Sunday, July 18, 2010

Sold 100 of the 300 OSM at 16.87/Sold BACPRW at 23.55/WBS BAC GE/CPI/Bought 100 of the CEF HPI at 17.76/Bought 40 TOBC at 21.35

With a significant fall in consumer confidence in July, as measured by the Thomson Reuters/University of Michigan survey (Bloomberg), the decline in CPI for June, and the lackluster loan growth shown in the recent quarterly reports from money center banks, fears of deflation returned with a vengeance last Friday. While contributing to a dive in stock prices, treasury bonds rallied with the 10 year note rising in price and falling in yield to 2.927%. The 30 year bond closed Friday at a 3.94% yield. The 2 year treasury note matching its historic low of .569% intra-day on Friday before closing at .589%. So far the intermediate term investment grade corporate bond ETFs LQD and VCIT have been rising in price and falling in yield too. This article at TheStreet mentions several ETFs for a deflationary scenario. I still believe, however, that inflation is the more likely scenario over the long term but inflation does not yet appear to be an emerging concern which explains the recent favorable price action in the bond ETFs.

1. Webster Financial (WBS)(owned): Webster reported better than expected earnings for the 2nd quarter, earning 15 cents per share. This was 8 cents better than the consensus estimate. Past due loans declined by 17% in the last quarter. Net interest margin was 3.27%. Book value was $19.75 per share and tangible book at $12.79. As of 6/30/2010, the tangible common equity ratio was 5.79%; the tier 1 risk-based capital ratio was 12.85%; the total-risk based capital ratio was 14.72%; and the Tier 1 common equity to risk weighted assets was 8.12%.

My main problem with WBS is that I have an unrealized long term capital gain in the shares bought at $4.58 in March 2009. Items 7 & 8 Buy of 50 WBS: Lottery Ticket The percentage gain is over 300%. Another problem is that bank is paying only a 1 cent per share quarterly dividend. On the other hand, WBS does have long term recovery potential. With a recovery over a long period of time, the bank will hopefully gradually restore its dividend to pre-Near Depression levels. Assuming the bank ultimately does increase the dividend back to 2007 levels, the yield at my constant cost of $4.58 would be over 25% per annum. { Rationale for the Regional Bank Stock Strategy; Item # 1 More on Regional Bank Strategy} So, I am conflicted about what to do with WBS. For the time being, I am going to leave it alone.

2. General Electric (owned): I have been accumulating shares in GE since the summer of 2008. I currently have close to 450 shares bought in 30 to 50 share lots between $10 and $16. I am also reinvesting the dividend. It does not appear that there will be any near term catalysts to drive the price over $16 with any long term staying power.

The Achilles heel of GE since the onset of the Near Depression has been GE Capital, who had the peddle to the meddle as the world's economy entered into the most serious credit crisis since the Great Depression. Possibly GE Capital has finally turned the corner, after shrinking its capital base, with pre-tax profits at this financial unit improving to 741 million. The profit after taxes from GE Capital was higher at 830 million

GE reported 3.11 billion in earnings for the quarter, or 28 cents per share, up from 25 cents in the 2009 linked quarter. E.P.S. from continuing operations was 30 cents. Orders for industrial equipment increased 17%. Industrial sales, however, were down 6% from the 2nd quarter in 2009. Overall, revenues fell 4.3% to 37.44 billion.

3. CPI: On a seasonally adjusted basis, CPI fell .1% in June, while the core CPI rose .2%. Consumer Price Index Summary A 2.9% drop in energy prices accounted for all of the decline in the CPI. Owner Equivalent Rent ( the fictional number calculated by the government of what homeowners would pay themselves if they rented their homes) appears to have stabilized and is starting to turn up. If that trend continues, this will start to push the core CPI up. (see Brian Westbury discussion at

Over the past 12 months CPI has increased 1.1% on a non-seasonally adjusted basis, down from 2% in May. This year-over-year number declined significantly from May due to the replacement of a positive .7 number from June 2009 with the negative June 2010 reading. Bureau of Labor Statistics Data This decline will have an impact on the penny rates for OSM and PFK. The non-seasonally adjusted CPI number for June used in those payment calculations is 217.965: For more information on how PFK and OSM calculate their monthly interest payments, see Item # 1 CPI. I can now calculate the October 2010 penny rate for OSM which will be $.0627. This number will be declining some starting in October. I calculated the September payment to be $.0854. The payment for July was $.0886.

4. Sold 100 OSM at $16.87 in Regular IRA (see Disclaimer): This security is barely appropriate for my Roth and regular IRAs due to the credit risk. Since those accounts are focused on current income generation, and it looks like the penny rate for OSM is starting to trend down again, the OG decided to sell the 100 shares recently bought about 1 month ago at 15.75 in the Regular IRA. The OG was proud of that percentage gain on the shares plus two interest payments, and looked around for other members of the staff here at HQ to give him the high five. The OG's hand was raised for about a minute before he realized that none of the other staff members were going to reciprocate. Of course, the OG is developing a case of the shakes again.

While I have been trading OSM in the IRAs my position in the taxable account has been kept constant at 200 shares. In May 2010, I increased the holdings in a taxable account to 200 shares by buying 50 at at 15.74. Since I am willing to take more risk in the taxable accounts, I have no intention of selling those 200 shares until I develop a rational concern about SLM surviving until March 2017, when the note matures.

I have also bought and sold ISM in the regular IRA, another CPI floater from SLM. Bought 50 ISM in IRA at $11.85 I am more reluctant to buy ISM because it matures after OSM, and that difference may become material at some point (ISM prospectus:; OSM prospectus:

Since I view Prudential to be a more solid credit, I am keeping PFK, its exchange traded CPI floater, in the IRA even though it is trading close to par value and I have a good unrealized gain. Bought PFK at 18.94 in IRA Added 50 PFK at $17.83 in Roth IRA Added 50 PFK in Roth at 20.88-Averaged UP I started talking about PFK when it was trading around $12. ITEM # 3 CPI & CPI Floaters Item # 1 CPI and CPI Floaters OSM and PFKPar value is $25 and this senior note matures in 2018. (see also: Comparing Prudential Floating Rate Bonds Tied to CPI and Fixed Rate Coupon Bonds Maturing in 2018)

5. Bank of America (own TPs, senior notes and common stock): Bank of America reported profits of 3.1 billion or 27 cents per share, as loan losses ebbed and BAC booked a series of one time gains. The forecast was for 22 cents. Net charge-offs decreased 1.2 billion from the 1st quarter. Provisions for credit losses fell 1.7 billion from the 1st quarter. Trading profits fell to 1.2 billion from 5 billion in the 1st quarter. The Countrywide unit turned in a loss of 1.5 billion as it had to buy back 802 million in mortgages originally sold to the bankrupt Fannie and Freddie, due to faulty underwriting. And I would not expect that any of those loans are performing. Another problem is the decline in total loans. BAC's total loans fell 2% in the 2nd quarter compared to the 1st quarter.

The net income number for BAC was almost entirely due to the release of loan losses, which results in an an accounting increase in income, and a 1.2 billion dollar net gain from the sale of BAC's shares in Sanatander Mexico, Mastercard and Itau Unibanco. I did not care for the results and neither did the market. BAC common fell on Friday $1.41 to $13.98, a 9.16% decline which is huge for a company this size.

As of 6/30, the total capital ratio was 14.77% and the Tier 1 common ratio was 8.01%.

BAC said that the new financial reform legislation could reduce revenues at its Global Card Services unit by $1.8 to $2.3 billion by 2011, due to potential limits on debit interchange fees. This is due to the Durbin Amendment in the new legislation that grants to the FED the power set interchange fees for debit cards, possibly wiping out much of this highly profitable business. NYT BAC estimated that this legislation will cost it about 5 billion dollars in annual revenue from consumer banking by 2011. It intends to take a goodwill charge as soon as Obama signs the legislation.

As pointed out in the NYT article, when Australia passed limits on interchange fees, consumers lost out as the banks raised annual fees for the cards and reduced rewards. While Durbin claims that the purpose of this Amendment is to help consumers, the only beneficiaries are large retailers who pay the interchange fees. Interestingly, this amendment was not supported by 11 Democrats and managed to pass only with the support of 17 Republicans who apparently are for price controls when they benefit some of their big donors.

6. Sold 50 BACPRW at 23.55 in IRA (see disclaimer): I will limit my exposure to one company to no more than $10,000. This is one of LB's bevy of rules. Exceptions are allowed for only short periods of time. With the BAC TPs, the recent acquired principal protected notes and the BAC common, I have been over that limit for a few weeks. By selling BACPRW and 100 of the 200 shares of SFH (Bought 200 SFH at 10.18), I bring myself back into compliance with this capital preservation rule with a thousand or so to spare. So I may buy another BAC TP provided there is a decline and I can buy 50 shares for less than a $1000.

I made a small profit on the BACPRW plus one quarterly interest payment. Bought 50 BACPRW at 22.62 in the ROTH For Bank of America, this leaves me with my BAC common shares, five senior notes from either Merrill or BAC tied to indexes (LMZ, SFH, SDA, SJV & PGEB-roughly $5,000 in those), and the TPs KRBPRE and CPP (close to $2500).

Another reason for the sells of OSM and BACPRW was to build up enough cash so that I can take advantage of any opportunity which may arise in the coming days or weeks. The retirement accounts did well on Friday, down less than $100.

Lastly, I did not like the earnings report which was probably the precipitating factor in bringing me back into compliance with this $10,000 limit rule. That limit requires the aggregation of all securities (common, preferred stock, junior bonds or trust preferred, and senior bonds).

7. Bought 100 of the CEF HPI at 17.76 (see disclaimer): HPI is the symbol for the CEF John Hancock Preferred Income Fund. While this fund calls itself a preferred fund, it owns mostly junior bonds. Some of the bonds are what I would label hybrid securities. This would include European hybrids and U.S. trust preferred stocks, and both of those types are securities are in essence junior bonds masquerading as bank equity for regulatory purposes. The status of the trust preferred issues for U.S. financial institutions is about to change in a major way, as banks with over 15 billion in assets as of 12/31/2009 will no longer be able to count TPs as part of TIER 1 equity capital with a five year phase in period. (see recent discussion in Item # 1 Sold KEY at 8.12; and earlier discussion in Trust Preferred Securities & Financial Reform) The fund also holds some senior bonds and one traditional preferred stock issued by a reinsurance company.

The John Hancock CEFs can be found at John Hancock Funds - Closed-End Funds - Daily Prices. This is a link to the sponsor's web page for HPI: John Hancock Funds - Preferred Income Fund (HPI) - Overview

Distributions are paid monthly which was one of the reasons for buying some shares on Friday. The current rate is $.124, a reduction from $.155 in early 2009. Preferred Income Fund - Historical Distributions With interest rates trending down, it is not usual to see reductions in payouts from funds that wish to avoid return of capital distributions which are illusory dividends.

The yield at a total cost is about 8.38%.

The last SEC filed quarterly report for the period ending in April 2010 can be accessed at

This fund uses leverage which is helping it now given the low short term rates. The borrowings are tied to 3 month LIBOR so I will consider selling this position when that short rate rises above 1% and even more serious consideration at over 1 1/2%.

I am familiar with virtually all of the securities in HPI's portfolio since they are traded on the stock exchange. For the most part, these securities are perpetual (e.g. European Hybrids) or are long term bonds, both subject in my opinion to a ton of interest rate risk. That is another reason to have a predetermined trigger for selling HPI. You do not want to own a leveraged bond fund owning long term obligations in a rapidly rising rate environment!!! For now, I am just trying to add to my cash flow with these kind of buys (e.g. BDF, HSF, BAB, PGX, WIW, IMF), and I am taking a chance on some of these bond funds given the lack of viable alternatives for yield at the current time.

As of Friday July 16, 2010, the NAV for HPI was $19.13 and the discount to NAV based on Friday's closing price was 7.16%.

8. Bought 40 Tower (TOBC) at $21.35 (Regional Bank Stocks basket strategy)(see disclaimer): Friday was a bad day for the money center banks and my regional bank stock basket. I believe that the financial reform legislation will have a more deleterious impact on money center banks than the medium and small regional banks that are part of my long term (5 to 10 years) basket strategy. I noticed late in the day that Tower Bancorp had fallen almost 5% on no news specific to it. It was near the top of my monitor list. Since the Old Geezer forgot why it was near the top, and the market was about to close for the day, I only bought 40 shares to keep my exposure to less than $1000, at least until the LB can remind the OG why it was near the top of the monitor list.

Tower is headquartered in Harrisburg, Pennsylvania and has 27 banking offices, mostly in Franklin and Fulton counties in Pennsylvania, with some locations in Washington County Maryland. Your Tower Bank The market cap at the current price is around 152 million. I was somewhat intrigued by the consensus estimate from 3 analysts of $1.62 in 2010 and $2.42 in 2011. This would put the P/E at 8.82 times the 2011 estimate with a growth rate from 2010 to 2011 at 49%. TOBC: Analyst Estimates for Tower Bancorp Apparently the market does not buy into those estimates since the bank came close on Friday of hitting a 52 week low. The five year chart shows a stock selling at over $45 in 2004 and 2005, then starting a decline in July 2007 at around $45 that took the stock to $19 in March 2009. Chart The stock then rallied to over $37 by July 2009 before falling again. Since November 2009, the stock has been moving mostly in a $20 to $25 channel and is currently below its 200 day moving average.

The bank earned 27 cents in the 1st quarter. Form 10-Q I did not see any government preferred stock on its balance sheet. The capital ratios as of 3/31/2010 were well in excess of the levels for well capitalized banks (page 39). The allowance for credit losses as a percentage of nonperforming loans was 108.28% at the end of the March quarter (page 36). Nonaccrual loans to total loans was just .92%. Nonperforming assets to total assets was .85%.

I think this purchase brings the basket up to 39 names.

Tower is in the process of acquiring First Chester (FCEC): Press Release First Chester operates primarily in Chester County, PA. with 16 branches in that county: First National Bank Apparently the delay in finalizing the acquisition is mostly due to FCEC's inability to file its annual report and latest quarterly reports with the SEC. After reading that filing, I suspect some investors are wondering why Tower wants to complete the acquisition. If completed this acquisition would take the bank into a new geographic area just west of Philadelphia, PA. The source of the problem with First Chester appears to be an idiotic decision to acquire a mortgage banking concern in January 2008 called AHB. Management changes were made in October 2009: The chart reflects a bank with problems: First Chester County Corporatio Share Price Chart | FCEC I suppose Tower sees some value in First Chester's branch network and would want to get rid of AHB either before or soon after the completion of the acquisition.

LB declines to discuss further trading activity.

Per the agreement ending LB's strike, Headknocker states that the RB is an idiotic Lame Brain, and that the LB is not a showboat with ego issues.

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