Wednesday, December 30, 2009

Resolutions


Year end. Time for recaps and predictions. Looking back and looking ahead. Time for resolutions in the two senses of the word: those things that were resolved and those things we promise to address in the future.

Looking back, 2009 was a banner year for most investment categories. Financial markets recovered from the brink of despair, in a move so quick and furious that it offered great opportunity to those who remained alert, while those who passively stuck with their positions throughout could still find comfort in meaningful recovery. On the other hand, those investors who bailed out of the crisis at the wrong time, found themselves longing for those opportunities which passed them by, while they scoffed with skepticism or cowered with fear, unable to pull the trigger and return to the game.

Risk taking was richly rewarded, as the pendulum, which had swung high in favor of safety in 2008, came rushing back in the opposite direction. Playing defense was a losing game this year.

Two of my favorite categories: high yield fixed income and emerging markets, were the hottest tickets of the year. Russian Bonds, for example, with a little bit of both characteristics, were a great place to be.

On balance, it was terrific year for me personally also. My health improved, my family has been wonderful and Uncle Sam is going to smile when he gets my check next April. My clients are very happy to have heeded my advice. Vision and/or luck? A little of both perhaps, but does it matter?

I also had the opportunity to strike a few things off my “bucket list”. Check out the picture at the top. I’m sure you’ll recognize the place. (If not, please rent the whole Indiana Jones series).

The Stanford affair was perhaps the icing on the cake (my 15 minutes?). Aside from the excitement and the attention, it was a messy issue that helped put things in perspective for me. Everything can change in a minute, so don’t take anything for granted. I still follow the case but stopped writing about it. Maybe I’ll do a book about the whole ordeal some day. I certainly have enough material and it’s the only way I can think of to get on “The Daily Show with Jon Stewart”. Nowadays everyone writes a book. Even Sarah Palin!

Looking forward to 2010, challenges abound (there’s a cliché!). Starting with the markets, the easy gains have been made. I still see some opportunities in fixed income, because the dynamics of that market are still favorable. Low base rates, stingy banks, aging populations with more retirees (looking for income) and a few decades of “underhyping” of the asset class. Let’s face it, the media forgot bonds existed back in the early 80s (the 1780‘s) and are only now beginning to rediscover them.
Equity markets don’t appear so clear to me, although accommodative monetary policy lends little reason for selling. It’s a simple case of “what are you going to do with the money?” I have read a lot of research looking for enlightenment on the issue.

As for New Years resolutions, aside from the 20 pounds I vow to lose (this year I’m serious!), I will try my best to blog more. This humble little blog is receiving some pretty consistent traffic and when you have an audience, even a small one, you have an obligation to it. I’ll blog about the markets, investments and probably a lot about bonds and fixed income. It’s not the idea to “fixate” about fixed income, but while there are millions of blogs on stocks, there isn’t a lot of free commentary about bonds.
I’m going to try my best to make a least a post per week, which may not sound like much, but remember this is not my real job.

So, have a really peaceful and joyful rest of this holiday season, a great year in 2010 and thanks for reading my junk.

Tuesday, December 15, 2009

Online Junk


Since I’ve written quite a bit about fixed income, I’ve gotten some inquiries (well, ONE) about how one goes about trading bonds as an individual investor.
I’ve looked around a bit for some family members and myself and I’d like to share some of those findings.

There are of course, the full service brokers: Merrill, Goldman, Morgan(s), European banks, Asian Banks/Brokers…etc. etc. If you have an account at one of these, you can usually call up your rep and get him/her to get you some bonds. They will mostly likely balk at your request for junk, trying to guide you towards some other lower-yielding safer fixed income alternative. Preferably one that makes more money for them. In the end, if you’re lucky, they will comply to your wishes, after telling you more than once that “the bank doesn’t recommend this” to cover their Armani-draped butts.

When you get your fill, you’ll pay a nice commission, but you may never know exactly what the bond actually cost, since the price was most likely marked up along the way, either by your broker or the dealer(s) through which the bond was bought.

I know this sounds like a rip-off, but dealers make their living working these sometimes illiquid markets and its only fair that they get some compensation for that and the risk of carrying inventory in some of these exotic assets.

Remember, however, that everything is negotiable and since there may not be a “market” per se, it makes no sense to place “market” orders. You can always haggle a bit or limit your bid. And you can always say no. Never forget to use this power.

That certainly sounds like a lot of work and hassle. But if the idea is to hold these positions for relatively long periods of time (years), it doesn’t turn into a job.
The back and forth can be a bit annoying and unless you have a Bloomberg or other access, your rep/broker will usually have a better beat on market conditions than you.

If you are like me, you tolerate this process, but you hate it and avoid it if possible. Which is why I buy my cars used at Carmax where the prices are fixed and I’m not locked into a battle of wits with a salesman, with his children’s new shoes at stake.

And it’s why I’ve been trading stocks online since the early ‘90s (CompuServe, remember that?). There is nothing I like better than a simple click, instead of having to chat for half an hour with some person over the phone, before you can get them to put in an order to buy 100 shares of IBM for the account (or something equally insipid).

Unfortunately, buying bonds online is not as easy as buying shares. But it can be done. If you have experience buying stocks online, you should be able to make the adjustments. If you have never transacted through an online broker, bonds are not the place to start.

For beginners, most of the online discount brokers get their offerings through a platform called “Bonddesk” (http://www.bonddeskgroup.com), which specializes in odd-lots (less than 1 million) offerings. They may include (or not) other sources. But if you look for a specific bond on several discount broker sites, you will likely find the same offers (amounts) and bids. Prices MAY vary as several of these online brokers add a markup (usually 0.5%) to the price they get through BondDesk.

What you will find are munis, corporates and government bonds. My particular interest is corporates, so I can’t tell you how the munis or government bond trading works (I’ll assume it’s similar).

The offerings are mainly US corporate bonds, although you may find some sovereign and foreign issuer bonds (yes, even Venezuelan Globals) sprinkled in. All in US dollars. You won’t find a Naftogaz or Hong Kong real estate companies’ bonds here (darn!). No Dubai. No Turmekistan.

Online brokers have search tools, with which you can narrow down the offerings. This is particularly useful, since you may be looking for a particular issuer (which has many bonds), maturity, yield etc. This is important, because it is not like stocks, there is not an offer on every single bond. Some things may not be available today (but maybe tomorrow).

There isn’t much room for haggling online, the price on the board is usually it, but some brokers will allow you to solicit an “ask” quote, which on occasion can be better than the executable price on the board. (Here’s a good description of the process. LINK).
If it is a bit complicated, you can call customer service and they will work you through the process of buying and selling.

Now here’s a rundown of the online brokers I’ve used or researched. Not supposed to be comprehensive or a plug for any one in particular and reader feedback is encouraged.

E*Trade Securities. I have been a client for years, so I’m biased, but this online broker has really gone after the retail bond investor and actually advertises the fact prominently on their site. No markups (from the BondDesk offerings) and commissions of $1/bond, with a $10 min and a $250 maximum. There are other brokers offering lower commissions, but not really low enough for me to switch.
The search tool is good and you can even access a particular bond's trading history with a link to the TRACE system.
Investment Grade, High Yield and even defaulted bonds are available for purchase.

Fidelity. From what I’ve seen on the “outside”, the workings of the fidelity online bond site is similar to E*Trades. The price is also $1/bond with a $250 max. Their fee schedule, however, states that below-investment grade bond trades must be placed through a representative, which defeats in part the whole online deal. Their search tool excludes D-rated bonds (defaulted), so these may not be available to trade. (Would you want to? Why not?). LINK

Schwab and TD Ameritrade limit online trading to investment grade bonds (BBB or better). Schwab marks up prices over the BondDesk ask price but has a similar commission schedule to E*Trade. ($1/bond, $10 min, $250 max). TD Ameritrade is just the markup apparently (I called them), but I was told elsewhere that there was a $3/bond commission also. FirstTrade also works on a markup basis.

OptionsXPress isn’t very expressive in the bond market. They offer the fixed income alternative, but at $5/bond with a $14.95 min, and a markup on the price, its obvious from their name what business they are really after. TradeKing is similar.

Interactive Brokers. This is one of best options in terms of commissions. The inventory appears to be BondDesk’s, but the commission is lower: $1/bond on the first 10 and $0.25/bond thereafter, with a $5 min. ($n250,000 is only $70 vs. $250 for E*Trade).

The “problem” with Interactive Brokers is that the interface is a complex trading station and it takes getting used to. Some bonds, which show up on the other brokers search tools may not show up here (I have not been able to find convertibles). And they expect you to trade; so if you don’t you’ll get a monthly charge assessed (not much, $10 IIRC).
For my Venezuelan friends, this is an option, since E*Trade no longer opens accounts for Venezuelan nationals. (They say they can’t verify identities…go figure).

Zion’s Direct is another alternative. They claim not to charge markups and there is a flat $10.95 per trade also using the BondDesk inventory. They call the service “Bonds for Less” and they seem to be interested in developing the niche. Only US Residents, however. LINK

A number of online discount houses don’t even bother with bonds: Zecco, First Trade, Sogotrade and others are not interested. They are after the stock day traders.

In conclusion, the retail investor CAN find a way to trade some corporate bonds online. It’s not easy, but it can be done.

The retail fixed income online trading landscape seems to be evolving and we should see changes as investor interest picks up. We could compare it perhaps to online stock trading circa 1992. Ah…who can forget those modem connection tones!
If so, we can expect it to evolve and the market for bonds and credits in general could become more transparent, liquid and accessible (although it may not be in Wall Street’s best interest).

One reader pointed out to me in my blog about my wife’s junk bond portfolio: Why bother? Just buy a bond fund and be over with it. Let someone else bother with defaults, tenders, calls, bid/ask spreads, credit ratings and the like. I promise I will get to that post. This one is already too long.

Friday, December 11, 2009

CIT: It Lives!



Back in August, I blogged about CIT, the middle market financing company which was facing trouble funding its operations. It was a case of an apparently solvent company with a flawed business model.

LINK.

There was an interesting bond trade to be made, with CIT paper (many maturities and options) at below 70 cents on the dollar and as low as 45% for some maturities. It seemed like a decent wager at the time.

Well, after a relatively short 3 months, in which the company struggled with funding options, reorganization plans and dissident bondholders, and in the end settled for pre-packaged Chapter 11 bankruptcy, CIT emerged yesterday Dec 10 (after only 38 day in Chap 11). LINK.

My old bonds were replaced with new notes, laddered with maturities from 2013 to 2017 plus some NEW CIT shares. In all, the market value today of that package is about 80 cents of the original par value of the bonds. So, chapter 11 and all, if you tossed a few coins at this opportunity in August, today your bet is looking good.

However, if you opted for CIT shares, you came up with snake eyes. Those are worthless, as is the US government’s $2.3 billion TARP investment made in 2008. LINK.

And of course, if you are an original CIT note holder, you may not be happy looking at those 80 cents, but you’re still better off than having sold before Chap 11 and certainly happy you didn’t tender your bonds to Carl Icahn (who offered to buy them at 65 cents).

The point is that in bondland, default can mean many things, but not necessarily: “ you lost all your money”. So when you read about “default rates”, events may be included which may not be catastrophic. Chapter 11 can be a blessing.

Distress can be a synonym of opportunity, so don’t back down. But don’t be reckless and remember to spread it around.

Disclaimer: I already sold the shares, since I don't have a clear idea of how much the new reorganized company could be worth. The new bonds, which aren't your standard bonds (par value is $1 and interest is quarterly), have traded well, so I'll hang on to them for a while.

Thursday, December 3, 2009

All that Glitters…


…is a barbarous relic. In this case, one made out of shiny and precious gold. Gold has been in the headlines a lot in the past months and for good reason: its price has increased well over 30% this year and now stands at or very close to an all time record against the US Dollar (and other currencies as well!)

So just about everyone is saying what a great investment Gold has been or will be in the future. Before you go jump on the bandwagon and exchange your Euros, Swiss Francs or Bolivars for some shiny metal, take some time to read up about gold.

I’ll suggest the wiki page, which isn’t too long and quite informative. LINK.

Here’s my take:

Gold is the ultimate “want” material. Its demand is mainly from “want” and not from “need”. Gold’s limited industrial applications absorb around 300 tons of the stuff a year and it can be readily recycled and usually is, due to its cost. Total demand, however, is closer to 4000 tons a year. Most of that (over 80%) is for jewelry and almost a quarter of that is for India (800 tons). Gold is ideally suited for jewelry since it is attractive and highly malleable. It’s shiny.

However, despite arguments from my wife and Hindu brides-to-be, I think we can reasonably classify jewelry as a discretionary purchase. No one NEEDS jewelry.
Other uses include coins and bars. People buy these and stuff them in safe deposit boxes.

So basically, humans buy gold to hoard it. In jewelry boxes, in safe deposit boxes, in our temples, in our (OMG) central banks or buried under the sand on a tropical island.

An alien visiting our planet would find this behavior amusing (Spock says “illogical but fascinating”), but it’s something our cultures have been doing for centuries. National Geographic estimated that humans in our history have mined 161,000 tons of gold. It sounds like a lot, but since Gold is so dense, that’s only about enough to fill two Olympic sized swimming pools (again wikipedia is the source). It’s all hoarded or hidden somewhere.

Extraction of gold is running about 2500 tons a year, so there is a deficit of about 1500 tons a year, which is satisfied by recycling the gold in those two swimming pools. People (and I mean humans) will pull out their heirlooms, raid someone’s temple, find a buried treasure or simply sell their stash.

These market dynamics make Gold (and its poor cousin Silver), prime material for bubbles. Why? Because humans are greedy. Although the rational behavior of “homo economicus” would be to demand less gold when the relative price of it rises, many times it will be the opposite, the expectation of even higher prices will spur more demand and more hoarding.
Given the need for a voluntary recycling of gold stock to keep demand and supply in balance (and prices in check), small changes in behavior can cause major price swings.
Add in speculation, and you have all the ingredients for a bubble. One thousand tons of gold today are “worth” about $40 billion. A few hedge funds, some changes in allocation recommendation by some global players and you can add that kind of demand easily (or more). Gold futures allow mini-speculators like myself to control thousands of ounces without much collateral, not to mention what the likes of GOLDman Sachs can do.

In those circumstances, there is no upper limitation to price. Put enough players on the buy side of the gold trade and the result could be anything. Two thousand dollars, five thousand dollars. Whatever. Think Dot-Com circa 2000, Housing Circa 2007, Beanie babies, Tulips, etc. or….GOLD itself in 1979-80.

Goldbugs point to the metal as an “inflation hedge”. There is some logic to this rationale. Since the stock of gold is relatively stable, its value relative to other tradable goods (including stuff people actually NEED) should be relatively constant and unaffected by the high-speed currency printing presses flooding the world with their filthy “paper money”. (Here’s a good link about this).

This argument, however, assumes that people are rational in their trading of gold (sell high, buy low). But of course, if humans were totally rational, they wouldn’t hoard this stuff in the first place (or destroy the environment pulling it out of the ground).

Like it or not, Gold is destined for booms and busts.

Now that I have figured that out, the only rational recommendation would be NOT to invest in gold.

So, don’t INVEST in Gold. SPECULATE in Gold.

If humans are going to be irrational, herd-like and emotional, it would only be logical to try to benefit from that behavior. So trade the bubble.

How? First, forget physical gold. No coins, bars or heirlooms. The problem with these is that you won’t sell them when it’s time to do so. It will be stuck in box somewhere, and you’ll say “I’ll sell it when the market rebounds” or “I’ll get it tomorrow” and then you’ll fight with the dealer or jewelry shop guy over a few dollars. You’ll end up hoarding this stuff until the next bubble comes around, or maybe you’ll stuff it in your sarcophagus.

The other thing is that the gold rally didn’t start yesterday. The price has gone from around $300/oz in 2002 to $1200/oz today. Although I don’t think so, we could be nearing a top. But essentially, either it spikes further from here or it stops. If it stops, then why bother?

So, here is how I plan to play the gold bubble. Options. Normally I don’t buy options (I write them), but this is a place where I’d want to use them.

For example, September 2010 140 calls on GLD (a gold ETF aprox 1/10 price of gold), trade for about $5.75. I’ll buy 10 contracts for $5,750.

If all hell breaks loose on the gold market and everyone piles in, let’s say the price shoots up to $2500. I just turned those 10 contracts into 100 grand. If it all fizzles out, well there goes the Jamaican vacation. But that’s it and I won’t have to worry about finding someone to buy my Beanie Baby…er gold bar.
Classic high risk/high return bet. I like the odds better on this than eighteen red on the wheel.

Disclaimer: Caveat, Caveat. This isn’t investment advice and if you aren’t legally able to absorb it, please close your eyes and erase your memory.

Memory lane: you may have the impression that I don’t like gold. Not so. I made my first “killing”, if you will in the 79-80 bubble. At the time, I convinced my dad to buy some gold at $350/oz. in Sep 79 and piggybacked on the trade. A few months later the Russians, bless their souls, invaded Afghanistan and gold spiked. We cashed out in early 1980 at $620/oz, IIRC, after not selling at $800/oz or $720/oz or $680/oz. (ah… greed). I pretty much forgot about gold after that, but Dad lost precious time and money on silver mining companies and the like. (I lost my time and money elsewhere). Bubbles don’t grow again quickly after busting.

This one took 30 years!

Tuesday, November 17, 2009

Companies De-lever, Bonds De-liver


Last week, retailer Dollar General joined a growing list of companies who have taken advantage of the recent strength in the stock market to issue stock, mainly to REDUCE DEBT.

These kind of deals are normally very well received by bondholders, since in most cases, they make the existing and remaining bonds more "payable" and therefore more valuable. They are often followed by a tender offer for the bonds or an upgrade by the rating agencies.

Of course, attention to detail is important. In DG's case, of the 34 million shares sold, 22 million were new shares while the rest were shareholder sales (KKR, which took the company private two years ago). So the company only received about $450 million (the offering priced at $21). But then, DG had paid a $239 million special dividend back in September. So, all-in, the increase in equity is only about $210 million. Still, for bondholders this is "free" money and they'll take it. The fact that the company is now public, also offers more financing options for the future. It could always issue more shares, if needed and if the buyout company (KKR) needs to realize their investment, they can always sell shares into the market instead of taking dividends out of the company.

As for other companies who have done the same, the list is long. Here are a few: Dole Foods, Gaylord Entertainment, Louisiana Pacific, Cemex, United Airlines, Brigham Exploration, E*Trade Financial, Saks, AMR (American Airlines), Heidelbergcement, Huntington Bancshares, Sonic Automotive, Smithfield Foods, Xinao Gas, Office Depot (preferred), Arch Coal, Marfrig...etc., etc.

Most of these bonds have performed quite well, pre and post stock offerings. The stocks themselves...a mixed bag. As for specific tips, one of our favorite de-leveraging plays is Smithfield Foods. The company has had its troubles (swine flu, hog oversupply, falling demand, etc.), but seems to be coming out of it.

This meat packer, owner of the "Butterball" brand of Turkeys has a variety of bond "flavors" for every taste.
There are the senior unsecured, with a mouth watering yield of over 10%, maturing in 2013 and 2017. There are the senior secured for those who are a bit "insecure" and need the extra guarantee and convertibles for those who want some equity taste spicing up their bonds.

Enjoy...Thanksgiving is next week!

Sunday, October 18, 2009

Naftogaz Defaults, Bondholders Rejoice



A little update on my post a few weeks back on Naftogaz. As "kind of" expected, the company failed to make the principal payment on its $500 million bond issue back on Sep 30, generating what the rating agencies called a "technical default".
They did come up with the interest coupon, however. LINK

Since then, and also as expected, the company held a bondholder vote, and with an overwhelming majority (92%), holders of Nafto paper agreed to swap their "defaulted" paper for the to be issued 9.5%, 5 year, govenment-backed bond that Naftogaz was offering in exchange. Even the dissident group went along. LINK

A few lessons here. One is that despite the showdown and drama that played out in the press, there was no real interest in any other outcome. Bondholders weren't necessarily obsessed with collecting their money, just getting a decent deal in the exchange (which they did). It's not like there are ton of better opportunities elsewhere.

The next lesson is that not all defaults are created equal. There is a huge difference between this "pseudo-default" (although it was defined as such for effects of making good on CDS), and defaults such as the Argentine default in 2001 and the recent Ecuadorian default. No one's going to lose money on this one, and I wouldn't be surprised if the new Naftogaz bonds were trading above par in less than a year.

Finally, if Ukraine wants to be a player in the capital markets, they really have to get their act together. This back and forth about paying or not paying and letting everything go down to the last minute (and beyond) was totally unnecessary and counterproductive. A little professionalism and foresight go a long way towards reducing country risk (and hence interest expenses). Ukraine could certainly take a lesson from Russia in this aspect, as much as it may pain them to do so.

Saturday, October 10, 2009

The AIG Trifecta Part III – American General Finance



Now, the last part to the seemingly endless AIG trifecta, brought to you by this blog, chock full of ideas that may or may not make you money. (Now you know why I never went into sales).

American General Finance. I wonder, who came up with that catchy name? In any case, its subsidiary of AIG and it also has bonds out in the markets with double digit yields on them.

Should you buy?

First of all, understand that AGF is a consumer loan company. They will give people loans to buy a refrigerator or send their kid to college or (drumroll) to buy a house. The get their money from the same “wholesale” model that we discussed here with CIT and ILFC. For those who haven’t been reading, that means they issued commercial paper and mid-term bonds to the market. They would then lend that money to individuals (as opposed to businesses for CIT and ILFC).

I’ll link to the 10-Q, but here are the basic numbers: a loan portfolio of about $20.7 billion, of which (yikes) $15.5 billion are real estate loans. On the other side about $20.9 billion of long and short term debt.

AGF has the same problem that CIT faces: they don’t have access to capital markets right now to roll over debt as it matures. They also have the additional problem that their real estate portfolio -well- is not great. About a third is “sub-prime” (FICO less than 619), another 20% is “non-prime” (FIC0 between 619 and 660) and the rest is “prime” as defined by these guys (FICO over 660). (Nowadays, TRY getting a loan with a 660 FICO score…)

Delinquency rates are up and the average yield on the portfolio (about 10%) is high, but can’t support higher funding costs.

Trying to not get too numeric, there is a real problem here.

Fortunately for AGF, there are some things they can do. First, liquidity. They are in “collection” mode, as in collecting more than they lend out, so they are generating some cash. They are cutting costs by closing branches, etc. Plus, consumer loans and mortgages, as maligned as they may be are still “pseudo commodities” and they can be packaged and sold or securitized and used as collateral for lower cost loans (and AGF has done so). As long as AGF can collect and sell assets, they can service debt as it matures (until they run out, but that could take a while).

Second there is support. This year, AIG came up with over $750 million in fresh equity for AGF. That’s money AGF does not have to pay back (unlike the money AIG lent to ILFC). A “bailout”, if you will. AGF could need more in the future. How much? I’d say about $2 billion tops.
Additionally, AGF has “lent” its parent AIG over $1.5 billion at low (Libor plus 50 bp) rates, but at an interest rate nonetheless.

The idea is not to dwell on these transactions between parent and subsidiary, but to understand that as AIG and AGF become more intertwined, they also become less separable. AIG has only formally committed to supporting AGF until Aug 15, 2010. But how do they cut loose, once they have intermingled the finances of parent and subsidiary? It’s not that simple.

So the credit holder in AGF is basically watching a game of chicken with the government “supporting” AIG (can they really cut loose?) and AIG supporting AGF. Methinks that if all it takes is another $2 billion of equity infusion in AGF, AIG (and the government) will prefer to pay it than deal with the public opinion consequences of an AGF failure.
And frankly, who is going to know? Like anyone noticed when AIG put $750 million into AGF to shore it up this year. Two billion is a drop in the bucket in the whole AIG mess.

So there you have it, your “bailout” opportunity number three. AGF bonds are available in a number of flavors. Here are a few options:



I’m not particularly partial to this particular AIG flavor (AGF), but if you understand the risks, well that’s what its all about. Potential double-digit returns do not come without some risks these days, even if a government bailout is involved.

Psst. If you ask me, I’d get the short dated paper (May 2010), at least AIG has committed to support through that date.

And so ends the AIG trifecta. Yes, there is still more to AIG, like AIGFP, which was an integral part of the financial meltdown mainly due to the CDS it wrote on CDOs, like RMBS and CMBS, leading to TARP, TALF and many, many more acronyms.
But no.

Monday, October 5, 2009

The AIG Trifecta Part II – ILFC


As promised, the rest of the AIG trifecta. Part II is ILFC or International Lease Finance Corporation, an AIG subsidiary.

This part of AIG has been quietly “discovered’ by the mainstream press over the past year. So many of you may have read about it. LINK. LINK. (Very alarmist, not particularly insightful).

ILFC leases airplanes. Over 1,000 of them. They are the leaders in the business, which is dominated by themselves and GE Capital Aviation Services (a division of GE Capital).
Before you sigh and say “Oh no, the airlines are such terrible businesses, o dear me”, try to remember when they WEREN’T such terrible businesses. You can’t, can you? (unless you are really old, of course).

That’s why leasing exists and is so big for ILFC and GE. If the airline goes broke (as they periodically seem to do), the lessee takes its airplane back home and goes to play with someone else.

This has historically been good business. ILFC has been doing it since 1973, so they’ve been through ups and downs. This isn’t their first recession. The business is profitable: the company booked profits of $440 mm in the first half of 2009 and hasn’t registered a losing quarter as far as I looked back. LINK to 10-Q (if can you read these things).

So what’s the problem? Funding is the problem. ILFC would basically fund its operations two ways: commercial paper and notes (mostly medium term). It made sense, a typical airplane lease is three to five years, and so funding the purchases the same term is what would seem to be logical.
ILFC mid-term notes were even distributed on a retail basis as ideal investments for income-seekers looking for a bit more than the local bank offered (nothing strange with this, Ford, GMAC, GE, Dow and others do the same thing).

But when both the commercial paper and bond markets dried up, ILFC found itself in a bind. Notes were maturing at a quick pace and to boot they were a “part’ of AIG which was and to a point continues to be, financial caca (no touch!). The company was prepared (with credit lines) for temporary disruptions in the market, but this was and is and ongoing business. There were/are airplane orders in the pipeline, with which ILFC had to comply. These planes have airlines wanting them, but there is a cash imbalance in the process.

Mama AIG, now in government hands (kind of) has been both helpful and hurtful. On one hand AIG Funding lent ILFC $1.7 billion so it could keep up with maturing debt obligations and the purchase orders for new aircraft. (Taxpayer money? Not really, but the talking heads complain).

And AIG hasn’t been requiring dividend payments. But on the other hand AIG has been trying (unsuccessfully so far) to sell or otherwise dispose of this unit and that has undermined ILFC’s possibilities of obtaining stable (and inexpensive) sources of funding. Who is going to lend ILFC money (i.e. buy bonds), if they’re not sure what is going to happen to the company?

So there’s a kind of catch-22 going on with this. The press is focusing on the upcoming maturities as some kind of “impending doom”. Which I guess it could be. The notes are coming due constantly, as will the credit line (in 2010 and 2011).

However, if there is any rationality left in the market, this company should be able to come up with a solution, even if it is more stand-by financing by Mama AIG or even the government. AIG has committed to fund ILFC through August 2010.

A restructuring “a la CIT”, in which debt is capitalized wouldn’t seem necessary, since ILFC is far better capitalized than CIT. Not that it couldn’t happen, though. The ideal would be a return to the credit markets, which are thirsty for new paper. That return, however has been running into the concerns raised above about ILFC’s ownership.

The investment opportunity here is, of course, in ILFC notes and bonds, of which there many different options. The maturities are from now through 2013 and the yields currently around 11-13%. There are some large liquid issues, plus those retail “notes” that can sometimes be snapped up on the cheap, but which probably don’t have a good secondary market (so, you’ll have to hold them to maturity).

I’ve been a buyer, because frankly I can’t see a scenario where a Chap. 11 or a forced restructuring of this company makes sense. More likely they’ll come back to the credit markets sooner or later (as did Ford Credit) and get back to business.

It would be a shame that those shiny new 787 Dreamliners that Boeing is making should gather dust in the showroom.

Monday, September 28, 2009

Hertz: “We’ll come and get you” ®


Sorry, for the interruption in the middle of my multi-part AIG analysis, but I just had to write this up.

Reuters is reporting that Hertz has decided to file a defamation suit against an Independent Research Firm, for suggesting that it might go bankrupt. This has to be the most outrageous thing I’ve read all year.

Hertz was included in a list of “Twenty companies most likely to go bankrupt” which was published and circulated by Audit Integrity, Inc, an independent research firm.

The outrage is not that Hertz may go bankrupt, (I have no idea) but that Hertz actually files this suit and considers it an “appropriate response”.

So now every time an analyst states something a company may not like, the “appropriate response” is to sue? Wow. Just Wow. (Any lawyers out there willing to represent me on the cheap?).

A research report is an opinion. Like…first amendment protected? Remember that? Opinions are an integral part of the market, without them we would not have two sides to a trade. Shut that down and we can say goodbye to any remnants of transparency. It was bad enough when everyone had to be “hush, hush” last year about the collapsing banks due to “public interest”. Now we can’t state an opinion about a car rental company’s prospects?

As for the report, I haven’t seen it, but Seeking Alpha has the list. I obviously don’t agree with it, since I own credits for a number of the names on the list (no not Hertz).

That is not the point. Obviously. I can only hope (because if I predict, I get sued), that Hertz gets this thrown out and Audit Integrity countersues and takes Hertz to the cleaners. Maybe it will throw the company into bankruptcy. LOL. (That was a joke, Hertz people).

I certainly KNOW which rental car company I won’t be using EVER AGAIN. I think that is an “appropriate response”.

Bailout Bonds or The AIG Trifecta (Part I –AIG)


I got a ping on my Blackberry from a colleague/friend: “What do you think about AIG?” He was talking, of course, about AIG stock, which has been a trader's delight for much of 2009, from the short and long sides.

He might as well have asked me to tell him how general relatively is explained by string theory.

AIG is an analyst’s nightmare. Take one look at those financial statements and you can understand why the black hole that lurked within the company went undetected until it was too late.

Nowadays, even post-bailout, AIG’s 10-K (annual SEC report) is 344 pages long and its latest 10-Q (quarterly) is 221 pages strong. That’s without getting into the supplementary statements. To make matters worse, you can go through those reports with a comb and STILL not come away with an understanding of the company and much less a valuation of it.

You see, AIG is a holding company with different operating companies, all mainly in the financial area. To BEGIN to understand and value it, you’d have to go through all the main subsidiaries and drill down THEIR portfolios (now that we’re not sure of the value of anything) and businesses and add all that up.

Sorry, amigo, don’t have that kind of time. It also brings up the analyst’s conundrum: by the time the analyst has done the work, figured it out and written it up, the market has probably gone way ahead (perhaps on insider knowledge). So it’s not worth it. And as far as I have been able to find, there hasn’t been any deep research done on the company this year. Goldman Sachs, often fingered as the beneficiary of the AIG bailout lists the company as a “Not a GS-followed company”. (If someone can find a good report, send it my way, please).

I can’t say I blame them. I wouldn’t have an analyst spend time on unraveling the mysteries of the AIG universe, either.

Of course, you can read the WSJ and the Internet blogs. You’ll find outrage, opinions, conceptualizations, but very little in terms of hard numbers.

As frustrating as it may seem, sometimes you have to make use of less than perfect information and make some assumptions when investing. AIG and others like it, just stretch that reality a bit further than most.

With all those caveats, luck has it that that sometimes you can find tidbits of information that are particularly useful. Earlier this year I had been browsing through that mountain of AIG data, and I found this. LINK. Open it in a new window. Look it over, it’s important.


It is AIG’s post-bailout capital structure, explained by AIG itself. I know it may seem like Chinese to some, but basically this is the “pecking order” of AIG’s creditors, and bonds and shareholders.

First in line is the Federal Reserve Bank of NY, which basically has the first dibs on the sale/spinoff of several of AIG’s insurance businesses. AIG owes FRBNY over $40 billion.

Second is Senior Debt. Yes, Bonds. AIG has a number of senior debt issues outstanding.

Number three on the list is Junior Subordinated debt. Also bonds. A couple of these caught my eye. Will explain further down.

Four and Five is government bailout money and last on the list is the common stock.

So here’s how it works: if you were to value all of AIG’s assets (something I’m not going to do) and assign the value to the stakeholders in order of preference, there would certainly be enough for Level One. Also probably Level Two and probably Three. Levels Four or Five, not so sure. What’s more, we hear all the time that the government isn’t certain that they’ll get their money back. LINK. Well, until the gov is paid, there is nothing for level SIX.

How much is level SIX worth? No idea. If there are enough in assets and/or ongoing businesses to satisfy ONE through FIVE, level SIX is worth something. If not, it’s worthless. Right now, Mr. Market says that level SIX is worth $6 billion. Maybe it is. Maybe it’s worth 10 times that. Maybe zero.

I told my friend to trade the stock technically, if he was into that. What else can you say?

However, there is a lot to be said about Levels Two and Three. (Yeah, bonds). These guys collect BEFORE the government with its preferred stock. And so far, AIG has been making its debt payments on time and in full.

Not that this is secret to the bond market. Last year in the midst of the crisis, AIG senior bonds maturing in one year later (i.e. now) was trading at 50 cents on the dollar. Those brave enough to get in there, made their double. (Compare to those who dared to buy stock). (No, I wasn’t that brave).

Today AIG senior bonds are trading with yields mostly below 10%. They have been on a tear lately, since yields were in the high double digits only a few months ago.

Better returns are still available in the Level Three bonds, the junior subordinated ones. I’ve been able to get my hands on two different issues, the A-6, which matures in 2058 and the A-1, which runs through 2087.

The A-6 bond pays 8.175% coupon until 2038, when it changes to Libor plus 4.195%. Currently yielding about 14% until my kids inherit and something variable thereafter (which my grandkids might enjoy).

The A-1 is set up similarly, 6.25% until 2037, Libor plus 2.0568% thereafter until 2087. Trading around 50% currently, there’s some good interest payments left in those bonds until my great-grand kids collect the principal.

I was fortunate enough to get those bonds at a lower price, but would still consider buying them. AIG got its bailout, here’s a way get a bailout of your own.

As for the other two flavors of AIG. Next post. This is long already.

The Picture? Wayne Rooney. AIG used to be the sponsor of the Manchester United side. Ah, the good old days.

Sunday, September 20, 2009

Update on My Wife’s Junk



In one of those routine wanderings that people do while on the net pretending to be working, I waltzed over to Bank of America’s web site to check their CD rates.

One month: 0.30%
6 months: 0.50%
12 months: 0.95%
etc.

LINK

It only gets a bit better when you go out two to five years. (2 to 3%). Yes, FDIC insurance is included but only up to only $250,000.

BTW, notice how “interest checking” is accruing all of 0.01%. Seriously, how does BofA pay 0.01% and still call it “interest checking”?

Getting back to the rates, it’s got to be a tough pill to swallow if you’re a retiree or simply saving for something down the road and don’t want to risk it on the stock market.

Investors are moving into bonds. Can you blame them?

I’ve been harping on the issue for a while, I know. A few months ago, I ran a post describing my wife’s junk bond portfolio. It’s not the idea that those investments are specific recommendations. This was simply to show that a person with limited financial knowledge could put this together with a little help. So, other people can, too. (Notice I don’t say “anyone”, some people can’t or simply don’t care enough…but that’s for another post).

Here’s the link to that post. It’s not a long read.

My Wife’s Junk

Also, here is a table of what her portfolio looked like back then:

TABLE 1

A few things have happened between then and now. First of all, none of these companies has gone bankrupt (despite all the talk of “default rates”). Second, most of these bonds have moved up in price and there has been some corporate action. Third, my wife has made some necessary changes.

First she sold her Home Depot bonds (number 6 on the list) The yield on these came down to well under 3% and that is the “mortgage threshold” in this household (might as well pay down the mortgage). I had mentioned that she was thinking about doing this.

The Corrections Corp bond (number 4 on the list) was called. For the bond newbies (like my wife): some bonds have a provision that allows the issuer to pay them back before maturity. That one did. They paid back two years ahead of time. It doesn’t matter if you tell them nicely to keep your money. They still pay you, even if you don’t want them to.

The Owens-Illinois bond got a tender offer (see my post about Tenders...here). At 104%, for a bond with a year left, it was an offer she couldn’t refuse.

Here's the portfolio as of today. Click on the image to make it larger (and readable).



The new additions were as follows. The theme, is “flawed but fair”, as it should be with junk.

Interpublic 2014 6.25%. Interpublic is large global advertising company, whose claim to “shame” is being GM’s ad agency. The balance sheet checked out ok and, let’s face it, GM STILL needs to run ads. Now more than ever.

Dole Food 2013 8.75%. Food is stable business of course, but Dole was part of a leveraged buyout so it’s heavy on debt. But there is talk of taking the company public once again, which would improve the company’s balance sheet (and make the bonds less risky). S&P downgraded. Go Figure.

Continental Airlines 2011 8.75%. With this one, my wife kind of jumped right into the “risky” waters. Airlines are notorious for their tendency to go into bankruptcy and Continental has been in there –twice. But my wife figured, “hey, its only two years, Continental’s not doing that badly” and she has profits to fall back on. It’s always easier to take some risks when you’re already sitting on profits. S&P recently downgraded to CCC+ (from B-). The bond subsequently rose from 66% to 87%!

As for the rest of the portfolio, here is what it looks like now:

Advanced Micro Devices: This bond was downgraded from B to CCC+ by S&P in April. The bond has risen from 57% back then, to around 87% today. Thank you, S&P! In S&P’s defense, they are only assessing default risk, and not considering if the bond should rise in price. But seriously, do we really expect AMD, the world’s second largest microprocessor company, now with the backing of Middle East money, to go under?

Alcoa: Price is up, yield is down. Still beats the “mortgage benchmark”. So it stays.

Chiquita: Won’t go Bananas and sell now. S&P upgraded to B.

Davita: Has been stable, as expected. That’s why she bought it! (Dialysis Centers)

Jo-Ann Stores. This was upgraded to B- by S&P. This bond is going to a problem for my wife, because I believe it will probably be called next March. It’s hard to find, but if you want an easy 7%+ yield for about six months, I would recommend buying this (try to get it under par).

Seagate and Starwood. Nothing to say here. Just clipping coupons.

There it is, still short duration (average 3.35 yrs to maturity), still a decent overall yield (8.59%). A little riskier, perhaps (in S&P’s opinion). But my wife is still happy with it. And if she’s happy…well…you get the idea.

Note: comments now open to anyone. The death threats have waned. Just keep it on topic, ok?

The picture? Not my wife, but Ukrainian-born Olga Kurylenko, the latest “Bond Girl” (pun intended).

Thursday, September 17, 2009

A Kodak Moment in Junkland


Sometimes you make an investment and you feel uneasy about it almost immediately.
I had such a moment, a “Kodak” moment, back in January when I picked up some Kodak bonds.

These were 7.25% 2013s, yielding around 17% at the time and price of purchase. I had checked out Kodak’s financials and though they weren’t pretty, figured that the cash balance of over $2 billion would buy the company some time to get its act together. And it wasn’t a large investment. I was buying a lot of bonds at the time and trying to “spread it around”.

Yes, I was aware of Kodak’s problems. Bonds don’t get the “junk” label if they aren’t somehow flawed. But c’mon, it’s KODAK, the camera Dad used to take my baby pictures.

Then the First Quarter 2009 results came out (ugh) and later the second quarter performance was just as ugly. The cash balance was now down to $1.1 billion. Not unexpected, I guess, since there IS a recession going on (in case anyone on Wall Street forgot). This wasn’t just the recession, though; Kodak has been spiraling downwards for over a decade and now very sharply over the last five years. Sales for 2009 are likely to be approximately half what they were in 2004. Cash flow was negative. No tangible equity left on the books.

Consumer Digital Imaging Sales (i.e. Digital Cameras for us consumers) were down 33% Q/Q in Q2 09. And that’s the business that’s supposed to be a “keeper”. Kodak’s attempts to regain market share have been futile.
This was bad upon bad.

Despite a booming high-yield bond market; my Kodak bonds were floundering about where I had bought them. I pondered selling them, but the market was so good…maybe they’d catch up anyway.
But they sat there until about a week ago, when they jumped from the 65-70% range, to close to 80%.

Today I found out why. KKR will buy up to $400 million in SECURED senior bonds with warrants attached (maturity 2017) and Kodak plans to issue an additional $300 million in convertibles. This money comes at a hefty price. The KKR bonds haven’t priced yet (as far as I could see), but Kodak will pay KKR a 3% placement fee (for selling the bonds to itself, I guess) and the coupon is set at 10-10.5%. The details of the other issue (the convertible) haven’t been disclosed yet, but expect the financial cost to be high.

First order of business for these $700 million will be to pay off Kodak’s 3.375% 2033 convertibles, which have a put option (holders can and WILL sell them back to Kodak) in October 2010. That totals $575 million. Those bonds are trading close to par now (logically) after this announcement. LINK

So KKR’s deal bought Kodak some time and perhaps brought some frustration to stockholders who resent the possible dilution. Bondholders were mostly happy with the development (I sure was).
Who knows? Maybe Kodak will get its act together or develop some radical technology it can capitalize on. Or just survive to pay those 2013 bonds (all $500 million worth). These “maturing” companies sometimes decline gracefully. More often, they don’t, but still seem to find some nostalgia-filled white knight to give them a second, third or fourth lease on life. Not that KKR fits that bill, but…

I won’t hold my breath. My plan with most bond purchases is to hold until maturity and junk investors are optimists almost by definition. But when you make what you think is a mistake and you get a chance to correct it –at a profit- you have to take it.

So, with the bond trading up into the high 80s today, I’ll be looking for a chance over the next few days to sell these and let someone else enjoy a Kodak moment. Say CHEESE!

Tuesday, September 15, 2009

The Long and Short of Naftogaz


Ukraine’s state-owned gas company is not usually at the top of the business news here in the Western Hemisphere. But there is a story to it, and like usual in this blog, an investment opportunity.

So here’s the short story and the long story.

The Short Version

Naftogaz, 100% owned by the Ukraine Government, is not in the finest of financial conditions these days. But as a government entity, the Ukraine government by way of subsidy or capital infusion has bailed it out, time after time.

The company has a series of loans and other debt obligations coming due over the next two years, which it wishes to reschedule. The total is $1.7 billion. The interesting part (for us) of these obligations is a $500 million bond issue coming due September 30. Two weeks from now.

All summer long, Naftogaz has fueled speculation about whether it would pay these bonds on time. At one point, it seemed they would pay. And then they’d be back in the “restructuring” mood.

Two weeks ago, they hired Credit Suisse to help them with the process, so the “restructuring” seemed to back on. LINK. Yesterday it was announced that talks with bondholders were beginning. Some tentative terms were leaked to the press. LINK.
Not everyone is happy with this, and there is a dissident group trying to block the efforts and make Naftogaz pay up on time. LINK.

Naturally, all this has bondholders quite nervous and that 2009 bond (with a 8.125% coupon) maturing in two weeks is trading at 85-86%.

The terms “leaked” about the restructuring are a coupon of 9.5%, an additional five years, an explicit government guarantee and possibly an upfront “consent” payment. If that’s it, sign me up.

Certainly, Ukraine is not an easy place to invest, and there is a rocky road ahead. But it’s not easy finding double digit yields anymore, not even in the emerging markets. This is a risk I can stomach. This isn’t Ecuador, who thumbed its nose at the international financial markets, recently. LINK.
Ukraine has a $16 billion program with the IMF established last year in the midst of the global crisis. You don’t sign on with the IMF, if your plan is to default a few months later. (You default FIRST, and THEN go to the IMF)

Now the LONG version
(more interesting…but well, LONGER)

The Ukraine and Russia have had a complicated relationship going back centuries. I’ll let you wiki that if you will, but here’s how it all relates to gas.

Russia has gas, with 25% of the worlds known reserves. Europe needs gas, since it gets cold in the winter (and at other times also) Since the 1970’s, the Soviet Union has been exporting gas to Eastern and Western European countries through a network of pipelines.

Here’s a great map of those pipelines. LINK. (Don’t you just love maps?)

I did write “Soviet Union”, but the USSR is no more and the main trunkline of the pipeline now goes straight through now independent Ukraine. That pipeline now belongs to Naftogaz. But the gas belongs to Gazprom (Russia).

If this sounds like fertile grounds for conflict, it has been. Through the 1990s, Ukraine and Russia quibbled about these issues and in particular gas debts, since Ukraine had the habit of getting behind on payments for the gas it consumed.

Not surprisingly, things really started to get testy after the Ukrainian “Orange Revolution” of November 2004-January 2005, from which a pro-Western government emerged with talk of joining the European Union and (OMG) even NATO.

So at that time, Gazprom figured out that it was about time to look at the easy terms (below “market”) that Ukraine was enjoying for the gas it consumed, and of course, Ukraine wanted more money for “transit fees” through its territory. Naftogaz admitted to “turning the valves” its way (diverting gas for domestic needs).

The dispute culminated with Gazprom turning off the gas for EVERYONE on Jan 1, 2006. The Europeans, not really enjoying the prospect of freezing in January, helped broker a deal and supply resumed. A similar spats over debts and prices resulted in a disruption in supply earlier this year, again with some Western European intervention.

At the moment, Naftogaz is current with its payments to Gazprom, but that probably doesn’t leave a lot of room for other creditors (hence the proposed restructuring). Add to this the fact that Naftogaz still subsidizes local gas consumption heavily (something the IMF isn’t particularly happy about) and Naftogaz’ financial situation is still suspect. But, as stated above, there is an “implicit” government backing and frankly for all practical purposes, Ukraine can not cut Naftogaz loose.

If all this weren’t convoluted enough, Ukraine is scheduled for presidential elections in early 2010. The incument president (Yushenko) AND primer minister (Tymoshenko) are expected to run, as well as former president (and loser in the “Orange Revolution”) Victor Yanukovych, (Putin’s favorite., BTW)

If all this is a little too complex for your stomach, well, maybe investing in the emerging markets is not your cup of tea. Personally, I love this stuff, especially when I’m sitting 6,000 miles away. I’ll take the Florida heat over the Ukrainian winter (with or without gas) anytime.

PS. The picture is of Prime Minister Yulia Tymoshenko, who has the Princess Leia look down pat. She appears to be Yanukovych’s (the pro-Russia ex-prez) strongest opponent in the upcoming elections. Incumbent President Yushenko, the Orange Revolution “Victor”, is nowhere to be seen in the polls.

Sunday, August 30, 2009

Death of a Model?


While the Chicken Littles of the financial world have been relatively quiet in the past few months, there continue to be pockets of anxiety. Perhaps the name most mentioned in the past few weeks is CIT.

This relatively obscure financing company deals in what they call “middle market business and commercial loans, financial services and solutions”. So we’re talking about Small Business Administration Loans, Factoring (lending with receivables as collateral), leasing, etc. Middle sized companies, like retail chains, service providers and specialty manufacturers turn to these guys for money. On the consumer side, they finance student loans.

So basically no “mortgage meltdown” here, although the recession has affected their loan and lease portfolio and write-downs put the company’s results into the red for the last few quarters (not unlike most financial institutions). CIT received TARP money last year (again…like everyone else).

The balance sheet appears to be solvent, with $64 billion in liabilities to $6.1 billion of equity. Hardly levered compared to most, you could say. Cash flow is quite positive.

Nonetheless, CIT tethers on the edge of bankruptcy. Why?

The problem is funding. For years, CIT has financed its operations by issuing notes and commercial paper to the “market” and then using those proceeds to lend out. They call it the “wholesale model”. Get money in the market at 4, 5, or 7%, lend it out at 9-12% effective rate. Live happy ever after.

Of course, something happened on the way to the bank (or middle market finance company). The credit freeze happened. All of a sudden the “market” for CIT’s paper was no longer there. CIT did a few things, like issuing commercial paper with a government guarantee (for a while) and converting to a bank holding company, which allows it to get FDIC-insured deposits. Additionally, CIT reduced its portfolio (essentially lending out less than it was collecting).

But it hasn’t been enough. Notes issued in previous years are coming due at a quick pace ($13 billion for the next 12 months). Funding has not been forthcoming quickly enough (deposits at the CIT bank are only $5 billion). At least not CHEAP funding.

There is a price for everything and CIT recently got a SECURED $3 billion credit line from Barclays and a syndicate of banks. But at a price: LIBOR plus 10%, with a 3% LIBOR floor. (That’s a 13% floor and there are other fees associated,too). They got some of the cost back buying back some notes at a discount, but it doesn’t offset that much.

This is obviously not a permanent solution. CIT can’t operate funding at over 13%. And of course, while its liquidity problems remain, it can’t fund cheaply. S&P already has them at CC.

It’s a catch-22. CIT can’t get the money it needs because it has no money. Rinse, lather, and repeat. Can the “wholesale model” escape this circle?

Of course, CIT itself is lobbying quite clearly for a bailout. Just check out its website. HERE. They have a point. How is CIT that much different from another banking holding company (Citi? Morgan Stanley?) or GE Capital for that matter (GE continues to get TALF support). On the other hand, shouldn’t the “market” have a market-based solution for this?

If CIT is indeed solvent as it’s balance sheet indicates (you can never be sure), shouldn’t there be a buyer for it? And also if so, shouldn’t CIT be able to return to its original business model (selling notes at “normal” yields).

Of course, there is an investment opportunity here. These “survival” plays tend to carry a very interesting risk/reward ratio. CIT’s stock has been volatile for sure. But a bailout could carry a hefty price in terms of dilution, so no simple solution there. Potentially large payout, however, CIT trades at a market cap of only $600 million (excluding the TARP money…which could convert).

And there are bonds, of course. Bets on “survival” generally have worked well since Lehman collapsed last year. Solvent companies with liquidity problems can find buyers (as was the case with Nova Chemicals) or a government hand if they are “too big to fail” (Banks, AIG and subsidiaries) or something in between (Ford Credit. GMAC).

In any case, CIT paper maturing in the next 2-4 months is trading at 60-70% of par. Putting down 60 with an upside of 100 in a few months, with only one major outcome in play (survival), is a tempting bet. In the case of bankruptcy, CIT’s long-term notes, trading at around 45-47%, would seem to indicate that the expectation of recovery is relatively high.
So overall, I kind of like those “pot odds”.

Friday, August 21, 2009

Fun with Standard and Poors


On Tuesday (Aug 18) S&P downgraded the debt of homebuilder Beazer Homes (BZH) to “SD” or selective default. Two days later, the homebuilder’s credit (but not its bonds) was upgraded again to CCC, or basically where it was to start the week.

Before you say “whaaa”, lets just say that there is a reason behind the madness. What happened was that Beazer, seeing that its notes were trading below 50%, went out and bought a chunk of them back at those distressed levels. They invested $54 million to buy back $116 million worth of notes due in 2011-2016. Financially it makes a lot of sense, since they’re buying back bonds with yields of 30-50%. They’re not going to make that kind of cash building homes. Not these days, at least.

Well, S&P doesn’t like that very much. They call it a “selective default”. Basically, the company is taking cash on which all creditors have a claim and giving some bondholders (the ones selling) an early payment, while others get nothing. But you can also argue that by retiring debt at such a deep discount, the company puts itself into a better position to pay all creditors down the line. The market tended to agree with the latter assessment and Beazer bonds have rallied from as low as 22% at one time to 60-85% (depending on maturity).

As a (happy) holder of Beazer bonds, I don’t mind this kind of transaction, since it certainly beats other options available to distressed companies. Those usually involve issuing high-yielding secured debt, which basically puts itself in front of the creditor line and pushes us unsecured creditors down. S&P and Friends, on the other hand, don’t mind those as much.

Of course, S&P didn’t find out about these purchases until Beazer published its quarterly report (10-Q) a few days ago, and when they did, they proceeded to downgrade, but only for two days, since the fact is that the bonds outstanding are not really in default (and most probably are in a slightly better position to be paid).

This kind of thing happens in the strange world of debt and not only with obscure names such as Beazer. Earlier this year, Ford saw that its bonds were trading around 20% and instead of trying to purchase them in the market, decided to launch a tender at 30%. It was a total success with $9.9 billion in notes bought up by the carmaker. LINK. There was even a small arbitrage window, as those bonds traded around 20% for a few days AFTER the tender was announced (thank you, Ford!).

S&P weighed in to say “naughty, naughty”, but still had to reverse the downgrade a day later.

As for those bonds? Now trading around 70-75%. “Selective Default” indeed!

Disclaimer: I own Beazer and Ford bonds.

Tuesday, August 18, 2009

Love Me Tender


It’s always flattering when someone comes up to you and makes an offer for something you own, even if you weren’t intending to sell it.

Well, bond investors are being flattered enough to blush lately as a spate of tender offers has hit the markets in the past few months.

Here’s what’s happening:

When credit markets “froze” up last year, so did the market for new bond issues. Companies, which were looking to refinance to improve their maturity profiles or simply raise capital for some corporate purpose, were essentially locked out. And we know what happened to the secondary market.
When your “old” bonds are yielding in double digits, who is going to buy some new, probably longer dated ones, at a lower rate. So very few new issues hit the market.

But as the markets have thawed, it has enabled issuers to come to market, selling new longer-dated bonds at “decent” rates and usually accompanying it with an offer to repurchase some outstanding shorter dated.

Just to name a few issuers doing this: International Paper (twice!), Owens Illinois, Corrections Corp of America, Centex/Pulte.

Now a couple of examples to understand that mumbo-jumbo.

Two weeks ago, Jabil Circuit issued $312 million of 7.75% notes at 96.143% (yield 8.50%). Here’s a Link.

At the same time, they offered to buy back the $300 million outstanding of their 5,875% July 15, 2010 (that’s less than 1 year) notes for a “total consideration” of 103.125%. That price is equivalent to a yield of only 2.45% for the remaining term of the bond. LINK.

As a happy owner of the 2010 notes, I was glad to turn them in a year before I expected to collect (2.45% doesn’t meet my yield threshold…might as well pay down my mortgage).

So why would Jabil issue notes at 8.5%, to buy back an equal amount of notes at 2.5%? Well, obviously they want to extend maturities. The market is quite open right now for new issues and they can’t assume it will necessarily stay that way. It’s an extra $18 million in interest expense for the year for a company that only earned $157 million pre-tax in its last full fiscal year. The comfort that liquidity offers comes at a hefty price.

The holders of the 2010 note had a relatively easy choice. Accept the attractive tender (98% did accept) or keep their 5.875 % note and collect the principal next June. There is little doubt they will be paid. The 2010 bond will obviously have reduced liquidity now, but frankly, most of these notes are bought to be held to maturity.

Of course, once Jabil pays for the tendered bonds, what do you do with the money? Well, the Jabil 2016 notes don’t look too bad (can you get me some?).

Another recent example is Brunswick Corporation (bowling, marine equipment). Brunswick, being heavily in the non-discrectionary consumer category, is having a hard time with the recession.

The folks at Brunswick sold $350 million of 11.25% SECURED (i.e. collateralized) notes due 2016 at 97.036% (yield 11.89%) and have tendered for $150 million of their 5% June 2011 notes. They’re offering 97% for the notes, plus a 3% “consent fee”, for a total of 100%. LINK

No premium this time, but I’ll be tendering happily again since this credit was making me a bit nervous. The terms that Brunswick has paid to make the new bond happen, clearly shows that others are a bit skittish also.

In any case, I can’t buy the new issue, since it is a Rule 144A/Reg S. Non-US persons can, but frankly I’m not recommending this risk right now.

Although at some times its hard to say goodbye to a bond for which a tender has been made, it also allows you to adjust your portfolio and move to a more profitable section of the yield curve. Selling those notes with 1 or 2 years left and where most of the profit has been made –with very little cost-, is a great deal.

So for now…keep ‘em coming. I’m loving these tenders. On the other hand, the bond calls…well that’s another issue. (and another post).

Wednesday, August 5, 2009

Too Good to be True?

Corporate Bonds have gotten quite a bit of ink lately.

Here’s a link from Reuters “Nonstop corporate bond rally raises eyebrows"”and the more sensational headline from Bloomberg "Junk Bonds Make Loomis Sense Dot-Com-Like Danger”. Take some time to read those links.
Don’t panic, yet.

Basically, the storyline is “Hey, look at this great rally we all missed”. Since we all missed it, it has to stop. It’s a bubble, help us!

Or something like that.

As a confessed bond junkie (bond junker?). I’ll admit that things have been good. Unexpectedly good. Historically good.

Not unlike the equity markets, the rebound of the bond market has been fast and furious. Perhaps even more furious than stocks. According to the Reuters article July was the first month in many in which stocks outperformed bonds.

Here’s a graph from the St. Louis fed showing the yields of Baa rated (Moody’s – think BBB for S&P).



Since prices move in the opposite direction as yields, prices have been shooting up as those yields have collapsed. The move in junkier bonds has been even more dramatic.

Which is good, but it’s also bad because unlike stocks (remember the dot coms), bond prices are bound by rational limits. A risky (non-treasury) bond should not trade a yield below the corresponding treasury of the same duration. And of course, it makes no sense to buy a bond with a negative yield.

Treasury yields have trended up, as evidenced by this nice graph of the US yield curve.




Bond yields collapsing, treasury yields rising, spreads (the premium over the treasury yield) falling .we’re in for trouble, right?

Not so fast. Here’s a practical example. Let’s say back at the end of April you decided to buy some Alcoa 6% July 2013 at 92.75%, to yield a solid yet unspectacular 8.2%. Not bad for 4 years and Alcoa isn’t an extreme risk (BBB-, just what they call “investment grade). Good for you.
Today that bond is trading around par (100%), yielding 6% to maturity and you’ve made more in a single quarter (9.4%....the 1.5% coupon plus the price appreciation of 7.8%), than you expected to make on average in a year of holding the bond. Time to take profits and move on, right?

Well sure…you can sell. And do what exactly with the money? Put in in CDs? You’re lucky to get 1% on a three-month CD and 3% on a 5-year one. Treasuries? 2.63% for 5 years.
Less yield, lower risk.

You could increase risk, moving down in credit quality or longer in duration, looking for a bigger payout. Higher yield, higher risk.

Or you can stay put, which makes a lot of sense. First of all, because 6% YTM ain’t bad for 4 years and second because ot the shape of that yield curve.

The yield curve is seriously inclined and looks to continue to be that way for a while, even if it does move around a bit. For argument’s sake, let’s say that Alcoa’s spread vs. treasuries remains the same a year from now (330 bps) and that the three yield treasury remains at 1.66%. The bond would yield about 5% and trade around 102.75%.

So…it nothing changes and you wait a year on the bond, you’re looking for 6% in interest and 2.75% in capital appreciation over the next year. 8.75%!!! Not bad.
Sure, things can move, but as of now 8.75% is your base scenario for the next 12 months, not 6%.

That’s how powerful that incline in the yield curve is.

So, yes…this may be the beginning of a bubble. And yes, it the market has run quickly and far. And yes…this is like a bargain basement, all the good stuff gets picked up first (and is gone now), so you have to rummage through the bins to find value.

But when the yield curve is like now, think of how much fun it is to “slide down” as if it were a water slide.

So for now, I’m still buying bonds, and selling the bubble story.

Friday, June 19, 2009

Man of the Hour



I'm told by a friend that the picture is of none other than Leroy King, the recently indicted, currently on paid vacation, head of the Financial Services Regulatory Commission of Antigua.

According to the criminal charges brought against him today, he would have received payment in exchange for looking "the other way" when reviewing Stanford's financials.

So I guess this would be Mr. King in his favorite pose.

Stanford: Circle of Trust


As reported by just about everyone but very well by the Houston Chronicle (LINK), Allen Stanford was indicted by a Grand Jury in Houston. This came as a shock to only a very few “conspiracy theorists” out there who remain convinced that Allen was (and is) the victim of SEC overzealousness (or some other even further fetched concoction). A little reality check, please, people.

As for “what took them so long?”, I think it would be rather “how did they get this so quick?” It took about two years to get Ken Lay of Enron indicted. In any case, the indictment itself seems to lend some answers. Along with Robert Allen Stanford and CIO Laura Pendergest-Holt there were three others indicted: Houston-based accountant Gilberto Lopez; Houston-based global controller Mark Kuhrt; and Leroy King, a joint American-Antiguan citizen who was the head of the Financial Services Regulatory Commission down in Antigua.

Mr. King was the same one who in February declared that “everything was fine” in the morning, only to later say he would be “taking off the gloves”.
Apparently the US will try to extradite Mr. King from Antigua.

As for Mr. Lopez here's a cute comment from the Chronicle board"

I am oh so happy to see that they also picked up Gil "The World Revolves Around Me" Lopez. That man was as dirty as they come. Why don't they pick up his daughter Susan who also conveniently worked in the Accounting Dept. Oh, and his son Gil Lopez III who also had a high ranking position, for a contractor. We could all see if from the inside that it was a house of cards


Now this should be the answer of “what took so long”. CFO Davis, who apparently is being charged separately, and who has been cooperating with the authorities (i.e. singing like a canary) mostly likely had a good idea of “who knew what” and if he is trying to gain some favors with the authorities to see if they cut him some slack, well…you get the idea.

The authorities have to be frustrated with the Madoff case, where only Bernie sits in jail at this point. Davis’ insight may not help them recover more money (because there isn’t much more to recover), but he certainly has insights into who was in Stanford’s “Circle of Trust”.

These indictments are just the beginning. And here’s a tidbit I was sent, supposedly from a court document. If you have PACER access, maybe you can check is authenticity (at least if it was really filed as evidence). You know how it is with emails.

Additionally, the detailed recounts from Stanford executive meetings found in the SEC complaints are further evidence that not only Davis, but others have been “cooperating”. The authorities appear to be after the whole “circle” not just the main cogs.

Of course, all of this should give a certain relief to Stanford's thousands of victims, who may get at least some form of justice.
These developments, however, are likely to have little bearing on the ongoing receivership/liquidations processes, which are bogged down by in-fighting at the moment.

It's now up to the authorities to make these charges stick. Expect a very long and tedious (years) judicial process. The lawyers are licking their chops already.

UPDATE: Matt Goldstein at Reuters with another good take on the proceedings. Plus he uploaded the indictment. Good work!

UPDATE2: The SEC put its second amendment of its complaint up on its website. If you want the "juicy details" about how the books were cooked, this is a great read. LINK.

Wednesday, June 10, 2009

Kazakh Update


Here’s a quick update for the nine readers of my post on Kazakhstan back in April. President Double N sees signs of stabilization, according to Bloomberg and that "there is a possibility to stabilize the economy at the end of the first half. The financial sector stabilized and the construction sector revived.”
The kind of thing we’d like to hear around these parts.

To make things better and to show how I called something right (for once), it seems that the IFC (international finance corporation – investment arm of the World Bank) is looking at a 10% stake in Bank Centercredit, the bonds of which we mentioned in our Kazakh post.
As reported by Rencap and Interfax.

Of course, Centercredit bonds are up sharply from when we mentioned them, but still yielding around 15%. The IFC endorsement would give it a huge credibility boost.

Borat would be proud.

The picture is a yak, of course.

Tuesday, June 9, 2009

First Stanford Book: Imperio de Papel


To no one's surprise, books about the Stanford case are beginning to appear. This is the first one I've seen: "Imperio de Papel: El caso Stanford desde adentro" (Paper Empire: the Stanford case from the inside) edited in Mexico and as far as I can see only available in spanish for now.

It seems author Gabriel Bauducco sat down with a Mexican Stanford advisor (Hombre X) and turned it into a book. If I get my hands on it, I'll skip through to the end to see where the money is. Don't hold your breath though.

I'd expect a few more books to be on the way, now that we've already seen at least two TV specials (CNBC, BBC). Looks like somebody, aside from the lawyers and receivers, may make some money on this after all.

Saturday, May 9, 2009

Stanford Venezuela Recapitalized


The Venezuelan government announced that Banco Nacional de Credito (BNC) was the winner of the auction to control the assets and liabilities of Stanford Bank de Venezuela, a local commercial bank.

Although the press is characterizing this as a "sale" it was not really a sale, but rather a "recapitalization" and here is why:

In February, Stanford Bank de Venezuela, owned by Allen Stanford, was taken over by the Venezuelan government after the SEC filed a civil complaint that Mr. Stanford was running a ponzi scheme out of his Antigua bank.

Subsequently, the bank was declared insolvent and equity was written down to ZERO (declared lost). At that point it had NO capital and the owner was basically NOBODY.

An auction process to recapitalize the bank and assume the bank's liabilities (deposits) and assets was initiated and after two failed trials, BNC was declared the winner.

BNC will inject 240 million bolivars ($112 million at the official rate, $35 million at the rate everyone else has to use) to replish Stanford Bank de Venezuela's capital. This money will go into Stanford Bank de Venezuela, which will be then merged with BNC. BNC is basically paying to cover any further losses at what is now its own bank. The Venezuelan government gets NO money from this sale. Allen Stanford's "estate" gets NO money from this sale. The bank was basically given away to whoever put enough money in to recapitalize it.

For the depositors of Stanford International Bank in Antigua there is nothing to see here.

Stanford Bank de Venezuela reported a book value of Bs.88.3 million ($41 million official rate, $13 million otherwise) as of December 2008.

Thursday, April 30, 2009

Economic Learnings of Kazakhstan for Make Benefit Glorious Investors



My relentless quest for Junk takes me to the far corners of the earth. Figuratively, that is. Today’s subject of interest is Kazakhstan. A country I’ve had to learn about from wikipedia, since it didn’t exist when I was a lad. (and Borat).

Born (or reborn) in the breakup of the Soviet Union, It’s not hard to find on a map, since it is HUGE. It’s the eight or ninth largest country in the world, depending on your calculation method and sparsely populated with only 17 million inhabitants (about half Mulsim, half Russian Orthodox Catholics).

The place is a mineral treasure trove with practically every element in periodic table, including that ever-important U. Oil (about 3% of the worlds reserves) and gas, to boot.
(They need the gas…it gets REALLY cold in Kazakhstan in winter).

Sounds like a great place to invest, right? Well, that depends. Politically, it is led by a “demtator” Mr. Nursultan Nazarbayev since its breakaway in 1991. The constitution allows him to run for president as long as he lives, although future presidents will be limited to two five year terms (we know that can always change). Dissidence is not well tolerated. So keep that in mind



Unlike some of his South American demtator counterparts, however, Mr. NN has embraced market economics and the country has moved in that direction. The Heritage Foundation ranks it 83rd among nations in terms of economic freedom with a “moderately free” classification. (Venezuela is currently 174th, only surpassed by Eritrea, Burma, Cuba, Zimbabwe and North Korea). The economy has enjoyed stellar growth since 2000 until, well, recently (like everyone). Transparency International has Kazakhstan at 2.2 in the corruption scale. (0-10, 0 being the worst).

To his credit, Mr. N has done a pretty incredible foreign policy balancing act. He gets along well with the neighboring Chinese and Russians. He has visited Iran, which lies across the Caspian Sea from Kazakhstan, and still also enjoys relatively good relations with the US and Israel.

The country is facing an economic crisis, the onslaught of which was about a year ahead of the rest of the world (except perhaps Iceland). Banks are the center of the crisis, as local institutions, which financed domestic consumption and construction excesses with foreign capital (sound familiar?) find themselves in trouble.

A few weeks ago, fourth largest bank Alliance, found a $1.1 billion “surprise” liability and has defaulted. This week, the largest bank BTA, already taken over by the government in February, is facing the prospect of default and failure if it is unable to restructure its over $13 billion in foreign borrowings, despite receiving a $2 billion capital infusion from the government. LINK LINK2

In summary, it’s a mess, like everything else, except this mess is an 8-hour plane trip from civilization in every direction.

Invest? Sure. You could make your way down to the Kazakhstan Stock Exchange in Almaty or buy some bonds.

For the adventurous but risk-adverse, we offer Kazmunaigaz, the state-owned gas concern. Its 2013 bonds with a 8 3/8% coupon are trading at around 92%, yielding around 11%, while the 9.125% 2018s are around 87%, yielding close to 12%. Kazakhstan has $18 billion in reserves and I don’t think their gas company is going to default.

On the other hand, for those wishing to roll the dice a bit, we’ll make a suggestion in the banking sector. Not BTA and Alliance, although their bonds trading at 10-20% of par are enticing, restructuring and all. The one we like is Bank Centercredit, a smaller bank, whose largest stockholder (with 30%) is Kookmin Bank, the largest bank in South Korea.

BCCD’s 2011 bonds are trading at 61% to yield a whopping 41% to maturity, while its 2014 offering goes for about 50% to yield 28%. It may be a “coin flip”, but considering the backing, the chances for recovering the full amount at maturity look good enough.



There is a catch, however. If you are a US Person these bonds are off-limits. You can not buy them, you can not read about them. Please stop now before your eyes explode!

Why, you may ask? Well the US may enjoy economic freedom as far as the Heritage Foundation is concerned, but in terms of “investor” choice and freedom, its down by the bottom. Kazakhis can buy US bonds, but US investors cannot return the favor.

But that’s another story.

*demtator = democratically elected dictator. Dictocracy already has an entry in the Urban Dictionary and it means something else.