Wednesday, July 18, 2012

GJN Redemption/CPI and CPI Floaters/KO GS/ Sold 50 SHOPRA at $25.44/Bought 1 J.C. Penney 7.95% Senior Bond Maturing on 4/1/17/GJN Redeemed-Payment to Swap Counterparty From Proceeds?

After reading a article about microbes, the OG started to wonder whether Howard Hughes may have been on to something. The article mentioned that the typical human has 10,000 species of bacteria, yeast, fungi and other critters and more than 1 billion per centimeter of buggers on the human hand. While the OG was not surprised by the sheer number and variety, he was surprised that someone would take the time to count them.

The government reported that CPI was unchanged in June on a seasonally adjusted basis, with the core up .2%. Consumer Price Index Summary On a non-seasonally adjusted basis, CPI has risen 1.7% over the past year. The non-seasonally adjusted number is used in the computation for the exchange traded senior bonds OSM, ISM and PFK whose monthly coupons are tied to a spread over annual CPI with a three month lag. The monthly distributions for those securities will trend down in the coming months with the recent CPI numbers. The data used in those calculations can be found at the I explain the computation in Item # 3 PFK.

This is how to perform the calculation with the new data, which will provide the monthly penny rate for PFK (with the lag):

June 2012 CPI: 229.478
June 2011 CPI: 225.722
Difference: 3.756
Divide 3.756 by June 2011 CPI # of 225.722=.01664
Add Spread of .024% to .01664=  .04064%
Multiply .04064 x. $25 par value= $1.016 per share annualized (now compute monthly)
Multiply $1.016 x. 30/360 (if 30 days in computation period, Sept. has 30 days)=
October Penny Rate=$.08467

PFK Prospectus: Pricing Supplement No. 122 dated March 31, 2006 Bought 100 PFK at 18.47Bought 90 PFK in IRA $18.94Added 50 PFK at $17.83Added 50 PFK in Roth at 20.88-Averaged UP. This note has a $25 par value and is currently selling significantly over that par value. The note matures on 4/10/2018. I am considering selling the shares held in the ROTH IRA, but have not yet made a decision:

ROTH IRA 100 PFK Unrealized Gain +$848.86 
Citigroup reported better than expected earnings on Monday. MarketWatch  NYT I will review this bank's earnings reports solely due to my ownership of 8 $1,000 par value, senior unsecured, exchange traded, "principal protected" notes issued by Citigroup Funding and guaranteed by Citigroup, all maturing in 2014 at $10. When reading the earnings report, I am only attempting to make a judgment about the likelihood of Citigroup surviving until those notes are paid off in 2014. Item # 5 Exchange Traded Bonds: New Gateway Post I also reviewed this release from Fitch discussing this earnings report. Currently, I am not worried about my 8 notes being paid off during 2014. Prudential Financial Inc. Prudential Financial Inflation linked Retail Medium Term Note PFK) closed at $28.26 yesterday.

I mentioned in a recent post a low volatility ETF, SPLV, that has been outperforming the S & P 500 this year. A similar ETF is offered by Ishares with only a .15% expense ratio. iShares MSCI USA Minimum Volatility Index Fund (USMV). Both SPLV and USMV are discussed in this article at ETF Trends. SPLV has a .25% expense ratio. S&P 500 Low Volatility Portfolio I added USMV earlier this week which I will probably discuss in Friday's post.

As noted in a Bloomberg article published yesterday, Bill Gross believes the U.S. is nearing a recession. GS lowered its forecast for second quarter GDP growth to just 1.1%.

The Coca-Cola Company (own) reported second quarter E.P.S. of $1.21 on revenues of $13.085 billion, close to flat compared to a year ago. The consensus estimate was for $1.19 on $12.98 billion according to YF.  Net revenues grew 3% on a reported basis and 7% on a comparable currency basis. Global volume growth was up 4%, which I view as the most important number in this report. KO is currently facing both currency and commodity headwinds. Coca-Cola  (KO) rose $1.21 in trading yesterday to close at $77.69.

Goldman Sachs reported net earnings of $962 million or $1.78 per share.  As of 6/30/12, the firm's "global core excess liquidity was $175 billion" and its "Tier 1 capital ratio under Basel 1 was 15%." I do not own the common. I own 150 shares of GYB and 50 shares of JBK, both in the ROTH IRA. Those securities are trust certificates that contain as their underlying security a trust preferred security issued by GS Capital. I also own two GS floating rate equity preferred stocks in a satellite taxable account. Those positions require me to at least examine an earnings report. GYB is a Synthetic Floater that pays the greater of 3.25% or .85% over the three month LIBOR rate on a $25 par value, and will mature at the same time as the underlying TP in 2034.  The equity preferred floaters pay qualified dividends at the greater of a minimum coupon or a float above the three month LIBOR on a $25 par value with no maturity date. Advantages and Disadvantages of Equity Preferred Floating Rate Securities

1. Bought 1 J.C. Penney 7.95% Senior Bond Maturing 4/1/2017 Last Friday (Junk Bond Ladder Strategy)(see Disclaimer): Both stock and bond investors have turned very negative on JCP's prospects. The common stock has been more than cut in half from its 2012 high. JCP Interactive Chart The bonds have been downgraded well into junk territory and have been driven down in price. I looked at the trades in early April, and this 2017 bond was trading consistently over 110 on good volume.

JCP has been around a long time, around 110 years, weathered many storms, and it is at least questionable whether its current CEO, Ronald Johnson, can destroy the company in a few months with his strategies. It is hard to understand what in Mr. Johnson's background convinced the Board that he knew anything about JCP's customers or department store retailing.   

The next quarter is likely to be a disaster. The current forecast is for a loss of 16 cents, and I would not be surprised by a much higher number before special items. The current forecast is of $1.26 in the F/Y ending January 2013 and $2.31 in the 2014 F/Y. JCP Analyst Estimates If the company is able to come close to the 2014 estimate, I suspect that this bond will be selling at above par value. Morningstar currently has a five star rating on JCP's common shares.

The last earnings report, summarized in this CNBC article, was a disaster. The company eliminated its 20 cent per share common dividend when making this announcement.   SEC Filed Press Release 

However, a continued stream of significant negative news developments could push the price to 80 or even lower. Whatever happens over the next year or two, I am not so concerned about JCP defaulting on its bonds that I would avoid its debt altogether. I am sufficiently concerned to place a 3 bond limit on my purchases. With the addition of the 2017 bond, I now own 2 bonds.

FINRA Information on 2017 bond.

The downgrade in JCP's debt by S & P contributed to a decline in this bond's price. TEXT-S&P The rating was cut to B+ from BB-.

My confirmation states that the current yield at my cost 8.153% and the YTM is 8.602%:

JCP 2017 Bond Confirmation/Commission Added to Price Paid
Added: I had the purchase price wrong in the original post. The purchase price would be the number shown in that confirmation (97.5) minus the brokerage commission. I bought another bond at 94.25, the Quicksilver Resources 2015 discussed in the prior post. Vanguard Star and Life Strategy Growth Funds /Bought 1 Quicksilver Resources 8.25% Senior Bond Maturing 8/1/2015 at 94.25/GFW Redeemed by Issuer/Bought 50 of the ETF EMLP at $20.87

2. Sold 50 SHOPRA at $25.44 Last Friday (see Disclaimer): These shares were bought in May 2011: Bought 50 SHOPRA @ 24.35 I have received five quarterly dividend totaling $125 for this 50 share lot ($.5 quarterly dividend per share). The dividend rate is 8% on a $25 par value.  

2012 SHOPRA 50 Shares +$38.58

I am not a fan of REIT preferred stocks: REIT Cumulative Preferred Stocks: Advantages and Disadvantages I do not view these securities to have much, if any, upside when selling at small premiums to their par values. And, as shown during the Near Depression, there is substantial downside risk.

If bought at or near par value, I will sell a REIT preferred stock after collecting one, preferably several dividend, and then harvesting whatever profit is available, no matter how small.

For those REIT preferred stocks bought during the Near Depression period, the largest percentage gainer was GRTPRF that was bought at $2.9 and sold earlier this year at $25.42. Some others rose over 100%. So the opportunities are gone. CUZPRA is available for purchase at $11.5 (December 2008). LXPPRD was bought at $7 in the Roth IRA (March 2009).  FRPRK was bought at $8.4 (February 2009 Regular IRA). Bought SLGPRC was bought at $10.5 (March 2009) and at $11.89 (February 2009).  CBLPRC was bought near $10 in October 2008. Except for the First Industrial preferred, the others are selling above their respective $25 par values. And, many REITS are redeeming their preferred stocks at par value plus accrued dividends.

So, the days of opportunity are gone-gone for now.  

A detailed discussion of this company and its equity preferred stocks can be found in a Item # 2 Bought 50 SHOPRD at 24.15 in Roth IRA and Item 3  Bought 50 SHOPRA @ 24.35.

Sunstone Hotel Investors Inc. 8% Cum. Redeem. Pfd. Series A (SHO.PA) closed at $25.49 yesterday.

3. Trust Certificate GJN-Underlying Trust Preferred Redeemed by J P Morgan/Payment Made to Swap Counterparty with Redemption Proceeds of Underlying Security?:

This is going to be a boring discussion that would be of interest to the owners of GJN on the redemption date and to us few souls who have delved into the exchange traded synthetic floaters which have been good to me. I have traded them actively.

My last transaction was to sell 150 shares at $23.02 (April 2012):

2012 Roth IRA GJN 150 Shares +$422.44 
For the reasons discussed below, I would appreciate knowing  the redemption amount paid to any owner of GJN, and anyone can send me an email or leave a comment to this blog below.

An issue arose late last night about GJN's redemption price, since there is an issue about receiving less than par value. I was informed that an owner received less than $15 for this $25 par value security. While I reviewed the snapshot, I can not say whether this is an error or something that was intended by the trustee.

If you enter a search term that includes the name of this security, Google will send you to my blog as the top selection. That is true for most of the esoteric subjects that I discuss.

When I  want an answer to this type of question, I will look at the prospectus which is what everyone needs to do. I have not been actively monitoring this kind of news for GJN since I sold out of my position a few months ago. I have only been monitoring its price occasionally.

While this will take some time to explain, it was not difficult to arrive at a preliminary opinion by simply reviewing the prospectus in light of JPM redeeming the underlying bond without making a make whole payment and to at least start raising some legal issues, if necessary, to fight back.

The Old Geezer can not remember every detail in this type of document and has to refer back to prospectuses to answer many questions. Nor can I devote time explaining all of the details contained in these prospectuses and discuss every conceivable scenario that may possibly arise in the future, when writing this blog, particularly when I direct the reader to the prospectus each time I discuss buying a bond. I can discuss a specific issue that may come up in the future, which is what I am doing now.

In my blog, I can only hit the high points that are generally applicable. Readers already complain to me about the details that I do provide and the length of my blogs which touch on a very large variety of securities and topics. This is probably the most detailed oriented blog about investments in the world as it is.

So here I go. I suspect that this will be the most detailed, public discussion of this issue as of this time, and probably for all time.

I reviewed the GJN prospectus last night, looking for provisions dealing with the redemption amount, and there is an anomaly in the GJN prospectus which is probably being used to justify the smaller redemption payment, assuming that has happened to everyone owning the security and it was intentional.

The prospectus contains a statement that a redemption by the issuer of the underlying security could trigger a payment to the swap counterparty that would be deducted from the redemption proceeds of $25 par value trust certificate:

Prospectus at pages S-3 to S-4. Please note the deduction for the amounts owed to the swap counterparty.  

More information is provided at page S-14; S-23 (particularly ix); S-24-25.

I believe those later two pages may be at the heart of the issue, assuming the redemption amount below par value is correct:

As of right now, I have studied the issue sufficiently only to form a preliminary opinion on the correctness of any payment to the swap counterparty out of the proceeds of JPM's redemption. I can only make initial observations. I am not even sure at this point that a payment was made to the swap counterparty, as opposed to an error in the redemption amount.

At first glance, the important phrases in the above snapshot appear to be "swap termination event" and "trust termination" event. If a swap termination event is also a Trust Termination event, then a termination payment may be due to the swap counterparty when this provision is read in isolation from the entire agreement (first paragraph of snapshot). Another important passage can be found at pp. S-23 to S-24 that a swap termination event occurs when the issuer redeems the securities prior to the maturity date (ix), and that event is  also a trust termination event:

I would also have no way to calculate the correct amount of any such termination payment to the swap counterparty. At first blush, that payment appears to be similar to the make whole payment that JPM would have to pay the owners of the TP for a voluntary redemption prior to maturity, unless that payment could be avoided by an exception. And that is when the literal reading of these passages starts to break down.

I would hope the possibility of a lawsuit against the swap counterparty is investigated soon, if my information is correct that the owners of GJN received less than $15. I do not believe the intent is to reward the swap counterparty with a substantial termination payment when there was no make whole payment made by JPM. The overriding intent of the prospectus is to pay the owners of GJN the $25 par value when the underlying security is redeemed by the issuer, in my opinion, and to pay the pass through any make whole payment to the swap counterparty. The issue may need to be litigated.  The amount at issue may be several million dollars.

The swap counterparty is Wachovia, later acquired by Wells Fargo (WFC).

To avoid unjust enrichment to the swap counterparty, and to avoid an injustice antithetical to the spirit and intent of the agreement with investors in GJN, the swap termination payment ought to be paid only when there is an early termination with a premium make whole payment made by JPM, so that the TC owners receive their $25 principal amount and the make whole payment flows through to the swap counterparty. That is the spirit of this provision, but those intent on working mischief and causing unnecessary harm to investors in furtherance of their rampant greed (i.e. Wall Street assholes and their Dickhead asshole lawyers) could try, and may have done so successfully so far, to interpret these provisions literally, in a manner to benefit themselves, and contrary to what a fair minded person would construe as their purpose and intent.

I did read some material last night that highlights how J P Morgan was able to avoid the make whole provision when redeeming the underlying security. TheStreet  That story has a list of the securities called by JPM.  Some of what I am about to say was drawn from that article.

The make whole provision would have made it unlikely that JPM would redeem the underlying security years before maturity-- unless there was an escape hatch that would allow it to avoid that significant premium payment.

The underlying TP in the synthetic floater was issued by J P Morgan Chase Capital XVII which had a 5.850% coupon and was scheduled to mature on 8/1/2035. That security had a make whole provision for an optional redemption, which would have required a premium payment, but the Capital Treatment Event was an exception, see page S-7GJN Prospectus.

I was somewhat surprised to learn that JPM would even want to redeem a junior bond with a 5.85% coupon maturing in 2034 that has liberal rights to defer interest payments even with that escape hatch.

As a result of new capital rules recently announced by the Federal Reserve, J P Morgan was able to redeem a number of trust preferred stocks at par value rather than at a premium. TheStreet The escape hatch for JPM was a prospectus provision that allowed for early redemption upon a "capital treatment event". (see the preceding link) If there was a capital treatment event, then JPM could avoid the make whole payment to the owners of the TP, a similar type payment to the one that may have been made to the swap counterparty for early termination of the swap agreement and the trust.  The make whole payment and the swap termination payment could offset one another and the owners of the TC would then be able to receive the $25 par value plus accrued interest.

I noted in an earlier post extremely unusual trading activity for GJN on the day prior to this post: June 13, 2012 Post This security rose 13% on very heavy volume on 6/12, and I could not find any news at that time to account for the sudden move on extremely abnormal volume. Based on the date of the press release discussed in TheStreet article, I now believe that those investors were reacting to JPM's announcement about redeeming the underlying security without reading the prospectus.

I doubt that those investors read the prospectus before buying, and assumed that the payment would be $25, which would be the case for a fixed coupon Trust Certificate. Those securities do not have these swap agreements attached to the TC, and it is that swap agreement which is the ultimate source of the issue and problem.

GJN is not a fixed coupon trust certificate. It is instead a Synthetic Floater which has a swap agreement.

This issue would be relevant to an early redemption for a synthetic floater. It would become significant when the early redemption by the underlying security issuer avoids the "make whole" provision due to the escape hatch. If JPM had made the make whole payment for a voluntary early redemption, which it did not do, I suspect that this kind of premium payment would have be sufficient, or close to it, to cover the swap termination payment to the swap counterparty so that the owners of GJN could receive the entire $25 payment of principal.

If the redemption amount paid to the owners of GJN was correct, and it was legal to make a termination payment to the swap counterparty, then this sell was fortunate.

The foregoing reinforces my admonition for everyone to read these prospectuses. I constantly harp on that point. This issue was apparently not picked up by the institutions that were buying this security heavily when JPM gave this notice of redemption. I would note, in their defense, that this issue has never come up previous to this redemption, to my knowledge, and would probably not be an issue if JPM had not been able to escape the make whole provision.

I reexamined the prospectus of GYB, which contains a trust preferred issued by Goldman Sachs capital, to determine whether it has a similar issue to GJN. I own 150 shares.

The underlying security contains a make whole provision (see pages S-25 and S-26). This would make an optional call by GS years before maturity unlikely. I did not see any provision in that prospectus that would give GS an exemption to the make whole provision for a so-called "capital treatment event" which was JPM's escape hatch (see summary at pages S-7 to S-8,  Prospectus). Lastly, there is no provision for payments to the swap counterparty when the issuer redeems the underlying security:

GYB Prospectus at page S-39

As a result of that review, I do not plan selling GYB due to the GJN development. Based on my first look, this appears to be an unusual confluence of events that adversely impacted GJN owners and unjustly rewarded the brokerage firm who was the swap counterparty.

The other synthetic floaters that I own (GYC-100 shares), (GJR-50 shares) and (GJT-50 shares) have senior bonds as their underlying securities and were issued by non-banking institutions; AT & T Proctor & Gamble and Allstate respectively. All of those senior bonds have make whole provisions, which will make an early call years before maturity unlikely due to the premium payment Those prospectuses do not have escape hatches for "capital treatment events" which is relevant to banks wanting to use trust preferred securities as Tier 1 Equity Capital for banking regulatory purposes. If the issuer did call early the senior bond, then I would anticipate a fairly close match between the make whole payment and any amounts due the swap counterparty connected to those synthetic floaters, though I do not have the necessary information to make that calculation which involves discounting some interest rate to present value. Each prospectus has to be checked individually for these issues. The purpose of the swap termination payment would be to channel the make whole payments to the swap counterparty.

I also had another successful trade of GJN:
2010 Roth IRA GJN +$460.53
Added: I did confirm later this morning that the trustee did pay $10.9683 per Trust Certificate to the GJN swap counterparty out of the proceeds paid by J P Morgan when it redeemed the underlying trust preferred security. I was not certain of that payment when I posted a discussion about this development earlier today. The liquidation proceeds were $25.6541 per TC, which left a balance of $14.6857 to be paid to the owners of GJN plus accrued interest. I noticed the information at quantumonline this morning which published the trustee's notice from 7/17/12. I could not find that notice myself this morning with a Google search, but I am confident that quantumonline reproduced it accurately. I hope that none of the readers of this blog got screwed on this one; and I said a prayer asking the Lord to forgive the swap counterparty for its greed. The swap counterparty did not bear the risk of a JPM default or a possible deferral of interest payments.

Another area in need of investigation and legal research is the amount of the payment. I am aware that there is a mechanism in the prospectus for calculating that number. My problem with that mechanism from my perspective is  that any number would be  speculative and incapable of determination in good faith, an implied obligation in every contract, since no one knows what the 3 month treasury bill rate will be over the next 22 years. While the swap counterparty was earning a spread between the minimum coupon rate and the coupon rate of the TP, that situation would not be likely to persist, and there would likely be extended periods of time when the swap counterparty would have to be reaching into its pocket, since the amount due the owners of GJN would be more than the amount received from GS. In other words, the amount is too speculative to permit a good faith estimate, assuming of course that one was even attempted rather than a "i'll scratch your back on this one". The higher coupon payment would have to be made when the 3 month treasury bill exceeded 2%.

Relevant Subsequent Posts:

Floyd Norris has published an article about GJN:  NYT

District Court Decision in Turkle Trust v. Wells Fargo (N.D. Cal)/Summary of Argument: JPM Potential Obligation to Pay Make Whole for its Recent 2035 TP Redemption/Other JPM Capital Trust Preferred Securities: Language on Make Whole Payment and Capital Treatment Event (8/13/12)

More On JPM Potential Liability for a Make Whole-Redemption 2035 TP (8/10/12 Post)

J P Morgan-Make Whole Payment-Redemption of Its 2035 Trust Preferred/Those Who Wish To Defend Wells Fargo In Connection with GJN Need to Specifically Address the Facts (8/7/12)

GJN-JPM-Make Whole Payment (8/6/12 Post)

Stocks, Bonds & Politics: GJN-Wells Fargo/More on When Does A Capital Treatment Event Occur (8/3/12 Post)

Stocks, Bonds & Politics: GJN-Wells Fargo-New York Times (8/2/12 Post)

Wells Fargo-GJN-Securities Act of 1933 (7/30/12 Post)

Wells Fargo-GJN (7/30/12 Post)

Item # 1 When Does a Capital Treatment Event Occur? (7/24/12 Post)(on JPM's potential liability, in need of further legal research)

The Egregious Swap Termination Fee Paid to the GJN Swap Counterparty (7/19/12 Post)

Related Subsequent Posts:

Sold 50 JBK at $22.75/Reassessment of Current Synthetic Floater Positions (7/21/12 Post)

Sold 100 GYC at 22.22 : Ongoing Reassessment of Synthetic Floaters (7/28/12 Post)


  1. GJN was the so called 3rd Party Trust Preferred, which are rare (only 2 pages on Quantum). They very cleverly utilized a deeply buried provision to scam the investors out of roughly 50% percent if their investments.

    The question is are other trust preferreds also susceptible to this scam? Like not called yet IGK, OKSBP,STL-A, etc. Anybody knows?

  2. Thanks for your comment. It is a good question. I will be commenting on this matter here as other people ask questions.

    You can get emails of post made in this thread by checking the box below.

    As I stated in today's post, I believe that this issue is limited to the so called thirty party trust preferred securities that have a swap agreement attached to them. This is a unique feature present in exchange traded "synthetic floaters" only to my knowledge.

    Those synthetic floaters are very few in number. I discuss GYB, GJR, GJT and GYC in the blog today. There are a few more.

    JBK is a special case, since it was originally a synthetic floater with a swap agreement and the trustee took the position that the swap agreement was terminated when the swap counterparty, in that case Lehman, filed for bankruptcy. I may delve into that one more deeply, since I currently own 50 shares. It has the same make whole provision as GYB and no out for a capital treatment event. For now, I would avoid buying it. I just have not decided whether I need to take a proactive position on my small position.

    So I would only include as potential problematic the third party trust preferred list at Quantum that involves synthetic floaters with swap agreements rather than the fixed coupon trust preferreds. I have had a number of fixed coupon Trust Certificates redeemed by the owner of the call warrant without having any problem or issues.

    I would hope that the major owners of GJN are at least investigating the possibility of legal action against the trustee and swap counterparty. I outlined some potential legal theories in the post today, primarily in the addendum.

    I own 200 STLPRA in a ROTH IRA. There is no "swap agreement" for that trust preferred. It can be called now by the issuer at the par value of $10. That is actually my main concern is losing the security to such a call.

    I no longer own the ING hybrids. Those are in effect baby bonds that can be called by the issuer at par value plus accrued dividends, and do not have swap agreements attached to them. The swap agreement is a limited and unique feature applicable to synthetic floaters.

    It is the swap agreement attached to GJN which creates the floating rate out of a fixed coupon TC and it is that swap agreement which is the source of the problem for GJN's owners.