Friday, August 10, 2012

More On JPM Potential Liability for a Make Whole-Redemption 2035 TP/More on Commonwealth REIT/Earnings: XIDE, Momentive, Macy's, KWK, Travelport/ Added 50 IRR at $10.98/The WFC and JPM Apologists Have Had Their Say/

Headknocker (HK): Our Great and Supreme Leader, The Boss of Everything/the LB on Steroids/A Real Hard Case

Left Brain (LB): Also Known as the Nerd Machine,  Lame Brain, Stock Stud and Mama's Boy Depending on Who is Speaking

Right Brain (RB):  Also Known as Nitwit, the Real Man, the Real Stock Stud, and Mr "Go All In", depending on who is speaking. RB is on a quest to acquire Canada and rename it Northern Tennessee, never sweats the details and refers always to LB's trading rules as those "stinking rules"

Old Geezer: Also Known as the "Old Goat", way past his prime,  a more mellow alter ego version of HK who is frequently wrecked with anxiety and nerves, in constant need of chill pills and rehabilitation stints at the Old Folk's Home, where he can listen to Frank Sinatra music and play checkers all day, frequently allied with the RB and scared to death of HK.

Perhaps my Oregon reader, who wants me to say whether I would buy this or that, could help the OG on one for a change. Would he sell or hold the recent 30 share purchase of Terex. Mr. G from California can chime in with his two cents too. No hold that thought about Mr. G, he would just say sell, as in buy low and sell high, never a better phrase invented about investing:

30 TEX Bought 7/25/2012 Up 48.67% as of 8/9/12

Bought TEX at $14.43-LT Category RB wanted to buy a zillion.

I wanted to summarize some recent false statements made by Obama and Romney.

Obama said that his tax plan would ask millionaires to pay "a little more" I would regard that statement as false for the reasons given by PolitiFact. I would not call an average $190,000 tax increase to be a "little".  So that statement is more than just a stretch or an argument. For voters, it is always important to identify "arguments" stated as facts. Frequently, the argument has little or no factual support or is refuted by the most reliable factual evidence.

It is my view that Romney is incapable of telling the truth. While all politicians lie, unfortunately on a far too frequent basis, Romney is pathological, as shown by the constant repetition and sheer number of his lies. The most recent examples include the following:

PolitiFact gave a "Pants on Fire" rating that Obama's plan for welfare did not require recipients to look for work or to retrain for another job. According to Romney, Obama would send them a check when they asked for it. The obvious purpose of that distorted factual statement is to inflame pre-existing prejudices among white middle class voters.

PolitiFact rated as false another recent Romney statement that Obama is trying to disenfranchise voters in the military.

In addition, Senator Reid's statement that Romney has not paid incomes taxes in 10 years was given a Pants on Fire rating by PolitiFact.  Romney did pay taxes for the only tax return that he has disclosed to date. I understand why he refuses to disclose more. But no one has hard evidence that his use of tax shelters, foreign trusts and bank accounts, and other loopholes eliminated his tax obligation, as opposed to reducing it to say the average rate paid by a factory worker.


RRsat, a recent LT purchase at $3.95, reported net income of 7 cents per share for the second quarter on a 2.2% sequential growth in revenues to $28.1M. Earnings were negatively impacted by currency exchange rates. Cash was at $34.2M at quarter's end. The Board declared a $.10 dividend. RRsat is an Israeli company, and the OG has forgotten about foreign tax withholding from that country. So Headknocker ordered the LB to answer that question, not that it is material when you own just 50 shares and the dividend is 10 cents per share. LB replied "screw the HK", maybe it is 25%, "LB has more important things to do".

I finished reading the transcript of the CWH earnings call last night. I do not recall such pointed criticism of management by analysts. It was fun to read, until the OG realized that he owned 170 shares in the company and then the mood turned less chipper. I am still staying with it and will simply vote my shares against management.  The transcript can be found at Seeking Alpha, and an excerpt of analyst questions can be found at Wall St. Cheat Sheet

I would not regard it as debatable that management needs to be fired. The Stifel analyst downgraded the  CommonWealth REIT to sell. They point out management's conflict of interest and the likely dividend cut, estimating a reduction from $2 annually per share to $.5 to $1.2. I am guessing that the jerks will cut it by 50% to a $1 annually or $.25 per quarter. According to the excerpt of that report which I reviewed, the analyst believes that those issues will over shadow an otherwise attractive valuation, which confirms my belief that management has to go. CWH shares took another dive yesterday. A lot of this action has to do with the negative analyst view of CWH's management.

FPC Capital I 7.10% Cum. QUIPS Series A (FPC.PA) is ex interest today for its quarterly interest distribution. I anticipate a call, but nothing has happened yet to my knowledge.

There are three individuals who have started to come this blog for one limited purpose. To repeat over and over and over again how any fool could have understood what was about to happen to the GJN owners since the prospectus was so obvious and clear. Occasionally, while claiming to be proficient in the "clear" prospectuses, they demonstrate a startling lack of knowledge about them as shown by their comments, such as not having a clue about the meaning of a "make whole" provision. They insist on ignoring everything that I am saying about the matter and just repeat over and over their contention in various forms, for reasons that are not clearly apparent to me. There is one possible explanation which makes sense to me. I am going to cut off those persons from further comments on this blog.

They have had their say, and I have given them more than sufficient opportunity to blame the GJN owners, including all of the purchasers of GJN after 6/11/12, all of those owners who owned the security as of 6/11/12 and failed to sell before the redemption date including those with professional advisors at Wells Fargo and other brokerage firms; and all sellers of the security after 6/11/12 who failed to short the stock after realizing how much was about to be lost due to their reading of that "clear" warning in the prospectus. I have had enough. Those individuals can take their arguments to another blog.  Of course, they would give both WFC and JPM a pass and would view any claim to the contrary to be barking up the wrong tree or having no possible merit worthy of judicial resolution.

Anyone interested in what these WFC and JPM apologists have to say can review their extensive and repetitive comments found at Stocks, Bonds & Politics: GJN-Wells Fargo-New York Times. I found it virtually impossible to focus them are actually responding to the points that I have actually made, which are distorted and given little credence by them. As I have said, their only reason for coming to this blog is to blame solely the GJN owners for the injury suffered by them, which makes them suspect in my book.

The GJN trustee was U.S. Bank, whose headquarters is incidentally located in Minneapolis-St. Paul, Minnesota. The trustee paid out the GJN owners money to WFC without knowing how that huge number was calculated by WFC. Just give me the money, WFC said, and the Trustee sent them a $12+ million dollar check from the redemption proceeds from a JPM bond, beneficially owned by those who owned the GJN trust certificates. I have not confirmed that myself.  A reader that I trust confirmed that information by talking directly to the person responsible at U.S. Bank. Anyone contemplating a suit would be looking at the Trustee's potential liability under various theories, including their refusal to challenge the JPM payment to the trust before disbursing the funds to WFC. The redemption proceeds could have been placed in escrow until a lot of issues were addressed by the trustee. I am no more than an interested bystander calling balls and strikes.

If any of those three individuals want to post a comment on another topic totally unrelated to their repetitive comments in the preceding linked post, I will give them the opportunity to do so, provided the comment is germane to that other topic.

Of course, I do not care whether these individuals read this blog or not. I receive no compensation for writing this blog, and have done nothing to promote it. When I talked with Floyd Norris at the NYT about this matter, I told him that I did not want any publicity, but he insisted on using my name and made his own decision about hyper-linking a reference to my blog.

Another writer has picked up on this issue. He referred me to his thoughts on the matter: An Unconscionable Security - Business Insider His name is Ken Frankel, a managing member of an investment firm.

Notwithstanding what apologists say about JPM's obligation to make a make whole payment, the trigger for the Capital Treatment exception is whether JPM can make a reasonable determination based on any law, regulation, etc. Some will never accept that point. And, it is important to remember the general rules of contract construction about construing ambiguities against the drafter which was JPM. Lastly, a court may also consider that the interpretation placed by JPM and its supporters would cause damage to the bond owners. Therefore, it would be strictly construed as an exception for that reason and also because a liberal interpretation would cause unnecessary disruption in market pricing over an extended period, as JPM says that this proposed regulation or that proposed regulation starts the 90 days running again, when everything that needed to be known to make that reasonable determination of a Capital Treatment Event was known in July 2010. That 90 day period has run its course.

Nothing has changed since July 2010. It was known then, as now, that JPM would have to phase out the use of trust preferred securities as TIER 1 equity capital.

Bond pricing can key off the "make whole" provision, provided the issuer does not create continuous ambiguity about its applicability. Certainty about the applicability of the make whole provision is crucial to the proper functioning of the market.

JPM's argument is obvious on this issue. Their argument would key of any regulation, law, etc, that discusses this topic, over and over again, even though the reasonable determination is the same as it was  back in July 2010.

The legal issue is not whether someone who had no clue about the meaning of a "make whole" provision twenty four hours ago agrees with the foregoing. It is not even relevant that no one can predict the outcome of a legal contest on such an argument with any certainty, one way or the other. Trial lawyers know about uncertainty. Both sides have arguments. Instead, the issue is whether the plaitiffs' argument has sufficient merit that it would be worthwhile to make JPM justify its actions in a court of law. Let the court decide rather than JPM making a unilateral self-interested decision invoking a limited and time sensitive exception to the general rule requiring make whole payments for optional redemptions when that amount exceeds the principal amount of the bond.

If the owners of the $500M in the 2035 JPM TPs win this issue, most likely decided in a summary judgment, the reward for the costs would be gigantic, and the GJN owners could also be made whole. Basic risk/reward analysis, a common tool used by trial attorneys and investors, tells me that this one is a go, and it needs to start now.

I do not have the software necessary to calculate the make whole payment on $500 million of a 5.85% bond maturing on 8/1/2035. This is a standard calculation and would represent the principal amount and all interest payments from July 2012 to August 2035 discounted to present value using the applicable Treasury Rate, which would be abnormally low now. I would make a wild guess that the sum may be $75 to $100 million on top of what JPM paid in July 2012.

For long time readers of this blog, the 25 or so, who have suffered for years reading LB's frequently long  lectures, one point is reasonably clear. Headknocker is not likely to bend down and kiss the ass of a large financial institution, and then get down on his knees to lick the turd off their shoes. There is no doubt in my mind that the Masters of Disaster are primarily responsible for the Worldwide Near Depression and the suffering that has occurred thereafter. I am going to cut them any slack.

I have a fairly significant position in securities bought with Canadian dollars on the Toronto exchange. I am focusing mostly on securities that pay me monthly dividends in Canadian dollars, which increases my CAD stash which is then used to buy more Toronto listed securities over time. On 8/7/12, I received the following distributions from three of those securities:

CAD Dividends Received Main Taxable Account 8/7/2012

I own both Canadian ETFs and individual Canadian stocks. The largest individual stock position is 200 of Husky Energy. I have also focused on buying Canadian REITs.

1. Exide (own 2 senior secured 2018 bonds: Junk Bond Ladder Strategy): Exide Technologies had another disappointing quarter. After adjusting for a non-cash $1.14 per share charge related to a "deferred tax asset", the company reported a net loss of 25 cents per share on revenues of $693.4M for its second fiscal quarter. According to the company, net income was adversely impacted by unprecedented prices for spent lead battery input costs and foreign currency exchange. Earnings Call Transcript - Seeking Alpha The company ended the quarter with cash of $130.1M and $152.5M of liquidity available under its bank credit facility.

{While there is no need for me check the prospectus for this bond now, I am cognizant that it is a senior secured bond. However, as a general rule, a bank credit facility has priority even over that kind of security. In effect, when the company draws down on that credit facility, it is creating a first lien priority superior to what has become a second lien bond to the extent of that drawdown. Both forms of debt would be senior secured, and superior in the capital structure to senior unsecured debt, to the extent of their respective liens. In a bankruptcy liquidation, just to highlight the issue, the assets are sold for $200M and then distributed to the owners of the debt. Assuming that there is a 150M bank first lien, that debt would be paid leaving $50. If there was another 100M of senior secured on those assets and 100M of senior unsecured, then the second lien owners would receive 50% of their par value back, while the most junior senior unsecured would see their money go poof}

Inventory builds up in the first and second quarter in anticipation of demand in the current quarter, which is apparently the seasonally strong quarter. That inventory build up required a $21 million use of free cash flow. Operating income for the last quarter was reported at $1.1M.

As noted in a prior post, the company is closing a facility in Frisco, Texas by the end of this year. After completing a remedial environmental cleanup, the company will sell land around that facility to Frisco and realize net proceeds of around $37 when the transaction closes. I do not specifically recall, but I believe that number is after the cleanup expenses. 

While keeping its "B" rating on the senior secured notes, S & P recently downgraded the "recovery rating" in the event of a default. TEXT-S&P The new recovery rating is 4 which indicates a 30% to 50% recovery after a payment default.

Currently, I am near break-even on my two Exide bonds. Bought 2 Exide 8.625% Senior Secured Bonds Maturing 2/1/2018 at 81.375 (December 2011). I have liquidated my LT position.

2. Added 50 IRR at $10.98 (see Disclaimer): This brings me up to 250 shares. ING Risk Managed Natural Resources Fund (IRR) is a closed end fund that invests in natural resource stocks. Whenever I see "risk managed" or similar terms in a fund's name, that will indicate the probable use of a buy-write strategy to hedge downside risk.

On 8/8/12, IRR closed at $11.02 and then had a net asset value of $11.89 per share, creating a discount to net asset value of -7.32%.

IRR page at the CEFA

SEC Form N-Q for the fiscal year ending 2/28/12 showing the holdings. That form shows the use of a buy-write option strategy.

Daily prices for ING's CEFs can be found at the sponsor's website, among many other places:  ING Funds - Daily Prices

Sponsor's Webpage: ING Risk Managed Natural Resources Fund - Fund Profile

From that website, I took a snapshot of the top ten holdings as of 6/30/12:

Morningstar has a two star rating on it, which is below average of course. I view it as a negative that the generous dividend is supported by a return of capital. The only way for the fund to earn that dividend would be through capital gains. Morningstar shows the expense ratio as 1.22%, which is neither bad or good from perspective. I bought earlier this week the CEF PEO which has a much lower expense ratio.

The dividend is overly generous given the earnings. Dividends are paid quarterly at the current rate of $.33 per share. ING Risk Managed Natural Resources Fund - Fund Profile - Distributions

I also over 534+ shares of Blackrock Real Asset Equity Trust (BCF), another CEF that invests in natural resource stocks. That fund is currently selling at a small premium to its net asset value.

Some investors might prefer to own an ETF in this space and there are plenty out there.

They include the following:

Energy SPDR-XLE (low cost-energy companies in the S & P 500)

iShares S&P North American Natural Resources Sector Index Fund (IGE)

iShares S&P Global Energy Sector Index Fund (IXC)

WisdomTree Global Natural Resources Fund (GNAT)

I will trade the ETFs too.

This is a snapshot of an example:

2010 IGE 100 Shares +$449
3. Momentive (own 1 senior 2016 bond: Junk Bond Ladder Strategy): Well, at least Momentive is earning money which is more than I can say by other junk bond issuers. SEC Filed Press Release Momentive reported second quarter net income of $28 million on revenues of $1.3 billion. As of 6/3012, debt was uncomfortably high at $3.5 billion,  and liquidity of $602M. Part of that liquidity included unrestricted cash and cash equivalents of 333M and another $187M of available capacity under its secured credit facility. Owners of unsecured senior debt need to know about the amount of borrowing under that facility, and why is that?

I am near break-even, based on the last closing price, but would have considerable difficulty selling this bond due to its low volume and my ownership position being just 1 bond which is hard to sell even where there is more trading volume: Bought 1 Borden Chemical 8.375% Bond Maturing 4/15/2016 at 96.85 April 2011).

4. Quicksilver Resources (own 3 senior unsecured bonds: Junk Bond Ladder Strategy): KWK told investors in its earnings release that it was in "advanced negotiations on two joint ventures" and that those "negotiations have progressed significantly". Hopefully, those ventures will relieve the financial pressure on the company.  SEC Filed Press Release

As noted in prior posts, KWK is in a jam. It is highly leveraged and its main product, natural gas, has plummeted in price. That is obviously a bad combination. The company is taking measures to "aggressively" attack costs and capital expenditures. Personally, I would hope that the Darden family would just sell the company to a more financially stable company and have them assume that debt. But, I understand why they would be unwilling to do so after the stock price has been crushed to the low single digits. They are hoping for a recovery, and that will happen at some point in the future. The question is whether the company can make it until natural gas prices recover, or their emerging oil plays pay off in a big way.

The adjusted net loss for the quarter was $21M.

As noted in this article published byMarketWatch, natural gas prices have spiked up since hitting a 10 year low in June.

I am not even going to guess about natural gas prices over the near or intermediate term. Over the long term, industrial demand will likely rise, particularly as a fuel for gas turbines, for a simple reason. Coal plants are being shut due to new EPA regulations and it would take an awful long time to build a new nuclear unit, assuming any utility really wants to pursue that alternative in a meaningful way.

5. Macy's (own 1 senior bond: 2030: Junk Bond Ladder Strategy):  I own 1 senior bond originally issued by May Department Stores that was subsequently acquired by Macy's after the bond's issuance. That bond will be rated the same as bonds originally issued by Macy's.

When I purchased that bond as part of the junk bond ladder strategy, it was rated in junk territory and has now moved into investment grade territory. Bought 1 Macy's 7.85% Bond Maturing in 2030 @ 99.5 Hopefully, over time, I will have more of the junk bonds bought under this strategy work their way into investment grade ratings.

Macy’s reported second quarter earnings of 67 cents per share on a 3% rise in revenue to $6.12 billion. This beat the consensus estimate by 3 cents. Macy's also raised slightly its F/Y 2013 year guidance to $3.3 to $3.35.

I originally assigned a 3 risk rating to this bond in my Personal Risk Ratings For Junk Bonds and see no reason yet to revise that estimate.

6. Travelport (own 3 bonds: Junk Bond Ladder Strategy):  My Travelport bonds are extremely high risk, and I have close to a $1000 unrealized loss on them altogether. One way for my junk bond ladder strategy to ultimately succeed is to avoid a default on these dicey issues. In my junk bond basket strategy, my objective is to break-even on the bonds while capturing a nice interest rate. That objective would be easier to achieve with Travelport finding a way to survive.

Travelport reported a net loss of 20 million dollars for the second quarter on revenues of $506 million. PRESS RELEASE The year earlier period had a $312M gain from an asset disposal net of tax. The company claimed to have generated $63 million in operating income during the quarter and adjusted EBITDA of $120. The problem is the size and maturity schedule of the debt. The company is way over leveraged with net debt of $3.067 billion. Year to date, the company claims to have generated $128M in operating income. The debt service payments were $144M to date.

The OG finds nothing comforting or excessively frightening about this report.

2014 Senior Unsecured

2016 Senior Unsecured

2016 Senior Subordinated-extreme danger (subordinate to other senior debt including senior secured)

I am keeping my personal risk ratings of 10+ on the senior subordinated and 10- on the senior unsecured bonds.  Personal Risk Ratings For Junk Bonds

Needless to say, no one is capable of avoiding losses, that is just an inevitable part of the game that I am playing.  It is certainly questionable whether I can break-even on the junk bonds over the life of this strategy. I hope to transition to an investment grade ladder in 4 to 5 years, when hopefully a decent yield could be secured from better quality bonds than now.   


  1. Oregon here, trust me you do't want any advice from me on stocks, I'm that bad, that's why I'm reading YOU.

  2. Mr. Oregon: Please, please help the OG on TEX.

    Now you have not answered my question about what, if anything, happened after you got me to say what I would do with LSI, MTOR, etc.

  3. Mr. Oregon: The OG may die before he hears back from you or become so confused with that creeping old age disease that he will forget how to turn on a computer.

  4. Hi!

    First of all, I wanted to say thank you in general, thank you for writing about the sort of weird investment products in which I often invest - QO covers the numbers well, but noone seems to write about them, and thank you especially for the series on the JPM make-whole business. I owned some GJK and after reading what you wrote and the NYT article, and rereading the prospectus, I decided to get rid of it. I sold it at 25.00, it's now at 25.18, and I'm sure I did the right thing, especially if my need to sleep soundly is taken into account. (I also own some GJI, which I'll probably hold on to, though I'm not sure.)

    I hope that my sale doesn't make you feel too involved. I attribute to you no knowledge of anything, and in any case since it's my money, it can never become anybody else's responsibility, except perhaps by outright fraud in certain strange circumstances. I do my best to judge the claims and the evidence, such as they are, and I make my own decisions.

    I was also pleased to see you attack Obama's "false statement". I was beginning to think that you were totally, mouth-frothingly partisan on Romney/Obama. I'm not sure that I agree with you about that particular statement by Obama, though. I suspect that the words "a little more" have so little real denotative content in that context that they cannot be false (or true). If I say about a certain woman that 'She's OK', can those words possibly be false? Have I said anything about her at all? Could anyone mistakenly think that I had?

    In any case, I can't imagine successfully assigning a meaning to that "little" without knowing some numbers relating to the people who will be affected. $190,000 compared to what?


  5. On Tuesday, I will have an even more comprehensive analysis of the Capital Treatment Event exception to the make whole provision. Bond investors place a lot of value on those provisions, as shown by how investment grade obligations are now trading with make whole provisions. The underlying AT & T bond in JZJ has a make whole and is trading over 150 for example. If it did not have that provision and was redeemable now, it would be hugging 100.

    The issuer receives a lower rate with that sort of provision at the outset. An exception which nullifies it should be strictly construed particularly on a time limit provision for invoking the exception.

    I may not remember you right, but are you a lawyer from Chicago?

    I found a summary of a Federal District Court decision called Turkle Trust v. WFC decided 7/2/12, where the court held that a reasonable determination of a capital treatment event could have been made when Obama signed the Dodd-Frank bill. It does not appear to me that the plaintiffs or the Court understand the true implication of that holding. It would not cost much to litigate this legal issue for the aggrieved GJN owners.

    There was an exchange with a reader involving these shorter term synthetic floaters in the comment section to 7/21/12 Post titled Sold 50 JBK. . .. The massacre of the GJN owners was caused by two events: (1) the long period until maturity and (2) the lack of a make whole payment by JPM.

    GJK matures on 3/15/2014. GJN matured on 8/1/2035.

    While it has been a very long time since I owned GJK, I do recall that the underlying security is not a TP but a subordinated bond. This suggests that the Capital Treatment issue is not present. If I owned GJK, and I do not, I would look at the prospectus to see whether that escape hatch exists and whether the bond is subject to a make whole for an early redemption.

    I actually spent a few minutes looking at the prospectus and found at page A-2 a statement that JPM can not redeem the security early. So, the GJN problem of an early redemption does not exist for GJK. That is one reason why the price has not been impacted by GJN.

    The $190,000 would be an average for millionaires. Someone like David Koch would be paying considerably more.

    I do not believe that either political party will be capable of addressing the burgeoning budget problems.

  6. David: I thought that I would add a comment about bank subordinated bonds that were never treated as Tier 1 equity capital. Under prior regulations, the junior bond would have to meet several criteria before it could have been included in TIER 1 equity capital. One requirement is that interest can be deferred for long periods. Banks will issue subordinated bonds that do not permit interest deferral. Another requirement is that the junior bond must have a very long maturity to qualify as Tier 1 equity capital. These subordinated bonds which do not so qualify will frequently have shorter maturities.

    The Capital Treatment Event exception to a make whole provision only exists for TPs that met all of the requirements for inclusion in TIER 1 Equity Capital. I summarized those conditions in an earlier post:

    "The Federal Reserve requires several characteristics to be present before it will allow a bank holding company to include TPs as part of Tier 1 capital. One requirement, found in all of the prospectuses that I have examined, is a deferral right for a minimum of five years for distributions. Another is a long maturity, generally 30 years from the date of issuance is deemed to satisfy this requirement. There are other requirements not pertinent to the buyers of these securities. A third is that these securities have to be subordinate to all other debt. These requirements explain the deferral provisions, the low priority, and the long maturity. But, unlike the hybrids issued by the European financial institutions, the American institutions do have maturity dates for their TP securities, and a long one of 30 years is still better than no maturity at all. And, the American government has not come close to announcing, let alone implementing, a burden sharing policy for hybrid owners. Another distinction is that the American TPs do have limits on the period for deferrals, generally five years, and period limits are absent in the European hybrids."