Thursday, October 7, 2010

Modification Regional Bank Strategy/VZ/Sold: 50 BOFI @ 12.66, 50 YCS @ 16.4, 50 DFP @ 23.10 and @23.17/Bought 75 DFY @ 25.31

ADP reported yesterday that its measure of private sector employment showed a decrease of 39,000 jobs in September. September_10.pdf This report took some of the air out of the recent giddiness. But bad news on the economic front is now viewed as increasing the odds of another round of quantitative easing by the Federal Reserve, which is viewed as a positive for the economy and stocks, at least in the short term. The market appears to be increasing its odds of another bout of QE, and the knee jerk response is to bid up commodities (particularly precious metals) and to sell the USD.

1. Modification in Regional Bank Stock Strategy: My regional bank stock basket still has 50 stocks in it which is excessive for any basket strategy. It may take some time but I intend to reduce the basket to 35 to 40 names without lowering my overall dollar exposure currently devoted to this strategy which is 44 thousand. To accomplish that task, I will need to raise the maximum limit to any one bank from $2,000 to $3,000. As of the market close yesterday, my unrealized profits from this basket was $2,901, down from over 6 thousand at the end of April. This unrealized profit was primarily concentrated in just a few names:

50 Webster Financial (WBS)= + $677
100 New York Community (NYB)= + $534
50 United Bankshares (UBSI)= + $447
100 Washington Trust (WASH)= + $415
100 Citizens & Northern (CZNC)= + $184
50 WestBanco (WSBC)= + $198
50 Regions Financial (RF)= + $207
100 New Hampshire Thrift (NHTB)= +$200
And 6 others between $100 to $200

This shows either the value of a basket strategy or the need to improve my stock selection skills. I can no longer post the table containing my current holdings due to the length of the portfolio, which can no longer be captured with a single screen shot even on the lowest resolution.

I still intend to substitute a few names for existing ones, to achieve a better geographic diversity and/or a higher dividend yield.

I am tracking the realized gains in Item # 3: 2010 Realized Gains Regional Bank Stock

The rationale for the strategy is explained in a number of posts going back to March 2009 when I started to implement it. More recent summaries can be found at item # 2 Regional Bank Stocks' Basket Strategy; Item # 1 Rationale for the Regional Bank Stock Strategy; and Item # 1 More on Regional Bank Strategy.

2. Sold 50 BOFI at 12.66 (Regional Bank Stocks' basket strategy)(see Disclaimer): I had to start chopping the regional bank basket somewhere. Since this bank was a new addition and does not pay dividends, I elected to sell it and that leaves me with a net pare of ten or so more names to bring this basket down to a more manageable size. This transaction has almost nothing to do with my opinion of this bank. I bought those shares last month at 11.84.

3. FSBK and FBSS (own): Both of these small banks recently cut their dividends. I mentioned in a prior post that First South (FSBK) needed to reduce its dividend to bring it more in line with net income. At that time, I suggested a dividend cut to 10 cents per share. Item # 2 Added 50 FSBK at 9.81 The payout ratio was over 100% prior to the reduction. The bank reduced its quarterly dividend from 20 cents to 9 cents per share. First South earned 16 cents in the Q/E 6/2010. 10q. This bank did not participate in TARP. I have decided to stay with it until I have an opportunity to review its earnings report for the third quarter.

In its press release announcing the dividend cut, FSBK mentioned that the reduction occurred after receiving the following "guidance" from the Federal Reserve Bank of Richmond:

The Company is expected to act as a source of strength to the Bank. The payment of dividends exceeding net income is questionable in these uncertain times as continued high levels of loan losses and problem loans can require significant capital. We consider it more prudent to reduce shareholder dividends at this point and maintain capital in the Bank”. .pdf

The net interest margin is good at 4.54%, as of 6/30, compared to other small banks that I own in my basket. The capital ratios exceed the well capitalized levels (see page 13 _10q).

The other bank that cut its dividend was Fauquier Bankshares, bought by the RB who liked the name, sounding like a French word for amour to the Lame Brain. Bought 50 FBSS at 14.08 Unlike the reduction at First South, this cut was a surprise since FBSS was earning its dividend. Fauquier is also in the Richmond Fed's district which may explain it. FBSS earned 28 cents per share in the last quarter and paid out 20 cents in a quarterly dividend (see page 4:e10vq) The dividend was reduced to 12 cents. EX-99.1 Unless the bank has recently experienced some unexpected loan losses, I would view this cut to be entirely unwarranted by the Board unless the Board was pressured by the Richmond Fed. If that is what happened, then I would view the interference by the government to be totally unwarranted unless there were new significant and unexpected loan losses.

My opinion on this matter is justified by the following: (1) As of 6/30/2010, the bank had NPLs to total loans of .53%; NPAs to total assets of 1.12%; and allowances for loan losses to non-accrual loans of 217.71% (p. 13: e10vq). (2) the bank did not participate in TARP. EX-99.1 (3) the company made the following statement in the 10-Q filed 8/9/2010: "The Company evaluated subsequent events through the date of filing this document. Based on the evaluation, the Company did not identify any recognized or non-recognized subsequent events that would have required adjustment to, or disclosure in, the financial statements." (4) the net interest margin is good for a small bank in the current environment at 4.1% (p.28). (5) the capital ratios exceed well capitalized levels, with the Tier 1 to risk weighted asset ratio improving to 11.26% on 6/30/2010 from 10.97% on 12/31/2009. So I am curious about the rationale for such a big cut.

4. Pared Trade in Roth IRA: Bought 75 DFY at 25.31 and Sold 50 DFP at 23.1 (see disclaimer): I used to have more shares of Delphi Financial Group's (DHG) senior bond (DFY) maturing in 2033, but the company has implemented two partial calls of that bond at its $25 par value plus accrued interest. This left me with just 25 shares. The coupon on this senior bond is 8%: At a total cost of $25.31, the current yield for this investment grade bond is around 7.9%.

I sold 50 shares of the Delphi junior bond (DFP) at $23.1. The current yield on that junior bond is around 7.93% at a total cost of $23.1. In this particular kind of pared trade, I manage to keep about the same current yield by upgrading to the senior bond, while at the same time shortening the maturity and booking a good profit on the DFP shares. I bought those 50 shares in the ROTH IRA at $17.10 in December 2009. As noted in that post, that purchase was part of similar pared trade made in the same two securities, except I was selling DFY at $24.95 to buy DFP at $17.1.

At the prices prevailing yesterday, I would prefer to own the senior bond. Since Delphi has been doing partial calls of DFY, I would not want to pay more than par value plus accrued interest.

I discuss DFY in several prior posts: Bought DFY at 22.48 Bought 50 DFY at 24.36

This is a link to the prospectus for DFY: SEC The prospectus for the junior bond DFP can be found at the SEC's web site.

I have also bought and sold DFP in the regular IRA this year: Added 50 DFP at 19.75 Sold 50 of 150 DFP at 21.7

Interest payments are made quarterly for both securities.

5. Sold 50 DFP in Taxable Account at 23.2 (see disclaimer): After thinking about it some more, I decided to sell 50 DFP in a taxable account bought at the same price of $17.1. I would not buy that security at $23.2 given its potential maturity, its priority, and the deferral rights endemic to junior bonds in exchange for the yield at that price. I am playing with the house's money on these two Delphi bonds now.

6. Sold 50 YCS at 16.47 (see disclaimer): I gave up on my double short for the Yen, taking a small loss on shares purchased shortly before the intervention at 16.92. While the USD popped some after the Japanese government's intervention, the USD/JPY conversion has declined since that initial pop. Personally, I view Japan as being in far worse shape long term than the U.S. The recent action by the Bank of Japan, discussed in this article at Reuters, did not weaken the Yen at all. As Japan's population ages, and need to draw on their pensions invested in Japanese government bonds yielding near zero, the Japanese government will no longer be able to float its debt to the locals and a reckoning will occur. Japan, the world's second largest economy, is running a debt to GDP ratio of close to 200% now, The Global Debt Bomb, and that is becoming more dire by the year. It is only able to finance itself now with the accumulated savings of its aging population, who buy around 80% of the Japanese governments debt.

6. Verizon (own senior bond in TC form PJL and common stock): The WSJ reported yesterday that Apple will start manufacturing more IPhones by the end of 2010 to enable VZ to sell that phone by early 2011. BOUGHT VZ at $26.74 VZ was ex dividend yesterday, and closed at $33.36.

I will discuss the remaining transactions from Wednesday in the next post.

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