Tuesday, April 16, 2013

Zurich Financial, XRX, MSFT & INTC/Gold & Silver Plunge/GSE Mortgage Refinancing for January/Bought 100 LBAI at $9.46/Bought 70 ARCC at $17.24-REGULAR IRA /Added 40 SAN at $6.8/Bought 100 of the Global Bond CEF BWG at $20.87-ROTH IRA/Sold 50 FMER at $16.9-2nd Pare of Higher Cost Shares

Big Picture Synopsis

Stable Vix Pattern
Short Term: Slightly Bearish (expecting a 10+% correction)
Intermediate and Long Term: Bullish

I have been noting for a few weeks a slightly bearish tilt for stocks over the short term. The S & P 500 closed at 1,593.37 on 4/11/13. A 10% correction from that high would take this index to 1,434.03.


Short Term: Neutral
Intermediate Term: Bearish
Long Term: Extremely Bearish 

FED Meeting Minutes:

The minutes of the FED meeting held on March 19-20, 2013 confirm my current belief that QE will end late in 2013 while ZIRP may continue into 2015.

There is simply to much dissension in the committee about QE for Bernanke to continue buying treasuries and mortgage backed securities into 2014 (see pages 11-12).

If the purchases continue at the same pace through the end of this year, the Fed's balance sheet will be near $4 trillion dollars. FRB: Recent balance sheet trends - Credit and Liquidity Programs and the Balance Sheet That level looks and smells like debt monetization by the Federal Reserve, the main buyer of new U.S. treasury debt, with the purchases financed with newly created money.

I would anticipate that QE will not end abruptly. Instead, the Fed will reduce its purchases from the current $85B per month first.

FRB: FOMC Minutes, March 19-20, 2013

John Hussman's Outlook

I view Hussman as an intelligent and well informed stock market bear who will generally find a multitude of cogent reasons to be negative about stocks. He is the kind of investor that might become positive when stocks have been shellacked, something similar to what happened in the 1929 to 1932 or 1974. His negativity has led to poor results in 2009-2013 in his Hussman Strategic Growth fund, up only 4.63% in 2009 and down 3.62% in 2010 and 12.62% in 2012 respectively. That fund has a one star rating by Morningstar. HSGFX

The Hussman Strategic Total Return (HSTRX) has done somewhat better and is rated three stars by Morningstar. 

It generally does not pay long term to ignore the positives and to focus on developing arguments why all or most asset classes, particularly stocks, are poor investments. Hussman will look prescient when stocks crater again, which will eventually happen, as will his fellow ghouls Alan Abelson and David Rosenberg. 

In a recent Weekly Market Comment, Hussman does present a cogent and intelligent bear case. His primary argument is that corporate profit margins are "dramatically elevated" and constitute a bubble. He claims that corporate profit margins are "more than 70% above historical norms" and consequently forward earnings projections are unreasonable. He views that the "present bubble is systemic", impacting the prospective returns of "virtually" every asset class. He believes that the prospective returns for virtually all asset classes will be "close to zero" over a 5 to 7 year time span.

Hopefully, the OG will be able to do better than zero.

Gene Peroni and Goldman Forecasts for the S & P 500: 

Peroni has a positive view of the stock market's technicals and risk reward ratio. MarketWatch He is estimating that the DJIA will close between 14,750 and 15,100 this year and foresees in his crystal ball that the DJIA will hit 18,000 before the current bull cycle ends in 2015.

The global equity team at Goldman Sachs forecasted a 20% rise in the S & P 500 index by the end of 2015. CNBC Those analysts see a greater return-21%-in Asia's stocks ex-Japan and 19% in the European stock market.

I would tend to agree with Peroni that the current bull cycle will top out in 2015, which will be followed by a significant market correction and long period of market consolidation before the long term secular bull market reasserts itself, similar to what happened between 1987 to 1991 without the drama of October 1987. I would anticipate at least one 10%+ temporary dip lasting several months this year.

That dip may have already started.

The Goldman forecast is probably too bullish in my opinion.



At least I sold some gold bullion when the price was over $1,900 back in September 2011. Recent Gold and Silver Sales (September 2011) I sold some junk American silver coins in September 2011 when the price was over $40 per ounce. Sold Some Junk Silver Coins Yesterday I sold more in early January 2012 realizing a gain of $3,420 which was reported on the Form 8949 (the version where there is no 1099) that I just mailed to the I.R.S. The largest single gain was $1,125 in a one ounce gold eagle  proof.

The spot gold price fell $84 per ounce last Friday.

The selling accelerated yesterday with a $140+ price decline.

The market in gold is subject to manipulation given its size. The recent precipitous decline may at least in major part be due to price manipulation by large investors.

Another reason for the decline is the division in the Federal Reserve about continuing QE. The minutes were released last Wednesday, April 10th. Gold's ascent in price is due in part to QE and the concomitant money printing.

The gold price decline is exacerbated by a variety of ETF products, which can be bought on margin, including the double and triple short ETFs  and paper gold (GLD) which makes gold easy to buy, sell and short.

Back in the day, an investor had to buy the physical metal with cash and then store it. The general tendency, which is certainly applicable to me, is to buy and forget about gold and silver bullion. Out of sight-out of mind.

It took a $1,900 per ounce gold price and over $40 per ounce in silver to get me out of my chair, go to the bank, pull the stuff out of a lock box and then take it to a dealer to be sold. Now, an investor so inclined can sit at their desk and buy a double short on the gold price, ProShares ETFs: UltraShort Gold, or even a triple short, VelocityShares 3x Inverse Gold ETN.

While liquidity is mostly a positive, liquidity can also provide a breeding ground for panic.

How many investors of physical gold have sold over the past few days compared to the owners of GLD bought on margin? Thousands of investors have probably had GLD sold by margin clerks yesterday.

I do not have a single margin account and buy nothing on credit.

Last Wednesday, Goldman advised investors to short gold. The GS analysts cut their gold price target for 2013 to $1,450 per ounce and the 2014 target price to $1,270 per ounce. UBS also cut its 2013 forecast to $1,740 from $1,900. Is Goldman trading gold for its own account?

Adding to the angst, there were a number of reports that Cyrus may need to sell its gold reserves, up to 400 tons, since the EU apparently underestimated by several billion Euros the amount of money needed by Cyprus.

The gold holdings of the ETF GLD declined to 1,181.4 tonnes last Thursday, the lowest level in three years. Spot gold has now declined more than 20% from its September 5, 2011 high of 1896.5 (A.M. London fix, Kitco Inc. - Past Historical London Fix) The spot price pierced $1,900 to the upside.

In August 2011, the ETF GLD topped $77 billion in assets.

The wind is definitely blowing in the direction of lower prices, at least for now, and analysts know how to change their recommendations by putting their finger up in the wind and informing investors whether it is blowing south or north.

I have nibbled at gold miners, attempting to catch a falling knife in my Lottery Ticket and Flyers Basket   Strategies and have so far only succeeded in nicking my hand.

I will probably devote a few more hundred to buys in this sector, but I may wait for the wound in my hand to heal. I am by nature naturally contrarian and actually find the decline appealing.

I simply view gold primarily as an alternate currency and secondarily as a hedge against problematic  inflation.

Inflation can become bad enough, as it did in the 1970s, where people lose faith in the value of paper currencies.

It will always be a currency alternative to the paper money printed by central banks which apparently knows no limit. At least gold has a limited quantity.

I am neither a buyer nor a seller of either gold or silver at current levels. I have not bought any gold or silver bullion in years. My last purchases were at less than $400 ounce for gold and less than $8 an ounce for silver.

Yesterday's Closing Prices:
GLD: $131.31 -12.64 (-8.78%)
SLV: $22.09 -3.19 (-12.62%) : iShares Silver Trust
SIVR: 22.60 -3.28 (-12.67%) : ETFS Physical Silver Shares Trust

China Growth and the Slump in Commodity Prices:

Commodity prices plunged yesterday in response to slower than expected GDP growth in China. The National Bureau of Statistics reported that China's economy rose 7.7% in the first quarter, compared to the 2012 first quarter. The consensus estimate was 8%.

Cramer opined that the decline in commodity prices was good for most U.S. corporations and U.S. consumers.

I would generally agree with the following caveats.

The decline will need to be non-temporary in order to have any meaningful positive impact.

A decline in raw material prices will benefit corporations only to the extent that they are able to keep the savings, rather than to pass through most or all of the savings in lower prices. A deflationary environment is not a positive for corporate margins.

If lower commodity prices are signaling slower growth, which may be case now, then that factor could easily offset any savings from the decline in commodity prices due to lower revenues and profit margins.

There are several ways to track aggregate commodity prices. The simplest would be the price of the iPath Dow Jones UBS Commodity Index (DJP).  After hitting a high of $45.52 on 9/14/12, DJP has been hitting a series of lower lows after experiencing brief rallies:  iPath Dow Jones UBS Commodity Index Chart This is a link to the weightings in that commodity index ETN. As of 2/28/13, industrial metals are at 16.51%; precious metals at 14.04%; agriculture at 31.02%; energy at 33.34%; and livestock at 4.98%.


2013 1st Quarter PC Shipments

Both IDC and Gartner estimated a precipitous decline in PC shipments during the 2013 first quarter. IDC estimated a 13.9% plunge, while Gardner's data showed a 11.2% decline with 79.2 million units shipped during the quarter.

PC Shipments  (IDC Press Release

PC Shipments (Gartner Press Release)

Windows 8 has certainly not been a driver so far in a PC upgrade cycle. I have read a number of reports that corporate IT managers see no reason to upgrade to Windows 8 from Windows 7. A number of those IT managers also note that using Windows 8 would cost the company as employees would need some training on the new operating system. And, I noted a few reports where employees were increasingly requesting Apple computers.

Microsoft was cut to sell from neutral by Heather Bellini, the Goldman Sachs analyst. She maintained a $27 price target.

Nomura's analyst, Rick Sherlund, who has been covering MSFT for a long time, downgraded the stock to neutral.  He maintained a $32 price target. Sherlund started to cover Microsoft in 1986 while at Goldman Sachs.

A good summary of the GS and Nomura downgrades can be found in Tiernan Ray's post published by Barrons.com.

Johanna Bennett argued that MSFT shares were a "smart play" in a world where slow growers like Proctor & Gamble, the toilet paper and soap sellers of the world, were selling near twice the earnings multiple . Barrons.com Her take is that the analysts are not giving MSFT a fair shake, noting that the company is generating nearly $30B per year in free cash flow, hardly consistent with the broken company thesis,  and pays a secure 3% dividend which is likely to be raised gradually.

Link to MSFT FCF numbers at YCharts

MSFT and Intel (both owned) declined in response to the dismal data about first quarter PC shipments and analyst downgrades.

The Argus analyst cut Intel to hold and lowered his earnings estimates slightly for both 2013 and 2014.

Closing Prices as of 4/11/13:

MSFT: 28.93 -1.35 (-4.44%)
INTC: 21.83 -0.43 (-1.95%)

Microsoft had a decent rally in progress, at least for it, immediately prior to the IDC and Gartner data releases, rising from a $28.59 close on 4/8/13 to a close at $30.28 on 4/10/13. MSFT Historical Prices

Home Mortgage Refinancings:

The HARP refinancing program has been extended to 12/31/2015 from 12/31/13. This program permits underwater homeowners, meeting certain criteria, to refinance loans owned by Fannie and Freddie. ‎www.fhfa.gov/pdf

The Federal Housing Finance Agency reported that 97,600 refinancings were completed under the HARP program during January 2013. Of those, borrowers with loan to value ratios greater than 105% accounted for 47% of the HARP refinance volume. The total number of Fannie and Freddie refinances for January was almost 469,953 (page 9: Jan 2013_Refinance_Report.pdf)

I view refinancing activity at abnormally low interest rates to be an important component and driver of a long term economic recovery. The debt payment to disposable income ratio has returned already to historic lows, with data going back to the 1980 first quarter, and is likely to continue declining through 2013 in my opinion. This simply means that households in aggregate have more disposable income to spend and/or to save.

Household Debt Service Payments as a Percent of Disposable Personal Income - St. Louis Fed

Household Financial Obligations as a percent of Disposable Personal Income - St. Louis Fed

Household Debt Service and Financial Obligations Ratios (U.S. Federal Reserve)

Goldman Sachs estimates that about $3.1 trillion in mortgages are capable of being refinanced, saving the borrowers at least $150 per month in monthly mortgage payments. WSJ

According to that WSJ article, the Mortgage Bankers Association is forecasting a 5.7% decline in mortgage originations in the 2013 4th quarter, compared to the 2012 4th quarter.

Last week, Wells Fargo reported a 9% sequential decline in mortgage originations in the 2013 first quarter. WFC reported home lending originations at $109B, down from $125B in the prior quarter.  SEC Filed EarningsPress Release I would not draw any firm conclusion about that decline, given the time of year and cold weather throughout much of the country. The next two quarters may see a significant rebound. The WFC application pipeline had declined to $74B at the quarter's end, down from $81B as of 12/31/12, however.


I thought this article in the NYT was interesting. Tiny Chiplets Xerox has apparently invented chiplets, no larger than grains of sand, that can be both microprocessors and computer memory as well as other electronic circuits.

This Tiny Technology is also discussed in a Motley Fool article.

On 4/11/13, Piper Jaffray initiated coverage on Xerox with an overweight weighting and a $12 price target. The upgrade was apparently based on Xerox's transformation into higher growth and margin businesses.

The stock popped on the Piper upgrade, closing at $9.27 on 4/11/13, up $.31 or 3.46% for the day.

I initially bought XRX shares as part of my Lottery Ticket Basket Strategy and later upgraded the shares to The $500 to $1,000 Flyers Basket Strategy.

Bought 40 XRX at $7.55 as LT; Item # 1 Added 60 XRX at $7.1 (9/28/12 Post)

XRX Key Statistics

Xerox declined 15 cents to close at $8.91 in yesterday's rout.

Goldman Sachs on Interest Rates:

Goldman is predicting that interest rates will rise significantly in the coming year, with 2013 being the transition year to higher rates.


I have not been paying much attention to Zurich. I did notice last Thursday night that my unrealized profit had declined some. The decline was attributable to a $1.782 annual dividend per share, which went ex dividend on 4/8/13. ZURVY Historical Prices The 2012 dividend of $1.863 was classified as a return of capital for an esoteric reason, and consequently there was no Swiss withholding tax applied to the payment. (see discussions at Item # 2  BOUGHT 100 ZFSVY at $24.72 and at Item # 2  Zurich Financial) As noted in that later post, my broker reduced my cost basis in ZURVY to reflect that return of capital, reducing it to $22.95 per share.

{Subsequently, the symbol for the ADS shares changed from ZFSVY to ZURVY.}

One ADS share equals .1 ordinary shares traded on the Swiss stock exchange. Swiss Exchange - Zurich Insurance Group AG

The value of the ADS shares will be impacted by the relative currency exchange rate between the USD and the Swiss Franc (CHF). International Trading and Currency Risks

Last Thursday, Zurich Financial closed at 250.5 CHF on the Swiss Stock Exchange. Using the Currency Converter at Yahoo Finance, those Swiss Francs were worth about $269.54 on 4/11/13. Since 1 ADS share equals .1 ordinary shares, I need to divide $269.54 to obtain the equivalent value for the ADS share which would be $26.95. ZURVY closed at $26.91 on 4/11/13 and traded as high as $27.05.

I did note a statement in the 2012 Annual Report that the current dividend "will be paid from the capital contribution reserve" and "will be exempt from Swiss withholding tax". I did not see a statement about the dividend being classified as a return of capital.  I suspect that the dividend will be so classified given that it is being paid out of "capital contribution reserve". Zurich has more than enough earnings to cover the dividend payment.

This is a link to the Reuters summary of the last earnings report.

Yesterday's Close: ZURVY: 26.49 -0.49 (-1.82%)


All of the following purchases were made last week and can be bought at lower prices after yesterday's shellacking.

1. Bought 100 LBAI at $9.46 (Stocks, Bonds & Politics: REGIONAL BANK BASKET STRATEGY GATEWAY POST)(see Disclaimer):

This was a marginal buy. I was seeking a partial replacement for the 200 shares of Sterling (STL) that was recently sold after it agreed to be acquired by PBNY. Sold 200 STL at $11.39 (4/9/13 Post).

Security Description: 

Lakeland Bank currently has 46 branch locations in Northwestern New Jersey (Sussex, Warren, Morris, Essex, Bergen and Passaic counties in New Jersey)

Lakeland Bancorp is in the process of acquiring Somerset Hill Bancorp (SOMH), the parent company of Somerset Hills Bank which has 6 banking offices in New Jersey (four in Morris county; its main office in Somerset County; and one office in Union County) The acquisition is expected to be  accretive to Lakeland's earnings and immediately accretive by approximately 25 basis points to Lakeland's tangible common equity as a percentage of tangible assets ratio. The acquisition is mostly in stock with a 10% cash component and the remaining 90% of the merger consideration in Lakeland stock)

Link to Acquisition History: Lakeland Bank Acquisitions

Lakeland was formed in 1989. Since 1998, Lakeland has opened nineteen branch offices and has acquired four community banks.

Prior Trades: None

Last Earnings Report: The last earnings report was for the 4th quarter of 2012: Lakeland Bancorp Reports 11% Increase in Fourth Quarter EPS and Record Full Year Results (SEC Filed News Release)

2012 4th Quarter
Net Income: $5.8M up 21% from $4.8M 2011 4th Q
Diluted E.P.S.:  $.20, up from $.18
Net Interest Margin: 3.67%
Efficiency Ratio= 59.49%
Quarterly Dividend: $.07 per share
NPA Ratio: .98%
Coverage Ratio: 103%
Total Capital Ratio=12.77%
Annualized Return on Net Assets: .81%
Annualized Return on Average Tangible Equity: 12.06%
E.P.S. for 2012=$.76, up from $.66 in 2011
Tangible Book Value Per Share= $6.52

Lakeland repaid a $25M trust preferred security, with a coupon of 7.535% (8k), in the 2012 4th quarter using the proceeds from a capital raise. The shares were sold to the public at $9.65 per share. Final Prospectus Supplement

2012 Annual Report: Form 10-K (historical performance 2009-2012 at page 25)

Lakeland participated in TARP and redeemed the remaining government's preferred stock and warrants in February 2012 (10-K at page 80)

Rationale: (1) Total Return Potential: After cutting its dividend in 2009, Lakeland has acted to restore the dividend to prior levels through several dividend raises starting in 2011. A return to the 2008 level of $.0907 per share, adjusted for the subsequent 5% stock dividends, would generate a yield of 3.83%. The current yield with a quarterly dividend of $.07 is about 2.96% at a total cost of $9.46.

The stock will be viewed as more attractive as the bank continues to increase its dividend and earnings.

My goal for this stock would be a total annualized return of 8% to 10% which appears doable. The current consensus estimate is for an E.P.S. of $.8 this year and $.86 in 2014. LBAI Analyst Estimates A 12 multiple on the 2014 earnings estimate would yield at $10.32 price. A 15 multiple would generate a $12.9 price Without a dividend increase, I can achieve close to a 10% return in one year with four quarterly dividend payments and an approximate price of $10.3, which factors in the round trip commission cost for 100 shares ($16).

Risks: (1) I view the major risks to small community banks to be net interest margin compression and increased costs connected to regulatory compliance issues. Recessions will cause bad loans to spike. Lakeland lost $7.777M or $.33 per share in 2009 but rebounded in 2010 to +$.57 per share.

My initial reaction to Lakeland's acquisition strategy is positive. The acquisitions are relatively small and within a contiguous geographic area in NW New Jersey. However, there is always integration risks and the possibility down the road of one too many.

I did look at the 2012 10-K filed by Somerset, the small banking institution that Lakeland proposes to acquire. (see page 13). The bank looks fine to me. Somerset did not lose money during the recent Near Depression and actually maintained earnings at a relatively stable level. The capital ratios are good, see page 26. ROA was .95% in 2012. Tangible common equity to tangible assets was 11.34% at year end.

(2) Recent History of Dividend Cuts: A significant negative is recent cuts in the dividend, always viewed negatively. The annual rate was $.36 in 2008; $.27 in 2009;  and $.19 in 2010. The annual rate in 2011 was $.23 and $.25 for 2012 (2012 Annual Report at page 25) Those numbers were adjusted down to account for a 5% stock dividend. They were shown to be slightly higher in the 2011 Annual Report at page 24, Form 10-K).

The quarterly dividend was from $.0907 to $.454 in the third quarter of 2009. Lakeland Bank Investor Relations The dividend was then raised to $.0571 in the second quarter of 2011; to $.06 in the second quarter of 2012 and to $.07 in the third quarter of 2012. The two small dividend raises in 2012 is at least movement in the right direction again.  Those numbers have also been apparently adjusted down for the annual 5% stock dividend. The 2009 third quarter was actually $.05. Press Release

Lakeland has been paying a 5% stock dividend for several years. I view a 5% stock dividend to be a non-event except that it requires an adjustment in the historical data and an investor's cost basis, far more trouble than any value conferred on existing shareholders which is nil.

Future Buys/Sells: I am not likely to buy more. I would consider selling in 12 to 14 months at $10.4 or higher.

Yesterday's Close: LBAI: $9.08 -0.49 (-5.12%)

2. Bought Back 70 ARCC at $17.24-Regular IRA (see Disclaimer):

2013 Regular IRA Bought 70 ARCC at $17.24

I currently own 100 shares in a taxable account.

As noted in my last post, the shares fell after ARCC announced another share offering, a common malady among Business Development Corporations and a known risk for investors in those companies. ARCC (4/9/13 Post)

The compensation of the BDC's managers increases with the amount of assets under management, giving them an incentive to find numerous ways to increase those assets through repetitive common and preferred share sharing offerings and debt issuances including in some cases convertible bonds. All of the foregoing types of capital raises may or may not be in the best interests of shareholders. Time will tell.

I view this type of incentive as creating potential conflicts of interest. Ultimately, the shareholders will find out whether the BDC's new investments were prudent. A lot of problems will generally start to show up during a recession.

Some BDCs have repeatedly issued common shares at below net asset value per share, diluting existing shareholders.

Ares reported that the net asset value per share was $16.04 as of 12/31/12. SEC Filed Press Release-2012 4th Quarter Earnings2012 Annual Report

The underwriters bought the shares at $17.43 and sold them to the public at a higher price.  Prospectus Supplement So, this last purchase was made below the underwriter's price.

A good discussion of Ares can be found in this article published by Seeking Alpha. There are a number of SA contributors that know much more about BDCs than I do.

I just dabble in them to generate some extra income, primarily in the ROTH IRA. I will not hold them for long periods in a retirement account, and will try to exit the positions at any profit after collecting several dividends. They have too many negative features and risks that militate against a long term hold in a retirement account, where I place an emphasis on capital preservation first and income generation second.  I have tended to keep small BDC positions in taxable accounts, where I am far more willing to take risks with a much longer time horizon. My taxable accounts are almost ten times larger than the retirement accounts.

Security Description: Ares Capital is the largest Business Development Corporation (BDC). A BDC is required to pay out at least 90% of its taxable income to its shareholders. While that requirement results in a higher than normal dividend, due to the avoidance of double taxation, the payment of such a large dividend depletes the BDC's capital cushion and inhibits organic growth originating from retained earnings. This depletion of capital through dividend distributions, along with the inevitable loan losses and the compensation incentive of the managers to grow assets, contribute to a steady flow of common share sales.

A list of its investments can be found, starting at page F-6, in the recently filed Annual Report: 10-k I have never heard of most of those private companies. As with most investors, I am depending on the expertise of the ARCC managers.

The company has a partnership with GE to invest in first lien senior secured loans of middle market companies. That program is described more fully at pages 62-66 of the 2012 Annual Report, but I did make a snapshot which summarizes that partnership:

Senior Secured Loan Program with GE
Prior Trades: I still own the following shares held in two taxable accounts: Bought: 50 of the BDC ARCC at $16.17 and at $16.3 (January 2011)

I have sold some shares: SOLD 100 ARCC at $17.54-IRAs in Two 50 Share LotsAdded 50 ARCC at $16.9-Regular IRABought 50 ARCC at $16.89

I have also bought and sold a senior exchange traded Ares Capital bond: Added 50 ARY @ $23.75;  Bought: 50 ARY at $24.2; Sold 100 ARY @ 24.6.

Rationale: (1) While trying not to sound like a broken record, it is all about income generation in the retirement accounts. At a total cost of $17.24, the yield is currently around 8.82% based on the current regular quarterly dividend rate of $.38 per share. ARCC :: Investor Resources :: Dividends

Ares did pay in 2012 two special five cent per share dividends. I would not factor special dividends into my yield but would simply note that the yield could improve with dividend increases or deteriorate with dividend reductions, based on subsequent developments.

The general idea is to capture a 10%+ annualized yield on this kind of investment which would require a small profit on the shares after collecting four dividend payments.

Risks: Anyone investing in BDCs needs to fully appreciate the risks. There is a price for the high dividends.  I discuss some of those issues above. It needs to be kept in mind that a BDC is lending money to relatively high risk private companies. Recently, in order to improve their yields, BDCs have increased their allocation to unsecured senior subordinated and senior debt from secured lien debt. While those loans are not generally rated, most of them would fall into the CCC to BB range. It is not only that the default risk is higher for those loans, compared to investment grade debt, but the recovery in the event of a default would also be lower.  In some cases, the recovery rate after a default would be minimal or possibly nothing at all in a bankruptcy reorganization. I received for example 43 shares of newly issued Reddy Ice stock in its bankruptcy organization, which is traded on the Grey Market only, in exchange for one $1,000 par value second lien note. Those shares are worth slightly over $200, assuming I could find a buyer for them.

A long litany of risks is set out starting at page 29 in 2012 Annual Report: 10-k The summary of risks end at page 50. There is no such thing as a free lunch when reaching for yield.

Future Buys: I may buy 50 more shares in a taxable when and if the price falls below $16.

When there is fear in the air, as there was yesterday, I would expect BDCs to perform worse than the S & P 500.

S & P 500: 1,552.36 -36.49 (-2.30%)

Yesterday's Closing Prices for owned BDCs:
BKCC: 9.28 -0.40 (-4.13%)
TICC: 9.22 -0.31 (-3.25%)
ARCC: 16.87 -0.46 (-2.65%)
PSEC: 10.65 -0.21 (-1.93%)
PNNT: 10.53 -0.17 (-1.59%)

Yesterday's Closing Prices on Other BDCs that are not currently owned:
FSC: 10.35 -0.41 (-3.81%)
ACAS: 13.99 -0.50 (-3.45%)
HTGC: 11.83 -0.42 (-3.43%)
TCAP: 26.29 -0.90 (-3.31%)
MAIN: 30.07 -0.92 (-2.97%)
MCC: 14.34 -0.42 (-2.85%)
AINV: 8.06 -0.23 (-2.77%)
SLRC: 22.62 -0.55 (-2.37%)

3. Added 40 SAN at $6.8 (see Disclaimer): While I have had several profitable trades on Santander's floating rate equity preferred stock, STDPRB, and have unrealized gains in my remaining positions, I made a mistake of buying Santander's common stock in 2010, failing to fully appreciate the potential losses from its operations in Spain while overestimating the near term potential of its operations outside Spain, particularly in Latin America. Those kind of mistakes are inevitable due to error creep. ERROR CREEP and the INVESTING PROCESS

The successful investor will only succeed in minimizing mistakes, or keeping them at a non-lethal level, due to error creep by following the investment process, described throughout this blog and generally in my post on error creep.

After making the mistake in 2010, and then failing to recognize the mistakes to cut my losses, I have gravitated toward reinvesting Santander's generous dividend to buying more shares, starting in May 2012, which avoids Spain's withholding tax according to Vanguard and Fidelity, and to buying small odd lots to lower my average cost some. I would not be surprised to see a dividend cut.

This last purchase was made after a decline in SAN's share price (SAN Historical Prices) and was made the day before the last ex dividend date for a $.187 per share distribution:

Added 40 SAN at $6.8
The prior average down was not discussed but was made in July 2012:

Bought 50 SAN at $5.55

My current average cost is $9.8 which will be lowered a tad when I receive the reinvested shares purchased with the last dividend payment.

Security Description: Banco Santander S.A. ADS  (SAN) is one of the largest banking institutions in the world, headquartered in Spain and with significant operations elsewhere in Europe, the U.S. and Latin America.

The current consensus estimate is for an E.P.S. of $.76 this year and $.82 next year.  SAN Analyst Estimates The five year estimated P.E.G. is shown at .45 at Yahoo Finance's Key Statistics' page.

Banco Santander Profile Page at Reuters

Banco Santander Key Developments Page at Reuters

Company Website: Investor Relations

As recently as April 2008, the stock traded over $21 before a waterfall movement to around $6 in February 2009. Thereafter, the shares did a bungee jump, topping out at over $17 in Nov before jumping off a cliff again. SAN Interactive Chart

2012 Annual Report.PDF

During 2012, SAN sold 24.9% of Santander Mexico for €3,178 million. The share price of Santander Mexico ended the year up 33.8% and the value at year end was $21,959 million.

Total customers totaled 101.9 million for the Group with 44 million in Latin America, 30 million in Continental Europe, 1.7 million in the U.S. and 26.2 million in the UK. The total number of branches stood at 14,392. (page 32 Annual Report)

Prior Trades: In addition to the purchases mentioned above, I discuss buying the common shares, when the symbol was STD, in these posts. Bought 50 STD at $13.35 (April 2010); Bought 50 STD at $12.35 (April 2010)

I have also traded the floating rate equity preferred stock STDPRB and currently own 180 shares. Bought 100 STDPRB at $15.3-Sold 100 STDPRB at 18.11Added to STDPRB at $18.6Added 50 STDPRD at $18.54Bought 50 STDPRB @ 17.96Sold 50 STDPRB at 19.64 in the Roth IRASold 50 STDPRB at 20.2Sold 50 STDPRD at $20.34Bought 30 STDPRB at $13 (still own); Added 50 STDPRB at $15.44 (still own); ; Bought 50 SANPRB at $16.93-Roth IRA (still own); Sold 50 of 230 SANPRB at $20.77

See also: Advantages and Disadvantages of Equity Preferred Floating Rate SecuritiesFloaters: Links in One Post

Recent Earnings Report: Heavy loan loss provisioning eat into results for 2012. The pre-provision net operating income was €23.56 billion for the year, up 1.6% compared to 2011. Santander took heavy provisions for losses in Spain during 2012, with a €9 billion provision for loan losses. Real estate loans were €6.14B of that €9. The provisions stood at year end at levels higher than required by the government. Since the onset of the crisis in Spain, Santander has specifically provisioned €23 billion or 10% of its loan portfolio in that beleaguered country. The provisioning has put the bank with the lowest exposure to real estate among its peers, The NPL ratio stood at 4.54% at year end, with the core capital ratio improving 31 basis points to 10.33%. The coverage ratio was at 72.6%.

The net profit for 2012 was recently restated to €2.296B from €2.295.  Form 6-K

Q4 2012 Results - Earnings Call Transcript - Seeking Alpha

Rationale (1) Total Return Potential: I am betting that Europe will start to recover later in 2013 or possibly in early 2014. Hopefully, most of the bad debts in Spain have been written off. Santander's U.S. operations have recovered from losses suffered in 2008-2009 (Sovereign Santander), and their large presence in Latin America affords the bank significant growth opportunities.

{Soverign Santander 2012 Annual Report: Santander Holdings USA 10-K 2012 (over 720 branches as of 12/30/12 with its principal markets in the northwestern U.S.)}

In 2007, Santander reported diluted earnings per share of €1.4139, up from €1.2091 in 2006 and €.993 in 2005.  2007 Annual Report at page 7 The €1.4139 would translate into around $1.85 as of 4/12/13.

So, there is recovery potential. Poor economic conditions do not last forever. Things do change notwithstanding the human tendency to project current conditions, good or bad, way into the future.

Patience is required to wait for the turn.

Risks (1) A dividend cut is certainly a possibility.

(2) Europe and Spain in particular may easily continue to slide into the abyss as austerity programs make dire economic conditions in southern Europe worse.

(3) Loan losses at Latin American operations are at somewhat elevated levels. Santander Brazil, for example, reported that loans in arrears for more than 90 days rose to 5.5% of total loans during the 2012 4th quarter. BSBR's allowance for loan losses jumped to R$13,233 million, up 39.8% in 12 months. (pages 11 and 17 2012 4th quarter earnings release filed with the SEC-6k)

Future Buys: I may continue to average down in small odd lot purchases below $7 per share, spacing the purchases out in time and after reviewing the latest earnings report to evaluate SAN's recovery potential.

Yesterday's Close: SAN: 6.79 -0.21 (-3.00%)

4. Bought 100 of the Bond CEF BWG at $20.87 (see Disclaimer):

2013 ROTH IRA Bought 100 BWG at $20.87

Security Description: Legg Mason BW Global Income Opportunities Fund (BWG) is a leveraged global closed end bond fund. Some of the currency risk is hedged by the fund. The fund was organized and commenced operations last Spring.

Sponsor's website: Legg Mason Individual Investor - Closed-End Funds Details

Full Holdings as of 2/28/13: Closed-End Funds Details (tab "full holdings")

Distributions are paid monthly at the current rate of $.12 per share ("distributions" tab)

The next ex dividend date is April 17th: Legg Mason BW Global Income Opportunities Fund Inc. (BWG) Sets New Rate and Announces Distributions for the Months of March, April and May 2013

Tax information provided by the sponsor shows that none of the dividends paid in 2012 were supported by a return of capital, but had to be supported by capital gains. leggmason.com/PDF (income $.5692 per share; ST Cap $.2708; LT Cap. $.10). The first dividend payment was $.1175 in May 2012.

SEC Form N-Q: Holdings as of 1/31/13 (total cost of investments $580.+M/Value $620+M as of 1/31/13)

Last SEC Filed Shareholder Report:  Period Ending 10/31/12

BWG page at CEFConnect

BWG page at the CEFA

Morningstar page for BWG: LeggMason BW Global Income Opportunities

Credit Quality And Currency Exposure as of 12/31/12:

While the fund has some exposure to junk rated bonds, the weighting is in BBB and A rated securities.

BWG Data on 4/11/13 (day before purchase)
Closing Net Asset Value Per Share= $22.65
Closing Market Price= $20.79
Discount= -8.21

BWG Data on 4/12/13 (date of purchase)
Closing Net Asset Value Per Share= $22.67
Closing Market Price: $20.76
Discount: -8.43

The WSJ shows the net asset value declining to $22.39 yesterday. If accurate, that would be a significant decline on a day when most bond funds that I own were steady to up slightly in net asset value per share. The stock is not ex dividend until April 17th so that issue can not account for the 1.235% drop in net asset value from last Friday's close.

I suspect most of the drop is explained by BWG's foreign bond holdings, and the USD strength yesterday against most currencies other than the Yen.

ETF Bond Closing Prices from Yesterday:
LQD: 121.47 +0.04 (+0.03%) : iShares Investment Grade Corporate
TLT: 122.99 +1.06 (+0.87%) : iShares Barclays 20+ Year Treasury
JNK: 41.00 -0.22 (-0.53%) : SPDR Barclays High Yield Bond
IBND: 34.92 -0.13 (-0.38%) : SPDR Barclays International Corporate
BWX: 58.98 -0.02 (-0.03%) : SPDR Barclays Intl Treasury Bd
EBND: 32.78 -0.21 (-0.64%) : SPDR Barclays Emerging Markets Local Bond

As shown above, there was weakness yesterday in junk, international corporates and emerging market bonds. Some of the foreign bond weakness was due to the USD rising in value against the Euro, CAD, Brazilian Real, and Aussie Dollar yesterday. I just took the closing prices of some relevant currency ETFs:

FXE: $129.18 -0.69 (-0.53%) :  CurrencyShares Euro;
FXC Canadian Dollar: $96.97 -1.12 (-1.14%);
FXA Australian Dollar: 103.05 -2.13 (-2.03%);
BZF: 19.57 -0.31 (-1.55%) : WisdomTree Brazilian Real Fund

The currency ETF for the YEN rose in value: FXY: 101.20 +1.91 (+1.92%) : Rydex CurrencyShares Japanese Yen FXY has been sliding since September 2012 when it closed over $126.

Rationale: (1) Again, I am simply trying to generate some tax free income in the ROTH IRA. While the fund pays taxable dividends, those payments become tax free in the ROTH IRA, which is one reason for buying this bond CEF in that account.

At the current monthly rate of $.12 per share, the dividend yield is about 6.9% at a total cost of $20.87.

There is some possibility of capital appreciation which would add to the return. Potentially, a gain could be realized with the net asset value per share remaining about the same with the discount narrowing. If the discount narrows at a time when the net asset value is rising, then that scenario would obviously increase the profit. The converse is also true of course. The discount for a CEF could be expanding at a time when the net asset value is declining, or the premium to the net asset value per value shrinking, as the case may be, subsequent to purchase, increasing the loss potential of this CEF or any other.

My goal for this type of investment is to harvest a number of dividends and to exit the position with a 10+% annualized gain. It is easier to accomplish that goal with 7% is provided by the dividend, leaving just 3% for the net gain on the security.

Risks: The risks include the normal ones for a leverage bond CEF that invests globally in bonds, including junk rated bonds. Yesterday's net asset value change highlights the currency risk and the risks associated with lower quality debt when investors become fearful.

The worst possible combination of risks would involve an acceleration of defaults,  significant increases in the cost of borrowing as that increase decreases the value of the bonds owned by the fund, and an unhedged strength in the USD causing a decline in foreign bonds, all of which would contribute  to investor flight from the fund and an increase in the discount to net asset value.

In short, a plethora of plagues can cause a loss in principal.

I noticed that the fund had a significant exposure to Portugal's debt as of 2/2/13. That is a concern. I did not see any exposure to Argentina or Venezuela.

Hopefully, I will not own any leveraged bond funds when those type of events come to pass.

Future Buys: I will probably buy another 100 shares on a downdraft, but only in a taxable account given the numerous risks.

It is sad that the OG's of the world have to take on this plethora of risks to acquire a 7% yield.

Yesterday's Closing Price: BWG: $20.69 -0.07 (-0.34%)

5. Pared FMER By Selling 50 at $16.9 (Stocks, Bonds & Politics: REGIONAL BANK BASKET STRATEGY)(see Disclaimer): I will just briefly discuss this transaction. In my regional basket strategy, I will buy and sell odd lots to lower my average cost per share over time. The FMER shares sold last Friday did generate almost two years of dividends.

SOLD 50 FMER at $16.9
I use FIFO accounting. The 50 FMER shares sold last Friday were my highest cost lot bought in the market. Some shares bought with reinvested dividends have a higher cost.

The disposition of that lot lowered my average cost per share from $14.97 to $14.48. I made a small profit of just $ on this 50 share lot. I do not take snapshots of profits or losses less than $30, and this gain will not be included in my realized gain total for this basket.

I did take two snapshots to show what I am doing with this position.

The first snapshot was taken shortly before I sold the shares. It shows the 50 shares bought in May 2011 at a total cost, including commission of $16.34. The snapshot also shows my average cost per share to be $14.97:

The second snapshot was taken after I sold the 50 shares:

I now own 140+ FMER shares.

I will probably not be able to do this type of trade again with FMER since my next odd lot purchase, made in August 2011, was at a total cost of $11.62. Bought 30 FMER at $11.35 While online commission costs are very low, and at least allow for this kind of strategy, the commission cost on a thirty share lot drove the average cost of that lot from $11.35 to $11.62. An average cost of a 100 share lot purchased at Fidelity would be $11.43 at the $11.35 price.

If I decide to sell FMER shares again, I will sell all of them. I may buy more below $15.

I am reinvesting the dividend to buy additional shares.

Since I have currently a positive long term view of FMER's acquisition of Citizens Republic Bancorp, I am likely to keep my remaining FMER shares long term. I discuss that acquisition in two posts: Item #2 Added 50 FMER at $15.2 (September 2012) and at Item # 3 Added 50 FMER at $15.09 (2/13/13 Post).

FirstMerit consummated its acquisition Citizens Republic last Friday and now has more than 400 branch locations.

This last FMER transaction was my second pare of higher cost shares: Sold 50 FMER at $17.3 (March 2012).

Yesterday's Closing Price: FMER: $16.03 -0.65 (-3.90%)

My regional bank basket was hit pretty good yesterday, falling 3.15% in value.


This post is long enough. I will discuss two other sells in my next post. I will raise my cash allocation slightly whenever I believe the market is at high risk of a correction.  

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