Saturday, November 21, 2009

Treasury Bills and Notes-Negative Real Rate of Return/Dividend Paying Stocks & Bonds/LB Defends ZBPRC purchase

1. Treasury Bills and Notes: The 3 month treasury bill briefly went into negative territory last Friday before closing at .015%. MDC - Java Chart - The 2 year treasury note closed at .728, a little closer to 1%. MDC - Java Chart - CPI is about to turn positive year over year when the government releases the November number on 12/16/2009 which will replace the deeply negative number for November 2008. Bureau of Labor Statistics Data In a few weeks, the purchasers of the two note will not be able to claim it produces a real rate of return after inflation. It will be clear that all of the shorter dated treasuries have negative real rate of returns. This is already the case for the 3 and 6 month treasury bills that have been auctioned over the past several months when the CPI numbers have already turned up for the corresponding maturity periods for those treasury bills. For an individual buying those securities in a taxable account, the taxation of the minuscule interest simply adds insult to injury, and produces an even greater negative real rate of return. The treasury is auctioning on Monday 44 billion in two year notes, matching the prior month's record. On Tuesday, the treasury will auction 42 billion of five year notes, and 32 billion of 7 year notes on Wednesday. Two-year The five year note closed Friday at 2.14% yield.

There is some debate about what these low rates are signaling. At a minimum, the fall in 2 year rates indicates a belief that the Federal Reserve will maintain the federal funds rate at its abnormally low 0% to .25% for about another year. Even 7/10 of 1% is better than another year of nothing in the bills and money market funds. In case anyone is interested, an investment earning a tax free yield of 1% will take 69.66 years to double. Estimate Compound Interest (.5% takes 138.99 years). This bleak state of affairs for a conscientious saver, who borrowed earlier in life only what could easily be repaid and who has no debt now, is starting to influence my current decision making process more than any other event or opinion, and has caused me to restart purchases of bonds including some that I sold earlier in the year (e.g. EMO & JBI). I will then reassess in a few months whether or not to pare again some of the lower yielding, longer dated maturities. By lower yielding I am referring to fixed rate coupon bonds that yield in the 7 to 8% range, particularly those bought at or near par value.

Another interpretation of the low yields goes beyond the current Federal Reserve policy. This view is simply that the recovery will at best be anemic and short lived before turning down again. For those who believe that the economy is about to sputter again, and deflation or disinflation is still the likely course of events, the return of your money is more important than the return on your money. Those who advocate this view include Alan Abelson and his soulmate David Rosenberg, and some of the data points relied on by them are included in Abelson's Barrons column at page 2. Some of Rosenberg's recent missives are available for reading on Scribd. Dave 112009 Dave 111909

I am not going to buy any common stocks on Monday. I want to see how the market reacts to a revised GDP forecast for the 3rd quarter scheduled to be released on Tuesday. The original number was 3.5% growth and the consensus is now saying that number will be revised down to 2.9%. Table I will continue the bond buying.

2. Dividend Paying Stocks: I focus most of my buying on securities that pay dividends or interest. As a rule, I will not invest more than 10 thousand dollars in securities from a single issuer. It would not be unusual for me to own the common, a preferred issue(s), and one or more bonds issued by a single firm, and frequently I will have more funds invested at the top of the priority ladder than at the bottom. For example, I have more money invested in senior AT & T bonds than the common, but I still own some common shares in both a taxable and a retirement account. There is both order and a reasoned structure. Making a fund allocation between the various securities requires an analysis of several variables and ultimately a judgment call.

In Barrons this weekend, the cover story recommends several dividend stocks including At & T and Verizon. To start the process of deciding what to buy and how much, and being focused on income, I first want to identify all of the income generating securities by type. I would want to know whether any of the bonds are contained in Trust Certificates which will frequently provide me with a better yield than a purchase of the underlying bond. For some companies, there may be a wide variety of securities, including equity preferred stock (floating rate and/or fixed coupon), trust preferred and junior bonds, senior bonds, and secured bonds.

For Verizon, the current yield on the common stock is about 6.3% at the current dividend rate and a price of $30.4. I would then check the dividend growth history for the last 10 years and the current pay out ratio. According to Value Line, which has different numbers than Morningstar (which I can not explain), the dividend was maintained at $1.54 from 1998 to 2005, when it was raised slightly to $1.62 and kept at that level for 2005 and 2006, and then gradually raised to $1.87 in 2009. I view this type of dividend history negatively, barely better than a fixed coupon bond. Over a 11 year period, the dividend increased about 21% or 2% per year. And the pay out ratio is relatively high for the past six years at over 60%. So even though Verizon has a good current yield, that is more of a function of the share price going down over the past decade, and showing few signs now of perking up. So, I have bought and sold the common twice this year for small profits, clipped a few dividends, and do not currently own it. I may at any point buy it back for a trade.

Verizon does have a senior bond as the underlying security in Trust Certificates, and I own both PJL and XFL. I probably needed to buy those two securities in the retirement account, and the common in the taxable account. Both of the TCs are in the taxable account, and I do not recall why. XFL was bought at around 19, and my yield is around 10.35% at my cost until the underlying bond matures in December 2030. I discussed these TCs in depth in one of my first posts, from October 8, 2008, when the prices were hovering in the $19 to $20 range: Trust Certificates PJL and XFL: Verizon Bond

Now, I want to know what the bonds yield. The senior bonds can not have their payments reduced or eliminated and are consequently more certain to be paid than a common dividend. I randomly picked some senior bonds from the Finra site. Until I moved to bonds maturing in 2023, I would have received less of a current yield with a Verizon bond than with the common stock. (the FINRA yield calculation is yield to maturity which would be lower than current yield at the last trade since many of these bonds trade at a premium to par value). By 2023, I could buy a bond with a greater yield, but not by much, somewhere around 6.75%. I only picked up about a .25% moving five years further out, and another .25% by moving all the way to 2031, where I could buy one with a current yield of 7.28% but I would lose money at maturity. I just did a random check and this is the list:

One of the main benefits of a common stock over the bond is the increased dividends paid over time. I would much prefer buying a Sysco when it yielded 5%, and SYY has a contemporary history of doubling a dividend in seven years, than a Verizon which yields over 6% with a small rate of growth in its dividend payments. The SYY dividend has increased from 7 cents in 1993 to $ .92 in 2008, and has been increased in every year from 1993 according to the VL data. I would expect that the pace of dividend to slow down however. Another benefit of the common stock for a wealthy U.S. taxpayer is that it pays qualified dividends. The tax issue can be negated by holding the bond in a retirement account.

Is the Verizon dividend secure or how secure is it? This is a much harder question to answer. What would you have said in response to that question about GE or Bank of America three years ago? I would just try to identify potential problems and get a "feel". One problem is that Verizon is losing its land line customers at a rapid rate. The other problem is that its main engine for growth, Verizon Wireless, is owned 55 (VZ)/45(VOD) with Vodafone. Another problem is competition from cable and disrupters like Skype. Then you have the issue discussed in the recent cover story in Forbes, about new technology that reduces the cost of service for wireless calls and certain competitors intent on using that advantage to take away customers from the incumbent carriers. (my discussion at item # 9 /VZ & T-Forbes) So what can anyone say about the future? I suspect that the VZ dividend is not as safe as many think, probably safer in the short term than the long term, and most likely not a candidate for a dividend double in 10 years or even 15 years.

I am not going to buy any more Verizon bonds. But, if I had to make a choice between the common and a senior bond maturing in 2023 with a current yield of 6.75%, selling at no more than a minimal premium to par, I would go with the bond.

On the dividend front, AT & T common stock is currently yielding about 6.3% at the closing price of $26.07. Unlike Verizon, AT & T has shown decent dividend growth. It has been raised most years shown in the VL data which starts in 1993. Starting in 1998, the dividend was 94 cents and it was $1.64 in 2008, a 74% increase compared to the 21% for Verizon. The payout ratio is high currently, however, at over 70% (dividends to net profits). An important consideration for me is that AT & T owns 100% of its wireless network. I am price sensitive on my adds to AT & T with all of the buys betweem $23 and $25, and I went to nothing after selling all my shares, then in a retirement account, at close to $40 shortly before 9/2008. When I looked at a one decade chart, there seemed to be support in the $20 to $25 range: T Stock Charts So, I look at AT & T common more favorably than Verizon based on a few simple criteria: a similar dividend yield with AT & T having the better historical growth rate for the dividend and 100% ownership of its wireless network. The Iphone is just a minor point for me in its favor, and will most likely not be a lasting advantage for AT & T.

The Barron's article, on the other hand, has the Verizon common on its "A" team and AT & T on its "B" team. Since I sold my Verizon common recently, I only own Intel common on Barron's A list. I do not own Santander common and prefer owning its floating rate equity preferred that I bought at a good price a few weeks ago, STDPRB: Bought 100 STDPRB at $15.3/ At my cost, the guarantee is worth about 6.5% and I will receive more when 3 month LIBOR rises above 3.48% during the relevant computation period:

I also recently sold PG, MSFT, and WMT, which are on Barron's lists, and maybe I need to call the broker and explain that the Old Geezer did that and maybe he deserves a mulligan or some kind of do over given his age and mental infirmities. I wonder whether they would understand, surely they would.

3. LB Wants to Defend Its Purchase of ZBPRC: LB is feeling unappreciated here at HQ, and can not help but notice that its buy of ZBPRC was given as one reason by Headknocker (HK) for its dismissal as Head Trader. HK said that he will allow LB some space to explain its rationale, provided LB uses no numbers, uses no more than 300 words, keeps it simple and avoids being too boring. RB just piped up that LB is too much of a nerd's nerd to comply, and HK then added another reason for dismissing the LB, allowing the RB to make a trade on its own. As readers may remember, LB was so grateful at having another chance as HT that it allowed the RB to make a decision, and RB bought Yahoo. Bought 100 Yahoo at Open HK reminded all traders that the RB is not allowed to make any decisions in such an unhindered manner, and certainly nothing resembling a decision involving deployment of HK's capital.

LB's defense: As long as Zions is not seized by the FDIC, it will have to pay the ZBPRC dividend for as long as it continues to pay the common dividend. If the common is eliminated then ZIONS would have to restart the preferred dividend when it reinstates the common and the common shareholders expect a dividend. Zions would not defer paying the government its dividend unless it was in dire straights which it would have to do if it eliminated the ZBPRC dividend. If conditions improve, ZBPRC may be called after 9/2013 due to its high coupon of 9.5%. And the yield is tax advantaged at close to 13% at HK's cost. Morningstar rates the common five stars and says that the average loan to value ratios for the construction an land development loans is around 60%, so that provides some leeway before Zions takes a hit.

HK thanked the LB for not being too boring. If the investment makes HK money, all will be forgiven, all is well that ends well. On the other hand, if HK loses money, then this particular rationale given for LB's dismissal will be put in large red letters. Heads I win, HK purred, and tails you lose LB. RB just marveled at the wisdom of Solomon expressed by the GL.


  1. I agree that T is better than VZ at the moment. Almost identical yield but T has a far more favorable balancesheet as VZ is levered more by almost a factor of two. One big plus for T is that they've been buying back stocks at a rapid rate the last few years. Too bad it seems that they stopped doing it because this would seem to be the time to do it.

    I sell puts on AT&T regularly with the intention of owning AT&T if i would get assigned.

  2. One advantage for Verizon longer term is a more aggressive roll out of fiber optic television (FiOS TV).
    /FiOSTV/Overviewab/Overviewab Their dense territory in the northeast lends itself more to this kind of rollout than AT & T's service territory, which is an amalgam of the former baby bells of BellSouth (Southeast U.S.) and Southwestern Bell (SBC communications) plus what was left of AT & T.

    AT & T and Verizon common stocks have gone nowhere for almost fifteen years. I just pulled up an interactive chart covering the maximum time period at Yahoo Finance, and noted that Verizon was selling at $30 in 1993 and 1995. I then overlaid a maximum chart of AT & T. Since 1982, T has done a bit over 100% better but the charts are very similar to one another for extended periods.;range=my;

    AT & T is currently trading at 1995 levels. I discuss the history of the currently configured AT & T in this post:

  3. I don't think you can expect much appreciation in the AT&T or Verizon price because they don't have much room to grow and they return most of their earnings to the shareholder. That's why I don't think it's very useful to make a comparison between the today price with a price in the past. It doesn't include the massive dividends paid.

  4. Both phone companies are shrinking in their land line businesses and continuing to grow significantly in their wireless businesses. The newer businesses of providing internet service and TV are growing fairly rapidly. For years now, some experts have argued that the wireless growth was about to peak, and then both T and VZ would report a significant increase in new customers. Part of the growth in recent quarters has been at the expense of other wireless carriers.

    Verizon added 1.2 million wireless customers last quarter. AT & T increased wireless customers by 2 million in the same quarter.

    If an investor expects nothing greater than the dividend over a long period of time holding the stock, then the bonds would be a better alternative based on that expectation. The common dividend can be cut or eliminated. A senior bond payment can not be deferred, reduced or eliminated if the firm wants to remain in business outside bankruptcy court. At the Finra site, I found that the Verizon senior bonds started to yield more than the common by going out about 15 years.

    My approach is to own the bonds and trade the stocks. The stocks will appreciate, and have a good period of price appreciation. The dividend affords the owner the luxury of being patient for that price move. When it occurs I will sell my AT & T common shares and keep my bonds, most of the bonds were bought at prices which will yield more than 10% per year. The best of those buys was JZE at $12.5.

    My point in the blog is that someone who held the common stock for the past 15 years would have had only the dividend, and the total return would have been less than the current dividend yield of 6.3%, since the dividends were lower during most of that 15 year period. If held in a taxable account, the after tax return for a U.S. taxpayer would have barely exceeded inflation which I view as inadequate. To improve that return, the common shares have to be traded, buying the dip which I did with AT & T with buys in the 23 to 25 range and selling at some point in a cyclical bull move in the stock. I am not sure now when I may sell but I doubt that I will wait for a 40 handle again.

  5. To correct a statement made by me in one of these comments, Verizon owns 55% of Verizon Wireless to 45% by Vodafone, but that does not change the point that I am making.

    The current issue from Barrons, which was offline most of yesterday and is a subscription based service, contains a favorable article on AT & T.

    I believe the current subscription rate is $49 per year for the online edition.