volatility in a trading strategy is discussed in a May 2009 post. Embracing Volatility as A Risk Management Tool In the Sub-Asset Class of Equity Preferred Stock
So, volatility and risk are just known hazards. Know what you are buying, its history and characteristics.
Equity preferred stocks were hit harder in many cases than fixed income preferred stocks from the same issuer when rates spiked up starting in early May.
GS.PC declined from a closing high of $24.97 in May 2013 to a $19.47 low during October.
GS has two fixed coupon equity preferred stock that pays non-cumulative and qualified dividends. GSPRB has a 6.2% fixed rate coupon on a $25 par value. Prospectus That one closed at $25.81 on 5/7 and at $23.46 on 8/19. GS.PB Stock Chart
GS has recently issued one 5.85% fixed coupon equity preferred stock: Goldman Sachs Group Inc. 5.95% Non-Cum. Pfd. Series I) (GS.PI ) That one traded at over $26 in May, GS.PI Stock Chart.
Another recent one from GS is a fixed to floating rate equity preferred stock: Goldman Sachs Group Fixed-to-Floating Rate Stock (GS.PJ). That one has a 5.5% fixed coupon until 5/10/23 and three month Libor plus 3.64% thereafter. PROSPECTUS SUPPLEMENT If the Libor rate is high, I would expect a redemption by GS on or after 5/10/23. I recently bought that one and will discuss that purchase in my next post.
2. No Coupon Bump Likely for Several Years: The likely continuation of ZIRP for two more years and the likely slow pace of the subsequent tightening cycle after ZIRP's end will combine to keep the 4% minimum coupon as the applicable rate for several years. It would take a rise in the 3 month LIBOR rate to over 3.25% during the relevant computation period to trigger any increase in the coupon. I do not currently see that happening before 2017.
On the flip side, GSPRC at least produces a current real rate of return of close to 3%, before taxes, based on the currently forecasted inflation rate embodied in the ten year TIP price which is 2.19% as of today's closing prices.
Closing Price 11/6/13: GS-PC: $19.99 +0.06 (+0.30%)
Politics and Etc.
1. Obama's Lack of Involvement: I first noticed that Obama was going to be a Bystander in Chief when he allowed the Democrats in Congress to piece together the 2009 stimulus bill known as the American Recovery and Reinvestment Act of 2009.
I regarded that $787B stimulus bill to be poorly designed and woefully inadequate in infrastructure spending that the nation needed to do anyway.
Can you point to any structure built with those funds? I can only point to a $787B in more debt that the government will be paying interest to finance and refinance, most likely for as long as the U.S. exists.
The stimulus bill did soften the impact of the recession and probably provided a significant and temporary lift to the economy. However, if the nation is going to spend that kind of money, then the benefits need to be long term too.
In Nashville, I can point to several structures still in use, including the Tennessee Supreme Court Building and the Nashville Courthouse that were built during FDR's stimulus programs during the Great Depression.
This is a link to a map of structures still in use throughout the U.S. built during that earlier time. New Deal Project Map | Living New Deal
Another stark contrast between a competent President and Obama is that the competent President realizes when executives and experts in private businesses need to be brought into government to run certain projects. FDR frequently relied on business executives to get things done. There are legions of examples, such as the appointment of William S. Knudsen, the President of GM, to help lead the nation's war material production efforts during WWII.
Obama relied on a clearly unqualified politician from Kansas and a bureaucrat way above her head to coordinate the launch of Healthcare.gov
Obama knows how to win elections, but does not have a clue how to govern effectively. I would agree with John Dickerson's observations on that point. CBS News
Obama is a better President than his predecessor, but that is not a compliment.
2. Substantial Health Insurance Premium Increases for Small Employers Due to Obamacare: An article published in USATODAY last Monday claimed that small businesses with less than 50 employees, who provided health insurance, will be experiencing "30% to even 100%" increases in premiums upon renewal due to Obamacare. Businesses with a preponderance of young employees will be hit the hardest since the Affordable Care Act "ACA" prohibits insurance companies from charging older persons more than 3 times their premiums for younger individuals.
3. Linda Ronstadt: I only recently became aware that Linda had to retire due to the onset of Parkinson's disease. YouTube
I was reading a WSJ article about the song 'Different Drum' that was released in 1967 when Linda was the lead singer for a group known at the Stone Ponys. I watched the YouTube Video of her live performance of "Different Drum" that is embedded in the WSJ article which started me on a tour down memory lane.
I was always partial to her rendition of Heat Wave (1976) Offenbach, Germany, originally performed by Martha & the Vandellas - Heatwave - YouTube
There really is no comparison with Miley Cyrus and Lady Gaga.
It is a travesty that Linda has not been inducted into the Rock Hall of Fame. She does not care. latimes.com Don Henley referred to that omission as a travesty. Did you know that the Eagles started out as her backup band, and she helped them get started on their own? "The Eagles talk about Linda Ronstadt and The Rock and Roll Hall of Fame" - YouTube
I care, so I took the time to cast a vote on her behalf. Online Fan Poll | The Rock and Roll Hall of Fame and Museum
