Wednesday, September 8, 2010

Bought TC GYC at $21/Sold VNOD at 26.87/Basel/FRD/ SOLD CPB at 35.79 and Bought 100 of the ETF XLP at 27.25/ADDED 60 BRKS at 5.8

A German paper reportedly obtained a draft proposal from the Basel Committee, which is drafting new recommendations on bank equity capital, that calls for a minimum TIER 1 capital ratio of 6%, up from the current 4%, but the minimum level could be increased to 9% during bad times and up to 12% in good times. NYT Bloomberg TheStreet And, at least 5% of the TIER 1 capital would have to be comprised of pure equity and retained earnings. There would also be a transition period of several years to give the banks an opportunity to adapt to the higher capital levels. If that report is close to being accurate, and are implemented by the governments, a number of banks would have to raise capital in the coming years. For example, the German banking association estimated that the top 10 German banks would have to raise €105 billion to meet the additional capital requirements. Reuters The tier 1 capital is the ratio of a bank's core equity equity capital to its total risk-weighted assets. A number of the large U.S. banks already exceed 9% in the Tier 1 Capital ratio, however. JPM reported at the end of 6/30/2010 a TIER 1 capital ratio of 12.1% SEC Filed Press Release The banks took a hit yesterday. The SPDR KBW Bank ETF (KBE) fell 2.77% to $22.49; XLF declined 2.3% to close at $14.19; and the SPDR KBW Regional Banking ETF lost 2.4% of its value. My regional bank basket declined 2.11%. The S & P 500 was down 1.15%.

There was an article yesterday in Bloomberg about the number of companies whose dividend yields exceeded the 3.8% average rate in the credit markets.

German manufacturing orders fell 2.2% in July from June. The estimate was for a .4% increase.

Gold for September delivery rose $8.1 to close at $1257.30. Spot gold prices broke their previous record high of $1258 before closing at $1,255.2, up $8.6. New York Gold Chart The maximum level for MOL is $1,391.70 to and including 11/18/2010: Item # 5 Bought 200 MOL at 9.95 If there is one day where the spot gold price closes above that maximum level between now and the closing date, there will be a reversion in the coupon to 2%. As of yesterday's close, gold has increased 7.328% above the starting value for the current coupon period. MOL closed yesterday at $10.04 on light volume of 1,012 shares.

1. Bought 40 of the TC GYC in Regular IRA at $21 on Friday (See Disclaimer): GYC is a Synthetic Floater that pays the greater of 3.25% or .65% over the 3 month LIBOR with a 8% maximum coupon. Par value is $25. This means that the minimum yield for this security at a total cost of $21 would be 3.87%. (.0325% x. $25=$.8125 annually for 1 share ÷ $21=3.87%). The 3.25% guarantee is the current rate. The maximum rate at the $21 cost would be 9.25% (.08% x. 25=$2 ÷$21=9.52%). The maximum rate would be hit at a 3 month LIBOR rate of 7.35%. At a 5% 3 month LIBOR rate during the relevant computation period, the yield would be 6.72%. I bought only 40 shares on Friday since I did not have sufficient funds to buy more. In addition, this security is at best a marginal buy at its current price level. Due to tax issues, I will buy the synthetic floaters only in retirement accounts.

My last buy of this security was at $15.50 in the ROTH IRA, and I still own those shares. The min at that cost figure is 5.24% and a max at 11.8%.

The underlying bond is a senior bond originally issued by SBC Communications, now known as AT & T that matures on 6/15/2034. The TC will mature on the same day. Information about the underlying bond can be found at FINRA. The underlying bond prospectus can be found at the SEC web site.

As with the other synthetic floaters, an owner of GYC will not receive the coupon payment made by AT & T for as long as the swap agreement remains in force. AT & T pays the trustee the fixed coupon amount of the underlying bond which is 6.45%. The trustee exchanges that payment with the swap counterparty, in this case UBS, for what is due the owners of GYC, currently 3.25%. Consequently, the swap counterparty is making 3.2% annualized without taking the risk of AT & T defaulting. UBS has no real skin in the game. When the 3 month LIBOR rises to over 5.8% during the relevant period, the swap counterparty would not be receiving a net positive cash flow from this transaction.

There is a call warrant attached the trust certificates. This would allow the owner of that call warrant to redeem the TCs at the $25 par value plus accrued interest, and then receive from the trustee the underlying AT & T bonds. The underlying AT & T bond is selling at a premium to its par value. It would be profitable for the owner of the call warrant to exercise it and then sell the bonds. However, assuming the swap counterparty and the owner of the call warrant are both UBS, it would be more profitable to collect the spread between what AT & T pays and what is paid the owners of GYC.

If I was doing the calculation on when it would make sense for UBS to exercise the call warrant, I would want to make a reasonable estimate of the present value of that spread over the next 24 years. I would not assume an annualized spread of 3.2%, since it would be reasonable to predict that the LIBOR float provision will raise the rate to the TC owners during lengthy periods of time over the next 24 years and thereby reduce the spread available to the swap counterparty. For some periods, the spread will likely turn negative or be close to minimal. If I assumed an average 4% 3 month LIBOR rate, this would reduce the spread to 1.8%.

Just to get an idea, I would assume an average annualized spread of 2% over the remaining 24 year life of this security and then it would be necessary to discount that figure using the comparable rate of treasury bonds with a 24 year maturity. Let's assume that I could make 10% by exercising the call warrant and selling the bonds. How would that sum compare to the present value of the spread over the next 24 years. The spread would win now.

I would not purchase GYC based on this kind of amorphous consideration, but it is possible that an owner of GYC may not have to wait until 2034 to receive par value due to the exercise of the call warrant.

I am not set up to that kind of computation, and I am sure UBS could do it in an instant. At some point, with a rise in the value of the underlying AT & T bond above its par value, and a contraction in the time remaining until 2034, it might make sense to exercise the warrant. A bird in hand might eventually become better than two in the bush.

2. Sold 50 VNOD at 26.87 in the Roth IRA on Friday (see Disclaimer): VNOD is a senior bond from the REIT Vornado that matures in 2039. The interest rate risk on such a long bond transforms most of these securities into short term trading vehicles for me. At close to $2 above its $25 par value, I have no interest in this security and I have now sold out of my entire position in it.

Those shares were purchased at 24.86. I mentioned in a prior post that the remaining shares of VNOD held in the Roth were "on a very short leash". Item # 5 VNOD This security closed at $26.97 on Tuesday, 9/7/2010.

3. SOLD CPB AT $35.79 and Bought 100 XLP at 27.25 on Tuesday (see Disclaimer): I was disappointed with Campbell's last earnings report and particularly the decline in soup sales. I decided to harvest the long term capital gain from the shares bought in March 2009 at 25.35, over a 50% total return. (see article at Investopedia discussing the latest CPB results)

2010 CPB 70 Shares +$714.84
In its place, I bought 100 shares of the ETF XLP, which contains the consumer staple stocks (including CPB) that are part of the S & P 500. Select Sector SPDRs Dividends are paid quarterly. The expense ratio is .21%: FactSheet_XLP.pdf.

This is the current weighting of the top 18 holdings out of 41:

This index does include a few retailers.

I have occasionally owned the ETF KXI (BUY OF KXI) which contains both international and domestic consumer staple stocks which has an expense ratio of .48%. iShares S&P Global Consumer Staples Sector Index Fund (KXI) Nestle has the highest weight in KXI.

4. Barclays on Semiconductor Equipment Companies: Several of the semiconductor equipment companies fell yesterday in trading after Barclay's analyst, C. J. Muse, lowered his ratings on several companies due to weakening demand. Brooks Automation (BRKS) was reduced to equal weight from overweight, and that was the only company mentioned in the report where I have a position. BRKS was bought as a Lottery Ticket. Bought 40 BKRS at $7.72. I also own 100 shares of AMAT which was bought recently.

5. Friedman Industries (FRD)(own-LOTTERY TICKET category): I bought 50 shares of FRD at $5.76 and that purchase has been out of sight, out of mind. I happened to notice yesterday that this micro cap steel company had raised its quarterly dividend from 4 to 8 cents per share. Friedman Industries. Seeking Alpha I then checked out the last quarterly report and found that FRD had reported earnings at 21 cents for the Q/E 6/30/2010, up from a loss of 2 cents in the year ago quarter. e10vq FRD closed yesterday at $6.69. Price to sales is currently around .56 and price to book is .79, FRD Key Statistics.

6. Added 60 Brooks Automation (BRKS) at $5.8 (see Disclaimer): The RB is in charge of the trading desk here at HQ and it goes without saying that it could care less about the LB's stinking rules. One of those rules, which the RB violated with its usual verve, is the $300 limit on Lottery Ticket purchases. Brooks is an existing LT position, with 40 shares bought at $7.72, so the addition of another 60 shares at $5.8 violated that $300 limit after adding the profit of the prior BRKS trade to the $300. The RB was subsequently relieved of its command at the trading desk.

Brooks fell 88 cents or 13.15% yesterday to close at $5.81 per share. Cash per share is around $1.59 based on the most recent earnings report. Book value is $5.48 per share. BRKS Key Statistics While Brooks' business is highly cyclical, it is anticipated to earn 73 cents per share in its current fiscal year ending in September 2010 and $1.13 per share for FY 2011. I discussed the last earnings report at Item # 10, BRKS. The last filed quarterly report (10-Q) is available at the SEC's web site.

Price to sales is less than 1 and the five year estimated P.E.G. is .52: BRKS Key Statistics

I am now caught up summarizing my trades.

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