Wednesday, June 9, 2010

Bought 100 IFO at $9.35-Regular IRA/Sold 50 RNRPRD at 22.05 & Bought 50 REPRB AT 20.78/POM/SWISS FRANC-U.S. DOLLAR/SHORT TERM BOND ETFs

In yesterday's post I mentioned that the average driver here in the SUV Capital could drive an additional 1.3 to 1.5 miles per gallon by making some minor and sensible adjustments to their frequently bizarre driving habits. Driving One of the most bizarre is keeping the peddle to the meddle when it is obvious the vehicle is approaching a red light rather than coasting into a red light. A sub-set species of drivers will actually speed up and pass me as I coast into the red light, for the simple reason that I am not moving fast enough toward the stop.

To be conservative, I am going to postulate that 1 gallon of gas could be saved per day with modest driving changes in our peddle to meddle society for each of the 255 million registered vehicles. (DOT has 255 million passenger vehicles registered in the U.S. as of 2007, Wikipedia) At 255 million gallons per day over a 365 day year, this would translate into about 93 billion gallons of gas over the course of the year. This would save several billion barrels of oil. Those funds could be used to pay down credit cards or to otherwise improve the American consumer's balance sheet. Presto-I have made significant headway in solving two problems.

1. Bought 100 IFO at $9.35 on Tuesday in Regular IRA (See Disclaimer): IFO is a senior note from Citigroup Funding that is guaranteed by Citigroup as provided in the prospectus. This is a "sort of" principal protected note with a $10 par value, as discussed below. Of course, as with all of these securities, I am not principal protected in the event of a Citigroup bankruptcy and am subject to the same credit risk issues as any owner of unsecured and uninsured senior debt issued by Citigroup Funding.

IFO is different than the other Citigroup Funding notes discussed in earlier posts. No distributions are paid by IFO prior to its maturity on 12/3/2012 (closing date). The payment at maturity depends on the closing value of the S & P 500. The note is principal protected provided there is no close (or intraday low) before the closing date below 663.74 on the S & P 500. So, I feel good about that number. The most recent low in the S & P 500, reached near the end of the catastrophic phase of the bear market in March 2009, was 666 which has been unnerving given its connotation. (intraday on 3/6/2009 at 666.79: ^GSPC: Historical Prices for S&P 500 INDEX,RTH)

Now, if there is no close between now and 12/3/2012 below 663.74, I will receive the greater of 12% ($120 for 100 shares) or the percentage change in the S & P 500 over the starting value of 1106.24. If today was 12/3/2012, with the index closing below 1106.24, I would receive the 12% plus the $10 par value per share. The total return (profit and dividend) in that hypothetical would be about $175 on a $945 investment in about 30 or so months. So, if there is no close or intraday trade below 663.74 between now and up to and including the closing date of 12/3/2010, the note is in effect principal protected, assuming Citigroup remains solvent of course. It is not principal protected in the event of a trade below 663.74.

This one has to be studied some to get the hang of it. This is a link to the prospectus: e424b2

LB is of the opinion that IFO makes sense only if you believe that a close in the S & P 500 below 663.74 on any day between now and 12/3/2012 is extremely remote. If there was one such close, and the index thereafter rallied to say 880 by the closing date, then the hypothetical shown in the prospectus shows the final payment to be $8 for this security, which would result in a loss. For IFO to work there needs to be no close below 663.74. Then in that case, assuming Citigroup survives to 12/3/2012, I will receive at a minimum 12% on the $10 par value plus the $10 principal of the note. (for comparison purposes, this is a link to FINRA information on a fixed coupon Citigroup bond maturing in April 2013, yielding at the current price less than 5%).

Since this purchase increases my exposure to Citigroup Funding by $1,000 more than my comfort level, I will have to sell one of the others owned, a list can be found at Item # 2 Principal Protected Notes.

I also have the possibility of some upside to that 12% provided the market recovers and hopefully resumes an upward path. If the S & P 500 closed at 1300 on the closing date, that would mean a 30% distribution on the $10 at maturity or $13 per share. (see table at PS-14). I put this security in a retirement account to avoid any potential tax issue which is discussed at length in the prospectus.

2. Sold 50 RNRPRD at 22.05 and Bought 50 REPRB at 20.78 (See Disclaimer): I would call this exchange a dispersion of risk in the reinsurance industry. After selling RNRPRD, I still own 50 shares of a preferred stock issued by RenaissanceRe, RNRPRB. /Bought 50 RNRPRB at 24.24 I purchased the 50 shares of RNRPRD at 19.58 in early May and received one quarterly dividend payment.

REPRB is a Trust Preferred of Everest RE Capital Trust II, a Delaware Trust. It is a typical TP issue. Trust preferred securities are sold to the public in order to raise funds for this trust to purchase junior bonds issued by Everest Re. The TP represents an undivided beneficial interest in the assets of the trust which consists of these junior bonds with the same terms as the TP issue. The junior bond and the TP both mature on 3/29/2034. The TP's coupon is 6.2% with a $25 par value. Interest may be deferred for up to 5 years with a typical stopper provision. In any deferral period, Everest Re can not pay a dividend on any junior security, which would include its common stock, or to repurchase any junior security. In effect, the stopper provision means that no deferral can occur for as long as Everest Re continues to pay dividends on junior securities. When you think about it for a moment, this makes sense. I am not familiar with a single instance where a company could continue paying a dividend on a junior security while attempting to defer payment on the more senior one.

This is a link to the prospectus: Final Prospectus Supplement The stopper provision is at page S-23.

Payments will be taxable as interest and hence are not qualified dividends. The RenaissanceRe security which was sold to buy REPRB is a preferred stock, a form of equity, whereas the Everest TP is properly viewed as a bond, more senior in the capital structure than any form of equity. The labeling of the security as a Trust Preferred confuses individuals as to the defining characteristic of this type of security. Yes, it is a prefered stock issued by a trust, but that stock represents an interest in the asset of the trust which is a junior bond.Regular Preferred and Trust Preferred Trust Preferred Securities: Links in One Post

The QuantumOnline site shows the Everest RE TP rated at investment grade by both Moody's and S & P. The
FINRA page for this TP shows a Baa1 rating by Moody's, with Fitch at BBB+ and S & P at BBB.

Interest payments are made quarterly with the next ex date on 6/11: Everest RE Capital Trust II The current yield at my cost is around 7.4. Since a TP has a maturity date, I also have a YTM which is around 7.9% using the Morningstar Bond Calculator and plugging in the maturity date of 3/29/34, the 6.2% coupon, the $25 par value and the cost at $20.78. Needless to say when you have a maturity this far out, there is a lot of interest rate risk. But at least this TP has a maturity date which is lacking from the RenaissanceRe equity preferred stock sold yesterday to fund the Everest Re TP purchase.

3. Swiss Franc-USD: I did an exercise last night to see what would be the impact on the Roche ADR, RHHBY, in the event the Roche ordinary shares remained at the closing price on Tuesday of 157.8 CHF but the exchange rate was as of 3/10/2008, when 1 CHF would have bought .9818 USD. I would divide 4 into 157.8 CHF since 1 RHHBY equals .25 of the ordinary shares, which gives me 39.45 CHF. This gives me a U.S. share price of $38.73 using the exchange rate for 3/10/2008. Of course, it works both ways.

Another issue is the impact of currency conversion on the value of the dividend. When the dividend is paid in CHF and then converted into USD, I will receive more when the Swiss Franc is stronger against the USD, buying more dollars, than when the USD has risen in value against the Swiss Franc. So in the example given above, I would receive more in USD for a dividend paid on 3/10/2008 in CHF than now.

4. Recommendation Made by Jack Albin: I saw this story at CNBC. Albin is the Chief Investment Officer of Harris Private Bank. After the S & P 500 broke 5% below its 200 day moving average, Albin said that individual investors need to sell stocks and move into cash and short term bonds. He maintains that some individuals need to reduce stocks by 30%.

There are a number of short term bond ETFs. Ishares has an ETF that invests in 1-3 Year Treasury Bonds (SHY) with a .15% expense ratio. Ishares also has a 1-3 Year Credit Bond Fund (CSJ) ETF, with a .2% expense ratio, that corresponds generally to the investment grade corporate credit sector in the U.S. And, SPDR has similar products. SCPB is their short term corporate bond fund which has a .12% expense ratio. Vanguard has a short term bond ETF, BSV, with a .12% expense ratio. The problem with short term bonds and bond funds, after the two year Jihad by the Federal Reserve against savers, is that their yield is negligible. While they have interest rate risk, it is less than bonds and bond funds with longer maturities. (Impact of Rising Rates on Bond Prices; discussion starting at page 8: _Spring 2010.pdf; SIFMA discussion at Rising Rates and Your Investments). The modest interest rate risk can be avoided by simply purchasing individual bonds (Fidelity discussion at Bond Funds vs. Bonds and FINRA discussion)

I am not adverse to hiding some in short term bonds. I moved a substantial amount into individual short term bonds in 2007, creating a ladder of 1 to 5 years and then sold all but one of those before moving back into stocks in March 2009, as previously discussed in posts from February through April 2009. The yields then were over 5%, however.

5. Cramer on Pepco Holdings (POM) (owned): In his show yesterday, Cramer mentioned that Pepco, with its 7% dividend yield was his favorite electric utility stock now. He also likes the fact, which I previously mentioned, that POM is returning to its core business of distributing electricity. POM did go ex dividend yesterday. I have decided to reinvest my dividends on the shares recently purchased. Bought 100 POM at 15.96


  1. Hedge an equity-based portfolio until credible data on the oil spill is trusted. "Haines bottom" IS in play. Still purchasing some sovereign debt on dips as well as some select technology names...but this thing is generationally bad and getting worse.

  2. Sorry, meant to leave this comment on your 6/10/2010 post in response to your BP comments. BTW, BP will protect through bankruptcy. Now, it's a matter of when.