David Clayton

Buffett's $5B Goldman Investment Up $2B? Try $6B

One correction. I wrote in my ending scenario:

"Suppose GS redeems the preferred for $5 billion on October 1. Berkshire will have received $500 million in dividends, or 13.9% of the investment less the initial value of the warrants."

The redemption premium must also be included here. In the scenario, Berkshire would receive $500 million in dividends and a $500 redemption premium, or $1B. Divided by the investment less the warrants' initial value, the return is 27.7%.

For those who have said $2.2 billion is the "correct" value of the warrants, please explain why an option that expires in January trades for more than one that expires next month.

Ford Takes Major Step to Reduce Debt

Currently, the Ford trust preferred shares, which are convertible into 2.8249 common shares, are trading at a premium to common of 5.0% ($10.88 vs. $3.66 x 2.8249). Starting with the April distribution of $0.8125 per share, Ford started a deferment period on this issue as part of its cash preservation strategy. The dividends are cumulative, which means that if Ford continues as a going concern, it must pay all deferred distributions plus interest within 5 years.

At the current price level, the nominal dividend rate is 29.9% ($3.25/10.88). There is a tax question which I have not resolved to my satisfaction, which may mean it's preferable to own this in an IRA or other tax-sheltered account. More information can be found in the articles listed here: seekingalpha.com/symbo....

DISCLOSURE: Long F-PS, GXM.

Berkshire Hathaway Faces Higher Funding Costs Now

@Ravi Nagarajan: You wrote: "While yesterday’s notes were priced to yield 282 basis points over Treasuries, the yield spread was only 220 points in January when Berkshire sold $250 million of 5.4 percent notes due in 2018."

Please consider these other data points that help to explain differences in the Treasury-corporate yield spread:

1. It appears that as maturities increase, spreads tend to narrow. The spread on 10-year notes is running about 297 bp right now, while on 5-year notes it's about 339. Berkshire's bonds this week mature in 3 years, and I think should be expected to have a wider spread than its January bonds, which mature in 9-years.

2. Spreads are different now than in January. They've mostly narrowed. Yields on 5-year notes are 13-14 bp lower, while on 10-years it's 5 bp.

I guess the differences in the lending market and the maturity lengths explains something more than half of the increased spread.

Trust Ford's Trust Preferred Shares

Prospectus:

www.sec.gov/Archives/e...

Trust Ford's Trust Preferred Shares

@STASH48126:

You would not collect any dividend. Prospectus page S-52: "On the interest payment date occurring at the end of each deferral period, Ford shall pay to the holders of the debentures of record on the record date for such interest payment date (regardless of who the holders of record may have been on other dates during the deferral period) all accrued and unpaid interest on the debentures, together with interest thereon at the rate specified for the debentures."

As for the taxes paid, I assume you would then be able to write off any accrued dividends paid, but would consult a tax professional for guidance.

> If I held on to my Ford preferred for another year, then I sell it.
> I know that I have to pay on the dividend income, but when and if
> Ford pays the dividend, will I receive the dividend income that I
> paid taxes on or does it accrue to the stock and payable to the last
> holder of the stock as of ex dividend date.

Trust Ford's Trust Preferred Shares

A commenter at my latest article pointed out that I've been miscalculating the nominal yield. The dividend is $3.25 per share. So when this was $5.22, the nominal yield was 62.3%. At today's close of $8.33, it's 39%.

Ford's Debt Reduction Plans Are Working

For some reason the link to my previous article doesn't work:

seekingalpha.com/artic...

Ford's Debt Reduction Plans Are Working

@UpsideHunter: I believe you are correct. I have no idea where my error crept in, but I've been making it for a while now. The dividend is $3.25 per $50 (par) share, putting the current nominal yield at 39%.

www.sec.gov/Archives/e...

On Pensions and Tax-Exempt Bond Insurance

As I recall, Berkshire Hathaway's sales in the municipal market has been wholely or mostly secondary insurance, meaning that the primary insurer would have to be unable to pay claims (i.e. bankrupt) for Berkshire to have any liability. That bondholders see value in such insurance says much about the state of the insurers, fear of the future, or both.

High Yielding Preferred Stocks Could Also Get the Dividend Ax

@djhernandez - I only know PGF, and it tends to trade very near its NAV, so it's traded up because the underlying preferreds have traded up. I haven't looked at these closed-end funds before. The first thing I noticed on BlackRock's page for BTZ is that they say it's trading at a 20% discount to NAV. Next thing I see is total expenses of 1.65%. The quick answer is that PGF is almost entirely bank preferreds, while BTZ is much more diversified.

The Real Reason Behind Berkshire's Exploding CDS Spreads

@BS Detector: The idea of reverse-engineering the Berkshire index puts intrigues me. Have you made any progress, or would you mind if I put an article together on it?

High Yielding Preferred Stocks Could Also Get the Dividend Ax

@paultaut: when news of the C deal broke, I looked up the TruPS of C and also BAC, since its the most likely bank to be forced into a similar kind of deal. The idea being that the C action would be a model for BAC if things get worse. It was very interesting that C's TruPS remained unscathed and actually reaffirmed. I guess that was because converting that debt to common would be complicated by the trust structure. Since C specifically said the TruPS would continue to be paid, I thought they would gain stability from the announcement. Didn't happen. I thought BAC's preferreds would get support. Didn't happen. If I wrote something that indicated I thought BAC is in danger it was a mistake--I moved some of my PGF into the former Merrill Lynch preferred BML-PQ because it was the highest-yielding of the BACs. I think the C news moves the chance that BAC stops preferred payments to near-zero. As with C, which will no longer have any non-TruPS preferred, BAC would also offer a conversion to common. Of the TruPS I like MER-PK best because of the higher yield and trading volume.

I also looked at the Ford TruPS when the Ford debt conversion news came out, and wrote something about it here: seekingalpha.com/artic...

Trust Ford's Trust Preferred Shares

My submitted title was "Trust Ford's Less Preferred Trust Preferreds?" Too cute, I guess.

epeon - today's news about the union accepting reduced compensation is really a great indicator that the union recognizes the seriousness of the problems, and is truly taking steps to help keep Ford out of bankruptcy.

jdmballm - I'm not an accountant, and I haven't looked into the "why," but it is certainly the case that tax is due on these dividends as they accrue, whether they are paid then or later (it's plainly stated in the prospectus). I'm guessing it's all part of the favorable tax treatment the company gets in payments to the trust preferreds - because the trust issues debt to the company, the company's payments are interest and therefore pre-tax.

richandmer - I haven't investigated any of Ford's securities beyond those that have been in the news lately.

Brian - You clearly have better information on the trading nuts and bolts than I do. I'd be much obliged for any information sources.

High Yielding Preferred Stocks Could Also Get the Dividend Ax

The stated yields are incorrect. Current yields (at specific prices):

PGF ($6.50): 21.5% - www.invescopowershares...
PFF ($13.62): 14.4% - us.ishares.com/product...

Also, the management fee of PGF is scheduled to increase to 1.00% in August.

You failed to mention that Citigroup's action suspending the preferred dividend included an offer to convert them to common shares at a premium. The preferreds jumped 30-60% on the day of the announcement.

Cutting dividends on preferreds is very much a last-gasp survival tactic. With the common stock so low, a secondary of common isn't feasible due to the dilution, so preferred is the only viable capital raising mechanism. Killing the preferred dividends damages their value tremendously, and makes raising capital with additional non-cumulative preferred issues impossible. When Ford deferred its cumulative trust preferred dividends last week, the shares lost 40% of their value and now trade at 21% of par. And those are dividends that will be paid eventually if the company survives.

So what C was doing was throwing in the towel. Citi does not expect to raise private capital again (though they left the trust preferreds intact, so there is a small window there), and so it is taking extreme steps, backed by the government, to preserve every dollar it can.

BAC might find itself in a similar position, but I don't think any other national U.S. bank is in anything close to this condition.

In addition to the fact that PFF holds a significant amount of trust preferreds, the other differential between these two ETFs is the foreign exposure in PGF. Many of the foreign banks are struggling at least as mightily as Citigroup, and investors are much more inclined to believe that governments will take them over. Currently, the highest-yielding U.S.-based components are BAC, averaging about 25%. Yielding more than this are preferreds of Aegon (34%), ING (37%), and RBS (42%).

Compare the average 25% yield on BAC preferreds with the current yields of WFC-J (14.8%), USB-L (12.0%), and JPM-I (11.5%), and you can see that the market does not share your concern about those dividends.

While I own the PGF (and have taken a bath), the European shares definitely make it quite speculative. I am fairly confident about the BAC preferreds at this point, and moved some of my PGF holding into BML-Q after the Citi debacle (my opinion here: seekingalpha.com/artic...). I hope to write a piece soon explaining my opinions on a number of preferred issues.

Glancing at the holdings of PFF, which I don't own, it looks very solid to me. Yes, there are a few problem children, but I don't think there's much question about the vast majority of the components' ability to pay dividends indefinitely. That's why the dividend is only 2/3 that of PGF.

When Preferreds Aren't Preferred

howisbiz - I don't know the mechanism, I suspect that you'll be getting something from your broker, as you would for other shareholder questions. As for the price, I think they probably selected a premium to market to dampen any potential shareholder unhappiness, and that the 20-day average is just a coincidence. My opinion.

I believe your cost basis will carry through to your converted shares, so you'll end up with $7307 common shares with a basis of $3.42 and fractions. Again, what you get from your broker should explain it.

MarkTwain - I have no problem with the pricing - I have a problem with the dual treatment and the uncertainty it introduces. We don't need more uncertainty.

drbob - While I think the government's action is a bit damaging to the capital raising prospects of the banks - such as they are - I don't think it's a big negative for PGF; the market's clearly already discounting the chances of future dividends significantly. Current price: $5.93 for a nominal yield of more than 24.5%. I think PGF is as good a way to stay in financials as anything, but I've thought that since it was in double digits. Make sure you're diversified - beware the black swan.

By the way, I'm intrigued by the effects of the C action on BAC preferreds. Clearly, BAC is the next most likely to receive this conversion treatment, which would put a (wobbly) floor under it. And yet its preferreds are falling like nothing's changed. The best IMO is BML-Q, a PGF component, which is now yielding 37.9%. I think the government action makes this a much safer investment, and yet it's lost 25% this week, falling in tandem with BAC. A short BAC hedge could make a long BML-Q position profitable in almost any scenario.

Thanks for the conversation.