Saturday, November 14, 2009

Goodyear Tire XKK/Confirmation Bias/PSEC/Exxon

1. Goodyear Tire Senior Bond in XKK: When discussing my positions in junk bonds recently, I mentioned my positions in PKK (Liberty Media Senior Bond in TC) and a Hanover Insurance TP (PKM & KRH). I neglected to include my 550 share position in XKK, a Trust Certificate containing a senior bond from Goodyear Tire maturing in 2028, which I have discussed in this blog when it was more than 50% cheaper than its current price.Buys of CPB LQD SYY XKK The total value of these positions is close to being equal, in the 4 to 6 thousand area per firm, and that would be the maximum range for me for a junk rated security. This would indicate that I have more confidence in those firms compared to the other junk rated credits that I currently own where the position would be in the $300 to $2000 range. After doing my research, and making a good faith effort to determine the risk in relation to the potential reward, I then decide how much in capital to risk, which is always a key point for me. I may have 10 grand in AT & T bonds but I may have had less than $1500 in Ford Motor Credit (FCZ) before selling that position. The junk credit would have paid me more, which was a reason not to avoid it altogether, so I controlled my risk to issues like FCZ or DKR by first limiting my capital exposure.

The XKK security is more fully described in a prior post: Goodyear Tire TC xkk It was one of my leading percentage gainer last Friday, moving up 5.45% to $8.7. XKK: Summary for LEHMAN ABS 8.00 Par value is $10 and the coupon on this TC is 8%, higher than the 7% coupon on the underlying bond. This is a link to the prospectus: This is a link to the FINRA page on the underlying bond: FINRA - Investor Information - Market Data - Bonds - Bond Detail

The reason for the positive movement on Friday probably had to with a Goldman Sachs upgrade of the common shares (GT) to buy. StreetInsider Goodyear also announced recently a 6% rise in replacement tires in the U.S. Reuters

With Goodyear, I know that there is some there there. Was there anything there when Lehman Brothers blew up? So, even in a bankruptcy, I would expect a senior bond holder to recover something, so my downside is somewhere north of zero.

Sometimes, a reader asks how the TC can have a higher coupon than the underlying security. I said in one of my first posts on TCs, dated October 6, 2008, that the coupon payment for the TC may be the same, more or less than the underlying security coupon, and the number of bonds deposited in the trust are adjusted to make up any differences. Trust Certificate JZJ AT & T BOND The total value of GT bonds in the trust is listed at $49,860,000 or 49,860 $1000 par value bonds which will generate per year at 7% ($70 per bond) $3,490,200. The trustee pays out that exact sum to the TC holders based on the 8% coupon and the number of certificates outstanding.

Another concern is that the name of this security, which has the name Lehman ABS in it. Lehman ABS is now bankrupt. When the Grantor trust was formed by an agreement between Lehman ABS and the trustee, Lehman ABS was responsible for purchasing the bonds and depositing them into the trust. The bonds were paid for by the issuance of the Trust Certificates to the public (see page 8). The prospectus makes it clear that Lehman was to transfer ownership of the bonds to the Trustee:
"In addition, Lehman ABS will, with respect to each Deposited Asset, deliver or cause to be delivered to the trustee (or to the custodian hereinafter referred to) all documents necessary to transfer ownership of such Deposited Asset to the trustee. "  (see p. 44: /  
Page 1 of the prospectus says the Trust "will own" a publicly issued fixed income debt security.  On the same page, it is stated that the Trust Certificate represent interests in the Trust. This is in the general part of the prospectus that would be part of each individual issue.   On page S-1, which is the section just for XKK, it is stated that the Certificates "represent an undivided beneficial interest in the assets of the Trust".  At page S-7, it is stated that the owners of the Trust Certificates are entitled to the interest paid by the underlying securities to the extent necessary to pay the 8% coupon, and to receive the principal at maturity to the extent necessary to pay the $10 par value per TC.     
Since the Lehman bankruptcy, the trustee has continued to collect the interest payments made by Goodyear and to pay out those sums to the trust certificate owners:   /
I came close to selling XKK on Friday.  The Old Geezer would have sold it which is why the Young Stud, focus machine LB is the one currently being channeled here at HQ.   Though, the OG is continuing to reassert himself, as the distance in time makes it more difficult to connect with and channel the spirit of that 16 year old Stock Stud. The LB reasoned that it would be better to hold onto the income generation of this security, a better alternative than having more cash earning nothing in a money market account.  Would I buy XKK now at $8.7 if I did not own it?  I would say no, but ask me again in a few more months of earning nothing on my cash in a money market fund. 
I watched Uncle Warren, everyone's uncle, and Gates at CNBC's forum at Columbia Business School.  Warren said cash is trash.  Okay, it is trash and even more so now earning nothing.  But then, he was asked why he kept so much of it on the balance sheet at Berkshire until recently.  His response was basically that he helped him sleep at night, and he was waiting for opportunities which came along starting last September.   I have a similar view of the cash allocation, raised mostly in 2007.  This is a link to the transcript of that show:   CNBC TRANSCRIPT: Warren Buffett & Bill Gates  
2. Exxon (owned):  Andrew Bary wrote a favorable article about Exxon in this week's  I would certainly agree with his assessment that Exxon has the best balance sheet and reserves in the industry, and its sheer size has worked against it this year as institutional investors buy smaller and more narrowly focused firms.  I prefer the defensive characteristics of Exxon.  I do prefer the dividends paid by the other majors.  Exxon is on track to double the dividend every 10 years, which is too long a period for a double in my view given its earnings.  In 1999, the dividends totaled $.84  and this rose to just $1.55 in 2008.  The 2009 rate will be $1.66.  But some of the other majors, whose dividends result in a higher yield at current prices, have similar dividend growth percentages.  Chevron for example was at $1.24 in 1999 and $2.66 this year.  ConocoPhillips (COP), which I have bought and sold this year, has raised the dividend by significantly more than 100% over the past 10 years, going from $.68 to $1.88.   I think that it is important for an investor in these large companies to look at historical growth rates in the dividend, and the payout percentages to profits. 
I made an analysis of Coca Cola, which has been on a trend to double its dividend every 7 years, and this was important in deciding the price that I would sell my shares bought at $38.72 in early March 2009.  Barrons Recommendations and My Trades in The Barron's Columnists' Recommendations in 2009
3. Prospect Capital (owned): PSEC is a Business Development Corporation that is similar to a REIT, in that most of the income has to be paid out to the shareholders.     Business Development Company This will generate more of a dividend yield, but at a price.  The BDC is constantly selling shares to raise capital, and those issuances have recently been at below book value.  Another problem during the recession is that many of these firms have had investments go sour on them.  My last purchase of PSEC was in mid- September at  $10.48 Bought 50 PSEC .  I currently own 200 shares and I have been disappointed with the performance of this firm.  Part of my disappointment has been in the constant stream of share issuances recently:  Item # 3  Federal Reserve  The other issue is disappointing results, with the latest example being its last report: 10-Q   The net asset value of PSEC's investments declined  to $11.11 from $12.4 at the end of Q/E 6/30/09. This is part of what amounts to in my view a systemic problem with management, as NAV has continued to decline.  NAV was $15.08 at the end of Q/E 9/30/2007  So I voted against allowing the management of this company to issue more shares at below book value.  I view it as someone analogous to the management of some of the regional banks.   Eventually, when the economy improves, and starts to lift all boats, the management of this BDC will start to look good. Possibly, the NAV will start to go up.  In the meantime, the dividend yield is about 16.3% at the $10 price:   PSEC   I have not discussed PSEC since my last buy, and I decided to bring it up again after seeing a money manager recommend it in this week's  Barrons.  I view the common shares of PSEC to be equivalent to a junk bond, one in which I do not have much confidence, so my exposure is limited to $2500 and no more.  Also, Morgan Keegan, a regional brokerage firm based in Memphis, downgraded the stock to market perform in mid September, and Wells Fargo downgraded to market perform last week.    The Chairman and CEO is a Harvard law school graduate, Princeton undergrad.Prospect Capital Corporation  The portfolio companies are listed on this page:  Prospect Capital Corporation
4. Confirmation Bias: One of the frequent topics of discussion in my blog is confirmation bias. It is without a question one of the more dangerous tendencies of human beings.  While all human are afflicted with this problem, the True Believers take it to an art form, and most of my discussion about confirmation bias has been in relation to them. 
 Distortion of Reality to Serve an Ideology  
 BlackJack and Stock Investing: Lessons Learned & Applied   
 Torture and the Imperial Presidency: Why are those Conservative Values?/   
 Idealogues on A Mission: Revisionism Already Well Under Way to Explain the Origins of the Mortgage Crisis     
Jason Zweig has a good discussion of confirmation bias relevant to investors in his column in the WSJ this Saturday.  I would just add to his column that confirmation bias goes beyond searching out information that only confirms pre-existing beliefs.  It goes far beyond that undesirable personality trait.  It also encompasses a real time distortion of information to fit the beliefs, deliberately ignoring sources of reliable information (such as a TB refusing to read reports from "mainstream" media and relying on Fox, Limbaugh or Glen Beck instead), dismissing reliable information because it does not fit with the pre-existing belief, refusing to accept (or event to admit to) an erroneous decision or to analyse in any meaningful why a decision turned out to be erroneous, and rarely if ever challenging a belief as wrong, even possibly wrong.   In other words, would you want someone like that managing your money, and there are millions of them floating around?  
It is hard to be a good investor.  You have to challenge your opinions all of the time, every decision has to be assessed after the fact as if someone else made it.  You have to gather information, discern what is material and reliable, assess what is questionable, known, and unknowable, and then exercising good judgment based on objective criteria and good judgment.    

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