Wednesday, July 6, 2011

GIS/Harland Clarke/ITC Decision on EK Patent Litigation/Exchanged VIPSX for VGHCX/The Foreclosure Mess-Rewards for Failing to Pay One's Obligations/

In effect, the Federal Reserve's JIHAD against savers is a confiscatory tax on responsible Americans, and a forced wealth transfer from the responsible to the irresponsible, at least for the most part. I am using irresponsible in the broadest sense to also include criminal behavior, such as lying on a mortgage application about income, and to what is routine behavior by the Masters of Disaster on Wall Street.

The current money market yield for the Vanguard Prime money market fund, with over 90 billion in assets, is .04%. Barrons If my math is correct, that rate would give me about $400 annually on a million dollars, give or take a buck,  before our destitute Uncle Sam takes his share in taxes.  Of course, even before tax, the real return on virtually all "safe" investments, where the value does not fluctuate, is negative adjusted for inflation. This would include FDIC insured certificates of deposits and savings accounts, treasury bills and notes.

Over the past several months, I have read a number of articles about the rewards granted by our system to those who have defaulted on their mortgage obligations. Due to the negligence of banks in preparing paperwork, there is frequently a question of who owns the mortgage note. There is not an issue that the borrower signed the note and has a quit paying anything on the loan. In literally hundreds of thousands of cases, the homeowner can stay in the home, for years in many cases, without having to pay anything, a process that makes those who pay their debts look like saps. What happens when you stop paying your mortgage? - CBS News

In Tennessee, the process is quick compared to those states who are intent on rewarding borrower defaults. The lender in Tennessee has the right to collect a deficiency  judgment in the event the property is sold in a commercially reasonable manner at an amount less than the loan balance plus the costs of foreclosure. I do not have a mortgage. If I did and defaulted, I would be out of my home in a few months and the bank would come after me in the event of a deficiency. Thus, a strategic default would not be an option for anyone with money in Tennessee.

In NY, the foreclosure process has slowed to such a crawl that it would now take 62 years to foreclose on all of the delinquent mortgages.  NYT New Jersey would take 49 years. This meltdown in the foreclosure process actually encourages more defaults, particularly in states where foreclosures are handled by the courts and the law provides for no deficiency judgments against borrowers who have defaulted on the loan. 60 Minutes The homeowner who has admittedly defaulted can continue to live in the home rent free until the foreclosure is finally completed, assuming that ever occurs for some homeowners. Item # 4 Strategic Defaults;  NYT (article on strategic defaults by homeowners that could make their mortgage payments.)

I read of one case in Florida where the homeowner has been living in her home since 1985 without making any payment on the defaulted loan. I have to tip my hat on the resourcefulness of that homeowner.  But, is there any doubt that she has defaulted on the note?

If the  government wanted to encourage responsible behavior, rather than to reward irresponsible behavior which must be the desired objective in the U.S., this situation could be quickly addressed in a fair manner. National legislation could be passed overriding state laws on foreclosure in some limited respects, or the states could modify their own foreclosure laws. For example, in states where courts are involved in the foreclosure process, a brief hearing would be required to ascertain whether (1) the homeowner signed a promissory note and (2) whether or not the homeowner has stopped making payments. If both conditions are found to exist, or the homeowner refuses to testify or appear at the hearing, then the homeowner would be either required to leave the home or to pay the mortgage payment.

In the event of any challenge to the legitimacy of the foreclosure, irrespective of merit, the homeowner would be required to make that payment into court until ownership of the note was resolved in a later proceeding. If the homeowner was unwilling to make such payments, then they would have to vacate the premises. This would take away the incentive for strategic defaults, i.e., the ability to continue living in the home indefinitely free of charge after admittedly defaulting on the loan. It would also speed up the foreclosure process and the eventual recovery of housing prices.  There would be legal challenges to such legislation initiated by those who favor rent free living but do not want to frame the issue in that way. Another legislative change would be allow for deficiency judgments in all states.

It has to emphasized that it is very rare for the issue to be the borrower's non-payment of a binding legal obligation embodied in a promissory note.  Instead, the issue is who owns the promissory note or who has the right to foreclose on the security for the note and take possession of the property.  This kind of approach is not politically feasible in the U.S. since the borrowers who admittedly fail to make payments and who are allowed to live free of charge in their homes are viewed as victims. They are certainly portrayed in the press as the victims.  The real victims are those who pay their obligations and have had the values of their homes decline due to the foreclosure mess and to  those who never had the income to buy the home in the first place.  

Senator Rand Paul (R-KY) claimed that he was not "completely without the sense that we may need to raise the debt ceiling"   C-SPAN I would give this Senator his due, he is completely without any sense at all and is not surprising that he is a Tea Party favorite. Paul would consider voting for an increase provided it was coupled with a balance budget amendment, which would require cutting a trillion or so in spending per year.  He voted against the Ryan budget plan since it did not go far enough in gutting Medicare and other entitlement programs.   In the name of conservatism, Paul would roll the U.S. back to the blissful days of the 19 century.  Rand Paul-Reactionary Not Conservative  I have an idea, why not allow the residents of Kentucky to actually experience his vision for about a decade. Item # 3 Conservative or Delusional Reactionaries?  (March 2010 Post)

Moody's downgraded Portugal's debt to junk yesterday. WSJ The downgrade was four notches to Ba2 from Baa1.  That action sent the market lower immediately after its release.

1. GENERAL MILLS (own: Common Stock Dividend Growth strategy)General Mills raised its annual dividend by 9% to $1.22 per share from the $1.12 per share in effect for its 2011 F/Y. The new quarterly rate will be $.305 per share. GIS and its predecessor have paid dividends without interruption or reduction for 112 years. 

General Mills also announced that it completed the acquisition of a 51% controlling interest in Yoplait S.A.S and a 50% in a related entity that holds the Yoplait brands for $1.2 billion.  The OG consumes one Yoplait yogurt a day, much preferring that brand over Dannon. Someone who does not believe in the consumption of sugar forced the OG to consume an organic yogurt which the OG promptly spit out and threw in the garbage. I am not saying she tried to poison the OG with that organic crap. To prove his forgiveness, and to show that the OG was not opposed to eating organic, he promptly purchased some Organic Lollipops to share with all.

GIS also reported results for its 2011 F/Y 4th quarter, ending on May 29.2011.    SEC Filed Press release of General Mills, Inc. dated June 29, 2011 The company reported diluted earnings per share of 55 cents. Excluding items, the E.P.S. was 52 cents for that quarter, up from 41 cents a year ago.  Net sales grew by 3% in the quarter to $3.6 billion. For the 2011 F/Y, GIS reported an E.P.S. of $2.48 excluding items, up from $2.30 on a comparable basis for F/Y 2010.  

Due to commodity price increases, GIS forecast F/Y 2012 at $2.6 to $2.62 below the then consensus of 2.68. The company estimated that energy and ingredient would rise 10-11% in F/Y 2012. That guidance does not include the Yoplait acquisition however.  

The Credit Suisse analyst, Robert Moskow, downgraded GIS to neutral yesterday, while maintaining his target price of $40, based in part on concerns about peak margins and commodity costs.

This is a snapshot of a long term chart of GIS, showing 3 two for one stock splits:

GIS Stock Price/2 for 1 Splits Shown with "S"

2. Eastman Kodak (own 2013 Senior Bond only):  This bond fell from 96.3 to 92.6 last Friday (FINRA) after the International Trade Commission issued a ruling on Kodak's patent infringement claims against Apple and RIMM.   RB Bought 1 Eastman Kodak Bond Maturing 2013 When I first bought this bond, I knew that the administrative law judge had ruled in favor of Apple and RIMM. Since royalties from patents is Kodak's profitable business, I view that earlier decision to be a negative.  I was simply betting that Kodak would survive long enough to pay off this bond maturing in November 2013.

Kodak attempted to spin the ITC decision as a victory. ( EK Press Release: ITC Commission Issues Favorable Ruling in Kodak Patent Case Against Apple and RIM)  The market clearly disagreed with that spin, taking the common stock (EK) down 14.25% last Friday. The common (EK) fell another 4.56% yesterday.  The EK bonds also fell in price, but not as much as the common stock.

I really do not see much long term hope for Kodak and do not own the common stock. The company is probably has some value for its intellectual property but its operations continue to lose money. As previously mentioned, the last quarter's earnings were awful. Form 10-Q And, the recent secured bond sale indicates to me a company in financial distress. EK recently sold 250 million of 10.625% senior secured notes maturing in 2019. SEC Filed Press Release That says a lot about how the bond ghouls view this company. EK used 50 million from the sale of the 2019 bond to redeem part of the outstanding 2013 bonds. Page 11 Form 10- for Q/E 3/2011

I see no reason to disagree with the market's view of the ITC's decision. Some articles discussing this decision can be found in the very bearish article at Motley Fool and at Bloomberg,

This is a link to the ITC's decision. .pdf The case is not over yet. The case is being remanded to the ALJ to consider several issues before the ITC renders its final decision. 

I will continue to hold my 2 EK 2013 senior bonds until I have a chance to review the next EK earnings report and the ITC's final decision.

3. Exchanged All Shares of Vanguard Inflation Protected Securities (VIPSX) for Vanguard Health Fund (VGHCX) (see Disclaimer): I had a good gain built up in the Vanguard Inflation Protected securities fund.  Based on the robust rally in treasuries, the coupon yield of inflation protected treasuries has fallen to a negligible level. The income generation from TIPs is simply not attractive to me. I will wait for better buying opportunities in this bond sector before repurchasing shares in VIPSX or the TIP ETF. My current thinking is to wait until the coupon yield on the 10 year TIP approaches 2%, close to where I purchased the 10 year TIP at auction in 2009, and the break-even spread is around 2% or less. The coupon now on the 10 year TIP is around .67%, while the coupon on the five year TIP is actually negative according to data at Bloomberg.

I do own individual 10 year TIPs in the ROTH IRA, maturing in 2019, that were bought at auction. I will hold those bonds until maturity.

I have limited exposure to healthcare stocks which was one reason for buying shares in the Vanguard Health Fund (VGHCX). In addition, the fund has opened its doors to initial investments and has lowered the initial purchase minimum to $3000 after being at $25,000. Vanguard cuts fund minimums, opens door to new investors This fund has had a good long term record but has not fared particularly well given the lackluster performance of large cap healthcare names over the past few years.

Since inception in 1984, the annual average return return has been 16.84% but only 6.4% over the past five years as of 6/30/2011: Vanguard - Health Care Fund Investor Shares - Price & Performance

The average expense ratio is low at .35%. Vanguard - Health Care Fund Investor Shares - Fees & Minimums

This is a link to the top holdings of VGHCX: VGHCX - Fund Top 25 holdings

While it is a cliche to say that demographics favor healthcare companies in the coming years, I do believe that cliche is true. Many of the big pharmaceutical companies have been lackluster performers due to patent expirations and failures to develop new drugs, and that appears to be changing for many of them.

4. Harland Clarke (own bonds: Junk Bond Ladder Strategy): I own three Harland Clarke senior bonds maturing in 2015. Item # 2  Bought 2 Harland Clarke 9.5% Senior Bonds Maturing on 5/15/2015 at 91.375 Bought 1 Harland Clarke Senior Bond Maturing 2015

This is a link to the FINRA Information on this bond.

Harland Clarke is an indirect wholly owned subsidiary of the publicly traded M and F Worldwide Corp (MFW) . I have no interest in the common stock of MFW due to Ronald Perelman controlling M & F Holdings.

I would note that MacAndrews and Forbes Holdings proposed the acquisition of MFW for $24 per share, Reuters, and that caused a number of law firms to launch "investigations" since M & F Holdings owned 43% (sc13d) of the outstanding MFW stock. SEC Filed Letter  Key Developments | Reuters  {See also discussion at this Seeking Alpha article and in an article written by Andrew Bary at who refers to Harland Clarke as "debt heavy", which it is of course}  In an earlier article, Bary mentioned the declining business of Harland:

The offer made on 6/13 did not appear to me to have any impact on the 2015 senior bond which was trading at in a range between 91-93 both before and after this offer. I view the last earnings report, which was disappointing, as the cause for the roughly 5% decline in the bond's price to the current range.  Item # 2  Harland Clarke

I am mentioning this information since some readers are interested in the situation. Until a deal is struck, I am not able to evaluate the possible repercussions on the bond.  


  1. Why would Perleman buy 57% of Harland Clarke parent company (MFW) that includes a huge Harland Clarke debt load which the parent company is not responsible for. Buying MFW and ridding itself of Harland debt via Ch 11 sounds like a possible plan. Might be a good time to sell those 3 bonds.

  2. The licorice business is worth about $10 PER MFW share according to an article written by Andrew Bary cited in my post. If that is anywhere close to being accurate, Perleman would lose a lot of money by bankrupting Harland after paying $25 a share for MFW. That would not make any sense at all.

    So, I would draw the opposite conclusion. Perleman sees value in Harland notwithstanding the debt issue. He may be wrong of course. Harland is profitable and is in the process now of negotiating with its lenders to extend the secured debt facility.

    Another possibility is that Perleman will sell some of the pieces of Harland in an IPO if he is successful in the MFW acquisition which remains to be seen, and then use the proceeds to pay down some of Harland's debt.

  3. After posting my reply earlier today, I noticed that Bary had raised the value of the licorice business to $15 per MFW share in his article dated June 13th which I cite in the post. He earlier had given a value of $10. The change was apparently caused by a recognition that the licorice business, which is separate from Harland, has 100 million in cash according to Bary. He is placing a 200 million dollar value on the operations of that business or 300 million in total with the cash, giving that business a $15 or so per MFW share.

    Still, it would not make any sense to bankrupt Harland after paying $24 or more per share for MFW, such an approach would be a guaranteed loser for M & F.

    If he gains control of MFW, Perleman may intend to sell the licorice business to help finance the purchase of 57% of MFW, and then split up Harland, selling its testing business in an IPO to pay down Harland debt. Then, at some later time, Harland may look better than now, less debt heavy, and he could sell part of Harland in an IPO. I of course do not know what he is up to, except bankrupting Harland is not a good option after paying $24 or more per MFW share. Harland may end up in bankruptcy but it will not be a desired alternative for Perleman.

    All of the junk bonds that I own are risky and some are clearly more risky than my 3 Harland bonds.