Tuesday, April 7, 2015

Paired Trade: Sold 300 out of 600 ACG at $7.715 and Bought 2 Gastar Exploration 2018 Senior Secured 8.625% Bonds at 93.7

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:

The BLS reported that there were 5.1M job openings on the last day of February, seasonally adjusted, the highest level since January 2011. Job Openings and Labor Turnover Summary

Job Openings: Total Nonfarm- St. Louis Fed

The ISM NMI for services was reported at 56.5% in March,  down slightly from 56.9 in February. The new orders index rose to 57.8 from 56.7. The employment index remained strong at 56.6, up from 56.4.


1. Sold 300 of the 600 ACG at $7.715 (see Disclaimer): I sold the shares bought in a taxable account and kept the 300 shares bought in a Roth IRA. Generating Tax Free Income In The Roth IRA: Bought Back AllianceBernstein Income Fund-AllianceBernstein Income Fund (NYSE:ACG)-Seeking Alpha

Snapshot of Trade:

Snapshot of Profit:

2015 ACG Taxable Account 300 Shares +$41.28

Bought 300 ACG at $7.53 (10/17/14 Post)

Dividends: $52.62

Total Return: $93.9 or 4.15% (holding period 6+ Months)

ACG Trading Profits= $459.2 

Prior trades are detailed in the SA article linked above.

Security Description: The AllianceBernstein Income Fund (ACG) is a leveraged closed end bond fund that is weighted in investment grade rated bonds, and has close to a 60% portfolio weighting in U.S. treasuries as noted below. This fund also has a significant weighting in junk rated bonds.

Sponsor's Website: AllianceBernstein Income Fund, Inc.

The sponsor claims that the effective duration was 5.09 years as of 2/28/15.

The general rule of thumb is that the securities owned by a bond fund with a 5.09 year duration will decline about 5.09% for each 1% rise in interest rates.

Bond Fund Duration: Vanguard Publication

Interest Rate Risk and Bonds: FINRA Publication

A 2% rise in interest rates would offset approximately 2 years of dividend payments. Interest rate and leverage risks are material.

Data on Date of Trade 4/6/15: 
Closing Net Asset Value Per Share: $8.51
Closing Market Price: $ 7.73
Discount: - 9.17%
Average Discounts:
1 Year:  - 10.78%
3 Year:  - 10.54%
5 Year:  - 10.06 %

Sourced: CEFConnect Page for ACG

The discount was -10.26% on the date of purchase (10/10/14).

Last SEC Filed N-Q: AllianceBernstein Income Fund, Inc. (holdings as of 12/31/14; unrealized appreciation=$109.1+M, see page 48)

The largest weighting will be in U.S. Treasury securities. As of 12/31/14, there was a 61.78% weighting in AAA rated bonds.

ACG has a 1 star rating from Morningstar.

While the fund in weighted in "AAA" due to the treasury holdings, there is a significant exposure to junk rated securities that provide more yield but also exposes the fund to credit risks.

The fund also assumes some foreign currency risks with foreign bonds priced in local currencies.

Leverage is high at 36.67% as of 12/31/14. The fund does not specifically state whether or not its duration number is adjusted for leverage which increases duration.

When looking at those historical average discount numbers, the only conclusion to draw is that this fund sells at a persistent discount close to 10%. This pricing may of course change. A continued consistent trend removes the potential of a market price gain due to a significant narrowing of the discount after purchase.

A common trading technique is to buy a closed end fund when it is selling at a substantially larger discount than the historical averages for the past 1, 3 and 5 years and then to consider selling or paring the position when the discount narrows to the historical range. Hopefully, the net asset value per share has also materially increased adjusted for the dividend payments. In that kind of optimal scenario, the investor makes money in three ways: (1) the narrowing of the discount to net asset value after purchase; (2) dividend payments; and (3) an increase in net asset value per share which hopefully will be reflected entirely in the market price.

ACG Filings with the SEC

The fund is currently paying a monthly dividend of $.03455 per share. AllianceBernstein Income Fund, Inc. Monthly And Special Distributions There was a slight addition to the December distribution that brought the total up to $.03679 per share.


Assuming a continuation of that rate, which is in no way assured, the dividend yield would be about 5.37% at a $7.72 total cost per share.

ACG cut its monthly dividend rate to .0346 from $.04 effective for the August 2013 distribution.

There was apparently a significant capital gain distribution of $.5687 per share in December 2012.

Provided a fund desires to avoid supporting a dividend with a return of capital, it is to be expected that a bond fund will cut its dividend during a prolonged period of declining interest rates. As vintage bonds mature or redeemed by the issuer before maturity, the reinvestment opportunities will generally have lower coupons, possibly even with the assumption of more credit risk, and new bond purchases will consequently produce lower amounts of income.

Rationale: ACG pays non-qualified dividends, which militates against holding shares in a taxable account except as a short term trade. The fund has significant leverage and interest rate risks, and the yield is viewed by me as inadequate compensation for those risks. Whenever I buy this low yielding leveraged CEF, I view it as a victory to collect a few dividend payments and then to escape with a profit. Sooner or later, when there is a non-temporary rise in short to long term interest rates, I may get caught holding shares of leveraged bond CEFs delivering to their unfortunate owners the infamous triple whammy: (1) increased borrowing costs; (2) owned securities losing value including those bought with borrowed money; and (3) an expansion of the discount due to herd movement out of those CEFs.

Future Buys and Sells: I am in a trading mode for this leveraged, low yielding bond CEF, as shown by my numerous trades summarized and linked at  Generating Tax Free Income In The Roth IRA: Bought Back AllianceBernstein Income Fund - AllianceBernstein Income Fund (NYSE:ACG) | Seeking Alpha.

2. Bought 2 Gastar Exploration 8.625% Senior Secured Bonds Maturing on 5/15/2018 at 93.7 (high risk Junk Bond Strategy)(see Disclaimer):

I am basically substituting two $1,000 par value bonds for the 300 ACG.

Cost 2 Gastar Bonds (excluding Accrued interest)= $1,878 with a $4 commission
Proceeds 300 ACG= $2,306.5
Balance to Cash: $428.5

These two trades were made in different taxable accounts. The 2 Gastar bonds were bought in a Vanguard taxable account where my commission was $4, as shown in the following snapshot that contains the order details:

Order Details: The Vanguard order detail page contains relevant details about this bond and appears prior to entering the order:

All of my accounts are cash. I do not buy anything with borrowed money.

Even though this is a secured bond, it is nonetheless rated deep into junk at Caa2 (Moody's) and B- by S & P.    

This snapshot also shows that I had to pay $69.48 in accrued interest to the seller. That was for 145 days.

Interest is paid semi-annually with the next payment due on 5/15/15.

Assuming Gastar survives to make that interest payment, I will receive the $69.48 in accrued interest back, plus a few more dollars in interest. There will need to be an accounting adjustment for interest reported and actually received on my 2015 tax return. Accrued Interest; Accrued Interest and Bond Premiums

The preceding snapshot shows my yield to maturity ("YTM") at 10.995%. The YTM assumes that the bond owner will receive all interest payments and the principal amount ($2,000) at maturity. Assuming Gastar survives to pay the principal amount of $2,000, then I will receive a profit of $122 that is included in the YTM yield calculation.

My current yield is lower than the YTM at 9.185% ($8.625 annual interest ÷ $93.9 total cost=9.185%)

Snapshot of Order Confirmation: 

Snapshot of Order Confirmation 
Security Description: I bought a senior secured bond issued by Gastar Exploration Inc. (GST ), that pays 8.625% on a $1,000 par value. The bond matures on 5/15/18.

Gastar describes itself as an independent company engaged in the exploration, development and production of oil and natural gas with an emphasis on "unconventional reserves, such as shale resource plays." The company sold substantially all of west Texas properties in 2013. The company is developing "liquids rich natural gas in the Marcellus Shale" region of West Virginia. Gastar is also focused on "primarily oil bearing reservoirs of the Hunton Limestone horizontal play in Oklahoma and plans to test "other prospective formations on the same acreage . . . "  Page 8, GST-12.31.2014-10K

The trading history and other information about this bond can be found at Finra's website. This bond traded over 107 in July and slid to $82.75 (1/22/15) due to the crash in energy prices. Over the past two months, the bond has traded in a 91 to 98 range.

The total principal amount outstanding is $325M. This bond is described by the company starting at page 89,   GST-12.31.2014-10K

Collateral Described at page 27-28 Bond Prospectus:

The 2018 senior secured bond is in effect a second lien bond. The first lien consists of loans made under a credit facility. As of 12/31/14, the credit facility had a borrowing base of $145M, of which $45M had been drawn by Gastar. Effective 3/9/15, the borrowing base was increased to $200M and was scheduled for redetermination next November.

I view this bond as extremely risky under the current circumstances and consequently would not buy more than two bonds at a discount to par value.

Gastar also has outstanding two equity preferred stocks that will be junior to all bonds in the capital structure:

Gastar Exploration Inc. 8.625% Cumulative Preferred Series A

Gastar Exploration Ltd. 10.75% Cumulative Preferred Series B

I view it as material to at least look at the following items, sourced from the recently filed 10-K.

Production and Costs: 

Proved Reserves:

Proved Undeveloped Reserves: 

Gastar SEC Filings

Those statistics provide some comfort to me that a second lien bond is likely to have some value even in a worst case scenario.

Prior Trades: None for this bond.

Related Trades: I have traded the common shares as a Lottery Ticket and currently own 50 shares: Stocks, Bonds & Politics: Update for Lottery Ticket Basket Strategy as of 2/20/15/Bought Back as Lottos: 50 GST at $2.53 and 50 TTI at $4.94; Sold 100 GST at $4.1 (11/25/13)(snapshot of profit $126.09)-Bought 100 GST at $2.68 (7/29/13 Post)

The common shares rose 6.43% today (4/7/15) to close at $2.98. GST Interactive Stock

GST fortunately for it, and unfortunately for the purchasers, sold 17M shares at $6.24 in mid-September 2014.

I also currently own 50 shares of a GST issued equity preferred stock:

GSTPRB as of 4/7/15:

My cost basis has been adjusted by a return of capital.

Recent Earnings Report: For the 2014 4th quarter, Gastar reported net income of $26.7M or $.34 per share which included a $24.9M mark-to-market of outstanding hedge positions. Adjusted net income was reported at 2 cents per share. EBITDA for the 4th quarter was stated at $25.9M, a 22% increase compared to the 2013 4th quarter with revenues before hedging activity increasing 13% to $33.1M. Revenues from liquids represented about 77% of total production revenues for the quarter. The company noted that it has reduced its 2015 capital budget but still expected to increase production by about 22% compared to 2014. The company had approximately $11M in cash as of 12/31/14 plus the borrowing capacity remaining under its credit facility.

Sourced: GST 4Q14 Financial Results

Q4 2014 Results - Earnings Call Transcript | Seeking Alpha

Hedges in effect as of 12/31/14 are described at pages 61-62, GST-12.31.2014-10-K

After this report, Global Hunter upped GST to buy while Canaccord maintained as a buy after reducing its target to $4 from $5. Seeking Alpha

Rationale: The only reason for buying this bond is to generate income and hopefully a small profit.

If I hold to maturity, which is doubtful, and Gastar survives to pay par value at maturity which is at least open to debate now, then the YTM of 11% per year for over three years is excellent IMO, particularly given the elevated stock valuations and low investment grade bond yields for similar maturities. I would not be surprised at all to see a 11% annualized return beat the S & P 500 between now and 5/15/18. And, my return is locked with the important caveat that Gastar must survive to make all interest payments and the principal amount at maturity.

Money doubles in 6.64 years at 11% before taxes and inflation.

Risks: The company discusses risks factors incident to its operations starting at page 28 of its recently filed SEC Annual Report. Other risks are discussed in depth between pages 19 through 27.

The company describes risks relating to the notes starting at page 8 of the prospectus.

Personally, I am not concerned about interest rate risk for a note maturing in slightly more than 3 years. There is a refinancing risk for Gastar that may relate, at least in part, to interest rates prevailing in 2018.

My main concern is credit risk which is significant without question IMO. I am dealing with this risk primarily by limiting my exposure to just 2 bonds and secondarily by trading the bonds profitably when and if I have the opportunity to do so.

Future Buys/Sells: I have noted in my blog and at SeekingAlpha a propensity to trade these junk E & P bonds.

I have, for example, already bought and sold the Linn Energy 2020 bond twice since December.

Bought 2 LINN Energy LLC 8.625% Senior Unsecured Bonds at $81 (4/15/2020 Maturity)-Sold 2 Linn Energy 2020 Senior Bonds at 90

Bought Back The Linn Energy 8.625% Senior Unsecured Bond Maturing In 2020 at 80.63- Linn Energy, LLC (NASDAQ:LINE) | Seeking AlphaSold 2 LINN 2020 Bonds at $88.5-Bought at $81

I have also recently bought and sold senior unsecured bonds issued by Sandridge, Oasis Petroleum and Northern Oil.

I still own 2 Vanguard Resources senior unsecured bonds and 1 Petroquest senior unsecured.

Bought 2 Vanguard Natural Resources 7.875% Senior Unsecured Bonds Maturing 4/1/20 At 86.59 - South Gent | Seeking Alpha

The Petroquest bond has a 10% coupon and matures on 9/1/17.

This somewhat hyper trading since December indicates that I am really not comfortable investing in the junk E & P bond space, but can justify small purchases for the yields/income generation in a world without meaningful risk free yield.

I will not hesitate to sell the Gastar bonds for a profit or to stop a loss from gathering further steam to the downside.