Nowadays I am enamored with income investing. It may be a case of the the Stockholm syndrome due to my FRE preferred positions. But who says market investing is not a case of constant flogging anyway, up or down.
Soooooo here is what we have learned over the year...
BSC preferreds were a great bet...
WM preferreds got wiped out...
C preferreds are hanging on and continue to pay...
WB preferreds, after much stomach flipping turmoil, were also a good bet...
My rational attraction to preferreds and income trusts stems from the low yields available in the market. It appears to me that there are some very stable companies being treated like they have serious default risk. Thus the spread between risk free income and corporate investment grade yields is very wide. Moreover, in the case that the economy is deflating at 3% this year, then the DUK debt will a real 12% yield. Not to mention the comparison between the income and general market performance.
10 year Treasury - 2.5%
Duke BBB Junior Debt (JBI) - 8.5%
BMY Debt Notes (XFR) - 8%
BAC Preferred Floating (BAC-PE) - 11%
Transparency: The author has established a position in JBI (Duke Energy Debt Trust) at 21 (8.5% real yield) and a position in BAC-PE at $8.1 (10% real yield).
Showing posts with label Preferreds. Show all posts
Showing posts with label Preferreds. Show all posts
Tuesday, December 9, 2008
Friday, August 22, 2008
Fannie, Freddie : Beyond the Balance Sheets
1 Kings 19:11-13
“The LORD said, "Go out and stand on the mountain in the presence of the LORD, for the LORD is about to pass by."
Then a great and powerful wind tore the mountains apart and shattered the rocks before the LORD, but the LORD was not in the wind. After the wind there was an earthquake, but the LORD was not in the earthquake. 12 After the earthquake came a fire, but the LORD was not in the fire. And after the fire came a gentle whisper. 13 When Elijah heard it, he pulled his cloak over his face and went out and stood at the mouth of the cave.”
The story of Elijah is a spiritual example of how investors need to demonstrate discipline and discernment. Each of the seemingly apocalyptic events that occurred in front of Elijah could have caused him to react prematurely or fear something not worthy of fear.
On a much more worldly level, such is the case with Freddie Mac (FRE) and Fannie Mae (FNM) preferred shares. In the past few months, the din of negative assessments of the GSEs situation has been deafening. Stories of representatives of foreign sovereign financial institutions calling Paulson himself to explicitly guarantee the US government financial backing for the FRE and FNM are accepted as truth. There has been an unprecedented selling of FRE and FNM preferred share securities, over $12B worth, in just a few weeks. For any smaller or non-government entity, this would be a sign that the corporation was worth no more than junk.
Even more telling is estimates regarding the net worth of GSEs. By many mark to market measures, there is negative net worth to the organizations. No one really disputes this, but many market participants expect that this is grounds to seek bankruptcy proceedings for these entities. The roar of the critics and investors disillusioned by the state of the credit markets expecting honest reporting and vindication for predictions of this outcome of easy credit is deafening.
Yet this is all noise. The authority, the US government has completely different agenda. The US government must maintain the stability of the US and implicitly the US housing and credit markets. The calculation of the net worth of FRE and FNM completely discounts the goodwill value of having a government organ able to keep mortgage markets from freezing up completely and starting the economy in a free fall. To the government, FRE and FNM are one of the few remaining levers to keep the markets moving. How much is that worth? In a whisper, that value is beyond the value of any bailout cost in dollar terms.
Why keep value in the preferreds and even the common then? Scream any profanity appropriate about how unfair it is for investors not to pay for their faith in insolvent corporations, but what about the intangibles? The biggest currency the US government has right now is faith that it is a good place to invest and that it will pay whatever debt is owed. A tremendous amount of the preferred securities were purchase based on the implied backing of the US government. To repudiate that assumption at this point will to risk total loss of faith in the US government as debtor. How much is that worth?
Why hasn’t the authority spoken to revive faith in these institutions and let all this noise come out speaking of their demise? In the financial classic “"Manias, Panics, and Crashes: A History of Financial Crises" the author, Kindleberger, explores how financial crises unfold and what is the options of those seeking to alleviate the crisis. A reviewer gives a synopsis of Kindleberger’s conclusion…
“What, in the end, is Kindleberger's moral? …. The solution, he believes, lies in having a lender of last resort. The trick, of course, is to avoid moral hazard and prevent the public from gambling due to the reassurance of a lender of last resort. The answer is ambiguity: the lender can come in and save the day but investors should never be certain that help is forthcoming."
Elijah never knew how many dramatic events would occur before he would hear The Lord speak. Such is the case with FNM and FRE, there is no motivation for the government to establish a floor because of the risk of inspiring moral hazard in the market is too great.
In the end, some time soon the cacophony of market opinions will subside and the market will realize that FNM and FRE serve a purpose much larger than just what balance sheets suggest. Then, at that grand final moment, the authority in this matter will honor the faithful.
Disclosure: Lockstep Investing is long FRE Y Series and Z Series preferreds
Lockstep Proposed Position: Buy FRE Y Series preferreds below $9 / share.
“The LORD said, "Go out and stand on the mountain in the presence of the LORD, for the LORD is about to pass by."
Then a great and powerful wind tore the mountains apart and shattered the rocks before the LORD, but the LORD was not in the wind. After the wind there was an earthquake, but the LORD was not in the earthquake. 12 After the earthquake came a fire, but the LORD was not in the fire. And after the fire came a gentle whisper. 13 When Elijah heard it, he pulled his cloak over his face and went out and stood at the mouth of the cave.”
The story of Elijah is a spiritual example of how investors need to demonstrate discipline and discernment. Each of the seemingly apocalyptic events that occurred in front of Elijah could have caused him to react prematurely or fear something not worthy of fear.
On a much more worldly level, such is the case with Freddie Mac (FRE) and Fannie Mae (FNM) preferred shares. In the past few months, the din of negative assessments of the GSEs situation has been deafening. Stories of representatives of foreign sovereign financial institutions calling Paulson himself to explicitly guarantee the US government financial backing for the FRE and FNM are accepted as truth. There has been an unprecedented selling of FRE and FNM preferred share securities, over $12B worth, in just a few weeks. For any smaller or non-government entity, this would be a sign that the corporation was worth no more than junk.
Even more telling is estimates regarding the net worth of GSEs. By many mark to market measures, there is negative net worth to the organizations. No one really disputes this, but many market participants expect that this is grounds to seek bankruptcy proceedings for these entities. The roar of the critics and investors disillusioned by the state of the credit markets expecting honest reporting and vindication for predictions of this outcome of easy credit is deafening.
Yet this is all noise. The authority, the US government has completely different agenda. The US government must maintain the stability of the US and implicitly the US housing and credit markets. The calculation of the net worth of FRE and FNM completely discounts the goodwill value of having a government organ able to keep mortgage markets from freezing up completely and starting the economy in a free fall. To the government, FRE and FNM are one of the few remaining levers to keep the markets moving. How much is that worth? In a whisper, that value is beyond the value of any bailout cost in dollar terms.
Why keep value in the preferreds and even the common then? Scream any profanity appropriate about how unfair it is for investors not to pay for their faith in insolvent corporations, but what about the intangibles? The biggest currency the US government has right now is faith that it is a good place to invest and that it will pay whatever debt is owed. A tremendous amount of the preferred securities were purchase based on the implied backing of the US government. To repudiate that assumption at this point will to risk total loss of faith in the US government as debtor. How much is that worth?
Why hasn’t the authority spoken to revive faith in these institutions and let all this noise come out speaking of their demise? In the financial classic “"Manias, Panics, and Crashes: A History of Financial Crises" the author, Kindleberger, explores how financial crises unfold and what is the options of those seeking to alleviate the crisis. A reviewer gives a synopsis of Kindleberger’s conclusion…
“What, in the end, is Kindleberger's moral? …. The solution, he believes, lies in having a lender of last resort. The trick, of course, is to avoid moral hazard and prevent the public from gambling due to the reassurance of a lender of last resort. The answer is ambiguity: the lender can come in and save the day but investors should never be certain that help is forthcoming."
Elijah never knew how many dramatic events would occur before he would hear The Lord speak. Such is the case with FNM and FRE, there is no motivation for the government to establish a floor because of the risk of inspiring moral hazard in the market is too great.
In the end, some time soon the cacophony of market opinions will subside and the market will realize that FNM and FRE serve a purpose much larger than just what balance sheets suggest. Then, at that grand final moment, the authority in this matter will honor the faithful.
Disclosure: Lockstep Investing is long FRE Y Series and Z Series preferreds
Lockstep Proposed Position: Buy FRE Y Series preferreds below $9 / share.
Monday, July 28, 2008
Crocodiles smile at Bank of America
“Crocodiles are ambush hunters, waiting for fish or land animals to come close, then rushing out to attack. As cold-blooded predators, they are lethargic, therefore survive long periods without food, and rarely need to actively go hunting.”
In this time of pain and turmoil, investors need to come out of their defensive positions and find easy prey. The J series preferred shares of Bank of America (Ticker:BAC-PJ) are that prey.
For investors, the recent banking turmoil is both a blessing and a curse. On one hand, castrophic losses have threatened the viability of the US banking system. On the other hand, for the surviving companies, there will be tremendous opportunities with reduced competition. This conclusion was presented during the recent JP Morgan Q2 conference call where analyst Mike Mayo, observing the opportunities of big banks to take advantage of weakened competition, approached JP Morgan CEO Jamie Dimon with a point blank question.
“You have been waiting your whole life for this environment,” Mayo asked, so what is holding JP Morgan back from growing through mergers with so many competitors hurt?
Bank of America is in a similar position. Despite the significant downside exposure of the Countrywide purchase, Bank of America deposits-on-hand is enough to weather any major storm. Although common shares may ebb and flow with the distress of the credit crisis, there are lower risk areas that pay premium amounts for capital. Thus, the recent opportunities to buy Bank of America preferred shares at reduced prices have been tremendous.
Any investor in this security will receive a 7.25% coupon with a par value of $25 a share for five years ending 2012. If the investor can buy the shares for less than the par value, then the yield on the shares will be higher. During the recent sell off in financial stocks in July, the shares dropped to $16 which meant a yield of 11.3% on any share purchased.
The J series preferred shares are non cumulative, meaning Bank of America can suspend paying the dividend at any time and will not incur any liabilities. For the investor, this is the downside risk of preferreds. Yet banks often issue their shares as non-cumulative because under accounting rules it allows them to use proceeds of the preferred issue toward their Tier 1 capital reserves. In most cases preferred share dividends are not cut unless common shareholder dividends are reduced to zero and/or bankruptcy occurs. In comparison, even the Bear Sterns non-cumulative preferred shares are still being paid out by JP Morgan without disruption. As of July 28, 2008, Washington Mutual (Yahoo! Ticker: WM-PR) is still paying out their preferreds shares at a 16% yield. Although I view dividend cuts to Bank of America common stock over the next two years very likely due to Countrywide exposure, credit card exposure, and real estate exposure, I do not foresee a total suspension of the dividend in any scenario.
There will only be a few times when high quality will be available at discount price. The turmoil that brought the shares down to $16 will happen again, probably sooner rather than later, and probably in relation to a bank bigger than Indymac. In most cases, the general market will be in fear of complete collapse or unknowledgeable about the opportunities that abound at this time. I recommend waiting until these preferred shares once again reach $16 / share before buying. In most cases, the general market will be in fear or unknowledgeable about the opportunities that abound at this time. Only crocodile investors who wait until the conditions are appropriate will be astute enough to identify this opportunity and enjoy the best returns.
Transparency: Position initiated on Oct 10, 2008 at $16 / share. On that day the security reached an intraday low of $15.50 / share.
In this time of pain and turmoil, investors need to come out of their defensive positions and find easy prey. The J series preferred shares of Bank of America (Ticker:BAC-PJ) are that prey.
For investors, the recent banking turmoil is both a blessing and a curse. On one hand, castrophic losses have threatened the viability of the US banking system. On the other hand, for the surviving companies, there will be tremendous opportunities with reduced competition. This conclusion was presented during the recent JP Morgan Q2 conference call where analyst Mike Mayo, observing the opportunities of big banks to take advantage of weakened competition, approached JP Morgan CEO Jamie Dimon with a point blank question.
“You have been waiting your whole life for this environment,” Mayo asked, so what is holding JP Morgan back from growing through mergers with so many competitors hurt?
Bank of America is in a similar position. Despite the significant downside exposure of the Countrywide purchase, Bank of America deposits-on-hand is enough to weather any major storm. Although common shares may ebb and flow with the distress of the credit crisis, there are lower risk areas that pay premium amounts for capital. Thus, the recent opportunities to buy Bank of America preferred shares at reduced prices have been tremendous.
Any investor in this security will receive a 7.25% coupon with a par value of $25 a share for five years ending 2012. If the investor can buy the shares for less than the par value, then the yield on the shares will be higher. During the recent sell off in financial stocks in July, the shares dropped to $16 which meant a yield of 11.3% on any share purchased.
The J series preferred shares are non cumulative, meaning Bank of America can suspend paying the dividend at any time and will not incur any liabilities. For the investor, this is the downside risk of preferreds. Yet banks often issue their shares as non-cumulative because under accounting rules it allows them to use proceeds of the preferred issue toward their Tier 1 capital reserves. In most cases preferred share dividends are not cut unless common shareholder dividends are reduced to zero and/or bankruptcy occurs. In comparison, even the Bear Sterns non-cumulative preferred shares are still being paid out by JP Morgan without disruption. As of July 28, 2008, Washington Mutual (Yahoo! Ticker: WM-PR) is still paying out their preferreds shares at a 16% yield. Although I view dividend cuts to Bank of America common stock over the next two years very likely due to Countrywide exposure, credit card exposure, and real estate exposure, I do not foresee a total suspension of the dividend in any scenario.
There will only be a few times when high quality will be available at discount price. The turmoil that brought the shares down to $16 will happen again, probably sooner rather than later, and probably in relation to a bank bigger than Indymac. In most cases, the general market will be in fear of complete collapse or unknowledgeable about the opportunities that abound at this time. I recommend waiting until these preferred shares once again reach $16 / share before buying. In most cases, the general market will be in fear or unknowledgeable about the opportunities that abound at this time. Only crocodile investors who wait until the conditions are appropriate will be astute enough to identify this opportunity and enjoy the best returns.
Transparency: Position initiated on Oct 10, 2008 at $16 / share. On that day the security reached an intraday low of $15.50 / share.
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