Thursday, March 12, 2015

Continued Paring Interest Rate Risk: Sold 50 EMQ at $26.01-Roth IRA/Bought 50 of the ETF VFH at $49.15/Bought Back 50 CIZN at $18.76-Regional Bank Strategy

Stable Vix Pattern (Bullish):
Links to SeekingAlpha Instablog, Articles and Comments:

South Gent's Instablog | Seeking Alpha

South Gent's Articles | Seeking Alpha

South Gent's Comments | Seeking Alpha


Recent Developments:

Retail sales fell .6% in February.  The decline in gasoline prices is one factor reducing the retail sales number. Bad weather in parts of the country was also a factor. Before drawing any conclusions, I will want to see the data from March and April. This will give bond prices a lift today, but it does not take much data to cause the Bond Ghouls to accelerate their gloom and doom  future scenario. If retail sales pick up in the Spring, they will find other data points to justify their dire forecasts about the economy until the end of days.


1. Sold 50 EMQ at $26.01 (see Disclaimer):

Snapshot of Trade:

Snapshot of Recent Roth IRA History:

Interest Payments: $37.5

Snapshot of Profit:

2015 Roth IRA 50 EMQ +$30.98 
Item # 4 Bought Roth IRA: 50 EMQ at $25.11 (8/23/14 Post)

Total Return: $68.48 or 5.24% (8 months, unsatisfactory except as a placeholder for MM cash paying .01%)

Prior Trades: 

Item # 2 Paired Trade: Sold 50 EMQ at $26.49 (11/6/13 Post)(profit snapshot=$68.97)-Item # 5 Roth IRA: Bought 50 EMQ at $24.83 (8/31/13 Post)

Item # 3 Sold  50 EMQ $25.61 (2/17/15 Post)(profit snapshot=$18.08)-Item # 2 Bought: 50 EMQ at $24.93 (2/10/14 Post)

Security Description: The Entergy Mississippi Inc. 6.00% Series First Mortgage Bonds 2032 (EMQ) is a first lien bond issued by Entergy Mississippi, a wholly owned subsidiary of Entergy Corp. (ETR).   

Entergy Mississippi is engaged in the distribution and transmission of electricity that serves 440,000 or so customers in 45 of Mississippi's 82 counties. A map of its service area can be found at Entergy Mississippi - Service Area.

EMQ is a first lien bond on "substantially all" of Entergy Mississippi's property. The coupon is 6% on a $25 par value. EMQ mature on 11/1/2032, but may be called now at the $25 par value plus accrued interest. This security just went ex interest on 1/29/15 for its quarterly distribution.


The secured interest is described starting at page 5 of the Prospectus.

Moody's  has a A3 rating on this first lien bond.

Interest rate risk is the dominant risk.

Interest rate risk is asymmetric between the owner of this bond and its issuer. Entergy Mississippi could redeem it at anytime now when it is in its interest to do so. The reason for a redemption would be that the issuer could refinance this debt at a lower coupon rate and possibly even extend the maturity.

On the other hand, if rates rise, the owner of the security would be stuck with the two undesirable options: sell at a loss and then reinvest the proceeds into a higher yielding security or keep EMQ as the price falls and forego the increased income from another security that could have been acquired with the funds tied up in EMQ.

In this kind of heads the issuer wins, tails the owner loses, there is not much upside when buying near par value but the downside risk could be considerable with a significant spike in long term rates given the long duration of this bond.

Rationale: Given the optional call right, this bond is not going to stray to far about its par value plus accrued and unpaid interest. A $26 price is about all that I will be able to squeeze out of it. I have only been able in recent years to buy these exchange traded first mortgage bonds, issued by Entergy (ETF) distribution subsidiaries, at relatively small discounts to their $25 par values. The profit potential is consequently severely restrained by the optional redemption rights at par plus accrued interest.

I can not muster much interest in a potentially long term bond that has a 6% coupon and is selling over its par value with that optional redemption right at par.

I still own in the Roth IRA EFM and ELB.

Entergy Mississippi Inc. 6.20% Series First Mortgage Bonds 2040 (EFM)

Entergy Louisiana LLC First Mortgage Bonds 6.00% Series 2040 (ELB)

Future Buys: I am surprised that Entergy Mississippi has not called this bond. In the event I can buy it back at less than its $25 par value, I will consider doing so, but that will depend on my then current opinion about interest rates.

2. Bought Back 50 CIZN at $18.76 (REGIONAL BANK BASKET STRATEGY GATEWAY POST)(see Disclaimer): This stock went ex dividend for its $.23 distribution shortly after my purchase on 3/12/15.

This was a marginal buy for the reasons discussed below.

Snapshot of Trade:

2015 Bought 50 CIZN at $18.76
The stock traded only 700 shares on the day of my trade, with the low price shown at $19.05: CIZN Historical Prices  My day limit order was filled at $.29 below that low price. I have had in the past an odd lot limit order filled below the lowest price shown for the day when the shares are thinly traded. The purchase simply does not register anywhere except in my account.

Limit orders for this stock are a necessity given its huge bid/ask spread.

Company Description: Citizens Holding Co. (CIZN) is the parent company for The Citizens Bank of Philadelphia, both headquartered in Philadelphia, MS. This bank has 24 branches located 14 counties in East Central and South Mississippi.

Branches | The Citizens Bank
Map of Branchs.pdf

The Molphus Company recently filed a Schedule 13G with the SEC claiming to own 247,925 shares or 5.083% of the total outstanding as of 12/31/14. Richard "Dick" Molphus is a Mississippi businessman who is President of the Molpus Woodlands Group/Molpus Timberland Investment.

There are two noteworthy items revealed by a long term chart. CIZN Interactive Stock Chart The shares did not go down much during the recent Near Depression, and the shares have been mostly range bound between $17 to $23 since 2003, except for a brief spike to over $31 back in June 2009.

Prior Trades:

Item # 4 SOLD 100 CIZN at $20.56 (3/2/11 Post)(profit $185.61):snapshot in Gateway Post)- Item # 2 Bought 50 CIZN @ $18.7 (11/19/2010 Post) and Item # 2 Bought: 50 CIZN at $18.25 (12/6/10 Post)

Dividend: Citizens Holding Company recently increased its quarterly dividend to $.23 per share from $.22.

The bank did not cut the dividend during the Near Depression period or its aftermath.

The $.22 quarterly dividend was kept constant for 16 quarters, however, starting in the 2010 4th quarter. The dividend rate was $.12 in 2002 so the rate of dividend growth is slow and was slowed down more by the recent recession.

At a total cost of $18.76 per share, the dividend yield is about 4.9%. 

Recent Earnings Report: Citizens Holding Company reported 4th quarter net income of $1.662M or $.34 per share, down from $2.122M or $.41 in the 2013 4th quarter. Book value per share was reported at $16.78.

Net interest margin declined 3.48%, down from 3.65%, "primarily because of the decrease in yields on earning assets was greater than the decline in rates paid on interest bearing accounts".  Net interest margin compression has adversely impacted earnings.

For 2014, E.P.S. was reported at $1.53, up from $1.47 in 2013. ROE was 10.17%. ROA was .84%. Deposits increased by 6.3%.

This small bank provides few details in its earnings release. Consequently, I had to go to 10-Q for the Q/E 9/30/14 to find the capital ratios. I would not expect much change in these ratios, which are good:

Capital Ratios as of 9/30/14
Page 32 10-Q

Rationale and Risks: There are three reasons for buying a small lot: (1) the dividend yield is good and there is some dividend growth; (2) the bank could easily be swallowed by another bank; and (3) the TTM P/E is reasonable at 12.26 at the $18.76 price.

The company discusses risks incident to its operations starting at page 10 of its 2013 Annual Report: Form 10-K

The non-accruing loans are higher than most banks in my basket. A large segment of the bank's service area is economically depressed. That can be seen just by driving around Philadelphia, MS. using google maps.

If intermediate and longer term rates turn up, that will relieve the net interest margin compression that is a restraint on earnings growth. Hopefully, we are near the end of the FED's interest ate suppression.

Future Buys/Sells: I will not bother buying more. I may sell on a pop. The best outcome would be for a premium price takeover. However, I have no reason to believe that this will occur and I will not buy a stock based on the possibility that such an event may occur.

3. Bought 50 of the ETF VFH at $49.15-Commission Free at Vanguard (see Disclaimer):

Snapshot of Trade:

Security Description: The Vanguard Financials ETF Fund (VFH) is a low cost stock ETF that owns banks, insurance companies, asset managers, and REITs.

This fund can be bought by Vanguard brokerage customers commission free. I bought this lot in a taxable Vanguard account.

Sponsor's Website:  Vanguard Financials ETF (VFH)(expense ratio .12%)

I took a snapshot that includes the top 28 weighted positions as of 1/31/15.

The top ten had a 34.43% weighting as of 1/31/15.

Prior Trades: I will periodically trade financial ETFs that I can buy commission free, either in my Fidelity or Vanguard brokerage accounts.

I have had three prior VFH round trip trades that have netted $615.72 in profits.

Snapshots can be found in Item # 1, Sold 50 VFH at $33.56 (10/18/12 Post).

Of those trades, the largest gain was $403.28 realized from a 100 share transaction in 2011. Item # 2 Sold 100 of the ETF VFH at 34.88 (2/27/11 Post)Item # 7 Bought 100 ETF VFH at 30.85 (11/5/2010 Post)

The other two trades were just 50 share lots held for about 1 month.

Dividends:  This fund has been tax efficient.  Financials ETF - Distributions

VFH Dividend Date & History

To the extent its holdings raise their dividends in coming years, most of that increase will flow through to the ETF owners due to the low expense ratio.

Berkshire Hathaway, which has the third highest weighting in this ETF, does not pay a dividend; and a number of other large financial institutions are still well below the levels reached prior to the recent Near Depression.

Bank of America and Citigroup may not return their dividends to pre-slash levels in my lifetime:

Bank of America Dividend History

Citigroup Dividend History

U.S. Bancorp (USB) is returning more quickly to the pre-slash levels. USB Dividend/Stock Split Information;

Wells Fargo (WFC) and J.P. Morgan have already exceeded their pre-slash dividend rates. Wells Fargo-DividendsDividend History | JPMorgan Chase & Co.


a. Beneficiaries of Rising Rates: Non-REIT financial stocks have frequently been viewed by investors as beneficiaries of higher interest rates. That was certainly the case in 2013 when non-REIT financial stocks outperformed the S & P 500 as the ten year treasury rose from a 1.66% (5/2/13) to a 3.04% yield (12/31/13). Daily Treasury Yield Curve Rates

2013 Total Returns Based on Net Asset Values:

S&P Regional Banking ETF (KRE) 2013 Total Return: 47.34%

PowerShares KBW Insurance ETF (KBWI) 2013 Total Return: 55.64%

S&P 500 ETF (SPY) 2013 Total Return: 32.21%

Common stock industry sectors viewed by many as "bond substitutes" would have been a drag a major market returns during 2013:

Vanguard Utilities ETF (VPU) 2013 Total Return: 14.93%

Vanguard REIT ETF (VNQ) 2013 Total Return: 2.42%

With rates rising, insurance companies will be able to invest new premium dollars in higher yielding assets; and banks may experience an increase in their net interest margins assuming their deposit costs rise at a slower rate than the interest received by them either through loans or investments.

Interest rates have risen since the ten year treasury yield hit 1.68% on 2/2/15. Yields have been drifting back down over the past few days. It remains to be seen whether inflation and a gradual end to the FED's extremely abnormal monetary policies will cause a return to more normal intermediate and long term rates.

I discussed the factors that could lead to a rise in rates in a recent article here, which also summarizes the factors that are keeping rates low: An Analysis Of The Risk/Reward Balance For Intermediate And Long Term Treasuries | Seeking Alpha

b. Increasing Dividend Payouts: Banks were at the epicenter of the Near Depression and several of the larger ones are still in a relatively slow recovery mode compared to prior banking disasters, including Bank of America, Citigroup (C), Zions Bancorporation (ZION),  Huntington Bankshares (HBAN), KeyCorp (KEY) and Regions Financial (RF). Many of those stocks are substantially below their pre-2008 highs and have long term recovery potential.

Several of those banks were allowed by the FED to increase their dividends and to buyback stock after passing the recent stress test: Bloomberg Business Citigroup will be raising its quarterly dividend to 5 cents from just 1 cent per share and has the authority to buyback up to $7.8B in stock over the next five quarters. JPM and Wells Fargo will increase their dividends by 10% and 7% respectively.

c. Loans Are Increasing as Non-Performing Loans and Charge-Offs Decline:

Charge-Offs are Back to Historical Lows:

Charge-Off Rate On All Loans, All Commercial Banks- St. Louis Fed

The Non-Performing Loans to Total Loan Ratio (NPL Ratio) is Moving Down (1.91%-2014 4th Quarter Down From High of 5.64%)

Nonperforming Loans (past due 90+ days plus nonaccrual) to Total Loans for all U.S. Bank-St. Louis Fed

Commercial and Industrial Loans are Hitting News Highs:

Commercial and Industrial Loans, All Commercial Banks-St. Louis Fed

Consumer Loans, All Commercial Banks-St. Louis Fed

Delinquency Rate On Consumer Loans, All Commercial Banks -St. Louis Fed

S&P/Experian Consumer Credit Default Composite Index

S&P/Experian First Mortgage Default Index

Just to emphasize a point. Loans up/Charge-offs and NPLs down. 

c. I obtain some exposure to larger banks with this ETF that I normally avoid. 

In the financial sector, I will buy mostly individual securities and will trade financial sector ETFs in small lots. Most of individual stock exposure will be in my regional bank and REIT basket strategies which I will periodically update in my blog.

The last updates were earlier this year:

Stocks, Bonds & Politics: Update for Regional Bank Basket as of 2/13/15 /Added 100 FNLC at $16.81/Recent Earnings Discussions for BHB, FNB, FFBC, NPBC, WTBA and BKSC Only

Stocks, Bonds & Politics: Update for Equity REIT Common and Preferred Basket as of 1/21/15

I have been discussing here at SA adds to insurance stocks and foreign banks (e.g.: Added To MetLife)

I will use the REIT basket as a hedge for non-REIT financial stocks that are more likely to respond positively to a rise in interest rates, as explained in this March 2014 post: REIT and Regional Bank Baskets

In 2015, I have been slightly increasing my non-REIT financial position and slightly decreasing my REIT exposure. I have several core REIT stocks that were bought, mostly in December 2013 as part of a sector rotation, that will likely be kept long term including Omega Healthcare and Realty Income.  Bought: 100 OHI at $29.85Bought: 100 Realty Income (O) at $36.96


a. Net Interest Margin Remains Under Pressure: 

Net Interest Margin for all U.S. Banks-St. Louis Fed

That is the main general problem now. Extremely abnormal and long lasting central bank monetary policies have caused compression in the net interest margin.

b. Return on Equity at 8.91% Is Still Below Well Below Pre-Near Depression Levels:

Return on Average Equity for all U.S. Banks-St. Louis Fed

c. Banks Blow Themselves Up and Dividends Are Therefore Unreliable: In my lifetime, banks have blown themselves up, with exceptions, on three prior occasions. No one needs to be reminded that the banks recently came really close to causing a worldwide financial collapse due to their greed, reckless lending activities and "financial innovations".

Back in 2008, the NYT wrote a series of articles about the most recent banking self immolation in a series called The Reckoning Series. When I read those articles, I was not surprised by the level of greed, lack of good judgment, or incompetence. A small dose of common sense and far less greed would have short-circuited most of the problems described in those articles. I have linked some of the more noteworthy ones:

How Merrill Lynch Faltered and Fell
Citigroup Saw No Red Flags Even as It Made Bolder Bets
AIG: Behind Insurer’s Crisis, Blind Eye to a Web of Risk
WaMu Built an Empire on Bad Loans

Real estate loans are frequently the main culprit in those episodes, and the problems are aggravated by a recession at least partly due to the banks making improvident and/or recklessly imprudent loans. Those frequently foolish loans are written down, credit conditions tighten even for worthy borrowers, and borrowers teetering on the edge before the economic downturn default causing more problems for the economy and the banks.

What happens is each successive generation unlearns the lessons from the past. Greed and an overall lack of ethics at larger institutions leads to frequently questionable, morally bankrupt and illegal activities. Financial creations are developed that create profits, but then those "innovations" turn into kindling for the fire that rages when reasonably predicted consequences are meted out for improvident decisions.

Future Buys/Sells: I will be more likely to add to my individual selections than to buy more VFH which is more of a trading vehicle for me, as reflected in my prior trading history.  I do not have a target price.

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