Friday, November 9, 2012

Anxiety Returns/Bought 100 BRKL at $8.48 and Sold 100 NBN at $9.5 /Bought 50 SBSI at $20.2/Bought 100 RRD at $9.94-Sold 1 RRD 8.875% Bond Maturing in 2021 at 101.355/Bought 50 DRE at $13.79-ROTH IRA/Sold 100 MFA at $8.25-ROTH IRA/Terex Bond Redemption

In addition to my new weekly post, I have decided to have one monthly post devoted to updates of my Lottery Ticket and Regional Bank Basket strategies that are not discussed in the weekly posts. Consequently, I will continue to update those two Gateway Posts shortly after the publication of the monthly update which will be published on the last Monday of each month. Lottery Ticket Strategy: New Gateway Post; REGIONAL BANK BASKET STRATEGY GATEWAY POST In the update, I will also post the tables of the holdings in each of those basket strategies.

Big Picture Synopsis:

Stable Vix Pattern-A Bullish Cyclical Pattern
Cautious-Slightly Bearish Short Term
Bullish Intermediate and Long Term

Slightly bearish means that I anticipate a 10% to 15% correction off the recent high made in mid-September. Due to this opinion, I have been adding to my cash allocation by net selling of stock positions. This has been ongoing since late September but has tapered off this past week. I was a buyer yesterday but only with a total add of slightly more than $1,000. One of those purchases is discussed below, the common shares of Duke Realty, a REIT, which is ex dividend today.


Neutral Short Term
Slightly Bearish Intermediate Term
Extremely Bearish Long Term

The S & P 500 broke through its 200 day SMA, which was around 1,380, to the downside yesterday: S&P 500 Index Chart The breakdown occurred near the close and may easily carry over into today's trading.

There are several reasons for the slightly bearish near term stock outlook.

First, I have previously noted that the stock market appeared overbought to me, particularly in light of several recent negative earnings report which caused me to pare my stock allocation throughout October. I noted that a 10% decline from the recent S & P 500 high of 1,465.77 (9/14/12) would be viewed as a positive. I would much prefer buying some stocks when the S & P falls below 1300 than now, even with last Wednesday's downdraft.

Second, there is no resolution of Europe's problems. The anxiety about those problems increased last Wednesday, contributing to the market's free fall, when the EC cut its 2013 eurozone growth forecast to .1% from 1% (table 1, ‎ Growth in Germany was cut to .8% from 1.7%. The mood was further darkened by remarks from the ECB President Mario Draghi who said that he anticipates weakness for the "foreseeable future", whatever that means. For our LB, the foreseeable future is almost the next one second. The OG would anticipate weakness continuing in Europe through at least 2013.

Third, there will be a lot of hand wringing about the upcoming fiscal cliff. My outlook on that issue is discussed in the "Politics and ETC" space below.

Fourth, the precipitous and sharp decline in Apple shares is probably contributing to the angst. I noted in a 10/26/12 post that a research firm had already concluded that the shares had formed a double top, with no discernible downside support, before the company released a disappointing fiscal 4th quarter report and guided down its fiscal first quarter revenue and earnings forecasts. Text of press release issued by Apple Inc. on October 25, 2012 Apple shares closed at $537.75 down -$20.25 yesterday, and are now trading well below their 50 and 200 day SMAs. AAPL Interactive Chart I have no position.

In the big picture analysis, sometimes called the Great Waves, I am attempting to look out several years into the future, always a precarious undertaking fraught with difficulties. The most important issues are the large macroeconomic forces likely to last for a decade or more. Europe will survive. At least the Europeans have started to address their spending and budget issues which is more than anyone can say about the U.S.

When undertaking the big picture analysis, I tend to devalue what other people view as important.  For example, from the big picture perspective, it did not matter whether Dwight Eisenhower or Adlai Stevenson won the 1952 or 1956 presidential races. The economy and the stock market were going to be strong between 1950-1965 irrespective of who was President or the party controlling Congress. Inflation and interest rates were low and generally well behaved, Europe and Japan were in a strong recovery and rebuilding mode, and the Age of Consumerism was becoming a dominant economic force in the United States. {historical CPI:;  3 Month Treasury Bill Rates Since 193410 Year Treasury Rate by Month since 1871 (note how the rates started to trend upward in the mid-1960s, the acknowledged onset of a long term secular bear market in both bonds and stocks); see also Historical Returns on Stocks T. Bonds and T Bills Since 1928}

The large macroeconomic forces in the 1982-2000 period, another Great Wave, were more important to the stock market and the overall health of the economy than the policies of Ronald Reagan and Bill Clinton and their respective political parties. In reality, there are not very significant differences between those two Presidents, capable of influencing the Great Wave for better or worse, a comment likely to produce a howl or two among Reagan True Believers.

The primary reasons for the longevity of the previous long term secular bull market had nothing to do with the tax policies of either President. GOP partisans will never accept that observation and that explains why they were so vociferous in their criticism of a recent Congressional Research Report showing no significant impacts from tax policy. Tax policy can have a negative impact when taken to extremes, but ultimately it is not relevant to the big picture whether the Koch brothers pay 35% or 39.5% marginal rate except to them of course.

Instead, as I have maintained in numerous prior posts, the large macroeconomic factors caused the economy and the stock market to have the largely virtuous cycle between 1982-2000. The most important lift occurred early in that cycle when the Federal Reserve successfully tamed inflation and interest rates started to fall. One of the major tailwinds in that prior virtuous cycle was the long term bull market in bonds, due to downward sloping interest rates. A headwind would not necessarily follow from a rise in rates from the current abnormally low levels to more normal rates.

The other two major lifts involve the incredible explosion in spending, using borrowed money, by both governments and consumers throughout the developed world. Spending borrowed money by the boatloads will provide an impetus to economic growth until the party ends. I call that period the Age of Leverage.  What Will Produce Growth after the Age of Leverage? (September 2009); Underlying Cause of the Current Long Term Bear Market is Too Much Debt (June 2010 Post);  The Importance of Identifying the Underlying Causes of Long Term Bull and Bear Markets (June 2011 Post)

Lastly, the other primary mover was technological innovation, primarily involving computers, the emergence of the internet, and communications, which together improved productivity and lowered costs.  

I have previously discussed the new emerging Great Wave.

The President of Valley National, Gerald Lipkin, aptly summed up the adverse impacts of the Federal Reserve's monetary policy in the last earnings call. Earnings Call Transcript - Seeking Alpha I particularly agree with statement that the nation's recovery is being "disproportionally placed on the backs of our senior citizens" who are being punished for exercising fiscal restraint.

For anyone interested, Edison Mission had a dismal third quarter  earnings report. The company raised the possibility that it would not make the next scheduled interest payment on its bonds. EME 2012 Q3 at page 5. The company reiterated its prior statement that it does not have sufficient liquidity to pay the $500M in debt maturing in June 2013. I views a bankruptcy filing to be virtually certain. See also,  Item # 5 Edison Mission Statement SEC Form 10-Q on Bankruptcy Option (8/7/12 Post).

McDonald's reported yesterday comparable store sales fell 1.8% in October, the first such decline since March 2003.

1. Pared Trade: Bought 100 BRKL at $8.48 and Sold 100 NBN at $9.5 (Regional Bank Basket Strategy)(see Disclaimer):

Security and Company Description: Common Stock. As of 9/30/12, this bank has approximately $5.1B in assets and 44 branches throughout Massachusetts and Rhode Island. Its headquarters is located in Brookline, Massachusetts.

Brookline Bancorp Profile Page at Reuters. 

In January 2012, BRKL completed the acquisition of the 17 branch Bank Rhode Island. 

Trading Activity: I previously sold 101+ BRKL shares in a knee jerk reaction after the bank disclosed in October 2011 that it was delaying its earnings release to look into an accounting issue. SEC Filed Press Release; Item # 5 Sold 101+ BRKL at $8.23 The company thereafter released its earnings and noted that no material adjustments needed to be made. SEC Filed Press Release-Earnings 2011 3rd Quarter

I bought these shares before the election. Regional banks tanked on Wednesday, possibly in reaction to the election results and an irrational belief that Romney would be able to reverse the bevy of financial regulations passed under the Obama administration particularly certain parts of Dodd-Frank law.

Yesterday's Closing Price: BRKL: 7.98 -0.12 (-1.48%) 

Recent Earnings ReleasesSEC Filed Press Release 

Net Income: $11.401M or $.16 per share (ups from $.12 9/30/11)
Net Interest Margin: 4% (up from 3.74% 9/30/11)
Efficiency Ratio: Not Provided in Press Release
NPL Ratio: .51%
Coverage Ratio:
NPA Ratio: .47%
Return on Average Assets: .9%
Tangible Book Value Per Share: $6.32
Tangible Equity to Tangible Assets: 9.08%

Brookline does not provide efficiency and most capital ratios in its earnings press release. That information can be found in the SEC Form 10-Q. As of 6/30/12, the efficiency ratio was 60.44%; and the capital ratios were good. (see pages 48 and 71 SEC Form 10-Q for the Q/E 6/30/12


1. Reasonable Valuation: The current consensus E.P.S. estimate is for 56 cents in 2012 and 67 cent in 2013, almost a 20% year-over year rate of growth. BRKL Analyst Estimates The capital and loss ratios are good. 

2. Dividend Support: The current quarterly dividend is $.085 per share. That basic rate has been in effect since the third quarter of 2002 when it was raised from $.0732. Since that raise in the basic rate, BRKL has paid 11 special 20 cent per share dividends.

Two of those special dividends were paid in 2004, 2005, 2006, 2007 and 2008. The last one was paid in January 2009. Brookline Bank - Dividends If the bank resumes that special bi-annual special dividend, and keeps the basic quarterly dividend at $.0850 per share (total of $.74), then the yield at a total cost would be about 8.73% at a total cost of $8.48. It may be years before the bank's earnings could support that kind of payout. The payout ratio would be over 100% at the 2013 forecasted E.P.S. with two $.20 special dividends. The bank actually had a payout ratio of substantially more than 100% for those years when the special dividend was paid. 2010 Annual Report at p. 16 (e.g. 2007 payout ratio of 246.67%). The bank had apparently built up an excess capital position. At the end of 2009, it still had a total risk based capital of 19.4%, with 10% considered to be well capitalized. 2010 Annual Report at page F-33 

If no special dividend is paid, and the basic rate is maintained at $.0825 per share, the yield would be about 4% at a total cost of $8.48.

Brookline was ex dividend for its quarterly distribution on 11/7/12: BRKL Stock Quote

Prior to buying 100 BRKL, I sold 100 NBN at $9.5 (see Disclaimer). I was not pleased with the last earnings report given the risks flowing from the purchased loan portfolio strategy:

2012 NBN 100 Shares +$64.07
Bought 100 NBN at $8.7 (8/22/12 Post)

I discussed this report at Item # 2  NBNNortheast Bancorp Press Release F/Y 1st Q. Earnings

2.  Pared Trade: Sold 1 RRD 8.875% Senior Unsecured Bond Maturing in April 2021 at 101.355  (Junk Bond Ladder Strategy) and Bought 100 of the Common RRD at $9.935 (see Disclaimer):

Company Description: R.R. Donnelley is a large commercial printer. It provides printing for magazines, newspaper inserts, forms and labels, catalogs, financial documents, forms, labels and other products. The company wishes to be known as more than a printer and points to its growing logistical business. Logistics The earnings of this company will in significant part be dependent on advertising.

The kinds of services provided to RRD clients are described in this press release describing a recent contract with AARP. Multi-Year Agreement by AARP

R.R. Donnelley & Sons Profile Page at Reuters

R.R. Donnelley & Sons Key Developments Page at Reuters

Company Website: Print, Digital and Supply Chain Solutions

Trading Activity:

I have bought the common shares on two prior occasion. I flipped a 100 share lot bought in a taxable account, holding the stock long enough to receive one quarterly dividend: Bought 100 RRD at $11.6 (April 2012)-Sold 100 RRD at $12.24 (May 2012). I repeated that process with a 50 share lot purchase in the Roth IRA. Bought 50 RRD at $10-ROTH IRA-Sold 50 RRD at $11.92-Roth IRA (July 2012). I am not likely to hold these shares for vey long, unless I see a significant improvement in operations and some major changes in the management of the business.

I bought the 100 shares in a taxable account:

2012 RRD 100 Share Purchase

The stock was scheduled to go ex dividend the next day, 11/6/12, and generally I will not buy a dividend. I will consider buying the stock immediately before the ex dividend date provided there is a decline in the price about equal to or greater than the dividend, which was the case on 11/5/12. The stock closed at $10.19 on 11/4/12.

In anticipation of buying of buying the common shares at less than $10, I sold 1 RRD bond earlier.  

I have also been flipping RRD bonds. For the 8.875% senior unsecured bond maturing in 2021, I have now bought and sold it twice, and would buy it again at the right price. The prior round trip involved a purchase at 92.69 and a sale at 100 about two months later. Sold 1 RRD Senior 8.875% Bond Maturing 2021 at 100 (April 2012)-Bought 1 R.R. Donnelley 8.875% Senior Bond Maturing 5/14/2021 at 92.69 (February 2012)

The bond sold at 101.355 was bought at 96.95 last May. Bought Back R.R. Donnelley 8.875% Senior Bond Maturing in 2021 at $96.95

The broker will report to the IRS that I received in $91.96 in interest from this 1 RRD bond during my two brief periods ownership periods. However, I paid to the sellers accrued interest totaling $38.46 which is included in that $91.96 total. For the reasons given in earlier posts, I will deduct the accrued interest paid to the bond sellers in my Schedule B. Item # 1 Tax Accounting For Bonds Purchased in the Secondary Market ( and see: Accrued Interest on Bonds)

Recent Earnings Release: For the 2012 third quarter. RRD reported adjusted net income of $92.9M or 51 cents per share, compared to $98M or 51 cents per share in the 2011 third quarter. SEC Filed Press Release 3rd Q. Earnings The revenue side highlights some of the problems. Sales decreased 6.5% from the 2011 third quarter due in part to price erosion and volume declines. Gross margin declined to 22.8% from 23.4%. The company expects full year non-GAAP E.P.S. to be between $1.84 to $1.92 on revenues of $10.1-$10.2B.

Year-over-year, product revenues declined 8.2% to $2.17B, while service revenues increased 6% to $337.4M.

As of 9/30/12, the company had cash of $392.9M and long term debt of $3.422+B.

Earnings Call Transcript - Seeking Alpha


(1) Valuation and My Contrarian Streak: At $9.94 per share, I simply view that this stock has value, notwithstanding all of RRD's issues. The consensus E.P.S. estimate is currently $1.83 for 2012 and $1.8 in 2013. RRD Analyst Estimates Based on a total cost of $9.94 per share, the forward P/E is around 5.53 based on the $1.8 per share estimate.  Price to sales is less than .2.  Book value is $6.72 per share. The company has $2.18 per share in cash. RRD Key Statistics Unless the economy is about to enter into another downturn, it is hard for me to visualize now much downside to a $9.94 price given these valuation metrics.

The stock slide from over $43 in 2007 to the current price is appealing to my naturally contrarian instincts, when the firm has earnings, a low price to sales ratio and/or price to book, a low P/E and a dividend. The long term chart does look awful with the current price returning to the levels prevalent in 1985 which suggests that a change in strategy is in order. RRD Interactive Chart

With an improving economy, which I am predicting, both pricing and volumes will likely improve leading to better than expected results. Given the negative sentiment reflected in the current price, a year-over-year increase in revenues and profits could be so unexpected that the shares could pop, and the dividend could become, at least temporarily, more secure than now.

The dividend yield on the stock is more than on the bond that I sold.

S & P currently has a 4 star rating on the stock with a $17 one year price target. I would be shocked to actually see a $17 price within the next 12 months.

RRD has a 4 star rating from Morningstar with a current FV estimate of $12. I would view a one year price target of $12 to be more realistic.

(2) Dividend Yield Is Extremely High: Subsequent to my purchase, the stock went ex dividend on 11/6/12 for its quarterly distribution of 26 cents per share. RR Donnelley Board of Directors Declares Quarterly Dividend Assuming a continuation of that rate, which is questionable for the reasons discussed below, the yield would be about 10.45% at a total cost of $9.95 per share. I would have a low confidence level in the long term continuation of the current dividend rate for the reasons discussed in the risk section below.

The dividend is currently taxed at a maximum 15% rate while the interest payment on the lower yielding 2021 bond is taxed at my highest marginal rate. The tax rates may change next year.

(3) Risks: Many of the risks are highlighted in the S & P report that reaffirmed the "BB" debt rating but changed the outlook to negative from stable. TEXT-S&P

(a) Declining Industry That is Price Competitive: RRD operates in a highly competitive and fragmented industry. Some parts of that business are in a long term secular decline. Particularly during recessions, pricing power evaporates and volume declines which create excess capacity. Barriers to entry are relatively low. Customers have more leeway to influence a downward adjustment in the effective price. I read the recent Morningstar report on RRD that goes into this problem in more detail. Evidence of those pricing issues can be found in recent RRD earnings reports.  

(b) Capital Allocation Increasing Debt Costs: When I first bought a RRD bond, the bond was rated investment grade. The senior unsecured bonds are now rated BB by S & P and Ba3 by Moody's according to FINRA. The current yields on the bonds suggest that investors are assigning a lower investment grade. The 2021 bond had a YTM of about 8.7% when I sold it at 101.355.

By going to FINRA's advanced bond search page, I can compare that yield with similarly rated corporate bonds maturing at about the same time and this is what I found, with yields calculated on the day of my RRD bond sale:

Scott's Miracle Grow 6.625% 2020 YTM 4.53% Rated BB by S & P
Dana Holding 6.75% 2021 YTM 5.64% Rated BB by S & P
Precision Drilling 6.625% 2020 YTM 4.95% Rated BB by S & P

Obviously, the YTM of 8.7% for the RRD 2021 bond is out of sync with those other "BB" rated bonds, indicating that professional investors believe that the RRD bonds need to be downgraded further.

As many corporations are able to issue new debt to refinance existing debt at much lower rates, due to the Federal Reserve long standing Jihad Against the Saving Class now entering its fifth year, RRD is refinancing debt at a higher rates than the existing debt. I will list some examples:

2004 Issuance $600M at 4.95%: FINRA Maturing 2014-Outstanding $258+M
2005 Issuance $500M at 5.5%: FINRA Maturing 2015-Outstanding $299+M
2007 Issuance $625M at 6.125%: FINRA Maturing 2017-Outstanding $523+M
2010 Issuance $400M at 7.625%: FINRA Maturing 2020-Outstanding $400M
2012 Issuance $450M at  8.25%:  FINRA Maturing 2019-Outstanding $450M

RRD could eliminate the dividend, saving roughly $188M, based on 180.4M non-diluted shares outstanding, and apply all of those funds to debt reduction. There would be just about enough to retire the two bonds maturing in 2014 and 2015, referenced above, without having to sell new bonds at a substantially higher rate than those maturing. While the stock would probably take a temporary hit with a dividend elimination, the long term stock prospects would improve in my opinion. The company would likely be able to issue new debt at substantially lower yields, at least during the current period of abnormally low rates,  making the business more valuable over the long term.

In short, I believe that a better capital allocation would be to eliminate the dividend now and to use those funds to retire debt, thereby reducing leverage. Under this type of capital allocation scenario, some new debt could be issued to retire or buy back higher cost debt maturing after 2015.

The debt and maturity schedule can be found in note 14 at page 25, Form 10-Q.

(c) Unfunded Pension Liabilities: As of 12/31/11, Donnelley had underfunded its pension and postretirement plans by about $1.074B and $228.4M respectively. (page 24 Form 10-K) The company expects to make cash contributions of approximately $152M to its pension and postretirement plans in 2012 and another $40M in 2013. Form 10-Q at page 39 Those contributions were significantly reduced by virtue of a law enacted in 2012.

(d) Stop the Acquisitions And Reduce the Share Repurchases by 50%: There is no reason to have confidence in RRD's ability to make sensible acquisitions. Since 2005, RRD has spent $4.5 billion to make acquisitions and has a current market capitalization of about $1.8B. (e.g. Banta $1.3. in cash, Bowne $487M, Pro-Line Printing $122M in cash; Von Hoffmann for $412M in cash; Helium for a reported $57M; OfficeTiger for $250M; etc.)

In addition, the company has taken $3B in asset impairments since 2005, which reminds me of hapless acquisition strategy of Hewlett Packard.

With that kind of record, the Board needs to put the kibosh on all large acquisitions proposed by management and virtually all others unless extremely strict criteria are met. (see article at  Seeking Alpha).

In 2011, RRD had $553M in free cash flow and spent all of it and more on share repurchases and the dividends (over $700M). That needs to stop, with at least 50% of the cash flow being redirected to debt reduction.

The foregoing is not likely to happen anytime soon which I view as a negative.

(e) Dividend Cut or Elimination Risk: The dividend is certainly at risk of at least a 50% reduction.  

Future Buys: I am in a trading mode for all RRD securities. I am not a long term holder of RRD bonds or its common stock.  I will likely sell the common shares on a pop over $11 and definitely at over $12. I will consider buying back RRD bonds maturing prior to 2022 at less than par value and only when the current yield exceeds 9%,  more likely when the current yield exceeds  9.5%.

Ex-Dividend Day RRD Closing Price:  RRD: $9.99 +0.32 (+3.32%)

Yesterday's Closing Price: RRD: 9.61 -0.01 (-0.10%)

3. Bought 50 SBSI at 20.2 (Regional Bank Basket Strategy)(see Disclaimer):

Company Description: Southside Bancshares is the holding company for Southside Bank headquartered in Tyler, Texas. Tyler is located about 90 miles east of Dallas and 90 miles west of Shreveport, Louisiana.

Southside has 48 branches including two in Fort Worth. Nineteen of those branches are in grocery stores. The bank also has 12 motor bank facilities. 2011 Annual Report at p. 2

Southside Bank Branch Locations.pdf

Southside Bancshares Profile Page at Reuters

Trading Activity: I have previously bought and sold SBSI shares. Bought 50 SBSI at $19.49Bought 50 SBSI @ $18.73; 5% Stock Dividend Paid; Sold 107+ SBSI at $20.5Bought 100 SBSI at $20.4Sold 100 SBSI at $21.53

Total Realized Gain=$315.74 (snapshots at Regional Bank Basket Strategy: Gateway Post)

11/1/12 SBSI Buy 50 Shares
Yesterday's Closing Price: SBSI: 20.50 +0.38 (+1.89%)

Recent Earnings Release: SEC Filed Press Release 2012 3rd Q Earnings

Net Income 2012 3rd Q: $8.6M or $.50 per share ($.5 2011 3rd Q)
Net Interest Margin: 3.22% (down from 3.6% 2011 3rd Q)
Efficiency Ratio: 59.85%
NPL Ratio: .97%
Coverage Ratio: 175.5%
NPA Ratio: .49%
Return on Assets: 1.02%

This bank will provide capital ratios in its 10-Q filing.  I would not expect much change from the capital ratios provided in the 10-Q for the Q/E 6/30/12 at p. 48. Those ratios are excellent:

SBSI Capital Ratios as of 6/30/12
For banks with assets between $1B to $4.9B, the average efficiency ratio is 66.76%.

For banks with assets between $1B to $15B, the current average NPL ratio is 3.17% as of the 2012 second quarter, down from 3.88% in the 2011 second quarter. ‎ Like most of the banks in my regional bank basket, SBSI's NPL ratio is less than 1%.

NPL Ratio; Banks With $1B to $15B Assets

(1) Dividend & Dividend Growth Support:

SBSI's quarterly cash dividend has been trending up since 1996 and has been augmented periodically by 12 special dividends starting in 2000. Southside Bancshares Cash Dividend History In 2000, the basic quarterly rate was .0263. By 2010, it had reached $.1543 and is now 20 cents per share.

After the close yesterday, Southside Bancshares declared a regular quarterly dividend of $.2 per share, a special dividend of $.13 cents per share and a one time special dividend of $.2 per share, apparently due to the possible change in the dividend tax rate. The Board also authorized the repurchase of up to $10M of the stock.

At the $.2 quarter rate, and no special dividends, the dividend yield would be about 3.9% at a total cost of $20.2 per share. Any special dividends would add to the yield.  

In the foregoing trading history, I noted the payment of a 5% stock dividend. This bank has paid a 5% every year since 1997. Southside Bancshares Stock Dividends and Splits I view the 5% stock dividend to be only important in relation to the cash dividend history. The cash dividend is going up unadjusted for the stock dividend shares.

2. Reasonable Valuation: The stock is selling at slightly more than 10 times 2012 estimated earnings. When looking at the valuation issue for a regional bank, I will also rely on the dividend yield at my purchase price, the prospects for dividend growth, and the factors impacting the safety of that dividend.

3. Positive View on the Safety of the Dividend: The factors that will influence my judgment about the reliability of the dividend include the NPL ratio, the coverage ratio, the capital ratios and the payout ratio.  I would also be interested in knowing whether the bank remained profitable during the most recent recession.  SBSI remained profitable during the last recession:

2008 Net Income: $30.696
Diluted E.P.S.= $1.96
Dividends Per share: $.60

2009 Net Income= $44.396M
Diluted E.P.S.= $2.82
Total Dividends Per Share= $.75

The 2007 dividends totaled $.6 per share. While past performance is no guarantee of future performance, an investor still can draw reasonable conclusions about the competence and prudence of a bank's employees with this kind of historic information. It is also relevant that the bank increased the dividend during this period and still remained well below a 50% payout ratio.

A payout ratio of less than 50% provides a measure of comfort that the dividend will not be cut by the bank. SBSI's payout ratio is currently less than 50%.

I would also look at the capital ratios when making a judgment about the safety of the dividend. A bank with capital ratios well in excess of the minimum level for well capitalized banks, which is the case for SBSI, has cash available to support the dividend.

The historic NPA and NPL ratios give me a good measure of the bank's prudence in extending loans. Simply put, if the bank can avoid losing a lot of money due to bad loans, the dividend is going to be more secure. I am also interested in those ratios during recessions. Even a bank operated in a prudent manner will likely see the NPA and NPL ratios exceed 1% during a recession, but I would still prefer seeing those ratios remain under 3% even in an economic period like the recent Near Depression.

The historic financial ratio can be found in a bank's annual report (SEC Form 10-K). For SBSI, I looked at the 2011 10-k and just kept scrolling until I found the data from the Near Depression period at page 66:

On 12/31/2007, the NPA ratio was .18% and the NPL ratio was at .30%. The NPA ratio hit 2.27% on 12/31/2009 and then started to come back down. As of 9/30/12, it was at .49%.  NPLs were at 1.8% on 12/31/2009 and started to come down too. As of 9/30/12, the NPL ratio was .97%.

All of those factors enter into a judgment call about the safety of the dividend. Barring any unforeseen calamity, I would have a high level of confidence that SBSI will not cut the dividend. The bank further has the ability to raise the dividend some, over the next few years, even without E.P.S. growth.

In short, I would have far more in SBSI at least maintaining its dividend than R. R. Donnelley or Windstream.

3. Unfavorable Issues: 

(a) Lack of Earnings Growth: The most unfavorable metric is the lack of earnings growth, a problem caused in large part by the Federal Reserve's monetary policy. The current consensus estimate, originating from three analysts, is for an E.P.S. of $1.96 in 2012 and $1.81 in 2013. I suspect that the 2013 is not adjusted for the regular 5% stock dividend. Even after making that adjustment, however, the consensus forecast would be predicting a slightly negative E.P.S. growth rate in 2013 compared to 2012. For the stock price to gain some momentum, SBSI will need to be beat the 2013 consensus estimate by at least 5%.

(b) Reliance on Realized Gains from Security Sales: Another issue is that the bank's earnings have been dependent on realized gains from security sales:

2007:  $    .897T
2008:  $12.334M
2009:  $33.446M
2010:  $25.789M
2011:  $11.795M

See line item at page 34, form10k.

This kind of data is causing erratic E.P.S. While it is commendable that the bank has been this successful, those gains represent a significant part of total net income. A more dependable source of earnings would be from operations.

During the 2012 third quarter, the bank reported a $4.302M gain on the sale of securities. For the first nine months, the realized gain was reported at $13.571M, up from 9.08M in first 9 months of 2011.

(c) Net Interest Margin Contraction: The net interest margin is an important ingredient in a bank's profitability. SBSI reported a substantial decline in net interest margin year-over-year in the third quarter. The CEO spent some time explaining this decline and factors that will hopefully lead to a widening of that margin later this year. The primary reason for the net interest margin compression was "an increase in prepayments on the mortgage backed securities which resulted in increased amortization expense".

During the quarter, the bank increased its investments in municipal bonds and decreased the size of its securities portfolio by selling some of the higher priced mortgage-backed-securities.

On cost of funds, the bank highlighted that many of its higher cost FHLB advances will mature over the next 12 months. Of the $231 million in FHLB advances with rates higher than 2%, which are labeled "high cost" by the bank, about 65% with an average cost of 3.76% will mature over the next year. In addition, the bank noted that its 6.86% fixed coupon TP (principal amount $36.1M) will transition to a floater this quarter, paying just 1.64% over the three month LIBOR rate.

Future Buys: I will consider rounding my position to a 100 share round lot by adding 50 more shares below $19.5.

Adjusted for the 5% annual share dividend, the share price has mostly moved in a $18-$22 price channel since mid-2006, except for two relatively brief downward spikes during the Near Depression period. Prior to the formation of that channel, the stock had a run from $4.6 in 2000 to over $22 in late 2006. SBSI Interactive Chart

4. Bought 50 Duke Realty (DRE) at $13.79-Roth IRA Yesterday (see Disclaimer):

Company Description: Duke Realty is a REIT that owns or controls 759 industrial, office and retail properties. 3Q.10Q.2012 at page 22

In its most recent quarterly report, Duke provided lease information for its properties:

Occupancy Analysis as of 9/30/12 at page 24
Duke Realty Profile Page at Reuters

Duke Realty Key Developments Page at Reuters

Company Website:  The online home of Duke Realty

Trading Activity: Within the prior decade, I flipped a 50 share lot in the ROTH IRA after receiving one dividend.  Bought 50 DRE @ 13.45-ROTH IRA-Sold DRE at $15.31 (May 2011).

I bought those 50 shares back yesterday at $13.79.

2012 ROTH IRA DRE 50 Share Buy at $13.79
Yesterday's Closing Price: DRE: 13.76 -0.19 (-1.36%)

Recent Earnings Release:  As shown in the the preceding snapshot, the occupancy rates for industrial and medical properties are generally good, while the office property occupancy rates have room for improvement. Duke Realty Reports Third Quarter 2012 Results 3Q.10Q.2012 Overall occupancy was good at 92.5%.

Duke reported core FFO at 26 cents per share for the third quarter. Adjusted funds from operations, which I interpret as a Cash Available for Distribution (CAD) calculation, was 20 cents per share. The board declared a 17 cent quarterly distribution.

The adjusted FFO number subtracts such items as building improvements, leasing commissions, and tenant improvements.  For the first nine months, adjusted FFO was 61 cents per share, versus common share dividends of $.51.

Duke is repositioning assets by increasing its investments in medical office properties. During the quarter, the company bought a medical office portfolio consisting of seven buildings with 334,000 square feet. The buildings were 100% leased to the Harbin Clinic, one of the largest multi-specialty physician practices in Georgia.

After the end of the third quarter, Duke closed on medical office portfolio for $343M which includes a geographically diverse portfolio of 14 buildings, with over 1.2M square feet that was 89.4% leased at the time of closing.

In its earnings press release, the company described a fairly large development program:

Properties Under Development as of 9/30/12

Late last year, Duke sold 79 office buildings for $1.06B. SEC Filed Press Release Needless to say, Duke Realty is a large REIT.

During the last quarter, Duke Realty Partnership sold $300M in a 3.93% effective coupon ten year note. PROSPECTUS SUPPLEMENT

Earnings Call Transcript - Seeking Alpha


(1) Dividend with Some Potential Appreciation: I do not see much room for dividend growth near term. However, even if the current 17 cent per share quarterly dividend rate is maintained, and I see no reason why it would be cut, based on currently available information and a reasonable forecast for the future, the dividend yield would be about 4.93% at a total cost of $13.79 per share.

Duke Realty raised its quarterly dividend from $.475 to $.48 in the 2007 third quarter. The quarterly dividend was then raised to $.485 in the 2008 third quarter and kept at that level for just two payments before it was slashed to $.25 in the 2009 first quarter and then to $.17 in the 2009 second quarter, where it has remained since that time. - Investor Relations - Dividend History That kind of history will be remembered by many investors for a very long time.

Consequently, I only need to pick up another 5.07% in stock appreciation, after commissions, per year to realize a 10% annualized total return. A 6% return on the shares would cover my round trip commission costs, which means that I could capture a 10% annualized return by selling the stock at $14.75 one year from today. That seems doable to me and not an unrealistic goal.

The stock of Duke Realty had a good run from the $3 neighborhood in 1990 to over $44 by February 2007, adjusted for stock splits. The price then crashed during the Near Depression period, cascading down until bottoming out near $5 in March 2009. DRE Interactive Chart

While I am certainly not suggesting a return to the 2007 within the foreseeable future, the stock does not have to do anywhere near that well to be a satisfactory investment. As I just mentioned, a $15 price in one year would be more than satisfactory. The stock closed at over $15 fifteen times during September 2012. DRE Historical Prices

A return to $20 in five years, which would probably require a continued recovery in the U.S. with no major downturn, would result in about a 42% return on the shares, unadjusted for the commission. When the dividend is added to the share return, the annualized total return would be over 12%. In a previous period, the stock moved from around $14 in October 1996 to consistently over $20 by December 1997. During the recession in 2000, the stock returned to $18+ before recovering to trade consistently over $25 by February 2003 until the collapse mentioned above.

Of course, the past is not always prologue to the future, but that price action does provide some guidance to how the stock may react to a sustained up cycle in the economy.

I am not likely to hold this security for very long in a retirement account. The foregoing discussion would be more relevant to me in the event Headknocker becomes an involuntary long term investor in this stock.

The stock is ex dividend today for its 17 cent per share quarterly distribution: DRE Stock Quote

The earnings were released after the close on 10/31/12. The stock closed at $14.48 on 10/31/12, so it had slid far more than the value of the dividend before my purchase yesterday. DRE Historical Prices

The most recent S & P report (9/12/12) assigned a 4 star rating to the DRE shares with a $17 one year price target.

After the earnings release, BMO Capital reiterated its outperform rating and designated DRE as a "top pick".

5. Sold 100 MFA at $8.2541 in Roth IRA/More on Net Interest Spread Compression (see Disclaimer):

Company Description: MFA is a Mortgage REIT that invests in both agency and non-agency mortgage backed securities.

MFA Financial Inc (MFA) Profile Page at Reuters

Trading History: I bought the shares sold  last year in two 50 share lots.  Bought 50 of MFA at 8 in ROTH IRA (June 2011); Added 50 MFA at 7.78 in Roth IRA (July 2011). I have no prior trading history in this security.

Recent Earnings Release: MFA released third quarter earnings on 11/6/12, the day that I sold the shares. The shares rose over 1% in response to this release. Considering the unfavorable interest rate environment that is causing a compression in the interest rate spread, I thought that MFA's earnings report was satisfactory, particularly in the book value increase. MFA Financial third quarter core earnings per share of 19 cents and an increase in book value to $8.8 from $7.45 as of 6/30/12. The company attributed the increase to investing in both agency and discounted non-agency mortgage backed securities. The later are more risky, however.

MFA Financial's CEO Discusses Q3 2012 Results - Earnings Call Transcript - Seeking Alpha

Rationale: Whenever I buy a Mortgage REIT or a Business Development Corporation (BDC), the goal is simply to harvest several dividends and then to exit the position at any gain whatsoever.  I accomplished that goal with MFA as shown in the following snapshots:

Dividends Received $132.5
The realized gain on the 100 shares was negligible at $14.89, which is acceptable given the dividend yield.

2012 MFA 100 Shares +$14.89
The total tax free return was $147.39 or 18.34% based on a total cost of $803.5.

Investors had a negative reaction to the earnings report from Annaly Capital, released on the same day, that highlights the problems facing Mortgage REITs now. NLY's net interest spread contracted to 1.24% from 1.96% as of 9/30/11. Those issues are also discussed in this Seeking Alpha article. I also own 100 shares of Annaly in the ROTH IRA. I changed my distribution option for the NLY dividend to reinvestment, indicating that I am now an involuntary long term holder of that stock. Book value was reported at $16.6 per share. NLY shares dropped on the news: NLY Close 11/6/12: $15.34 -0.55 (-3.46%)

Future Buys: I will consider buying up to 100 shares of MFA on a decline below $7.5. I also have the MFA's equity preferred stock under consideration for a 50 share purchase, but the price has to fall below $25.5 before I will consider it. MFA Financial Inc. 8.50% Cum. Redeem. Pfd. Series A, (MFA.PA)

Yesterday's Closing Price:  MFA: 7.95 +0.08 (+1.02%)

6. Terex 2017 Bond Redemption ( own 1 2017 Senior Subordinated Bond): I am no longer updating the Junk Bond Ladder Strategy Gateway Post or any other prior post relating to this strategy. I am about to lose another junk bond to redemption. Terex announced yesterday that it had priced $850M in a 6% senior bond maturing in 2021. TEREX FWP 11-08-12 The company intends to use the proceeds to redeem its 8% senior subordinated notes maturing in 2017. The first stage of that redemption involves a consent solicitation tender at a premium. Tender Terms. Since I only own one bond, I will wait for the company to redeem my bond under the terms of the prospectus. For a redemption after 11/15/2012 to 11/15/2013, an optional redemption can be accomplished at 104% plus accrued interest.

‎Prospectus at page S-83

I bought this bond in August 2011: Bought: 1 Terex 8% Senior Subordinated Bond Maturing on 11/15/2017 at 96.947

I am also about to lose a Gray Television senior secured bond due to the issuers optional redemption at 107.875.

Bought 1 Gray Television 10.5% Second Lien Bond Maturing 6/29/2015 at 95 (November 2011); redemption is also discussed at Item # 3 Stocks, Bonds & Politics

Politics and Etc.

1. Election Results and the Fiscal Cliff: I would assess the tax and spending parts of the fiscal cliff separately.

(a) Taxes:The election results increase the odds that the U.S. will not be able to reach a compromise on the extension of the Bush tax cuts which are set to expire on 1/1/13. I do not see the GOP controlled House of Representatives approving a deal that would raise taxes on their benefactors, even if that results in a tax hike for everyone else.

The Democrats are by nature more willing to compromise, but it would be politically difficult for them to extend the Bush tax cuts for the rich other than for a few months to give the two sides more time to reach a deal.

One possible road to compromise would be to close several tax loopholes, including the one involving carried interest, in exchange for extending the Bush tax cuts for everyone for 2-4 years. This last option would be opposed by most GOP House members, viewed as hard line reactionary ideologues, but a well crafted compromise along these lines could peal off enough GOP votes from the herd to pass.

I am aware of Boehner's comment, made after the election, that the GOP would be open to "new revenue under the right conditions", and those conditions would be a tax code that fosters in their view faster economic growth and entitlement "reform". What does that code mean to the GOP other than tax cuts for the rich, now called the "Job Creators", and spending cuts in programs for the poor and the middle class? I would agree with the comments made in a Bloomberg article that Boehner only sounded conciliatory without changing GOP policy. If the Democrats agree to cut taxes for the rich, reduce spending on programs for the poor and middle class, and "reform" entitlements, then the GOP will agree to that plan which in their view would generate faster economic growth. Give them everything that they want and the GOP will agree to it!

(b) Spending: Both sides have an incentive to avoid the automatic spending cuts, and I would anticipate some kind of resolution on that issue without the automatic cuts taking effect. Most likely, the Senate will have to take the lead, since I do not see any hope that the GOP ideologues in the House are able to craft spending cuts that any Democrat would approve. The Senate Democrats and around 5-6 GOP senators may be able to craft a deal on spending. I voted for Senator Corker (R), and he would likely be one person willing to work with the Democrats on a sensible compromise on the spending issue. Susan Collins of Maine would be another possibility. If the spending cuts fashioned by compromise in the Senate are close to the amount contemplated by the automatic cuts, then there could be enough votes peeled away from the GOP herd in the House to approve the deal.

2. Obamacare Will Not be Repealed Prior to 2017: At a minimum, Obamacare will not be repealed prior to 2017.

This could have long term adverse repercussions for the GOP.

When the Medicare legislation was passed, there was a wing of the GOP who voted with the Democrats to pass this law, mostly those Northeastern GOP politicians who no longer have a place in the modern GOP (13 GOP senators and 70 GOP representatives voted for Medicare when it was originally passed in 1965). PolitiFact correctly gave a "false" rating to a statement by Howard Dean that Medicare passed with no GOP support, as did Social Security in 1935.  

Obamacare has zero support among GOP politicians who have made it crystal clear, to even the most uninformed and dumb citizens, that they would repeal that law whenever they are given a chance to do so.

After Americans become familiar with how the law operates, two developments could easily occur. Popular opinion could swing in favor of Obamacare, and the GOP will not be as successful garnering votes based on repetitive misrepresentations about this law. For those Americans who are not blind to information, they can see for themselves whether the representations are true or false based on actual events observed by them. There will still be hard core opposition to the law in most Red states, but the tide could shift in some Red states like Tennessee and all swing states, making repeal after 2017 highly unlikely.

3. Republicans Have Some Serious Long Term Problems: The election results reveal several long term problems for the GOP. The extremism of the Tea Party is one problem. There is no doubt in my mind that  Richard Lugar would have retained the Senate seat in Indiana for the GOP but for his defeat in the GOP primary to Richard Mourdock, the tea party candidate.

A less reactionary GOP candidate would have likely unseated the Missouri senator Claire McCaskill (D), but the tea party candidate Todd Akin won the GOP primary. Candidates like Akin and Mourdock can still win in places like Utah, as shown by Mike Lee winning the general election after beating the traditional republican incumbent Bob Bennett. However, except for states like Utah, Idaho, Nebraska, Mississippi, Alabama, South Carolina, Oklahoma and a few others, nominating an extremist candidate will likely result in a Democrat victory even in traditional republican states like Indiana. The same thing also happened in North Dakota with the Democrat Heidi Heitkamp defeating Rick Berg. Romney carried ND 58.7% to 38.9%. The GOP believed that taking back the Senate was almost a sure thing, yet they managed to actually suffer a net loss of two seats. WSJ The independents Angus King from  and Bernie Sanders from Vermont are expected to caucus with the Democrats giving them a 55 to 45 advantage.

The exit polls reveal only a 21% approval rating for the Tea Party,

The exit polls also reveal that Romney did as well as any GOP nominee among white voters. The problem is that white people are becoming less important by the year, particularly in several battleground states. Obama won only 39% of the white vote, yet he had almost 3 million more votes than Romney nationwide ( and trounced Romney in the electoral college vote. As I have noted, the GOP's racist Southern Strategy, which was deployed nationwide after its successful debut in the South back in the 1960s, has already reached its maximum potential and is now producing diminishing returns as well as a backlash. One author gave the Southern Strategy a eulogy.  I would not go that far. It is still a successful strategy for whites, particularly in gerrymandered congressional districts drawn by GOP dominated state legislatures which played an important role in saving Tea Party sponsored representatives elected during the last election.  What is the Appropriate Political LabelThe GOP's Retrogression-Please Bring Back the Eisenhower Republicans

Obama carried about 93% of the black vote and the Latino vote by 71% to 27%. Pew Hispanic Center George Jr. carried 40% of the Latino vote in 2004.

The republicans have serious problem with women and young people. Romney won only 44% of the female votes; and 37% of the the 18-29 crowd. Changing Face of America Helps Assure Obama Victory | Pew Research Center for the People and the Press

An article published in the NYT yesterday highlights the GOP's problem by focusing on the election results from Prince William county in Virginia. That county used to be solid GOP territory but Obama won in that county by almost 15%. The GOP has now lost Virginia in the last two Presidential races after carrying that state in every election since 1964. And North Carolina is now in play too.

4. A Few Old Filthy Rich White Guys Were Not Able to Buy an Election: After spending hundreds of millions on false and frequently fraudulent advertisements, the handful  of filthy rich old white guys found out that it will be more difficult than previously thought to shape America more to their liking. The Koch brothers and assorted ilk were the big losers in this week's elections.


  1. Hi,

    First, congratulations on your new format with the thorough discussions for each trade.

    Second, I have a question regarding DRE:
    If one does not seek appreciation in the stock, and want only a >6% dividend, what do you think about some of its preferreds which are tradinag at about par? The only issue is that they can be called at anytime, but if you buy at par, get a few dividends and get called, >6%/yr isn't a good deal? Also, isn't there a lower down potential in the preferreds as opposed to the common?

    I am curious about what your thoughts are about DRE's preferreds as opposed to the common?


  2. I would not buy the preferred unless it offered a significant yield advantage over the common which is not the case with the DRE preferred stocks.

    There are several reasons. I will just mention the most important for me.

    There is almost no appreciation potential in these REIT preferred stocks when bought at or above par value. For a patient investor, it would be reasonable to forecast a 10% annualized total return for the stock which would require a combination of 5% annual appreciation in the share or some lower percentage with future dividend increases. There will be no dividend increases on the fixed rate preferred shares. While there will not be a dividend cut with the preferred, which happened with the common shares during the Near Depression, I do not view it likely that there will be another common dividend cut, without a severe recession, and a more likely possibility would be a series of divined raises over the course of the next five to ten years which would also buoyed the stock returns.

    Both the common and preferred shares will get walloped in a recession. I was able to buy preferred shares from well managed REITs at more than 50% discounts to par value, including SLGPRC as low as $10-11 which has now been called.

    If you buy a preferred stock, you will need to pay attention to the call right date. While the REIT has no obligation to ever redeem the preferred stock, an unfavorable characteristic of the security, it will have the right to do so. Duke has called, for example, DREPRM in March 2012 even though the coupon was only 6.95%. This is particularly relevant for any purchase over par value. I believe that DREPRK; DREPRL and DREPRJ can be called now and that could happen at anytime. DREPRO has a call date on or after 2/20/13 and that one will certainly be called in my opinion given its 8.375% coupon.

    I noticed that Quantumonline shows investment grade ratings on these preferred shares. The quality of the company and that investment grade rating are two reasons for taking a contrary approach to me, provided the purchase is made very near par value with a recognition that the security could be called at anytime.

  3. Your section on evaluating RRD common stock in this post is _so good_. I mean, really good stuff!

  4. Lute: I am tempted to add another 50 RRD if it falls below $9 again, possibly in the ROTH IRA.

    RRD is about to be kicked out of the S & P 500. It does have some modest recovery potential.

    I recently posted a comment to a SeekingAlpha article discussing RRD bonds. That article was published on 12/7/12: