Tuesday, November 11, 2014

Sold 50 AIY at $25.23-Roth IRA/Bought 100 VRP at $24.89/BANC and EPR

Big Picture: No Change

Recent Developments:

Banc of California completed its acquisition of Popular's California branches. I discussed that acquisition in a recent SA Instablog: Banc Of California: Bought 100 Shares At $11.7 - South Gent | Seeking Alpha

EPR Properties CEO believes that the midterm elections will be a positive for EPR's charter school business. I currently own 30 EPR shares that were bought after selling another 30 share lot at a higher price. Item # 1 Bought 30 EPR at $50.72 (10/4/14 Post); Item # 6 Sold 30 EPR at $55.22 (8/9/14 Post)(snapshot of profit $41.66)-Item # 1 Bought 30 EPR at $53.3 (3/17/14 Post)

While that kind of earlier trade may seem picayune, I did harvest a profit after collecting some monthly dividend payments and then reset my average cost per share at a lower level than my first purchase cost ($50.72 vs. $53.3) which improves my dividend yield going forward.  


I will receive my first monthly dividend payment on 11/17/14. EPR Properties Dividend Date 

At the current monthly rate of $.285 per share, the dividend yield is about 6.74% at a total cost of $50.72 per share.


1. Bought 100 VRP at $24.89 (see Disclaimer): This is a very low expectation purchase.

I expanded the discussion of this purchase in a SA Instablog: Income And Risk Assessment Balancing-Bought 100 Of The ETF VRP - South Gent | Seeking Alpha

This security can currently be bought by Schwab customers commission free: PowerShares Expands ETF offerings on Schwab 

Snapshot of Trade: 


Security Description: PowerShares Variable Rate Preferred Portfolio Fund (VRP) is a new ETF that owns variable rate "preferred" stocks and bonds. 

Sponsor's Website: Invesco - Product Detail

Sponsor's Fact Sheet 9/30/14

Semi-Annual Report 4/30/14 (starts at page 70; as of 4/30/14, the allocation was 44.1% in bonds and 55.1% in equity preferred stocks)

Given the low status of preferred stocks in the capital structure, and this fund's concentration in preferred stocks issued by financial institutions, there will be a significant weighting in junk rated issues:


The weighting is in BBB/BB (S & P) and Baa and Ba (Moody's). The BB and Ba ratings are high end junk ratings. 

This fund is currently paying monthly dividends of $.10 per share. At that rate, the dividend yield is about 4.82% at a total cost of $24.89 per share.  

The sponsor lists the effective duration as 4.08 years. 

The expense ratio is high at .5%. 

As of the date of my purchase, the fund owned 88 securities. 

Looking at the portfolio, the fund owns both trust preferred (or subordinated debentures) and traditional preferred stocks. Holdings A trust preferred is technically a "preferred" stock, but is in reality a bond. Stocks, Bonds & Politics: Trust Preferred Securities: Links in One PostStocks, Bonds & Politics: Regular Preferred and Trust Preferred (1/1/2009 Post) That type of hybrid security has a superior claim than traditional preferred stock which is superior only to common stock in the capital structure. 

Some examples of trust preferred securities owed by this fund are as follows: 

Trust preferred securities pay interest. 

Some examples of equity preferred stocks owned by this fund are as follows: 

The preceding equity preferred stocks pay qualified dividends.

A number of the bonds owned by the fund are traded in the bond market and have $1,000 par values:

ChubbProspectus (fixed at 6.375% to 4/15/17 then floats at 3 month Libor + 2.25%

American Express; Prospectus (fixed at 6.8% to 9/1/16, then floats at 3 month Libor + 2.2275%)

So the dividends paid by this ETF will have both qualified and non-qualified components. 

I have bought and sold the GSPRJ, and will simply drag and drop my discussion about the advantages and disadvantages of this type of security. Item # 4 Bought: 50 GSPRJ AT $22.78 (11/12/13 Post) 

Description of a Fixed-To-Floating Rate Equity Preferred Stock: 

A fundamental problem with this type of security is that the investor has to accept a somewhat lower coupon than a pure fixed rate preferred stock, while possibly never receiving the benefit of the Libor float provision. These fixed to floating rate securities give the issuer the right to redeem at anytime after the fixed rate coupon period expires. 

To illustrate the issues, I will simply discuss one security in detail. 

The Goldman Sachs Group Inc. Fixed-to-Floating Preferred Rate Stock (GS.PJ) is a fixed to floating rate equity preferred stock issued by Goldman Sachs.

GSPRJ will pay quarterly non-cumulative dividends at the rate of 5.5% per annum on a $25 par value. The 5.5% fixed coupon rate will be applicable from the issue date to, but excluding 5/10/23. 

On or after 5/10/23, GS has the option to redeem this security at par value plus any accrued dividends. If the security is not redeemed, the coupon transitions to a floating rate on 5/10/23. The floating rate would be a 3.64% spread to the three month Libor. PROSPECTUS SUPPLEMENT DATED APRIL 18, 2013

The coupon rates on GS fixed coupon preferred stocks are higher, though the actual current yield will depend on the total cost paid for the stock. Goldman Sachs Group Inc. 6.2% Series B Non-Cumulative Preferred Stock (GS.PB)Goldman Sachs Group 5.95% Non-Cumulative Preferred Series I (GS.PI) 

This security has a typical stopper clause, summarized at page S-3 of the prospectus, that prevents GS from paying a cash common dividend after eliminating the non-cumulative preferred dividend. In order to legally eliminate the dividends on its non-cumulative preferred stocks, GS must first eliminate the common stock dividend.

As with other equity preferred stocks issued by Goldman Sachs, GSPRJ is currently rated junk by both S & P and Moody's. S & P has it at BB+. Moody's rates it at Ba2. 

This security will pay qualified dividends.

Initiation of the Floating Rate May Result in A Redemption:

If the Libor rates are high enough in 2023 or anytime thereafter, GS may elect to redeem this security. 

Investors do not want a redemption when the comparable alternative securities produces less income. GS would not redeem a 5.5% fixed coupon perpetual preferred stock in order to replace it with a 7.5% coupon preferred stock. It might replace that 5.5% fixed coupon preferred when it has to pay 7.5% due to the Libor float activation. GS will do whatever it perceives to be in its best interests when this security makes the transition from a fixed to floating rate. 

If GS chooses to pay the 3 month Libor + 3.64%, it will be because it views that rate as favorable to it. To result in an increase to the 5.5% fixed coupon rate in existence before the activation of the floating rate, the 3 month Libor would have to be over 1.51% during the relevant computation period.  

A fixed to floating rate preferred stock will have a theoretical duration less than a fixed coupon preferred stock (see page 8: cohenandsteers.com When_Interest_Rates_Rise.pdf) I would not personally use the bond concept of duration in connection with perpetual preferred stocks unless it was likely that the issuer would exercise its right to redeem the security. 

In practice, if short term and long term rates remained abnormally low after the GSPRJ option right comes into existence, the duration would remain perpetual for GSPRJ until such time as short term rates rose to a level where it would make sense for GS to redeem it.

Equity preferred stocks issued by heavily indebted financial institutions would become worthless in a BK. Their lowly status in the capital structure, superior only to common stock, creates volatility in the share price in times of economic stress. The non-cumulative feature will on occasion provide fuel for that volatility. A rise in interest rates will cause declines as more senior securities become more competitive. 

A company like GS and other highly leveraged financial institutions have all kinds of inherent risks. (see discussion of risk factors starting at page 24 in the GS 2013 Form 10-K. Risk factors relating to GSPRJ are discussed in the prospectus starting at page S-8)

This fund also owns some equity preferred floating rate securities that are discussed in this Gateway Post: Advantages and Disadvantages of Equity Preferred Floating Rate Securities

Recent discussions of that kind of security can be found in these posts:Equity Preferred Floating Rate Stocks: Added To MSPRA At $19.87 - South Gent | Seeking AlphaItem # 6 Bought 50 GSPRD at $20.2 (6/7/14 Post)

The trust preferred and subordinated debentures ("junior bonds') will generally grant the issuer the right to defer interest payments, but any deferred amount accrues interest generally at the coupon rate. The deferral right will generally be conditioned on a stopper clause that would require the issuer to cease paying cash dividends on junior securities before exercising the deferral right (e.g. page S-14 of  Chubb prospectus). For junior bonds, both common and equity preferred stocks are junior securities.

I am talking generally here. I have certainly not read the prospectuses for most of the securities owned by this fund.

Rationale and Risks: This is simply a trade and is viewed as a source of income generation superior to a money market fund. Hopefully, I will be able to exit the position at a profit after harvesting several dividends.

In a BK, a "preferred" security or junior bond issued by a bank holding company or other leveraged financial institution will likely become worthless; and that would include both junior bonds in addition to the equity preferred stock. Depending on the circumstances, there could be exceptions to that general rule.

Given their issuance by leveraged financial institutions, and their lowly status in the capital structure, they will also tend to be volatile in price, with a strong downside bias, in times of financial distress.

As mentioned above, the investor in the fixed to floating rate securities is accepting a lower current fixed coupon rate in exchange for the "insurance" protection afforded by the Libor float without any guarantee that any benefit will actually be received from the floating rate when it would be beneficial to the investor.

However, if there is not much difference in the starting yield, which is the case now for GSPRI (6.12% at $24.32) and GSPRJ (5.67% at $24.24), I would probably go with the fixed-to-floating rate security since it is less likely to remain a perpetual security compared to the fixed coupon 5.95% GSPRI. If interest rates are high when the float provision comes into effect, GS might elect to redeem GSPRJ at the $25 par value plus the accrued dividend, thus giving the investor an out. The owner of GSPRI would need to recognize that rates were trending up in a non-temporary manner and hopefully sell before the security lost too much in value. The market may also anticipate a rise in rates and start to reflect that eventuality in the fixed coupon preferred stock price before rates actually rise meaningfully.

The junior bonds have optional redemption dates and generally long term maturity dates assuming no exercise of the optional redemption right.

A number of the securities owned by this fund are trading above their par values. An issuer redemption at par value plus accrued dividends would result in a reduction in the net asset value per share and possibly a loss for the fund depending on its average cost per share. There is also more room to the downside in price than upside.

The sponsor describes risks at its website and it the Prospectus starting at page 5.

2.  Sold 50 AIY at $25.23 Roth IRA (see Disclaimer): 

Snapshot of Trade: 

2014 Roth IRA Sold 50 AIY at $25.23
Interest Paid: $42.96 

Snapshot of Profit: 

2014 Roth IRA 50 AIY +47.48 

Total Return: $90.44 or 7.49% (holding period about 6+ months)

Security Description: Apollo Investment Corp. 6.875% Senior Notes due 2043 (AIY) is an Exchange Traded senior baby bond issued by the BDC Apollo Investment Corp. (AINV).

This security will make quarterly interest payments at the fixed coupon rate of 6.875% on a $25 par value. This bond went ex interest on the day of my purchase for its $.4296875 per share distribution, so the price was adjusted for the amount of the quarterly interest payment. I will not receive that distribution, since the position was not owned on the ex interest date. Exchange traded bonds trade flat, unlike bonds bought and sold in the bond market which require the buyer to pay accrued interest to the seller. 

Apollo has the right to redeem this bond at par value plus accrued interest on or after 7/15/18. Prospectus 

Interest rate is asymmetric between the issuer and the owner of this security, with the favorable interest rate risk decidedly in favor of the issuer. If rates go up, then the issuer has locked in a favorable rate long term and the bond owner faces one of two bad choices: (1) sell at a loss or (2) hold as the value sinks, foregoing more income with the funds tied up in a losing position. If rates go down, the issuer can refinance on or after the optional call date, delivering the proceeds to the owner who will then have to accept less yield in another similar bond or the same yield with a riskier one.

I would note that interest rate risk is mitigated when an investor has built up a significant cash flow that can be reinvested in higher yielding securities when interest rates rise and the small payments made by 50 AIY would be aggregated with payments from other sources to effectuate such purchases.

Credit risk is enhanced with an externally managed BDC, given the extraordinary compensation paid to the managers and the requirement that at least 90%+ of net income be distributed to shareholders in order to maintain the BDC's tax status. In other words, money is flying out the door, providing little of a capital cushion for bond owners.

Related Trades: I currently own 200 shares of the common. Added 50 AINV At $7.94 - South Gent | Seeking AlphaBought: 100 AINV at $7.95 (5/10/14 Post)

I sold 155+ AINV shares last September: Sold 155+ AINV at $8.81 (9/20/14 Post)

Recent Earnings Report: For the 2014 third quarter, Apollo Investment Corporation reported net investment income of $.28 per share. Net asset value per share was reported at $8.72 as of 9/30/14.

Rationale: I was not not trying to do much with this purchase other than harvest a few quarterly interest payments and to exit the position at a profit.

Future Buys: I will want a much better re-entry price than $24 for AIY, preferably one that creates a 7.5%+ yield, before considering a repurchase. I have tentatively market a potential repurchase price at $22.75 or lower.