Friday, November 4, 2011

Potential BAC Exchange for Preferred Securities/ The Freddie Mac Black Hole/ EARNINGS: HCA GT MWA FBSS/Sold 100 NBB at $20.07/More Tax Cuts for Large American Companies Necessary as a Predicate for Job Creation-Really?/Added 50 FBSS at $11.79-Averaged Down

The market apparently liked the rate cut by the European Central Bank yesterday. The ECB cuts its key rate to 1.25% from 1.5%. ECB: Monetary policy decisions The ECB, like our FED, believes that inflation will decline in 2012 from its current elevated levels. I am not able to share the market's enthusiasm for that rate cut or the long term continuation of the Jihad against savers worldwide. I view this monetary policy to be counterproductive now, and will likely fuel inflation. I also view that both the FED and ECB are pushing on a string with a continuation of their abnormally low interest rate policies, which is one reason for labeling their current policies as counterproductive. The Real Cost of The Federal Reserve's Jihad against the Saver Class What Are the Reasons for a Continuation of the Fed's Jihad Against the Saver Class

For whatever reason, the market apparently liked the backtracking on the referendum in Greece.  NYT I can understand the predicament of Greece's P.M. He is wedged between the EU demanding "austerity" and a population who wants to continue spending other people's money without restraint. His referendum gambit did apparently focus attention on the consequences of a failure to approve the "austerity" measures demanded by Greece's lenders: ejection from the EU, a return to the Drachma, and a cut off from foreign credit for years to come.

The ISM services index for October was reported at 52.9, lower than the consensus forecast of 53.5. The new orders component fell to 52.4 from 56.5. The employment component, however, was encouraging, rising to 53.3 from 48.7. Still, I would call the current reading an expansion crawl.

Reuters reported yesterday that 30 large American corporations paid no income taxes from 2008 through 2010. The GOP claims that those corporations need more tax breaks in order to create jobs, as well as a substantial reduction in the tax rate for repatriating cash from their foreign subsidiaries, where those companies have exported jobs formerly held by Americans. (see summary of GOP candidates tax plans at Reuters) That position is advanced notwithstanding the already low effective tax rate for many companies. And, those GOP positions are advanced without regard to known facts that are inconsistent with the alleged job motive given for lowering those taxes. The cash hoard for U.S. financial companies is already over $2 trillion as of 6/30/11 (WSJ), excluding cash held by foreign subsidiaries, and that sum is growing every quarter. So, do they really need more cash to hire? Really?

And, it is clear that jobs were not created as promised on the last occasion the repatriation tax was lowered for the alleged purpose of creating jobs. Instead, the corporations used the cash to increase the already outrageous compensation of their executives and some for stock buybacks. Tax on Repatriated Foreign Earnings of U.S. Corporations The fifteen companies that benefited the most from the 2004 repatriation tax break cut almost 21,000 jobs.  Fox Business The reason for the GOP proposals have absolutely nothing to do with job creation and instead are sops to those who providing cash to their campaigns. The same is true for the Democrats supporting those tax proposals.

It will take almost a week to describe the trades from yesterday, given the time being devoted to discussion of earnings reports. I did buyback two hedges near the close yesterday. Hedging is now allowed in an Unstable VIX Pattern when the VIX is over 20 due to a recently adopted modification on hedging rules. Stocks, Bonds & Politics: Mark Hulbert and the Use of the VIX as a Timing Model/Modification # 1 To Vix Asset Model Approved re: Hedging

Freddie Mac reported a 4.4 billion loss in the 3rd quarter and will need to borrow another $6 billion from our destitute Uncle Sam just for the third quarter.  SEC Filed Press Release  Oddly, part of the borrowing from the government is necessary to pay a 10% dividend to the government for the aid. I believe that this particular black hole has sucked $71 billion out of the U.S. treasury and then paid back $15 of those borrowings in dividends to the government for the aid.  The other black hole, Fannie Mae, has yet to report how much it will need. Fannie's life support has cost around $90 billion to date adjusting for its 10% dividend paid back to the government. WSJ Both firms have to borrow the money from the government to pay the government's dividend.  What can you say about it without becoming physically ill?

Bank of America filed its SEC Form 10-Q for the third quarter late yesterday.  BAC-9.30.2011-10Q In that report, BAC said that it was exploring the issuance of common stock and senior notes for preferred stock:

This kind of exchange has occurred previously. I used the pop in the preferred shares to sell my positions. Sold BACPRE/BAC Exchange Offer to Convert Equity Preferred into Common Stock (May 2009 Post);  Sold BMLPRG  (May 2009 Post). It is my understanding that this kind of offer, when and if made, would be voluntary.  I own several equity preferred and trust preferred securities that are BAC obligations, even though none of them were originally issued by Bank of America. It is not entirely clear to me at the present time that BAC is contemplating making an exchange for the equity preferred stocks. Trust preferred stocks are specifically mentioned in the preceding snapshot. I will be interested to see how the equity preferred issues react to this news today.

In this blog, I am going to continue my discussion of earnings reports from companies where I only own bonds.

1. HCA (own 2 bonds): HCA Holdings (HCA) reported net income of $11 million or 11 cents per share for the third Quarter, which included a 49 cent charge for early retirement of debt. SEC Filed Press Release Excluding that charge, the company earned 60 cents per shares, beating the consensus estimate of 43 cents.  Same facility admissions increased 3.2%; adjusted EBITDA increased 4%; and revenues rose 5.5% to $7.31 billion.  

There was an article published in, written by a couple of accountants, that questioned HCA's use of pooling-of-interest accounting. As noted in that article, HCA defended its accounting.

After the earnings report, Barrons published another unfavorable article on HCA, using terms like "precarious financial situation" as a constraint on profitability. That article also quotes a negative opinion from a Morningstar analyst.  On a very bad day for the stock market, the common rose five cents after the earnings release to close at $23.5 last Tuesday.  Morningstar has a three star rating on the common.

HCA is excessively leveraged as I highlighted when purchasing the bonds. Unfortunately for current shareholders, this firm was taken private in a 33 billion dollar leveraged buyout in 2006 by Bain Capital, KKR and the Frist family. Those kind of transactions create unnecessary debt,  frequently at excessive levels that threaten the long term viability of the company.  As of 9/30/11, HCA had long term debt of $25.871 billion., down from $27.633 as of 12/31/2010. 

I have no interest in the common shares. And, given the excessive leverage, I am at my limit with two bonds.

2. Goodyear Tire (own TC XKK):  Goodyear Tire reported better than expected earnings for the third quarter.  Revenues increased 22% to $6.1 billion.  The company reported net income of $161 million or 60 cents per diluted share, up from a loss of $20 million in the year ago quarter. 

I currently own 200 shares of the Trust Certificate XKK, which contains as its underlying security a senior GT bond maturing in 2028. The TC has a 8% coupon on a $10 par value. The underlying bond has a 7% coupon. Trust Certificates: New Gateway Post

I have also recently bought and sold a senior GT bond maturing in 2020.  Sold 1 Goodyear Tire Senior Bond at 106.02 

I am concerned about the sheer magnitude of GT's debt. As of 9/30/11, the balance sheet showed long term debt and capital leases at $5.559 billion, up from $4.319 billion on 12/31/2010.  Cash and Cash equivalents stood at $2.216 billion. 

The debt is discussed by GT in note 8 of its recently filed Form 10-Q at page 13.  As shown in a table found at that page, the 2028 note is the longest dated maturity. 

3. SOLD 100 of 200 NBB at $20.07 Last Tuesday (see Disclaimer): I am transferring my ownership of this bond CEF to retirement accounts. NBB owns taxable municipal bonds issued under the Build America Bond program. I have bought and sold this fund for small profits. The dividend is paid monthly. I bought 50 of the 100 shares sold last Tuesday at @ 19.24 last December. My most recent purchase was 50 shares in the ROTH IRA in late September 2011.  Added 50 NBB at $19.55 in the ROTH IRA  Other posts discussing this bond CEF include the following:  Bought 50 NBB at 19.67 (June 2010);  Bought 50 NBB @ 19 (November 2010): Sold 50 NBB @ 19.24 in the Regular IRA (Dec. 2010); Bought Back 50 NBB @18.4  in IRA (December 2010)

4. Added to Fauquier (FBSS) at $11.79 yesterday (own common: Regional Bank Stocks Basket Strategy): Fauquier Bankshares, reported a 16.9% increase in net income to $1.15 million from the $982,000 earned in the 2010 third quarter. The E.P.S. number increased to 31 cents in the 2011 third quarter, up from 27 cents in the year ago quarter. As of 9/30/11, the net interest margin was 3.97%; NPLs to total loans stood at .99%; the total risk-based capital ratio was 13.29%; the tangible equity to assets ratio was 7.77%; the allowance for losses as a percentage of NPLs was at 152.97% and 84.91% when the bank includes real owned and other repossessed assets; and the efficiency ratio was at 67.43%. I view this as a good report from this small bank operating in two northern Virginia counties, though I would like to see the efficiency ratio fall below 60%.

I am in the hole on this one, but will start reinvesting the dividends effective with the next payment. Bought 50 FBSS at 14.08 Bought 50 FBSS @ 13 I also decided to average down by buying another 50 shares yesterday. The bank cut its dividend in September 2010, soon after I bought the first lot,  even though the dividend was well covered by earnings and the bank did not need the capital in my opinion. FBSS did not participate in TARP. I suggested then that maybe management needed to cut their compensation instead, thereby reducing the efficiency ratio to below 60%. The stock, which is thinly traded with a large bid/ask spread most of the time, has never recovered from that unnecessary dividend cut. Perhaps some of the damage could be undone by at least starting to raise the dividend, by around 10% per year, at least until the quarterly dividends reaches the amount prior to the cut which was 20 cents. The quarterly rate now is 12 cents.

The Royce Funds are the largest institutional owner of this bank, assuming no recent change in its position. SEC Schedule 13 G The last SEC filed report for the Royce Micro Cap Fund (RMT-owned) shows a 160,800 share position as of 6/30/11 (page 23 of semi-annual report The same amount is also owned by the Royce Value Trust (RVT-owned)(see page 21 While that does not sound like much, Fauquier only has around 3.67 million shares outstanding. It would take awhile to unload the Royce position, absent an acquisition offer for this bank. I still view the bank as a possible takeover target by a larger bank, given the location of its branches and market share in those two Virginia counties.

The trading volume is very light. FBSS Historical Prices  Just to get the order executed yesterday, I hit the ask price of $11.79 with a limit order, when the bid was $11.45, with only 400 shares traded at the time of my order execution.

5. Mueller Water (MWA)(own 1 bond): Mueller Water Products reported a 3 cent loss for its fiscal 4th quarter, excluding items, missing the consensus estimate by 3 cents. Revenues increased 7.8% to $373.6 million. The company said that it was making progress on "transactional scenarios" that could result in the the disposition of its money losing U.S. Pipe operation.  The company continues to be negatively impacted by tight municipal budgets for water projects.

I bought back 1 senior subordinated MWA bond after making a small profit on my first purchase.Bought Back 1 Mueller Water 7.375% Senior Subordinated Bond Maturing on 6/1/2017 at 94.5 If I had waited a few months, I could have bought that 1 bond back for around $200 cheaper. FINRA The bond has recovered recently after sinking into the mid 70s early in October.  

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