Thursday, March 4, 2010

Joseph Stiglitz on U.S. Economic Conditions/Bought 50 FBSS at 14.08/ISM Services Index/Forsyth Column On Bonds

1. Interview with Joseph Stiglitz in For the past month the RB and LB have been in a heated discussion about the Regional Bank Stocks strategy, which currently has 29 positions in it, and the source of the debate involves some points made by Stiglitz in this interview. Stiglitz did win a noble prize in economics and that for some would make him more of an authority on that subject than me, particularly since I have never read an economic textbook or taken a course in the dismal science. Actually, I would not call economics a science, more like an ideology or a secular religion with a lot of numbers. Economists: Secular Theologians with a lot of Numbers Stiglitz is a liberal, and sometimes it is difficult to separate his economic opinions from his political or social ones. The same is true for conservative economists too. In his interview, he mentioned a point about commerical mortgages that has been troubling the LB for weeks.

I mentioned in a recent post discussing Porter Bancorp that commercial mortgages are frequently of short duration, with a three or four year term being common. Many of those mortgages were based on valuations in effect prior to 2007 and will have to be renewed during the next few years. This could lead to some meaningful writedowns at the banks. Item # 4 PBIB Porter, for example, increased its loss reserve dramatically in the 4th quarter of 2009.

Stiglitz points out that about 500 billion of commercial mortgages will have to be rolled over during the next 3 to 5 years, and many of those loans are under water and some of those loans have been securitized which would add to the difficulty in trying to refinance them. So, there is reason to be concerned about the regional banks having to take significant loan losses on commercial loans in the coming years, unless there is a fairly dramatic return to economic growth accompanied by significant appreciation in the value of the collateral for those loans.

Based on this potential problem morphing into a really serious one, the LB wants to abandon the regional bank strategy altogether right now, sell everything, take the money and run for cover. This is part of its trading mentality, never go broke taking a profit being the LB's favorite saying. So far, the regional bank strategy has worked extremely well with a number of positions gaining over 100% and several more increasing over 50%. The RB says that this is shortsighted at best, typical for a linear thinker like the LB, and forgets the big picture lessons from the last banking debacle in late 1980s and early 1990s, the last time the banking industry blew itself up. The ones that survived rose like a Phoenix from the ashes, and started a long term secular bull move that lasted close to 15 years, with many ten baggers for those who had the vision to buy at or near the bottom in 1990-1991 and to hold. And the LB rightfully added that this time may be different. Then, as one would expect, the name calling started, with the RB saying that the LB was more of a Girlie Man than the Old Geezer.

This debate is becoming heated at times, and no resolution has yet to be made by the Headknocker. Since the strategy is still in place with a goal of 30 names (Headknocker likes round numbers), the LB is being forced to add two more names, and # 29 was added yesterday.

2. Bought 50 FBSS at 14.08 (See Disclaimer): Fauquier Bankshares, is an extremely thinly traded issue with a normally large bid/ask spread so limit orders need to be used. I did not do that yesterday and got screwed. When I place the odd lot market order, there was a narrow spread when I placed the order of just five cents, which apparently disappeared as soon as I sent the market order. My order was filled about 30 cents higher than the ask price at the time the order button was clicked. There was something odd though which I will mention and hopefully remember. 100 shares were for sale at around 13.75. I entered a market order for 50. It did not fill immediately, so I tried to cancel it which is my routine practice for odd lot market orders. I will give it five seconds tops. For the first time, I could not cancel the order. I will cancel a market order that is not filled immediately, and have never had a problem doing it for these thinly traded issues. It was labeled a "pending order" which could not be cancelled. I also noticed that no "route" was listed in the order information, which was also a first. The order then filled with the order routed through my broker. I suspect that the broker bought the 100 at 13.75 and then sold me shares at the higher price. I could not cancel the order, I suspect, because the broker was busy snapping up that 100 shares to fill my odd lot order for 50 shares. I do not have any problems about 95% of the time with my odd lot limit and market orders, but something does occasionally happen which I do not like. I will just log it as something to remember for the future.

I am placing FBSS in Category 2 of the Regional Bank Stocks stratagem. I did not want to buy 100 shares of this small regional bank with a market cap of close to 50 million.

This small regional bank is based in Virginia with nine banking offices located in Facquier and Prince William counties. The bank recently declared its regular 20 cent quarterly dividend or 80 cents annualized. At that rate the dividend yield at a total cost of 14.08 would be 5.68%. The bank recently opened two new branches . The Fauquier Bank Opens Two New Branches So it is growing.

The bank reported 4th quarter earnings of 23 cents per share, up from 22 in the year earlier quarter. Earnings for the year fell to 95 cents per share compared to $1.03 earned per share in 2008. EX-99.1 As of 12/31/2009, the Tier 1 risk-based capital ratio was 10.91% and the total risk-based capital ratio was 12.15%, both exceeding the levels for "well-capitalized" banks. The net interest margin was 4.33%. Non-performing loans to total loans was .75% at the end of the 4th quarter. Nonperforming assets to period end total assets was 1.26%. The efficiency ratio was 67.97%.

I view it as a plus that Facquier did not apply for Tarp funds: EX-99.1

3. ISM SERVICES INDEX: The non-manufacturing ISM index rose in February to 53 from 50.5 in January. The employment component is moving closer to 50, rising to 48 from 44.6.

4. Randall Forsyth: In Forsyth's column in Barrons on Wednesday, he makes the case for continuing to own bonds. While he acknowledges the arguments of bond bears, he mostly dismisses those concerns as overblown, emphasizing that the 10 year treasury provides a lot more yield now then treasury bills, and that is of course true. In prior tightening cycles in 1987, 1999 and 2004, he points out that the 30 year treasury was "remained essentially unchanged".

I would be in the bond bear camp for many of the reasons cited by Forsyth which he asserts are overblown. Nonetheless, I am trying to keep the income generation of my bonds now, hoping that I will be able to lighten up before inflation takes a significant toll on the price. I realize that the proceeds from any bond sale now would most likely end up in a money market account earning zero. So, I have to take that into account even though I am far more negative than Forsyth about the prospects for bond values over the long term from current levels. I would point out that the 30 year bond was in the 9 to 10% range mostly in 1987, much different than now. .txt The range was 6 to 7% in 1999. The current yield is 4.58% as of yesterday. So I do not view his point valid comparing now to 1987. I would also point out that long term treasuries have already took a hit from their lows reached last year. I pointed out in an earlier post that the Vanguard long treasury fund fell 12% in 2009 after a 1% rise in rates: Item # 7 GE Intel Yahoo/Conspiracy of Silence/Added 100 HRPN AT 19.15/BERNANKE CONFIRMATION (fund performance information at VUSTX)

5. Dividends and Interest: The most central part of my investment strategy is revealed in this section of my post. I do not add it everyday, but I could just about do that. The central thrust of what I do is to buy income generating securities which throw off a constant stream of cash flow, and then I reinvest that income by purchasing mostly more income generating securities. And I do not use any funds in the brokerage accounts to pay for personal expenses or even taxes on the income generated.

In today's WSJ dividend page, I noted that the floating rate equity preferred, and the fixed rate equity preferred from Odyssy Re, recently acquired by the Canadian company FAIRFAX FINANCIAL HLDGS LTD, will go ex dividend for their quarterly payments on 3/29.Bought 50 ORHPRB at $20.93 Bought 50 ORHPRA Several synthetic floaters declared their monthly payments, all of which pay a greater of a guarantee or some percentage over LIBOR. These include GYC and GJL: bought another 100 of gjl at 20.6 Bought 100 GJL at 20.75/ Bought GYC at 15.5: Synthetic Floating Rate Bond I have sold my positions in some of the other floaters referenced on this dividend page including GJP, GJO and GJK. GJL and GYC are both paying their guarantees at the present time. For all of these securities, I would not be a buyer at current prices. One facet of my investing philosophy is to wait for your opportunity, and then seize it. If for some reason GJP fell back to say $19, I would consider buying back the shares that I just sold. Sold 100 GJP at 22.42

It has certainly become more difficult to buy income generating securities at favorable prices after nearly a two year Jihad by the Fed against savers. I have been buying some securities that I would normally not buy, such as the Sprint TC DHM bought last Monday, as I run out of options. Due to diminishing opportunities in the bond sector, I have by necessity become more lenient and liberal in what I am willing to do. Still, I will limit my risk by simply limiting my capital exposure to these more risky income securities.

This is a couple of links to the FINRA site that contains helpful information about bond terminology:

6. Trust Certificates Trade "Flat" on the stock exchange in Contrast to the Trading of the Underlying Bonds in the Bond Market: Another factor to keep in mind is that Trust Certificates trade "Flat". If I buy a TC one day before the semiannual interest payment ex date, I will receive the entire payment and the prior owner will not receive any of the interest. The TC price will be adjusted on the ex interest date to reflect the interest payment. So, by way of example, if the TC pays $1 per TC in interest and closes at $20 before the ex interest date, the adjusted price on the ex date would be $19.

The underlying bond in the TC does not trade flat. If I owned it for one day during the relevant 6 month period, I would receive 1 day of interest and the prior owner would receive the remainder. As an owner for one day, I would be paying the "dirty" price. Bond Accrued Interest I believe that last linked article may provides more information than the average investor needs to know unless they are active traders in the bond market.

This is a quote from page s-21 of the prospectus for the TC DHM: "The Certificates are expected to trade flat. Trading “flat” means that any accrued and unpaid interest on the Certificates will be reflected in the trading price, and purchasers will not pay and sellers will not receive any accrued and unpaid interest on the Certificates not included in the trading price." Prospectus Supplement

7. Australia GDP: The 4th quarter Australian GDP rose a greater than .9% from the 3rd quarter: 5206.0 - Australian National Accounts: National Income, Expenditure and Product, Dec 2009

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