Sold PICO at 31.51 and Added 50 MWR at 22/CSCO/Interest on U.S. Government Debt/ BOUGHT 50 STIPRA at 19.85

The treasury is currently financing the exponentially growing federal debt at abnormally low rates by historical standards. Yet, in fiscal year 2010, the U.S. incurred $413,954,825,362.17 in interest expense servicing the national debt, up from 383 billion in F/Y 2009: Government - Interest Expense on the Debt Outstanding 

Two events are inevitable. 

The interest rates to finance the debt will increase as well as the amount that needs to be financed, with the later number growing at a trillion plus dollar rate per year now.   

I was asked by a reader whether I was predicting a U.S. government default in my post yesterday.  Financial Armageddon-Avoided or Just Delayed Yes, I am.  I do not believe that it will occur prior to 2020, though I plan to adjust the possible time frame based on subsequent events. 

The default will be manifested in a series of failed treasury auctions, where the U.S. is not able to sell all of the paper necessary to retire existing debt and to fund the government. 

That default will trigger the first worldwide depression since the Great Depression. 

And I do not view that as an outlandish prediction. Too much debt almost triggered a worldwide depression in the fall of 2008.   

I am not managing my money now based on that prediction, except to a limited degree. The most important financial planning goal for such a scenario will be to own everything outright. Staying out of debt is something that I would do anyway. Some of my existing investments might work in such a dire scenario such as gold and silver bullion tucked away in a safe deposit box at a bank, sovereign debt issued by Canada, Australia and Switzerland, and senior bonds from financially stable U.S. corporations. I will need to be much closer to the event to have a better feel for those asset classes likely to outperform when and if this scenario unfolds, which I view as inevitable.       

I did mail yesterday the necessary forms to move my Roth IRA from Fidelity to another firm. This is a direct response to the prohibitions being implemented by Fidelity on the purchase of a variety of exchange traded bonds that have been a staple of my IRA investments for two years now.  

I do not like being told that I can not buy what I deem to be appropriate for those accounts. Fidelity Brokerage Extends Denial of Trading Opportunities to Synthetic Floaters and Even an Exchange Traded Junior Bond DFP

I also mentioned yesterday that I do not regard a trust preferred security as part of a bank's equity capital. Really, who would? It is a bond after all. Why would anyone classify a bond as part of equity capital? That is just one indication that the world is just not straight in the head.

The following table contains my regional bank basket, as of yesterday's close. Michael Kahn, the Barrons' technical analyst, believes this sector is poised for a pullback after its recent outperformance, compared to the S & P 500, but he believes the uptrend will remain.

Regional Bank Basket as of 12/27/2010

I am keeping track of the realized gains in 2010 from this strategy in Item # 3 2010 Realized Gains Regional Bank Stock.  I am not keeping track of the dividends being generated, nor do I include in this table the shares purchased with reinvested dividends. I suspect that the dividend generation is somewhere in the $1,600 to $2,000 per year range.

1. Sold 30 PICO at 31.51 and Added 50 MWR at $22 (see Disclaimer): With the OG in charge, the emphasis is on the purchase of income producing securities. The  reasons for selling 30 shares of PICO was to realize a $100 or so profit and to redeploy the proceeds into an income producing security. PICO does not pay a dividend. RB Buys 30 PICO at 27.89  Besides, PICO was a RB buy anyway. 

I noticed that MWR was falling some yesterday morning so I added 50 shares at $22 in a taxable account. MWR was discussed in yesterday's blog after I purchased 50 shares at $22.25 in a the regular IRA. I have nothing to add to that discussion. Bought 50 MWR in regular IRA at 22.25  

I am hoping that MS will redeem this TP at some point before 2016, when it can no longer be included in Tier 1 equity capital. 

The purchase is not based on that premise however. I bought it for diversification purposes, as well as the yield, which is over 7%, and the quarterly interest payment schedule.  

2. Bought 50 STIPRA at 19.85 on Monday (see Disclaimer): STIPRA is a non-cumulative equity preferred stock issued by SunTrust Banks (STI) that pays the greater of a 4% guarantee or .53% above 3 month LIBOR. Par value is $25. Final Prospectus Supplement 

Buying this security at a discount to par value will increase the value of the guarantee and the LIBOR float when it becomes a greater rate than the guarantee. This is a thinly traded security. 

When I placed a limit order to buy 50 at $19.85, the bid was $19.8 and the ask was at my limit price of $19.85. No shares had been traded up to that time which was mid-day. 

I have bought and sold STIPRA. Sold: 50 STIPRA @ 21.24 (Dec. 2010); Bought 50 STIPRA @ 19.75 (Oct. 2010); Sold 50 STIPRA at $20.90 (March 2010); Bought 50 STIPRA at $17.2 (Sept. 2009)

The extension of the qualified dividend rate for all taxpayers makes this kind of security more attractive, since its distributions are taxed at the 15% qualified dividend rate.  

I also suspect that we are moving closer in time to a period of rising short term interest rates. Maybe that will not start until the second half of 2011. 

Eventually, the short term rates will start to rise to more normal levels. 

Based on history, a 4.5% average LIBOR rate over a long period of time would be a rational forecast. At times, it will likely be much higher, and then much lower as now.  During the low periods, the guarantee will provide a cushion.  

The LIBOR float would be activated after the 3 month rate increases above 3.47% during the relevant computation period. At a 6% Libor rate, the coupon becomes 6.53% which translates into a current yield of 8.25% at a total cost of $19.8.  

I give a more detailed discussion of this type of security in Advantages and Disadvantages of Equity Preferred Floating Rate Securities, a post that I view as important. 

Suntrust still has government preferred stock on its balance sheet. In fact, I believe that STI has the largest outstanding amount of government preferred shares among the banks at 4.5 billion.  

STIPRA stands at the same level of priority as that government preferred stock. For STI to eliminate the STIPRA dividend, it would first have to eliminate the common stock dividend, just a penny a quarter, and to defer the government's preferred stock dividend. 

While that is a possibility, particularly if the economy turns south, I doubt that the management of STI would do it unless it became absolutely necessary. The signal, that such actions send to the market and to its customers, could only be characterized as dire. 

STIPRA pays quarterly dividends and just went ex dividend in late November.

3. Cisco (owned):  Cisco fits into my large cap valuation strategy. Item # 1 Large Cap Valuations;  Item # 3 Large Cap Valuation Strategy-A New Long Term Strategy (May 2010); Item # 1 Explaining Low Valuations of Large Cap Tech Stocks The stock made no sense to me when it was selling at 130 times pro forma earnings, somewhere near a valuation where Cisco would have to grow so large that it would have to swallow the U.S. GDP within the confines of the company in order to justify the multiple. Maybe that is a  slight exaggeration but what does Cisco's price in 1999 say about the efficient market hypothesis?  Now, Cisco is trading near 12 times earnings and has 40 billion in cash, close to 1/3 rd of its market valuation. The foregoing points are made in the Barrons cover story this week, written by Michael Santoli. In response to that cover story, the stock popped yesterday, rising 47 cents or 2.47% to close at $20.16.

There is nothing new in Santoli's piece.  The article is filled with obvious observations.  

When I bought 50 shares of Cisco at 19.55 after the last earnings release, I mentioned the P/E and the cash per share. 

I knew the foregoing when I sold 50 shares @ 24.42 shortly before the last earnings report, having just bought those shares at 20.39. 

And I made the same point when I sold shares in August 2010, shortly before the prior earnings release. 

This trading activity shows a recognition of Cisco's low valuation and its cyclicality, which makes quarterly earnings projections unreliable, plus an awareness of Cisco's execution problems. 

I doubt that the recent story in Barron's will cause the stock to run much more, given the huge disappointment announced at the end of the last quarter. 

Instead, for Cisco to approach $25 again, which is likely to prompt another sale by me, there will need to be an earnings surprise and an upbeat future assessment. Then the stock will quickly recover back to $25. This may not occur until the middle of 2011. 

My last purchase at $19.55 was based on a belief that the stock was mostly washed out at that level, rather than a belief that it had much upside until it had a more positive story to tell.   

In short, I did not see much risk at $19.55 and I was willing to be patient to receive a 20% or so upside.

I will discuss the remaining trades from Monday in the next post. I am coasting to the end of 2010, satisfied with what I have accomplished already this year. Part of that coasting will be shorter blogs for the remainder of 2010. 

Financial Armageddon-Avoided or Just Delayed/Bought 50 WMT at 53.52/Bought 50 MWR in regular IRA at 22.25

I have started to think about what I can do to lessen the impact on my family, when Financial Armageddon returns with a vengeance. I believe that it will before 2025, most likely between 2018 to 2025. While governments in the developed world averted a financial collapse in the Fall of 2008, they will be powerless to stop the next one from occurring for a simple reason.

They will be the cause of it, with the U.S. government leading the way. The U.S. is proving that a majority of its citizens will not support the measures necessary to avert a financial catastrophe.

Politicians from both tribes lack the courage to deny anyone most of whatever they want, without paying for it of course. There is a total unwillingness to live within our means or anywhere close to it.

And that is true for both governments at all levels and the nation's citizens.  The U.S. and its citizens are addicted to spending borrowed money, with no regard to the inevitable consequences. And there is no indication yet that even hints at a willingness to deal with the looming crisis in an intelligent manner. It is not helpful that ideology trumps facts for members of one political tribe whose tendency toward reality creation is constant source of amusement. 

For the past two years, and for many years to come, the U.S. will be adding over a trillion dollars a year to its national debt. Municipal and state governments have also been unwilling to address their own fiscal problems, much preferring to postpone their day of reckoning with accounting gimmicks and legerdemains.   There seems to be a belief that the remainder of the world will finance U.S. irresponsibility and  profligacy indefinitely.

One day, in the not too distant future, there will be an unwillingness to buy U.S. debt, at least in the quantities necessary to feed the beast, and there will be insufficient funds to retire maturing debt and to pay the bills.

The rest of the world will sense correctly that the U.S. has no means to pay back any lender except by borrowing more money from those same lenders seeking to be repaid, in effect paying them back with their own money.

Before that day arrives, the interest rates necessary to attract capital will start to accelerate, eventually rising after five years or so into the double digits, which will simply hasten the inevitable, and then there will be no takers for our paper at any price.

This will be due mostly to the market's downgrade of U.S. sovereign debt which will occur before the rating agencies lower it one notch.  Inflation and a growing loss of confidence in the USD will accelerate that rise in rates.  

How will the deficit start to look when the financing costs of that debt averages 10% and the baby boomers are drawing their social security and relying on medicare?  

I view the outcome as inevitable. But economists believe that the U.S., which can print money and issue debt in its own currency, can not default. I suspect that common belief will be proven wrong,  possibly before 2025. 

The nation is like some crack cocaine addict driving a vehicle at 100+ miles per hour headed directly for a steel wall. The wall is seen and not seen. If I am generally right about the future course of events, and nothing is certain about the future, then what could be done to protect our family which is all that I can do?

My first answer is that hopefully I will see events unfold in a proper perspective and consequently be able to recognize the asset classes that may hold their value. I do not know now what those assets will be, but I suspect that  government debt at all levels in the U.S. would more likely be a source of the problems rather than a refuge for those seeking safety.  

My first approach will be to avoid debt for the remainder of my life. Most asset classes will fall in value or even lose all or most of their value in my dire long term forecast. I have started to invest in government bonds issued by sovereign states that I view as far more responsible than the U.S. government. It is possible that gold and silver may hold their values.

I view the bull market in precious metals to be a vote of no confidence in the long term value of the USD or the Euro, and assets valued in those currencies.   The Swiss Franc may be another option. I am just starting to think about it more, as in everyday now, after the two tribes came to an agreement to add another trillion dollars to the deficits over the next two years. Based on what I now see, it is impossible to envision a favorable outcome when so many are so delusional.

The foregoing long term forecast is intended by me to provide a framework for evaluating future events and to plan accordingly.    

1. Bought 50 shares of Wal-Mart on Thursday at $53.52 (see disclaimer):  Near the end of a long term bull market, valuations will become absurd even for companies likely to survive and to prosper for many decades to come. This is part of the euphoric phase of a long term secular bull market. By the late 1990s, blue chip companies like GE and Wal-Mart were selling at 30 to 50 times earnings. The long term secular bear market, which naturally follows, will compress those P/E ratios, even for the long term survivors, to the single digits. 

In 2000, WMT shares hit $69. The company earned $1.4 per share in 2000, giving it a P/E of over 49 based on the peak share price for that year.  Since 2000, WMT has been increasing earnings every single year. The company earned $3.70 per share in 2009 (using Morningstar's data) and is estimated to earn $4.05 in its F/Y 2010 ending in 1/2011. The consensus for F/Y 2012 is currently $4.45 per share. The forward P/E has been compressed to just 12 times earnings. I view that compression to be a normal evolution in a long term bear market.

The stock is viewed negatively now because it has gone nowhere for a purchaser in 1999.  

However, that is not an indictment against WMT but against the purchaser who paid over 40 times (or even over 20 or 30 times) earnings for this company.   WMT has done just fine as a company over the past decade even as the stock has stagnated. (See Item # 3. Multiple Compression for Many Large Cap Stocks/Long Term-Large Cap Valuation Strategy at  Large Cap Valuation Strategy-A New Long Term Strategy)

I discussed the multiple compression issue as it relates to WMT in a post from July 2010, when I decided to pass on buying WMT shares:  Item # 1 Consumer Debt Levels-Still Way too High (see also  Large Cap Valuations)

At the present time, I do not see much downside and a decent chance for the shares to hit $60 within a year. 

Since 2000, WMT has been increasing its dividend every year, starting with an annual rate of 24 cents in 2000 which more than doubled to 54 cents annually in 2004.  The dividend doubled again to $1.09 in 2009.  The current quarterly rate is $.303 per share or $1.212 annually. The payout ratio is less than 30%.  That dividend was an 11% increase over the dividend paid in the prior year. (Form 10-Q at page 24). 

WMT's future growth prospects are probably being under estimated in its current valuation. International sales make up about 26.6% of revenues for the Q/E 10/2010, and are growing at a rapid clip. (Form 10-Q at page 16)

Operating income for WMT International rose 13.5% in the last quarter. The recently announced acquisition of the South African based Massmart Holdings, if consummated, will likely give WMT a good foothold for expansion on the African continent.  

Since starting this blog in October 2008, I owned 100 shares of WMT briefly, buying at $49.55 in July 2009 and selling those shares at $51.2 in November 2009. 

2.  Bought 50 MWR at $22.25 on Thursday in the regular IRA (see Disclaimer):   Fidelity allowed me to buy this exchange traded bond after I was denied the opportunity to buy a synthetic floater due to its most recently announced prohibition.  Fidelity Brokerage Extends Denial of Trading Opportunities to Synthetic Floaters and Even an Exchange Traded Junior Bond DFP  MWR was my fall back option for some of the cash received as a result of the DFY redemption by Delphi Financial.  I am far from enthusiastic about this purchase.  

MWR is a typical trust preferred security. The issuer is Morgan Stanley Capital Trust III, a Delaware Trust formed by MS to issue trust preferred securities to the public and then to use the proceeds to purchase a junior bond issued by Morgan Stanley. The TPs represent a beneficial interest in the bonds owned by the trust.

Distributions will be taxable as interest and are paid quarterly.  The coupon is just 6.25% on a $25 par value, giving me about a 7% current yield at a total cost of $22.25.  The TP matures on 3/1/2033.

MWR Prospectus:  www.sec.gov 

By typical TP, I mean that the interest payments may be deferred for up to five years provided no payments are made on a junior security such as common stock or an equity preferred stock.  

In order words, the common share dividend and the dividend on MSPRA would have to be eliminated before MS could defer the interest payments on MWR or its other TP securities. If the interest payments are legally deferred, then those distributions accumulate and earn interest at the coupon rate. 

The TP can be included in the TIER 1 equity capital of a bank holding company, but that treatment is being phased out for those institutions with over 15 billion in assets, as of year-end 2009, under the recently enacted financial reform legislation.  

While I did not research the issue in any depth, I believe that MS converted to a bank holding company in 2008 and would be required to exclude its TPs from equity capital by 1/1/2016 after a three year phase-in period. I have no idea what MS intends to do with the large amount of TPs it has outstanding. One option would be to redeem them. TruPS Moving From Tier 1 to 2nd Rate

MS can redeem MWR now at par value plus accrued interest. (page S-7).

As discussed in this recent FDIC publication, TPs are in reality junior debt. www.fdic.gov .pdf (pages 2 - 16). I do not regard debt to be a component of equity capital.    

 Trust Preferred Securities: Links in One Post

Fidelity Brokerage Extends Denial of Trading Opportunities to Synthetic Floaters and Even an Exchange Traded Junior Bond DFP

I received the redemption proceeds of DFY on Thursday.  I owned 210 shares of this senior bond in retirement accounts.  For reasons that are not capable of being understood, Fidelity is currently preventing its customers from buying DFP, another exchange traded bond issued by Delphi Financial that I no longer own. Bought 100 DFP at $17.1   Bought 50 DFP at $17.10  Sold 50 of 150 DFP at 21.7 Added 50 DFP at 19.75  Sold: 50 DFP @ 23.10 and @ 23.17 There is simply no rational justification for that prohibition.  I will just assume that someone who has no idea about investing made the decision at Fidelity.  I was thinking of buying back DFP to replace DFY.

I then discovered that Fidelity was no longer accepting orders on synthetic floaters, thereby becoming the only brokerage company to my knowledge who is denying their customers access to those securities.  For those who read this blog, the synthetic floaters have been particularly beneficial to advancing my capital base in the retirement accounts.  I find this latest action by Fidelity to be inexcusable.  I did check all of the synthetic floaters mentioned in my gateway post for this security: Synthetic Floaters.  Fidelity Brokerage now prohibits buy orders for all of those securities.  I have not yet checked to determine how many other exchange traded bonds are now off limits to Fidelity customers.  I do expect Fidelity to extend its denial of trading opportunities to other exchange traded bonds as time progresses, and they are not responsive to customer complaints on this issue, except to say that the complaint has been sent to "upper management".  I previously noted many months ago that Fidelity had prohibited the purchase of exchange traded "principal protected" senior notes whose interest payments were tied to the performance of an index.  Fidelity Prohibits New Purchases of SIPs

I can confirm that JBK, which is currently a fixed coupon trust certificate containing a junior GS TP, is no longer available for purchase by Fidelity customers.  I made a fair amount of money trading that one.    Bought 100 JBK at $16.15 Bought 50 of the TC JBK at $16  Sold 100 JBK at 21.59 Sold 50 JBK @ 21.59  This is just an outrage!

I have recently expanded my brokers to include Vanguard and Schwab.    The latest action by Fidelity, which denies my access to securities that I view as important to managing my retirement accounts, will require the  removal of my Roth IRA from that firm.

I really believe it is a waste of time to complain to Fidelity.  However, if you have a brokerage account at Fidelity and wish to at least have the option of buying exchange traded bonds at that firm, I would suggest sending them an email recognizing of course that is a waste of your time.  

Since Fidelity is denying me the opportunity to manage my Roth IRA in a manner deemed appropriate, I have already completed a transfer application for that account.  I also did another Roth Conversion this morning, further diminishing the importance of the regular IRA at Fidelity.  So I will just leave that account there until I reach 70 and then distribute it to a taxable account.

If Fidelity continues to extend its denial of trading opportunities to include more Trust Certificates and other exchange traded bonds, then my much larger taxable account will be moved to a brokerage company more responsive to their customer needs.  I have already started to move funds out of that one in response to the Fidelity policy on SIPs.

This is the message that I received when I attempted to buy GJS today in my Roth IRA:

Pared FNB and AF-Regional Bank Basket Strategy/Bought 50 PIS at 24.88 in Roth IRA/Bought 50 HPQ at 41.57/Sold 300 WIW at 12.43

Three banks in my Regional Bank Stocks' basket strategy are included in TheStreet's list of 10 efficient, stable and profitable banks.  They are NYB, ORIT, and HCBK.  I have bought and sold another on this list, WIBC, and have some of the others on the large monitor list for this strategy. Sold 110 WIBC at 10.99

Sometimes, perception of reality is more important than the reality.  Over the past several days, I have read a number of commentaries predicting a tsunami of regional bank mergers.  An acceleration of mergers in 2011 may be in the offing, and consolidation is one of the rationales for the regional bank strategy, though it is certainly not the most important. Rationale for the Regional Bank Stock Strategy 

There have been several recent announcements that lend some credence to these predictions.  The most high profile announcement came from Bank of Montreal (BMO), who announced its intent to acquire Marshall & Illsley (MI)  I had owned shares in MI, but sold them before the merger announcement  at 7.14, a price higher than where the shares are trading now. Yesterday,  Hancock Holding announced its acquisition of Whitney Holding.

So far in 2010, two of my bank stocks, Wilber and Wainwright, jumped on acquisition news.  Bought 50 WAIN at 8.72  Sold 50 Wain at $18.7-Being Acquired Sold 151 GIW @ 9.26

I mentioned in yesterday's post that the regional bank stocks had shifted into another gear. My regional bank basket had another good day yesterday, rising $730 or 1.48%.   

1.  Sold 50 AF at $14.09 and 100 FNB in two 50 share lots at $10 and $10.18 (Regional Bank Stocks' basket strategy) (see disclaimer):  I sold shares of Astoria that were part of my 100 share lot purchased at 13.08.  This kind of transaction books a small profit while lowering my average cost for the remaining 100 shares using FIFO accounting.  After buying 100 at $13.08, I averaged down by buying  50 AF @ 12.08.  

I also sold my highest cost shares of FNB, which were purchased at 9.36 and at 8.42.  I kept the shares bought  at $7.8 in a satellite account.  The shares, which were sold, were in two separate accounts which accounted for the differences in their respective sales prices.  

2. BOUGHT 50 of the Trust Certificate PIS at $24.88 in the Roth IRA (see disclaimer):  PIS is my replacement for the 50 KRH that was redeemed yesterday.  PIS is a Trust Certificate (TC) that represents an undivided beneficial interest in Liberty Media senior bonds owned by the trust.   PIS is classified by me as an Exchange Traded Bond.  Par value of the trust certificate is $25.   Both the TC and the underlying bond mature on 2/1/2030.  The TC has a higher coupon than the underlying bond.  The bond has a 8.25% coupon whereas the TC has a 8.75% coupon.  Since I bought those shares at close to their par value, my current yield and yield to maturity would be very close to the 8.75% coupon. This is a link to the FINRA information on the Liberty Media 2030 bond.  The same bond is also the underlying security in  PYL and PYA.  PIS had the best current yield yesterday in this grouping.  All three of these TCs make semi-annual interest payments with the last ex date on 7/28.  

PIS Prospectus: SEC 

The underlying bond is rated junk by all three rating agencies.  Moody's rates it B1. 

I have bought and sold PIS, and another TC with a different Liberty Media senior bond (PKK), at lower levels.  

This is a link to the last filed Form 10-Q for the Q/E 9/2010. The debt is listed at page 23. 

3. Bought Back 50 HPQ at $41.57 (see Disclaimer): When HP released its earnings report for its fiscal 4th quarter ending on 10/31/2010, it raised the mid-point for fiscal 2011 GAAP E.P.S. to $4.47 from 4.4 and raised the midpoint of its 2011 revenue guidance to 133 billion. HP's non-GAAP E.P.S. estimate for F/Y 2011 (ending 10/2011) was in the range of $5.16 to $5.22. SEC Filed Press Release It is not often that I can buy such a quality company for less than 10 times earnings. Price to sales is currently around .75 with a forward five year P.E.G. at .84, according to HPQ Key Statistics at YF.  

Since I am not comfortable investing in technology, I limited myself to a 50 share purchase, buying back the fifty shares previously sold at a slightly higher price. Bough 50 HPQ at 38.2 (Sept. 2010) Sold: 50 HPQ @ 43.11 (Oct. 2010).   I am also not going to invest much money in any common stock that pays such a miniscule dividend.  

Hewlett-Packard Company closed yesterday at $41.48, down 43 cents.  

4. Sold 300 of the Bond CEF WIW at $12.43 (see disclaimer):  This one was a trade with the 300 shares just purchased  at $12.14.  I have been in a trading mode on this security, clipping small gains, and a few dividends here and there. Bought 300 of the CEF WIW at $11.94; SOLD 200 of 300 WIW at $12.5 Bought 200 WIW at 12.29 Sold 300 WIW at $12.53 For this last trip, I will receive just one monthly dividend.   

I am in the hole on many of the recently purchased bond CEFs that have reacted poorly to the recent correction in treasuries.   I will use the proceeds from WIW to average down in small increments on those higher yielding CEFs such as HPF.  {Sold HPF at 20.35 in Roth Bought 100 HPF at 19.09 in Roth IRA} {Bought:  100 HPF at 19.89  Added: 100 HPF @ 19.14  Bought 50 HPF @ 17.55 and at 17.76} I am at my limit on ERC and GDO, though I intend to add 50 shares to GDO,  and I do not care to add to BTZ, PSY or BHK. I am trading GDO some to lower my average cost, which will require buying slightly more than I want on occasion and then paring some later at over $19. 

One of LB's PAIRED Trades: Bought 50 AEF at 22.29 in Taxable Account-Sold 50 AEF at 22.35 in Roth IRA/Sold 50 of 100 FJA at 24.75/Bought 50 PJA at 24.65

Peter Morici, one of those economist who likes to hear himself talk on TV, argues that U.S. debt needs to be downgraded to junk.  Seeking Alpha  That may be a harsh assessment.  My personal grade is BBB with a negative credit watch.  Both political Tribes have proven, without any doubt, that they are simply unable to address the looming fiscal crisis in the United States.  Instead, they find ways to make it far worse.   


The regional bank basket kicked into another gear yesterday, passing easily the 7 thousand in unrealized gains mark.


I received this morning the redemption proceeds for both KRH and XFB, two trust certificates called by their respective call warrant owners, not by the issuer.    KRH-Exercise of Call Warrant  

1. Bought 50 of the Aegon Hybrid AEF in a Taxable Account at 22.29 and Sold 50 of AEF in the ROTH IRA at  22.35 (see Disclaimer):  This paired trade of the same security only made sense to the LB, who, when questioned about it by other staff members here at HQ, launched into a three hour dissertation, accompanied by powerpoint presentations and slide shows.  

I am playing with the house's money on the Aegon hybrids.  This is a link to a post that discusses them in detail:  Aegon Hybrids: Gateway Post  During the Near Depression period, the Aegon hybrids were smashed to smithereens and it was possible to buy them with current yields of over 30%.  While that sounds ridiculous, and it was, I still own one of the hybrids, AEH, that was purchased in the regular IRA at $4.63.  All of the Aegon hybrids traded in the U.S. have $25 par values.  The yield at my cost for AEH is around 35%, and it has never missed a dividend payment.  I also still own shares of AEB, the floater, that were purchased in the $4 to $8 range.  

The shares of AEF sold in the Roth IRA were purchased at $16.82 in September 2009.   LB's reasoning for selling those shares and then buying them back in the taxable account has many layers, and only a few will be summarized in this post.

First, with the extension of the qualified dividend tax rate, it makes more sense for me to own the Aegon hybrids in a taxable account since they pay qualified dividends.   So I will replace AEF in the Roth IRA with a bond that pays interest that would be taxable at my highest marginal tax rate if held in a taxable account.  

Second, costs associated with these two transactions are immaterial.  The brokerage commission is so low that it is a non-issue.   And, since I do not pay taxes on gains realized in the retirement account, I do not have consider the impact of taxes on the profitable AEF transaction in the Roth IRA.  

Third, I believe that the Aegon hybrids involve more risks than standard bonds and that risk is better suited to one of my taxable accounts than an IRA.    After all, AEF could have been bought at $3.9 on March 6, 2009.  AEF Historical Prices  As I said, the prices were just smashed.   

There are a number of reasons for the volatility.  These securities are in fact bonds, but they are the most junior bonds in the capital structure.  They have no maturity dates, which makes them vulnerable to interest rate risk in a similar fashion as the long bond.  They are also very vulnerable to a multitude of fears.  During the Dark Period, one fear was that the European Commission would force a deferral, and this never did happen.  But these types of junior bonds, which are treated as part of equity capital for regulatory purposes, are without question susceptible to a deferral if Aegon ever has to apply for state aid again.   If that happens, deferral of the hybrid dividends will most likely be a condition attached to the EC approval of that appeal under its "burden sharing" policy.   And another fear is the credit risk on the balance sheet of European financials in particular and all financials in general. 

The most cogent explanation, however, for the extreme volatility in the hybrid prices during the Near Depression, was the dependable and predictable irrationality of human beings.   The pricing of the European hybrids during the Dark Period is just one example of the laughable absurdity of the efficient market hypothesis.  Efficient Market Hypothesis as Hokum 

Recently, the Aegon hybrids have declined some in value.  I attribute that small decline to three factors.  One is the omnipresent concerns about sovereign debt issues in Europe, which ebbs and flows, and has recently been back in the headlines with negative connotations for the European hybrids.  The other is the decline in bond prices in general due to fears about interest rate risk.  Lastly, these securities just went ex dividend for their quarterly distributions and this seems to cause some investors to sell. 

I would add that Aegon is not paying a common stock dividend. My view was that the transaction associated with repaying the Dutch state in December 2009 triggered at most 4 mandatory payment events for the hybrids.  Aegon and the European Commission  This does not mean that Aegon will defer a hybrid dividends. I doubt that it will.  It only means that there is currently no legal impediment in my opinion that would stop it from doing so.  

I did buy and sell AEF previously.    Added 50 AEF at $18.38  Sold 50 of 100 AEF at 23.43 

AEF PROSPECTUS: www.sec.gov  AEF has a 7.25% coupon. 


At a total cost of $22.29, the yield is around 8.14%.  There are not many securities that pay qualified dividends yielding over 8%. 

I still own 100 shares of AEB in the ROTH IRA with an average cost basis of $6.06 per share with commissions. That security, which pays qualified dividends, is being kept in both taxable and non-taxable accounts due to its deflation and inflation protection components.   Managing Interest Rate Risk


All of the fixed coupon Aegon hybrids are functionally equivalent.  There is no reason to prefer one over the other, assuming the investor does not have a fetish for a particular symbol,  except for the yield at the investor's purchase price at the time a decision is reached to buy one of them. Based on yesterday's closing prices, the yields for the other fixed coupon Aegon hybrids traded in the U.S. were:


AED 7.97%  www.sec.gov
AEH 7.86% /www.sec.gov
AEV 7.98% www.sec.gov


Link to Aegon web site on its hybrids: Capital securities - AEGON Group

2. Bought 50 of the TC PJA at $24.65 in the Roth IRA (see Disclaimer):  I bought 50 of this TC in a taxable account  at 19.45 last December and still own those shares.  Most likely, I will sell them for a long term capital gain.   I will simply copy that part of my earlier discussion from December 2009 which describes this security: 

"This one had a tight spread for a lightly traded TC. At the time the order was placed, the bid was $19.41 and the ask was at $19.45 so OG entered a market order which was filled at $19.45. (Added to original: the spread was tight on 12/21/2010 too, when I placed the order yesterday, with a bid at 24.64 and a ask at 24.65)  LB said "don't buy any" and RB said "buy a 1000" . OG said in response that the underlying bond is an issue from Qwest Capital Funding (formerly known as U.S. West Capital Funding), a wholly owned subsidiary of Qwest Corporation, a large regional phone company with a lot of hard assets. Qwest provides telecommunications services in 14 midwestern and western states, including the metropolitan areas in Denver, Portland and Seattle. Qwest had some positive news a few days ago about its cash flow projection for 2010.Reuters Cramer said recently that he had even started to warm up on Qwest stock. TheStreet.com While the bond is rated junk, the yield at HK's cost is over 10% (10.28% at a total cost of $19.45), which looks good in the current zero short rate environment. Besides, the LB has already picked over virtually every exchange traded bond worth buying, leaving scraps for the OG, and there was little left to buy at reasonable prices, especially given the projections being made by the LB, as Chief of All Things Important Requiring Thought, about the probable course of interest rates over the next decade.

The coupon on the TC is 8% with a maturity in 2031. PJA had the best yield yesterday compared to PKH, another TC with the same bond which was yielding around 10.21%. PKH Stock Quote That one has a 7.75% coupon like the underlying security. www.sec.gov Another one, KCW, was priced at around $20.4 yesterday to yield, at 9.20%, about one percent less than PKH or PJA: KCW Stock Quote - Corts Tr Us West Communicatn CORTS 7.5% OG almost bought that one, since it was issued by U.S. West Communications, acquired by Qwest in 2000, and would be viewed as some as a better credit. (prospectus link:www.sec.gov) That set off a howl by the RB, calling the Old Geezer a stick in the mud, way too cautious by a factor of at least a zillion to one, at the minimum, and RB said to go for extra 1% if the OG had to buy this boring security. So after a series of compromises, it was decided to risk less than a 1 thousand on the higher yielding, and possibly less secure, PJA. The HK just said that the OG should never try to compromise with the RB, just listen to it.

(Qwest Corporation is a subsidiary of Qwest Services Corporation, and its consolidated subsidiaries, which is in turn a subsidiary of Qwest International Services Inc, the ultimate parent company of Qwest Corporation. The history of Qwest can be found in Wikipedia. It is my current understanding thatQwest Corporation is the entity formerly known as U S West Communications, /www.sos.state.co.us )

This is a link to the TC prospectus: www.sec.gov Interest is paid in February and August. Par value is $25. The maturity date is 2/15/2031. The underlying security has a lower coupon than the TC at 7.75%. The purchase yesterday was made at a 22% discount to par value.

This is a link to the prospectus for the underlying security:http://www.sec.gov Qwest guarantees the debt of Qwest Capital Funding.(so this is more indirect than a bond issued by U.S. West)

The links to the Finra data on the trades for the underlying bonds in Trust Certificates is accessible at this Gateway Post: LINKS TO FINRA INFORMATION ON UNDERLYING BONDS IN TRUST CERTIFICATESThis is a link to the Finra data on the underlying bond in this TC: FINRA - Investor Information - Market Data - Bonds - Bond Detail The underlying bond is lightly traded. For anyone interested, and are new to using the quantumonline site, there is a general description of the bond which can be assessed by clicking the symbol, PJA, on this page: Third Party Trust Preferred Securities Table - QuantumOnline.com which takes you to this page: PJA Search Results - QuantumOnline.com

The LB added that there are many reasons why it did not buy one of these TCs when it was the Head Trader. Qwest does not own a cellular network, and is instead merely reseller of wireless services from Verizon. It is also a reseller of TV services from Direct TV, which places it behind the competitive curve in that sector too. Qwest is therefore far more dependent than AT & T and Verizon on the land line business. For good measure, the LB emphasized that Qwest has lost lost a third of its residential customers over the past five years. OG replied that Qwest is profitable with net property, plant and equipment of 10.804 billion, about 3 billion higher than long term borrowings of 7.845 billion : www.sec.gov LB said that the OG, possibly being in early stages of senility, forgot to add the long term pension expenses and other post-retirement benefits. And for the coup de grâce, the LB pointed out that this security was a long term bond, and better results for 2010 is not the relevant consideration. Instead, the land line business over the long term is analogous to the newspaper business, a perpetual state of decline, thus undermining the security of a long term bond maturing in over 20 years. Do you expect the land line business to be improving in the years to come, OG? And, the OG said there is always hope, LB is being too pessimistic, as usual, and LB said it was a realist who saw the world as it is, in a totally logical and rational manner devoid of ideological prisms."  

ITEM # 2   Bought 50 PJA at 19.45 


So this bond generates a lot of controversy among staff here at HQ. 

At my purchase price yesterday, the current yield is slightly more 8%. Interest payments are made semi-annually with the last ex date in August.  

I would just add that Qwest has since agreed to be acquired by CenturyTel. Possibly, if this acquisition is completed, it will improve the rating of the Qwest bond in this TC. Qwest and CTL Bonds  Another alternative would be a downgrade of CTL bonds, or both. 

3.  Sold 50 of the 100 FJA at 24.75 (see Disclaimer):  The TC FJA contains a senior Embarq bond, and CenturyTel acquired Embarq.   So, I added 50 of Qwest bond in the Roth and sold 50 of an Embarq bond in the taxable account, thereby maintaining my weighting in CenturyTel bonds, assuming the Qwest acquisition is ultimately completed by CTL.   I also have a higher yield on PJA than on FJA at current prices. 

FJA proved to be a good investment.  I realized a long term capital gain on those 50 shares, which were part of a 100 share lot purchased at 15.35.    The remaining 50 shares were purchased at below $15.  Bought another 50 FJA at 14.2

FJA Prospectus: www.sec.gov

Finra Information on Underlying Bond: FINRA 

Bought 1 Cincinnati Bell Bond Maturing 2018 at 94/Added 50 REPRB at 22.03/Added to OSM at 18.47

I received yesterday the redemption proceeds of RNRPPB that was called by its issuer, RenaissanceRe. That one was an equity preferred stock which paid qualified dividends and had a 7.3% coupon on a $25 par value. 

There are two remaining equity preferred stocks issued by RenaissanceRe, RNRPRC and RNRPRD. 

All of these issues are rated investment grade (BBB+ by S & P). However, their yields are below 7% based on their current prices.  

Most non-REIT equity preferred stocks do not have cumulative dividends. The RNR equity preferred stocks do have cumulative dividends.

Before buying the highest yielding remaining RNR preferred stock with the redemption proceeds received for RNRPRB, I will consider adding to my existing position in a trust preferred issue, REPRB, which is in essence a junior bond from Everest Re. Sold 50 RNRPRD at 22.05 & Bought 50 REPRB AT 20.78 That one pays interest rather than qualified dividends. The yield is about the same as the two equity preferred stocks from RenaissanceRe. The TP has a maturity date, which I view as important, while the preferred stocks are perpetual like their common stock cousins.  

Steve Kroft interviewed Meredith Whitney for a 60 minutes segment titled State Budgets: The Day of Reckoning. The segment was biased clearly in favor of Ms. Whitney's dire forecasts, and the municipal bond market reacted on Monday by resuming its selloff. Other than Ms. Whitney's forecast of 50 to 100 "sizable" municipal bond defaults, there was no new news in the broadcast.   

I last mentioned Meridith's frequently alarmist views back in November 2009 when she was extremely bearish on the market. Item # 5 Sarah and Meredith A municipal bond ETF, MUB, continued its descent yesterday, falling $1.08 to close at $98.85. 

Webster Financial (WBS), my best percentage gainer in the Regional Bank Stocks' basket strategy among the stocks that are still owned, announced its intent to sell 6.630 million shares and will use the proceeds to repurchase the 200 million in government preferred stock. WBS closed yesterday at $18.49. Buy of 50 WBS at $4.58 

1. Added 50 OSM at $18.47 on Monday (see Disclaimer): After reading Andrew Bary's favorable column in Barrons about SLM (Sallie Mae), I felt better about the creditworthiness of Sallie Mae, at least until its exchange traded CPI floater OSM matures in 2017.  

Of the three SLM exchange traded bonds, Bary only specifically mentioned JSM, a 6% fixed coupon senior bond maturing in 2043, www.sec.gov. I have zero interest in that one. JSM has about a 8.09% current yield at yesterday's closing price of $18.88 ($25 par value), up 35 cents for the day.   

I have bought and sold the other CPI linked note, ISM, that matures in 2018. Bought 50 ISM in IRA at $11.85 (prospectus: www.sec.gov)

Prior to yesterday I had pared my position in OSM to just 100 shares after hitting a high of 300 shares earlier in the year. Yesterday's purchase brings me to the mid-point of 150 shares, where I have some comfort level with the risk/reward. When I started to purchase shares in OSM back in October 2008, when the price was close to $10, my major concern was credit risk. I would still be extremely concerned about credit risk for a SLM note maturing in 2043, such as JSM, and the interest risk for that fixed coupon, long maturity bond would be in my estimation considerably greater than the two CPI floaters, OSM and ISM, that mature in 2017 and 2018, respectively. And OSM and ISM are floaters tied to CPI which in itself reduces interest rate risk. 

As discussed in several posts from December 2008, OSM is a senior bond issued by SLM that matures in March 2017 at $25 per share. (December 2008 posts: cpi floaters pfk and osm   cpi floater: osm  cpi and cpi floaters-osm inflation or deflation: bond alternatives)

This bond pays monthly interest based on a 2% spread to a complex CPI calculation which I am about to perform for anyone interested in this security. www.sec.gov Due to the recent low CPI numbers, the interest payable by OSM will be trending down in the months to come. Consequently, this security will likely be generating modest income well into 2011. The primary appeal to me now is not so much current income  but the increasing likelihood that SLM will survive to par value in March 2017, creating a decent return just on the share profit of about $6.5 per share at yesterday's last purchase price.

In addition, while inflation may be tame for many more months, it is certainly possible that CPI will start to rise to much higher levels than now before this bond matures, thereby generating more current income.

To calculate the monthly interest rate, SLM uses the CPI Index for All Consumers without seasonal adjustment, and that data can be found at research.stlouisfed.org. The calculation uses a twelve month percentage change in that CPI, and there is a 3 month lag.

I last calculated the penny rate for November 2010 that was based on the percentage change between July 2009 and July 2010,  Item # 1 CPI for July:

July 2010 218.011

July 2009 215.351  

Difference 2.66

Divide Difference by 215.351=.01235

Add Spread .02 for OSM= .03235

Multiply .03235 x. $25 par value= $.80875

Multiply $.80875 x. 31/365=  $.068688

The penny rate reached almost 9 cents earlier in the year. See Item # 9 Bought 50 OSM at 15.74  So the penny rate had already started to trend down before the release of the latest low inflation numbers. 

With the release of the November CPI number, I can calculate the penny rate for March 2011:

November 2010   218.803

November 2009   216.330

Difference          2.4733

Divide Difference by 216.33 =  .011432

Add Spread of .02 for OSM=  .03143

Multiply .03143 by $25 par value= .78575

Multiply .78575 by 31/365 = $.06673  (if the payment period is 30 days, then the multiplier would be 30/365) 

Since I was more comfortable with the credit risk of Prudential, I decided to keep my shares in the PRU CPI floater, PFK, that were bought at favorable prices. Bought 100 PFK at 18.47 Bought 90 PFK in IRA $18.94  Added 50 PFK at $17.83 Added 50 PFK in Roth at 20.88-Averaged UP  I am just sitting on those shares. I am not inclined to sell those shares even though that security has been trading at over its par value. I am not interested in buying more shares at current prices, however.   (see also July 2009 Post: Comparing Prudential Floating Rate Bonds Tied to CPI and Fixed Rate Coupon Bonds Maturing in 2018) 


My average cost for the remaining 100 shares of OSM was below $16, so this last purchase of 50 shares will raise my cost basis some. The last purchase was in May 2010 at 15.74. The lower cost shares were sold using FIFO accounting.


2. Bought 1 Cincinnati Bell Bond Maturing in 2018 at 94 with concession (see Disclaimer):  I have nothing to add to my recent discussion of Cincinnati Bell made in a post earlier this month when I bought another one of its bond Bought 1 Cincinnati Bell Senior Bond Maturing in 2020 at 96.8  I would just note that the common stock (CBB) has been subject to some selling pressure for several trading sessions, falling from a close at $2.66 on 12/10 to  $2.34 yesterday.   And I believe the bonds have fallen some too.

This particular bond is a senior "subordinated" bond maturing on 3/15/2008 and has a 8.75% coupon.  This is a link to the FINRA site that contains information about the ratings and trades for this bond.  It is rated junk.   Fitch has the lowest grade at CCC.

This bond was originally issued in March 2010.

This is a link to the prospectus: Final Prospectus Supplement

Given the risk, I do not intent to buy any more bonds from CBB. I am considering a purchase of the common stock in the LT category.

The confirmation statement showed a YTM of 9.764%, and a current yield based on my cost of 9.229%.

3. ADDED 50 REPRB at 22.03 on Monday (see Disclaimer): I decided to round my lot to 100 shares in REPRB with the proceeds received from RNRPRB yesterday. This security is a typical trust preferred, and was issued by Everest Re Capital Trust II. That trust used the proceeds from selling the TPs to the public to buy a junior bond from Everest Re. The TP represents an undivided beneficial interest in that junior bond. I simply view this kind of security as a junior bond with liberal rights of deferral. Interest payments are cumulative and are paid quarterly. This security just went ex interest. It is rated investment grade.

The TP and its underlying bond mature on the same day in 2034 (3/29/2034).  Everest Re is paying a common stock dividend. To defer interest payments to the owners of REPRB, Everest Re Group, Ltd  (RE) would first have to eliminate the common stock dividend.

I have previously bought and sold this security: Bought REPRB at 20.19  Sold REPRB at 24.36

This is a link to the prospectus: Final Prospectus Supplement  The coupon is just 6.2%. This gives me a current yield of about 7% at a total cost of $22.03 and a higher YTM given the purchase at a discount to the $25 par value.

REPRB blew through my limit order at $22.05 on its way down to 21.74 yesterday, and then recovered some to close at $21.96, down 28 cents for the day.

Trust Preferred Securities: Links in One Post

I ran out of desirable bond buys last year.  Now, as bonds are called, I am simply reduced to finding the least undesirable replacement.

I am scheduled to receive the redemption proceeds from KRH and XFB tomorrow, DFY on Thursday, and TDA on Monday, respectively.