Thursday, March 3, 2011

HCBK/Bought 100 of the Bond CEF ERC at 15.13/MBC & MOU/Sold 50 ANIK at 9.43/Sold 100 VEU at 49.19/Edison Mission/FE

There is a mostly negative article about Cisco and John Chambers in this week's Forbes. The author asks rhetorically whether John Chambers has a problem.  The answer is that he has a bunch of problems and appears to be in denial. 

Another article in Forbes  discusses a study made by three professors that found that a portfolio of stocks with a low volatility and a low beta will substantially outperform a portfolio with high betas and volatility. In this study, beta is simply how much a stock swings up and down compared to a market average whereas "raw volatility" measures the up and down movement of each stock. I am not familiar with a stock screen for "raw volatility" but YF has one that includes "beta".  

I received a $270 annual interest payment yesterday on the $10 par value "principal protected" note, MOU, whose annual interest payments are linked to the performance of the Russell 2000.   MOU Ends Second Annual Coupon Period With a 27.93% Gain  Apparently, there is a rounding to $279 from $279.3:

I bought MOU at $10.12.  MOU is a senior unsecured note with a $10 par value, issued by Citigroup Funding  and guaranteed by Citigroup as provided in the prospectus, that matures on 3/10/2014.  It is just impossible for me to comprehend how any investor believes that this security is "principle protected" in the event of Citigroup's bankruptcy.  Any investor, who believes that is the case, has no business managing their own money.  Did any of them look at the prospectus before buying a Lehman note?  Personally, I would not trust a broker to manage my money, never have and never will, nor would I ever have any confidence in their knowledge about securities recommended by them.

If I own this note at maturity, and I probably will, I will receive $1000 for my 100 shares, provided Citigroup has not been seized by the FDIC or filed for bankruptcy.  Provided Citigroup survives to pay the principal in 2014, the worst outcome would be to receive the 3% guarantee in each of the remaining three annual coupon periods.  

While I like MOU, I would not pay much more than par value for one of these notes.  I have noticed some MOU trades on and after the ex interest date over $12, and I would have to disagree with the decisions being made by those buyers. MOU closed at $10.75 yesterday, and I would not buy it at that price either.  I would consider buying another 100 shares near par value.

I also own 200 shares of MBC, bought at below its $10 par value, whose interest payments are also linked to the Russell 2000.  I would not be surprised to see a reversion back to its 3% guarantee during its current coupon period.  (SEE ITEM # 5  MBC: maximum level in the ^RUT of 844.07 on or before 5/20/2011)  One reason to have two notes tied to a particular index is that one may have a good payday like a MOU in its 2nd annual period or MKN in its first, while another like MKZ ends up paying the guarantee, based mostly on a combination of different annual periods and allowable percentage increases in the relevant index.   It would be a bonus for both MOU and MBC to have a good payday in 2011.

1. Added 100 of the Bond CEF ERC at $15.13 in the ROTH IRA on Tuesday (see disclaimer):  This brings me up to 550 shares of this CEF, with 450 shares held in a taxable account.  It would make more sense to own the shares in the ROTH IRA since this CEF does not pay qualified dividends and the yield is over 8%.  In the Roth IRA, that would in effect be a tax free yield, whereas I am paying my top marginal tax rate on the dividends paid by ERC for the 450 shares held in a taxable account. 

(Correction to original Post: ERC did just lower the dividend from .1083 to 10 cents per share, effective for the March distribution, which reduces the yield to 7.93% at a total cost of $15.13. That is still almost a 4 1/2% spread over the 3.55% rate on the 10 year treasury as of the 3/4/2011 close, see comments to this Post)

As noted in several prior posts, ERC is a multi-sector bond fund, and that name describes its approach.  This fund will own bonds issued by governments and corporations throughout the world, both investment grade and junk bonds. 

Morningstar has a 3 star rating for ERC.  As shown on the preceding linked page, the fund is leveraged and none the dividend distributions have been classified as returns of capital since April 2010.   

This is a link to the last SEC filed shareholder report for the period ending 10/31/2010: Annual Report  The interest rates paid on borrowings can be found at page 33, note 6. 

The daily net asset value can be found at the sponsor's web site, the Closed-End Fund section at the WSJ under "other domestic taxable funds", and at the Closed-End Fund Association web site.  On Tuesday, the day of my purchase, I only knew  the net asset value for the previous day, which was $16.54 per share as of 2/28/2011.  The closing price for Monday was $15.16, creating a discount to net asset value at that time of -8.34%.  NAV rose two cents on Tuesday to $16.56 and the closing market price was at $15.19, creating a 8.27% discount.  On Wednesday, the shares closed at $15.29, with the net asset value at $16.57 per share.   

I have previously discussed this CEF in a number of posts including the following:  Bought Back 100 ERC at 15.63 (December 2010)  Sold 100 ERC at 16.27 (October 2010)  Added 100 ERC at 15.23 (September 2010) Added 100 of the CEF ERC at 15.25 (August 2010)  Added 50 of the CEF ERC at $14.14 (February 2010) (noting a prior purchase of 100 shares at $12.96 on 7/30/2009,  Item # 3 7/30/2009 Post)

2. Edison Mission (own senior bonds):   Edison Mission filed its 2010 Annual Report with the SEC on Monday:  Page 88 shows net income of 164 million in 2010. Adjusted operating income for 2010 is stated to be  502 million at page 44.  On page 89, the balance sheet shows 1.075 billion in cash and cash equivalents on a consolidated basis, with 427 million held at the holding company level (pp. 42-43).  Long term debt, net of current maturities, is high at 4.342 billion dollars. Property, plant and equipment is carried at 5.332 billion as of 12/31/2010. The environmental litigation is one major concern, particularly as it relates to the large Homer City generating station.   (see, e.g., page 150). A prolonged discussion of the debt and maturity schedules can be found between page 113 to 118, a must read along with the environmental issues for anyone contemplating a purchase of these high risk bonds.  I own just 2 bonds and will not add more:  1 Edison Mission Energy 7.75% Senior Maturing 6/15/2016 1 Edison Mission 7% Senior Bond Maturing on 5/15/ 2017   Both of those bonds, as noted in those posts, were bought at significant discounts to par value.

3. Sold Remaining 50 shares of ANIK at $9.43 on Wednesday (LOTTERY TICKET strategy) (see Disclaimer):  I was just waiting for this small position to turn into a long term capital gain before selling the shares.  Headknocker has expressed his serious displeasure with all traders here at HQ after seeing his tax bill for all of the short term trades made in 2010. Our Great Leader demanded that the LB, responsible for most of that trading, to pay the charitable contribution to our destitute Uncle Sam.

I bought the 50 shares at $6.3.

There has been some recent news about ANIK, and it has just been too hard for the OG to determine whether the positive news outweighs the negative.  There was a press release in mid-February that knocked the stock down temporarily relating to the speed of the FDA's process for approving MONOVISC.  Based on that release, the stock declined from $9.52 to $8.13 on 2/15: ANIK Historical Prices

Yesterday, Anika Therapeutics announced a five year distribution deal for its recently approved FDA product ANIKAVISC, an "ophthalmic viscoelastic" product (see for a technical explanation:  Use of viscoelastic substance in ophthalmic surgery)

Then the company mentions that its existing product AMVISC, will continued to be distributed by Bausch & Lomb, but the new agreement, which changes from being an exclusive to a non-exclusive deal, will result in "significantly less revenue" in 2011.  All of this is way beyond the Old Geezer's ability to process.  Thankfully, there is Google which allows the OG the ability to quickly discover what "ophthalmic viscoelastic" means, at least to the extent his addled mind, rapidly turning to mush, can comprehend.

I would note that there have been a number of Schedule 13-G filings for Anika.  SEC Filings for Anika These will show the acquisition of more than 5% of the outstanding shares by an entity or person.   The latest one is by Eliot Rose Asset Management, noting a 5.1% stake. This is a decrease from 8.3% reported in 2/2010. Another is by Wellington Management disclosing a 5.59% stake.  Since Anika is such a small company, it would not take much of a large mutual fund's money to acquire a 5%+ stake.

4. FirstEnergy (FE)(own: core electric utility strategy):  FE completed its acquisition of Allegheny Energy, formerly traded under the symbol of AYE, by issuing .667 shares of FE for each share of AYE.   Form 8-K   Morningstar has a four star rating on FE.  This acquisition will grow FE's customer base by about 35%.  I recently pared my position in FE by selling my highest cost shares for a small profit, with the intent to buy back those shares when the purchase would reduce my average cost per share.  SOLD 50 FE AT $40.7 (2/3/2011 POST). After reporting  disappointing 4th quarter earnings (item # 3  FE), the shares has since slid to below $38.   My last purchase was  @ 36.1 last October.  I am reinvesting the dividends and my current average cost per share is $38.32. Under my trading system, I can buy back those shares at below that average, but I would prefer a lower re-entry point. FE just went ex dividend on 3/1 for its quarterly dividend payment. The current dividend is 55 cents per share: FirstEnergy Corp.- Investor Relations - Dividend History

Barclays Capital recently raised its price target to $40 and maintained an equal weight recommendation.

Since February 2010, this stock has been working its way up and down within a narrow channel between $35 and $40.   FE Interactive Chart   It has recently crossed below its 50 day moving average.

5. Hudson City (HCBK)(own: Regional Bank Stocks basket strategy): Hudson disclosed yesterday that the U.S. Office of Thrift Supervision is about to issue a memorandum forcing changes in Hudson's business.  Reuters This kind of memorandum may require approval by the government of dividends and changes in the business model and risk taking. I would no longer view Hudson's dividend as secure under these circumstances.    While I have been critical of all of HCBK's earnings releases since I initiated a small position, I was surprised by this development.   (for critiques, see e.g. Item # 3 HCBK-1/20/2011 Post)

I found the following statement at page 40 of the recently filed Annual Report:

"As a result of the enhanced regulatory scrutiny, our interest rate risk position, our funding concentration in structured borrowings, our significant growth since 2005 and certain regulatory compliance matters, we expect to become subject to an informal regulatory enforcement action in the form of a memorandum of understanding (“MOU”) with the OTS. Under an MOU, the Bank may be required to reduce its level of interest rate risk and funding concentration, adopt certain policies and procedures to achieve such reductions and address certain compliance matters. In addition, the OTS has the authority to establish higher capital requirements for individual institutions, impose restrictions on distributions from the Bank to the Company and restrict the ability of the Company to pay dividends to its shareholders, to repurchase stock and to incur debt. We have the intention and the ability to comply with an MOU"   SEC Filed  2010 Annual Report

This is a link to a NYT article on this matter.

I intend to hold my position even though the dividend is in danger of being cut or eliminated.  No one should be surprised at this point with the government prohibiting dividend payments until Hudson makes changes in its business model deemed appropriate by the OTS, though it is not certain that the OTS will take such action at this time.  Hudson's capital levels are still good even though its net interest rate margin is one of the narrowest that I have seen among profitable banks.   I have noticed in the past that bad news emanating from Hudson has dragged down the entire regional bank sector, irrespective of the relevance of Hudson's issues to those other financial institutions.

The current price of Hudson's stock is near the March 2009 low:  HCBK Interactive Chart  I will not add to my position.

HCBK fell 9.01% in trading yesterday to close at $9.92.  That decline was deserved in my opinion, taking into account this broadside blow against HCBK's shareholders, the recent dismal earnings reports, and the downbeat guidance previously given by management for 2011 and discussed in a prior post.

An alternative view of HCBK can be found in this article, published today at Seeking Alpha, by a long time bull on this bank.

6. Sold 100 VEU at 49.19 (see Disclaimer):  This is my second round trip on this Vanguard ETF during the past year.  I collected the annual dividend and made a few bucks on the shares bought at  $47.73 last November.  I am simply selling some stock ETFs to raise my cash allocation.  The OG is nervous and has to relieve his anxiety attacks by reducing the stock allocation some.

The OG is always worrying.  What will happen if Saudi Arabia erupts in a manner similar to Libya?  There is considerable unrest in Yemen, located on the southern border of SA:     NYT  The photo of the guy in that article, with the dagger in his belt, is not someone that I would ever want to meet in person.   I doubt that he would listen to LB's reasoning and logic, which would be the case for all True Believers, domestic and foreign.

The remaining trades will be discussed in the next post.   One of the trades was to unload WBS for a 400% LT gain rather than to continue obsessing about it. 


  1. Just wondering about your CEF ERC buy. Won't ERC behave like a bond mutual fund in a rising interest rate environment and lose value?

  2. The short answer is yes to your question.

    But, there are at least four other considerations that come into play.

    (1) While I believe that rates will rise, I may be wrong. This falls under the heading of who knows what the future will bring.

    (2) It is important to look at the bond funds duration and effective maturity. A long term bond fund will be more adversely impacted by rising rates than one with a short average duration. According to the Fact Sheet for this fund, which can be downloaded at the sponsor's web site, the current effective maturity is 4.6 years and the average duration is 3.4 years. This gives the fund some flexibility to respond to higher rates given the number of bond owned with shorter maturities. The fund had 672 holdings.

    (3) The current yield of over 8.5% annualized at the current monthly payment rate provides me with compensation to assume the interest rate risk, as does the large discount for a bond fund to current net asset value. And,

    (4) I have sold some shares in this bond fund when the price exceeded $16 and will likely do so again. This paring process will lower my average cost over time. In the event I become really concerned about interest rate risk, I have the option of selling some shares at a loss too. Hopefully, if that happens, the dividend will provide me with an acceptable total return.

    Under no circumstances would I hold this bond fund when I am sure that a long term secular bear market in bonds is well underway. I believe that one has started but I am not confident yet in that belief. One way to protect myself is to have a trigger for reducing the position in bond funds.

    My trigger is a rise in the 10 year treasury note to over 10%. When that happens, and I believe that it will start in 2011, I will start the paring of bond funds without a term date, staring with the ones that have the longest durations.

  3. Thanks for that explanation. Just please clarify "a rise in the 10 year treasury note to over 10%". I assume you mean 10% off the low?

  4. correction on my prior comment: I did notice later today that ERC had reduced its dividend rate for the next monthly dividend from $.1083 to $.10 which reduces the yield to 7.93% at a total cost of $15.13. This does not change my opinion expressed in the prior comment given that I have to buy junk bonds to get a 8% rate.

  5. The reference to 10% is the result of some sort of brain malfunction. I meant to say 4%. The ten year note is now yielding 3.557% as of the close today. So I pick up almost 4 1/2% over that rate by investing in ERC at its current monthly dividend rate.

    I have previously mentioned a 4% yield on the 10 year as a trigger for a reduction in my bond fund holdings. I am also using a rise above a 1% to 1 1/2% 3 month LIBOR as a possible trigger on reducing my positions in leveraged bond funds who borrow at a spread over 3 month LIBOR.

    My last post mentioning the 4% yield trigger in the ten year treasury is from 1/7/2011, near the end of the introduction. Needless to say, at a 10% ten year treasury, bond fund investors would be in a world of hurt.