Added 5/5/2010: The most complete discussion of the AEGON hybrids (called preferred stocks incorrectly by many in the U.S.) can be found in a later post: Aegon Hybrids: Gateway Post The Gateway Post for ING hybrids is ING Hybrids: Links in one Post
1. Functionally Equivalent Securities: Exchange Traded Aegon and ING Perpetual Debt Securities
What do I mean by functionally equivalent? Securities issued by the same firm, at the same level of priority, and having no material differences on material provisions other than the coupon rate, are functionally equivalent in my opinion. I have said the coupon does not matter, and why is that? Once a decision is made to buy one of the functionally equivalent securities, based on a thorough analysis of all pertinent factors, the only relevant issue left is the comparable yield of those securities at the time of purchase. It is entirely possible at any given point in time for the security with lowest coupon to have the highest yield. Yesterday, when I bought IGK, it had both the highest coupon and the highest yield based on the then prevailing prices. (see generally: Functional Equivalence in Bond Trading Buy 50 KTV) I have bought the equivalent security with the lowest coupon several times when it yielded more than the other functionally equivalent ones. This happened several times last Fall, and an example was the Trust Certificate, KVF, which contains a junior AON bond, which has a lower coupon than the functionally equivalent KVW, KTN and DKK.
Prices are as of Thursday's close, 8/13/2009, and the yields at those prices are provided by Marketwatch:
The prospectuses for these securities need to be read for the details, and can be found at the QuantumOnline.com site, in this blog (e.g. ING) or at the companies web sites: Capital Securities - AEGON Group Debt securities ING Groep N.V. | ING
AEH $17.74 8.98% AEH Stock Quote - Aegon N V PFD PERP 6.375
AED $18.25 8.9% AED Stock Quote - Aegon N V PERP 6.5%
AEV $19.32 9.14% AEV Stock Quote - Aegon Nv PFD PER 6.875%
AEF $19.05 9.31% AEF Stock Quote - Aegon Nv PFD PERP 7.25%
ISG $18 8.51% ISG Stock Quote - Ing Groep N V PERP DEBTS
ISF $18.34 8.69% ISF Stock Quote - ING Groep N V PERP HYB6.375%
IND $19.92 8.85% IND Stock Quote - Ing Groep N V PFD 7.05%
INZ $20.47 8.79% INZ Stock Quote - ING Groep N V PFD PERP DBT
IDG $20.19 9.13% IDG Stock Quote - ING Group Nv 7.375 Perp PER HYB CAP
IGK $22.4 9.49% IGK Stock Quote - ING Group 8.5PC Perp Hyb
The mere fact that one these ING or Aegon securities provides a better yield than the others is not a reason to buy ING or Aegon debt securities. It would simply be a reason to prefer the highest yielding one, at a particular moment in time, once the decision is made to buy based on other considerations. The other considerations would primarily concern an analysis of the default risk, and the relative advantages of disadvantages of these securities compared to alternative investments in the same general investment category. The three main disadvantages of all of the securities listed on this page (unrelated to credit issues) are their perpetual nature (no maturity date), their low priority in the event of a bankruptcy, and the elimination of a common stock dividend by both firms. Payment of a dividend to the common shareholders provides a legal guarantee that my dividends, as an owner of IGK, IND, INZ, AEH, will not be deferred by these firms. The same can be said, as a general rule, about other equity preferred and junior bond issues. One benefit of owning securities ranked senior to common is a superior claim to the payment of dividends or interest. I am not aware of a single instance where a firm could pay a common stock dividend, and eliminate a non-cumulative equity preferred dividend or defer payment on a junior bond.
2. AEB-Aegon Floating Rate Debt/Equity: I have not included the Aegon floating rate security, AEB, in the functionally equivalent list of Aegon securities, since I do not view it as functionally equivalent to the other listed Aegon issues. The payment provision of AEB, the greater of 4% or 7/8% above 3 month LIBOR, makes it sufficiently unique that it is not equivalent to any fixed rate coupon bond in my opinion.
If and when LIBOR starts to move up to troublesome levels, anything similar to inflation problems experienced in the late 1970s and early 1980s, then the benefit of the LIBOR float will become apparent to everyone. Also, the LIBOR float will start to enhance the yield of this floater when it moves over 3 1/8%, and stays at a higher level for a sufficient time to trigger the float provision. When I have bought AEB, and discussed the purchases in this blog, I always calculated what the impact would be on my yield at a higher LIBOR rate. In one of my first posts, since starting this blog, I discussed this security and demonstrated to anyone interested in it how a rise in the LIBOR rates, coupled with buying this security at a large discount to its $25 par value, would substantially enhance the yield (see item # 5 LIBOR AND THE AEGON FLOATING RATE PREFERRED STOCK) At that time, AEB was trading at $7. I later made purchases at $5.5 and $4.8, as previously discussed in the blog. AEB thereafter fell to below $3. It is trading near $15 now. The guarantee generated a yield of 14.2% at a $7 total cost. That is what I call the investor's deflation protection in spades. Then I calculated what would happen if the 3 month LIBOR rate rose to just 5%. The result was a yield of 20.98% at that $7 cost. A 5% LIBOR rate is not unusual: LIBOR Rates History (Historical) That last linked website starts off with the LIBOR rates in September 1989. At that time the 3 month LIBOR was 9.125%. The float would yield 10% at a 9.125% LIBOR at the $25 par value. My last purchase at $4.8 would then yield 52%. ( 9.125% LIBOR + 7/8% spread=10% x. $25 par value=$2.5 a share in annual dividends, divided by cost per share of $4.8=52% annualized). So, you see why I would want to hang onto it. My only concern now is the creditworthiness of the borrower. I have both inflation and deflation protection in this particular bond at my purchase prices.
All of these securities are grouped at the free quantum site (registration required) under those securities that pay qualified dividends, a consideration relevant to a U.S. taxpayer. Preferreds eligible for the 15% Tax Rate Table - QuantumOnline.com
Although I own several of the above referenced securities, my interest them now is best described as subdued and underwhelmed. It goes without saying that as the price increases the yield goes down. I did buy IGK yesterday, and that was difficult for me to do. Bought 100 IGK/Bought 50 SSW as Lottery Ticket in Roth IRA/Sunopta I did it only because the yield was still enticing at my cost, and my credit concerns about ING are no longer acute. Although I am still concerned about about credit risk, I am just not worrying about it -incessantly-now.
3. CPI: Seasonally adjusted, Consumer Price Inflation was unchanged in July, with the core CPI rising just .1%. Consumer Price Index Summary The year-over-year decline is now at 2.4%, the sharpest fall since 1950.
Before seasonal adjustments, the rate declined .2%.
I own some securities whose interest rate is calculated based on CPI, including the TIP ETF, OSM, ISM, and PFK.
I mentioned in an earlier post that several long term fixed rate coupon bonds, bought at less than a 20% discount to par value, would be on the sell block as soon as I become concerned about inflation on the near horizon. It does not appear to be on the horizon yet, but I am nonetheless concerned about inflation becoming a serious problem a year or more down the road, which is why I have have recently started to buy some inflation linked bonds, particularly those selling at large discounts to par value and maturing within 10 years.
4. Industrial Production: U.S. Industrial output rose in July for the first time since last October, but is still down 14.6% since the onset of the recession. Output increased primarily due to increased auto production. The gain last October was due to a hurricane led rebound. Excluding that month, this was the first increase since December 2007. Industrial Production and Capacity Utilization
The consumer sentiment data, which was worse than expected, is contributing to the decline today. I am basically in a wait and see mode. What I basically do during this kind of period is to look for lottery tickets to buy, where the amount of money involved is immaterial, and no damage can be done by buying an extremely small position. I am certainly not going to make any big leaps after a 50% run up, unless I have a great deal more confidence in a lasting economic recovery. The VIX was rising again this morning, up over 4% to close to 26, a pattern that is still well within the parameters of an Unstable VIX Pattern.