Thursday, March 31, 2011

KTV and Wells Fargo Notice of Redemption of Certain of its TPs/MKN Closes with a 25.56% Gain/ADP Private Payrolls/Bought 50 HPQ at 41.15/Bought 1 Reddy ICE Second Lien Senior Bond at 88.875/Sold 100 of 200 DKF at 26.8/

 Fortune magazine has an article discussing the foibles of Microsoft (owned).  According to a note in  Barrons, IDC recently predicted that Microsoft's operating system will have a 21% share in smartphones by 2015.

Wells Fargo filed a  Form 8-K with the SEC on 3/29/2011 giving notice that it will redeem several of its trust preferred issues.  Since Wells will have to phase out the use of TPs as Tier 1 equity capital, it is not surprising to me that it will start to redeem those securities. Among the TPs being called is WSF, issued by Wells Fargo Capital IV. For reasons that I do not understand, WSF was apparently halted all day yesterday, no trades were reported, even though the redemption is not scheduled to occur until 4/25.  I do not own WSF.

I was surprised, however, to see the TP from First Union Institutional Capital I among those being redeemed by Wells.  First Union was acquired by Wachovia, and Wachovia was later absorbed into Wells Fargo during the Near Depression period. The First Union TP is now a Wells Fargo obligation. Rounded KTV to 100 Shares (2/18/2009 Post) This particular TP requires a premium payment for an "optional" early redemption.   I own a Trust Certificate (KTV) that has this Trust Preferred as its underlying security.  A bond call by the issuer will result in the automatic call of the TC too.

KTV is scheduled to pay its semi-annual interest payment on 6/1. Par value is $25. The average total cost for the KTV shares currently held in a taxable account is $18.16 per share:

KTV Average Cost Per Share of $18.16
I also own some recently acquired shares in the regular IRA that will result in a negligible gain upon redemption plus interest payments.  And, I have already harvested some profits. So this security has been good to me.

I have decided that I do not yet know for certain the redemption price of KTV if Wells claims that there is a Regulatory Capital Event. I have no idea now whether Wells is even making such as claim. A Regulatory Capital Event would include the 2010 financial reform bill that requires banks with over 15 billion in assets to phase out TPs as part of TIER 1 capital.    (Dodd-Frank Act)

Normally, without such an event, Wells would have to pay a premium to redeem this TP now (102.412% during 2011) This would equate to a $26.11 principal payment per certificate plus accrued interest for a KTV redemption in 2011. See Page S-14: Although I would prefer just to keep KTV, which has a 8.2% coupon, I would not be too upset to receive that premium payment plus accrued interest.

But if Wells claims a Regulatory Capital Event has occurred, then there is a different formula governing the redemption price of the TC KTV, which at least requires the payment of par value and accrued interest at the minimum:

" In addition, if a Tax Event or a Regulatory Capital Event (collectively, a "Special Event") occurs and is continuing, First Union may, at its option, prepay the 8.04% Junior Subordinated Debentures in whole (but not in part) at any time within 90 days of the occurrence of such Special Event, and therefore cause a mandatory redemption of the Underlying Capital Securities, and consequently the Certificates (such redemption, a "Special Event Redemption"). The redemption price in the case of a Special Event Redemption (the "Special Event Redemption Price") will equal the greater of (i) 100% of the principal amount of the Underlying Capital Securities or (ii) the sum of the present values of the principal amount and premium payable as part of the Optional Redemption Price with respect to an Optional Redemption of the Underlying Capital Securities on December 1, 2006, together with scheduled payments of interest from the redemption date to December 1, 2006, in each case discounted to the redemption date on a semiannual basis (assuming a 360-day year consisting of twelve 30-day months) at a certain treasury rate plus 0.50%, plus, in each case, accrued interest thereon to the redemption date."

Page S-14 of the Prospectus 

The language following the word "or" clause in that quote is just too much for the OG to process, and the LB sees no need to even try since I am not going to do anything other than wait for my shares to be redeemed anyway.   I also do not know whether the notice was given within 90 days of the Regulatory Capital Event as defined in the TP's prospectus. The bill was signed by Obama on 7/21/2010, more than 90 days ago, and it is my understanding that the phase out period for Wells use of TPs starts on 1/2013.  So I do not see how the Regulatory Capital Event method for determining the redemption price could be invoked now, but I have no need to figure it out either. Perhaps, an enterprising legal beagle can dig deep into it if Wells does not pay the premium that would result in a $26.11 redemption amount plus accrued interest for the owners of KTV.   

ADP, the payroll processor, estimated that private payroll employment increased by 201,000 February to March. ADP revised the estimated change in private payrolls from January to February down by 9,000 to 208,000. .pdf Still, these are encouraging numbers.

One interesting piece of information in this report is the estimated decline in construction employment of 2,126,000 since January 2007.  Much of the GDP and employment growth in Bush Juniors term were due to the housing bubble and the rapidly expanding spending of borrowed money by consumers and governments.   What Will Produce Growth after the Age of Leverage?  More Meanderings on Corporate Tax Rates & THE Multitude of Factors Impacting Growth

Once the housing bubble burst, and the jobs created about it vanished, so did the 3 million jobs created during the 8 years of Bush Junior's term in office.  And those 3 million jobs were the worst record in modern American history.  Bush On Jobs: The Worst Track Record On Record - Real Time Economics - WSJ Bush Lead During Weakest Economy in Decades Aughts were a lost decade for U.S. economy, workers - Economy Made Few Gains In Bush Years - CBS News

As LB is fond of saying, it is still waiting for the economic stimulus of the 2003 Bush Tax cuts, the magic elixir for economic growth, to work their magic. 

I received a notice yesterday that my senior bond from Telephone and Data Systems will be redeemed at $25 plus any accrued interest on 5/2/2011. This is an exchange traded bond, TDA, and it just went ex interest for its quarterly distribution on 3/29.  I have an odd number of shares left in two retirement accounts and one taxable account after TDS performed a partial call of this bond late last year.  So all of this redemption activity that I have discussed over the past several months has been a primary moving force in the Junk Bond Ladder Strategy, since I am losing most of my investment grade bonds with decent yields to calls or to profit taking due to what I regard as irrational prices (e.g. PJL and DKF). 

1. RB Buys 1 Reddy Ice Second Lien Senior Secured Bond at 88.575 on Tuesday (Junk Bond Ladder Strategy)(see Disclaimer): This was not a rational bond buy. Instead, it is more of the OG becoming exasperated with the three year Jihad against savers and responsible Americans, conducted by the Federal Reserve, to benefit primarily the Masters of Disaster and associated scumballs.

Reddy Ice Holdings (FRZ) is a publicly traded company that has difficulty earning money.  At the current market price, the market cap is close to 69.5 million, with long term debt as of 9/30/2010 at 450.662 million dollars.  That is not pretty. The one analyst that renders earnings estimates predicts a loss of 67 cents for 2011, improving some to a loss of 19 cents in 2011 FRZ Analyst Estimates | Reddy Ice Holdings  This company makes ice.  Company Profile |

When an investor sees the phrase "second lien", then you have to find out about the first lien.  And, besides the operating history and the sheer magnitude of the debt which is worrisome for this small company, the size of the first lien note creates even more potential problems for the second lien note owner. As noted in the Reuter's  Key Developments section, Reddy Ice sold 300 million dollars ofthe first lien note in 2010.  And, importantly, that not comes due on 3/15/2015. (see p. 14  Form 10 Q) The second lien note comes due thereafter on 11/1/2015. A legitimate question could be asked whether the second lien note is secured by anything, sort of like a lot of second mortgages on homes throughout America now.  

The second lien note is described at page 16 of the Form 10-q for the Q/E 9/2010. It is not surprising that the coupon of this note is 13.25%, and I was able to buy it at a significant discount to par value. The possibility of a default is high, and any potential recovery in a bankruptcy is problematic.  I had to pay the seller $55.21 in accrued interest.

This is a link to the FINRA information on this bond:  FINRA

My confirmation states that the current yield at my cost is 14.825% and the YTM is 16.642%.  Those kind of yields today represent a clear danger signal, flashing red lights with bells and sirens screeching.

Reddy Ice released a disappointing earnings report earlier today, and the common stock is diving in response. 

2. Sold 100 of the TC DKF at 26.8 on Tuesday (see Disclaimer):  This TC represents a beneficial interest in senior Goodrich (GR) bonds maturing in 2038.  I sold 100 on 3/29, one day before the ex interest date, as other investors were apparently buying the semi-annual interest payment.   I sold the shares in the taxable account.

I am keeping the 100 shares owned in the ROTH IRA.  The first lot of 50 shares was in the ROTH IRA at $20, which gives me a current yield on this investment grade bond of 10% per annum until it matures in 2038 or upon early redemption by either the call warrant owner or the issuer. Buy of 50 DKF at $20 in Roth IRA (3/12/2009)   Since the underlying bond has a make whole provision,  it would be more likely for the call warrant owner to exercise its option than for Goodrich to redeem the bond. Item # 3 Make Whole Provisions For Long Term Bonds I added to the position in the ROTH by buying 50 shares last December:

I also included in the preceding snapshot the position in PFK, which was located just above DKF, that is owned in that particular IRA account. 

The underlying bond has a lower coupon than the TC. The TC has a 8% coupon,,  whereas the underlying bond has a 7% coupon. Nonetheless, the underlying bond is trading at well over par value. FINRA  

However, this TC is very vulnerable to a redemption by the call warrant owner at $25 per TC plus accrued interest. Besides the underlying bond selling at a premium to its par value, there is what I would call a surplus of bonds owned by the trust to support the higher TC coupon, the same situation that recently led the owner of a call warrant to exercise the option even when the underlying bond was selling at or slightly below its par value.  

TRUST Certificates: Links in One 

3. Added 50 HPQ at $41.15 on Tuesday (Large Cap Valuation Strategy) (see Disclaimer):   Credit Suisse started HPQ at an outperform rating with a $60 price target earlier this month.  The CS analysts believe HPQ will "easily" deliver $6 per share in earnings in calender year 2012.   The report had more detail in its 112 pages than the OG could absorb.  LB added for good measure that the OG took a nap after reading page 1, more or less.  The report is available to Schwab customers.  

Hewlett-Packard closed at $41.11 on Tuesday, down 2.44% or $1.03. 

There is invariably a short-sightedness that infects investors that is aggravated by a frequent belief that the future will merely be a continuation of the past. This will lead investors to predict growth rates that are unlikely to be achieved for some companies and to penalize others for events which are not likely to occur.  A corollary of that flawed thought process is the tendency to blow a problem way out of proportion, such as stagnant PC sales, while failing to appreciate progress made in other segments of the business.  Group think is the norm.

Companies that were considered too cheap at P/Es in excess of 30 or even 40 are deemed to be undesirable a few years later at less than 10 times, notwithstanding improvements in the business, earnings, dividends, and overall financial position. Nothing inconsistent is seen in those two judgments.  This result is not reached by the rational analysis of all available information in an efficient market as postulated by certain professors. The foundation of modern economic thought, the so called rational man, is simply the figment of over active imaginations, a modern equivalent of snake oil.  Efficient Market Hypothesis as Hokum  The underlying thesis of the large cap valuation strategy is that investors were not rational in pricing these large cap companies, like HPQ, in 1999-2000, and are no more rational now.  

How close will HPQ have to come to the $5.69 consensus estimate for F/Y 2012 (ending 10/2012), before the efficient market recognizes that a $41 price is too low?  HPQ Analyst Estimates   If the company hit $5.69, the forward P/E now would be about 7.2 with a P.E.G ratio of less than 1,  Key Statistics, and a dividend likely to grow in the double digits. There are undoubtedly many rational men who believe that is reasonable, though our OG is not one of them.  Absurd was the only word uttered here at HQ to describe the current HPQ valuation.  But, admittedly, the OG did not read all 112 pages of that CS report, nor can the remnants of his brain measure up to the brilliance of the Masters of Disaster who make decisions in the financial centers of the world. 

This last purchase of 50 shares brings me up to 100 shares. Bought 50 HPQ at 41.57 (see also Bought 50 HPQ at 38.2 (Sept 2010)-Sold: 50 HPQ @ 43.11 (Oct. 2010). HP's Board recently took a baby step toward a reasonable dividend payout by increasing the quarterly dividend to 12 cents from 8 cents and stating that it intended to increase the dividend year-over-year in the "double digits", subject to conditions of course. 

4. MKN Ends Its Second Annual Coupon Period with a 25.56% Coupon Payment: MKN is an unsecured note, issued by Citigroup Funding and guaranteed by Citigroup, that has a $10 par value and matures in 2014.  Interest is paid annually.  The interest computation is based on the greater of 3% or up to 33% based on the percentage gain of the DJ-UBS commodity index, provided there is no close in that index above 33% over the starting value.   If there is one close above the maximum level, which just happened to MKN's cousin MKZ, then MKN would have paid the minimum 3%.

Fortunately, there was no maximum level violation for MKN during its second annual coupon period and there was a significant rise in the commodity index from its starting value of 132.67.  The last day in the second coupon period was yesterday, 3/3/0/2011, and the commodity index closed at 166.58:  I calculate that the index increased 33.91 or 25.56%.  So depending on how that is rounded, I will receive on 4/6 about $256 in interest on that 10 dollar par value note. The ex interest date is not given in the prospectus but will generally be soon after the end of the closing period since the payment date is 5 business days after the closing date of 3/30.   I will check on on 3/31 and 4/1 to see if MKN is ex interest its annual payment.  Sometimes, a few individuals mistakenly pay up when one of these securities are ex interest.  When I check the quote, I can tell when the security has gone ex interest for such a large percentage payment.

The starting value for MKN's third annual coupon period will be the ending value for the second period: 166.58.  This places the maximum level at 221.55 for the third annual period.  One close during the third annual period above 221.55 will trigger a reversion to the 3% minimum payment, irrespective of the percentage increase in that index on the closing day.   So, assuming Citigroup survives to make the interest payment, the worst that can happen is a 3% payment for the 3rd annual period.   I received 18% for MKN's first period.

If you are a Fidelity customer, you will not be allowed to buy this kind of note.

Bought 100 MKN at 9.85

The remaining junk bond bought by the OG and his ally RB last Tuesday will be discussed in the next post. HK was flabbergasted by the buy, and is embarrassed to even mention it in public, but it was the last straw. It was a GMAC bond. That is just against the most fundamental tenet of HK's religious beliefs.  HK could barely contain his anger, fired the OG on the spot, and brought back the Nerd Machine as HT.

Wednesday, March 30, 2011

Bought Back Synthetic Floater GJP at 22.25-ROTH IRA/Tax Accounting For Bonds Purchased in the Secondary Market-Too Complicated/

In an article in the WSJ, I noted several interesting facts that I wanted to jot down.   Profit margins for companies in the S & P 500 were 8.2% in the 4th quarter of 2010, the third consecutive quarter over 8%.  While that sounds good, the author of the article, Ben Levisohn, noted that this is about as good as it gets based on history.  Another measure of corporate profitability is the percentage of corporate profits as a percentage of national income.  The FED reported this number at 12.7%, which is also near the top of the historical range.  In other words, the question is whether it is rationale to predict over the near term a continuation of a historically high trend?  Possibly, while profit margins may not shrink much, profits could continue to increase by expanding revenue rather than profit margins.

S & P cut Portugal's debt rating to BBB- from BBB.  Of interest to European financial institutions, there was a statement from last week's EC summit confirming press reports that sovereign debt restructuring may be required before a government can access the European Stability Mechanism when it replaces the EC's existing emergency funding in 2013. ESM  A government's senior debt will be subordinated to any loans secured through the ESM.

The Case Shiller index of home prices in 20 metropolitan areas continues to confirm a double dip in housing prices.  As shown by the data on page 3 of that report, the only area experiencing an increase in home prices was the Washington, D.C. metropolitan area, leading the pack with a .1% increase in January over the December number. D.C. and San Diego were the only metropolitan areas showing an increase over the prior 12 months, though S.D. barely eked out a gain of .1%. The index is accessible by clicking the appropriate link at The latest data released yesterday is from January 2011.

Today is the final day in MKN's second annual coupon period. It will have another good payday for this period, the only question being how much. The DJ-UBS commodity index closed yesterday at 166.55,  MKN will make its annual interest payment on April 6, 2011 (see page PS-2: Pricing Supplement).  I received an 18% interest payment on my 100 shares for the 1st coupon period. Par value is $10 and the note matures in 2014. Bought 100 MKN at 9.85 (see also Item # 1  MKZ and MKN Now) The starting value for the second coupon period was 132.67. I will be able to compute the interest rate for the current period this afternoon.  A close at 166.55 today in the commodity index would mean a 25.5% coupon payment.   MKN has been a real hoss so far.  Its cousin, MKZ, has been a dud so far.  Things change.

1. Tax Accounting for Bond Purchases in the Secondary Market:  I had never purchased a bond in the secondary bond market prior to 2010. I did purchase a number of bonds in 2007 at par value directly from the issuer, as I shifted out of stocks into bonds.  I did not have to pay accrued interest for those purchases.  I knew that bond purchases made in the secondary market would require the payment of accrued interest to the seller.  A broker furnished me with a list of those payments made in 2010 at page 55 of my 1099:

Since I prepare my own tax return, and would not even consider paying anyone to do it,  I have to figure out how to account for the interest paid to the seller.  Was the interest paid added to my cost basis in the bond?  I quickly find out that my broker was not including those amounts in my cost basis.  Yet, when I receive the first semi-annual interest payment after purchasing the bond, I will receive the total amount, including what I had paid the seller of the bond, and the total amount will likely be included in interest income by my brokerage firm.  

Of the bonds listing in the above snapshot, all purchased late in 2010, I did not receive a semi-annual interest payment in 2010, but have started to receive payments in 2011.  

This was my first experience in trying to figure out the tax accounting interest associated with accrued interest paid to a bond seller.  I am handicapped in resolving that kind of issue by a number of factors, including a lack of any training or education in accounting matters.  In an earlier post, I mentioned that my law school, George Washington, required me to take a course in Federal Income Taxation back in 1974.  I attended one day of classes, decided that I could not stand it, and next appeared in the classroom for the final exam.  I also did not read any materials other than a perusal of the J.K. Lasser 1974 tax guide.  Somehow, I manage to pass the exam, though the margin over failure was not very large. 

Based on reading a number of articles found with a Google search, the consensus among those who appeared to be experts made sense to my simpleton mind.  I needed to include a line item in Schedule B deducting the amount of interest paid to a seller in the year that the issuer pays me provided the broker includes the amount that I paid to the seller when reporting my interest income in my Form 1099 for the 2011 tax year.

This adjustment to interest income is not yet being made by the broker.  For example, United Refining recently paid me $52.5 for 6 months interest on the one bond that I own, which reflects an entire 6 months interest on one 10.5% $1000 par value bond.   That entire amount is currently shown as interest income paid to me by my broker.  I paid the seller $33.25 of that $52.5.   If my broker does not adjust that $52.5 down by $33.25, then I need to have a line item in my 2011 Schedule B making that adjustment for that interest payment and all others similarly situated which will be all of the ones shown in the snapshot above and all others where I bought the bond in 2011, paid the seller accrued interest and later received an interest payment that year from the issuer.  

As I understand it, and this makes sense to me, I could not deduct the interest paid to the seller in Schedule B until I actually receive an interest payment from the bond's issuer and that entire payment is included in my broker's 1099 without any adjustment.  

I am just relying on what I read, which included the following: Accrued Interest on Bonds  I subsequently found some material on the subject from the IRS: 

This is a quote from an IRA publication 550 on this subject: "Accrued interest on bonds.   If you received a Form 1099-INT that reflects accrued interest paid on a bond you bought between interest payment dates, include the full amount shown as interest on the Form 1099-INT on Schedule B (Form 1040A or 1040), Part I, line 1. Then, below a subtotal of all interest income listed, enter “Accrued Interest” and the amount of accrued interest you paid to the seller. That amount is taxable to the seller, not you. Subtract that amount from the interest income subtotal. Enter the result on line 2 and also on Form 1040, line 8a." Publication 550 (2010), Investment Income and Expenses

Fortunately, my main broker does keep tract of a really complex issue arising when I sell a bond bought at a discount to par value which I have started to do in 2011.   While the first issue discussed above makes sense to me, the following issue appears to me to be needlessly complex. 

Yesterday, I mentioned that the profit shown by the broker for the 1 U S G bond sale was $32.44:

The proceeds from this transaction do not include the accrued interest, which will be reported as part of the interest income section in Schedule B. The proceeds includes just the amount received from the 1 bond adjusted for the commission paid. The amount paid to me by the purchaser in accrued interest is already reflected as interest income received in 2011. 

However, the cost basis shown is not the amount paid for that bond, which was $898. Instead, my broker has increased the cost basis to $902.06, and placed a "d" symbol next to the adjusted tax basis.

The reason for that adjustment is explained in note "d" and it is not the kind of adjustment that I would want to make on my own: "d - Adjusted cost basis reflects any cumulative original issue discount, premium, or acquisition premium (including any year-to-date amount). It assumes such amounts were amortized or accrued for tax purposes from the acquisition date through the disposition date (or, for securities still held, through the maturity date). Premium amortization was calculated using the yield-to-maturity method. Acquisition premium was calculated using the ratable accrual method. Any market discount accretion for this position was calculated using the straight-line method and, if applicable, recognized upon disposition. Gain/loss displayed for this position is calculated using the cost basis adjustments as described above."

This issue is discussed in this article: Cost Basis - Bonds bought at a discount

A separate schedule reflects details for realized market discounts and shows that the U S G transaction resulted in a $4.06 upward adjustment in my cost basis with the symbol "r" next to that number:  " r - Market discount income was calculated using the straight-line method from acquisition date through disposition date. This market discount income is included in the adjusted cost basis provided. Our calculation assumed the taxpayer elected to defer recognizing market discount until sale (or other disposition)."  This $4.06 accounts for the tax cost difference shown in my confirmation of $898 and the $902.06 shown as my adjusted cost basis by the broker. 

Since I did not sell a bond purchased in the bond market until 2011, I can work more on addressing the tax accounting issues next year.  My question now is where else that $4.06 has to show up if I add it to my cost basis as my broker has already done. I suspect, though do not yet know, that it would have to appear as OID interest income.  If that proves correct, then I would be adding $4.06 in Schedule B and in effect subtracting $4.06 from the Schedule D total creating a wash.  Since the U S G bond sale was a short term capital gain, there would be no impact on a federal tax liability by those adjustments.   It could have a negligible impact only if I had a long term capital gain on the bond sale, which I did not, and my highest marginal rate was greater than 15%.  

The Nerd Machine is proud of the fact that the HK's 1099s and associated tax information are approaching 100 pages.  One of its goal in life is cause the Heaknocker's return to exceed the width of the Nashville phone book and to require the resolution of tax issues that would perplex the Almighty.   

2. Bought 100 GJP, A Synthetic Floater, at $22.25 on Monday (see Disclaimer): I am gradually moving toward playing with the house's money on this security, though I have not yet realized a large percentage gain trading it.  I have been in a trading mode for GJP since 2009:    Bought 100 GJP at $18.97 (Oct 2009)  Sold 100 GJP at 22.42 (Feb 2010)  Bought 50 GJP at 20.55 (July 2010) Sold: 50 GJP at 23.31 (Oct 2010)  Bought 100 GJP at 21.95 (Jan 2011) Sold 100 GJP @ 23.52 (February 2011).  I also bought some shares back in April 2009 at  $17,75

GJP is a trust certificate (TC).  It is also a Synthetic Floater. The trust owns a senior bond 5.95% coupon issued by Dominion Resources (D), a large electric utility based in Virginia. Both the TC and the underlying bond mature on 6/15/2035.  The TC has a $25 par value.  The owners of GJP are entitled to receive, by virtue of a swap agreement, the greater of 3% or 1.15% over the 3 month treasury bill rate.  GJP has a maximum interest rate of 8%.  So, for as long as the swap agreement creating a floater remains in effect, I know the minimum and maximum interest rates for this security at a total cost of $22.25.  The minimum coupon will be 3.37%, which is being paid now, and the maximum yield at that total cost number would be about 8.99%. The maximum rate would be hit with a treasury bill rate in excess of 6.85%.

While the owners of GJP do not receive the fixed coupon of the underlying bond, unless the swap agreement terminates for some reason (e.g. JBK), they are nonetheless vulnerable to the credit risk of the issuer of that bond.  If Dominion fails to pay the GJP trustee the interest owed on the 2035 bond, then the owners of GJP will not be paid.

I am comfortable with the credit risk. S & P rates the underlying bond at A-. This is one reason that I continue to come back to this security.

GJP also makes monthly interest payments, another plus.

I am not that much worse off than a buyer the underlying note, which is trading slightly above its par value.  FINRA The owner of that bond does receive the fixed coupon of 5.95%, but their current yield is closer to 5.83%, whereas the TC owner would receive 3.37% at a total cost of $22.25.  So, I am giving up a little less than 2.5% in current yield.  In exchange I receive three benefits compared to the owner of the fixed coupon bond.

First, I am paid monthly rather than semi-annually.

Second, I will make an additional yield by holding the TC to maturity representing the difference between my purchase price of $22.25 and $25, while the buyer of the underlying bond would have a slight loss on the security by holding until maturity.

Lastly, and more important, I have some inflation protection with GJP's float which is good at 1.15% over the 3 month treasury bill.  That provision will kick in when the three month treasury bill exceeds 1.85%, a low number by historical standards.  When the 3 month T Bill hits 4.8%, a buyer of GJP would have the same coupon as the owner of the underlying fixed coupon bond at 5.95%.  A buyer of GJP at a total cost of $22.25 would hit that 5.95% current yield, assuming a total cost purchase of the underlying bond at par value, at slightly less than a 4.25% 3 month treasury bill rate during the applicable computation period for GJP and would thereafter exceed it.  The break even point would be lower if the underlying bond was purchased above its par value  (Calculation: .0425% 3 month treasury bill + .0115% spread= .054% coupon multiplied by $25 par value= $1.35 annually per TC divided by a total cost of $22.25= .0607%)

GJP Prospectus:
Underlying Bond Prospectus: FORM 424B5

YF does not show any shares traded on Monday when I bought my 100 shares.  Only 400 shares are shown as traded yesterday, with a price range from $22.24 to $22.7.  This is a very thinly traded security. I used a limit order.  

Tuesday, March 29, 2011

Eastman Kodak (EK)/Hudson City (HCBK)/Bought 40 VCBI as LT at 5.56/Sold 1 USG Senior Bond at 94.25 & Bought 1 First Data Senior Sub at 98.75-Both Maturing 2016

GE (own) has apparently found a new source of income, tax refunds from our destitute Uncle Sam.  NYT  In 2010, GE requested a tax refund from the government of 3.2 billion dollars.  And over the past years, GE has reported 26 billion in profits from its U.S. operations while claiming a tax benefit of 4.1 billion.  Perhaps, GE could develop a new business, renting out its tax lawyers and accountants to other companies, thereby enabling all of America's richest corporations to escape income taxation and to collect their fair share of refunds paid by money borrowed from China.

Last Friday, shareholders of Eastman Kodak received some good news. The International Trade Commission will review an administrative law judges finding that Apple and RIM did not infringe EK's image review patent. BusinessWeek  Reuters This is a link to the ITC's notice of review: .pdf The EK common shares rose 5.29% in trading yesterday. While this is not equivalent, of course, to a reversal, it does make it more likely that Apple and RIM will settle with EK, as noted by by the analyst Shannon Cross, quoted in a WSJ article on this subject. EK needs the money and settling patent litigation appears to be its primary profitable operation. I own just 1 senior EK bond maturing in 2013 and have no interest in the common stock.  RB Bought 1 Eastman Kodak Bond Maturing 2013 at 94.9 That bond is now selling near its par value. FINRA

Hudson City Bancorp (HCBK), one of my two problematic holdings in the Regional Bank Stocks' basket strategy, announced after the close yesterday a restructuring charge of 644 million dollars or $1.34 per share.  (SEC Filed Press Release)  HCBK significantly reduced higher cost borrowings by paying off 12.5 billion dollars in "structured quarterly putable borrowings" that was funded by the sale of 8.68 billion in securities and 5 billion short term borrowings. As discussed previously, Hudson's regulator was concerned about Hudson's ability to cope with increased rates. Item # 5  HCBK (3/3/2011 Post).  The putable borrowings represent a significant part of Hudson's interest rate risk, "both in current market pricing (reflected in our calculation of net portfolio value) and sensitivity to price changes from interest rate movements."  HCBK will still have approximately 16.6 billion in quarterly putable borrowings, but the bank intends to hedge or modify "certain" of those borrowings.  The bank expects to continue paying a dividend at a rate to be set by the Board at its next meeting on 4/19/2011.  Assuming a dividend is allowed by the U.S. Office of Thrift Supervision, I would anticipate a significant reduction in the current payout. 

1.  Bought 40 VCBI at $5.56  Last Friday (LOTTERY TICKET strategy)(see Disclaimer):  RB, who was then Head Trader, considered buying  either Virginia Commerce Bancorp or  Webster Financial (WBS) and was about to buy VCBI based on the allure of the name Virginia.  Fortunately, LB took possession of the trading desk, nixed the RB's plan to buy VCBI and instead bought 50 of WBS at $4.58, later sold at $22.59. Frequently, there is a razor's edge between success and failure.  The action at HQ's trading desk that day was described as follows in a Post Dated March 26, 2009 (with some deletions to shorten the quote): 

"For whatever reason, Mr. Right Brain wants to focus on buying lottery tickets in banks stocks.  He narrowed today's choice down to two banks, Webster Financial and Virginia Commerce Bancorp.  The last earnings report from Virginia Commerce showed an acceleration of loan losses and delinquent accounts. . . As a result of an infusion of capital under TARP, the bank claimed to have as of 12/31/2008 a Tier 1 ratio of 13.07% and a qualifying capital ratio of 14.44%.  It operates in the relatively affluent area of Northern Virginia and is headquartered in Arlington, Virginia which is a suburb of Washington, D.C.  VCBI . . . To even buy a lottery ticket in these small regional banks, there has to be some faith in a recovery starting later this year and that the worst is behind us.  Right Brain (RB) is always optimistic, willing to not only throw caution out the window but also to bury it where Left Brain (LB) can not find it again.  VCBI reached its high in 2006 at over 21 and the decline started to accelerate in April 2007.  Chart | VCBI 

The stock shows a lot of weakness, now trading below its 200 and 50 day moving averages.  The 200 day moving average was broached on the downside in 2006, so this is a strong and long downtrend showing no signs yet of reversing.  

The other stock considered by RB was Webster Financial (WBS).  This one looks more solid, though under a lot of stress.  This is the largest bank in New England that sold for over $50 a share in 2007 and was still over 40 when the bear market started.    Share Price Chart | WBS  It really started to tank in September 2008.  The problems accelerated with a 300 million dollar loss in the 4th quarter of 2008 consisting of an assortment of charges including goodwill impairments, write-downs and loan losses, the usual potpourri. . . 

One error by the bank was to venture into acquiring home equity loans generated by third party sources, always a bad idea in my book.  As you would expect in that loosey goosey corner of the mortgage market, sensible rules were not exactly followed, meaning there would be no income verification  and the loan to value ratio would be 90%.  However, the companies book of mortgage business with its banking customers appears sound with loan to value ratios as of November of 49% and an average FICO score of 731.  The bank also operates in a relatively affluent area of the country.  The dividend has already been cut to a penny a quarter so that piece of bad news is already baked into the stock price. . . . 

RB does not weigh pros and cons, just brings the idea to LB for analysis by the deep thinker.  If RB could decide, it would have picked Virginia Commerce because it likes the name Virginia.  LB, however, firmly in control of the keyboard here at the trading desk picked WBS for a 50 share lottery ticket purchase filled at $4.58."  

WBS was later sold at $22.49 (3/4/2011). VCBI has gone nowhere in price since it was considered for purchase in March 2009. VCBI closed at $4.34 on 3/30/2009.   VCBI Interactive 5 year Chart The losses experienced by VCBI thereafter kept the lid on any price share gains.  RB said so what, it still likes the name Virginia. 

Recent quarters, including the 4th quarter of 2010, have shown improvement.   For 2010, the bank earned 57 cents per diluted share, much better than the $1.42 loss from 2009. (2010 Form 10-K at p. 3).  As  of 12/31/2010, the efficiency ratio was at 52.45%;  the NPLs to total loans was at 2.72%, down from 4.6% as of 12/31/2008; the tier 1 capital ratio as a percentage of risk weighted assets at the holding company was 13.2%; the allowance for loan losses to NPLs was at 108.79%;   the tangible common equity ratio for the bank was 11.01%; and the net interest margin was 3.96%:  SEC Filed Press Release 

The consensus estimate for 2011 is 56 cents per share and 73 cents in 2012. If the bank's results show that kind of acceleration in earnings, I would anticipate that the share price will eventually pick up.  I view VCBI and Fauquier Bankshares, both operating in Northern Virginia, to be potential takeover targets for this rapidly growing geographic area.  (see discussion on FBSS at Bought 50 FBSS @ 13).

Unlike Fauquier, VCBI participated in TARP.  I noted a few months ago that VCBI wanted to sell 75 million in stock to pay back TARP but withdrew the offering after receiving a negative investor reaction.  TheStreet VCBI still has 71 million of the government's money on its balance sheet.  I view that as a major negative.  Still, it is low cost money, at least for the first five years. At the end of five years (2/15/2014 to be precise), the rate goes from 5% to 9%.

Hopefully VCBI will be able to successfully raise whatever capital is necessary to redeem the government's cumulative preferred stock before that increase takes effect.  The likelihood of a large share offering probably places a lid on the stock now, just due to the uncertainty and possible dilution down the road.

VCBI is not currently paying a common stock dividend, a major negative from my perspective and consequently another reason for the Lottery Ticket classification.

I also do not like that part of the TIER 1 capital comes from a trust preferred security (20.6%, p. 23 Form 10-K), which is viewed as a bond here at HQ.  VCBI is small enough, however, that it can continue to include that TP as part of TIER 1 after the passage of the 2010 "financial reform" law.  The rates payable by the TPs are discussed in note 15 at page 64.  Still, the terms of the TPs appear to be good for VCBI.

VCBI closed at $5.51 in trading yesterday.  A director recently acquired 426,000 shares at $5.62: Insider Trades - LEHMAN KENNETH R  This transaction with Mr. Lehman is further described in this SEC filing.

2. BOUGHT 1 First Data 11.25% Senior Sub Bond at 98.75 Maturing 2016 and Sold 1 6.3%  U S G Senior Bond at 94.25 Maturing 2016 Last Friday (Junk Bond Ladder Strategy) (see Disclaimer):  Both of these bonds mature in 2016 and are deservedly rated well into junk territory.  With the First Date Senior Subordinated bond, I pick up more yield in exchange for more risk compared to the senior U S G bond that was sold.  As previously mentioned, I am already past my comfort level in junk bonds and will try to sell one whenever I decide to add a new one.  A small profit was realized on the U S G sale. Bought 1 Senior USG Bond at 89 Maturing in 2016 (1/4/2011 Post).  My broker shows a $32.44 realized gain from the USG bond sale.  In addition to the principal amount, the buyer had to pay me $23.63 in accrued interest which will be included in the interest income section of my 2011 Form 1099.  There are several difficult to understand tax accounting issues for U.S. taxpayers connected with both of those numbers that I will discuss in later posts. 

I view all of the bonds in the Junk Bond Ladder Strategy as risky, and the First Data is extremely dicey given its high level of debt and earnings history.  The company was saddled with way too much debt as a result of a 27.5 billion leveraged buyout by KKR.  First Data' eliminated  1,700 job soon after KKR completed the acquisition.   

Leveraged buyouts serve no useful purpose and generally results in job losses for no good reason other than the necessity of reducing expenses due to the debt.  A healthy, vibrant company was turned into one where legitimate questions can be asked about its ability to survive.

A recent example of the damage inflicted on formerly vibrant companies by the Masters of Disaster can be found in the bankruptcy filing yesterday of Harry and David, a 75 year old company, that was loaded up with debt resulting from a leveraged buyout.

First Data recently filed its 2010 Annual Report with the SEC.  Form 10-K The company had revenues of 10.38 billion dollars and an interest expense for 2010 of 1,796 billion. Needless to say, with such an absurd level of debt, First Data had a net loss attributable to its shareholders of over 1 billion dollars, due to the ridiculous debt load.  There has been no progress of paying down the debt load incurred as a result of the KKR leveraged buyout. At page 23 of the Annual report, the long term debt is listed at 21.953 billion as of 12/31/2007. The company ended 2010 with 22.4388 billion in long term debt and had 509.5 million in cash and cash equivalents on a consolidated basis. (324.3 million held by non-guarantor subsidiaries, see page 125)

While the debt level is just horrendous, First Data has recently been successful in extending the maturities of about 6 billion in debt, see page 43.

My confirmation states that the First Data bond has a current yield of 11.3% and a YTM of 11.37%.  The bond matures on 3/31/2016. At the price that I sold the USG bond, the current yield is 6.741% and the YTM is 7.756%.   In exchange for the higher default risk connected with the First Data bond, I at least pick up about 3.54% in additional current yield per year.

This is a link to the FINRA information on this bond.  S & P rates it CCC+ and Moody's is at Caa2.  I am more in accord with the Fitch rating of CC.

Headknocker was not pleased with the First Data buy and told the Old Geezer to quit listening to the RB when making these trades. If another First Data bond is bought by any of the knuckleheads, HK will show his displeasure by kicking some serious ass, ass kicking is of course one of HK's most endearing qualities.  LB was quick to agree with the Great Leader, noting again that the unholy alliance between the OG and the RB has to end badly, one of LB's rules even says so, neither crunch the million or so variables and alternate scenarios before reaching a decision like the LB. Considering one variable is the maximum limit for the Old Geezer, assuming that variable is comprehensible to a four year old.

Hopefully, LB added with emphasis and urgency, there will be enough money left when HK fires the OG as Head Trader to enable the Stock Stud to repair the gaping wounds.  LB was quick to add that First Data was a typical lame brain decision made by the Nit Wit RB and the OG is just too feeble minded, possibly with early onset dementia, to resist the RB's incessant carnival barking babble.    carnival barker images 

Monday, March 28, 2011

Bought 1 Cenveo 7.875% Senior Sub Bond Maturing 12/1/2013/Sold 50 JZS at 23.1 in Roth IRA/Bought 50 IND at 22.95

Only twenty-eight per cent of the Portuguese population between 25 and 64 has completed high school.  WSJ  Portugal will likely be the third EC country to recieve a bailout, though the government insists that no bailout is necessary. The government debt in Portugal is approaching 90% of its GDP.

Shipping companies, fearing radiation, are avoiding the Japanese ports at Tokyo and Yokohama.  NYT

An article in Sunday's NYT reveals that the Fukushima nuclear station was not designed to withstand known risks.  The first clear reference to tsunamis by Japan's equivalent to our Nuclear Regulatory Commission came in 2006, when the word first appeared in standards for new nuclear plants. Those guidelines basically asked Japan's power companies to think about tsunamis when designing nuclear stations.

1. Bought 1 Cenveo 7.875% Senior Sub Bond Maturing on 12/1/2013 at 97.5 on Thursday (Junk Bond Ladder Strategy)(see Disclaimer):  Cenveo (CVO) is a publicly traded printing company. This is a link to the firm's web site: Cenveo  The consensus earnings estimate is for an E.P.S. of 50 cents this year and a $1 in 2012. Two analysts contributed to that estimate.  The market cap of the company at a $6.15 share price is around 385 million.  Revenues for the F/Y ending 1/1/2011 were 1.814 billion. cenveo10k.htm  The company lost $2.99 per share in that fiscal year.  A lot of that loss was due to a 181.4 million non-cash charges for goodwill and asset impairment in Cenveo's commercial printing operation. (p.180).  The debt level is uncomfortably high for this company in my opinion and is described at pages 24-25 and pages 47-52 of the last filed annual report:  Form 10 K

The note that I bought is called a "senior subordinated" note which means to me a junior bond for all practical purposes.  It is subordinate to a lot of more senior debt.  However, as shown in the chart at page 47, no other debt is due before the 2013 note matures which is a plus.

My confirmation states that the current yield at my cost is 8.011% and the YTM is 8.592%.

This is a link to the FINRA information about this bond: FINRA The bond is rated well into junk territory at Caa2 by Moody's and CCC+ by S & P.  RB just said that a C+ is almost a B-.  

2. Sold TC JZS at 23.10 in ROTH IRA Last Thursday (see Disclaimer):  JZS is one of several trust certificates that contain the 2033 senior Goldman Sachs' bond as its underlying security.  A Trust Certificate, which trades like a stock, represents an undivided beneficial interest in the assets owned by a trust.  An independent trustee collects the interest payments from the debtor, and then distributes those payments to the owners of the TC.  In the case of JZS, the TC has a coupon of 5.8%, lower than the 6.125% 2033 GS bond.

The TC coupon can be the same, higher or lower, than the bond owned by the trust.  Fewer bonds will be deposited into the trust to support a lower coupon than a higher one, and that fact alone can impact when and if the call warrant owner exercises its option to redeem the TC at par value plus accrued interest and to take possession of the bonds.

That issue came up recently in connection with the redemption of the TC XFJ , containing a Motorola bond, where the TC had a much higher coupon than the underlying bond.  I did the math to show why it was advantageous for the TC owner to call, given the number of bonds owned by the trust needed to support that higher coupon for the TC.  I thought that it would be helpful to copy that discussion, since JZS has a coupon lower than the underlying bond and one reason for buying it was a potential call by the warrant owner: 

"After the the owner of the call warrant exercised its option to redeem XFJ, I was curious why, since the underlying bond, a 2028 senior Motorola bond, was selling near par value.   In fact, I noticed that someone, most likely the owner of the call warrant, sold over 18 million of those bonds on the day of the redemption, with several entries at FINRA grouped together in time.  All of those transactions were near par value.

In answering this question, I am handicapped, in that I would prefer that someone else do all of my math chores.  I have had an aversion to math for my entire life, similar to my disdain for most vegetables.  And, it would add that I decided to go to Tulane in 1969 since that college allowed me to substitute philosophy for calculus.   But, I thought that a better understanding of this issue may be a relevant issue for the future, so I tackled it over the long weekend.

First, as previously discussed, it is common for a TC to have a different coupon than the underlying bond owned by the trust.  Where the TC has a higher rate, then the brokerage firm would have to deposit more bonds with the lower coupon in order to support the coupon payment.

For XFJ, there was a wide discrepancy in coupons.  The Motorola bond has a 6.5% coupon whereas the TC XFJ had a 8.375%.

Trustee's Distribution Statement shows $32,875,000 million in principal amount of the 6.5% MOT bonds.  Those bonds produced $1,068,437.50 of interest for six months, and those funds were distributed to the TC owners. The original Prospectus states that there are 1,020,597 trust certificates with a $25 par value.  Thus,  it took 32.875 million in principal amount of a 6.5% bond to support a 8.375% coupon for a 25.514925 million in principal amount of TCs.  But for a $25,514,925 payment to the owners of the XFJ, plus accrued interest, the call warrant owner could acquire title to $32,875,000.  So it would be become profitable for the call warrant owner to exercise the call even when the underlying bond is selling near par value.  The problem would be finding buyers for most of those bonds before the exercise to avoid holding such a large inventory.

Possibly, there were more TCs actually sold than noted in the prospectus. To check whether or not this happened, I performed the following calculation.  For a year, the bonds that were in the trust would generate $2,136,875 in interest.  The principal value of 1,020,597 TCs at $25 is $25,514,925 which would generate $2,136,874.97  in annual interest income at 8.375%.

Voila, the call warrant owner acquired $32,875,000 in principal amount for $25,514.925.  When the bonds are sold, the buyer would have to pay the accrued interest, so the call warrant owner does not lose anything by having to pay the accrued interest to the TC owners.   And, it would be profitable to exercise the call even if the call warrant owner could sell the bonds at or even below par value."   Item # 7  
More on Call Warrants and TCs 

I had previously traded JZS for a profit:  Sold: 50 JZS @24.15 (Oct 2010)- Bought 50 JZS at 22.95 (August 2010).  I decided to repurchase JZS and other TCs containing the 2033 senior GS bond, which were selling at discounts to their $25 par value, after the call warrant owner called DKW shortly after I made a 150 share purchase: Bought 100 DKW at 22.86 Bought 50 DKW @ 23.07 Alert on TC DKW-Exercise of Call Warrant/SOLD 50 OF 150 DKW @ 25.20 Sold 100 DKW @ 25.25 At that time, the 2033 bond was selling at around 104-106, so it would have made sense for the call warrant owner to exercise the option. Now, that bond is selling closer to its par value. FINRA  When the current price is taken in context with the number of bonds owned by the lower yielding TCs, then it becomes even more doubtful that the warrant will be exercised, thereby undercutting the reason for buying back these TCs after successfully trading several of them.  (for trading of the fixed coupon TCs containing the 2033 bond, see in addition to the forgoing links:  Bought 50 PJI at 20.85 Sold 50 PJI at 23.52 Bought 50 PJI at 23.11 Bought 50 PYB at 22.83).  I just received the semi-annual interest payment on all of the 2033 GS TCs.   The last sale of JZS was near break even after commissions and the interest payment: Bought 50 JZS at 23.37

While I do not view the yield of JZS as attractive, its yield is still better at the $23.15 price than the yield of the underlying bond at any price above par value, where it has mostly been trading for months.  So an institutional investor interested in buying the underlying bond would generally be better off from a yield perspective by buying one of the TCs.    

3. Bought 50 IND at 22.95 in a Satellite Taxable Account Last Thursday (See Disclaimer): IND is one of several ING hybrids.   ING Hybrids: Links in one Post This kind of security is called a hybrid since it is both part of ING's equity for regulatory purposes while being a junior bond. For U.S. taxpayers, the ING hybrids pay qualified dividends, rather than interest, but these securities are in fact junior bonds, the most subordinated debt in ING's capital structure.  I have owned and sold IND and my brokerage company classified all of its distributions as qualified dividends. My last transaction was to sell 100 IND @ 23.92 in October 2010. 

I still own in a regular IRA a functionally equivalent ING hybrid, INZ, bought at $7.82 during the Dark Period. Buy of 50 INZ at 7.82 INZ has a slightly higher coupon. I view the coupon as irrelevant when evaluating functionally equivalent securities. The issues are current yield and yield to maturity at my cost. All of the ING hybrids traded in the U.S. have $25 par values and are at the same level of priority. Since the hybrids have no maturity date, the YTM does not exist, but I would still factor in the likelihood of a call for these perpetual securities.

ING reserves a right to call the hybrids at par value plus accrued dividends, but has no obligation to do so. For the hybrids traded in the U.S. there is no limitation on the call right except for IGK and IDG.  IGK  can not be called before 9/15/2013: IGK Prosepctus  IGK is also the only ING Hybrid trading at above par value, and it is in my opinion the most likely to be called given its high coupon of 8.5%. IDG can not be called prior to 10/15/2012.  IDG Prospectus IDG has the second highest coupon among U.S. exchange traded ING Hybrids.  It has a 7.375% coupon and is consequently less likely to be called than IGK. I recently purchased 50 shares of IDG:  Bought 50 of the ING Hybrid IDG at 23.96 (3/11/2011)

IND has a 7.05% coupon.  I have never been able to find its prospectus at the SEC.  It can be found at ING's web site: Hybrid Securities - ING (456837202/IND)

At a total cost of $22.95, the current yield is around 7.68%.  

I recently raised over 15 grand by selling some stock ETFs in a satellite account. The purchases of both IND and IDG in that account is meant to temporarily soak up some of that surplus cash. I am more than a little reluctant to invest those funds in stocks at the moment, and a money market yield is even a worse alternative.

I have traded in and out of ING Hybrids since the summer of 2008, and do not find them compelling at their current yields.  The current yield has some minor attraction on an after tax basis, but its is unclear how much longer the maximum 15% tax rate for qualified dividends will remain in effect.  

According to, all of these ING Hybrids are currently rated in junk territory, though at a higher level than virtually all of the bonds purchased to date in my Junk Bond Ladder Strategy. Moody's rates them at Ba1 and S & P is now at BB. Before ING ran into trouble during the Dark Period, I believe these hybrids were rated investment grade, though at or near the lowest level.  

I would emphasize the importance of the new EC Burden Sharing policy.  If one of these European institutions ever need state aid again, the owners of the hybrids will be required in my opinion to share the burden.  This means that the dividends will be deferred as a condition to the receipt of state aid with one caveat. If there is in effect a Mandatory Payment Event, then I would doubt that the EC would require a deferral as a precondition until after the expiration of such an Event. Anyone who invests in Hybrids has to fully understand the meaning of Mandatory Payment Event before purchasing one of these hybrids. 

And, in the back of one's mind, there needs to be a place where the following information is stored.  I was able to buy one of these Hybrids, ISF, at $ 4.60, back in February 2009, when many believed that ING was toast. The yield at that price was around 33%. ING did not defer any dividends payable to the Hybrid owners, but the single digit prices for those securities during the Near Depression period could not even be justified by an actual, as opposed to a feared, deferral.  Those low single digit prices would be rational only if there were reasonable and well justified reasons for believing that a bankruptcy filing was imminent and having a greater than 70% or so likelihood of occurring.  When I bought ISF at $4.6, I noted that the price said more about human beings than ING.  It is therefore important to remember about the volatility to the downside.