Friday, May 6, 2011

SOLD 150 of the Bond CEF HPF @ 19.14 and 150 @ 19.38/CVO DUK HFBC UBCP SHO/Sold 200 BKK @ 14.98/SOLD 100 MUE @ 12.3/Bought 50 SHOPRA @ 24.35/Edison Mission

Most of last Monday's trading action involved a reduction in exposure to leveraged long term bond CEFs.  These kind of funds will suffer a double whammy when interest rates start to move up.  First, their cost to borrow will increase,  thereby reducing their yield spread. Second, the value of the bonds purchased with borrowed funds will decline. Both of those factors would lead to declines in net asset value. Most likely, a third whammy will hit those funds, as investors flee them, buyers evaporate, and their discounts to net asset value increase. During the Near Depression period, I was able to buy some CEFs at greater than 30% discounts to their net asset values.

For many of the taxable leveraged bond funds that I own, the discounts to their net asset values have already started to expand some. It is impossible to know when the worm will turn against the leveraged long term bond fund. The cost of borrowed funds is still abnormally low and the spread between that cost and the yield of bonds purchased with those short term loans is still wide.  So, I am in a hyper trading mode on all bond funds with no term date and particularly those that use leverage to buy long dated maturities.  I still own many of them, since their current yields are still good in this low interest rate environment and no one can be sure that the long term bull market in bonds has ended or is about to end.

Notwithstanding my caution on long rates, bonds had a nice rally yesterday, with the ETF for the 20+ treasury bond, TLT, rising .95% in value. The IShares Investment Grade bond ETF, LQD, rose .34%. Commodities dived in price with oil declining almost 9% to close below $100 per barrel.  Gold plummeted almost $38 per ounce. The ETN for the commodity index, DJP, fell 5.47%.  There are certainly many signs that the U.S. economy is slowing and weaker demand is not an ingredient supporting the recent parabolic rise in commodity prices.

Cenveo (own bond only) provided a first quarter update.  Based on preliminary results, CVO expects to report net sales of 503.1 million, an increase of 11% compared to the 1st quarter of 2010.   SEC Filed Press Release The company experienced mid-single digit growth in its custom labels, commercial print, envelope and speciality products.  Part of the sales growth was due to the mid-February acquisition of MeadWestvaco's Envelope Products Group.  The company expects adjusted EBITDA for the 1st quarter to be $51.1 million, an increase of 12% over the first quarter of 2010 due to "stronger performances across the majority of the company's product lines..."   Bought 1 Cenveo 7.875% Senior Sub Bond Maturing 12/1/2013 at 97.5 

1.  UBCP HFBC   (own Regional Bank Stocks' basket strategy):

 United Bancorp (UBCP), a small bank operating in Ohio, reported a 8.12% in net income for the first quarter compared to the 1st quarter of 2010. The bank reported earnings of 15 cents per share, up from 14 cents in the year ago quarter.  The Board also declared a regular 15 cent quarterly dividend, equaling a payout ratio of 93.33% based on the 1st quarter earnings.  The dividend yield is over 6% based on the current price, (UBCP).  There is always a possibility of a cut with such a high payout ratio. This is not to suggest that one is imminent, since management of this bank may believe that there is sufficient excess capital to support the dividend even with earnings remaining stable at current levels.  But, an owner of UBCP could not act surprised either if there was a reduction at some point unless earnings started to increase at a faster rate.

I also look at a few numbers to make a snap judgment about how well a bank is doing.  As of 3/31/2011, the net interest margin was relatively good at 4.18%; NPLs to total loans were 1.69% (generally, I do not like to see a number over 2%); NPAs to total assets were 1.55%; and the total allowance for losses to NPLs was a potentially worrisome 53.94% (I prefer that number to be over 100% to cut down on potential future surprises on allowances for bad loans). As with many micro cap banks I have to look at the last filed 10-Q or Annual Report to find the capital ratios, since they are frequently omitted in the press releases discussing earnings.

The capital ratios are okay as of 12/31/2010. The tier 1 total capital to risk weighted assets ratio was at 13.3% (well capitalized under FDIC criteria is a minimum 10%).

Many of these small banks also own their real estate.  UBCP owns its main office building and all of its branch locations except for the ones located in Dillonvale and St. Clairsville, Ohio.  2010 Annual Report at page  44  The president of this bank, James Everson,  is 72 and appears to run the bank in a conservative manner.  According to YF, he owns 242,940 shares. The OG does not care for swashbucklers and Masters of Disaster (MDs).  If there is  a hint that MDs are allowed to run loose, the OG will take a pass or assign any purchase to the LT category where exposure is limited to $300.

I do not expect much price appreciation in this stock until the bank shows more earnings acceleration.

HopFed Bancorp (HFBC), a small bank headquartered in Hopkinsville, Kentucky, reported a net loss of 2.098 million, or 29 cents per share, compared to a net profit of 44 cents in the year ago period. The loss was due to 4.5 million in loan loss provisions. Sometimes, bankers will blame just about anything other than their own poor decisions for loan losses.

In the case of HopFed, the excuses include high gas prices, the weather including a few tornados in the general geographic area served by this bank as well as come flooding of the Cumberland river, the earthquake in Japan, higher mortgage rates (still at historic lows), and high gas prices. Possibly there was one more excuse, bird dung hit the CEO's eyes, blinding him for months, and when the Good Lord gave him his sight back, the CEO immediately saw all of these loans that needed additional allowances.

As of 3/31/2011, the total risk based capital ratio was 16.38% at the bank level (19.27% on a consolidated basis); NPLs to total loans was at 1.02%; the tangible book value per share was $12.15 (significantly above the current share price); the allowance for loan losses as a percentage of non-accrual loans was at 228.96%; and the net interest margin was at 2.94%.  I have a small position and have already decided to stay with it.

I am curious about the addition to loan losses given the already high allowance compared to non-accrual loans.  While I do not know the answer, you will see some loans that are known by a bank as likely candidates for defaults which are still current.  Sometimes, the borrower is staying current by using part of the loan proceeds to make the required payments, or using dwindling other sources of cash, rather than funding those payments out of operations, and eventually the well runs dry.

I discussed this issue in connection with loans to developers and the failure of another bank to adequately disclose its problems loans.  Construction Loans & WL  The practice has several names, including "delay and pray" and "extend and pray", meaning the bank is hoping that things turnaround before the loan has to go on non-accrual and money set aside as an allowance for losses. USATODAY An outsider might look at the situation and say that a provision needed to be made sooner based on the known conditions, and it is misleading to actual and potential shareholders to keep the problem underneath their radar. This is why there is no absolute comfort provided by a high level of allowances to NPLs.

This is a link to a map of the HopFed banking locations in Kentucky and Tennessee.  Heritage Bank

2. Sold 150 of the Bond CEF HPF at 19.14 Last Monday in a Taxable Account and 150 at $19.38 in the Roth IRA (see Disclaimer):  I still own 100 of the leveraged long term bond CEF HPF.  The shares sold in the taxable account were bought in two increments, and I was able to clear a small profit due to the average down of 50 shares at $17.76. I also averaged down in the ROTH IRA account that day by buying 50 shares at $17.55 (ROTH IRA).  The other 150 shares that were sold on Monday in the taxable account were bought @ $19.14.  I am familiar with most of the bonds owned by this fund, and most of them are selling near or above their par values.  The leverage is generally hovering over 30%. Morningstar Unlike other bond CEFs that I own, this fund does not provide average duration. In its shareholder report, the fund does not identify the term of its bonds:  SEC Filed Semi-Annual Shareholder Report

An investor would have to be familiar with the maturity debts of the exchange traded bonds owned by HPF to realize that this is a long term bond fund.  I am critical of the failure to include this kind of basic information. Still, notwithstanding these issues, the current yield, the monthly dividend  and the discount to net asset value, are all still attractive.

I thought that the sale of 300 shares eliminated my position until I found another 100 shares in a satellite taxable account which I will now keep, sort of like finding lost money. OG said "I was lost and now I am found". RB says the OG is confused about the meaning of that phrase. LB said that losing things is becoming an increasingly common issue with the OG.  Intel's engineers need to develop a chip for insertion into the OG's brain that perform the same function as computer storage.  RB leaped to the OG's defense arguing that he does pretty well for an aging senior citizen whose brain is turning to mush. 

If an investor is not familiar with the bonds owned by this fund, information on most of them can be found at  (free site, registration required). 

HPF closed last Monday at $19.17, with a net asset value per share of $21.09.  The discount to NAV at those prices was then -9.1.

The rise in the share price last Tuesday was most likely due to a small increase in the monthly dividend to 14 cents from $.129. John Hancock Preferred Income Fund and Preferred Income Fund II Declare Increased Monthly Dividends I just used that pop to dispose of the shares held in my ROTH IRA. 

3. BOUGHT 50 SHOPRA at $24.35 Last Monday (see Disclaimer): SHOPRA is a typical REIT cumulative preferred stock. I discuss the advantages & disadvantages of this type of security in a 2009 Gateway Post.  This particular preferred stock is an issue of Sunstone Hotel Investors (common stock symbol SHO). As the name suggests, SHO owns hotels. 

SHOPRA is what I call an equity or traditional preferred stock. Such a security will be junior to all bonds in the capital structure and senior only to common stock.

Unlike other traditional preferred stocks, however, distributions paid by a REIT preferred stock will not be classified as "qualified dividends", though occasionally I will see a very small amount so classified. This has to do with the tax status of REITs, where income is not taxed at the corporate level and 90% of the net income is paid out to common shareholders.  On the bright side for a REIT preferred shareholder, the REIT will need to pay a common dividend when it has net income and that will activate the stopper provision for the REIT preferred shareholder. As long as the common shareholders are paid any cash dividend, the REIT preferred shareholder has to be paid in full (all or none).  If the REIT is losing money, then the common dividend may be eliminated and the preferred dividend deferred which unfortunately has unfortunate tax consequences when that security is held in a taxable account (think about what happens when you own a zero coupon bond in a taxable account).   

SHOPRA has an 8% coupon on a $25 par value. At a total cost of $24.35, the yield would be around 8.2%.

Dividends are paid quarterly in January, April, July and October.  I do not believe that this issue is rated which is normally the case for equity preferred stocks. The bond characteristics of these securities are dominant in my opinion.  For my purposes, I would rate it for sure in junk territory as a fixed coupon investment with dominant bond characteristics. The equity characteristic is undesirable, its perpetual nature.  There is no equity interest in the business, which the common stock does represent.  So, purely from the view of a "equity" investment, a REIT preferred stock is clearly inferior to the common.  Its advantage is its superior claim to a dividend. 

I am already familiar with this REIT.  Last year, it basically engaged in a number of strategic defaults on its mortgages. This can make sense when the lender has no personal recourse against the borrower. SHO just said take the property and those were some of its least desirable properties.  The remaining hotels are "mainly" in "upper upscale segment". 

The firm recently raised additional equity capital by selling a Series D preferred stock:   PROSPECTUS SUPPLEMENT Underwriting Agreement, dated April 1, 2011  

Sunstone recently gave an operational update: Press Release. In addition to pre-announcing operational details for the first quarter, the REIT announced the acquisition of a 75% interest in a joint venture that owns the 1,190 room Hilton San Diego Bayfront hotel and announced an agreement to sell the Royal Palm in Miami for 130 million with 40 million in cash. SHO will provide the buyer with a 90 million dollar loan and will have an earn out right based on subsequent performance.  Further details are provided in the Press Release.  When those dispositions are complete, the REIT will own 33 hotels with 13,457 rooms.  This press release is discussed in an article published by Zachs that I found at Forbes.  The author of that article claims that preliminary results for the 1st quarter were above expectations.

SHOPRA closed yesterday at $24.27.  The new SHO preferred stock, SHOPRD, has the same coupon and par value.

Sunstone reported first quarter results after the market close yesterday. claims that the company missed the consensus FFO estimate by 4 cents and guided F/Y 2012 below expectations.  The adjusted FFO for the 1st quarter was 7 cents and the estimate appears to be 11 cents.  The estimate provided by the company is for an adjusted FFO of 78 to 88 cents for 2012, while the consensus appears was $1.1 before this guidance.  

4. SOLD 200 of the Municipal Bond CEF BKK at 14.98 Last Monday (see Disclaimer):  For this fund, I simply elected to reduce my holdings by one-half.  This is a leveraged term fund with a 12/31/2020 liquidation date.  That term date in my opinion reduces interest rate risk, unlike a fund like MUE discussed below. The weighted average maturity date for the bonds owned by this fund is 11.28. BKK : Fund Profile  That average maturity date should be kept close to the liquidation date, assuming competent management of the fund.

If a fund actually owned bonds maturing in the year of liquidation, with a requirement that the redemption proceeds be held in short term, high grade paper, then that would further reduce interest rate risk associated with owning a bond fund, provided the term date was not too far in the future and the individual investor was highly unlikely to need the funds before the liquidation date, a situation that I call situational or unique risk that can create interest rate risk for a particular individual but not for other investors in the fund. There are some municipal bond and taxable ETFs that fall into this later category that I have discussed in prior posts, and those funds do not use leverage. Consequently, there yields are small.

Even with leverage, BKK yields about 5% based on a current monthly distribution of $.06225.  For recent distributions, Morningstar shows no returns of capital supporting that distribution.  It needs to be remembered that the fund's short term borrowings are at historically abnormally low rates and bonds have been in an abnormally long secular bull market. 

The shares sold last Monday were bought at @ 14.71.  

BKK closed last Monday at $14.98, which was at a premium 2.39% to its then NAV per share of $14.62.

5. Sold 100 of the Municipal Bond CEF MUE at 12.3 Last Monday (see Disclaimer):  I bought several municipal bond CEFs when their prices started to tank, based on fears of defaults fanned by the likes of Merideth Whitney late last year. 60 Minutes Interview Unfortunately, I was  a little early, which can be a problem when the LB engages in trading with an element of market timing.

The discounts to net asset value for the municipal funds did widen to higher than normal levels during this period, but the value of municipal bonds continued to be taken lower by the market after I made the purchases.  So, even though the discounts for those funds have substantially narrowed since my purchases late last year, the net asset values have not fully recovered from their prior level before the fear induced selling.  I have   GTC limit orders to sell a number of them, and the first one filled was MUE.  The shares were sold for a slight profit.

This fund does pay monthly dividends and the yield is around 7.2% based on a total cost of $12.3. However, with that kind of tax free yield, the investor knows that the risks must be significant.  The risks for funds like MUE are their investments in long term municipal bonds, which will of course have higher yields, and the use of borrowed money to buy more of those bonds.  The fund's "portfolio" page shows an average duration of 20.88 years and a leverage of 27.8% with preferred shares and 13.2% with Tender Option Bonds, as of 12/31/2011. MUE : Fund Profile  

MUE closed last Monday at $12.27, a -2.22 discount to its then net asset vlaue per share.

6.  Edison Mission (Junk Bond Ladder Strategy)(own 3 senior bonds):  Once a bond is owned, I will try to review the issuer's earnings releases. 

Edison Mission (EM) is a wholly owned subsidiary of Edison International (EIX). It is my understanding that Edison Mission's debt is not guaranteed by the parent.  Since EM has SEC registered bonds outstanding, it files quarterly and annual reports, as well as other documents, that would normally be filed by a public company. Those filings can be accessed at the SEC's web site. The most recent filing was the 10-Q for the quarter ending 3/31/2011. This filing was made on 5/2.

I knew that EM would be reporting a loss before looking at this document based on the earnings release filed by its parent which showed a loss for this wholly owned subsidiary.  The loss reported by EM was 20 million on 550 million in revenues, compared to a profit of 81 million on 651 million in revenues for the first quarter of 2010 (see page 1 10-q). Two million dollars of that loss came from discontinued operations.  The balance sheet shows 9.457 billion in assets, of which 5.350 billion is property, plant and equipment.  The total long term debt is listed at 4.492 billion as of 3/31/2011. The Homer environmental suits are discussed at pages 25-26.  The reasons for the lower revenue and earnings compared to the 1st quarter of 2010 are discussed by management at pages 31-32.  Some reasons are temporary or one oft issues. 

7. Duke Energy (own Core Electric Utility Strategy):  I recently pared my highest cost shares in Duke Energy, which were the first shares bought.  I did realize a long term capital gain on those shares and lowered my average cost some for the remaining shares.  My average cost for my long term shares is $15.03. I am not likely to sell any more partial lots.  The next open market purchase was a 50 share lot bought in October 2008 at a total cost of $15.95, and then there were purchases described in prior posts at even lower prices.  I will continue to reinvest the dividend until the share price consistently trades at over $20 for several months.  If I ever to decide to sell another share, it will likely be the entire position rather than a small lot.     

Duke Energy reported an adjusted E.P.S. of 39 cents for the 1st quarter up from 36 cents in the year ago quarter.  The company said that it on track to realized an adjusted E.P.S. of $1.3 to $1.4 in 2011.

DUK closed yesterday at $18.72.  Generally, under my trading system for long term holdings, I will simply wait to buy back shares previously sold until I am able to lower my average cost per share with that purchase. This would mean that I am not likely to make an open market purchase of Duke shares anytime soon.   While I could lower my average cost a tad by selling the shares bought at $15.95, I do not intend on doing so.  

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