Wednesday, June 6, 2012

ADDED 50 TRST at $5.1/Reddy Ice Emerges from Bankruptcy/Risk Rating Raised on Edison Mission Bond to 10- from 9-

The ISM services index rose to 53.7 in May, slightly ahead of the 53.5 estimate.  The new orders component rose to 55.5 from 54.6 in April. Employment, however, contracted to 50.8 from 54.2 in April.

France Telecom (FTE-own) was ex dividend yesterday. I believe that the dividend will be approximately $1.0492 per share.

BNC Bancorp (own as LT) announced that it will acquire FIRST TRUST BANK (NCFT) in a transaction valued at approximately 35 million, consisting 70% in BNC stock and the remainder in cash. First Trust has 3 branches in the Charlotte, N.C. area. While First Trust reported net income of $620,000 for the 2012 first quarter, it reported that NPAs were at 8.1% of total assets. When impaired assets are added to that number, NPAs were a staggering 10.7% of total assets. First Trust Bank Press News Release

BNC Bancorp also announced the private placement of $72.5 million in mandatorily convertible stock. The conversion price is $7 and the conversion would occur upon shareholder approval. BNC's largest shareholder, the private equity fund Aquiline Capital Fund, will participate in that offer. Ken Thompson, the former CEO of Wachovia which was based in Charlotte, is part of Aquiline. It was under Thompson's tutelage that Wachovia acquired GoldenWest for $26 billion, a dismal acquisition that directly led to a fire-sale to Wells Fargo. Prior to this latest deal, Aquiline owned about 9.8% of the outstanding BNC shares. BNCN Major Holders I was not surprised to see BNCN decline 5% yesterday to close at $7.03 in response to these developments.

Bought 40 BNCN at $7.09 as LT

Paul Krugman argues that the past two years of Obama's administration represent Republican "economic policy", NYT He is referring to the GOP orthodoxy that cutting taxes and slashing government spending will lead the economy into a perpetual growth and job creation machine. The time period does exclude the first two years which would encompass most of the stimulus spending passed early in Obama's term. Without question, the President has implemented GOP tax cut orthodoxy. The Democrats did agree to extend the Bush tax cuts through the end of this year in exchange for the GOP agreeing to reduce payroll taxes. Fact Sheet on the Framework Agreement on Middle Class Tax Cuts and Unemployment Insurance | The White House I am still waiting for the Bush tax cuts to create that perpetual job creation machine. Bush Tax Cuts and Jobs It would be comical, however, to maintain that the federal government has slashed spending. In Krugman's universe, a failure to continue large scale stimulus programs is probably tantamount to a slash in spending.

A similar view is expressed by the liberal economist, Joseph Stiglitz, who argues that a reduction in federal spending proposed by Romney would increase the likelihood of another U.S. recession.  Bloomberg

The TBs have long since forgotten, assuming that they ever knew, that a good chunk ($275B) of the American Recovery and Reinvestment Act of 2009 was devoted to tax cuts and credits. My criticism of that stimulus program was that virtually all of the funds needed to be devoted to infrastructure spending lasting at least a decade, which spending needed to be incurred anyway. If that had been done, there would then be something concrete to show for the budget hole created by that stimulus, and the stimulus would last for a long time. One problem with the Democrats stimulus program is that the money was spent over a fairly short  period of time when the demand problem was long term. {Stocks, Bonds & Politics- 4/27/11 Post)

1. Risk Rating Raised to 10- for Edison Mission Energy Unsecured Senior Bonds (own 1 senior bond: Junk Bond Ladder Strategy): Due to a number of adverse events, I raised the risk rating for EME bonds to 9- last March. Sold 2 Edison Mission 7.75% Senior Bonds Maturing in 2016 at 73.25 Those events include the closure of the Fisk and Crawford coal fired generating stations, continued poor pricing in the merchant power market, EME's excessive debt and particularly the maturity schedule of that debt, and an inability to generate earnings. The Fisk and Crawford stations will be shut down in September 2012.

I also noted an article that a recent energy auction yielded disappointing results. Edison Mission has also hired Kirkland & Ellis to assist it in assessing a possible restructuring or reorganization, which suggest a possible bankruptcy filing.  

In my Personal Risk Ratings For Junk Bonds, a 1 rating would be the lowest risk for a potential default and a 10+ would be the highest risk.

Back in April 2012, Fitch lowered its rating on the EME senior unsecured bonds to C. TEXT-Fitch A bankruptcy filing is a distinct possibility in 12 to 24 months in Fitch's opinion. I see no reason to disagree. 

Since raising the risk rating to 9-, the prices of EME's junk bonds have significantly deteriorated. The current prices send a clear signal, at least to me, about EME's prospects. I sold two 2016 EME senior unsecured bonds at 73.25 about three months ago. That bond closed at 48 on Friday. FINRA 

EME has another senior bond maturing 6/15/2013, FINRA. Last June, this bond was trading near par value, and it closed last Friday at 55.61. This kind of decline speaks volumes about how EME is viewed by professional bond investors. That price and maturity suggests to me that institutional investors view a default as a high probability event and are now attempting to place a value on EME's unsecured bonds during and after bankruptcy. While those investors may turn out to be wrong, there can not be any serious dispute that the pricing of all EME unsecured bonds reflect that collective judgment in my opinion. 

Obviously, EME could not refinance its debt at the current yields of its bonds and hope to stay in business. It is possible that EME could receive an equity infusion sufficient to pay off some or all of this 2013 bond, but I would not count on its parent company coming to the rescue. The parent company, Edison International, does not guarantee EME's debt. The principal amount of the 2013 bond is $500 million. EME did have 1.307 billion in cash as of 3/31/12 (EME 2012 Q1), and some of that could possibly be used to pay off the 2013 note. There is also a credit facility in the amount of $500 million, page 35. 

However, as noted in the last quarterly report, EME needs cash for capital investments. Capital expenditures were estimated in the last filed SEC Form 10-Q at $374 million for $2012; $232 million in 2013; and $358 million in 2014 (page 36). 

EME estimates that it will cost up to $628 million to retrofit its large coal fired units (Powerton, Joliet 7 and 8 units, Will County) with new environmental controls. The company sounds less certain that it would make the necessary retrofits for Juliet 6, so that one may be the next shutdown: 
10-Q for Q/E 3/31/12 at pp. 25-26
At the moment, EME seems willing to make the environmental retrofits on the following coal units: Joliet 7 and 8; Will County Units 3 and 4; the Powerton Units 5 and 6 and possibly Waukegan Units 7 and 8. EME estimates that it would cost $160 million to retrofit the Waukegan units.

Another troubled coal facility is the Homer operating station discussed at page 26.

In short, the company is losing assets due to the Obama administration's new emission rules for coal plants. To make matters worse, EME will have to spend a great deal of money on new retrofits at a time when energy prices are low.

Other utilities are also shutting down older plants rather than making the costly retrofits required by the EPA's new emission rules. An investor can argue whether these standards are wise or foolish, but their adverse impact on existing operators can not be disputed. With coal plants being shut down, and no large nuclear stations likely to produce power for a decade or more, it would not be surprising to see an energy shortage develop in the U.S. relatively soon after the U.S. enters its next boom cycle.  {Item # 3 Edison Mission Bonds, an article at Reuters generally, and the recent NYT on AEP's decision to shut down Big Sandy rather than spend $1 billion on EPA required retrofits}

As noted in the 2011 Annual Report, EME has interests in several natural gas and wind generating stations. Edison Mission Energy 2011 10K at pages 11-12.

The 2016 bond closed at 51 yesterday, with some trades below 50.   

The 2017 bond closed at 51 on Friday with $1.196096 billion outstanding.   The 2017 bond closed at 50.75 yesterday.

The 2027 bond closed at 50.625 on Friday with $700 million outstanding. It was close to unchanged yesterday.

The 2019 bonds trading close to 51, though FINRA does not show trades on that one. 

The debt is summarized at page 80 of the Edison Mission Energy 2011 10K. Some of the debt is non-recourse. 

Please note the flatlining of the price near 50, irrespective of the maturity date of the bond or the coupon.

What causes that kind of flatlining?

The similarity in pricing, irrespective of maturity, supports my opinion that professional bond investors are pricing a potential recovery after default as the primary factor influencing price. In a default situation, all of these bonds would be at the same level of priority, and there owners would oct likely receive the same consideration for them in bankruptcy. That is why, in my opinion, a 2013, 2016, 2017 and 2027 bond would have a similar almost identical prices now. The coupon and maturity date are no longer driving the price action. 

Due to my perception of the increasing risk, I have already disposed of all EME bonds except for 1 maturing in 2016. 

It is certainly conceivable that EME may be able to pay off the 2013 note and then hope that market conditions improve thereafter. And it would not be a bad idea for EME to buy as many 2013 bonds as possible now at close to a 50% discount to their par value.

Bond investors may be too pessimistic about EME's survival. But without a substantial improvement in market power prices, it would be hard for me to envision survival to 2016 or 2017. Low natural gas prices are placing downward pressure on the price energy produced by of coal plants. For their to be an improvement in realized prices for EME's coal generation, natural gas prices will probably have to rise by a significant amount, and I would not expect that to happen this year or next. And, the economy will need to improve so that there is more demand for energy.

If I was going to gamble now on EME bonds, it would be solely with the 2013 maturity, but I would make that bet with my eyes wide open on the potential for a bankruptcy filing before its maturity.

One potential wild card would be Obama's defeat this November, followed soon thereafter by the repeal of the new EPA rules impacting coal generation. The GOP's disdain for the EPA is readily apparent. Since investors must deal with reality, rather than living in a pretend world infested with reality creations, such an event could easily be a game changer for EME.

See Subsequent Post: Edison Mission Statement SEC Form 10-Q on Bankruptcy Option (8/7/12 Post)

See Subsequent Post:  Item # 3 EPA Emissions Rules for Coal Plants Struck Down in 2-1 Decision (8/27/12 Post)

See Subsequent Post in Introduction: Edison Mission (11/21/12 Post)(EME filed notice on 11/15/12 that it had failed to make interest payments due on 11/15/12-‎EME 8-K SEC Filing

2. Added 50 Shares of TRST at $5.1 (Regional Bank Basket Strategy)(see Disclaimer): This purchase brings me up to 420 shares bought in the open market. I have been reinvesting the dividends. The OG has bought TRST in two taxable accounts, with the intention of selling the shares at some point in the account which now holds 207+ shares while keeping all of the shares held in another taxable account. My target price range for selling shares is between $5.75 to $6.00.

TrustCo is currently paying a quarterly dividend of $.065625 per share or $.2625 annually per share. The shares were ex dividend a few days ago. At that penny rate, the yield is approximately 5.15% at a total cost of $5.1 per share.

Form 10-Q for Q/E 3/31/2012 and my discussion of that report at Item # 1 TRST.

Given the abnormally low interest rate environment, likely to continue for an "extended period" of time, a dividend yield of 5.15% looks attractive compared to alternative places to stash cash such as money market funds, treasury bills or a savings account. The trick will be to avoid losing money on the stock position while receiving that dividend yield and to hopefully realize net trading gains on the position. The optimal result would be an annualized total return of 10% which could be achieved with a 5% annualized increase in the stock price when the shares are sold.

Trustco Bank closed at $5.13 yesterday.

3. Reddy Ice (1 Second Lien Bond Exchanged into 43 Common Shares)  Based on my review of Reddy Ice's reorganization plan in bankruptcy, I anticipated receiving 43 shares of newly issued common stock. Item # 2  Reddy Ice (4/16/12 Post) I received those shares yesterday:

The company announced on 5/31/12 that it had emerged from bankruptcy: Reddy Ice The company reduced its outstanding debt by 32% or $145 in the bankruptcy proceeding.

The common stock in existence prior to the filing for bankruptcy will be canceled, and those shareholders will no longer have an ownership interest in the company when it emerged from bankruptcy.

I will record the likely loss from this position when and if I sell those 43 shares of common stock. I do not know now whether the company intends to have a stock IPO or when that may occur. 

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