Saturday, September 26, 2009

Ing and Aegon News/Sunopta LT/PG/Comparing Floaters/Fixed Coupon Corporates Uninteresting

1. ING (own hybrids only): ING announced an agreement to sell for 1.6 billion dollars its 51% stake in ING New Zealand and ING Australia, wealth management and insurance operations, to its joint venture partner Australia and New Zealand Banking Group. ING will keep INGDIRECT and ING Investment Management in Australia. ING will free up about 900 million EUROs in capital and will book around a 300 million Euro profit on the sale.

2. Proctor & Gamble (owned): PG was initiated by Jeffries yesterday at a buy with a $70 target.

3. SunOpta (owned-Lottery Ticket): STKL agreed to settle a class action suit for 11.3 million, which will be fully funded by its insurance. This was one of my concerns when I purchased this LT: Buy of Sunopta: Highly Speculative

4. Aegon (own hybrids only): Aegon's CEO said that AEG did not need the 3 billion Euros in state aid to survive the financial crisis. Aegon intends to pay back 1 billion Euros this year, and the other 2 billion "as soon as possible" within the 3 year time frame contemplated by the agreement. My discussion about the repayment of the 1 billion Euros later this year have focused on how any such payment would trigger four mandatory payment events on Aegon's hybrids after Aegon repurchases Junior Securities issued to its majority shareholder who then pays back the Dutch government's loan: Summary of Arguments To Stop EC from Causing Deferral of Payments on the Aegon Hybrids Impact of Any Payment to Dutch State in May

5. Merrill Lynch Preferred Stock: I am making a note to myself. The Merrill Lynch preferred stocks outstanding at the time of its acquisition, including preferred shares issued by Merrill to the government, are described on pages 51 to 52 of BAC's first quarterly report filed with the SEC in 2009: Form 10-Q The preferred stock issued by BAC, including the preferred stock issued to the government, is described in note 14 of BAC's 2008 annual report filed with the SEC at pages 156-157: Bank of America Corporation Form 10-K My current understanding is that the Merrill Lynch equity preferred issues which are now BAC obligations such as BMLPRH, stand at the same level of priority as the government's preferred stock, except the government's shares are cumulative and any unpaid dividend has to be paid on those cumulative shares prior to paying a dividend on any common or other preferred shares. If the non-cumulative preferred dividends and common dividends are both eliminated, then the government's dividend would have to be deferred. Once deferred it has to be paid in full prior to a resuming payment on the common or publicly traded preferred shares.

This is based in part on my analysis of the ranking of securities classified as equity preferred generally, and in part on this language from the prospectus for what is now BMLPRH:

"The Series 2 Preferred Stock will rank on a parity as to payment of dividends and distribution of assets upon dissolution, liquidation or winding up of ML&Co. with each other outstanding series of preferred stock of ML&Co." (Page S-5)

"We may not declare or pay dividends on, make distributions with respect to, or redeem, purchase or acquire (except for purchases by us or our affiliates in connection with transactions effected by or for the account of customers of ML&Co. or customers of any of our subsidiaries or in connection with distribution or trading of such stock), or make a liquidation payment with respect to, any of our preferred stock or any other of our stock ranking as to dividends or distribution of assets equal with the Series 2 Preferred Stock, unless, for such Dividend Period, full or pro rata dividends on all outstanding shares of Series 2 Preferred Stock have been declared, paid or set aside for payment." (Page S -4) Final Prospectus Supplement

It is my understanding that the government's preferred shares rank equal with these preferred shares. I would need to find the agreement with the government to confirm. To date, I have only found the agreement between Zions and the U.S. which confirmed my analysis with a plain statement that the government's preferred shares ranked pari passu with the publicly traded equity preferred series A and C issues: Item # 7 Sold 100 FBFPRN at $17.38/Bought 50 ZBPRB in Roth at $19.9

As a practical matter, I would generally expect that any bank will have to be in dire straits to defer paying the government its preferred dividend. Citigroup recently converted equity preferred shares into common shares, including all of the government's shares, and ceased paying dividends on its equity preferred shares which it could do since it also eliminated the common dividend. To my knowledge, the only publicly traded bank that has deferred paying the government its cumulative equity preferred dividend, and has not been seized yet, is UCBH and it also deferred paying interest on its junior bonds at the same time. UCBH Holdings The only way to defer paying interest on junior bonds is to eliminate the common and equity preferred dividends and to defer paying the government's its cumulative equity preferred dividend first.

So it can happen. But it would be a momentous step for any bank to defer paying the government its dividend.

6. TWM Hedge: On Friday, TWM rose 1.15% while the Russell 2000 fell .47%, a small tracking error in my favor. While a double short is in place as a hedge, I will monitor daily the tracking of the the double short ETF with the index.

7. Comparing Floaters: When deciding which floating rate security to buy, there are a number of moving parts to consider. And, it is important to keep in mind why I am buying them in the first place. I am buying them to achieve, as much as I can, a measure of protection in both inflationary and deflationary (or low inflation) periods in the same security. During the meltdowns, buying an AEB at $5 or a METPRA at $7 did not require much thought except on the issue of credit risk. The tremendous discounts to par value juiced both their guarantees and the value of their respective floating rate provisions. With the rise in prices for all of these securities over the past several months, the analysis has to become more discriminating.

For the floaters, I want to examine more closely now the alternative scenarios, keeping in mind the dual purpose of the security. That was the reason for the recent detailed analysis of two floaters where Bank of America is currently obligated to make payments: BMLPRH vs. BMLPRJ In that analysis, BMLPRJ had initially the appearance of being the better buy even though it cost $2.76 more per share at the time the analysis was made. In that post, I introduced the concept of comparing the floaters by buying equal dollar amounts of the two securities, and then comparing them under alternate scenarios. Since BMLPRH was cheaper, I was able to buy 121 shares for every 100 of BMLPRJ. I then demonstrated how that narrowed the initial advantage of BMLPRJ and then accelerated the advantage of BMLPRH as the 3 month Libor rate started to increase. One of my readers calculated that the cross over point would occur at less than 3% on the 3 month LIBOR (2.66%). At that point, the advantage to BMLPRH starts to accelerate. Why? The lower price has a pronounced impact on the benefit of the LIBOR component of the float and the lower guarantee for BMLPRH means that the LIBOR will kick in sooner.

To see the dramatic effect of the lower share price on the LIBOR float provision, I have calculated in a number of posts how cost differentials in the share impacts the yield once Libor starts to increase to produce a greater rate than the guarantee. Take METPRA which you could have bought at $7 a share not that long ago. Let's assume a buy at $7, $10, and $20, and calculate the yield at 5%, 7% and 10% 3 month Libor rates. This security pays the greater of 4% or 1% over 3 month LIBOR (so add 1% to the applicable Libor rate):

$7: 21.43% at 5% Libor 28.57% at 7% Libor 39.29% at 10% Libor

$10: 15% at 5% 20% at 7% 27.5% at 10%

$20: 7.5% at 5% 10% at 7% 13.75% at 10%

At the 4% guarantee:

$7 14.28%

$10 10%

$20 5%

I would highlight in this discussion the comments by Fed Governor Kevin Warsh: FRB: Speech--Warsh, Longer Days, Fewer Weekends--September 25, 2009:

"Ultimately, when the decision is made to remove policy accommodation further, prudent risk management may prescribe that it be accomplished with greater swiftness than is modern central bank custom. The Federal Reserve acted preemptively in providing monetary stimulus, especially in early 2008 when the economy appeared on an uneven, uncertain trajectory. If the economy were to turn up smartly and durably, policy might need to be unwound with the resolve equal to that in the accommodation phase. That is, the speed and force of the action ahead may bear some corresponding symmetry to the path that preceded it."

I do not know if he is expressing the view of the majority of the Fed. But I would not expect the Fed to start increasing the Federal Funds by the Greenspan baby steps of a quarter point when the Fed decides to end its accommodative policy. I would expect a "swift" move to 2% , perhaps in about 3 consecutive Fed meetings.

I would agree with Randall Forsyth that few values remain in corporate bonds, One of the formative experiences for me as an investor was actually living in the great bear market for bonds that culminated with the inflation of the 1970s and early 1980s. Inflation and its impact on fixed rate coupon bonds is just something imprinted on my brain forever. So, I want a nice cushion when buying fixed rate coupon bonds. I found that cushion starting last October when the corporate bond prices were shellacked, not due to inflation concerns, but out of credit fears which ultimately proved unfounded for the investment grade and even most of the better quality junk issues .

The time to buy corporates was during that earlier period during the credit crisis when fear was rampant, now passed, particularly during the Fall of last year, when there were historic spreads between corporate bonds and treasuries, when many investment grade bonds were priced to yield well into the double digits. Now, as a result of the tremendous price rise in corporate bonds, I have revisited some floaters that I ordinarily would not want to buy at their current prices, such as the recent purchases over the past week of BMLPRH, STIPRA USBPRH and STDPRB. At least I have some modest degree of inflation protection in their respective 3 month Libor floats, and the guarantees are not awful. And, now, maybe I am almost done buying floaters. Possibly, if the price is right, I may revisit one or two that I previously sold that do not have have guarantees.

8. Solar Stocks: The article about a supply glut will be enough to keep me on the sidelines for now, postponing any increase in my meager 30 share lot of TAN. I will eventually round that up to 100 shares but I have to remind myself that I know next to nothing about this industry so caution is the operative word.

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