Monday, January 10, 2011

Bought 1 Macy's Bond Maturing in 2030 @ 99.5/Sold 50 DKQ at 23.32/Sold 100 CHW at $8.41 and Bought 50 KVW at 25.3/Intel/Investment Process for Bond Investing

A Democratic Congresswoman from Arizona, Gabrielle Giffords, was shot in the head at a constituent meeting on Saturday.  She was shot with a  9mm Glock  handgun that the 22 year old murderer had no difficulty buying at the Sportsman Warehouse in Tucson. The shooter was identified as Jared Lee Loughner who, judging from his incoherent rants on a YouTube video, appears to be a True Believer of the criminally insane variety.  One of the hallmarks of TBs is to form a variety of non-sensical opinions devoid of any factual foundation, though Mr. Loughner's views would be more incoherent than the opinions of a majority of the TBs.

Based on evidence seized at Loughner's home, it is clear that he targeted Representative Giffords in what he viewed as an assassination.  Criminal Complaint Filed Against Loughner in PDF format   NYT

Ms. Giffords had narrowly defeated a tea party candidate from the Republican party in the last election by less than 4,200 votes.  She was targeted by the Tea Party for her vote in favor of Obama's "healthcare reform". The  Tea Party candidate was Jesse Kelly who was endorsed by TB's favorite candidate Sarah Palin.

Ms. Giffords was on Sarah Palin's "bullseye map" of Democrats in swing districts.      Sarah's map, which has Ms. Giffords in a crosshair sight of a gun, was on he facebook page on Sunday.    CNN  Sarah Palin

Federal District Court Judge John Roll, a Republican appointee, and five others were killed by the gunman including a 9 year old girl.   A 76 year old man was shot in the head as he tried to shield his wife.

As a result of these events, the GOP leaders in the House have put off a vote to repeal the healthcare reform bill passed last year.   While I did not support this legislation, being a true fiscal conservative rather than a pretend one, I find reprehensible the kind of lies routinely spread by the GOP to mislead the public about this law, including Palin's death panel assertion.  PolitiFact gave the GOP's assertion that this legislation was a "government takeover of health care" its Lie of the Year Award for 2010.   Apparently, being truthful and accurate are not conservative values practiced by the modern GOP.  After all it is so easy to mislead the faithful and many others with a nice phrase, repeated over and over again with a straight and serious face.

1. Process for Bond Investing: For several decades as an investor, I was almost exclusively a stock investor.  My idea of an income investment was to own some certificates of deposit, an occasional bond fund, and savings bond when our soon to be  destitute Uncle was still solvent and paying a 7.5% guarantee on new issues in 1992.    Individual - Series EE/E Savings Bond Rates    In  posts from October and November 2008, I discussed buying some longer term CDs. It was clear then that savers were going to experience an extended period of low rates.   I also started to buy bonds with gusto then, as documented in this blog which started in October 2008, along with other bond like securities that were being smashed to smithereens in the profound panic after Lehman's failure. 

It was easy to make the transition from buying stocks to bonds.   I followed the same discipline that I had developed over the years as a stock investor.   However, without the internet, which gives me access to the prospectuses and other pertinent information, I would not be buying individual bonds and would be shunning most bond funds now.

The following is just a general description of how I approach bond investing.  

First, I have to learn about the company that issued the bond. I have developed a store of knowledge, acquired over decades as a stock investor, about a large number of companies.  Still, I would- at a minimum- read the latest earnings report, any analyst report available to me,  and review the balance sheet.  For the balance sheet, I would find the latest SEC filed report that shows the types of debt and their maturities.    All of that would be done whether I wanted to buy the stock or the bond.

Since I am  focusing on a firm's bonds rather than its stock, I am first and foremost concerned about the credit risk, rather than the value of the stock.     I need to  make a judgment about the likelihood of a default.  Possibly, there are times when I need to be concerned about interest rate risk for a short term or intermediate term bond that I could hold to maturity.  Why?  A heavily indebted company needs to roll that debt and that could prove difficult when rising rates become problematic.

The judgment about risk can never be precise, particularly for those companies that take obfuscation of true earnings into an art form.  Even for corporations that are truthful, the future can hold an abundance of surprises, some of which can never be anticipated.  So there are always unknowns and unknowables.   And, as proven on countless occasions, an investor can not rely on the ratings agencies.   Their grade is just one piece of relevant information.  I would never even consider buying anything based on their ratings.

Second,  if the company has too much debt in my opinion based on their operating performance, which creates a risk of a default when and if something goes wrong, then I may still buy one of its bonds, provided I view the compensation for that risk to be adequate.   After weighing the risk with the potential benefit, I may go ahead and take what I view as an enhanced risk, but only with a small amount of capital.

Some examples include the recent purchases of some junk bonds, where I limited my exposure to one or two bonds.   In 2007, I was buying investment grade bonds in units of 5 for the most part, with some as high as 10 bonds.  I disposed of most of those to finance RB's buying stock buying spree in March 2009.  As an example, I would not consider buying more than 2 Alon Krotz Refinery Bonds, given the risk, even though the yield was close to 14% with a short 2014 maturity.    Bought 2 Alon Krotz bonds 

And, it goes without saying that the investor has to learn about the bond itself.  Many investors will simply not take the time to look at anything filed with the SEC.  At the bare minimum, the investor has to find the bond prospectus and then read enough of it so that you are familiar with its important terms.   Is the bond subordinated, for example, to senior bonds, or is it a senior bond?  Can interest be deferred?  If so, for how long can interest be deferred and will interest be paid on deferred interest?   Generally, a trust preferred contains a junior bond that allows the company to defer interest.  Other junior bonds may not have that option.  What are the facts that will trigger a default?  A senior bond may have a 30 day grace period.   Some of the bonds, like the Alon Krotz Refinery  bond mentioned above, create additional security interests for the bond owner.  It is important to at least make an effort to understand what protections are contained in the prospectus.  This will impact my decision on much risk to take, i.e., will I buy 1 or 2, or 5.  I understand that many investors will never take the time to review source materials which I would view as a cardinal sin.

Since the commission cost for buying an  Exchange Traded Bond is less than the purchase of a $1,000 par value bond in the bond market, an investor needs to become familiar with the various types of exchange traded bonds in order to determine whether one or more of them is a better alternative than venturing into the more costly bond market.   In addition to the higher commission cost, or "concession", there is frequently a large bid/ask spread in the bond market and the investor is required to place an order on the "ASK" side, or very close to it, to receive a fill.  Vanguard will only allow me to enter an order at the ask price, while Fidelity allows only a slight deviation before rejecting the order. More on Fidelity Investments & Online Bond Trading (Sept 2009 Post)

There are several ways to find the bond prospectus.  I may go to the FINRA site, enter the stock symbol, and then navigate to the bond pages for that company.  For example, say I wanted to buy a Macy's bond.  I would enter the stock symbol "M", click go, and then scroll from "equity" to "bond".  I would click the particular bond of interest, and it would tell me when it was issued.  I can access that information at my brokerages account also.  I would then go to the SEC website (Next-Generation EDGAR) , as every investor should do before giving any consideration to entering a buy order,  click "company or fund name", then enter "Macy's" as a search term.  Up pops a listing for Macy's Retail Holdings, click that red line under "CIK".  At the top, you will see another search box.  Say the bond was issued on 4/30/2005, information that I already gathered from FINRA or at online site of one of brokers,  I would enter a "prior" search date a few days or a month after then, I then find the first prospectus listed, click it and then see if it is the right one.  Sometimes, there are more than one for large companies, particularly financial firms.   This takes me at most a couple of minutes.

2. Bought 1 Senior May Department Store Bond Maturing in 2030 at 99.5 and Sold 50 DKQ at 23.32 (see Disclaimer):  As previously discussed in connection with the trust certificate DKQ which contains a senior May Department Store bond as its underlying security, May was acquired by Macy's.  This particular bond matures on 3/1/2030 and has a 7.875% coupon.  It consequently gives me a higher current yield than DKQ, recently bought at 22.06, which has a 6.25% coupon and a 2032 maturity.  I sold 50 of DKQ, which contains a senior May Department Store bond maturing in 2032.  DKQ matures in 2032 at $25 and has a 6.25% coupon.  I just bought DKQ.  I decided to go with the 2030 bond given its higher current yield and shorter maturity for my miniscule allocation to Macy's bonds.  Until I bought the 2030 bond in the bond market, I had limited my buying and selling to the trust certificate DKQ, always in small quantities and have done okay with it.   

My confirmation states that the current yield at my cost is 7.851%.   The current yield on DKQ is around 6.68% at a total cost of $23.32.   

According to FINRA, the 2030 bond is currently rated Ba1 by Moody's and BB+ by S & P. 

This is a link to the 2030 bond prospectus:  Interest is payable semi-annually in March and September. 

Since both Moody's and S & P rate this bond as junk, I have included it in my Junk Bond Ladder Strategy.

3.  Intel (own):  The head of sales at Intel claims that tablets are not replacing laptops, and Intel's "hair isn't on fire" about the impact of tablet sales on their business.   I made the point in a post last week that tablets were not viewed by me as a replacement for laptops, unless the customer never needed a desktop or a laptop anyway. Intel   I view the tablets as just a larger IPhone without the voice capability.  I would add however that I am no longer 16 years old, notwithstanding the current profile picture, and Old Geezers look at the world differently.   

4. Financials Take a Knock On Mass Supreme Court Ruling Voiding Two Foreclosures: Bloomberg has a good summary of the legal issues involved in this case.   While some partisan attorneys were quoted as saying this decision will have widespread impact, it is only binding in Massachusetts and other jurisdictions are under no obligation to follow it.  The decision is also fact sensitive, though the fact pattern may be widespread.   After reading the decision, there were repeated references to Massachusetts statutes by the Court which may not be applicable in other states.   Basically, there was an assignment of the mortgage by its a lender who left the assignee's name blank.   Apparently, that was viewed as fatal to the right to foreclose after the borrower defaulted on the mortgage.   The actual assignment of the mortgage occurred after the foreclosure.  I also thought that this sentence in the decision was interesting:  "In Massachusetts, where a note has been assigned but there is no written assignment of the mortgage underlying the note, the assignment of the note does not carry with it the assignment of the mortgage."  While small community banks took a hit on Friday along with the big financial institutions, I doubt that the small regional banks were anywhere near as sloppy as their big brethren on these kind of paperwork issues.    

5. Sold 100 out of 250 of CHW at $8.41 and Bought 50 of the TC KVW at $25.3 (see Disclaimer):  I sold 100 of the CEF CHW in the taxable account and used the proceeds to buy 50 of the trust certificate KVW which will provide me with more income.  I am keeping the 150 of CHW bought in the ROTH IRA.   While CHW will have more potential for capital appreciation than KVW, it also has more downside risk and pays me less to hold it.   This an OG type of decision.  I bought those 100 shares in the taxable account last September at $7.2:  Bought 100 CHW at 7.2

Since starting this blog I have been discussing purchases and sales of trust certificates that contain the same junior bond from in Aon Corporation, a large insurance broker that is a member of the S & P 500.   Some of my earliest discussions were about this grouping of TCs.  One of them, DKK, has been called by the owner of the call warrant and is consequently no longer available for purchase.   I did own some shares when it was called by the call warrant owner: DKK-Called by Owner of Call Warrant

I am going to discuss some of my historical trades on this bond, simply to show that it is possible to make decent money without investing a lot.

One of my earliest posts discussed the purchase of 50 shares of KTN at $13.1. TRUST CERTIFICATE AON BOND KTN ORDER FILLED  I still own those shares that are now selling at above their $25 par value. CorTS Trust Credit Enhanced For Aon Capital A, KTN Stock Quote

 The current yield on that position at my original cost, including the commission, is about 15.47% annually. I am receiving $102.56 per year on a $663 investment.  The TC and the underlying bond mature on 1/1/2027.   I attempted to calculate what I would receive by holding this bond to maturity, assuming AON made all of the interest payments and paid the principal amount at maturity.   I would make $587 on the shares, and another $1948.64 in interest payments over a 19 year period (1 payment received in 2008 and 1 in 2027).  Thus that $663 can generate $2,535.64 over the remaining life of the bond from my date of purchase in October 2008.   I could make more on the shares by selling now, but then I would lose the cash flow over the next 16 years.

At about the same time I bought 100 shares of KTN in my regular IRA:  GRTPRF: A WALK ON THE WILD SIDE/ KTN add.  I currently own 50 shares after selling 50 in 2010 at $28.17  Sold 50 of 150 KTN at 28.17  The profit calculation on the remaining shares is about the same as those held in the taxable account, though my average cost is higher at $14.16:

So just for KTN, I have already received several interest payments and harvested a $692.52 gain on 50 shares:

KTN has the highest coupon at 8.205% of these AON TCs, and  it is also the only one that does not have a call warrant attached to it.  I am not interested in buying any shares at its current price, however, which is well over its $25 par value.

I bought on Friday 50 shares of KVW, which has a 8% coupon, and the same Aon junior bond as its underlying security.  KVW has a call warrant attached to it, which will limit its appreciation above its par value.  I am consequently not likely to realize much on the shares from my purchase at $25.3.   I decided to add 50 shares since I had already realized profits trading this security and I still own 100 shares bought at a total cost of $16.16 in September 2008:

That 100 shares is generating a yield of 12.38% per year at my cost.

The KVW security is therefore been a source of realized gains and prior income generation.  I therefore felt that I could add 50 more shares just for the income generation which will be close to 7.9% at my purchase cost last Friday.   And, that is not bad for an investment grade bond maturing in 16 years.

KVW Prospectus: 424B5
FINRA - Investor Information on the underlying bond
Underlying Bond Prospectus:

The underlying bond is currently selling well above its par value as shown at FINRA.  This is one reason why DKK was called by the owner of the call warrant for that TC.  The call warrant owner could pay off the TC owners and sell the bonds for a profit.  That same issue is also what will cap the price of the TC KVW but not KTN.

I have also realized gains and income from DKK and KVF. Trust Certificates: Links in One Post  KVF is still trading but it has a lower coupon than KVW and a higher price last Friday. CorTS Trust III For Aon Capital A, KVF Stock Quote

By increasing my cash flow, I have more funds available to take advantage of whatever opportunities develop during 2011.  An opportunity in October 2008 was trust certificates containing investment grade bonds that were frequently yielding 3% to 5% more than the underlying bond.  So even though the opportunity has long passed to buy these securities at ridiculously low prices, it always behooves an individual investor to know about these esoteric securities so that you can recognize the opportunity when it arrives and then seize it.

For the most part in October 2008, I was just investing my cash flow to buy securities, and it was difficult for the OG to do that under the prevailing circumstances. 

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