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: www.usitc.gov/ .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.  www.sec.gov 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.  WSJ.com

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 

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