Wednesday, December 24, 2014

Bought Back 100 NRBAY at $11.56/Extreme High Risk Junk Bond Strategy: Bought 1 Petroquest Energy 10% Senior Unsecured Bond at $91.638 Maturing 9/1/17

Big Picture: No Change

Stable Vix Pattern (Bullish):

Recent Developments:

The government estimated that real GDP grew at a 5% annualized rate in the third quarter, up from its second estimate of 3.9%. News Release: Gross Domestic Product Real personal consumption expenditures increased by 3.2%. Durable goods increased by 9.2%.

Real disposable income increased .5% in November. Real personal consumption expenditures increased by .7%. The price index for PCE decreased by .2%. The PCE price increase 1.2% Y-O-Y through November. The personal savings rate declined to 4.4% compared to 4.6% in October. News Release: Personal Income and Outlays

Stephen Roach believes that the Federal Reserve is leading the U.S. into another catastrophe with its abnormal monetary policies.

There is a tribe of economists who believe that the abnormally low short term rates manufactured by central banks around the world is actually contributing to deflationary forces. They call themselves Neo-FisheritesFisher EffectTheories of Inflation.

Unfortunately, 2014 continues to be a banner year for large year end fund dividend distributions. I received several year end capital gains distributions from my Vanguard mutual funds including their Equity Income (VEIPX) and Health (VGHCX) mutual funds:


1. Extreme High Risk Junk Bond Strategy: Bought 1 Petroquest Energy 10% Senior Unsecured Bond Maturing 9/1/17 at $91.638 (see Disclaimer):

Snapshot of Trade:

Since I was unwilling to buy more than 1 bond, I had to pay a price that was about $60 over a per bond price for a 10 bond offer. I am more worried about Petroquest surviving to pay off the bond in 2017 than that $60.

Snapshot of Confirmation:

Security and Company Description: PetroQuest Energy (PQ) is an independent oil and gas company with operations in Oklahoma, Texas and the Gulf Coast Basin.

PetroQuest Energy Key Developments Page at Reuters

I bought a 10% senior unsecured bond maturing on 9/1/2017: Prospectus 2017 Note (risk summary starts at page S-14)

In 2010, the 2017 senior unsecured notes were issued in the principal amount of $150M. The company later sold another $200M that was used to purchase assets in the Gulf of Mexico shallow waters, including 16 gross wells located on 7 platforms.

Production and Proved Reserves from the Gulf of Mexico Acquisition  

The confirmation excerpt shows that my current yield is 10.818% and the yield to maturity is 13.435%. The bond is rated Caa1 by Moody's and B by S & P.

Petroquest has the option to redeem this bond at the following prices:

Optional Redemption Prices Page S-39 Prospectus
An optional redemption is not going to happen anytime soon. PQ can not refinance this bond at a lower rate. It would have to pay a higher coupon now based on the market's pricing of this 10% coupon bond.

There is a "change of control" provision in the prospectus that requires the repurchase of this bond at 101% plus accrued interest in accordance with its terms, see pages S-43 to S-46. If PQ was acquired by a Chevron or Exxon, the change of control provision would not matter. Both of those companies would exercise the optional redemption right. The change of control provision would be relevant when the acquiring company was not investment grade, particularly when the bond was selling at a discount to par value prior to the acquisition announcement and/or would not likely be called early due to the credit quality of the acquirer.

PQ 2017 Bond FINRA Page: Bond Detail

A recent investor presentation summarizes the then existing hedges:

Page 26: December 2014 Investor Presentation

A recent important oil discovery is discussed in this article: PetroQuest’s Thunder Bayou Well

2013 SEC Filed Annual Report: PQ 12.31.13 10K

Prior Trades: None

Recent Earnings Report:

PQ 9.30.14 10-Q

Rationale and Risks: There is only one reason for this buy: Yield in a World Without Yield

The risk is obvious. The risk of default is high under the current circumstances. It was not viewed as high by the market before crude oil collapsed in price. The FINRA page for this bond has a chart of its price history. For most of the period since its original issuance in 2010, this bond was trading over 104 and traded over 107 as recently as May 21, 2014. Starting in October 2014, the bond just cratered in price in response to OPEC's decision to maintain production.

The hedge book will help for awhile. It does not solve the liquidity concerns that will result from a prolonged period of relatively low crude and natural gas prices. The current price of this bond and the common stock reflect a current market consensus that this company has a dangerous road ahead of it.

PQ Interactive Stock Chart

The company discusses risks incident to its operations starting at page 19 of its 2013 Annual Report. PQ 12.31.13 10-K

Future Buys/Sells: In my extreme high risk category for junk bonds, I will buy no more than 1 bond at a discount to par value. If I am unable to buy 1, I will not buy any. I have no idea now for how long I will hold this bond. If crude remains weak into the summer, I may be looking for an exit.

2. Bought Back 100 NRBAY at $11.56 (see Disclaimer):

Snapshot of Trade:

Currency Conversion: Nordea's ordinary shares are priced in Swedish Krone. The ADR's are available on the pink sheet exchange in the U.S. where shares are purchased in USDs. NRBAY Nordea Bank AB

1 ADR=1 Ordinary Share

To know whether the ADR shares are being priced correctly, I need to know the closing price on the Stockholm exchange and then convert that price from Swedish Krone into U.S. Dollars:

I did a currency conversion based on the ordinary shares priced in Swedish Krona. The shares closed at SEK90.6, but were trading slightly lower when I made my purchase.

NDA:Stockholm-Nordea Bank AB - Bloomberg

I set my limit price slightly below the then existing USD equivalent for the ordinary shares priced in SEKs.

Prior Trade:

2013 NRBAY Sold 100 +$175.06
Item # 6 Sold 100 NRBAY at $11.265 (2/6/13 Post)-Item # 2 BOUGHT 100 of the ADR NRBAY at $9.36 (10/10/12 Post)

I regretted selling those shares, particularly since they continued to rise after I exited the position, topping out near $15 last June: NRBAY Interactive Stock Chart

Company Description: Nordea Bank is the largest financial services group in Northern Europe operating through approximately 800 branches primarily in Denmark, Finland, Norway, and Sweden. Some branches are in Russia, the three Baltic countries.

Nordea is currently rated Aa3 by Moody's and AA- by S & P. Ratings |

Company Website: Nordea

At the time of my purchase, the P/E at the SEK90.6 price, based on estimated 2014 earnings, was 11.32 with a P/B ratio of 1.29.  (Bloomberg Page for SEK Priced Shares)

I took a snapshot of the income and balance sheet items comparing 2013 with 2012:

The return on equity numbers remained over 8% during the recent Near Depression:

Page 2 Nordea_2013 Annual_Report_2013

Last Earnings Report: This snapshot contains the basic financial metrics:

Third Quarter Results 2014 | Nordea

Earnings per share, ex items, increased to €.30 from €.19 in the 2013 third quarter and to €.68 from €.58 for the ninth month period ending 9/30/14. The capital ratios are good in my opinion. The Nordea efficiency ratio, defined as costs to income excluding extraordinary items, is shown at 49%. That would be significantly lower than big U.S. banks and consequently much better.

Loan losses declined to €112M or .12% of total loans and have been trending down: Page 12, Media_analyst_presentation_Q314.pdf

Tier 1 Capital Ratio Chart:

Compare to ROE Averages for U.S. Banks: StatisticReturn on Average Equity for all U.S. Banks-St. Louis Fed

Dividends: The current dividend policy is to pay out more than 40% of the net profit for each year. That policy will result in some variation in the dividend rate. The dividend is paid annually. The last ex dividend date was March 21, 2014.

The dividend paid in 2014 was for 2013 and amounted to SEK3.84, up from SEK2.93 for 2012 and SEK2.32 for 2011.  Dividend | There was a lower than normal payout ratio in 2008 with a SEK2.17 dividend, down from SEK4.7 for 2007.

The dividend for the ADR will depend on the exchange rate at the time of conversion. If the dividend for 2014 was SEK4, and that amount was converted at the same exchange rate as prevailing on 12/23/14, the USD equivalent would be about $.5135 per ADR share or a 4.44% dividend yield at a total cost of $11.56 per share.

I can not compute the dividend yield until Nordea declares the dividend for 2015 early next year and then I would need to have the conversion rate too.

If I went to a high point in the SEKs value against the USD, say April 26, 2011, 4SEKs would be worth about $.6563 and then the dividend yield would be higher at about 5.68%.

The SEK is already near a the 5 year low set around 5/30/10. SEK/USD Interactive Chart

If I took the exchange rate for 5/25/10, which looks like the low point over the past 5 years just eyeballing the five year chart, a 4SEK per share dividend payment would buy $.505, which would be a slight dividend cut through currency exchange from the exchange rate on 12/23/14.

I go through this exercise to demonstrate that the price of the ADR and the value of the dividend are both impacted by the currency exchange factor.

Rationale and Risks: Nordea appears to me, sitting at a desk in Tennessee, to be one of the best European banks, probably the best large bank in Europe. Notwithstanding stagnation in its primary markets, Nordea is still generating good numbers. There is also decent dividend support and the valuation is reasonable at slightly over 11 times 2014 estimated earnings.

Economic conditions in Nordea's home markets are stagnating. It remains to be seen whether those Nordic countries will tip over into recessionary conditions. Economic downturns are unfavorable for banks which is an obvious point.

The currency conversion issue has been a major negative recently for owners of the Nordea ADR priced in USDs as reflected in the chart below.

Comparison Chart: This is a one year comparison chart featuring the ordinary shares priced in SEKs (blue line) and the ADR priced in USDs (brown line). When looking at this chart, I see a significant price divergence, starting in the 2014 summer, that would be caused by the SEK losing value against the USD.

NDA-SEK.ST Interactive Stock Chart

SEK/USD Interactive Stock Chart

The USD may continue its parabolic upside move which would be bad news for me now as an owner of NRBAY.

I am willing to accept the currency risk. I prefer to buy a foreign security when my USDs are strong relative to the ordinary shares foreign currency. And, it is a bonus from my viewpoint when I have the tailwind of the strong currency and a decline in the ordinary shares for non-fundamental reasons. The ordinary shares have declined almost 10% since 6/9/14: NDA-SEK.ST Interactive Stock  Chart

An investor needs to understand the currency risk thoroughly before an intelligent decision can be made on whether to accept or reject that risk. The risk can be a benefit too when the SEK rises in value against the USD after my purchase. If the SEK gains in value at the same time as a rise in the ordinary shares price in SEKs, then an owner of NRBAY will outperform the owner of the ordinary shares priced in SEKs. The worst possible scenario, the infamous double whammy, is a continued decline in the foreign currency occurring with a decline in the ordinary shares priced in SEKs.

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