Monday, April 6, 2009


Mike Mayo, a bank analyst with a degree of gravitas in some circles, stated today the banks loan losses will be greater than those experienced during the Great Depression.  He also started several large regional banks with sell ratings including US Bancorp, Suntrust and KeyCorp. I believe that he is referring to loan losses as a percentage of total loans. I remember that Mayo was recommending Lehman Brothers almost up to the day Lehman filed for bankruptcy.

I mentioned a new mini type strategy that I was going to try on for size.  The gist is that I would go ahead and start adding some stock ETFs now to replace some mutual funds that I would sell later on when the market was well into the next bull phase. A Good Month But Another Awful Quarter/Ingersoll Rand: Awful Guidance and a Dividend Cut/Can No Longer Rely on Dividends as a Source of Income/Alcoa  

I took a baby step by buying 100 shares of VEU at $29.8. The entire prior position was liquidated in May 2007 at around $52 and I have not been in it since that transaction. This ETF from Vanguard has a modest expense ratio of just .25% and includes around 2185 stocks from countries outside the U.S. Unlike other international index funds, it has exposure to Canada and the emerging markets. I simply look at it as a relatively inexpensive way to gain exposure to both emerging and developed international markets with one security and view that I am ahead by selling my last shares in VEU for  a good profit at a price about $25 higher than the purchase today. 

I also added 100 shares of the TC GJT, a relatively unattractive floater, at $8.30. This is a synthetic floater created by a swap agreement tied to a senior fixed rate bond issued by Allstate and maturing in 2036. The coupon for the underlying bond is 5.95% which would be received only in the event the swap agreement creating the floater is no longer in existence (see p. S-7 of the prospectus). Fitch rates this senior note at BBB+. Fitch Corporate The float has no minimum interest rate which is what makes it unattractive, but it does have a maximum level of 8%. The float is .8% above the 3 month treasury bill rate which is not bad. Since the 3 month bill bill is so low now, and probably for months to come, the current yield of this floater even at a substantial discount to par is negligible. 

With a T bill at .2%, which is close to the current rate, then the yield at par would be just 1% or about 3% based on my cost since the interest calculation is  based on par value, not my cost or the market value. My yield is determined by first calculating the interest payable at the par value and then dividing my cost into that sum. 

My primary reason for adding GJT to my stable of floaters is diversity. I do not own any Allstate common, preferred or other bonds.  Secondarily, I am planning for the future with the floater purchases, due to my concern of potential inflation problems down the road resulting from the Fed's debasement of the currency, quantitative easing and the massive fiscal stimulus and deficit spending. Others may not share that concern and may be predicting a prolonged period of deflation or low inflation which would make this security more unattractive. 

From September 2007 to September 2008, just prior to the Lehman bankruptcy, GJT floated in price between 16 to 20. It then caved to trade mostly in the 6 to 9 range, with one spurt to 10 in early November 2008 and a downdraft to 5 later that month. The 3 month treasury bill has plunged during this down period for GJT, with a 1% fall at the 9/19/08 auction, and down over 4% from the year earlier auctions. Since this type of security is valued in my opinion based on the here and now, and the here and now is a very low T Bill rate, the security is being priced as if that rate will last a very long time, as if the present will be the fate for the indefinite future.    

 My maximum rate on GJT is reached when the 3 month T bill hits 7.2%, which triggers the maximum 8% for this security. At 8% my effective yield would not be 8% however but 24%. At at 4% T Bill rate (calculate 4% + .8%), my effective yield becomes 14.45%.  By buying at a huge discount, I will juice my return later on when the T Bill starts to rise in yield.  This will work to my advantage provided there is not a prolonged period when the 3 month T Bill pays next to nothing as now and during the Great Depression. 

Since this security was purchased at a huge discount to its $25 par value and matures in about 27 years on 4/1/2036, there is the added benefit of a return representing the difference between cost and par value at maturity. On 100 shares that amounts to about $1660 based on my cost with commission.If paid at maturity, or called earlier, that would add about 7.4% per year calculated amortizing the spread on a straight line basis.   

The link to the prospectus: 

This kind of investment, along with several other similar ones recently bought including GJR, GJN, & GJO, will look smart only when the short rates return to 3+% from their currently abnormally low levels. When that happens, I suspect that these kind of instruments will be priced differently, more at a level where my interest in them would most likely be nil.  I am not thinking about the here and now when buying them but what may be, or most probably will be, based on my personal opinions as to the likely future outcome of the current state of affairs. Here and Now Valuations Versus the Reasonable Range of Future Forecasts 

If for example I posit a reasonable average of the 3 month T bill rate over the next 27 years as 3.2%, just for the sake of calculation, the GJT average rate based on par would be 4% which would translate to $1 per year in interest for 1 share. At a cost of $8.3, that would be 12%, plus another 7% annually from amortizing the spread or 19% annually for 27 years. All that needs to happen for that to occur is for Allstate to survive until April 2036 and for the average 3 month T Bill rate to average 3.2% which does not appear to be unreasonable based on past experience. And, I have to not be concerned about what is being paid now which is not much.   

I have a large number of different types of floaters in my portfolio, and I prefer those that provide the greater of a minimum guarantee or some percentage over a short rate such as the 3 month Treasury Bill or LIBOR. These floaters, probably more than 10 different issuers, along with inflation protected bonds like the TIP & WIP, are primarily purchased for their inflation protection, but the ones with minimum rates bought at deep discounts to par value also have a deflation protection component. Inflation or Deflation: Bond Alternatives/Bary's Column In This Week's Barron's: Floating Rate Preferred Stocks METPRA GSPRA HBAPRF BACPRE MERPRL 

  I am not a financial advisor but an individual investor trying to navigate my way through a difficult market. I have never worked for a financial institution and never will.  In these posts, I am acting as an unpaid financial journalist and an occasional political commentator.   I am also aggregating financial news stories that I view as important and providing any reader of these posts, assuming there are more than a couple, with links to those articles, sort of a filtered, somewhat intelligent, free search engine.  Any discussion made by me of particular securities  is not a recommendation to buy or to sell.  Trade at your own risk.  Consult with your financial advisor prior to making any purchase or sale. I will try to identify my sales too but it may take a few minutes after I implement them to create a post explaining my reasons.  The sale may before or after the post.  Before buying or selling any stock, even one recommended by a trusted financial advisor,  please research it and make up your own mind which is what I always try to do.  Research would include reading reports, reviewing financial records, earnings estimates, sec filings and prior earnings releases and news.  In this post, and all others by me, I am merely describing my reasons for purchasing  or selling securities, and the potential pitfalls that I identified prior to purchase or the reasons for a sale.  The securities mentioned in this and all posts written by me may not be suitable for others based on their unique financial position and risk profile.  By way of example, it is unlikely that I will ever need the funds contained in my retirement accounts. Always read the prospectus before buying a Trust Certificate, bond, preferred stock or other bond or bond like investments.  Information contained in my posts has been obtained from sources believed to be reliable but cannot be guaranteed.  It is always important to follow the investment process. the investment process/links to further information on canadian energy or royalty trustsInvestment Process Part II: Bonds and Bond Like Investments   NOT A RESEARCH SERVICE/Add of PWE Last Week   These posts by me do not constitute investment advice, nor shall they be construed as a guarantee of future results, or as an offer of any transaction in securities.   All content in these posts is provided for informational and entertainment purposes only, and it is a form of entertainment for me. 

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