Friday, October 24, 2014

BOUGHT 50 NGHCP at $24.3/Sold 50 AMNB at $23.03/Bought 100 PNNT at $10.66-Regular IRA/Bought Back PWCDF at $25.81/Bought 50 PSEC at $9.65-Roth IRA

Housekeeping: There will be no monthly update of the basket strategies. Google deleted that post today when I attempted to open it. Google Just Deleted My Monthly Update for the Basket Strategies-THERE WILL BE NO UPDATE THIS MONTH

I did discuss one Lottery Ticket purchase made over the past month in a SA Instablog: Lottery Ticket Basket Strategy-Bought 40 CORR At $7 - South Gent | Seeking Alpha

I also discussed one small addition to the regional bank basket at that site: Regional Bank Basket Strategy: Added 50 ONB At $12.45 - South Gent | Seeking Alpha

Google remains unable to take visitors to my blog who are using the correct blog URL. I have quit using it to gain access. Instead, I will bookmark the "blog archive" for the latest month. Stocks, Bonds & Politics: October 2014

I am now on an irregular publication schedule. Some trades will be discussed here and some individual trades will be discussed at SA.

Big Picture Synopsis 

Stocks:
Stable Vix Pattern (Bullish)(Requires a Trigger Event To End)                   
Short Term: Market Needs to Correct 10% to 15%               
Intermediate Term: Slightly Bullish (gains to date borrow from the future)
Long Term: Bullish

The VIX remains in a Stable Vix Pattern. The brief spike to the mid-20s was insufficient to generate a Trigger Event under the Model.

Close on October 24, 2014 VIX: 16.11 -0.42 (-2.54%)

Vix Asset Allocation Model - South Gent | Seeking Alpha

According to the S & P 500 chart, the rally today did not piece the 50 day SMA line to the upside, while that index did close above its 200 day SMA line and only traded a few days below that SMA line. Interactive Chart In several recent SA comments, I mentioned that the S & P 500 break below the 200 day SMA line was not a good sell indicator. I would want to see a close lower than 5% below that line and a Trigger Event in my Vix Asset Allocation Model.

Bonds:               
Short to Long Term: Slight Bearish Based on Interest Rate Normalization
The Difficult Path to Interest Rate Normalization


The 10 year TIP break-even spread closed today at 1.9% and has been trending down.

That forecast is known as the break-even spread, the average annual rate of inflation for the owner of the 10 year TIP to break even with the owner of the non-inflation protected treasury.

The break-even spread is calculated by subtracting the yield of the TIP
Daily Treasury Real Yield Curve Rates

From the Yield of the Non-inflation protected treasury
Daily Treasury Yield Curve Rates

A persistently low inflation rate is a predicate condition for a long term secular bull market in stocks.

For the 12 month period ending in September, the government reported that CPI rose at a non-seasonally adjusted rate of 1.7%  Consumer Price Index Summary

I do not believe that my Blue Cross health insurance premium increase for 2015 is included in that number. I did a mental calculation, always a hazard for an OG, and came up with 18+%.


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1. Bought 50 NGHCP at $24.3 (see Disclaimer):


Snapshot of Trade:



Security Description: National General Holdings Corp. 7.5% Pfd. Series A (NGHCP) is a new non-cumulative equity preferred stock that pays qualified dividends at the fixed coupon rate of 7.5%  on a $25 par value. The issuer, National General Holdings (NGHC), has the option to redeem the issue on or after 7/15/2019. This preferred stock will be perpetual until the issuer elects to redeem it. The issuer may redeem on or after 7/15/2019 when it is in its interest to do so.

Prospectus

The prospectus contains a typical Dividend Stopper Clause, the legal mechanism for enforcing the preferred shareholders superior rights to common shareholders:

Dividend Stopper Clause

Company Description: National General Holdings was formed in 2009 and is a speciality personal lines insurance holding company.  Profile

The company reported second quarter net income of $30.3M or $.32 per share up from $13.1M or $.22 per share in the 2013 second quarter.

National General Website

Investor Relations - National General

Key Developments Page at Reuters

The consensus E.P.S. estimate is fo $1.18 in 2014 and $1.59 in 2015. NGHC Analyst Estimates

NGHC 2014 2Q 10-Q

NGHC 2013 10K (risks discussed starting at page 25)

Rational: This security generates a yield of about 7.72% at a total cost of $24.3 per share. The dividends are qualified so that yield is tax favored in a taxable account when the taxpayer has a marginal rate in excess of 15% and a 15% cap on qualified dividends. Taxes on Income and Capital Gains for 2014

The after tax rate of approximately 6.56%, assuming a 15% tax rate, is significantly above the current rate of inflation.

The general idea is to harvest several quarterly dividends and to escape with a profit.

I view equity preferred stocks with some disfavor for the reasons outlined throughout this blog for the past 6 years and in the following section.


Risks: The company discusses risks incident to its operations starting at page 18 of the prospectus. One of the risks mentioned is phrased this way: "Our principal stockholders have the ability to control our business, which may be disadvantageous to other stockholders".

There are a number of investors who have issues with the principal stockholders. This preferred stock is selling at an unusually yield that may be due to what I would call the Michael Karfunkel discount.

Mr. Karfunkel is an elderly gentleman who co-founded the American Stock Transfer and Trust Company in 1971, a stock transfer company, that was sold in 2008.  He is a founder and Chairman of the Board of Amtrust (AFSI) and is also a founder of Maiden. It is the AmTrust connection that makes some queasy as I previously mentioned when buying 50 shares of its preferred stock. Item # 7 Bought 50 AFSIPRB at $24.79

National General started to pay a quarterly dividend of $.01 per share in the 2013 4th quarter. NGHC Dividend Date & History If that cash dividend is eliminated, there is no legal impediment to eliminating the non-cumulative preferred stock dividend. An elimination of that common dividend would likely cause the preferred stock to crater in price in my opinion. Why would a company eliminate a 1 cent per quarter dividend? The dividend stopper clause does prevent National General from eliminating the preferred dividend for as long as it maintains a cash dividend payment to the common shareholders.

The lowly status of equity preferred stocks makes them subject to severe downdrafts in price during periods of market turmoil and financial stress. Many of the non-cumulative preferred stocks crashed in 2008, falling in many cases to the single digits, even when the issuer kept paying the dividends. The most recent severe decline occurred during the 2011 stock market correction. I noted in a August 2011 post a really bad day for several different types of exchange traded securities, having a higher priority than common stock in the capital structure. Item # 1 Fear and Enhanced Volatility in Certain Classes of Income Securities

I lump equity preferred stocks with bonds since their bond characteristics are more dominant than their equity features. Many of their equity features are undesirable including their potential perpetual terms without actually having an equity interest in the business and with interest rate risk being asymmetric with the issuer. I view equity preferred stocks as a disfavored asset class and will consequently attempt to trade them opportunistically.

The interest rate risk is asymmetric between the issuer and the owner of the preferred stock.

If interest rates rise, the issuer will allow the owner to keep the preferred stock which is declining in value. The investor has the option to sell at a loss, or to keep the security declining in value and consequently lose the opportunity to reinvest the proceeds in a higher yielding security.

These securities can become perpetual for an individual's lifetime when rates rise and then remain at a level sufficiently high enough that it is not advantageous for the issuer to exercise their optional call right.

If interest rates decline and the issuer can refinance at lower rates, then the issuer has the option after the call date to redeem the security and to pay only par value plus accrued dividends, providing the investor with cash that can only then be reinvested in a lower yielding security.

When bought near par value, share price appreciation is minimal, while downside price risk is retained by the investor rather than the issuer, due to two factors.

First, in a declining rate environment, where the issuer is likely to redeem the security when it is legally able to do so (generally five years after the IPO), the price will be unable to rise much above par value even under optimal credit conditions for the issuer.

Second, the downside risk to the investor is not capped due to interest rates rising. In a rising rate scenario, the issuer has locked a favorable rate to its advantage, possibly into perpetuity, while the owner of the fixed coupon preferred stock has only bad choices left.

In a BK, an equity preferred stock is likely to meet the same fate as the common stock.

Future Buys/Sells:  I am always in a trading mode for equity preferred stocks. I have sold a bunch of them so far this year.

I summarized some of the REIT preferred stock dispositions in my recently published gateway post:

I have also bought and sold several equity preferred stocks this year. Stocks, Bonds & Politics: Gateway Post: Equity REIT Common and Preferred Stock Basket

See Also: Advantages and Disadvantages of Equity Preferred Floating Rate Securities (includes snapshots of profits)

Closing Price Last Friday: NGHCP: $24.30 +0.05 (+0.21%)

2. Bought 100 PNNT at $10.66-Regular IRA (see Disclaimer): 

Snapshot of Trade:



Company Description: PennantPark Investment is a BDC that invests in middle market companies, defined as companies with annual revenues between $50 to $1B. Those companies do not generally have bond ratings.

In early September 2014, PNNT announced that it wanted to sell 11 million shares. Preliminary Prospectus Supplement Perhaps, this game is becoming a bit tiresome and the BDC was only able to sell 8.5M shares at $11.63. PennantPark Investment Corporation Prices Public Offering There was a standard over allotment option.

The $11.63 price is the price paid by the public.

After underwriting fees and costs, PNNT received significantly less. SEC Filing ($11.2811 per share before $500,000 in expenses) The last reported net asset value per share was $11.33 as of 6/30/14. SEC Filed Earnings Press Release

PennantPark Investment Corporation is currently paying a quarterly dividend of $.28 per share.

Prior Trades: This trade brings me up to 200 shares. I also currently own 100 shares. Item # 6 Bought 100 PNNT Taxable Account at $10.84 (5/3/14 Post) The net asset value per share reported for the Q/E 3/31/14 was $11.13, 10-Q, so that purchase was below book value per share.

I last sold PNNT when the market price was at a premium to NAV per share, viewed as substantial for an externally managed BDC in my opinion. Item # 5 Sold 50 PNNT at $11.92 (12/17/13 Post)(profit $71.68)-Item # 6 Bought 50 PNNT at $10.2-ROTH IRA (11/21/12 Post) When I sold that 50 share lot, the last reported net asset value per share was $10.49 as of 9/30/13, so an $11.92 market price was a 13.63% premium to that NAV number.

Last Earnings Report: Prior to this last trade, the last earnings report was for the Q/E 6/30/14. SEC Filed Press Release PNNT reported core net investment income of $.28 per share and a 12.3% yield on investments at the quarter's end.

I do not find much comfort in the large weighting in second lien debt and securities lower down in the capital structure:

Click To Enlarge:
Portfolio Description

Rationale: As with all BDCs, my goal is to harvest a 10% annualized total return and will consider doing so when and if I achieve that objective. I could achieve that annualized return by collecting 4 dividends and selling the shares at a slight loss. I am not likely to sell the shares for a loss unless I become spooked about this BDC's performance.

The current quarterly dividend is $.28 per share. At a total cost of $10.66 per share, and assuming a continuation of that rate, the dividend yield would be about 10.51%.

The general idea is to harvest that yield and to escape without losing money on the shares. Easier said than done is my motto for externally managed BDCs.

By buying at below the last reported net asset value per share, I simply improve my chances of getting out with a share loss.

I placed this purchase in a regular IRA. If the shares fall by more than 10% from my purchase price, I will consider doing a Roth IRA conversion. My last IRA purchase was a 50 share lot made in a Roth IRA and sold at $11.92.

Risks: As with all BDCs, PNNT has considerable risks summarized in a very long discussion found in its F/Y 2013 Annual Report staring at page 14, Form 10-K

PNNT is not a serial issuer of common stock like PSEC which unfortunately also has a history of selling shares before net asset value per share.

BDCs invest in risky companies and do not retain much of a capital after paying dividends to their common shareholders. The shares will perform badly during a recession.

PNNT has an usually large allocation to riskier subordinated debt and a large second lien debt weighting (see above snapshot)

Loans made by BDCs are generally not rated by Moody's or S & P. If the loans were rated, most of them would be at CCC+ or lower.  An average portfolio yield of 12.3% adequately describes the risk when the ten year treasury is hovering around 2.2.%.

Future Buys and Sells: I will not buy more shares. I am full at 200 shares given my analysis of the potential rewards and risks.

I will sell the shares bought in the Regular IRA in accordance with the trading rules for externally managed BDCs. I am looking for an annualized total return in excess of the dividend yield. The goal is to harvest an annualized total return of 10% whenever that can be achieved through a combination of capital appreciation and/or dividends. I will consider selling shares whenever the market price exceeds net asset value per share by more than 5% and will consider buying share sold when and if the market price falls below net asset value per share.

Closing Price Last Friday: PNNT: $10.65 +0.03 (+0.28%)

3. Bought Back 100 PWCDF at $25.81 (see Disclaimer):  This trade is discussed in a recent SeekingAlpha Instablog.

Bought Back Power Corporation Of Canada at $25.81 (PWCDF) - South Gent | Seeking Alpha

Item # 5 Sold 100 PWCDF at $28.83 (8/2/14 Post)-Item # 4 Bought 100 PWCDF at $27.29 (7/12/14 Post)

Closing Price on Friday PWCDF: $25.97 +0.16 (+0.61%)

4. Bought 50 PSEC at $9.65-Roth IRA (see Disclaimer): Let me be clear in case anyone has not yet gotten the message. I do not like this company. I only like its current dividend.

Possibly, I do not have the same disdain that was evident in this SA Instablog discussing the many problems of externally managed BDCs.: Added 50 AINV At $7.94 - South Gent | Seeking Alpha

Snapshot of Trade:

2014 PSEC Bought 50 at $9.65-Roth IRA
This purchase was at a 9.64% discount to PSEC's last reported net asset value per share of $10.68 as of 6/30/14.

Company Description: PSEC is an externally managed BDC.

PSEC Interactive Chart

Annualized Total Return 7/27/2004 through 10/23/14:  6.13%, Calculator

That return is with dividend reinvestment.

PSEC has a bad history of selling stock at below net asset value per share. Seeking Alpha

Net Asset Value Per Share Destruction: The last reported net asset value per share was $10.68.  PSEC 10-Q Q3 2014

Sourced from PSEC's 10-Q Filings

6/30/2014:  $10.68 AUM $6.006+ Billion
9/30/11: 10.41 AUM=$1.652+Billion
9/30/09  $11.11
6/30/09 $12.4
3/31/08: $14.15 10q
6/30/07: $15.04
6/31/06 $15.31

Prior Trades: I have traded down to just a few shares in a taxable account.

PSEC 74+ Shares Average Cost Per Share  $9.46

With this 50 share purchase, I am just nibbling, replacing for now only 50 of the 100 shares sold in the Roth IRA a few weeks ago. Sold Roth IRA: 100 PSEC at $10.65 (9/6/14 Post) I accomplished my objective, escaping with a profit (+$30.99) after harvesting $230.67 in dividends. Bought 100 PSEC @ $10.2-Roth IRA (11/16/12 Post) So now I have reset my average cost at a lower number than the previous buy in November 2012 ($9.65 vs. $10.2, so my yield goes up and I have a better chance of escaping with a profit).

Rationale: The rationale starts and stops with the dividend. PSEC increasing the dividend by a minuscule amount each month since it slashed the dividend back in 2010, when it went from a $.41 quarterly rate to a $.10 monthly rate. PSEC Dividend Date & History For ease of computation, I will just call it a $.11 monthly rate. That produces about a 13.68% percent yield at a total cost per share of $9.65, which is tax free in the Roth IRA. Assuming I can escape with a loss on the shares, easier said than done, money will double in about at a tax free rate of 13.68%.

Risks: I have discussed the risks until I am no longer willing to repeat them. They can be found in prior PSEC posts here and at SA (South Gent's Comments on PSEC: Prospect Capital Corporation | Seeking Alpha)

I also discuss risks relating to externally managed BDC's in three recent SA Instablogs:

New Mountain Finance Share Offering Today Illustrates Multiple Risks Inherent In BDC Stocks - South Gent | Seeking Alpha

Added 50 AINV At $7.94 - South Gent | Seeking Alpha

Bought 50 ARCC At $15.41-A Typical Small Lot Purchase Of An Externally Managed BDC Stock - South Gent | Seeking Alpha

Extensive risk discussion can be found in PSEC's Annual Reports filed with the SEC.

Friday Closing Price: PSEC: $9.74 +0.10 (+1.04%)


5. Sold 50 AMNB at $23.03 (REGIONAL BANK BASKET STRATEGY)(see Disclaimer): 

My discussion of this sell was deleted by Google and was part of my regional bank update.

I am not going to rewrite it.

While this bank had several positive metrics in its last earnings report, the E.P.S. downtrend is viewed unfavorably. I may consider buying shares back at below $21. For now, I decided to chuck it.

American National Bankshares Inc. Reports Third Quarter 2014 Earnings

Snapshot of Trade:


Snapshot of Profit:

2014 Sold 50 AMNB +$77.57

Bought 50 AMNB at $21.16 (9/7/13 Post)

Closing Price on Friday: AMNB: $22.83 -0.16 (-0.70%)