Wednesday, August 22, 2012

SOLD 100 ONB at $13 & Bought 100 NBN at $8.7/Earnings: MWA, Reynolds Group

The fan on my new APPLE IMAC started to run continuously, making a loud sound. The OG could not concentrate while sitting at the computer. I downloaded software that told me that the temperature inside the computer was over 100 decrees. I took the computer to the Apple Store, no small task for the OG who grew weary lugging the contraption through the mall. After waiting for about 30 minutes past my appointment time at the "genius bar", I was told that the problem was not with Apple, possibly I needed to take it back home and unplug the printer which could be causing the computer to overheat. I lugged the computer back home, and disconnected everything from it. The computer started to overheat, and would do so irrespective of the electrical outlet or cord used by me. I called Apple support, and had to pay almost $50 for online support. Free online support has expired even though the computer was still under warranty. After running the computer in safe mode, it was determined by the technician that no third party software was causing the problem, and the problem had to be Apple computer. I was told to take it back to the Apple store. I elected instead to junk the computer, rather than continue this run around. I certainly was not going to continue running a computer which could catch on fire. A large number of people were complaining about the same problem in online message boards, and there was even YouTube videos capturing the noise. Apple had to know of the problem. I believe Apple products are way overrated by consumers.

I just read an article by Nicholas Marshi published at Seeking Alpha that discusses the disadvantages of senior debt issued by Business Development Corporations. I have discussed briefly one of those disadvantages which involves the lack of covenants in the prospectus. While he is correct that a BDC's unsecured senior debt is structurally subordinate to its secured credit facilities, and any borrowings of a subsidiary, that would be the case for every issuer, including even secured notes sold to investors that rely on the same collateral as the secured bank credit facility (e.g. Sears 2018 senior secured note which is in effect a second lien bond)

The senior secured debt for a BDC will be a bank credit facility. Marshii notes that Hercules Technology (HTGC) does not appear to be using its bank credit facilities as a source of permanent financing which is one reason why he mentions HTGC's senior unsecured debt somewhat favorably compared to others. Of course Hercules may change its approach to using its bank credit facility. (see page 48 Form 10-Q for 2012 second quarter)

I am keeping my exposure to BDC debt light. It has to be remembered that BDC's are making high risk loans to private companies who would ordinarily be unable to secure bank financing sufficient for their needs. The default rates for those borrowers will be higher than most banks would accept in non-recessionary conditions and will then significantly increase to even higher levels during a recession. That makes bank lenders to BDC's nervous, as shown by some of their actions during the Near Depression.

A BDC may only incur indebtedness in such amounts that its asset coverage is at least 200% of the debt when issued. The bank which lends to the BDC can become nervous, making demands on the borrower that create liquidity issues when the BDC's coverage ratio starts to substantially decline during a recession due to high default rates and one or more covenants in the bank credit facility are violated by the BDC.

More importantly for me, the yield on this debt is borderline for the risks, even with the relatively short maturities and the abnormally low yield for alternative investments. I currently own 200 HTGZ which Marshi discusses and just 50 of PRY.  Sold 50 NPBCO at $26.17 and Bought 100 HTGZ at $24.6-ROTH IRA (May 2012); Bought 100 HTGZ at $24.63 (May 2012); Bought 50 PRY at $23.58. I am not likely to add much, if anything, to that overall dollar exposure to BDC unsecured senior debt.

Exide Technologies announced that it will become the "majority supplier" of private label batteries for Pep Boys. I own two senior secured bonds: Bought 2 Exide 8.625% Senior Secured Bonds Maturing 2/1/2018 at 81.375

Goldman Sach's U.S. equity strategist David Kostin told investors yesterday to sell stocks based on the upcoming fiscal cliff which may not be resolved by year end. He is sticking by his year end estimate for 1250 on the S & P 500 which is now trading over 1400. CNBC

Why are the republicans so upset with Todd Akin's comments? Yesterday, their delegates approved a platform statement that abortion should not be allowed under any circumstances, including a pregnancy due to rape. That platform states that an "unborn child has a fundamental individual right to life which can not be infringed", which is the essence of what Akin was trying to say without the usual republican obfuscation on the subject.

Emerson Electric is the largest contributor to Akin's campaign. Emerson's CEO, David Farr, has personally donated the maximum to Akin.

Unlike prior platforms, the GOP platform committee refused to add a statement supporting the home mortgage interest deduction. Bloomberg It is generally recognized that this entitlement would have to be slashed for the GOP to lower tax rates for their wealthy donors and large corporations.

1. Sold 100 ONB at $13 Last Friday (Regional Bank Basket Strategy)(see Disclaimer): I had a $13 one year price target for this stock, purchased at $11.85 last May. So without any further adieu, the position was sold pursuant to a GTC All or None (AON) limit order at $13:

2012 ONB 100 Shares +$99.07
Quote: Old National Bancorp So far at least, I would have been better off staying with ONB: ONB: 13.40 +0.02 (+0.15%) 

Fidelity and TD Ameritrade will allow AON orders on 100 share lots.

2. BOUGHT 100 NBN at $8.7 Last Friday (Regional Bank Basket Strategy)(see Disclaimer): I pick up more than a 1% in dividend yield with NBN at $8.7 compared to ONB at $13.

Northeast Bank is a small community bank headquartered in Lewiston, Maine. The bank currently has 10 branches, 3 loan production offices, and 4 investment centers. Locations | Northeast Bank

The company offered 6.25M shares, plus an over-allotment option, in May 2012. Prospectus NBN sold 6,875,917 shares at $8 for aggregate proceeds of $55M and net proceeds of $52.8M.  This was a huge increase in the outstanding shares. The announcement in May 2012 caused a significant price drop from $10.75 on  5/14/12 to $8 on 5/16. NBN Historical Prices After selling these shares, the bank had about 10.38M shares outstanding as of 6/30/12.

Information about institutional ownership may be stale, but I did note four filings in May indicating significant hedge fund positions in NBN's stock. Except for Eagle Rock Capital's holdings, those positions may have originated from the public offering: (1) Bay Pond Partners owned 444,880 common shares or 5.12% as of 5/16/12 Schedule 13-G; (2) Castine Capital Managment owned more. Schedule 13-G; (3) Arlon Capital Partners owned 859,439 or 9.9% as of 5/21/12. SEC Schedule 13-G; (4) Eagle Rock Capital owned 671,939 or 7.74% as of 5/16/12, Schedule 13-D 

Before the Near Depression the shares were trading over $16 and returned to that level briefly in late 2010 and early January 2011. NBN Interactive Chart

The bank is currently paying a 9 cent per share quarterly dividend, which went ex dividend on 8/9/12.

For the bank's fiscal 4th quarter which ended on 6/30/12, NBN reported net income of $1M or 14 cents per share and $.41 for the fiscal year. SEC Filed Press Release  

As of 6/30/12, tangible book value per share was $10.63, so the stock is now selling at a sizable discount to tangible book.

As of 6/30/12, the net interest margin was 4.63%; the efficiency ratio was way too high at 81.1%; the Tier 1 capital ratio was 19.9%; the total risk-based capital ratio was 33.4% (both influenced by the sizable share offering); return on average assets during the quarter was .68%; NPLs to total loans were 1.5%; and the coverage ratio was very low at 14.4%.  
Most of the new capital is apparently used to purchase loans, both a potentially rewarding and risky strategy for such a small bank:
Quote: Northeast Bancorp

3. Mueller Water Products (own 1 senior subordinated 2017 bondJunk Bond Ladder Strategy) For its 3rd fiscal quarter, Mueller Water Products reported adjusted net income of 5 cents per share on a 6.3% increase in revenues to $275.9M. Adjusted EBITDA increased to $41.4M from $40.7M in the 2011 third fiscal quarter. Free cash flow was $5M in the last quarter. Mueller reduced its debt by $69.7M to $622.8M during the 2012 third quarter.

This 2017 subordinated bond is currently trading over 100. If I could sell my one bond online for any price over 100, I would do it. I have not noticed a single bid willing to accept just one bond however. For most of the junk bonds that I buy, liquidity on the sell side could be achieved most days with 5 bonds and less frequently with 2 to 4. It is hard to sell 1 bond unless there is a lot of volume, with a deep order book, in that bond. I have been successful in buying and selling one bond lots ($1000 par value per bond), but it takes time and is sometimes very difficult for some issues like this Mueller bond. Other one bond lots with liquidity issues would include my positions in Cascade, Gray Television, ArvinMeritor (2015) and Penn Virginia Resources. There is also no activity in some two bond lots, including Boise Cascade (OfficeMax) and First American (now CoreLogic).

4. Reynolds Group (own 4 senior unsecured bonds: Junk Bond Ladder Strategy): This company has grown by using debt to acquire companies. The end result is an extremely leveraged balance sheet. I own four bonds, originally issued by Pactiv/Tenneco Packaging, that were rated investment grade before Pactiv was acquired by Reynolds and are now deservedly rated well into junk territory. 

For the three months ending 6/30/12, Reynolds reported a loss of 55 million on revenues of $3.591 billion. Why the loss? The company had operating income of $304 million, before the interest expense on the excessive debt of $480M. The loss before tax was computed at $128M and a income tax benefit reduced the loss to $55M. (page 11, reynoldsgroup.pdf) Adjusted EBITDA, which adds back depreciation and amortization to operating income and does not subtract interest expense, was shown at $641 Million. For a heavily indebted company where interest expense is so important, I would not place much reliance on that number, though it would be alarming if the adjusted EBITDA number fell below the interest expense number.  

The balance sheet data can be found deep into the report at page F-3. As of 6/30/12, Reynolds Group Holdings had cash of $1.222 billion and $17.558 billion of non-current borrowings, up from $16.625B as of 12/31/11. If the goal is never to pay income taxes, and to depend on the kindness of lenders for refinancing needs, then the business can be operated in this fashion. 

Note 14, which starts at page F-25, discusses the debt. In the chart at that page F-25,  the notes issued originally by Pactiv, which I own, are listed: Pactiv Maturing 1/1/2018; Pactiv 2025; Pactiv 2027. I plan to sell one of the longer dated maturities, possibly within the next year. 

I raised my risk ratings on the Pactiv bonds back in June 2011. Tenneco Packaging and Pactiv Bond-Increasing Personal Risk Ratings The rating on the longer term Pactiv bonds was raised then to 8+. I seen no reason to lower that risk rating based on the earnings reports since June 2011. Arguably, the risk rating may need to be raised to 9, but I will wait until I see at least one more quarterly report.  

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