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
South Gent's Instablog | Seeking Alpha
South Gent's Articles | Seeking Alpha
South Gent's Comments | Seeking Alpha
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Recent Developments:
The March jobs report marked a sharp slowdown from prior months. The BLS reported that nonfarm payrolls increased by 126,000 in March. The consensus estimate was for 248,000. The January and February numbers were revised to show 69,000 fewer jobs. The average work week declined by .1 to 34.5 hours. Average hourly earnings rose by 7 cents to $24.6 which lifted the Y-O-Y gain to 2.1%. The unemployment rate remained steady at 5.5%. The labor participation rate declined by .1% to 62.7%. Employment Situation Summary The U-6 declined by .1% to 10.9%. Table A-15. Alternative measures of labor underutilization
Stock futures declined in response to this news while treasuries rose in price and declined in yield. The stock market was closed on Friday but the bond market was open. The ten year treasury declined to a 1.85% yield (4/3) from 1.92%, while the 30 year yield decreased to 2.49% from 2.53%. Daily Treasury Yield Curve Rates The USD declined in value.
The market is drawing too many negative conclusions from one month's employment report IMO. There is a slowdown in hiring and job losses in some industry sectors. That is to be expected due to the collapse in energy prices, the strong USD negatively impacting exports, the west coast dock strike and the severe late winter weather. Many of those negative events are already over while others may be ending relatively soon. I would anticipate a similar recovery in the economy this year as in 2014 after a dismal first quarter (-2.1%) due largely to a severe winter. United States GDP Growth Rates:1947-2015 Quarterly growth rates are historically very lumpy.
Continued weakness in the labor market over the next two months will likely cause the FED to postpone an increase in the FF rate to .25% until September.
McDonald's will increase pay at least $1 over the minimum wage for 90,000 employees working at company owned stores. Another raise to more than $10 per hour will occur before the end of 2016. The first wage hike does not take place until 7/1/15.
The Wal-Mart wage hike to $9 starts this month, so the 7 cent per hour increase in hourly earnings for March does not yet reflect the developing tsunami in wage increases for low skilled workers that gathered momentum with WMT's announcement last February.
Continuing unemployment claims fell to a 15 year low for the week ending 3/28/15. The initial claims for unemployment fell 20,000 to 268,000. dol.gov.pdf
4-Week Moving Average of Initial Claims-St. Louis Fed
Continued Claims (Insured Unemployment)-St. Louis Fed
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1. Bought 50 PJS at $25.2-Roth IRA (see Disclaimer):
Snapshot of Trade:
Security Description: The Merrill Lynch Depositor Inc. PreferredPLUS 7.55% Trust Certificate Series FAR-1 for First American Corp. (PJS:NYSE) is an Exchange Traded Bond in the Trust Certificate legal form of ownership.
A Trust Certificate ("TC") represents an undivided beneficial interest in bonds owned by a Grantor Trust. Those bonds are referred to as the underlying security.
The underlying bond owned by the PJS Grantor Trust is a CoreLogic Inc (CLGX) 7.55% senior unsecured bond that matures on 4/1/2028. The bond was originally a First American (FAF) obligation, and became a CoreLogic debt when FAF split into two companies, as more fully explained by me in Item # 3 Bought 50 of the TC PJS at $24.84 (8/19/2010 Post).
Corelogic Profile Page at Reuters
Corelogic Key Developments Page at Reuters
FINRA Data on Underlying CoreLogic 2028 Bond: Bond Detail (currently rated B1 by Moody's and B+ by S & P)
That bond is currently trading a small premium to its $1,000 par value.
The PJS coupon is also 7.55%, but the par value is $25. The TC also trades like a stock. Those two factors combine to make the trust certificate easier to trade than for most individual investors than buying the underlying $1,000 par value bond in the bond market.
Both the underlying Corelogic bonds owned by the trust and the TC PJS mature on 4/1/2028.
PJS went ex interest for its semi-annual interest payment a few days ago, as shown in Yahoo Finance's historical prices. PJS trades "flat" which simply means that the buyer does not have to pay accrued interest to the seller and the owner on the ex interest date receives the entire semi-annual interest payment. The price is adjusted for the interest payment on the ex date.
The TC may be called prior to the 2028 maturity date by the owner of the "call warrant", as more fully explained below.
The Grantor Trust is formed by a brokerage company who buys the bonds in the bond market.
The trust then buys the bonds from the brokerage company with the proceeds realized from the sell of TCs in a public offering.
The trust is administered by an independent trustee who is charged with collecting the bond interest payments and then distributing those funds to the owners of the TCs.
The trustee will file a distribution report with the SEC showing the principal amount of bonds owned by the trust and the semi-annual interest payment made to the owners of PJS. This is a snapshot of one of those:
SEC Filing
Most of the 2028 bonds that remain outstanding are owned by this Grantor Trust. The outstanding principal amount was $59.645M as of 12/31/14, see page 62 CLGX 10-K.
The longer term bonds contained in TCs will have Make Whole Provisions, a provision found in many long term bond prospectuses, that renders it far less likely that the issuer will redeem the bond.
Generally, a make whole provision requires the issuer to pay the sum of all remaining interest payments and the principal amount ($1,000 per bond) discounted to present value using the yield of a treasury security maturing at the same time, plus a minor spread to that yield. That is a punitive sum for the issuer, particularly when the interest payments and principal amount are being discounted to present value using an abnormally low treasury rate which creates a much larger sum than discounting at say 6%.
So, it is not likely that CoreLogic will redeem the bonds under the make whole provision contained in the prospectus.
However, when the Grantor Trust is formed, the agreement will generally grant the brokerage company, who created that trust, the right to call the TC at par value plus accrued interest. This right will frequently serve to cap the TC's price to $25 par value plus accrued interest, sometimes a little higher depending on individual investor demand, while the underlying bond with its make whole provision could be selling at a huge premium to par value.
PJS does have a call warrant attached to it that allows the brokerage company who owns it, probably Merrill Lynch who created the Grantor Trust, to redeem the trust certificates at their $25 par value, plus accrued interest. Once that sum is paid to the trustee, the call warrant owner would then acquire ownership of the bonds. The redemption proceeds would be paid to the trustee who then delivers those funds to the TC owners. A large number of TCs have been redeemed by the owner of their respective call warrants, not by the issuers of the bonds. The bonds for the most part are still trading in the bond market.
The risk associated with an issuer default rests with the owners of PJS. The call warrant provision is the legal mechanism that allows the creator of the Grantor Trust to capture the bond's appreciation due to low interest rates and the bond's make whole provision. The call becomes more likely as the premium price for the underlying bond increases. What do you expect from the "full service" brokerage firms? It is what it always is. Servicing their own interests above any and all other considerations is to be expected and the sine qua non of their existence.
Only a few TCs were created without a call warrant attached to them. I own one of them, KTN, that was bought at less than $14 during the Near Depression and now sells at over $31, a price that would not be possible with a call warrant attached to the TC. Structured Products Corp. 8.205% Credit-Enhanced CorTS (KTN:NYSE)(underlying security is a junior, investment grade AON bond, Bonds Detail)
Information about trust certificates can also be found at QuantumOnline.com (free site, registration required). The TCs are described as third party trust preferred securities at that site. I think that description will confuse some investors. Unlike the typical trust preferred stock that represents an interest in a junior bond owned by a Delaware Trust, a TC can represent an interest in either a senior or junior bond.
PJS Prospectus
I made a snapshot of the "make whole" provision in the bond's prospectus (most of it):
Underlying Bond Prospectus
PJS SEC Filings
Corelogic SEC Filings
Prior Trades: I currently own in a taxable account the underlying bond in PJS. The par value for the bond is $1,000. I took a snapshot of this holding on 3/31/15, the day that I purchased the trust certificate PJS:
Item # 3 Bought 1 7.55% CoreLogic Senior Bond Maturing 4/1/2028 at 94.975 (4/29/11 Post) and Bought 1 CoreLogic 7.55% Senior Bond Maturing 4/1/2028 at 84.95 (2/22/12 Post)
I received the semi-annual interest payments on those two 2028 CLGX senior unsecured bonds on 4/1/15:
Those two $1,000 par value bonds produce $151 in interest per year or about 8.32% based on a $1,815.25 total cost.
I have traded the trust certificate PJS profitably in the past, with the most profitable trades made in 2009-2010:
Item # 5 Sold ALL PJS (4/21/2010); Sold 50 of 300 PJS (1/16/2010 Post)
The most advantageous purchase was made during the Near Depression period at $7.2 (10/10/2008). In 2009, I bought some shares at $17.95 and at $17.8-Roth IRA.
I did some minor flips in 2011, netting a total profit of just $30,63, before deciding to buy the underlying bond that presented a better value than PJS when the later was selling at or above par value and the underlying bond could be purchased at a discount to par value.
Prior PJS Trading Gains: $2,210.03 plus interest payments
Recent Earnings Report: For the 2014 4th quarter, Corelogic reported net income from continuing operations of $16.5M or $.18 per share. Revenues increased by 5%, compared to the 2013 4th quarter, to $345.5M. The company repaid $81.2M in debt during the quarter. The company ended that quarter with cash and cash equivalents of $104.7M. Long term debt (net of current portion) increased to $1.319+B from $811.776M as of 12/31/13.
The increase in debt highlights a risk for a senior unsecured bond owner. The increased debt was sourced from a secured credit facility. That debt was incurred in order to finance the acquisitions of Marshall & Swift/Boeckh and DataQuick Information Systems for a combined $652.5M in cash, see note 16 at page 80 CLGX-12.31.2014-10-K. It remains to be seen whether those acquisitions will be worth the price.
I view a substantial increase in senior secured debt to be a potential problem for the unsecured bond owner:
Sourced Page 62, 10-K
The current E.P.S. consensus estimates are $1.58 this year and $1.94 next year. CLGX Analyst Estimates
Rationale: There is only one reason to buy this security in the Roth IRA. I will generate tax free income of about 7.5%. I have a reasonable chance, based on a rational prediction about interest rates over the next year or so, to exit this position, if I choose to do so, at a minimal profit after collecting one or more semi-annual interest payments.
This security has frequently traded over $26 over the past two years: PJS Stock Chart
Risks: Corelogic discusses risk factors incident to its operations starting at page 13 of its last SEC filed Annual Report, CLGX-12.31.2014-10K
Risks relating to PJS are discussed in the Prospectus starting at page S-12. One risk is that this security does not trade actively and liquidity for large lots is usually absent.
The substantial increase in secured debt used to finance acquisitions is a potential major risk for the owner of a senior unsecured bond.
On the day of my trade, the bid/ask spread was narrow for this security at $25.15/$25.2. Rather than fooling with an odd lot limit order at the bid price, which could have been filled with less than 50 shares and a 1 share fill for thinly traded securities has happened to me, I simply entered a limit order to buy at the ask price.
There is a risk that the call warrant owner will redeem this security as par value plus accrued interest. If that happens tomorrow, I will not break-even since the accrued interest will not cover my $.20 premium to par value plus the $7 purchase commission. I do not care about that insignificant sum, but I will generally limit my purchases to no more than $.2 over par value for an exchange traded bond or preferred stock that could immediately be called and it was at least rational to redeem it.
2. Bought 30 FNCL at $28.89 Regular IRA (see Disclaimer): As with any purchase made in a regular IRA now, I will transfer the position to a ROTH IRA when and if the security goes down 10%+.
Snapshot of Trade:
Security Description: The Fidelity MSCI Financials Index ETF (FNCL) is a low cost financial sector ETF that can be bought by Fidelity customers commission free. When a brokerage commission is eliminated, the investor can buy in small increments without worrying about the impact of a commission on the average cost per share. I bought this position in a 50 and 10 share lot.
This ETF will own banks, credit card and insurance companies, REITs and Berkshire Hathaway.
Expense Ratio: .12%
The dividend yield is currently low. The sponsor reported that the distribution yield was just 1.77% as of 2/28/14. A number of large financial institutions cut their dividends to 1 cent per share during the financial crisis and are still well below pre-2008 dividend levels. Some of them, like Citigroup and Bank of America, are unlikely to return to their pre-2008 dividend levels in my lifetime.
Citigroup Dividend History
Bank of America 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-Dividends; Dividend History | JPMorgan Chase & Co.
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.
Given the low expense ratio, most of the dividend increases will pass through to the ETF owners.
Top Ten Holdings as of 4/2/15:
Sponsor's website: FNCL | ETF Snapshot - Fidelity
Prior Trade: I flipped a small position earlier in a taxable account: Item # 2 Sold 60 FNCL at $28.75 (1/6/15 Post)(profit snapshot $135.71)
Rationale/Risks:
The following is excerpted from the prior blog post discussing the VFH purchase.
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, but the recent trend since early March has been back down. 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
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.
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
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.
Recent Developments:
The March jobs report marked a sharp slowdown from prior months. The BLS reported that nonfarm payrolls increased by 126,000 in March. The consensus estimate was for 248,000. The January and February numbers were revised to show 69,000 fewer jobs. The average work week declined by .1 to 34.5 hours. Average hourly earnings rose by 7 cents to $24.6 which lifted the Y-O-Y gain to 2.1%. The unemployment rate remained steady at 5.5%. The labor participation rate declined by .1% to 62.7%. Employment Situation Summary The U-6 declined by .1% to 10.9%. Table A-15. Alternative measures of labor underutilization
Stock futures declined in response to this news while treasuries rose in price and declined in yield. The stock market was closed on Friday but the bond market was open. The ten year treasury declined to a 1.85% yield (4/3) from 1.92%, while the 30 year yield decreased to 2.49% from 2.53%. Daily Treasury Yield Curve Rates The USD declined in value.
The market is drawing too many negative conclusions from one month's employment report IMO. There is a slowdown in hiring and job losses in some industry sectors. That is to be expected due to the collapse in energy prices, the strong USD negatively impacting exports, the west coast dock strike and the severe late winter weather. Many of those negative events are already over while others may be ending relatively soon. I would anticipate a similar recovery in the economy this year as in 2014 after a dismal first quarter (-2.1%) due largely to a severe winter. United States GDP Growth Rates:1947-2015 Quarterly growth rates are historically very lumpy.
Continued weakness in the labor market over the next two months will likely cause the FED to postpone an increase in the FF rate to .25% until September.
McDonald's will increase pay at least $1 over the minimum wage for 90,000 employees working at company owned stores. Another raise to more than $10 per hour will occur before the end of 2016. The first wage hike does not take place until 7/1/15.
The Wal-Mart wage hike to $9 starts this month, so the 7 cent per hour increase in hourly earnings for March does not yet reflect the developing tsunami in wage increases for low skilled workers that gathered momentum with WMT's announcement last February.
Continuing unemployment claims fell to a 15 year low for the week ending 3/28/15. The initial claims for unemployment fell 20,000 to 268,000. dol.gov.pdf
4-Week Moving Average of Initial Claims-St. Louis Fed
Continued Claims (Insured Unemployment)-St. Louis Fed
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1. Bought 50 PJS at $25.2-Roth IRA (see Disclaimer):
Snapshot of Trade:
 |
| 2015 Roth IRA Bought 50 PJS at $25.2 |
Security Description: The Merrill Lynch Depositor Inc. PreferredPLUS 7.55% Trust Certificate Series FAR-1 for First American Corp. (PJS:NYSE) is an Exchange Traded Bond in the Trust Certificate legal form of ownership.
A Trust Certificate ("TC") represents an undivided beneficial interest in bonds owned by a Grantor Trust. Those bonds are referred to as the underlying security.
The underlying bond owned by the PJS Grantor Trust is a CoreLogic Inc (CLGX) 7.55% senior unsecured bond that matures on 4/1/2028. The bond was originally a First American (FAF) obligation, and became a CoreLogic debt when FAF split into two companies, as more fully explained by me in Item # 3 Bought 50 of the TC PJS at $24.84 (8/19/2010 Post).
Corelogic Profile Page at Reuters
Corelogic Key Developments Page at Reuters
FINRA Data on Underlying CoreLogic 2028 Bond: Bond Detail (currently rated B1 by Moody's and B+ by S & P)
That bond is currently trading a small premium to its $1,000 par value.
The PJS coupon is also 7.55%, but the par value is $25. The TC also trades like a stock. Those two factors combine to make the trust certificate easier to trade than for most individual investors than buying the underlying $1,000 par value bond in the bond market.
Both the underlying Corelogic bonds owned by the trust and the TC PJS mature on 4/1/2028.
PJS went ex interest for its semi-annual interest payment a few days ago, as shown in Yahoo Finance's historical prices. PJS trades "flat" which simply means that the buyer does not have to pay accrued interest to the seller and the owner on the ex interest date receives the entire semi-annual interest payment. The price is adjusted for the interest payment on the ex date.
The TC may be called prior to the 2028 maturity date by the owner of the "call warrant", as more fully explained below.
The trust then buys the bonds from the brokerage company with the proceeds realized from the sell of TCs in a public offering.
The trust is administered by an independent trustee who is charged with collecting the bond interest payments and then distributing those funds to the owners of the TCs.
The trustee will file a distribution report with the SEC showing the principal amount of bonds owned by the trust and the semi-annual interest payment made to the owners of PJS. This is a snapshot of one of those:
SEC Filing
Most of the 2028 bonds that remain outstanding are owned by this Grantor Trust. The outstanding principal amount was $59.645M as of 12/31/14, see page 62 CLGX 10-K.
The longer term bonds contained in TCs will have Make Whole Provisions, a provision found in many long term bond prospectuses, that renders it far less likely that the issuer will redeem the bond.
Generally, a make whole provision requires the issuer to pay the sum of all remaining interest payments and the principal amount ($1,000 per bond) discounted to present value using the yield of a treasury security maturing at the same time, plus a minor spread to that yield. That is a punitive sum for the issuer, particularly when the interest payments and principal amount are being discounted to present value using an abnormally low treasury rate which creates a much larger sum than discounting at say 6%.
So, it is not likely that CoreLogic will redeem the bonds under the make whole provision contained in the prospectus.
However, when the Grantor Trust is formed, the agreement will generally grant the brokerage company, who created that trust, the right to call the TC at par value plus accrued interest. This right will frequently serve to cap the TC's price to $25 par value plus accrued interest, sometimes a little higher depending on individual investor demand, while the underlying bond with its make whole provision could be selling at a huge premium to par value.
PJS does have a call warrant attached to it that allows the brokerage company who owns it, probably Merrill Lynch who created the Grantor Trust, to redeem the trust certificates at their $25 par value, plus accrued interest. Once that sum is paid to the trustee, the call warrant owner would then acquire ownership of the bonds. The redemption proceeds would be paid to the trustee who then delivers those funds to the TC owners. A large number of TCs have been redeemed by the owner of their respective call warrants, not by the issuers of the bonds. The bonds for the most part are still trading in the bond market.
The risk associated with an issuer default rests with the owners of PJS. The call warrant provision is the legal mechanism that allows the creator of the Grantor Trust to capture the bond's appreciation due to low interest rates and the bond's make whole provision. The call becomes more likely as the premium price for the underlying bond increases. What do you expect from the "full service" brokerage firms? It is what it always is. Servicing their own interests above any and all other considerations is to be expected and the sine qua non of their existence.
Only a few TCs were created without a call warrant attached to them. I own one of them, KTN, that was bought at less than $14 during the Near Depression and now sells at over $31, a price that would not be possible with a call warrant attached to the TC. Structured Products Corp. 8.205% Credit-Enhanced CorTS (KTN:NYSE)(underlying security is a junior, investment grade AON bond, Bonds Detail)
Information about trust certificates can also be found at QuantumOnline.com (free site, registration required). The TCs are described as third party trust preferred securities at that site. I think that description will confuse some investors. Unlike the typical trust preferred stock that represents an interest in a junior bond owned by a Delaware Trust, a TC can represent an interest in either a senior or junior bond.
PJS Prospectus
I made a snapshot of the "make whole" provision in the bond's prospectus (most of it):
PJS SEC Filings
Corelogic SEC Filings
Prior Trades: I currently own in a taxable account the underlying bond in PJS. The par value for the bond is $1,000. I took a snapshot of this holding on 3/31/15, the day that I purchased the trust certificate PJS:
Item # 3 Bought 1 7.55% CoreLogic Senior Bond Maturing 4/1/2028 at 94.975 (4/29/11 Post) and Bought 1 CoreLogic 7.55% Senior Bond Maturing 4/1/2028 at 84.95 (2/22/12 Post)
I received the semi-annual interest payments on those two 2028 CLGX senior unsecured bonds on 4/1/15:
Those two $1,000 par value bonds produce $151 in interest per year or about 8.32% based on a $1,815.25 total cost.
I have traded the trust certificate PJS profitably in the past, with the most profitable trades made in 2009-2010:
 |
| 2010 Taxable PJS 250 Shares +$1,100.18 |
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| 2010 Roth IRA 100 Shares PJS +1,079.22 |
The most advantageous purchase was made during the Near Depression period at $7.2 (10/10/2008). In 2009, I bought some shares at $17.95 and at $17.8-Roth IRA.
I did some minor flips in 2011, netting a total profit of just $30,63, before deciding to buy the underlying bond that presented a better value than PJS when the later was selling at or above par value and the underlying bond could be purchased at a discount to par value.
Prior PJS Trading Gains: $2,210.03 plus interest payments
Recent Earnings Report: For the 2014 4th quarter, Corelogic reported net income from continuing operations of $16.5M or $.18 per share. Revenues increased by 5%, compared to the 2013 4th quarter, to $345.5M. The company repaid $81.2M in debt during the quarter. The company ended that quarter with cash and cash equivalents of $104.7M. Long term debt (net of current portion) increased to $1.319+B from $811.776M as of 12/31/13.
The increase in debt highlights a risk for a senior unsecured bond owner. The increased debt was sourced from a secured credit facility. That debt was incurred in order to finance the acquisitions of Marshall & Swift/Boeckh and DataQuick Information Systems for a combined $652.5M in cash, see note 16 at page 80 CLGX-12.31.2014-10-K. It remains to be seen whether those acquisitions will be worth the price.
I view a substantial increase in senior secured debt to be a potential problem for the unsecured bond owner:
Sourced Page 62, 10-K
The current E.P.S. consensus estimates are $1.58 this year and $1.94 next year. CLGX Analyst Estimates
Rationale: There is only one reason to buy this security in the Roth IRA. I will generate tax free income of about 7.5%. I have a reasonable chance, based on a rational prediction about interest rates over the next year or so, to exit this position, if I choose to do so, at a minimal profit after collecting one or more semi-annual interest payments.
This security has frequently traded over $26 over the past two years: PJS Stock Chart
Risks: Corelogic discusses risk factors incident to its operations starting at page 13 of its last SEC filed Annual Report, CLGX-12.31.2014-10K
Risks relating to PJS are discussed in the Prospectus starting at page S-12. One risk is that this security does not trade actively and liquidity for large lots is usually absent.
The substantial increase in secured debt used to finance acquisitions is a potential major risk for the owner of a senior unsecured bond.
On the day of my trade, the bid/ask spread was narrow for this security at $25.15/$25.2. Rather than fooling with an odd lot limit order at the bid price, which could have been filled with less than 50 shares and a 1 share fill for thinly traded securities has happened to me, I simply entered a limit order to buy at the ask price.
There is a risk that the call warrant owner will redeem this security as par value plus accrued interest. If that happens tomorrow, I will not break-even since the accrued interest will not cover my $.20 premium to par value plus the $7 purchase commission. I do not care about that insignificant sum, but I will generally limit my purchases to no more than $.2 over par value for an exchange traded bond or preferred stock that could immediately be called and it was at least rational to redeem it.
2. Bought 30 FNCL at $28.89 Regular IRA (see Disclaimer): As with any purchase made in a regular IRA now, I will transfer the position to a ROTH IRA when and if the security goes down 10%+.
Snapshot of Trade:
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| 2015 Roth IRA Bought 30 FNCL at $28.89 |
Security Description: The Fidelity MSCI Financials Index ETF (FNCL) is a low cost financial sector ETF that can be bought by Fidelity customers commission free. When a brokerage commission is eliminated, the investor can buy in small increments without worrying about the impact of a commission on the average cost per share. I bought this position in a 50 and 10 share lot.
This ETF will own banks, credit card and insurance companies, REITs and Berkshire Hathaway.
Expense Ratio: .12%
The dividend yield is currently low. The sponsor reported that the distribution yield was just 1.77% as of 2/28/14. A number of large financial institutions cut their dividends to 1 cent per share during the financial crisis and are still well below pre-2008 dividend levels. Some of them, like Citigroup and Bank of America, are unlikely to return to their pre-2008 dividend levels in my lifetime.
Citigroup Dividend History
Bank of America 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-Dividends; Dividend History | JPMorgan Chase & Co.
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.
Given the low expense ratio, most of the dividend increases will pass through to the ETF owners.
I recently discussed added a similar ETF that could be bought commission free in my Vanguard brokerage account: Increased Exposure To Financial Sector: Bought The Vanguard Financials ETF (VFH) - South Gent | Seeking Alpha
Top Ten Holdings as of 4/2/15:
Sponsor's website: FNCL | ETF Snapshot - Fidelity
Prior Trade: I flipped a small position earlier in a taxable account: Item # 2 Sold 60 FNCL at $28.75 (1/6/15 Post)(profit snapshot $135.71)
Rationale/Risks:
The following is excerpted from the prior blog post discussing the VFH purchase.
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, but the recent trend since early March has been back down. 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
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.
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
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.
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