Friday, March 26, 2010

Sold all of CEF OLA at 8.79/Bought 100 MHC at 9.8/Seven Year Note Auction

1. First American Core Logic Negative Home Equity Report: This service has a free report, available after registration, that goes into some detail about negative equity estimates by state. The Negative Equity Report Q4 2008 This firm estimates that it will take five to 10 years on average, depending on the location, for those homes to appreciate into positive equity territory.

The USATODAY front page yesterday has a story about negative home equity which is estimated to include approximately 11.3 homes nationwide. To highlight the problem, the story focuses on a few homeowners. One couple bought a house in Florida for $230,000 and the previous owner had made $100,000 in three years. Think about that for a second. The new owner actually expected a continuation of that parabolic rise. This was obviously unsustainable before there was a reversion to the mean. Another person, nearing retirement, spent $100,000 to renovate a basement to add a small theater and other amenities, borrowing the money, and will now how to go into foreclosure because the house can not be financed after falling in value.

2. Catholic Church and Its Decades Long Cover-Up of Sexual Abuse Cases: For decades, the officials in the Catholic Church swept sexual abuse by Priests under the rug to avoid adverse publicity. For years now, maybe for a couple of decades, there has been a stream of adverse publicity of the cover ups and what the church was willing to do to protect its reputation. The latest story reported on the cover of the NYT involves a priest who molested as many as 200 deaf boys. The NYT has an interactive with the documents relating to this story. Another story in the paper yesterday details some scandals that are now sweeping across Europe. NYT (see also NYT editorial on this subject). The Vatican claims that it knew nothing about the abuse of those 200 deaf boys until 20 years later. CNN.com The NYT has a story in today's paper that the current Pope, while he was a Cardinal, was told of a pedophile priest in Germany being returned to pastoral work within days after the Ratzinger sent him for therapy to overcome his pedophilia. The priest was later convicted of molestation.

3. Sold All Shares (421.751) in OLA at $8.79 (See Disclaimer): I mentioned in an earlier post that a significant percentage of dividend payments made by OLA in both 2008 and 2009 have been classified as returns of capital. This placed OLA, along with Eaton Vance's ETW, on my short list for possible disposal. I view return of capital "dividends" to be an illusion. The fund is literally creating a tax event for investors in non-retirement accounts by returning a portion of their capital investment in the shares back to them in the wrapping of a dividend. OLA was within 6% of its net asset value when I sold all of my shares yesterday. It had also underperformed many of my other CEFs in the market up cycle since March of 2009. Unlike ETW, where the returns of capital have resulted in an artificial gain as a result of the cost basis adjustment required by the IRS for returns of capital, OLA's return of capital had resulted in an artificially low loss (i.e. less of a loss for tax reporting purposes than with an unadjusted basis). Tax losses have some value in that I can use the loss to offset some of the gains already taken this year, which are close to 10 grand. OLA closed on 3/25 at a 6.24% discount to its net asset value. That would not be sufficient in and of itself to sell my shares. However, combined with the return of capital issue, the poor overall performance, and the benefit of taking the tax loss, there were more than sufficient reasons to sell my entire stake.

I have decided to give ETW another year. If my 1099 for 2010 shows another large return of capital distribution, I will look for my first opportunity to sell all my shares.

4. Bought 100 MHC at $9.8 (see Disclaimer): I have previously bought and discussed two similar type of securities to MHC. For those who read this blog daily, I am referring to MKZ and MKN. Both of those securities are senior notes from Citigroup Funding (guaranteed by Citigroup), maturing in 2014 at their $10 par value, paying the greater of 3% or a percentage increase in the commodity index from the start date of each annual period. The percentage increase, tied to the commodity index, is paid if it is greater than 3% and there is no close in the index about the maximum permissible level provided in the respective prospectuses. It looks like MKN will make it to the closing date of its first annual period (3/30/2010) without the commodity index exceeding its permissible maximum. Bought 100 MKN at 9.85 MKZ vs. MKN Bought 100 MKZ at 9.91 in the Roth IRA Bought 100 MKZ at 9.96

MHC is a similar security except the guarantee is 2% and the floating percentage is tied to the S & P 500. It is important to understand all of the terms of this kind of security. Before I invested in the first one, I read the entire prospectus and studied it until I understood it.


First, you need to know the starting date number for the first year Pricing Supplement The starting number for the S & P is 1050.78 which is computed as of 9/24/2009. So this one is in the money with the S & P over 100 points higher now. The percentage increase since the starting number would be greater than the guarantee of 2%.

Second, you have to understand the reversion. The most unfavorable aspect of this security is that the interest will revert back to 2% for an annual period if the S & P 500 closes at any time in excess of the maximum permissible level. The second unfavorable aspect of MHC is that the maximum is low, just 21%. So, multiply 1.21 x the starting value of 1050.78 and you arrive at the maximum number which is 1,271.44. If the S & P closed one day during the annual period above 1271.44, then there is a reversion back to 2% no matter where the S & P 500 ends at the closing date, which will be 9/24/2010 for the first annual period. This is the pertinent language in the prospectus:

"the percentage change in the closing value of the underlying index from the first index business day of the related coupon period through the last index business day of the coupon period (which we refer to as the index percentage change), if (i) the closing value of the underlying index on every index business day during the coupon period is less than or equal to 121% of the closing value of the underlying index on the first index business day of the coupon period (which we refer to as the starting value) and (ii) the index percentage change is greater than 2%"

Twenty-one percent is too small of a maximum number for the S & P 500. Still, the guarantee is 2%, and I bought the security below its par value of $10. So, assuming Citigroup survives, I know my downside and I may receive a sum greater than 2%, though less than 21%, for one or more years until the note matures on 10/8/2014.

One of the main considerations supporting this small purchase was the fact that my idle cash has been earning nothing in a money market account, and 2% is better than nothing.

I chose MHC for several reasons: (1) it is still within its maximum limit of 21% from the starting value, (2) it still has a cushion to run up without exceeding that limit and (3) the time remaining to the closing date for the first coupon has been cut almost in half from the start date. I would prefer to have the current S & P 500 number with only a month to run but I may not be able to buy it at less than par value if I wait for that possible outcome. If the S & P 500 exceeds the maximum before the closing date, I would not be surprised to see this security to fall some in value. It would also fall with some adverse development in Citigroup's credit risk profile.

I did check FINRA for a couple of Citigroup bonds maturing at about the same time as MHC for comparison purposes:

C.HTX MATURES on 1/15/2015 6.01% Coupon/ Yield at Last Price of 105.67=5.77%
C.GOS Matures on 10/15/2014 5.5% Coupon/ Yield at Last Price of 103.16=5.33%

So maybe I am giving up around 3.5% in a guaranteed yield per year by going with MHC. But, with just one year of 15% to 20% based on the S & P percentage gain, I would be ahead with MHC for the entire term compared to the fixed coupon bonds of comparable maturity.

5. Seven Year Treasury Note Auction: The auction for the 7 year note did not go well yesterday according to those in the know. Maybe if Uncle Sam would pay something to those willing to feed the beast, the auctions would draw more interest. The high yield for the 7 year was 3.374%. I think that it is just great that the government is able to borrow a ton of money (32 Billion) at that rate for seven years. It would just be my opinion, but I am in far better shape financially, with no debt, than the U.S. government with budget deficits growing at trillion plus dollars annually. And, no one is beating down the front door to loan me money for seven years at 3.374%. The coupon for this note is 3.25% and the OID makes up the remainder since the note was sold at a small discount to par value. www.treasurydirect.gov. pdf The longer dated treasuries sold off in response to the auction: WSJ

The head of PIMCO's Treasury and Derivatives trading is worried about the U.S. government's fiscal situation. WSJ The dollar continues to gain strength again both the Euro and the Japanese Yen: FXY: Summary for CurrencyShares Japanese Yen FXE: Summary for Currencyshares Euro Trust Prior to late yesterday, when the deal for Greece was announced, the Euro is starting to look like it has lost the floor that it was standing on a few weeks ago.

6. HealthCare Protesters: The media has been filled with stories of late about how the GOP egged on disruptive protests against the health care legislation. This recent report from CNN refers to GOP House members encouraging protesters in the halls of Congress who were carrying signs saying "If Brown won't stop it, a Browning Will", referring to the former State Senator, male model and driver of a truck, Scott Brown, that Massachusetts sent to the U.S. Senate to serve Ted Kennedy's remaining term.

There was a protest in the House Chamber which became unruly and disruptive. It would be standard practice for the non-partisan police to remove such people. When the protesters resisted and struggled to stay in place, GOP House Members cheered them on. msnbc.com BREAKING: An Ugly Scene msnbc.com: Did the GOP stir up trouble? Tea Party Protests: 'Ni**er,' 'Fa**ot' Shouted at Democrats A number of violent acts and threats have been made against those who voted for the bill.

At least the leader of the TBs is making headway signing a deal with the Discovery Channel for a reality show at 1 million per episode, produced by Mark Burnett of Survivor fame: chicagotribune.com Sarah Palin's TLC Reality Show She has certainly done well for herself after quitting her job as Governor, with the book, speaking engagements and now a TV reality show. Peggy Noonan summarized in her WSJ column an interesting portrait of Sarah during her debate preparation that caused the McCain staffers to hold a conference call about her. Would John Edwards have been better or worse as a VP? It does make the LB wonder about the process of selecting national political leaders.

7. Dividends and Interest: On Monday 3/29/2010, I noted that the following securities will go ex dividend or ex interest with their quarterly distributions: Glimcher Realty (GRT), Glimcher Realty Preferred F (GRTPRF), Kraft (KFT), Lexington Realty Preferred D (LEXPRD), Odyssey Re Preferred stocks A and B (ORHPRA & ORHPRB), Prospect Capital (PSEC), SL Green Preferred C (SLGPRC), Washington Trust (WASH), Wilshire Bancorp (WIBC) and Yamana Gold (AUY).

PJS, a TC with a senior First American bond, will go ex interest for its semi-annual payment.

The Telephone and Date Systems (TDA) bond which was bought this week will go ex interest next Monday for its quarterly payment. Bought 100 TDA at 25.22

GJN, a synthetic floater, will go ex interest for its monthly interest payment. As previously discussed, all synthetic floaters are held in retirement accounts due to tax issues.

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