Saturday, June 26, 2010

Trust Preferred Securities & Financial Reform/Bought 50 AFE and 30 SUSPRA in Roth IRA/Bought 50 CSCO and 30 MSFT/Sold 100 LINE at 25.90

1. Financial Reform and Trust Preferred Stocks: There is a provision in the "financial reform" bill that impacts trust preferred securities. In a prior post, I discussed how these securities are allowed to be treated as Tier 1 capital by the bank, while allowing the bank to deduct the interest payments. Item # 8 Added 50 of ABWPRA These securities are similar to the European hybrids, in that they are part of the bank's capital for regulatory purposes but are in reality bonds. This is part of my earlier discussion about them:

"The Federal Reserve requires several characteristics to be present before it will allow a bank holding company to include TPs as part of Tier 1 capital. One requirement, found in all of the prospectuses that I have examined, is a deferral right for a minimum of five years for distributions. Another is a long maturity, generally 30 years from the date of issuance is deemed to satisfy this requirement. There are other requirements not pertinent to the buyers of these securities. A third is that these securities have to be subordinate to all other debt. These requirements explain the deferral provisions, the low priority, and the long maturity. But, unlike the hybrids issued by the European financial institutions, the American institutions do have maturity dates for their TP securities, and a long one of 30 years is still better than no maturity at all. And, the American government has not come close to announcing, let alone implementing, a burden sharing policy for hybrid owners. Another distinction is that the American TPs do have limits on the period for deferrals, generally five years, and period limits are absent in the European hybrids."

The new financial reform bill prohibits some banks from using trust preferred issues as part of their equity. While I am not going to read this part of the bill, press reports say that TPs issued by banks with less than 15 billion in assets will be grandfathered so that they can continue to count the TPs as part of equity capital.

It is too early for me to form an opinion on what will happen with TPs issued by banks who will no longer be allowed to count their TPs as part of equity. I suspect that these banks may have to raise to equity capital to fill the hole left by the TPs. There is a 5 year transition period. Reuters

I personally never viewed the trust preferred issues as Tier 1 equity capital. Why? For one, the underlying security in the TP is after all a junior bond. In the last analysis, this provision was stuck in the bill because the FDIC Chairman wanted it, and it was an amendment offered by the republican Maine senator, Susan Collins, whose vote was needed to overcome the usual GOP filibuster.

The next question is what happens to the existing TPs? I will be interested in reading other people's opinions on this issue in the coming days, assuming this legislation passes. One option would be to just leave the TPs alone. Another would be use the proceeds from the new equity issuances to redeem the TPs. If that option is followed, and I do not have an opinion on its likelihood now, this could cause an early redemption at par value plus accrued interest, thereby creating a potential profit opportunity for those selling now at a discount and a possible loss of any bought at a premium to par. A third option might be to dissolve the trusts and then distribute the underlying bonds to the TP owners. A fourth option would be to offer an incentive for the TP owners to convert into common shares. I am just thinking out loud.

(For a subsequent discussion on how this legislation influenced a decision to sell a common stock of a bank with a large amount of TPs, and who has not yet paid back Tarp, see Item Item # 1 Sold KEY at 8.12/Sold 100 RHHBY at $36.2/NVS/More Evidence of a Slowdown/Sold 50 of 150 DKK)

1. Sold 100 Linn Energy (LINE) at 25.9 Friday (see Disclaimer): This netted close to a $1000 profit. I discussed buying some shares at $15.31 in April 2009. One reason behind this sell was to book a long term capital gain in 2010. 

2010 LINE 100 Shares +$971.97
I am also tired of the tax headache associated with these publicly traded limited partnerships. Lastly, I heard Cramer express some reservation about LINE as its hedges expire into 2011 and with the depressed state of natural gas prices possibly continuing. TheStreet I did not even want to make an effort to address that issue.

2. Bought in Roth IRA 50 AFE at 23.17 and 30 SUSPRA at 25.10 (see Disclaimer) AFE is a senior bond issue from American Financial Group Inc (AFG). I previously purchased this bond in a taxable account and discussed it in an earlier post. Bought 50 AFE at 22.87 Par value is $25. The bond matures on 2/3/2034. The coupon is 7.125%. At a total cost of $23.17, the current yield is around 7.69% with a YTM of about 8.09%. The bond is callable now. This is a link to the prospectus: American Financial Group, Inc. And this is the link to the Reuters profile page and to the analyst estimates for the issuer, AFG: Analyst Estimates for American Financial Group, Inc.. The bond is rated as investment grade according to QuantumOnline and FINRA, currently at Baa2 by Moody's and BBB by S & P.

SUSPRA is a trust preferred security issued by a delaware trust created by Susquehanna Bancshares Inc, (SUSQ) for the purpose of selling preferred shares in the trust to the public. The proceeds were then used by the trust to purchase a junior bond from SUSQ. The TP represents a beneficial, undivided interest in the bonds owned by the trust. The yield on this one is high due to its junk rating. At a total cost of $25.10, the current yield is around 9.37%. I bought 30 shares for one reason. I did not have sufficient funds left in the ROTH to buy 50 shares which would be my maximum exposure to this security. There are several reasons for the maximum limit. The most important are the junk rating of this security, the permissible time period for deferral of interest payments, and its maturity date (if extended as far as 2087) .

Unlike most TPs, which permit interest to be deferred for up to 5 years, interest may be deferred for up to ten years (40 quarters) for SUSPRA, but distributions are cumulative. After 20 quarters of deferral, an alternative payment mechanism is triggered. (see S-11: Final Prospectus Supplement) That provision is found in several junior bond type issues, and I discussed it some in a prior post in connection with an Aegon hybrid.

Interest payments may not be deferred as long as SUSQ continues to pay a common stock dividend or dividends on outstanding equity preferred stock. Although Susquehanna has redeemed some of the government's preferred stock, there are still shares outstanding. The bond contained in the TP SUSPRA would be senior to the government's equity preferred stock. In order for SUSQ to defer payments to the TP owners, it would have to defer paying the government its dividend, as well as eliminate the common stock dividend. This is call the stopper clause, found at page S-5.

This TP has a fixed coupon of 9.375% until 12/12/2037 and then this security becomes a floater. The float is 5.455% above 3 month Libor. The TP may be redeemed on or after 12/12/2012. The provisions for the extensions of the maturity date beyond 2057 are too complicated to discuss and are irrelevant to me anyway. I would expect this security to be called before 2037 given the high coupon provided SUSQ recovers and is able to refinance the security at a lower rate. The current credit ratings for this TP are Ba2 by Moody's and BB- by S & P.

I would add that SUSQ had, as of 3/31/2010, 13.779 billion in assets. Form 10-Q

I own 50 shares of the common in Category 1 of the Regional Bank Stocks basket strategy. That category is reserved for the more speculative names. SUSQ is on the borderline of being promoted to Category 2 based on recent earnings reports: Item # 7 SUSQ ; Item # 2 SUSQ The common shares were purchased at $5.85.

I own one TP with a lower credit rating in the ROTH, ZBPRB, which was bought at $19.9. The discussion in that post goes into detail about why that security is senior to the equity preferred stock issued to the government by Zions. The current yield at $19.9 price paid for ZBPRB is around 10%.

3. Bought 50 Cisco (CSCO) at $22.45 and 30 Microsoft (MSFT) at $24.54 (Large Cap Valuation Strategy-A New Long Term Strategy) (See Disclaimer) LB is not a wimp or a girlie man as the Lame Brain RB is fond of saying. To prove that point, and to demonstrate that the LB knows no fear, and is a risk taker known for its daring worldwide, LB bought 30 shares of Microsoft and 50 shares of Cisco last Friday.

RB could not maintain its silence any longer, saying, "Yea, the LB swings a really big you know what." RB added for good measure the remarks made in an earlier post: "Calling the LB a girlie man is an insult to girlie men worldwide, girlie man does not quite capture the essence of the LB. RB believes the LB has no Weenie at all, certainly no apparatus attached to the weenie, need the RB say more. Possibly, the RB is being too harsh, engaging in hyperbole about that weenie, if HK brought in an electron microscope to take a hard look at LB on high resolution, you know, take a look down there, something of a man nature might be detected under the highest resolution possible, RB would not totally rule that out, RB added in closing."

Not worth a response, the LB muttered. The large cap tech stocks do present interesting long term opportunities at their current valuations. IBM is one as argued by Bill Miller in this interview published at Morningstar. Microsoft and Cisco may present similar opportunities.

My last transaction on Microsoft was to sell my shares at $28.11, which had been bought at $17.99. I decided to re-enter that position with just a 30 share buy, given the current environment, after reading this summary of a Pacific Crest report at The report focuses on the accelerating enterprise sales of Windows 7. While I would acknowledge that it is difficult to teach an elephant to dance, the current price of MSFT is around 10.6 times the $2.31 consensus estimate for the fiscal year ending in June 2011. MSFT: Analyst Estimates for Microsoft Corporation MSFT has a cash hoard, a AAA debt rating, and prodigious cash flow of close to 1 billion dollars per month. It pays a dividend which is close to 2% at the current price.

CSCO is another tech titan that has fallen since the market topped out in April, falling to $22.18 at the close yesterday from $27.53 on 4/29/10: CSCO: Historical Prices for Cisco Systems, Inc. The current consensus estimate is for an E.P.S. of $1.79 in the fiscal year ending in July 2011, putting the forward P/E at around 12.39 at Friday's closing price. CSCO has close to 40 billion in cash, about $6.85 per share: CSCO: Balance Sheet for Cisco Systems, Inc. Free cash flow has converted over 20% of revenue into free cash flow over each of the past eight years. The estimated 5 year P.E.G. ratio is near 1: CSCO: Key Statistics for Cisco Systems

I last discussed Cisco briefly when making a 30 share purchase at $15.82 in January 2009.

Even the LB will admit that it is not much of a tech investor. Generally, I will stick to large cap tech purchases and then only when I believe the valuation is in my favor and my positions will be small. My only other position is Intel: Bought Intel at $15.87 Bought Intel at 15.25 Added to Intel at $19.08 Bought INTC at 14.46. I was reinvesting the Intel dividend, which is around 3% at the current price, but ceased to do that a few weeks ago.

I did change my distribution option on KO shares to reinvest the dividend.

No comments:

Post a Comment