Thursday, May 31, 2012

Spain/Bought 400 of the Bond CEF ACG at $8.19/Bought 100 WIN at $9.35-ROTH IRA

So, a tomato has more genes than a human. NYT

Perhaps, I do not find that surprising after just watching 6 hours of the mini-series about the Hatfields & McCoys on the History channel.

The lawyer Perry Cline, a distant cousin of Randall McCoy, who was portrayed in that mini-series as the most erudite and articulate of those involved in this multi-decade violent scuffle, wrote the following letter to the Governor of West Virginia, complaining about the Hatfields: "They have and can make the people sign any kind of petition they want. I was rased (sic) near them men and know them; they are the worst band of meroders (sic) ever existed in the mountains, and have been in arms since the war; they will not live as citizens ought to; they stand indicted in 4 bad cases of murder . ..last year's court was indicted for Ku-Kluxing and various other misdemeanor cases, in fact, we cannot hold our elections without them crossing the line and rung (sic) our citizens from the election grounds, and selling them liquors in violation of law, and these men has (sic) made good citizens leave their homes..."

A segment on CNN highlights the extreme difficulty associated with firing a tenured teacher in New York. The teacher allegedly told her female students to take off their clothes for a medical exam, and there were other allegations of inappropriate conduct. It costs almost $300,000 to dismiss a tenured teacher in NY, even when the conduct clearly warrants a dismissal. The basic constitutional precept of due process is without question being abused by teacher unions, aided and abetted by legislators willing to assist them. The students, their parents and the taxpayers are the true victims.

As the unfunded liabilities for retired government workers become current liabilities over the next two decades, state and local taxes will continue to rise for those living in California, Illinois, New York,  New Jersey and other high tax states.

The migration to low tax states will accelerate in the coming years, making the burden even more onerous on those unable or unwilling to move. Tennessee will be a beneficiary of that migration due to low property taxes and no personal state income tax except for a 6% tax on certain interest and dividend payments above a standard deduction. The City of Brentwood, where HQ is located, has not raised the property tax rate since 1991. City of Brentwood, TN My property taxes are around $2,100 per year.

SmartMoney.com recently published an article on affordable retirement havens in Tennessee.

The WSJ reported that the large Chinese banks have cut off some European banks from borrowing and derivative trading.

Spain's sovereign debt crisis has entered center stage once again, as Spain attempts to recapitalize its third largest financial institution, Bankia, which was formed by the forced consolidation of seven regional banks in December 2010.

On May 25, 2012, Bankia requested an additional €19 billion from Spain, WSJ, which Spain intends to raise by selling new debt. MarketWatch This latest government bailout has caused the yield on Spain's sovereign debt to rise. ES 10Y Govt Bond Benchmark With an unemployment rate hovering near 24%, and recessionary conditions in Spain, the ability of Spain to refinance its debts has become a relevant issue. Spain's stock market hit a nine year low yesterday. The iShares MSCI Spain Index Fund (EWP) is trading well below the Near Depression lows hit in March 2009: iShares MSCI Spain Index Fund ETF Chart

The problems in Spain's banking sector are due largely to a real estate bubble, similar in many respects to the bubble in the U.S. A similar situation has already played out in Ireland.

As noted by Michael Lewis in his book "Boomerang", Greece's banking problems do not originate from improvident decisions made by the bankers, but by the irresponsible and frequently fraudulent actions of the Greek government. An excerpt from that book, which deals with Greece, can be found at Vanity Fair.

The U.S. 7 and 10 year notes hit all time low yields yesterday. The 10 year treasury closed at a 1.618% yield. WSJ  The thirty year treasury bond is yielding about 2.71%.  Apparently, everyone has forgotten about the trillion dollar plus annual budget deficits, and the complete lack of restraint among U.S. politicians when spending other people's money.

The CBOE Volatility Index (VIX) rose 3.11 yesterday to close at 24.14.

1. Bought 400 of the Bond CEF ACG at $8.19 Last Thursday (see Disclaimer): The AllianceBernstein Income Fund is an investment grade closed end bond fund that uses leverage. Currently, the fund pays a monthly dividend of 4 cents per share. At a total cost of $8.19, the dividend yield at that penny rate would be approximately 5.86%. Given the low yield and the use of leverage, I will trade this fund for small gains, while capturing one or more monthly dividend payments. 

Last Thursday, the date of my purchase, ACG closed at $8.2 and had a net asset value per share of $9.08, creating a discount of -9.69 to net asset value per share at that time.

ACG Page at the Closed-End Fund Association


The fund has a significant weighting in U.S. treasuries. Most of the bonds owned by the fund are rated investment grade:


2011 SEC Filed Annual Report: AllianceBernstein Income Fund 

The latest monthly update of portfolio holdings can be found at AllianceBernstein Income Fund Releases Monthly Portfolio Update.

The next ex dividend date is 6/6/12 for the 4 cent per share dividend. AllianceBernstein Income Fund, Inc. Monthly Distribution

As noted above, I have not been a long term owner of this fund:


Generally, the OG will buy this fund whenever he starts to get the shakes.

AllianceBernstein Income Fund rose two cents yesterday to close at $8.22. As of yesterday's close, the net asset value per share was $9.13, creating a discount to net asset value of -9.97.

2. Bought 100 Windstream (WIN) at $9.35 Last Tuesday-ROTH IRA (see Disclaimer): The reasoning for purchasing WIN is similar to the rational underlying the recent 50 share purchase of R.R. Donnelley.  Bought 50 RRD at $10-ROTH IRA (5/23/12). My opinion is that investors have become too negative about both WIN and RRD, and both companies have generous dividend yields that become tax free when the stock is purchased in the ROTH IRA. Many investors undoubtedly believe that these high yielding stocks will not be able to continue their respective current dividend rates.

While the Windstream dividend exceeds its net income, the free cash flow does support the current dividend rate. (see discussion in articles at Motley Fool). When asked during the Lightning Round last Tuesday, Cramer said that he did not know whether the dividend was safe, given the "ugly" last quarter.

WIN is currently paying a quarterly dividend of 25 cents. Assuming a continuation of that rate, which is of course in no way assured, the dividend yield at a total cost of $9.35 would be approximately 10.7%, significantly higher than the junk rated unsecured senior bonds. I have sold my WIN senior bonds. Sold All Windstream Bonds: Two 2019s at 101 and One 2020 at 103.5 Those bonds were bought after selling my common stock position. Sold 300 WIN at 12.31 (August 2011. Now, I am gingerly moving back into the stock.

The amount and maturity schedule of the debt are concerns for both the bond and stock owners. As of 3/31/12, WIN had $8.788 billion in long term debt, mostly in bonds maturing before 2023 (see schedule at page 12 of 10Q for Q/E 3/12)

The recent downdraft in WIN's stock is linked in large part to the downward guidance for the wholesale business. I discussed that issue a few days ago in Item # 5  WIN. That reduced guidance caused institutional investors to question the recent $2.3 billion purchase of PAETEC.

I would be satisfied with a 10% annualized return from this purchase. Over the course of a one year holding period, and assuming no reduction in the dividend, that goal could be achieved by selling the stock near my purchase price. The roundtrip commission would be $14, so a sell a $9.5 after collecting 4 dividend payments would exceed that 10% annualized return goal.

If the price returned to a $11 to $11.5 range within a year, then I would likely sell the shares bought last Tuesday in the ROTH. I am not a long term holder of the stock.

The next ex dividend date is 6/27/12 according to Marketwatch. I will not be reinvesting the dividend to buy more shares.

Windstream declined 8 cents yesterday to close at $9.32. 

Wednesday, May 30, 2012

Exchange Traded Bonds: New Gateway Post

This post is an update of a 2009 Post on the same subject:  Exchange Traded Bonds

Exchange traded bonds are simply bonds traded on a stock exchange and consequently may be purchased or sold in the same manner as a stock. 

Most exchange traded bonds have $25 par values. The relatively low par value, coupled with the ability to trade them like stocks, make them more desirable to many individual investors, compared to $1,000 par value bonds traded in the frequently inhospitable bond market, where I am also an active participant primarily in the junk bond category. 

Exchange traded bonds will trade "flat", which simply means that the buyer does not have to pay accrued interest to the seller. The investor who owns the exchange traded bond on the ex interest date will receive the entire interest payment. As with common stocks, the price on the ex distribution date will be adjusted by the amount of the distribution. 

Exchange traded bonds come in a variety of legal forms. The most easily understood is the "baby bond". Bonds traded in the bond market will have $1,000 par values, whereas most baby bonds have $25 par values. 

The other categories of exchange traded bonds are Trust Certificates, Trust Preferred securities, synthetic floaters, European hybrids, and "principal protected" unsecured senior notes. Detailed discussions on those types of exchange traded bonds can be found in the following posts:


For European hybrids, I have focused solely on those issued by ING and Aegon.

Any investor desiring to purchase one of these securities needs to review the prospectus. 

Due to the long term secular bull market in bonds, attenuated and given longevity by the current Federal Reserve Board's zero percent federal funds policy, I no longer find most exchange traded bonds attractive.

For customers of Fidelity, there are entire categories of exchange traded bonds that are off limits to you. Currently, and for no legitimate reason, Fidelity customers are not allowed to buy exchange traded "principal protected" notes, synthetic floaters, and some other securities like the Aegon hybrid AEB and the fixed coupon TC JBK which started out as a synthetic floater but become a fixed coupon TC after the swap agreement with Lehman was terminated due to that firm's bankruptcy Fidelity Prohibits New Purchases of SIPsFidelity Brokerage Interference with Customer Trading Opportunities;  Fidelity Brokerage Extends Denial of Trading Opportunities to Synthetic Floaters and Even an Exchange Traded Junior Bond DFP. I am not aware of any other brokerage firm that interferes with its customers in a similar way.

Most exchange traded bonds are lightly traded, frequently with large bid-ask spreads, so limit orders need to be used.  If I am willing to accept the ask price, I will still enter a limit  order at that price, rather than a market order. 

1. Trust Certificates (TC): A Trust Certificate represents an undivided beneficial interest in a bond owned by a Grantor Trust. The Trust is administered by an independent trustee, charged with the responsibility of collecting interest payments paid by the bonds owned by the trust and then distributing those funds to the owners of the Trust Certificates. 

The TC will have the same maturity as the underlying bonds. The TC's par value will generally be $25, though there are exceptions. 

The Grantor Trust is formed by a brokerage company who buys the bonds in the secondary market. The trust buys the bonds from the brokerage company with the IPO proceeds from the sale of TCs. Since the bonds are purchased in the secondary market, their price may be at a premium or discount to their par values when originally purchased. That fact may result in the TC having a higher or lower coupon than the underlying bonds owned by the trust. 

Most of the underlying bonds in Trust Certificates have Make Whole Provisions that render a redemption by the issuer less likely. 

However, when the trust is formed, the brokerage company will attach a call warrant to the TC which gives the call warrant owner the right to redeem the TC at par value plus accrued interest in most cases. The existence of that right will restrain the appreciation of the TC. There is no duty to ever exercise that warrant. Call Warrants and Trust CertificatesMore on the Call Warrant in TCsCall Warrant Exercised on JZE and JZJCall Warrant Exercise for XFJCall Warrant Exercised on MJT and MJVKVW Called by Owner of Call WarrantDKK-Called by Owner of Call WarrantKRH-Exercise of Call WarrantVerizon TC XFL: Called by Owner of Call Warrant; Notice Filed for Redemption of Trust Certificate DKF.

I have lost a significant number of TCs to redemptions, not by the bond issuer, but by the owner of this call warrant.   

For example, I own a TC JZJ which has as its underlying security a 2031 senior bond issued by AT & T.  That bond is currently trading in the bond market at over a 40% premium to its par value. FINRA That bond contains a make whole provision which renders it less likely to be called by AT & T. The TC JZJ, on the other hand, trades at less than a 4% premium to its $25 par value. The presence of the call warrant attached to JZJ will restrain its upward price movement. In fact, JZJ has already been subject to a partial call at $25 plus accrued interest. Proceeds Received from Full Call of JZE and Partial Call of JZJ The owner of that warrant could take possession of the AT & T bonds owned by the trust after issuing a notice and delivering to the trustee the $25 par value, plus accrued interest, for each TC redeemed, and then sell the bonds for a no risk profit.

In short, the existence of a call warrant is a major disadvantage to this particular type of exchange traded bond, particularly in a period where long term interest rates are in a secular decline and the bonds have make whole provisions. 

Some TCs do not have a call warrant attached to them. I own one of them, KTN, which contains a junior bond issued by AON. TRUST CERTIFICATE AON BOND KTN ORDER FILLED 100 shares at $13.1 October 2008KTN add at less than $14 November 2008. KTN has a 8.205% coupon on a $25 par value, www.sec.gov, and is currently selling at over $28 per TC. Structured Products Corp. 8.205% Credit-Enhanced CorTS  (KTN)

I have owned other TCs containing the same AON bond as the underlying security and most of them have been called by their respective call warrant owners. The exception is MS Structured Asset Corp. SATURN Aon Capital Security Backed Series 2005-2 6.875% Deb. Cl A Call Un (HJO), which I own in the Roth IRA.

Snapshots of my realized gains and losses from trading Trust Certificates can be found at the end of Trust Certificates: New Gateway Post (September 2011 Post)

In my original gateway post on TRUST Certificates, published in 2009, I noted then the favorable pricing of these securities in 2008, particularly after Lehman's collapse, when it was possible to buy these securities at a 3% to 5% yield advantage compared to the underlying security. Those days are long gone. Some TCs now trade at less of a yield than the underlying bond, so it would be more advantageous to buy the underlying bond in the bond market rather than the TC. I may have played some role in popularizing this type of security.

Virtually all TCs were created before 2005.

See also: LINKS TO FINRA INFORMATION ON UNDERLYING BONDS IN TRUST CERTIFICATES

2. Synthetic Floaters: This type of exchange traded bond is attractively priced in many cases due to what I call the Federal Reserve's Jihad Against the Saving Class, likely to last well into 2014 and possibly longer. As a result of that monetary policy, short term rates are abnormally low at the present time. The float provisions of synthetic floaters will generally be a spread over the 3 month LIBOR or treasury bill rate, though some use other rates. The three month treasury bill rate is now hugging zero so offering a .75% or .85% spread over zero is not particularly attractive. Consequently, the prices of many synthetic floaters can be bought now at significant discounts to their par values.

Synthetic Floater is in the Trust Certificate legal form of ownership. So, before the investor can understood this complicated security, it is first imperative to understand the TC.

The synthetic floater adds levels of complexity to the TC. A brokerage company will buy fixed coupon bonds in the secondary market and transfer ownership to the Grantor Trust. When that trust is formed, the trust and the brokerage company also execute a swap agreement, where the trustee will "swap" the interest paid by the bonds for the amount due the owners of the TC.

As an example, I recently bought the synthetic floater GYB. Added 50 of the Synthetic Floater GYB at $16.5-Roth IRA That TC contains a 6.345% fixed coupon Goldman Sachs trust preferred security maturing in 2034. The trustee receives the interest paid by GS and then transfers those funds to UBS who in turn pays the trustee the amount owed by the owners of GYB.

Those owners are entitled to receive the greater of 3.25% or .85% above the 3 month LIBOR rate on a $25 par value, up to a maximum interest rate of 8.25%. Since I bought this security at a discount to par value, this will juice my overall current yield and yield to maturity. The minimum current yield at a total cost of $16.5 would be about 4.92% and the maximum yield would be approximately 12.5%. Assuming GS survives to pay off the underlying bond in 2034, the purchaser of GYB at a total cost of $16.5 would receive the additional yield representing the difference between that cost and $25.

The owner of GYB bears the credit risk associated with the underlying GS TP. If GS went bankrupt, that TP would likely become worthless, or close to it. I would lose most or all of my investment in that eventuality, but UBS would lose only the right to earn that spread between what GS pays the trustee and the amount paid by UBS in the swap transaction.

Another type of synthetic floater has no minimum coupon but simply pays a spread over another rate. For example, I own GJR in my Roth IRA, a trust certificate containing a senior Proctor & Gamble bond maturing in 2034. That TC pays a .7% spread over the 3 month T Bill on a $25 par value, with a cap of 7.5%. www.sec.gov

The price of many synthetic floaters are depressed for several reasons. One reason is that the float coupon provision is not likely to become the applicable rate anytime soon, where the security offers a minimum coupon, so the owners of these securities are stuck with the minimum amount payable by the synthetic floaters. And for those synthetic floaters without a minimum coupon, the current coupon rate will be even lower due to the absence of a minimum level.

Their attractiveness would obviously improve with short rates near or above normal or average rates, assuming no adverse change in the credit risk.

The basic terms of the exchange traded synthetic floaters can be bound at two of my posts:  Synthetic Floaters and Floaters: Links in One Post.


3. Trust Preferred: Like trust certificates, the Trust Preferred (TP) security represents an undivided beneficial interest in a bond owned by a trust. Invariably, that bond will be a junior bond and the lowest in priority debt security issued by a company, usually a bank holding company. There are some TPs originating from utilities and other non-bank companies.

Generally speaking, a company will form a Delaware Trust. That trust will then sell trust preferred securities to the public and will use the proceeds to buy a junior bond issued by the company. The TP will represent a beneficial interest in that bond. The terms of the TP and the junior bond will be the same. Both will mature on the same day and will have the same coupon and material provisions. Sometimes, the TP will become the underlying security in a TC and then there can be major changes in material provisions between the TP and the TC. (see, e.g. GYB discussed above which is a TC containing a GS TP).

The issuer of the underlying junior bond will generally have the right to defer interest payments, typically for up to 5 years, provided there is no activation of the "stopper" clause.  A stopper clause can be activated in a variety of ways. The main protection for the TP owner is the payment of a distribution on a junior security, which would include all equity securities such as common stock and traditional or equity preferred stock.

If there is a lawful deferral of the interest payment, interest will generally accrue on the deferred amount at the coupon rate. Interest payments are cumulative and remain obligations unless discharged in bankruptcy.  

It is important to keep in mind, when addressing priority and other issues, that the TP is in effect a junior bond, senior in priority to all equity securities. For bank holding companies that have their bank operating company seized by the FDIC, however, I would anticipate that owners of either the equity securities or the TP would receive nothing in most cases, though it is conceivable that the bank operating company would have other assets sufficient to pay the TP owners something, Regular Preferred and Trust Preferred. I certainly would not count on anything as a TP owner after such a failure. Anyone who owns a TP originating from a failed financial company can visit their money in money heaven.

The low priority can explain why many TPs issued by large financial institutions sank into the single digits during the Near Depression period. For example, I bought a Wells Fargo TP, JWK, at $9.15 (March 2009), later sold at 25.06. I had another large percentage gain in a BAC TP that was the underlying security in the TC MJH: Buy of 50 MJH at $7.51 March 2009-Sold 50 MJH at 23.6 June 2010.

For banks that survived the Near Depression, most of them never deferred interest payments including the hapless Citigroup and Bank of America. I doubt that the owners of junior securities will be so fortunate again, in the event banks need to grovel to Uncle Sam for taxpayer funds to bail them out from the wreckage caused by their Masters of Disaster.

The priority issue is also relevant to those financial companies that issued equity preferred stock to the U.S. government under the TARP program, see generally discussion at Item # 7  Bought 50 ZBPRB in Roth at $19.9.

Before a recent important change in the law, banks issued TPs since those securities could be treated as equity capital provided certain conditions were met. Item # 8 Stocks, Bonds & Politics/ Added 50 of ABWPRA

A bank can not deduct dividend distributions made by its equity securities, including its traditional equity preferred stock. The interest paid by the underlying bond in a TP would be deductible however. Thus, in essence, the bank could receive the tax benefit of a bond while treating the bond as equity which could be included to meet its Tier 1 capital regulatory requirements. A recent law change will phase out the use of these bonds as TIER 1 equity capital for financial institutions with more than 15 billion in assets as of 12/31/2009  {Trust Preferred Securities & Financial Reform; and see citations in Item # 2  Bought 50 SUSPRA at $25.25 ROTH IRA} Some large banks have started to redeem their TPs due to that law change.

For banks with less than $15 billion in assets as of 12/31/2009, and SUSQ may be the closest to that limit without going over among banks with TPs outstanding, TPs issued before 5/19/2010 can still be counted as TIER 1 capital, but no new issues.

Unless there is a change in the law, the TPs issued by bank holding companies will gradually become extinct as older issues are redeemed or mature.

As of 5/30/2012, I own four TPs in the Roth IRA, where interest payments are sheltered from taxation. Except for SUSPRA, all of these positions are subject to being called now. SUSPRA may be called on or after 12/12/12, which is certainly a possibility given its high coupon rate. All of my TP positions are small, reflecting their disfavored status, and include the following:

50 Shares of KRBPRE: (added 8/3/12: This security has been called, see subsequent post- Redemption Proceeds Received BAC Trust Preferred Securities)
Quote: MBNA Capital E 8.10% TOPrS Series E
Prospectus (now a BAC obligation)
Coupon: 8.1% on a $25 Par Value
Maturity: 2/15/33

80 Shares of SUSPRA
Quote: Susquehanna Capital I 9.375% Cap Secs. Series I, SUS.PA
Prospectus
Coupon: 9.375% on a $25 Par Value until 12/12/37, then 3 month LIBOR +5.455%
Maturity: Initially 12/12/57, but may be  extended under certain circumstances to 12/12/67, 12/12/77 or 12/12/87
This security has been called for 9/18/12: SUSQ Redemption of TPs 

200 Shares of STLPRA
Quote: Sterling Bancorp Trust I 8.375% Cum. Trust Pfd. Secs., STL.PA
Prospectus
Coupon: 8.375% on a $10 par value
Maturity: 3/31/2032
Sold 200 STLPRA at $10.5-ROTH IRA (8/17/2012 Post)
This security has been called by the issuer. 

50 Shares of FPCPRA (currently a PGN obligation)
Quote: FPC Capital I 7.10% Cum. QUIPS Series A, FPC.PA
Prospectus
Coupon: 7.1% on a $25 Par Value
Maturity: 5/15/2039
This security was been called in February 2013. 

4. European Hybrids: I have limited myself to buying hybrids issued by Aegon and ING, since I am familiar with both of those European companies. Other than Santander, I have very limited knowledge about other European financial institutions. I own an equity preferred floater, STDPRB, which is my exposure to Santander.

I give a detailed explanation of European hybrids when discussing those issued by Aegon. Aegon Hybrids: Gateway Post These hybrid securities are volatile. During the Near Depression period, I was able to buy them in the low single digits.

A hybrid is simply a security that has characteristics of both a bond and an equity security. The Aegon and ING hybrids are junior bonds, ranked lower in priority than any other debt security. They are senior to common stock and traditional equity preferred stock. For regulatory purposes, those securities are treated as equity capital, similar in that respect to the U.S. Trust Preferred stocks. Unlike distributions from TPs, which are classified as interest, the AEG and ING hybrids pay qualified dividends. Those European hybrids have no maturity date, which makes them more like common stock, than the U.S. TPs.

While AEG and ING hybrids did not defer dividends during the Near Depression, and both companies received state aid, the EU has made it clear that the hybrid owners will have to suffer in the event a financial institution receives state aid in the future. {page 8 at (26)  ec.europa.pdf} In the event that happens again,  a deferral of hybrid dividends will likely be a precondition to the receipt of state aid. The only way to avoid it, and this would be only temporary, would be the prior activation of a Mandatory Payment clause which in many cases would require 4 quarterly payments after the Mandatory Payment Event.

5. Principal Protected Senior Unsecured Notes: Many investors are confused by the meaning of "principal protected" in this context. For those who unfortunately owned these notes issued by Lehman, they soon found out the hard way that principal protected is limited in scope. Once the firm declares bankruptcy, the owners of a principal protected note are in the same position as any unsecured debt owner of the bankrupt firm. In short, you would be screwed which is hopefully not too difficult to understand.

I am not familiar with most exchange traded principal protected notes. A list can be found at QuantumOnline (free site, registration required). Generally, these notes have $10 par values, represent unsecured senior obligations, and have relatively short maturities. Their importance is due to their potential return, based on the performance of an index or the price of commodity like gold.

Many of them do not pay a minimum coupon or any distribution at all until the note matures. While I have owned some of those, I have focused on notes that pay the greater of a minimum coupon or some percentage based on the performance of a stock index or the price of gold. All of those notes were issued by Citigroup Funding and are guaranteed by Citigroup as provided in the prospectus. Those Citigroup Funding unsecured notes mature in 2014 at a $10 par value and have minimum annual coupons. I have received substantially more than the minimum coupon on several occasions which is why I own some of them. For example, MKN paid me a 18% in the first year of my ownership and over 25% the year after. However, the last payment was the 3% minimum coupon.  MKN Ends Its Annual Period With Minimum Coupon Payment Another one, MOU, paid out a 27.93% coupon. MOU Ends Second Annual Coupon Period With a 27.93% Gain Since I am satisfied barely with the minimum coupon, given the maturity date and the low interest rate environment, I view anything above that rate as a bonus.

Links to some of the discussions of Citigroup Funding Exchange Traded Senior Unsecured  Notes: Bought 100 MKN at 9.85Bought 100 MKZ at 9.91 in the Roth IRA100 MKZ bought at 9.96Bought 100 MYP at $10.12Bought 100 MHC at 9.8Bought 100 MOU at $10.12Bought 100 MBC at 9.84Bought 100 MBC at 9.78Bought 100 MKN at 9.85 January 2010Bought 200 MOL at 9.95Sold 100 MOL @ 10.3Bought 100 MTY at $10.03Bought 100 MTY at 10.49. MTY and MOL are linked to gold prices while the others are linked to indexes including both commodity and stock indexes.

For non-Citigroup Funding "principal protected" notes, I currently own 100 shares of a senior unsecured note issued by Bank of America that matures in 2015. This note will make only an interest payment when it matures which will be tied to the performance of the DJIA. Bought 100 SDA at $9.8-ROTH IRA. Attention needs to be paid to tax issues, explained in the prospectus, which may determine whether the security needs to be purchased in a retirement account.

My most recent sell was 100 shares of IFO, which matures later this year. Sold 100 IFO at $11.22-Bought 100 IFO at $9.35.

Any investor wishing to buy one of these notes needs to spend time reading the prospectus until it is understood. A major provision is what I call the Maximum Level Violation and the resulting reversion to the minimum coupon.

6. Baby Bonds: While most of the opportunities in 2008-2009 were in the categories mentioned above, baby bonds will likely become the dominant category for the future, particularly as TCs and TPs mature or are redeemed.  There will most likely not be any new TPs. The supply of TCs are not being replenished and many of them have already been redeemed by the call warrant owners as discussed above. There are also limited issuances of new principal protected notes and many of those outstanding will soon mature. The synthetic floaters are mostly still around, and present buying opportunities from time to time. If you were the swap counterparty, would you give up that risk free interest spread, even if you owned the call warrant too?

The new supply of exchange traded bonds is coming from baby bonds. Over the past year or so, however, many of them have been redeemed, as shown in notes made in my old Gateway Post on this subject: Exchange Traded Bonds

My only recent purchase of a baby bond was a recent issue by the Business Development Corporation Hercules Technology Growth Capital. Bought 100 HTGZ at $24.63Bought 100 HTGZ at $24.6-ROTH IRA. I am not thrilled with this bond's yield. However, since it matures in 2019, I do not face a lot of interest risk associated with the long bonds, and I was able to purchase this bond at below its $25 par value. The coupon is barely acceptable to me at 7%. Still, in the ROTH IRA, that yield in effect becomes tax free.

I have either sold most of my baby bonds or the bonds have been redeemed by the issuer. I did not want to lose several First Mortgage baby bonds, with $25 par values, issued by electric utility companies. Several of those type of bonds are still around but are selling way over par value and at unattractive current yields. (e.g. Entergy Texas Inc. 7.875% Series Mortgage Bonds 2039, EDT;  Entergy Louisiana LLC First Mortgage Bonds 6.00% Series 2040, ELBEntergy Mississippi Inc. 6.00% Series First Mortgage Bonds 2032, EMQ). These bonds will have call provisions.

Many of the baby bonds mature after 2040, which exposes the investor to a ton of interest rate risk. And, at least for the OG, holding such a long bond to maturity is not an option.

I noted in a recent post a number of newly issued baby bonds. New Exchange Traded Bonds Many of these bonds have maturity dates within ten years which is desirable for me. However, I am not interested in paying more than par value for them given their relatively low coupons compared to rates more normal for their risk profiles.

QuantumOnline has a good list of these baby bonds under the heading "exchange-traded debt securities". That list includes the European hybrids. By simply scrolling down that list, the investor can see that most of them have $25 par values which makes them more palatable to individual investors than $1,000 par value bonds. And, exchange traded bonds are easier to buy and sell in small lots than those $1,000 par value bonds in a mostly unfriendly bond market. Bond Market: Operated for the Benefit of Dealers and Not Really a Market 

Tuesday, May 29, 2012

Colt Defense Downgrade/Bought 50 SIR at $21.86/Sold 100 HTGC at $10.64/Bought 100 ONB at $11.85

It is rare to see a baseball player successfully steal home. An even rarer occurrence is a successful triple steal. Last Saturday, Vanderbilt was successful in completing the triple steal against Florida. Vanderbilt Triple Steal - YouTube

SunOpta, a LT selection, has agreed to sell its Canadian natural health products distribution business to Banyan Capital Partners. The transaction is valued at CAD $14.7 million. At closing, Banyan will pay CAD $14 million in cash. The remanding consideration is contingent on future EBITDA earnings targets. SunOpta rose 4 cents in trading last Friday to close at $5.85.

The VIX had its 10th consecutive close above the important 20 demarcation line last Friday. Mark Hulbert and the Use of the VIX as a Timing Model

The U.K.'s Office of National Statistics revised GDP for the 2012 first quarter to a negative .3% from -.2%.

According to the NYT, Nasdaq has admitted that 30 million Facebook shares were executed improperly. The losses to market makers are currently estimated at over $100 million. A good summary of what went wrong can be found in an article at Reuters.

According to a news release issued by Merchants Bank, that bank is ranked by two banking journals as one of the top performing small banks in the U.S. Bought 50 MBVT at $26.25 (5/2/12 Post); Bought 50 MBVT at 22.9 (April 2010 Post); SOLD 50 MBVT at 26.5 (July 2011 Post)

I received the stock dividend from Valley National last Friday, plus $5.7 in lieu of fractional shares:


Those stock dividend shares bring me up to 262 VLY shares. I have not been reinvesting the dividend.

1. Colt Defense (own 1 2017 Bond): Last Thursday, S & P downgraded the Colt Defense 2017 unsecured senior bond to CCC. TEXT-S&P In addition to its high leverage and several poor earnings reports since my 1 bond purchase, Colt recently lost the contract to supply the M4 carbine to the U.S. military. Colt has filed a protest to the government's award of that contract to Remington. S & P does note that Colt will receive a 5% royalty for the M4s manufactured by its competitor.

I recently increased my risk rating for this bond to 9+. Colt Defense-Raising Risk Rating to 9+ I am not optimistic about this company surviving to pay off this bond at maturity. (see also Item # 5 Colt Defense discussing earnings report for the 2012 first quarter). I have been disappointed by the performance of the company. 

2. Bought 50 SIR at $21.86 Last Friday (see Disclaimer): Select Income REIT is a recent IPO. The shares were priced at $21.5. IPO Prospectus With the over-allotment option, which was exercised, SIR sold 9.2 million shares. www.sec.gov As previously noted, this REIT was formed by Commonwealth REIT who contributed 251 properties to SIR in exchange for 22 million shares and a $400 million note. SIR intended to use the proceeds of the IPO to pay back that note. The note has been repaid in full,  Form 10-Q at page 6.

As of 3/6/12, the date of that prospectus, SIR's Hawaii properties contributed 68.1% of SIR's total revenues. Of the 228 properties located in Oahu, Hawaii, 215 are "commercial lands", most of which "are leased on a long term basis to tenants that operate businesses and have contracted buildings on our properties".

Simultaneously with the closing of the IPO, SIR entered into a $500 million credit facility. As of 3/31/2012, the company had borrowed $227 million under that facility.  (pages 6, 20 of  Form 10-Q)

SIR expects to pay a quarterly dividend of 40 cents per share for at least the first year following its IPO. (page 26 of the Prospectus) U.S. tax law requires a REIT to distribute annually at least 90% of its taxable income, excluding net capital gains.

Assuming the continuation of a 40 cent quarterly dividend, which is of course in no way assured, the dividend yield at a total cost of $21.86 would be about 7.3%.

The company reported $1.34 per share in net income for the first quarter of 2012. 10-Q at page 2 As of 3/31/12, the company had leases covering 95.2% of its total square feet. (page 9). The majority of SIR's Hawaii properties "are lands leased for rents that are periodically reset on fair market values, generally every five to ten years". (page 11)

While I can not examine any of SIR's Hawaii land leases, land leases generally do not require capital expenditures from the lessor since the lessee will build and maintain the structure on the leased land. As a consequence, a land lease can be close to pure profit net of any applicable taxes, with expenses generally limited to the costs incurred with the lease agreement, any re-zoning expenses, and any interest expenses associated with the land acquisition.

With this type of investment, my goal is a modest one. I would hope that SIR at least maintains the quarterly dividend at 40 cents. If I am able to exit the position with an annualized 10% total return, I will be satisfied with that result. Given the dividend yield, I can achieve that goal with a relatively small appreciation in the shares.

This is a link to SIR's investor presentation made last March:  sirreit.com 

LINK to Website: Select Income REIT

As noted in the press release announcing 2012 first quarter earnings, SIR signed agreements to purchase two single tenant office buildings in April 2012. SEC Filed Press Release  A 100% net leased office building located in Provo, Utah with 405,699 square feet will cost $85.5 million. The other office building is also 100% net leased to a single tenant and is located in Englewood, CO.

Select Income REIT Profile Page at Reuters

Select Income REIT (SIR) rose 6 cents in trading last Friday to close at $21.93.

3. Sold 100 HTGC at $10.64 Last Friday (see Disclaimer): After buying 100 of HTGZ in the Roth IRA last Thursday, I decided to liquidate the common shares of Hercules Technology Growth Capital. The common shares just went ex dividend prior to my sell.  HTGC Stock Quote HTGZ is a senior bond issued by Hercules with a $25 par value and matures in 2019 at $25.  Bought 100 HTGZ at $24.6-ROTH IRA I now own 200 shares of that bond which is all of the exposure that I want to this BDC. I realized a small gain on the HTGC shares plus two quarterly dividends.

Hercules Technology Growth Capital (HTGC) rose 5 cents in trading last Friday to close at $10.56.

4. Bought 100 ONB at $11.85 Last Friday (Regional Bank Basket Strategy)(see Disclaimer): Old National Bancorp is a bank holding company headquartered in Evansville, Indiana.  Through its banking subsidiary, Old National Bank, ONB operated 181 banking centers primarily in Indiana, Kentucky and Illinois as of 12/31/11. FORM 10-K

In January 2012, ONB agreed to acquire Indiana Community Bancorp (INCB) in an all stock transaction valued at approximately $79.2 million. INCB is headquartered in Columbus, Indiana and has 17 branches in south central Indiana. I did review the last earnings report for this bank, which was not good. Indiana Community Bancorp Announces First Quarter Results NPLs were 4.59% of total assets and the bank reported a loss for the first quarter. I would not even consider purchasing a bank stock as part of my Regional Bank Basket Strategy with that level of NPLs.  I assume ONB is interested in the branch locations and INCB's customers.

In 2011, ONB acquired Integra Bank in an FDIC assisted acquisition. Integra was also headquarterd in Evansville and operated 52 branches.

In another 2011 acquisition, ONB acquired Monroe Bancorp in an all stock transaction, which added 15 banking centers. Monroe was headquartered in Bloomington, Indiana. The Indiana University is located in that town. I counted 9 ONB branches in or near Bloomington using Google Maps.

It is clear that ONB has used the Great Recession period to considerably expand its geographic footprint and operations.

For the 2012 first quarter, ONB reported an E.P.S. of $.23 on a GAAP basis which included some extraordinary expenses associated with ONB's acquisition activities. SEC Filed Press Release As of 3/31/12, the net interest margin was at 4.2%; the TIER 1 leverage ratio was 8.8% and the total risk based capital ratio was 15.4%; NPLs to total non-covered loans was high at 2.77%; the coverage ratio for non-covered loans was at 48%; and the return on average assets was 1.02% for the quarter.  I prefer to see the coverage ratio over 100% and NPLs less than 1%.  {As a mitigating factor, I was not able to determine how much of the NPLs were associated with the Monroe Bank acquisition. That bank was publicly traded under the symbol MROE, and I briefly examined its last filed SEC Form 10-Q for the Q/E 9/2010. That acquisition was not FDIC assisted.}

The capital ratios are currently good:


Form 10-Q for the Q/E 3/31/12 at page 64.

The current consensus estimate is for an E.P.S. of 96 cents this year and $1.06 net year. ONB Analyst Estimates

In January 2012, Old National increased the quarterly dividend to 9 cents per share from 7 cents and further authorized the purchase of up to 2 million shares.

Assuming a continuation of that penny rate, the dividend yield at a total cost of $11.85 would be about 3%.

Link to Recent Investor Presentation: SEC Filing (contains map of branch locations)

While declining from over $13 per share earlier this year, ONB shares were still trading over their 200 SMA at the time of my purchase, but had pierced the 50 day SMA to the downside.  ONB Interactive Chart

Old National Bancorp (ONB) declined 14 cents in trading last Friday to close at $11.86. 

Friday, May 25, 2012

Sold 3 TIP Bonds Maturing in 2019 at 120.45/Sold 50 NPBCO at $26.17 and Bought 100 HTGZ at $24.6-ROTH IRA

Financial Institutions (FISI) raised its quarterly dividend to 14 cents per share from 13 cents. Bought 50 FISI at $15.55Regional Bank Basket Strategy

Valley National Bancorp declared a quarterly dividend of $.1625 per share, "relatively" unchanged from the prior dividend payment after adjusting for the 5% stock dividend scheduled to be paid today.

Markit's Eurozone PMI composite index fell to 45.9 in May, the lowest reading since June 2009 and the fourth consecutive monthly decline. The preliminary PMI manufacturing index for China, prepared by HSBC, declined to 48.7 in May from 49.3 in April. That index has had seven consecutive readings below 50.

The German two year note is nearing a negative yield. The German ten year bonds fell to a record low yield of 1.35% yesterday. 10YR_GER Bond Quote - (ICAPSD)Reuters

Earlier this week, the U.S. sold five year notes to yield .748%. treasurydirect.gov.pdf

Yesterday, the U.S. auctioned 7 year notes with a yield of 1.203%. treasurydirect.gov.pdf

According to Freddie Mac, the average rate on a 30 year mortgage was 3.79%, as of 3/17/12. The ten year mortgage rate was 3.04%.

1. Sold 3 Treasury Inflation Protected Bonds at 120.45 Last Tuesday-ROTH IRA (see Disclaimer): My realized gain on these three bonds will be greater than the total amount of interest paid by them until maturity. I am currently receiving slightly less than $60 in annual interest payments. The accrued interest, which will be paid to me by the buyer, is  only $21.37 for 129 days. Those bonds mature on 7/15/2019. At Vanguard, I am able to place online sell orders for U.S. treasuries without being charged a commission. The following are snapshots of my order and confirmation pages: 



Confirmation Excerpt

Please note that these bonds have a negative yield of -.89 at the $120.45 price. I bought those three TIPs at auction back in 2009: Item # 4  10 Year TIP Auction  I realized a profit of $838.87:


While I receive an inflation accretion to the principal amount of the bonds, that amount would be small compared to the realized gain received now by selling the bonds. The principal amount would be adjusted down for deflation which is not out of the question. Individual - TIPS: FAQsUSATODAY.com.; PIMCO | Investment Basics - Inflation-Linked Bonds

Advantages and Disadvantages of Treasury Inflation Protected Securities:

2. Sold 50 NPBCO at $26.17 Yesterday-ROTH IRA (see Disclaimer):  NPBCO is a Trust Preferred security with a 7.85% coupon on a $25 par value and a 2032 maturity date.  www.sec.gov This security may be redeemed now at par value plus accrued interest. For TPs subject to call and purchased near their par value, I will simply try to clip a few coupons and to sell the security at any profit.

50 NPBCO Total Cost Per Share $25.05

This purchase was discussed in Item # 4  Bought 100 NPBCO at 24.91 (April 2011 Post)

I no longer have a position in this TP.

Trust Preferred Securities: Links in One Post

NPB Capital Trust II 7.85% Cum. Trust Pfd. Secs. (NPBCO) closed at $26.24 yesterday.

3. Bought 100 HTGZ at $24.6 Yesterday-ROTH IRA (see Disclaimer): HTGZ is an exchange traded senior bond issued by the BDC Hercules Technology Growth Capital. This bond has a 7% coupon on a $25 par value and matures in 2019. Prospectus

I now own 200 shares. Item # 4 Bought 100 HTGZ at $24.63 (5/4/12 Post).

I also own 100 shares of the common stock which has a higher yield. Bought 100 HTGC @ $9.7 (1/26/12 Post)

Hercules Technology Growth Capital Inc. 7% Sr. Notes due 2019 (HTGZ) rose ten cents in trading yesterday to close at $24.8. The daily range was $24.47 to $24.85. My order was a limit order at $24.6. 

Thursday, May 24, 2012

Partial Redemption SCEDN/Added 50 of the Synthetic Floater GYB at $16.5-Roth IRA/Bought 40 LSI at $7.28-LT Category/MBC-3% Coupon for Third Annual Coupon Period/

After plunging yesterday morning, the market turned around at approximately 12.28 E.S.T. when the S & P 500 hit 1296.55. That confirms the importance of 1295 as a support level. (see discussion in 5/21/12 Post) I would now be more than a little concerned about the market piercing that level to the downside.

A Pakistani doctor, who helped the CIA find Osama bin Laden, has been imprisoned for treason by Pakistan. That action speaks volumes about Pakistan's true sympathies.

I noticed yesterday that Southern California Edison announced the partial redemption of its Series A preferred stock. SCE will redeem 750,000 out of 4 million outstanding shares. I own 50 shares. This preferred stock is traded under the symbol SCEDN. Par value is $100. SCEDN is an equity preferred floater that pays qualified dividends at a 1.45% spread over the highest of the 3 month LIBOR, the 10 year treasury note or the 30 year treasury bond. Prospectus Supplement At the present time, the 30 year treasury provides the highest yield at approximately 2.81% as of 5/23/12, WSJ.

I bought 50 shares at $84 (October 2009 Post). Fidelity will segregate the shares subject to call from the remaining shares:


This would allow me to sell the 41 shares that are not subject to redemption. I intend to keep them. The dividends paid by SCEDN have been classified as qualified dividends.

Southern California Edison Co Series A PFD closed at $99.55 yesterday.

Advantages and Disadvantages of Equity Preferred Floating Rate Securities
Floaters: Links in One Post

TD Ameritrade will not segregate shares in the same way. I noticed earlier this week that the Trust Preferred ABWPRA (ABW.PA) was subject to a partial call. Fidelity segregated the shares subject to call in the same manner as shown above for SCEDN.

Ameritrade, on the other hand, placed all of the shares under a "do not sell" restriction.

ABWPRA Do No Sell 50 Shares-Only 7 Subject To Call
While this may not be material, it would be important to anyone wishing to sell a security subject to a partial redemption.

Many years ago, I sold my entire position of a REIT preferred stock without knowing that it had been subject to a partial call. There was no notation in my account of the call and I had not yet noticed it. I had to buy back the shares subject to the call. So, there is a reason to place a restriction on the shares subject to the partial call. There is no reason to place a restriction on all of the shares.

I noted in an earlier post that PJR was called by the call warrant owner.

PJRCL
I could have sold that security yesterday at $25.8, but so no reason to incur a brokerage commission. I will receive one more semi-annual interest payment. Trust Certificate PJR Called


1. BOUGHT 40 LSI at $7.28 Last Monday (Lottery Ticket Basket Strategy)(see Disclaimer): I view this purchase to be the replacement for 70 shares of PLX Technology that I recently sold. Sold 70 PLXT at $6.66-Bought 70 PLXT at $3.37-a LT.

For LT purchases, it is not necessary that I actually understand the products made by a company. During the OG's lucid moments, he has at best an inadequate comprehension of LSI's products.  

Profile page at Reuters
Key Developments page at Reuters

During the Crazy Period of the Nasdaq Bubble, LSI stock traded over $70 per share for a brief period. LSI Interactive Chart I was aware of this company back then and do recall referring to that price action as nutty at the time. 

My first purchase of LSI stock was made last Monday. By classifying this purchase as a Lottery Ticket, I could not buy more than $300. The LB  will play a hand of blackjack for more money. 

LSI is expected to earn 78 cents per share this year and 85 cents in 2013. Assuming those consensus estimates prove to be prescient, then the P/E at a $7.28 price is around 8.56 based on the 2013 forward estimate. According to YF, the five year estimated P.E.G. is .54.

LSI also has a lot of cash and no debt long term debt. Cash was around $623.07 million, or $1.10 per share as of 3/31/12. 

As with most other Lottery Ticket selections, this purchase was made primarily on statistical data, primarily the forward P/E, the one year P.E.G. and the cash per share. 

I did review the recent quarterly report, Form 10-Q, and the SEC filed News Release announcing earnings for LSI's first quarter.  

The author of this article at Seeking Alpha argues that LSI is one firm likely to benefit from the emergence of solid state drives. One of LSI's products is a drive controller that handles access to the flash memory chips which store data. While I am not certain, I believe that LSI became a major player in this area when it acquired SandForce, see page 10 of Form 10-Q for the Q/E 4/1/2012 LSI used part of its cash to complete that acquisition. The acquisition was completed in January 2012 for approximately $328 million in cash, net of cash assumed, and the assumption of approximately $48 million of unvested equity awards held by SandForce employees.

Cramer interviewed the CEO of LSI yesterday. The SandForce acquisition is discussed in that interview.

LSI closed at $6.93 yesterday.

2. MBC Ends Its Third Annual Coupon with the Minimum 3% Interest Payment (own 200 shares): MBC is a senior unsecured note issued by Citigroup Funding and guaranteed by Citigroup as provided in the Final Pricing Supplement. This bond matures on June 9, 2014 at a $10 par value. MBC is an exchange traded bond.

Interest is paid annually at the greater of 3% or up to 30%, based on the performance of the Russell 2000 during the relevant coupon period. Again, as explained many times in prior posts, a single close in the Russell 2000 index above that 30% maximum level triggers a reversion back to the minimum 3% coupon, and it no longer matters where the index closes after a Maximum Level Violation.

For the Third Annual Coupon Period, the one that just ended, the Starting Value of the Russell 2000 Index was 829.06. The ending value was 764.63. ^RUT Historical Prices There was no Maximum Level Violation during the Coupon Period. However, whenever the index falls below the Starting Value as of the closing date, which happened during this period, the minimum coupon will become the applicable rate, so the owners of MBC will soon receive $30 in interest for every 100 shares owned by them. I will receive $60. That payment is scheduled to be made on May 29th. The ex interest date was yesterday.

Bought 100 MBC at 9.78

Bought 100 MBC at 9.84

Citigroup Financial Inc. 3.00% Min Coupon Princ Protected Nts for Russell 2000 Index  (MBC) closed at $10.33 yesterday.

3. Added 50 GYB at $16.5 Last Monday (see Disclaimer): GYB is a Synthetic Floater in the Trust Certificate legal form of ownership. It is categorized by me as an Exchange Traded Bond. This security pays the greater of 3.25% or .85% over 3 month LIBOR on a $25 par value. This security has a maximum rate of 8.25%. Interest payments are made quarterly.

The underlying bond, owned by this trust, is a fixed coupon Trust Preferred issued by Goldman Sachs Capital. The underlying bond owned by that trust is a Goldman Sachs 6.345% junior bond maturing in 2034. When the legal layers are removed, GYB represents an undivided beneficial ownership in a GS junior bond and a swap agreement with UBS that creates the coupon provisions of GYB. If the swap agreement is terminated for any reason, the TC GYB will pay the fixed rate coupon of the underlying TP.

GYB Prospectus: sec.gov

{A swap agreement connected with the TC JBK was in fact terminated when the swap counterparty, Lehman, went bankrupt, and that TC was transformed from a synthetic floater to a fixed coupon TC}

Given the abnormally low 3 month LIBOR rates, the GYB coupon is currently the minimum 3.25%.

When an investor buys GYB, it is possible to compute the minimum and maximum current yields over the life of the security. At a total cost of $16.5 per share, the minimum current yield would be about 4.92%, and the maximum current yield would be 12.5%. The maximum yield would be hit when the 3 month LIBOR hits 7.4%.

This brings me up to 150 shares of GYB in the ROTH IRA. I bought 100 shares at $17.2 last March.

I have traded GYB on several occasions. The largest percentage gain resulted from a 100 share purchase at $10.95  (April 2009), later sold at $18.09 (May 2010):

2010 Regular IRA GYB +$774.42  
Other trades were less profitable than the first round trip and include the following: Bought 50 GYB @19.07 (October 2010); Bought 50 GYB at 18.63 in the Roth IRA (January 2011); Sold 100 GYB at 19.7 in Roth IRA (May 2011); Bought 50 GYB at 16.95 in Roth IRA (August 2011); Added 50 of the Synthetic Floater GYB at $15.56: ROTH IRA (December 2011); Sold 100 GYB at $17.07 (January 2012).

Floaters: Links in One Post

Due to complex tax issues associated with the swap agreement, I will own the synthetic floaters only in retirement accounts.

The last ex interest date was 5/12/12.

Corporate Asset Backed Corp. CABCO Series 2004-101 Trust Goldman Sachs Capital I Float. Rate Call Ctfs (GYB) fell 46 cents in trading yesterday to close at $16.34. GYB Interactive Chart  

Wednesday, May 23, 2012

Facebook IPO/Bought Back R.R. Donnelley 8.875% Senior Bond Maturing in 2021 at $96.95/Bought 50 RRD at $10-ROTH IRA/Bought 80 TINY at $3.3-LT Category

SandRidge Energy, a LT selection, completed its $1.2 billion acquisition of Dynamic Offshore Resources. The consideration consisted of $680 million in cash plus 73,961,554 SD shares. Form 8-K The stock has dived, along with most energy stocks, since I purchased 40 shares at $7.68. Bought 40 SD at $7.68-LT Category (3/9/12 Post)

There was a media and investor frenzy before the Facebook IPO. That phenomenon, reminiscent of the Nasdaq 1999 bubble, is primarily relevant to those interested in behavioral finance and to those who unfortunately bought into the story being peddled to them. After the IPO, the media has started to examine in more detail problems with the Facebook business model and other issues that may have impacted the decisions made by individual investors, if disclosed by the mass media before the IPO, to buy into Wall Street's hype machine.

Some of those articles have focused on the lack of an adequate strategy for mobile advertising and other issues relating to mobile apps. WSJ Yesterday, Reuters disclosed that analysts for the main underwriters, Goldman Sachs and Morgan Stanley, had lowered financial projections for Facebook shortly before the IPO and only made their respective downgrades available to a select number of institutional investors. (see also similar articles at the WSJ and Barrons) When reading those stories, I can not help but think of the statement made by Leona Helmsley about the "little people".

For those individuals participating in the Facebook IPO at $38 per share, I suspect many of them did not question the valuation of a 100+ billion market capitalization company at close to a 100 P/E, when the company just disclosed a sequential slowdown in revenue growth (ForbesReuters), acknowledged issues with its mobile strategy, and suffered a loss of a major advertising client due to a lack of results shortly before the IPO. 

1. Bought 50 RRD at $10.00 Last Thursday--Roth IRA (see Disclaimer): Just prior to making a decision to buy back RRD, I read the Fitch report which reaffirmed its rating on RRD debt. TEXT-Fitch This report gave me some comfort that RRD would be able to maintain its generous dividend while reducing gradually its leverage. As noted in this report, there is no "tolerance" for a dividend increase.

I recently flipped RRD common after holding the stock just long enough to collect one quarterly dividend. Sold 100 RRD at $12.24-Bought 100 RRD at $11.6.

After buying and selling RRD bonds, I own only 2 RRD senior bond at the present time. One of those bonds was bought last August. Bought 1 R.R. Donnelley 6.125% Senior Bond Maturing 1/15/2017 at 89 (August 2011). The other was bought last Friday and is discussed in Item # 2 below.

RRD "anticipates" keeping the annual dividend rate at $1.04 per share. RR Donnelley - Dividends That remains an open question for the future of course. At that annual rate, the yield at a total cost of $10 would be slightly over 10%, a higher current yield than than the RRD bonds maturing prior to 2022. In the ROTH IRA, that dividend yield becomes tax free.

The current consensus estimate is for an E.P.S. of $1.81 in 2012 and $1.84 in 2013. At a $10 price, the forward P/E on the 2012 estimate is about 5.52 with a 10% dividend yield. To justify those numbers, the sellers of RRD stock must believe, with a high level of certainty, that the earnings will collapse and take the dividend with it. While I would view that outcome as a possible scenario, it is not a rational one based on currently available information.

A more optimistic spin on RRD appeared in a Barrons' article published last February.  

Since I do not share others optimism about RRD's long term prospects, I will keep my overall exposure, both bonds and the stock, relatively low. I doubt that I would buy more than 100 shares of the stock or own more than 3 thousand in face amount of the senior unsecured bonds. And, I will likely continue trading those positions regularly, moving my overall allocation from zero to a maximum limit of $4,000.

A long term chart looks awful after 1998: RRD Interactive Chart The stock was doing fine from around 1985 to 1998, topping out at over $43 per share in June 1998. A double top was formed in 2007, with the shares trading over $43 per share again before collapsing to below $8 by February 2009. Since 2/2009, the stock has been on a roller coaster ride to over $20 in what appears to be the latest double top, at less than 1/2 of the price of the former double top, before falling to the current level. In other words, no encouragement for a long term investor, just looking at the chart since 1998. RRD stock would have been a good long term investment from 1985 to 1999.

SEC Form 10-Q for the Q/E 3/2012: Form 10-Q

2011 Annual Report: Form 10-K

Profile Page at Reuters

I would be satisfied to receive a 10% annualized return on this stock purchase. Assuming the dividend is kept at the current level, that goal could be reached simply by selling the stock at break-even. My stock commission rate is $7 per trade at Vanguard. (the bond commission rate for Voyager customers is $2 per bond)

On the day of my purchase, the stock hit a new 52 week low, breaking $10 per share shortly after my day limit order at $10 was filled.

RRD has some issues. As noted earlier, the RRD pension plan is underfunded by about $700 million. The company operates in a industry that is in secular decline. And, the leverage is high, with $3.4085 billion in long term debt as of 3/31/12. Form 10-Q Most of the debt will come due before July 2020, see page 21. In March 2012, the company issued  $450 million of 8.25% senior notes maturing in 2020.

Yesterday, RR Donnelley announced an agreement to acquire Edgar Online (EDGR) in a deal valued at approximately $70.5 million. (Profile of EDGR)

R.R. Donnelley & Sons Co (RRD) fell 12 cents in trading yesterday to close at $10.32. 

2. Bought Back 1 R.R. Donnelley 8.875% Senior Unsecured Bond Maturing in 2021 at $96.95 Last Friday (Junk Bond Ladder Strategy)(see Disclaimer): I have previously bought and sold this bond: Bought 1 R.R. Donnelley 8.875% Senior Bond Maturing 5/14/2021 at 92.69 (2/13/12 Post)-Sold 1 RRD Senior 8.875% Bond Maturing 2021 at 100 (4/11/12 Post). This purchase brings me up to two RRD bonds ($3,000 in principal amount is my maximum permissible allotment)

According to FINRA, this bond is currently rated Ba1 by Moody's and BB+ by S & P.

My confirmation shows the same ratings.

My confirmation states that the current yield at my cost is 9.079% and the YTM is 9.248%.

3. Bought 80 Harris & Harris (TINY) at $3.3 Last Friday (Lottery Ticket Basket Strategy)(see Disclaimer): I probably lost money on this stock a few years ago. With the price scraping near a five year low, I decided to try again. TINY Interactive Chart TINY is a BDC.

The author of an article at Seeking Alpha argues that Harris & Harris is undervalued, and it is selling below its net asset value per share. As of 3/31/12, the net asset value per share was $4.89, up from $4.7 on 12/31/11 (page 2 Form 10-Q). I would add that a number of those firms are private, so there could be valuation issues. A list of TINY's investments can be found starting at page 9 of the 10-Q and at TINY's website.

However, this company invests largely in the high risk area of nanotechnology startups which is reason for caution. The firm has had a few of those companies go public. In 2011, two of those companies, Solazyme (SZYM) and NeoPhotonics (NPTN), completed IPOs. TINY had investments in three other companies that were acquired last year (Biovex, Crystal IS, and Innovalight).

NeoPhotonics highlights a problem. The company did have an IPO. Yet, in the 10-Q at page 9, TINY notes that the cost of its investment is $7,299,590 while the value was $2,132,790 as of 3/31/12.

Solazyme is the polar opposite, where the shares are valued at $33.8+ million, as of 3/31/12, with a cost at $5.44+ million. Since the shares are publicly traded the value will change. The Solazyme share price has declined from the $14.63 close on 3/31/12 to $9.71 yesterday. SZYM Historical Prices TINY owned 2,304,149 shares at the end of the first quarter, page 9 Form 10-Q.

SZYM is interesting, though not yet profitable. Quarterly Report on Form 10-Q The company is discussed in this Seeking Alpha article. SZYM did trade briefly over $26 last July, SZYM Interactive Chart, and then started to slide, closing as low as $8.29 by October 2011. (TINY was trading near $5.5 per share last July before sliding to $3.3 by October 2011, TINY Interactive Chart). The IPO was at $18. Prospectus

The NeoPhotonics' shares are close to unchanged since 3/31/12. NPTN Historical Prices

Harris & Harris issued a press release on May 17th noting that it had generated approximately $910,000 from selling call options on Solazyme and NeoPhotonics this year. In that press release, the company also discussed recent developments at three of its portfolio companies (Bridgelux, Laser Light Engines, and Metabolon)

TINY did realize a profit on the three companies acquired during 2011, but not enough to impress me given the risk and the fees paid to TINY's employees. In 2011, the company received $13,992,952 in upfront payments. The total cost of those investments was $11,383,299 in those three companies. I would not call that result a success, particularly when the investor factors into the equation operating costs. 

Another $953,480 was received for the BioVex investment in March 2012, after that sum was released from escrow. BioVex was acquired by Amgen, and TINY may receive some milestone payments from Amgen. TINY could receive up to $9,526,393 million in future payments. The value now placed on that possibility is $3,352.886 (page 60).

TINY has not paid a dividend in over a decade. The last dividend was $.02 a share paid in 2010. Harris & Harris Dividends It may be the only BDC that has that ignominious distinction. As noted previously, a BDC has to pay out at least 90% of its net income to maintain its tax status. The lack of dividends paid by BDC, therefore, is a clear manifestation of a lack of past success. That is another reason to classify the purchase of shares in this BDC as a Lottery Ticket.

Website: Harris and Harris Group

Harris & Harris Group fell 7.29%, or 24 cents, yesterday to close at $3.05, a new 52 week low.

Some of yesterday's weakness in the shares may be due to the potential blowback in the IPO market from the Facebook fiasco. TINY will monetize some of its investments through the IPO process.