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.

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