Wednesday, August 26, 2009

Bought 50 PZB at $16.05/Bought 50 PJS at $17.8 in Roth/Case Shiller/Budget Deficits/EC-Permanently Damaged its Banks/Ariad-Lilly Patent Litigation

1. Case-Shiller: I try to look at a fair amount of hard data that is publicly available. The Case-Shiller index is one piece in the puzzle as I try to figure out what is going on in the U.S., no small task. This index is released monthly and the for June 2009 was released yesterday: www2.standardandpoors.com/.pdf This index measures home prices in 20 large cities. For the second consecutive month, the composite price showed a gain, and the year over year decline decreased from the prior quarter. With the exception of Las Vegas and Detroit, all of the remaining cities showed gains in prices compared to the readings in May. San Francisco rose 3.8% versus May; Cleveland up 4.2%; Boston up 2.6%; Washington up 2.8%; etc (page 3). While I recognize that Alan Abelson is still bearish expecting the worse, waiting for the DJIA to fall to the 1932 lows before expressing a glimmer of hope, I would view it as important that housing prices have not only stabilized but started to turn up. If this trend continues, it will help those institutions holding home mortgage securities to realize less losses, possibility loosening up investor interest in acquiring what was formerly shunned, and allow many homeowners to refinance as equity returns to their home ownership. After all the original source of the near Depression was the improvident and reckless extension of mortgage credit in the U.S., which distorted price, causing an unsustainable parabolic rise in home prices that could not be supported by a rise in incomes. The bottoming of the home price decline, and even modest improvements off the bottom, can only be viewed as positive.

2. Budget Deficits: In a sense, the good news from the Congressional Budget Office and the White House Office of Management and budget is that the deficit will be 1.6 trillion for the fiscal year ending September 2009. /www.cbo.gov/2009BudgetUpdate_Summary.pdf How on earth could that number be good news? It is good only in the sense it is less bad than the previous forecast by the CBO to the tune of 80 billion, hardly worth even noting. The bad bad news is that the projected deficit between 2010 to 2109 increased by 2 trillion to 9 trillion. We know the old saw, a trillion here and a trillion there and pretty soon you are talking about real money. In Senator Dirksen's time (Everett Dirksen), he used a billion in that line, but a few billion is chump change in the U.S.'s current budget deficit saga, about what gets flushed down an Iraq sewer every week.

3. Bought 50 TC PZB at $16.05 Yesterday (see Disclaimer): Fifty shares is my limit on this security. The underlying bond is a junk rated senior bond issued by the Limited (LTD), owner of Victoria Secret and Bath and Body Works. The price fell about 40 cents yesterday so I did not mind buying it even though it will soon go ex interest with its semi-annual payment. PZB Stock Quote - Pplus Tr CTF A LTD1 6.7 Stock Quote

This is a link to the prospectus: http://www.sec.gov

The underlying bond matures on 3/1/2033. The underlying bond has a 6.95% coupon whereas this TC has only a 6.7% coupon. The par value of PZB is $25 dollar so my buy was at about a 36% discount to par value.

Trading data for the underlying bond, and additional information about it including credit ratings is available at the FINRA site: FINRA - Investor Information - Market Data - Bonds - Bond Detail Please keep in mind that the yield at the FINRA site is the yield to maturity ( or yield to call: FINRA - TRACE Reporting FAQ). So the figure yesterday of 71.1 includes the yield to maturity of capturing the discount to par value at maturity in addition to the annual coupon payments. The annual coupon yield of the underlying bond at a 71 price would be calculated by multiplying the coupon of 6.95% times 100 par and dividing the sum by 71. The result is a current yield of 9.79% at that price not the 10.215% shown on the FINRA page yesterday. The yield at a total cost of $16.05 on PZB would be slightly more at 10.44%, even with a lower coupon due to a larger discount to par value. The larger discount also means a larger yield to maturity from capturing the discount to par value at maturity. This assumes LTD survives to pay par value on 3/1/2033, and there is a lot of risk in that assumption. Most likely, I will sell this one with a pop in price close to 20 or even at a negligible after collecting a few coupons.

I was not current on this company and did not realize until a few days ago, when I started my research in preparation for this bond buy, that LTD sold a 75% interest in its Limited and Express Stores to a private equity group in 2007. (see page 14: Quarterly Report) I suppose that turned out for the best given what has happened over the past 18 months. My main concern near term is the balance sheet. LTD has a lot of debt but it also a lot of cash:LTD: Balance Sheet for LIMITED BRANDS INC I also looked at the last quarter's earnings report, which was better than expected, and okay under the circumstances. Excluding one time items, LTD earned 19 cents, but that was a fall from the 27 cents a year ago. So while the decline year over year was understandable, it was nonetheless a steep drop.

4. Forbes Summarizes a Merrill Lynch Report on Difficulties Faced by ING to Pay Back the Dutch Government:
This article contains a discussion of some of the difficulties facing ING in repaying the Dutch government. Merrill seems to think it would make sense for ING to sell common shares at price equal to or higher than 13.6 Euros or $19.5 due to the 50% premium which has to be paid for the shares. The other way would be to raise 6 to 8 billion Euros by selling 10 to 15 units. Merrill speculates that could take up to five years except a speedier recovery could shorten the time. This report was issued ahead of ING's earnings call. I suspect that opinion is too pessimistic. The CEO said at the time of the last earnings release that ING hoped to repay the Dutch state as soon as possible, but the timing was uncertain due to current economic conditions. WSJ.com ING is certainly into the Dutch government in a bigger way than Aegon, and making slower progress than AEG in paying it back.

There was a story this morning in the WSJ that at least 6 firms have been selected to enter the second round of bidding for ING's Swiss and Asian private banking operations. WSJ reported that observers estimated those operations would bring 1.8 to 2 billion dollars. This slow process is preferable to a fire sale.

5. Ariad (owned-Lottery Ticket Category): I would not purchase ARIAD based on the flow of news about its patent litigation with Eli Lilly. Back in 2006, Ariad won a patent infringement case against Eli Lilly after a jury trial. The jury found that Lilly had violated Ariad's NF-Kb patent with respect to LLY's Evista and Xigris. The jury awarded Ariad 65 million plus a 2.3% royalty on future sales of these two drugs. Lilly was upset: Jury Issues Verdict An appeal was taken to the Court of Appeals for the Federal District. The appeal is heard by a 3 judge panel who overturned the jury verdict based on its view of the patent being invalid for failing to meet a written description requirement. I have no idea what that means. Ariad was not quite dead yet since it could ask for a rehearing before the entire Federal District Court of Appeals which consists of 12 judges. This is usually a long shot. The entire Appellate Court agreed to hear the appeal, which results in the panel's decision being vacated. All this means is that Ariad is still alive. Possibly, there were some judges who disagree with either the reasoning or the result of the panel's decision, or it may simply mean that the underlying legal issue is viewed as important enough to require the attention of all the judges. I do not believe that it is possible to draw any firm conclusions one way or the other, except to say that Ariad's claim against Lilly is not dead yet. An assessment of Ariad's patent claim is given in this blog at Seeking Alpha. I have no opinion on the merits of Ariad's claim.

6. Time period for Notice of Deferral: The IGK prospectus says that ING has to give a deferral notice not less than 16 business days prior to the interest payment date. The payment date is September 15th. I am not aware of any notice being given. The optional deferral for AEB is "not less" than 16 days from the payment date which is also 9/15. ING discussed this issue in connection with its March payment when there was also a palpable fear of deferral: ING clarifies coupon payment on hybrid capital - ING So the time periods for giving notice of deferral for this quarterly payment has expired.

But you know, the mere fact that I looked at the prospectuses to ascertain the time period for a notice of deferral, and then checked the news this morning, is not a good sign. And I would add the same point made earlier, can a U.S. investor keep track of the machinations and brain dead policy announcements emanating from the EC, when it is hard to figure out what is really happening in our own country? Who reads EC policy announcements in the U.S.? Do I need to start searching for EC policy statements everyday now? In case you missed it here is a link to the recent EC burden sharing policy promulgated to harm European financial institutions long term by raising their financing costs and undermining their ability to finance their operations in the future with new hybrid securities issuances, which had been a cheap source of capital for them until the EC decided it knows best: ec.europa.eu/competition/state_aid/legislation/restructuring_paper_en.pdf

One thing to always keep in mind, deferral rights for the borrower are never in the lender's interest.

On the positive side for the U.S., the EC has probably permanently damaged the competitive position of its large financial institutions. Prior to 2009, firms like AEG and ING were able to issue hybrid bonds with no maturity payment, no need to ever pay the principal back, at rates largely in the the 6% to 7% range. The U.S. financial institutions actually agree to pay the principal back at some point, and it is not difficult to find higher rates and better terms in the prospectuses, such as a limit on deferral rights to five years. And, this is the kicker. The U.S. does not have an idiotic burden sharing policy, and none were required to defer coupons on junior debt as a condition to receiving state aid. When the next banking crisis roles around, the European firms will have to defer the dividends from the start, and this needs to be taken into account whenever any of them try to sell a new hybrid security. If the U.S. wanted to take advantage of the situation, it would allow its banks to issue perpetual hybrid securities, part bond and part equity, and then tax the distributions at a maximum 15% tax rate. This would give the American financial institutions a permanent financing advantage over their European competitors.

I know that Fitch had a teleconference call yesterday to explain its views about the burden sharing policy. I do not know what was said, though I noticed that the Aegon hybrids fell yesterday in price. I wonder if Fitch mentioned anything about what happens when Aegon buys back Junior securities? More on the Aegon Stopper: Priority of Aegon Hybrids Pay Back Dutch Government=Buying Junior Security=Mandatory Payment Event/Bond Investing Process I would like to hear a contrary opinion from anyone who has one. It seems to me, based on what I now know, that a Mandatory Payment Event is triggered by paying the Dutch government back, via purchasing securities Junior to the hybrids, which event would require the payment of any and all deferred dividends and require the payment of the next four quarterly dividends unless a valid Mandatory Deferral (solvency) occurred before one of the prospective four payments. Did Fitch mention that point? When you think about it for a few seconds, it makes sense. You would not want to allow a firm to use its capital to make a payment on a Junior Security or to buy a Junior Security when it is trying to defer payment on a more senior security. Again, anyone interested in this topic needs to read the prospectuses and form their own opinion. I am just thinking out loud.

7. Medtronic (owned): Excluding one time items, such as a litigation settlement with Abbott, Medtronic reported non-GAAP earnings of 79 cents on a 6% increase in revenues to 3.933 billion, or a 10% increase in revenues on a constant currency basis. The non-GAAP number beat expectations by a cent (even with the Yahoo estimate MDT: Analyst Estimates). MDT reaffirmed its 2010 earnings forecast of $3.10 to $3.2 MDT is on a fiscal year with the 2010 year ending in April of next year. My last purchase was around $25 on 3/6 during RB's stock frolic and detour, and most likely I will hold for a $45 price before considering a sale. After all 15 times earnings is not expensive for MDT.

8. Added 50 PJS in Roth at $17.8 (see disclaimer): This is an average up, and the trade was yesterday. The total cost of the PJS shares in the ROTH was $9.41 (about the same time as shares were bought at $7.20 in the taxable account during the wild and wholly days of October 2008 Some Nibbles Got Filled: JZE, PJS, INZ and FAX). This Trust Certificate is a senior bond from the title insurance company First American maturing in 2028. The par value is $25 and the coupon is 7.55%. At the $9.41 total cost of the existing shares the current yield is around 20% which looks pretty good for a senior bond still rated as investment grade. The buy today results in a yield of around 10.5%. The next ex date is in late September. I discuss First American some in item # 15 in this post: Sold 100 IRR at $16.92/Bought 50 PJS/Earnings: DUK, ED, PNW, NADX, MWA, PGN, EMR/Ariad/Foreign Currencies

The underlying bond rarely trades, as in a couple of small trades every six months or so, so I view the FINRA trade data as useless: FINRA - Investor Information - Market Data - Bonds - Bond Detail Still, if an investor could buy at the price of the last small trade, it would be better than buying PJS. The last significant trade was on 5/27 at about 20 points higher than the last small one. And FAF's business prospects have brightened some since May with a nascent housing recovery in the U.S.

One thought occurred to me before buying PJS yesterday. I did not want to muck up my earlier low cost trades by buying at a much higher price, then having something happen which causes the issue to crater. I remembered what I said when buying IGK recently. In that case, I had worked hard to trade the ING hybrids profitably during the volatile months between October 2008 and March 2009, and the shares currently owned, like ISF bought at less than 5 or ING in the 6 range, were now the lowest costs shares that I had ever bought. I was concerned I would muck things up by buying IGK at a much higher price. Bought 100 IGK/Bought 50 SSW as Lottery Ticket in Roth IRA/Sunopta This is what I said on August 13, 2009: "Having established a low cost basis, I did not want to muck my record up by buying one after they had more than tripled in price. That was just a lot of mental baggage to be carrying around." Well, what happened within a week after I worried about something untoward happening?

12 comments:

  1. I didn't hear the Fitch conference call, but there is a mention of it here:

    http://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=200908251237dowjonesdjonline000302&title=fitchhybrid-bond-ratings-wont-go-up-just-because-bks-turn-profit

    "Gerry Rawcliffe, managing director in Fitch's financial institutions group, said in a conference call that while some banks will undoubtedly return to profitability and may well be able to fund coupon payments from their core profits rather than state aid, this won't necessarily be the defining factor for the commission in deciding whether banks should be allowed to pay hybrid coupons."

    I very much doubt if Fitch mentioned the specific "stopper" provisions in the Aegon hybrids relative to repaying the Dutch government, which you have discussed in detail here. The rating agencies now seem to be following a buckshot approach, downgrading everything in sight without bothering to analyze the specific issues in each case.

    ReplyDelete
  2. Cathie: The quote from Gerry Rawcliffe suggests to me that the Commission will not allow hybrid coupons to be paid except out of profits. This is basically what I interpret their policy to mean at page 8 (26): http://ec.europa.eu/competition/state_aid/legislation/restructuring_paper_en.pdf

    Rawcliffe goes further than what I understood the burden sharing policy to mean when he says that having profits does not even guarantee that the EC will "allow" them to pay the coupon. That is just beyond the pale of being ridiculous. That is my take away from the quote. I do not want to draw any firm conclusions from an isolated quote but it does not appear to me that Fitch has considered the ramifications of the Mandatory payment provisions as applied to the purchase of Junior securities.

    ReplyDelete
  3. Part 1 of my comment:

    I agree with your findings reg. the ING and AEGON hybrids. One thing I would like to add:

    Both ING and AEGON made an interest payment to the Dutch state in May 2009 (in the case of AEGON the payment was made to the main shareholder who had to forward it to the Dutch state). The interest payment had to be made because ING and AEGON had declared interim (semi-annual) dividends on their ordinary shares in 2008. The payment to the Dutch state triggered a Mandatory Payment Event with the consequence that ING and AEGON were forced to make coupon payments on their hybrids for the 2 quarterly payment dates following the May payment. In the case of the AEGON hybrid AEH, for example, this means that a coupon payment had to be made on June 15 and will have to be made on September 15.

    After the 2 aforementioned mandatory quarterly coupon payments will have been made, both companies (ING and AEGON) are free to defer payments unless a new Mandatory Payment event occurs. Such Mandatory Payment Event will most likely not arise from a dividend payment to ordinary shareholders, because both companies are not expected to pay a dividend for the year 2009.

    The only other Mandatory Payment Event that might occur is a repayment of the Dutch state. In the case of ING, however, such repayment is unlikely to happen this year. ING has not indicated such payment this year. It does not have the funds and it has not indicated the issue of new shares to obtain the necessary funds. As a result, there is a high risk of future coupon deferrals as a result of the European Commission's
    burden sharing principle.

    Part 2 will follow in the next (separate) comment.

    ReplyDelete
  4. Part 2 of my comment:

    The situation in case of the AEGON hybrids is a little different. Aegon has announced that it will repay 1 million Euros to the Dutch state before December 1. This repayment (principal plus interest etc.) will trigger a new Mandatory Payment Event with the consequence that the following 4 quarterly coupon payments on the AEGON hybrids will mandatorily become due and payable without the right of an optional deferral. For the AEH hybrid, for example, this means that the coupon payments on December 15, 2009, March 15, June 15 and September 15, 2010, will have to be made and will be made, regardless of the European Commission. The European Commission has made it clear in other similar cases that it will not prevent banks from making coupon payments where the banks are legally obliged to pay (for example as a consequence of a Mandatory Payment event). The European Commission will only forbid coupon payments in cases where an optional deferral right exists.

    In summary: In my opinion there is a much higher risk for a coupon deferral in the year 2010 in the case of ING than in the case of AEGON. Aegon, if it repays the Dutch government before December as announced, will have to make coupon payments on its hybrids for another full year. What happens thereafter is unclear. But I think that Aegon will try to get rid of the Dutch state completely by the end of 2010. This can be done if the economic environment and, as a result, AEGON's financial situation keeps improving. A complete repayment in 2010 would mean that there will be no deferred interest payments on AEGON hybrids until late into the year 2011 due to the Mandatory Payment Event triggered by a payment to the Dutch state.

    I am not sure, however, if all market participants are completely aware of all these facts and the differences between the ING and AEGON situation. If the European Commission forbids coupon payments (whether in the case of RBS, LLoyds, ING or any other bank which received state aid) and if, as a result of this, coupon payments are actually deferred, the prices of hybrids of every European financial institutions will probably take a beating, including the AEGON hybrids, even though - at least in my opinion - a coupon deferral is less likely for this company than for ING.

    ReplyDelete
  5. michaelandfred: I agree with your assessment about Aegon triggering a mandatory payment if and when it buys back the junior securities sold to its majority shareholder. I understand that Aegon announced its intention to do make this payment. I would not be 100% certain at this point that it will be allowed to do it. I just finished listening to the Fitch conference call and Fitch has not picked up on the Mandatory Payment event being triggered by buying a junior security issued as part of last Fall's state aid. I would also agree that ING is in more danger than AEG of a deferral, also due to the fact that they are in deeper to Dutch government and will take longer to pay it back. That will give the EC more opportunity to perform mischief.

    The Fitch call was instructive on a few other points. One was the overall lack of concern at the EC about causing difficulties long term in the European institutions likely increased cost of capital due to this burden sharing policy. Another was an apparent belief the EC will want to exclude state aid that took the form of regulatory capital when determining solvency. And another was the frequent comment that the EC frequently gets its way in spite of implacable resistance at the State level.

    I was interested very much in your comment that Aegon and ING were already in a Mandatory deferral due to the payments made earlier in May. I do recall reading that there was such payments, and that would be a trigger for the Mandatory payment event. Payment is used broadly as something other than a dividend in the Mandatory Payment Event clause. I am curious why you think it is limited to six months rather than a year. Is it due to the payment on the junior security being a Partial Event and being just six months, so you match that to the two quarters? You might want to expand on that thought some for my readers.

    Also, for purposes of the Mandatory Payment Events, I don't think it would make any difference if Aegon paid its majority shareholder who then paid the dutch government. That is a distinction without a difference compared to ING. It is still a payment on a junior security.

    But another question that I would have for you is why wouldn't the June payment be the first of those two mandatory payments, the one made on June 15th and the next one being the one to be made on September 15th?

    After listening to the Fitch call, it confirmed my opinion that the EC leans for too close to Hugo Chavez for me.

    ReplyDelete
  6. Thank you for your additional comments. They are, as always, highly appreciated and helpful. You asked me two questions:

    1. Why - as a consequence of the payment to the Dutch state in May - are ING and AEGON forced to only make coupon payments on the following two quarterly payment dates (= 6 months)?

    I own AEH (Aegon hybrid). The terms and conditions of this hybrid are identical with most of the other AEGON hybrids reg. optional coupon deferrals, mandatory payment events, dividend stopper etc. The ING hybrid ISP has similar provisions. The AEH prospectus reads:

    "A Mandatory Payment Event occurs if...we declare, pay or distribute a dividend or make a payment (other than a dividend in the form
    of Common Shares) on any of our Junior Securities or make a payment on a Junior Guarantee..."

    The Convertible Core Capital Securities bought by the Dutch state (more precisely: by Aegon's main shareholder with a loan from the Dutch state) are Junior Securities. The interest payment in May is a payment on these Junior Securities and, therefore, triggers a Mandatory Payment Event in accordance with the AEH prospectus. The consequence of such Mandatory Payment Event is outlined in the section "Dividend Pusher, Mandatory Payments" in the same prospectus. This section reads:

    "If a Mandatory Payment Event occurs, then the Interest Payments payable on the next four
    consecutive Interest Payment Dates, the next two consecutive Interest Payment Dates or the next
    Interest Payment Date, as the case may be, following the Mandatory Payment Event, depending on
    whether the Junior Security, the Parity Security or the security benefiting from a Junior Guarantee or a
    Parity Guarantee pays dividends or income distributions on an annual basis, a semi-annual basis or a
    quarterly basis, as the case may be, will be mandatorily due and payable in full on the relevant Interest
    Payment Dates."

    It is my understanding after reading the terms and conditions for the investment of the Dutch state in ING and AEGON as published on their websites, that in both cases the first interest period is not a full year, but a short period that expired in May 2009. Thereafter, each interest period is a full year ending in May of each year. The reason why this was chosen is the fact that ING and AEGON usually pay their final annual dividends in May. The parties wanted identical payment dates for the dividends to ordinary shareholders and for the Dutch state. As a result of the first interest period being a short period, the following mandatory coupon payments will not have to be made for a full year, but only for the next two quarterly coupon payment dates.

    ReplyDelete
  7. As to your second question:

    I agree that due to the Mandatory Payment Event triggered by the payment to the Dutch state in May, the first mandatory coupon payment on the AEH hybrids was June 15 and the second mandatory payment date will be September 15. I thought I had said so in my first comment.

    ReplyDelete
  8. One more thing I would like to add as to whether AEGON will be allowed to repay 1 million Euros to the Dutch state this year. I do not share your view that it is doubtful whether AEGON will be allowed to do so. Quite to the contrary: It has always been the position of the European Commission that government aid should be paid back as soon as possible, provided the solvency and long-term viability of the financial institution is not affected by the repayment. In the case of AEGON, there are no reasons to prevent the partial repayment this year. The company is very solvent. It currently has more than 3 billion Euros in excess capital and, in addition to this, raised 1 billion Euros through a stock sale. Furthermore, there is only a very short amount of debt maturing this year and next. This means that refinancing requirements are very limited and manageable at AEGON. In the case of ING the situation is different. ING has much higher refinancing needs due to a high amount of debt maturing this year and next year. In addition, ING's capital base is weaker than AEGON's. In my opinion ING would have to make a substantial share offering to raise additional capital in order to get the approval of the Dutch regulator and the European Commission to repay the Dutch state in the near future. The sale of operating units and other assets alone will not do the job for ING, as this will take years.

    ReplyDelete
  9. michaelandfred: I see you did say mandatory for June 15th and September 15th-my apologies.

    I own AEH and AEB. The buy of AEH was at $4.63 and placed in an IRA due to deferral concerns.

    The buys of AEB were in the 4 to 5.5 range and at 8.

    When I say that it is not 100% certain that Aegon will be allowed to repay the Dutch government, that statement is nowhere near equivalent to saying it is doubtful. Instead, after listening to the Fitch call, whose analyst claimed to have talked to the upper echelons at the EC, it was stated that the EC wanted to exclude state aid when looking at the solvency issue. If they proceed along those lines, and there are apparently some legal issues about that alleged EC position, then Aegon is not sitting on 3.5 billion plus the 1 billion that was raised recently. Instead, the EC would subtract 3 billion Euros in state aid from that total. I believe that was Aegon's aid number.

    Another point made by Fitch was that being profitable or even solvent, until you paid it all back, was not the only criteria the EC would use when it tries to cram down a deferral decision.


    The more important consideration for me is the long term damage caused to all hybrid securities by the mere enunciation of the EC's burden sharing policy which is really not a burden sharing but a burden shouldering by the hybrid owners alone. The common shareholders have lost their dividend, as they would have to expect under the circumstances, but will benefit from the EC policy while the hybrid holders, the more senior security sold as income producing, feel the pain. The business can be stabilized on the hybrid owners back, with possibly fewer businesses sold to pay back the government. And, it would be reasonable to expect more of the same in any future financial calamity and there will be more for a perpetual security. Next time, however, the deferral will start right away. So even if there is a deferral, followed by a return of normalcy, profits & the good times start to roll again, the price of these securities will most likely be impaired by what has already happened, let alone what may happen over the coming weeks and months. A deferral of any kind, even for a few quarters under these circumstances when the firm is solvent and capable of making the payment as I have said, will have a profound impact for years to come.

    Since I have small position, which have mostly doubled or more in price, except for an ill timed decision to buy IGK, and realized trading profits some of which has been discussed in the blog, plus several dividend payments I need to decide soon whether to harvest more profits. Buying another European hybrid is out of the question for me.

    Also, I believe the AEGON CEO said that he did not intend to pay the Dutch government back after the 1 billion Euro payment for another 2 or 3 years, so it may be optimistic to suggest repayment of the balance in 2010. This is a quote from the CEO:
    "Mr. Wynaendts said, adding that he expects his company to repay the remaining €2 billion in two to three years at "maximal flexible conditions.""
    http://online.wsj.com/article/SB125015500015528639.html?ru=yahoo


    This article from Reuters explains why Aegon wants to pay the money back. It also mentions that it has to pay interest on the 1 billion tranche bringing the total payment to 1.13 billion Euros.http://blogs.reuters.com/commentaries/2009/08/13/aegon-raises-money-to-repay-the-taxpayer/

    ReplyDelete
  10. I agree with your assessment that the actions of the EC have caused long-term damage to hybrids. If a financial institution intends to issue new hybrids in the future, it will only be able to do so at a higher cost. Investors will undoubtedly ask for higher interest rates as a result of the increased risk of future coupon deferrals. For existing hybrids this increased risk means lower prices.

    However, with regard to existing hybrids, a distinction should be drawn between the "good banks" (those who did not receive state aid) and the "bad banks" (those who received state aid). The price action in hybrids issued by good financial institutions (e.g. Germany's Allianz) shows that investors are currently only asking a relatively small premium which means they are not too concerned about coupon deferrals. The hybrids that have taken a real beating are those of the bad banks. For these hybrids I expect prices to stay depressed for quite some time.

    In light of the good entry prices for your hybrids I would seriously consider a sale. The chances of much higher prices is currently substantially smaller than the downward risk. I have liquidated all my positions. If a coupon deferral actually occurs, you can expect prices to be cut in half within a day. This happened in the case of the british bank Northern Rock. When it announced coupon deferrals in mid August, the already distressed hybrid prices fell by 50% and are now appr. a fifth of their original issue price.

    However, the risk of coupon deferrals or the actual deferral of coupon payments might pose some interesting trading opportunities in the future. If prices fall further or - in case of an actual deferral - prices collapse completely, a purchase in the 3-5 dollar price range might be a good buy, provided one is convinced of the long-term viability of ING and AEGON. Example: Even if ING deferred its hybrid coupon payments for two or three years, all deferred coupons would become payable at the end of the restructuring period when a dividend to common shareholders will be paid again. As soon as this happens, the hybrids would again be priced north of 15 dollars. This would be a nice gain in addition to the accrued deferred interest.

    My comments should not be taken as an investment advice. I am just thinking out loud.

    ReplyDelete
  11. michaelandfred: Thanks for your comments. I and some of my readers have also enjoyed reading them.

    The market is currently giving AZM the benefit of the doubt, at least for now, but I am not sure how long that will last either. So I sold a small position today bought at a narrow discount to par value since I was not willing to take the chance of any future adverse market reaction. The market did not have such a high opinion of AZM in March when it changed hands at $8. Is it worth the gamble at the current price?

    Since we are both thinking out loud, I am inclined to keep my ING hybrids and AEB bought in a retirement account, and ride it out. Part of that has to do with the price that I acquired those positions, as throwing off high yields for my remaining years with the next few cumulative payments having a timing question. ISF was bought at less than $5 and INZ in the $7 range in the regular IRA. If they fall substantially in price, I will include them in a Roth conversion. Also it is conceivable that the EC will not entirely lose its marbles.

    I am more inclined to sell the ING positions in the taxable account to avoid the tax issue and to realize a profit. I am currently more inclined to stay with AEG than ING hybrids, and may wait and see if AEG buys those securities in DEC.

    I would expect further significant declines in the event of an actual deferral. At that time, a firm like Fitch might take the security down to the C level which will add more fuel to the fire. Some readers do not understand why, and all I can say is that I view a deferral as a default- a CCC. I don't care if it is a "legal" default, it is still a failure to pay when due.

    I will sometimes consider buying a security in deferral in a retirement account once I am comfortable that the firm will survive and eventually pay the interest. In the hybrid cases, however, I would need to also make a judgment as to when the firm will receive a get out of the EC jail free card. This may cause me to be more cautious.

    ReplyDelete
  12. Allianz is one of the best insurance companies in the world with a relatively strong balance sheet and a conservative management. I consider the risk of a coupon deferral very low. In light of the high yield (more than 8%) I would hold AZM, provided it is a long-term investment. You can ride out any near- or medium-term price volatility.

    As to the ING and AEGON hybrids: It makes sense to hold the positions in your retirement account and sell all other positions for the reasons outlined in your comment. The price risks are currently simply too high for a short or medium term investment in these hybrids. I think that if the coupon deferral talk intensifies or if a deferral actually occurs (e.g. at ING), the AEGON hybrids will suffer as well even if the company pays back 1 billion Euros to the Dutch state this year, thereby triggering a Mandatory Payment Event. As shown in the current price action, the market does not differentiate too well and treats ING and AEGON more or less equal. Therefore, I would not hold AEGON hybrids (with the exeption of the ones in your retirement account).

    ReplyDelete