Sunday, October 5, 2008


ADDED 5/7/2009: More recents posts on the MetLife floating rate preferred issue, METPRA, discussed toward the end of this blog in Item # 4 can be found at:


I would also recommend anyone interested in these types of securities to register at the free site: QuantumOnline Credit Ratings -

**********************original post revised to add Headings in Green:

1. Pseudo Conservatives Blame Minorities for the Mortgage Crisis: Before turning to today's topic, I want to expand on my comments yesterday about the efforts being made now by people who call themselves conservative to blame minorities for the current economic crisis. Rush Limbaugh claimed during his October 3, 2008 show that the federal government practicing "Marxist social engineering" required a relaxation of lending standards, an
"affirmative action via mortgage", to enable "minorities and poor people who could not pay it back" to receive loans. Ann Coulter stated in her column dated 9/24/2008 in Human Events that the government substituted traditional criteria such as the mortgage applicant's credit history and ability to make a down payment, with " nontraditional measures of credit-worthiness, such as having a good jump shot or having a missing child named "Caylee."

2. The Real Origins of the Mortgage Crisis: The preceding comments, including those made by my representative Marsha Blackburn summarized in yesterday's blog, mostly have to do with the Community Reinvestment Act of 1977 which was discussed yesterday. None of these comments take into account the role of investment banks in creating the mortgage fiasco. The activities of investment banks, including Bear Stearns, Lehman Brothers and Merrill Lynch, had nothing to do with any government program to encourage home ownership. It is impossible to understand their roles in the mortgage fiasco as "Marxist social engineering". Instead, their role, and it was a substantial one ignored by these "conservatives", was in furtherance of their own capitalistic goal to make as much money for themselves as possible. Their role in the mortgage fiasco and the credit crisis is documented in the new book by Paul Muolo and Matthew Padilla "Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis"

As described in that book and numerous articles written over the past two years, the investment firms provided financing for the independent mortgage companies like Ameriquest, New Century, and Argent Mortgage, and then grouped the subprime mortgages originated by these now defunct companies into pools called CDOs. Many of these loans were unscrupulous, containing high rates and hidden fees. Those bonds were then syndicated/sold by the investment banks to investors around the world. Money was made in a variety of ways by the investment banks. By 2006, the height of this madness, the sale of these CDOs had reached 503 billion, with 1/2 of that total made to people with poor credit, little loan history, or high debt according to Moodys Investors Service. In my prior blog, I tied this activity to the increased leverage the SEC permitted investment banks to carry in 2004. The excess leverage went into financing the expansion of the subprime mortgage industry and the problems started to spiral out of control shortly after this rule change by the SEC.

Compared to this often nefarious activity described above which is apparently of no import to those "conservatives" identified by name above, Janet L. Yellen, President and CEO, Federal Reserve Bank of San Francisco, made the following statement in a March 31 speech about the government program that Limbaugh, Coulter and Blackburn complain about:

"There has been a tendency to conflate the current problems in the subprime market with CRA-motivated lending, or with lending to low-income families in general. I believe it is very important to make a distinction between the
two. Most of the loans made by depository institutions examined under the CRA have not been higher-priced loans, and studies have shown that the CRA has increased the volume of responsible lending to low- and moderate-income
households. We should not view the current foreclosure trends as justification to abandon the goal of expanding access to credit among low-income households, since access to credit, and the subsequent ability to buy a home, remains one of the most important mechanisms we have to help low-income families build wealth over the long term."

3. Harry Reid Causes Life Insurance Companies to Tank by Repeating Multiple Hearsay Statements: This brings me to the main topic of the day: Libor and the MET LIFE Floating Rate Preferred Stock. Before discussing this preferred stock, I will mention a political event that makes it more attractive which happened last week. The Senate Majority Leader Harry Reid (D) told reporters last Wednesday that "one of the individuals in the caucus today talked about a major insurance company -- a major insurance company -- one with a name that everyone knows that's on the verge of going bankrupt." Senator Reid was basically repeating a hearsay comment that he heard at at meeting made by someone who heard it from somebody else. Even if there was a measure of truth in this multiple hearsay, it was still extremely irresponsible to say the least for Senator Reid to publicly repeat it in front of a group of reporters, needlessly fanning panic, a brain dead moment for the Democratic Leader of the Senate. The common shares of life insurance companies were thereafter trashed including Metropolitan Life (MET), with many of the companies falling far more than 20% over the next two days and the credit default insurance rates on their bonds skyrocketed.

4. Met Life and its Floating Rate Equity Preferred Stock METPRA: Barrons had a favorable article about MET Life in this week's edition. This article pointed out that the company had 14 billion in cash and 4 to 5 billion in excess capital. The company is still solidly profitable with the consensus estimated earnings at over 6 dollars per share in 2009.

Met Life has a preferred stock issue that also took a beating last week along with common stock. The symbol is METPRA, or MET-PA at yahoo finance or MET.PRA at Marketwatch. The par value of this preferred issue is $25 with no maturity date. As of last Friday, 10/3/2008, it closed at $9.8 per share. The floating rate provision requires Met to pay the greater of 4% or 1% over three month LIBOR (the London Inter Bank rate). For 100 shares, the annual interest payment at the guaranteed rate would equal $100 (.04% x 25 par=$1)
The coupon is calculated on the par value. However, when you purchase the security at $9.8 for example, the effective guaranteed yield at that price is 10.2% ($1 divided by 9.8 cost=10.2%). Thus, a purchase at last Friday's closing price excluding a brokerage commission would give you a guaranteed yield of 10.2% paid in quarterly installments.

The interesting thing about this floater is its float provision. As a result of the credit crisis, the spread between 3 month Treasury Bills and 3 month LIBOR has expanded to unprecedented levels. These two rates are usually about the same. Currently, the 3 month LIBOR rate was 4.33% last Friday, up from around 2.8 just a few weeks ago and the 3 month treasury bill was at .5%, far less than the current inflation rate giving you a very significant negative real rate of return at the treasury bill rate, even before adjusting the rate of return for taxes.

For purposes of illustration only, I would like to assume what effect a 3 month LIBOR rate at 5% would have on the MET LIFE floater. The rate would then rise to 5% + 1% or 6%. A 6% yield on a $25 par value bond like investment would yield $1.5 per share in interest per 1 share annually or a 50% increase over the guaranteed rate. Now, you need to do a calculation of the effective yield at a $9.8 cost per share. This is done as follows: $1.5 interest divided by $9.8 cost=15.3%. Of course, this yield will go up when the cost goes down; and the yield will go down when the cost goes up.

The downsides that I considered prior to making a purchase can be summarized as follows. First, the security has no maturity but Met Life could redeem the security at par value plus accrued interest in the event the float rate becomes too onerous for it which could happened with a prolonged spike in short term rates and an inverted yield curve, where Met Life could refinance with a longer dated maturity and save money. When purchasing a bond or bond like investment I always prefer issues that have a fixed maturity date. Second, this is a non-cumulative issue, which means that any interest payment missed does not have to be paid later. If missed it becomes like an eliminated common stock dividend where the company has no legal obligation to pay an eliminated dividend in the future. Generally, for non-cumulative preferred stock dividends, the company can not pay any common stock dividend and reduce or eliminate the preferred stock dividend. That is, if a common stock dividend is paid in any amount, the preferred dividend would have to be paid in full. Also, any elimination of a non-cumulative preferred stock divided would invariably be linked to a major solvency type issue. Bankruptcy in all likelihood would be just around the corner. So in many circumstances the importance of cumulative versus non-cumulative would not be material. Nonetheless, it is always better to buy a cumulative preferred stock which requires any missed payment to accumulate, sometimes with interest, and payment is not discharged short of bankruptcy. Third, a preferred stock only has preference rights in bankruptcy to assets over the common stock holders. The Lehman preferred stock issues are now worthless in that investment bank's bankruptcy. The most secure debt in the event of a bankruptcy is secured debt, like a mortgage on a building, then senior debt, then junior debt-sometimes called junior subordinated debentures, then preferred stock and lastly common stock. So the METPRA is just above common stock in this pecking order. It is however difficult for me to imagine now a bankruptcy for MET LIFE and this security does give you the benefit of a guaranteed rate plus protection in the floating rate provision in the event the short term LIBOR rate increases.

Tomorrow, I will discuss another floating rate security that provides a greater guaranteed effective yield from an insurance company, based on its current cost of about 1/4 of par value, and it is cumulative.

In full disclosure, I own shares of METPRA and will continue to buy additional shares at or below the current price, or even slightly above. This is not a recommendation to buy or to sell. Trade at your own risk, and perform research about this security by reading the prospectus at and further studying the financial health of MET Life (symbol MET at yahoo finance) before making any investment. Consult with your financial advisor prior to making any purchase. In this blog, I am merely describing my reasons for purchasing this security and the potential pitfalls that I identified prior to purchase. This security may not be suitable for others based on their unique financial position and risk profile. This caveat will apply to all securities discussed in all of upcoming blogs.

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