CIT/ ISM Manufacturing Index/EBAY & SKYPE/Aegon Hybrids & Moody's/Subordination of Government's Preferred Stock issued by KEY to Trust Preferred

1. CIT Deferral Of Interest on Junior Bonds: The troubled lender, CIT, filed a notice with the SEC that it will defer payments on its Junior bonds due in March 2067. form8ka.htm I am not familiar with this particular bond. CIT states in its SEC filing that this bond's indenture requires it to use "commercially reasonable efforts" to satisfy the interest payment through the Alternative Payment Mechanism (APM). An APM usually involves selling a sufficient amount of stock to satisfy the deferred interest payment. CIT claims that it is unable to execute the APM. I own a couple of CIT senior bonds (par value 1 bond= $1,000), one due in March 2010 and the other this December. Deferral is not an option for this senior bond. I am not surprised that CIT is deferring interest on its junior bonds now.

2. ISM Manufacturing Index: This index was expected to rise to 50.5 in August, as the median forecast. The index rose above 50 for the first time in 19 months, with a rise to 52.9% from 48.9% in July. The 50 level is the demarcation line between expansion and contraction. The new orders component, which signaled a turn months ago, rose to 64.9% from 55.3%. ISM I discussed in several earlier blogs the use of that component as one indicator of a turn: Some Signs of Light at the End of the Tunnel: End of the Recession?

3. European Unemployment: The rate of unemployment in Europe rose to 9.5%, with Spain rising to 18.5% and France to 9.8%.

4. Ebay (owned) to Sell Skype: The NYT reported this morning that EBAY had a deal to sell Skype to private investors. The deal was later announced with EBAY maintaining a 35% equity stake in Skype and will receive about 1.9 billion in cash and a note valued at 125 million. This is fine with me.

5. Copy of Agreement between KeyCorp and U.S. Government on Issuance of Preferred Stock to U.S. by KEY: I spent a few minutes today looking for a copy of an agreement between a U.S. bank and the government regarding the issuance of preferred stock in exchange for TARP funds. I found the agreement between KEY and the U.S. attached as Appendix A to this document filed with the SEC, starting after page 72, at page A-1.: FORM DEF 14A The preferred stock issued by KEY to the government is called a "cumulative perpetual preferred stock. series B". This stock is shown on the balance sheet as part of the equity (see page 3: FORM 10-Q), along with a 7.75% coupon non-cumulative perpetual convertible preferred stock, Series A. Based on this information, this confirms an earlier observation that the government's preferred stock is junior the the trust preferred issues, which are bonds, described by Key at pages 29- 30 of its quarterly report: FORM 10-Q

Of those trust preferred issues described on page 30, I have owned only one in the past, for a quick trade last Fall, called KeyCorp Capital V, symbol KEYPRA (after a quick pop from $7 to $12.05: TAX LOSS SELLING TODAY). The prospectus link: http://www.sec.gov/ This is a typical bank TP issue. Key forms a Delaware Trust solely for the purpose of issuing preferred shares to investors. KEY controls the trust as a result of common shares issued by the Trust to it. The Trust then sells those preferred shares to investors, and uses the proceeds to buy "junior subordinated debentures" from Key. That is just a fancy name for junior bonds. The preferred shares issued to the public in the Trust represent an undivided preferred beneficial interest in the assets of the Issuer Trust. That asset is a 5.875% junior debenture due 7/30/2033 issued by KEY. The par value is $25. The junior bond may have its quarterly payments deferred for up to five years. And, as you would expect, KEY can not defer payments for a junior bond and "declare or pay any dividends or distributions" on its "capital" stock (p.S-19), which I interpret to mean any form of equity capital, including equity preferred and common stock. This is what I would expect. A holder of a junior bond would not want to have their coupon deferred and then have the firm pay a dividend or distribution on a Junior Security. That is why a condition precedent of a deferral is the suspension or elimination of payments on the Junior Security.

The U.S. does not have a burden sharing policy for junior debt, where the financial institution needs to make enough money to pay the junior bondholders or face potential pressure to defer payments, even if the firm has adequate capital to make the payments and is otherwise solvent. And, a reader will note that KEY would have to stiff the U.S. government in order to defer payment on these securities. I do not own this security. This security could have been bought at less than $10 in March. KEY .PRA Stock Quote - Keycorp Cap V PFD TR 5.875%

This is the kind of analysis that needs to be done before buying a bank trust preferred now, at least in situations where the bank has not yet paid the government back.

6. BWX and WIP: I try not to dabble in individual foreign bond selections, and instead I own shares in two ETFs which own international government bonds, WIP and BWX. Previously, I have described on ongoing effort to manage currency risk in my BWX position, and I just leave WIP alone. One problem with both of these ETFs is the low dividend yields. For several months, no monthly dividend has been declared and there was no ex dividend today either, which those ETFs would normally go ex on the first business day of the month if a monthly dividend was going to be declared by them. This information can be found at the sponsor's web page, under "related items" on the left hand side, just click "PDF ETF Dividends" : https://www.spdrs.com/product/fund.seam?ticker=WIP

https://www.spdrs.com/product/fund.seam?ticker=BWX

7. Comments on Moody's Downgrade of Aegon's hybrids by one notch: I left a comment to an earlier post which contains some discussion about Moody's downgrade today of Aegon's hybrids. I thought that it would be helpful to reproduce my comment:

"Cathie: I listened to the Fitch analyst for the entire 1 1/2 hour teleconference call. It was clear that he had not studied mandatory event triggers since he kept saying that he was not a lawyer. You do not need to be a lawyer to be able to read a prospectus. Anyone with a brain can read. All you need to know are a few facts, which he should have already known, such as the priority of the securities issued to Aegon's majority shareholder in relation to the hybrids. Once you have that information, then there is only one more step, to see how Aegon would pay the Dutch government back. Would Aegon send the government a check? Apparently, that is the impression that Fitch and Moody's leaves with me. But that is not how it would work. It would require the purchase of those securities issued to the majority shareholder and then the majority shareholder pays off its loan from the Dutch government. I would agree with you that any effort to judge the likelihood of deferral has to consider mandatory payment event language which the rating agencies seem to be avoiding when venturing an opinion, though I say that with access only to the press releases and not the actual report which I would never pay for anyway.

And there also appears to be no analysis whatsoever whether or not a good faith argument can be made that Aegon is already in a four quarter mandatory payment starting with the June 2009 quarter." (comment to Pared 50 METPRA at $18.3/Largest % Gains Have Been in Disfavored Asset Classes)

This is another comment that I made in that post:

"I am not sure Moody's sees the connection between the mandatory payment event language in the AEG hybrids' prospectuses and repurchase of the junior securities in order to effectuate the repayment of the Dutch government. To my knowledge, the EC has not asked a firm to violate its loan covenants yet. To cause a deferral for Aegon, the EC would have to ask AEG to refrain from buying back those Junior Securities, and postpone paying the Dutch government back any funds, just to screw the hybrid owners with a delay in their coupon payments. While I view the EC policy as idiotic and counter productive, it is hard to see how anyone can be that idiotic, but you never know. THE EC has said in footnote 33 of its policy statement: "However, this does not prevent the bank from making coupon payments when it is under a binding legal obligation to do so." This is to me a reference to mandatory payment events without saying so specifically. "

Today seems like one of those days when nothing could have stop a decline. The news this morning was positive in my opinion.