Sold 50 of the 150 TAXI/Sold 50 of the 200 PSEC/Exxon/GYB vs. Its Underlying Fixed Coupon GS TP Maturing 2034/Insane Pricing of the CEF GUT

Recently, I have been listening to a lot of misleading and frequently inaccurate information about the use of the budget reconciliation process as a means to bypass the filibuster vote requirement in the Senate. I thought that this article form the NYT gave me some historical background about the use of reconciliation by both parties (click the multimedia chart in that article for the details). Reconciliation is used to avoid the 60 vote requirement in the Senate rules to end a filibuster, so that a vote up or down can be made on the legislation by a majority vote. The republicans have used it more frequently than the Democrats, and it has been done by them to enact major legislation impacting social welfare programs.

Obama has flip-flopped on the use of reconciliation, however, opposing its use while he was on the campaign trail. PolitiFact

Politico released a powerpoint presentation by the Republican National Committee that showed the GOP's strategy for this fall's election. The primary focus was to play on voter's fear of Obama and what the GOP views as a trend toward socialism. POLITICO.com I doubt that many of them have a clue about the meaning of socialism. I just glanced at this presentation, and noted some derogatory pictorial representations of Democratic leaders including the President, Speaker Pelosi and Senator Reed under the heading "Evil Empire". (page 31: www.politico.com/PDF) I did add a new word to my vocabulary after reviewing this presentation. GOP suggested giving "Tchotchkes" to wealthy donors.

FactCheck ran an analysis of an ad by State Senator Sue Lowden, who is running as a republican to unseat Harry Reid, and found Ms. Lowden's ad to be totally free of factual accuracy. FactCheck.org She is attractive however, and does talk the talk of the TBs. I suspect that this will be the norm in the upcoming election cycle.

The story in the NYT this morning about Governor Crist of Florida and his sweetheart deal with U.S. Sugar may be just another nail in the coffin for his Senate bid. Crist has been trailing Marco Rubio. I doubt that many members of that tribe read the NYT, but will undoubtedly hear about this story via approved media outlets such as Fox and Rush Limbaugh.

1. Medallion (SOLD 50 TAXI HELD IN ROTH AT $8.08 TODAY)(see Disclaimer): One problem with BDCs is that they do not provide a reliable dividend stream. Many of them have cut their dividend payments over the past two years.

I had just bought a small position in TAXI and was looking forward to receiving my first 19 cent per share dividend this month. Well, that is not going to happen. The dividend was cut to 15 cents. I did not notice it until this weekend but Medallion reported earnings and announced the dividend reduction Friday morning. Medallion reported a loss of 5.759 million during the 4th quarter due to a 9.342 million loss in investments made in Special Purpose Acquisition Companies (SPACS). Excluding that charge, the company did have net income of 3.583 million or 20 cents per share. None of the dividends paid in 2009 are classified as returns of capital, which is important. I do not view a company returning my capital investment in the form of a dividend to be a plus.

If the company maintained the 15 cent dividend for the entire 2010 year, which is an unknown at this time, this would reduce the dividend yield to 7.42% at last Friday's close of $8.08. I view that yield to be inadequate compensation for the risk of holding shares in a BDC, at least for my retirement account which is managed more conservatively than the taxable accounts. Further I was not impressed with this last report or the 9.342 million dollar loss in the SPACs. My position in TAXI is inconsequential but I nonetheless decided to sell 50 of the 150 shares held in response to the dividend reduction and this earnings report. The remaining 100 shares are held in the taxable account where I am willing to assume more risk. It is also possible that the dividend will be raised later on based on increases in investment income.

2. Sold 50 PSEC in Regular IRA at 12.16 TODAY (See Disclaimer): The dividend reductions recently made by TAXI and Hercules Technology have caused me to reassess my small holdings in BDCs. As a result of this reassessment, I have taken a more cautious stance. I will keep for now the 150 shares of PSEC held in the main taxable account. One reason for selling the 50 shares held in the IRA has to do with the significant percentage of PSEC's dividend for 2009 being classified as a return of capital. On the 150 shares, I received $66.98 in dividends classified as "non-dividend distributions" on my 1099, a return of my capital investment. I do not view that as a positive. The total amount paid on those 150 shares was $244.14.

For one, a company can not continue returning an investor's capital forever. The classification of a dividend as a return of capital may be a marker for a future dividend cut, since the firm is not earnings enough money to cover the dividend. This is not immediately inevitable, but certainly indicates that a cut may be in store down the road. And, there is no advantage to me to have a firm return my capital in the form of a non-taxable dividend.

While the return of capital portion of a dividend distribution is not included in taxable dividends in the year paid, it does require a reduction in the cost basis of the investment by the amount of the return of capital. This will then be recaptured when the security is sold. If held for a year, and sold for a gain, the recapture for a U.S. taxpayer would currently be at the maximum rate of 15% for long term capital gains. But what exactly is being taxed at 15%- a partial return of my original investment.

Part of PSEC's dividend is classified as a taxable non-qualified dividend. I just did a quick calculation on the last payment received for my 2009 tax year: $12.51 qualified; $31.98 taxable non-qualified; and $16.82 return of capital. So for a company like PSEC I would assume that a majority of that $16.82 return of capital would have been classified as a taxable non-qualified dividend if it had been earned and consequently taxed at my highest marginal rate.

In the last analysis, I would prefer having a bond in my regular IRA rather than either PSEC or TAXI. I at least do not have to be concerned with an interest rate reduction in a fixed coupon bond. Once part of the dividend is classified as a return of capital, there is an accounting headache for holding that security in a taxable account which is not present in the retirement account.

The PSEC shares in the IRA were bought at $10.48 last September: /Bought 50 PSEC/

The orders to sell PSEC and TAXI were limit orders placed before the market opened this morning. I will buy a bond in TC form to replaced them.

3. Consumer Credit: The Fed released its report on consumer credit for January 2010. There was an increase of 2.4% in total credit, both revolving and nonrevolving. FRB: G.19 Release--Consumer Credit--March 5, 2010 This was the first increase over the past year.

4. MKN (own): Sometimes I place a limit order and do not have any expectation that it will be filled. That was the case with MKN when I placed a limit order to buy just 100 shares at $9.85. There are days when this security has no volume and the bid/ask spread was usually large that day. Bought 100 MKN at 9.85

This security is interesting. It is a senior bond from Citigroup maturing in April 2014 at $10 that pays the greater of 3% or up to a 33% annual rate based on the percentage increase in the UBS commodity index from the start date of each annual period. The catch is that a close for just one day over that 33% increase from the starting value of the index will cause a reversion in the interest paid to the guarantee of 3% no matter how much the commodity index increases during the annual period. So, if you own MKN, you want to the index to gain a lot more than 3% but never more than 33% of the starting value. Pricing Supplement No. 2009- The first year for this security ends on March 30, 2010. The calculation will be made on that date with the interest paid on April 7. The starting value of the commodity index is set out in the prospectus as 112.43. That means that for the year ending on 3/30/2010, an owner of MKN would not want the commodity index to have a single close over 149.53. (starting value of 112.43 x. 1.33=149.53)

So far, based on the Java Chart that I use at the WSJ, there has not yet been a close above that level, and the index closed last Friday at 134.68. MDC - Java Chart - WSJ.com I did not buy this security initially until it retreated from the high reached on 1/6/2010 of 145.03, which was too close for comfort with almost three months left before the closing date. Now, I may be able to relax on this one with the closing date at the end of this month. The starting date for the next annual period will be March 31, 2010. If the commodity index closed at 134.68 on 3/31/2010, that would be a 19.79% gain for the period which would result in a penny rate of $1.979 for each share of MKN. The only tally which will hopefully matter will be done at the closing price on 3/31. I own 200 of a similar security MKZ that has a different annual period and a 31% cap.Pricing Supplement /Bought 100 MKZ at 9.91 in the Roth IRA Bought 100 MKZ at 9.96 Both MKZ and MKN mature in 2014.

5. Exxon (owned): Andrew Bary had some favorable comments about XOM in his Barrons column, pointing out that the stock is selling at about 11 times estimated 2010 profits, a "rare" discount to the overall market. He wrote a bullish cover story about Exxon in November 2009 when the stock was trading in the low 70s (11/16/2009 issue: Barrons.com) The stock closed at 72.47 on 11/13/2009 and at 66.47 last Friday XOM: Historical Prices for Exxon Mobil Corporation

On March 9, 2009, the start date for this cyclical bull market, Exxon closed at 64.03, so it has not participated in the rally that has taken the S & P 500 up 65.4% as of last Friday from that March 2009 low. dshort But the Exxon share price did not fall as much as the market averages during the bear market. The current analysis estimate is for earnings of $5.75 this year and $7.3 in 2011. XOM: Analyst Estimates for Exxon Mobil

As Bary points out in his column, this week is the one year anniversary for the bull countermove off the March lows, reminiscent of the cyclical bull move off the October 1974 low, so far at least. While mentioning his own article in that March 12, 2009 issue, Bary does not mention that Alan Abelson, the sarcastic pontificator who views any increase in the market averages as proof positive of the madness of crowds, was seething with pessimism in the Barron's issue released the weekend prior to the start of this epic bull move, citing none other than fellow ghoul David Rosenberg who was predicting further momentous declines for the stock market and continued pain and suffering for investors. Barrons.com There was also an interview with the Alan Levy in that same issue who was forecasting "gloom" as far as the eye could see and he recommended the purchase of 10 year Treasuries then yielding around 2.83%. Barrons Now that had to hurt for anyone buying into it! And, do you think that a ten year treasury yielding 2.83% will provide a positive inflation adjusted return after 10 years or inflation-adjusted after tax return? Going nowhere for 10 years is not my goal.

Abelson likes Levy almost as much as Rosenberg. Hey, I am still waiting for that range bound move of 450 to 600 on the S & P 500 that Rosenberg was forecasting in April 2009 at least until it made him look silly. Rosenberg

6. GYB vs. Its Underlying Fixed Coupon TP Bond: My initial purchase of 200 GYB was in two 100 shares lots at $10.95 and $11. Bought GYB Added another 100 GYB in Regular IRA/ This synthetic floater pays the greater of 3.25% or .85% above the 3 month Libor rate with a maximum rate of 8.25%: www.sec.gov A swap agreement with UBS creates the float. The underlying bond in GYB is a fixed rate TP from Goldman Sach Capital with a 6.345% coupon that matures on 2/15/2034. If you had to invest in one or the other, which one would I buy at the closing prices last Friday?

The last price shown for the GS TP was $93.140 as of 3/5/2010: FINRA It is a fairly actively traded bond. The current yield at that price is 6.81%. GYB closed at $18.10 with a $25 par value. So it is clear that it has more capital gains potential to maturity than the underlying bond. GYB is selling at a 27.6 discount to par value compared to the 7% discount for the underlying bond.

The current yield on GYB is based on the guarantee given the abnormally low 3 month Libor rate. I calculated the yield at 4.49% based on a total cost of $18.1. That is about a 2.32% current yield differential. The crossover in current yield would occur at around a 4.1% 3 month LIBOR. (.041% + .0085%= .0495% x $25 par value=$1.2375=6.837%).

We are probably near the end of a rate easing cycle so I would pay more attention to historical 3 month Libor rates that would easily average over 4.1% on average since 1989= LIBOR Rates History (Historical) Between September 1989 through April 1992, April 1994 to April 2001, and October 2005 to December 2007, the rate was above 4.1%, frequently well above that level.

I wanted to run the numbers assuming an average 3 month Libor rate of 4.5% (average coupon for GYB then at 5.35%) and calculate the yield to maturity using the Morningstar Bond Calculator for both securities:

Underlying Bond: YTM 6.97% (6.345% coupon, 93.14 price, maturity 2/15/2034)

Assumptions on GYB: 18.1 price; coupon of 3 month Libor rate +spread of .85%.

GYB: 7.99% at an average 4.5% Libor over the next 24 years.

AT 5% average for 3 month Libor=8.63%

At 5.5% average for 3 month= 9.28%

At 6% average=9.94%

At 6.5% average 10.6%

At 4% average 7.34%

On a YTM basis the crossover point would be lower than the crossover on a current yield basis given the larger discount to par value in favor of GYB. To arrive at a 7% yield to maturity for GYB, similar to the YTM for the underlying bond, the 3 month average Libor rate over the next 24 years would need to be lower than 3.72% (a 3.72% 3 month Libor would produce a 6.99% YTM on GYB).

This may be a matter of personal preference. I would give up the current yield advantage for the fixed coupon bond in favor of the potential long term benefits of the floater, which includes some protection in periods of high inflation or higher than currently anticipated inflation. Based on history, an average of less than 4% 3 month Libor over 24 years would not be the reasonable assumption to make about the next 24 years.

But, for me the practical choice is not buying the underlying bond but another fixed coupon TC with the underlying bond in it. There are several TCs that are fixed coupon securities that contain this GS TP. I just picked one of those at random, Pplus Tr GSC-3 TR CTF A, PYC, and it closed last Friday at $20.5 with a 6% coupon. www.sec.gov/ That one gives me a 7.69% YTM at Friday's closing price. So the other fixed coupon TCs, particularly JBK which has an issue dealing with the termination of the swap agreement with Lehman, are more competitive with GYB than buying the underlying bond directly, taking into account a reasonable long term forecast from my point of view.

{Note: JBK turned into a fixed coupon security after the swap agreement with Lehman was terminated due to its bankruptcy. So the JBK coupon now is 6.345%, the underlying bond rate rather than the rate created by the swap agreement with Lehman. JBK closed last Friday at $19.15, which gives it a 8.73% yield to maturity. Since this TC had an active swap agreement in effect at the time of the Lehman bankruptcy, the trustee took the position that the swap was terminated with the bankruptcy filing and started to pay the owners of JBK the fixed coupon semi-annual amount of the underlying bond in February 2009. However, the trustee took $100,000 out of that payment to cover its costs in the Lehman bankruptcy. www.sec.gov No subsequent payments have had a deduction (i.e. August 2009, February 2010). New Information about JBK /More on JBK bought 100 jbk at $16.15 Bought 50 of the TC JBK}

7. Gabelli Utility Trust (GUT): I do not own this closed end fund. And if I bought it, I would consent to my kin folk using any such purchase as evidence to appoint a conservator to manage my assets.

For as long as I can remember, this CEF has traded at a premium to its net asset value. On Friday March 5, 2010, it closed at $7.62, a 49.41% premium to its net asset value of $5.1. WSJ.com Why would any sane person pay $7.62 for assets worth $5.1. There is no rational justification for it. Well, the uninformed might say that GUT pays a good dividend. As Jason Zweig pointed out in a recent column, the dividend paid is about 90% a return of capital over the past year. He quotes Gabelli as saying the premium is "off the wall". WSJ.com I checked the web site and saw that the monthly dividend was 6 cents. How much of that was a return of the investor's capital? Subject to year end adjustment, the return of capital was running at $.05367 out of that 6 cent payment. Fund Tax Info Just incredible! A brief review of the WSJ pages on CEF pricing shows a number of funds selling at over a 20% premium to their net asset value. Personally, I do not think the boards of these funds are doing investors any favor my maintaining a distribution rate in excess of income.

8. Applied Materials (AMAT-owned): AMAT announced this morning a 17% increase in its dividend to 7 cents per share payable on June 16th to shareholders of record on May 26th. The company also announced a stock repurchase program authorizing up to 2 billion dollars in stock purchases over the next three years.