Friday, January 21, 2011

Bought: 50 LXPPRD at 23.28, 50 of the BDC ARCC at 16.17 and at $16.3/Sold LT PVSW at 5.68/Comparing Floaters with Guarantees

I watched a program about stress on PBS last Wednesday: Killer Stress | PBS.  The program referenced a study of British civil servants, called the Whitehall Study, that found a strong correlation between the level of civil service employment and cardiorespiratory disease and mortality rates. As you move up the levels of service, the researchers found that the risks of disease and mortality decreased. All of the employees studied had access to the same healthcare.  The lower level employees suffered more stress.

Brazil hiked rates 50 basis points to 11.25% as its inflation hit 6% in 2010. Inflation in China rose 4.6% in the 4th quarter.

RB has a plan that will save Headknocker about 10 grand in 2011, place a cease and desist order down on LB's trading activity.

The treasury is planning to sell 156 billion in securities next week. About 99 billion of that number will be shorter term notes with the remainder in the three and six month treasury bills. Positive numbers on unemployment claims and housing starts caused longer dated treasury debt to decline significantly in value in yesterday's trading. The long treasury bond ETF, TLT, fell over 1.38%% yesterday, closing at $90.74, and is rapidly approaching a 20% loss in value since reaching a high at $108.56 on 8/31/2010. TLT Historical Prices | iShares Barclays 20 Year + Treasury When a security is paying just over 4%, that kind of decline represents over three years of income, and it does not look to me like it is done going down.  This constant shellacking of the long treasury caused me to add a couple of floaters in the ROTH IRA late on Thursday, which I will discuss in the next post.  That account is loaded with longer term fixed rate coupon corporate bonds.  Rightly or wrongly, I believe that floaters add balance, always viewed positively here at HQ, to that portfolio.  So far, my longer term corporate bonds have not- yet- started to decline in value.  

The treasury auctioned 10 year TIPs yesterday. The coupon was a higher than expected 1.17%: The ten year non-inflation protected note fell 30/32 in price and rose in yield to 3.455%. That would place the break-even point for the 10 year TIP auctioned yesterday at around 2.275%. That is about how much inflation would have to average over the next 10 years for those purchasers to break-even with the 3.455% nominal yield.

The decline in  Hudson City Bancorp's stock over the past two days seems to be to be warranted given this bank's 4th quarter earnings report and prognosis for 2011. The stock has declined about 13.4% over the past two trading days. However, any  decline to below $11 would be unwarranted in my opinion, given the bank's strong capital position and good dividend. But this stock may be the doghouse for at least a year.

1. Analysis and Comparison Shopping Among Equity Preferred and Synthetic Floaters: I had a discussion with two readers about equity preferred floaters, which can be found in the comment section of Bought: 1 Travelport Senior Bond Maturing in 2016, 50 STDPRB @ 17.96, 50 HBAPRG at 23.31. There are a few points that I would like to reiterate about these securities.

First, as shown by their price action during the Near Depression period, they are extremely sensitive to investor perceptions about credit risk. When there is widespread concern about the issuers' credit risk, the security will decline in value. It does not matter whether the security is cumulative or non-cumulative, nor will investors be concerned about the guarantee or the float provision. All that will be seen is their money evaporating in front of their eyes. AEB, which has a cumulative feature, traded down to $3 during the Dark Period. METPRA from Met Life could have been bought for $7, even though it has one of the better guarantees and float provisions.

And, trust preferred stocks from financial institutions, which contain junior bonds, were also crushed in value, even though most of them continued to make all of their interest payments.  During that period, I bought at TC containing a Bank of America TP that provided me with a 25% yield. So, both real, and imagined, perceptions about credit risk can have a radical impact on price. Securities were crushed where there was no elimination of a non-cumulative dividend and no deferral of a cumulative dividend or interest payment.

Second, when considering a purchase of floaters from the same issuer, I would not make a decision on which one to buy based on the guarantee and the float. The one with the higher guarantee and better float provision may not be the best buy. Why? It comes down to price.

An example would be a floater that has a 4.5% guarantee that is selling for $24.8, whereas one with a 4% guarantee is priced at $23.3. (compare HBAPRG with HBAPRD) The yield at the buyer's cost would be about the same.

Another factor to consider in that example is that the float will kick in sooner for the security with the lower guarantee. In a rising rate environment, that is important. In the case of HBAPRG, the LIBOR float would become the applicable rate when the 3 month rate exceeds 3.25% during the relevant computation period. Since HBAPRD has a float tied to .81% of the highest of three rates, and has a higher coupon, there will be a crossover point where HBAPRD is still at its 4.5% guarantee whereas HBAPRG would have a higher coupon.  HBAPRG, with its .75% float over 3 month LIBOR, would hit 4.5% when the LIBOR rate exceeds 3.75%.

Another factor to consider is that the lower cost security may provide more bang for the buck. Say I wanted to buy $1000 of either HBAPRG or HBAPRD. I could buy 43 shares of HBAPRG or 40 shares of HBAPRD. Then, I would suggest running computations on the income generation produced by those shares at the guaranteed rates, and then at 3.5%, 5% and 10% 3 month LIBOR.

Another issue involves why the investor is making the purchase. If I am buying one or more of them as a hedge against unexpected inflation, then it becomes important whether there is a cap on the dividend yield and it would be relevant to at least compute what the coupon would be when the applicable short rate hits 10% or even 15%.

I have done similar computations with a variety of securities and was sometimes surprised by the results: BMLPRH vs. BMLPRJ Analysis of Prior Question: ZBPRA vs. ZBPRC OR ZBPRB

Advantages and Disadvantages of Equity Preferred Floating Rate Securities

And if there is the option to buy a synthetic floater in a retirement account, then I would include in any comparison shopping the synthetic floater tied to a bond from the same issuer as an equity preferred floater: Analysis of Prior Question about Goldman Sach's Floaters /GJS VS. PYT As of 10/8/09 This kind of analysis will depend on the prices of the comparable securities at the time an investor decides to make a purchase. Unlike the equity preferred floaters, the synthetic floaters have maturity dates, which at least gives the investor the opportunity to hold the security until it matures and then to make a profit on the shares, provided of course the issuer survives to pay par value. The synthetic that I bought yesterday was selling at more than $6 below its $25 par value. 

2. Bought 50 of LXPPRD at 23.28 on Thursday (see Disclaimer): LXPPRD was a profitable LOTTERY TICKET purchase during the Near Depression. I had traded it for a profit before buying 50 shares at $7 in March 2009. I was able to add my total profit from the prior trade to the $300 limit for LTs. Those shares were bought in the ROTH IRA and were later sold at 23.46.  So, I am playing with the house's money on this one.

I do not expect much, if any, price appreciation from my last purchase at $23.28. Par value is $25. A few of the REIT preferred stocks that I bought during the Near Depression are selling at slightly over their $25 par values: GRTPRF at $2.9, and  SLGPRC at $10.5 and at $11.89, and both of those preferred stocks are now trading at over $25.

I discuss REIT cumulative preferred stocks in more detail at REIT CUMULATIVE PREFERRED LINKS IN ONE POST: Advantages & Disadvantages

LXPPRD is a typical REIT preferred stock. Dividends are cumulative and have to paid as long as the REIT pays a common stock dividend. And, the REIT has to pay a common stock dividend to maintain its tax status, assuming of course it has net income. A deferred cumulative dividend will have adverse tax consequences, as explained in the prospectuses of these securities. This security has no maturity, and would be subject to price declines due to a significant change in investor's perceptions and concerns about interest rate risk. Who will want the risky LXPPRD when an investment grade corporate bond maturing in ten years has a 7% to 8% yield?

LXPPRD has a 7.55% coupon: At a total cost of $23.28, the effective yield would be about 8.1%. Dividends are paid quarterly.  I doubt that any part of the dividend would qualify as a qualified dividend.

Lexington was able to raise funds last December with a stock offering, always viewed positively by me when I own the preferred stock, since the REIT's liquidity is improved.

I am already familiar with Lexington.  Still, I will review the last filed earnings report before making a preferred stock or bond investment.  I am attempting to assess the credit risk and to judge the likelihood of receiving timely payments. form10q A business description can be found at

This is a link to a brochure from the REIT association that provides a lot of general information about these securities: PDF

3. Bought 50 ARCC at 16.17 on Thursday in taxable account and 50 on Wednesday at $16.3 in Roth IRA (See Disclaimer): The shares of Ares Capital, a BDC, fell 81 cents on Wednesday to close at $16.28 after the firm announced a private placement of senior convertible notes. The notes have a 5.75% coupon with an initial conversion price of $19.13 per share.  It is not unusual for the common shares to fall after such an announcement. Hopefully, after the Masters of Disaster are finished with their activities related to that offering, the shares will stabilize and turn up again. The quarterly dividend rate is current 35 cents which results in a tad over an 8.6% yield at a $16.17 total cost number.  Ares Capital Corp, ARCC Stock Quote

I viewed BDC's as a disfavored asset class. I currently own just 200 shares of PSEC and 150 shares of ARCC. Like a REIT, the BDC has to pay out at least 90% of its net income to maintain its tax status. Both the REIT and the BDC can have high dividends due to that payout requirement and the avoidance of the double taxation issue associated with dividend payments made by regular corporations. The downside is that the BDC is draining itself of capital needed for growth. Consequently, it is normal for the BDC's to raise funds by selling common stock and many of those offerings were at dilutive prices during the Near Depression period and its aftermath. Another problem is that the loans being made by the BDCs are frequently to more risky companies, and the failure rate is therefore higher than most banks. When you combine that factor with the depletion of capital resulting from the dividend payments, there may not be much wiggle room for the company during a modest economic downturn, let along another serious recession.

I would suggest that anyone unfamiliar with BDCs start by reading several columns written by Nicholas Marshi, which can be found at SeekingAlpha. He knows more about them than I do.

Another recent article at Seeking Alpha was written by an attorney.

4. Sold 50 Pervasive Software (PVSW) at 5.68 on Wednesday (LOTTERY TICKET strategy)(see Disclaimer): These shares were bought at 4.72 in December 2009. As previously noted, the Stock Stud LB has more important tasks to do, millions of them in fact,  than to research these LTs that are bought by the Old Geezer and its erstwhile ally, the infamous NIT WIT RB.

The OG and the RB are not exactly spending their time reading 10-Qs at the SEC web site, or doing much in whatever requires time and effort. No, the thankless job of researching the LT selections falls on the underappreciated, frequently maligned and forever undercompensated LB.

So, when the OG asked the LB last Wednesday "what's happening with Pervasive Software", the LB understandably said "stick it in your ear Old Goat" and immediately sold the stock before Headknocker could order the LB to conduct hours of research on why the stock was finally rising some. Some accuse the LB, unfairly of course, of having tunnel vision, and for not thinking ahead. That is just plain wrong. LB constantly crunches the infinite variables and alternate scenarios of what may happen in the next few seconds or minutes, and sometimes, only when absolutely necessary, even the next day. 

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