Tuesday, July 20, 2010

More on the Call Warrant in TCs/Baltic Dry Index/Intel/Bought 50 CNBKA at 20.53/Added 50 FNB at 7.8/Bought 2500 CAD

LB is not entirely satisfied with the strike settlement with Headknocker and has been mulling going back on strike again, unless HK disavows some of the more scurrilous remarks made about the Stock Stud by the Lame Brain, Nit Wit RB. Most of those remarks can not be repeated in a family publication but some of the more offensive comments include "girlie man " and "mama's boy". Out of nowhere, a defiant voice was heard to say, "LB is a Prima donna and a Showboat with an abundance of ego issues".

Headknocker could only apologize for the impolitic remarks of the RB and remind all that HK disavows any comment made by the RB, apologizes for all remarks in advance, particularly those that are politically incorrect.

1. Baltic Dry Index: This index tracks worldwide shipping prices of dry goods. After hitting a recent high over 4200 in May 2010, this index has fallen off a cliff and is currently hovering close to 1700, indicating substantial weakness in shipping prices for dry goods. BDIY: BALTIC DRY INDEX Summary - Bloomberg This is troubling. The index has not been this low since February 2009. BDIY: 5 yr Chart This falloff may indicate a decline in demand. China's imports of iron ore were down about 9.1% in June. Another factor may be the addition of a significant number of new vessels. This kind of imbalance in supply could cause shipping rates to fall with the decline accelerating when there is simultaneously some decline in demand. This is the gist of what is happening as explained in this Bloomberg article. Total bulk fleet capacity is estimated to grow 16% this year, twice as fast as demand.

2. Call Warrant Holder and Trust Certificates: There is one unique disadvantage to buying trust certificates that was brought home to me recently when the owner of the call warrant for the TC XFL exercised that warrant and redeemed that security at the $25 par value plus accrued interest. Alert on Verizon TC XFL

For trust certificates, the owner of the call warrant is most likely to be the original creator of the grantor trust who had bought the bonds and then transferred ownership of them to the trust. The call warrant allows its owner to buy back the bonds deposited into the trust at par value plus accrued interest. This is separate and distinct from the right reserved to the issuer of the bonds to call them for redemption. Verizon did not call the bond that was the underlying security in the TC XFL. Instead, it was the owner of the call warrant. And it made sense for the call warrant owner to exercise the call, since the underlying bonds in XFL were selling a significant premium to par value.

I discussed why the existence of a call warrant is disadvantageous to the TC owner in Call Warrants and Trust Certificates. I wanted to quote from some of that post since some of the points need to be kept in mind particularly now when a number of TCs are selling at prices in excess of their par values:

"First, the mere existence of the call warrant will place a lid on a "premium" price of the TC in certain contexts. If the TC and the underlying bond have roughly the same coupon, and the underlying bond is selling at a significant premium to par value, a rational market for the TC would still have the TC priced at a much lower premium to its par value, around par value plus accrued interest. So when the investor is considering the possibility of paying a premium for a TC, the percentage premium of the underlying bond and the existence of the call warrant need to be assessed, which will restrain me from buying at much of a premium in those type of cases. I always check the Finra data on the underlying bond before placing an order for a TC: LINKS TO FINRA INFORMATION ON UNDERLYING BONDS IN TRUST CERTIFICATES

Second, even in a long term bull market for bonds, where the underlying bonds accelerate to substantial premiums on their par value, the price of the TCs may stall at a much smaller premium. I would consider the potential profit restraint on the shares when making an investment."

An example of one that I own that is in danger of being redeemed by the call warrant holder is PJL which contains the same VZ bond as XFL did, and that bond is currently selling at over a 25% premium to its par value. At $26 PJL is selling at about a 4% premium to par value. It would not be rational for it to sell at much more than its $25 par value plus accrued interest given the presence of the call warrant which could be exercised at any time and it would be advantageous now for the owner of that warrant to exercise given the value of the underlying bonds in PJL.

When I started to buy TCs in late summer and early fall of 2008, I did not have to be concerned with this issue. The TCs that I was buying back then were selling at substantial discounts to their par values and were in many cases providing yield advantages in the 3% to 5% range to the comparable yields of their respective underlying securities. And, the underlying securities were being mauled, even investment grade issues, as spreads to U.S. treasuries with comparable maturities widened to historic levels. Now, the call warrant issue is front and center for several of the TCs where the underlying security is selling at significant premiums to par value. In those cases particularly, the call warrant issue has to be kept in mind by a purchaser of a TC at a price in excess of par value plus accrued interest on the TC.

I wanted to emphasize this issue again since another call warrant has recently been exercised by its owner.

The owner of the Call Warrant redeemed 15 million dollars of the TC GJB on 7/15/2010 at the $25 par value plus accrued interest. This TC has never been owned. The underlying security in GJB is a senior Boeing bond, maturing in 2038, with a 6.625% coupon. www.sec.gov GJB has a lower coupon at 6%. The underlying bond in GJB is trading at more than a 20% premium to its par value. FINRA It would be profitable for the owner of the call warrant to exercise it, pay par value to the owners of GJB, and then resell the bonds so redeemed at close to a 20% profit in the bond market.

3. Eric Savitz Bullish on Tech: Eric wrote in his Technology Trader column for Barrons.com that Intel and other tech titans are cheap at current price levels. After Intel reported its best quarter ever and made a better than expected forecast for the September quarter, the stock rallied and then pulled back on 7/14 on heavy volume, finishing that day up just 35 cents from Tuesday's close of $21.01 and had a small 15 cent gain last Thursday before losing all of the post earnings gains on Friday. The current consensus estimate is for earnings of $2.06 in 2010 and $2.13 in 2011. INTC: Analyst Estimates for Intel Corporation The high estimate for 2011 is $2.42 and the low is at $1.59.

One of the financial gurus commented that Intel has lost 80% of its value since the Nasdaq bubble burst in 2000. Intel did hit a high of $75.81 in 2000, a year that it earned $1.51. In 2001, earnings slid to about 19 cents and the stock declined to a low of $19. Thereafter, earnings recovered and accelerated back to $1.40 by 2005, and then started to meander in a range between $.77 to $ 1.18. The time to own Intel as a growth investor was from the early 1980s to 2000, as Intel grew into a mega cap company riding the super cycle of home computers. Those days are over. Now, Intel has be evaluated using the metrics of a value investor and one of those criteria is an earth bound P/E ratio. So, Intel was not worth anything close to $76 in 2000 based on peak earnings. At most, I would have applied a 15 multiple to $1.51 as the maximum fair price and a 12 P/E for determining a low price. This would give me a range of $18.12 to $22.65. Now, if I had bought shares in that range in 2000, I would not have made much money by holding the shares until today, but I would not have lost either compared to those investors who bought at $40, or $50 or $70. The mere fact that Intel has lost about 72% of its peak price in 2000 has no relevance in assessing the fair price now, and simply highlights the inability of investors to place an appropriate price on the shares then and now.

Over the past ten years, Intel has been increasing its dividend, another metric for a value investor such as myself. The current dividend yield for Intel is higher than the yield of the 10 year treasury note.

And, Intel has maintained its technological lead and expanded its product line, and it operates in a sector that is essential rather than discretionary. Still, given Intel's size and uneven, up and down earnings as a mature company, I would still place the reasonable range at 12 to 15 times earnings. One way to do that is with normalized earnings. For Intel I prefer to use the forward consensus estimate, possibly discounting that earnings estimate if I believe the earnings cycle has peaked. I do not think the current cycle has peaked but I suspect it is just beginning. This does not mean 20% compounded growth rates for Intel but more in the neighborhood of 8% to 15% annualized over the next five years.

The 2011 estimate is $2.13 so that gives me a range of $25.56 to $31.95. Since most of my shares were acquired between $14.46 and $15.87, I am standing pat based on this estimate of a reasonable valuation range. As mentioned in a prior post, this estimated valuation range would require me to seriously considering selling shares if and when INTC crossed $30, unless there was some new information that required a fundamental change in the valuation range. Item # 1 INTC

4. Miscellaneous: The Rivus Bond Fund (BDF), a CEF, declared its quarterly dividend of 28.75 cents with an ex dividend of 7/26. Bought 100 BDF at 17.2 Added 100 BDF in the Roth at 17.1 This one is subject to one of my automatic sell triggers when and if the 10 year treasury bond yield rises to over 4%. Otherwise, it is one of the recently added bond funds that will hopefully be a buffer in a low inflation to deflation economic scenario. Ultimately, no human knows what will happen next.

I mentioned in a post from yesterday that I sold 303 shares of EBI as it popped close to 14%. Sold 303 shares of the CEF EVERGREEN INTERNATIONAL BALANCED INCOME FUND at $15.05 I used part of the proceeds to buy 2500 Canadian dollars yesterday morning to replenish my CAD position which was almost exhausted after the recent buy of 200 CLF:TO AT 20.20 CAD. ( Claymore 1-5 Yr Laddered Government Bond ETF - CLF)

PFK, the CPI floater issued by Prudential, declared its monthly interest payment which goes ex on 7/28 at .0967. WSJ (info at WSJ dividend page changes daily) I expect this rate to start to decline for the same reasons discussed in connection with OSM. Both OSM and PFK use the same formula except PFK has a 2.4% spread.

A article in this Barron's recommends five bond ETFs to provide balance to investor's portfolios. Of those ETFs recommended, I own only BAB, a relatively new ETF that invests in taxable municipal bonds under the Build America Bond program. It is virtually impossible for me to accept the low yields of the other bond ETFs mentioned in that article. BND, the total bond index ETF from Vanguard, has a current SEC yield of just 2.97% as of 7/16/2010: Vanguard - Total Bond Market ETF As existing bonds mature in the current rate environment, I would expect new purchases to lower the yield further. I will start to eat spinach before investing in a bond fund with that kind of yield. For BND: Is it Safe is not the Right Question. Instead Ask What are the Risks & Rewards/Assume Lost of Principal Possible The meager yield offered by these bond funds provide virtually no compensation at all for interest rate risk. Notwithstanding what anyone says, moreover, I am going to avoid GSE debt which is part of some of the bond ETFs recommended in this article including one devoted to agency securities (e.g. Fannie and Freddie). iShares Barclays Agency Bond Fund (AGZ): Overview - iShares

5. Added 50 FNB at $7.8 ( Regional Bank Stocks basket strategy)(see Disclaimer): This purchase brings me to 150 shares and I changed my distribution option to reinvestment with this purchase. This last buy was my last average down on FNB, with the prior purchases at 9.36 and 8.42. This may work out long term provided FNB does not cut the dividend which is a possibility. The current annual rate is 48 cents which translates into a 6.15% yield at a total cost of $7.8. The bank has already redeemed the government's preferred stock with the proceeds of a stock sale.

6. Bought 50 Century Bancorp at 20.53 (CNBKA)(Regional Bank Stocks basket strategy)(see Disclaimer): I sold 50 shares of Wainwright (WAIN) after it popped 100% on a cash buyout. WAIN was a small bank based in Boston and I have been looking for a replacement. I decided to go with Century Bancorp which has several branches in Boston and in several nearby counties in Massuchusetts. This is a link to a map of the bank's 23 branch locations: Century Bank - About Century Bank - ATM/Branch Locations

Century has already reported earnings for the 2nd quarter. SEC Filed Press Release Net income was 2.9621 million or 54 cents per share, up from 36 cents in the 2nd quarter of 2009. Tangible book value is $25.25 so my shares yesterday were bought at a 18.7% discount to tangible book value. Total assets increased by 7.3% in the first six months of 2010.

The bank did not participate in TARP. Its capital levels exceed levels for banks deemed to be well capitalized. As of 6/30/2010, the total risk weighted capital ratio was 15.68%; the tier 1 risk weighted capital ratio was 14.47% and the leverage ratio was 7.23%. The net interest margin, however, is below average at 2.62%. Tangible capital to tangible assets ratio was 5.78%. Allowance for loan losses to total loans was 1.65%.

The bank also announced the reauthorization of its stock purchase program. This authorization permits the purchase of up to 300,000 of the Class A shares or 9% of the total. Press Release

The dividend is currently 12 cents per quarter which equates to a 2.33% yield at a total cost of $20.53.

This is a thinly traded stock. When I placed a limit order to buy 50 yesterday, the ask price was $20.53. That was satisfactory to me so I placed a limit order at that price. I quit placing market orders for these thinly traded securities to cut down on bad fills.

Part of this banks equity capital involves a trust preferred issue of 29.639 million maturing in 2029 with a 8.3% coupon. (e10vk at page 61). There is another TP that pays 6.65% until 12/2014 and then 1.87% over 3 month LIBOR with a 2034 maturity date ( page 62). Given the small size of this bank, less than 15 billion in assets, the TP can still count as Tier 1 capital. While the regulatory authority will still consider existing TPs to be TIER 1 capital for banks with less than 15 billion in assets, I do not personally regard a bond as equivalent to equity.

Overall, this bank's stock faired well during the Near Depression period. It has lost only about 2 bucks of its share price from October 2007: Century Bancorp, Inc. Share Price Chart | CNBKA

Only 1 analyst has an earnings estimate. That estimate is for an E.P.S. of $2.28 in 2010 and $2.42 in 2011.

I think this buy brings the regional bank basket to 40 names.

I bought a BDC, viewed as an undesirable asset class with currently difficult to resist dividend yields, on Monday which I will discuss in the next post.

LB is tired, and really tired of working 24/7 with no pay from Headknocker. Wasn't the sweat shop outlawed?


  1. I live down the street from a Century Bank branch and pass their swanky headquarters all the time. Century Bank is a special situation, and not in a good way. It is controlled by a local family through their ownership of a special class of stock, and the bank is run for the benefit of the family and their cronies, not the benefit of shareholders or customers. See for example this filing. Obviously, you should do your own research, but I would advise you to sell. There are plenty of other small Boston-area banks, and nearly any of them is a better bet.

  2. Events Calender: I reviewed the 2005 letter from Sy Jacobs that you reference, and found a few of the comments interesting.

    One of his comments involves an attack on the bank's caution in making commercial real estate loans, which have decimated so many banks since 2007. According to Jacobs, one of the major failings of Century's management was "The choice to deemphasize commercial real estate lending in recent years because management erroneously believed the real estate market to be overheated". That decision probably kept the bank from losing much value in 2008-2009.

    I would think the shareholders of Zions, Synovus, MI, Regions, and countless other banks who lost tens of billions on commercial real estate loans due to what was clearly- beyond question- an overheated market may have preferred the management at Century to their own swashbucklers. Fortunately, the bank apparently did not follow the recommendations of Mr. Jacobs. I had a different take away than you of this letter. I viewed it as hyperbole and self-serving garbage.

    I would be more concerned about the swanky headquarters. I may take a look on google.

    I was aware of the two classes of stock. The family that you mention controls the Class B which receives a 6 cent per share quarterly dividend. I own the Class A which is paid a 12 cent quarterly dividend.

    I did not seek anything in the last 10-Q that suggests that the insiders receive out of the ordinary compensation as officers and directors of this size of a bank. Perhaps, you can be more specific about how the bank is operated for the benefit of the family and friends.

    I did well in a short period with Wainwright, another small bank from Boston, doubling my money in a month or so.