Wednesday, June 22, 2011

Junk Bond Ladder Table/Prospect Capital (PSEC)/IMF Report on Euro-Area/ ADDED 2 Harland Clarke 9.5% Senior Bonds Maturing on 5/15/2015

The IMF released yesterday its Concluding Statement of the IMF Mission on Euro-Area Policies.  The IMF states that a broadly sound recovery continues in the Euro-Area, "but the sovereign crisis in the periphery threatens to overwhelm this favorable outlook". The IMF emphasized that policies "to stop contagion from sovereign debt adjustment or re-profiling are at a premium". 

1. Prospect Capital (PSEC) (own): Many of the Business Development Corporations are serial issuers of new stock, and PSEC is one of the worst. Prospect Capital Corporation announced after the close on Monday that it intended to offer 10 million shares and has granted the underwriters an option for an additional 1.5 million shares. The shares were later priced at $10.15. Whenever this happens, the share price sinks.  As of 3/31/2011, PSEC reported that its net asset value per share was $10.33. (Form 10_Q Q/E 3/2011 at page 3). The net asset value per share was at $14.58 as of 12/31/2008,, and $15.18 as of 3/31/2007,     

I own 250 shares of PSEC.  I will always maintain only small positions in BDCs due to their many disadvantages.  The primary advantage is their dividend yields that are generated by the same factors that cause me to underweight this class of securities.  These factors include the following: (1) the loans made by BDCs carry high interest rates since the borrowers are unproven businesses or businesses who would have difficulty arranging financing from banks due to their creditworthiness; (2) the BDCs have to pay out 90% of their net income to shareholders which depletes their capital for growth.  When you combine those two factors, a high loan loss rate with capital depletion through dividends, the third major negative comes into play, the need to raise more capital, even if that means selling stock at below net asset value.  That decision may not be in the best interests of existing shareholders, but may be in the interests of management based on their compensation arrangements.  I have discussed these issues in many prior posts. (See, e.g., Item # 5 Bought 50 PSEC at 9.5 (July 2010 Post); Item # 5 PSEC (February 2010 Post); Item # 3  Bough 50 of the BDC ARCC at 16.17 and at $16.3) Assuming the economy continues to improve, and with the wind at their back, hopefully the managers of this BDC will start to earn their generous compensation.

The base management fee for PSEC is 2% of gross assets, including amounts borrowed. (Form 10-Q at p. 43).   There is also an incentive fee.

PSEC sold 10 million shares of common stock at $11.4 in April 2011.  In February 2011, it issued $172.5 million in principal amount senior convertible note maturing in 2016. (see page 54 of 10-Q).

Prospect Capital closed yesterday at $10.14, down 5.06% or $.54 per share. 

2. Added 2 Harland Clarke 9.5% Senior Bonds Maturing on 5/15/2015 at 91.375 Limit on Tuesday (Junk Bond Ladder Strategy) (see Disclaimer):  I now own 3 of these bonds. The first one was bought near par value so I am averaging down with this last 2 bond buy. Bought 1 Harland Clarke Senior Bond Maturing 2015 (February 2011 Post).  The bond started to slide in value after a disappointing earnings report for the first quarter that I discussed at Item # 2  Harland Clarke

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

This is a link to the bond's prospectus:

Harland Clarke is an indirect wholly owned subsidiary of M and F Worldwide Corp (MFW).  

I would sum up the disadvantages to this bond as follows:

A. The firm is excessively leveraged with long term debt at $2.192 billion as of 3/31/2011. Form 10-Q for the 2011 1st quarter

B. The maturity schedules of the debt are relatively short, which raises the issue of whether or not a refinancing will be successful. 

C. There is a ton of senior secured debt owed by the company, and that facility matures in 2014 before the unsecured 2015 senior note. As of 3/31/2011, Harland had drawn $1.729 billion on that facility. The company is seeking to extend the term of that loan: In the event of a bankruptcy prior to maturity of the 2015 note, I would not expect to recover much of my investment given the sheer size and priority of the senior secured debt.  

D. Harland's business is declining in terms of revenues and profits. Although Harland is expanding into other businesses, it is still primarily a printer of checks.  Fewer people are using checks, preferring to pay bills online or to have bills automatically debited from a bank account which is something that I do. I still use some checks every month, however, and my bank uses Harland as their printer.   

For all of those reasons, the 2015 bond is deservedly rated junk. 

The positives are the high current yield, the potential for a capital gain given the purchase at a discount to par value, and Harland is still operating in the black even with the excessive leverage. The company reported earnings of $23.4 million in the first quarter on 403.9 million in revenues.

My confirmation states that the current yield at my cost is 10.351% and the YTM is 12.21%.  

3. Junk Bond Ladder Table:  This is a snapshot of my junk bond ladder graph.  My yield now is up to close to 10% with an average maturity in years of 7.28. Some of the higher yield is due to a recent decline in junk bond prices.   I am keeping for now my total dollar exposure to around $50,000, give or take a couple. That number is based on my own financial position and tolerance for risk.

The general idea is to break-even on the bonds. Item # 5 More on Rationale for Junk Bond Ladder Strategy I have already realized some gains. Item # 5 Realized Gains Junk Bond Ladder Strategy Hopefully, most of the companies will survive to pay me par value at maturity which would also result in a gain since I am purchasing these bonds at discounts to par value.  This means that I expect to suffer some losses through defaults.  Since I do not know which companies will in fact default, I am using a basket strategy where I spread out my risk to a large number of issuers, and limit my exposure to any one firm to a maximum of $5000. Even if I hit that maximum, I will preferably pare the position if and when the opportunity arises to sell one or two bonds at a profit.  I am avoiding some issuers altogether based on my view of the likelihood of a default being too close to certain.    


  1. Perleman (current owner of 47% of MFW) is currently buying remaining shares of MFW, the parent company of Harland Clarke. MFW is not responsible financially for Harland debt. With that much debt, not much possibility of a spin off. Just a heads up

  2. YES, I noted this offer in a subsequent post dated July 6th at Item # 4. The bond did not react to this offer. Instead, the price reacted negatively to the last earnings report and understandably so.

    Perleman must see some value in Harland, notwithstanding the excessive leverage, given the price that M & F for MFW. The licorice business is worth about $10 a share according to Andrew Bary in his article cited in that July post.

    A potentially important event is the current negotiation to extend the secured bank facility, so that it would mature after the 2015 note.