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laterre

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  • RadioShack Corporation: Bond Risk And Return Analysis Looks Grim [View article]
    Virtually no owned real estate, and what's owned (mainly inventories) is pledged to senior secured creditors. So there's no "Sears Holdings" liquidation/ reit story here. While the average lease term remaining isn't bad as far as retail goes (3ish years is my recollection), the leases are what makes closing all those locations so painful. Absent a Ch.11 filing (or some really creative subletting), they're stuck paying rent on closed locations for several more years...
    Mar 17 03:10 PM | Likes Like |Link to Comment
  • RadioShack Corporation: Bond Risk And Return Analysis Looks Grim [View article]
    Hey Don,

    Great analysis, as always! Agree that the bonds (taken by themselves) are overpriced relative to the risk. IMO, it's not a matter of a whether on the BK filing, it's a matter of when (though to be fair, thus far I've been early and wrong on their ability to stretch out their liquidity).

    But owning the 2019s and collecting some coupons along the way is a decent way to soften the theta burn on the short. If you assume that the equity will be a zero under any form of restructuring, then a capital arbitrage trade (long the bonds, short the common) can make sense depending on your entry point and the timing. A longer bk horizon (say, in early 2015) means that the unsecured bonds will end up being worthless (given the cash burn) as they draw on the senior secured lines of credit, but you'll pick up a nice positive carry along the way to support the short. On the other hand, a quick, surprise filing later in 2014 may mean some recovery (through a share of the post-reorg equity) on the unsecured debt, plus a nice fat payout on the short as the equity goes to zero. I don't love this arb trade any more, but if you get the balances right, it still has limited downside and a decent upside in a quick BK. Explains the interest in the 2019s.

    Bad signals sent by the cash retention bonuses if they make it to 2015. What that's saying to me is that they don't want stock options as they know that sooner or later the equity will be a zero. And you know the first thing that the unsecured creditors committee is going to argue is fraudulent conveyance to try to claw these back.
    Mar 6 12:13 PM | Likes Like |Link to Comment
  • What Are Puerto Rican Bonds Worth? [View article]
    Sure, makes sense, but again, the devil (and potential profit) is in the details...

    All this assumes a default--now or later. But at 15% tax adjusted yield and a 30-40% (or greater) initial discount to face, you're looking at a very healthy cushion against a default down the road in 2015 or 2016. Two years of coupons at that rate goes a long way toward softening the blow of the worst case scenario. I'm not saying that a default won't happen eventually, but the odds are stacked in your favor at current prices.

    The question of what advantages NY law bonds might enjoy against otherwise pari passu securities is interesting, but it's also a red herring at this stage of the game. You can understand why new creditors would want to ask for this, and you can also understand why PR will readily agree to it. If there is indeed no default, covenanting this costs PR absolutely nothing, and it's a concession they'll exchange for a lower interest rate in what is going to be an oversubscribed offering. So the new bonds will almost certainly have this covenant, and it may never matter.

    But the question is why, if this is supposedly so awful for existing creditors, bonds have been rallying in the face of this news? Look at the math. Assuming a default, and asymmetric bargaining power between new creditors and old creditors, what effect would a guarantee of a 100% recovery on the newest $3B in "senior" debt really have on recoveries of the outstanding $30 or $40B of GO debt that's supposed to be pari passu. If you assume there's some fixed amount that PR can afford to pay in a hypothetical restructuring, and that the new "senior" bonds get the first $3B 100% unimpaired, the proportional "impairment" to the outstanding non-covenanted debt is relatively negligible--maybe the difference between a .60 versus a .65 recovery.

    You talk about a "repudiation," by which I gather you mean a 100% haircut or total wipeout for PR law bonds. This is a worst case scenario--some radical party captures control of the PR govt and tells creditors to go pound sand. You can't rule this out, but I also think it's fantastic. Even with Argentina or other rogue serial defaulters arms-length from the rest of the world, it's never an absolute repudiation. The reason why Elliott et. al. have gone to war in the courts against Argentina is they chose to be holdouts (or bought the old debt at extreme discounts from earlier holdouts). It's always in the interest of sovereign debtors to deal, exchanging old debt into new for a haircut. In the case of a quasi-sovereign entity like PR, where the US exerts such leverage over the PR economy, there is no way under the sun that they could afford just to repudiate all the debt. Less favorable terms on the restructuring deal, sure, but at .50 on the $ and a 15% carry, how much more cushion could you ask for.

    One last thought, and then I'm done forever talking about a subject on which no one is willing to think inductively. PR is suffering a liquidity event, not a solvency crisis. Their aggregate debt load is fundamentally no worse than Japan, for example, or any number of Euro-zone nations who have been given a free pass by the capital markets. None of these countries could ever repay all the debt they have outstanding if it were to begin coming due. That's a sign of a shitty credit--the fact that it's mathematically impossible for it to ever be repaid. It's permanent or structural debt. But the fact that a debt can never be repaid doesn't *necessarily* mean that it's a bad investment so long as it can be perpetually rolled over. This PR thing has been every PM's dirty little secret for years. But as with Japan or Spain (or Illinois, California, NJ, etc), no one cares--and in some sense it really doesn't matter--so long as capital markets remain open for business and the debt can be perpetually refi'd.

    It's the same as someone carrying a huge balloon mortgage they can never pay back or a business line of credit. It may be reckless financial planning, or a crappy business, but so long as the debt can be serviced (can you afford the payments every month) and rolled when it comes due (your lender doesn't yank the loan one rainy day), you are not predestined for bankruptcy. That's where PR was 12 months ago, and likely where it will be again 12 months from now when everyone's done talking about the imminent default--a crappy credit that people in a ZIRP world are willing to subsidize at a marginal spread premium.

    LT out...
    Feb 23 10:17 AM | 2 Likes Like |Link to Comment
  • What Are Puerto Rican Bonds Worth? [View article]
    So let's assume that you're right in all of your assumptions and that some form of restructuring is inevitable--either this summer or in the next few years. I happen to think that's wrong, and that the scoop and toss is already a done deal, but leave that aside for now.

    Where do you come up with .30 on the $ as a number for recoveries? I get that's what YOU'D pay (the market disagrees with you) and thus we can see why you'd be short. [The negative carry on that trade would be brutal, BTW, and offers a horrible risk/reward...] But how did you pick this particular value? All of the considerations you cite (which are well known in the media and blogosphere) have to do with whether a default will occur. They say nothing about what the likely terms would be of a restructuring. Absent some consideration of the latter question, the former is nearly irrelevant when it comes to formulating an investment thesis.

    What I keep waiting to hear from all the shorts is how you come to the conclusion that GOs or other debts are a bad deal at some particular price. In order to determine this, you need to know more than the probability of default (which is something less than 100%...). More importantly, you need to consider: (a) What is the realistic capacity for debt service were PR to restructure its debts, and thus what kind of haircut from par would various classes of bondholders be facing? This would require modelling against baselines for multiples of debt service of corporations in Ch. 11, as well as successful municipal and sovereign restructurings to derive a confidence interval within which a restructuring makes sense for creditors; if you were sitting across the table from them in a negotiated restructuring, how much of a haircut (if any) would you be willing to take and what new bonds would you accept in exchange given a reasonable estimate of PR's capacity for debt service; (b) What have been the typical haircuts imposed on bondholders in previous restructurings, whether other territorial restructurings, municipal defaults in the US, or sovereign defaults (if you think cases like Argentina are really analogous to the PR case). Hint: they're significantly less than the 70% you're assuming or the 100% wipeout floated in the media.

    The bottom line: at some price, any investment can make sense. I tend to think this one offers a very attractive risk/ reward at .50-.60 on the $ for some of the bonds, but there's admittedly a lot of variance to this situation.
    Feb 20 05:04 PM | 1 Like Like |Link to Comment
  • American Capital Agency - Is Hatteras Cheap Or Is It Something Else? [View article]
    Hey, Dividends 1, yes, good to hear you're still in AGNC and had the sense to buy when others were selling. Take care of yourself in 2014.

    I say unpopular, critical things because, under ordinary circumstances, people systematically overestimate the probability of good things happening and discount the probability of bad outcomes.
    Feb 17 02:59 PM | 1 Like Like |Link to Comment
  • American Capital Agency - Is Hatteras Cheap Or Is It Something Else? [View article]
    "3.) The insiders own a substantial amount of the equity."

    Really, you think so? Originally ACAS owned a big share of the company, but they sold it off... GK owns 800K or so shares, which isn't spare change, but most of these were part of big stock grants insiders gave themselves. I've never seen conspicuous buying there from insiders, especially during their numerous SPOs.

    Now I will give Kain credit for MTGE. He ponied up a big chunk of his own cash when they IPO'd.
    Feb 17 02:48 PM | Likes Like |Link to Comment
  • American Capital Agency - Is Hatteras Cheap Or Is It Something Else? [View article]
    Nice catch--someone figures out the trick... Buying back your own shares permanently cancels those shares, lowering your AUM (and fees). Buying back a competitor's shares takes advantage of the discount, but gives you the flexibility to dump those shares (and redeploy the capital) whenever you see fit. I don't think it's purely about the fees, but that aspect of it is certainly a nice side-effect for the mgmt. They can't earn 20% ROE themselves any longer, so the best use of capital was/is share repurchases.

    The most telling line from your article: "During 2013 they sold over 57mm share at over $31/sh and repurchased 40mm shares at a price of $21..." Ouch. What do those numbers say about the magnitude of their blowup in 2013? Does it indicate their "savviness" as mgmt that they were doing massive SPOs at the top of the market and piling the proceeds into low coupon 30s with payups, when mbs was stupid rich, and then dumping those very same mbs in a panic at the bottom of the market last summer and fall? Tells me they do a heck of a lot better job trading off retail than they did trading mbs last year.

    The lesson here: do as they do, not as they say. When the mreits are selling shares, you want to be selling, and buy when they're buying.

    Disclosure: long MTGE
    Feb 17 07:53 AM | 4 Likes Like |Link to Comment
  • Puerto Rico And Municipal Credit Default Swap Trading Volume 2010-2013 [View article]
    Interesting. I'll have to look up the article, and thanks for the reference. Don't doubt that's true with respect to EQUITY, given the irrationality of the equity markets and the often jarring discrepancy between credit prices (signalling imminent default and partial recoveries for unsecured creditors senior to the equity in the capital structure) and ebullient equity prices right down to the moment of the Ch. 11 filing (or even afterward). If I see a junior bond trading at .60 on the $, I just assume the equity is a zero. But the vast majority of equity holders either don't pick up the credit signals or treat the equity as an overpriced option. Empirical case in point: after the BK, last summer Orchard Hardware had to put out an 8-K telling their moronic equity holders that their equity was worthless (equity RALLIED on the BK filing...).

    Still, that finding seems contrary to the rafts of evidence that a well-diversified basket of distressed CREDIT not only makes $ but outperforms IG credit. All the more so if you don't take an undifferentiated basket of distressed credits at T=0, as most of the research measures, but allow distressed investors to pick their spots where they know they have a margin of safety.

    Equity investors buy lottery tickets and play roulette heavily inflected with recency bias. Credit investors count cards and only make odds bets at craps.

    LT
    Feb 12 07:45 PM | Likes Like |Link to Comment
  • Puerto Rico And Municipal Credit Default Swap Trading Volume 2010-2013 [View article]
    PR can always default, and may very well do so at some point in the future. But unlike Detroit et. al., they can't seek bankruptcy protection via Ch. 9. That makes the potential costs of a default much higher for PR than for Detroit, Vallejo, Stockton, etc. Defaulting gains them absolutely nothing for the time being (they still owe all the debt), costs them precious access to capital markets, and so they'll continue to pay usurious rates as long as they are able, even if it means squeezing every last nickel from their shrinking economy. As far as political will, at least I give PR credit for being willing--unlike most sovs and munis--to tighten their belt buckles and balance the budget.

    To say that every bond is a risk is a truism. That's like saying every stock could go to zero like Lehman. The question for bonds is what is the downside. PR debt at 100 cents on the $ is a disaster waiting to happen. At .40-.50 on the $ there is limited downside, especially for debt secured by dedicated revenue streams. Could it go all the way to zero? Sure, but the asymmetric risk/reward still makes it attractive for some buyers.

    The bottom line is no one knows what's going to happen next. This is the closest thing you'll find to pure Knightian uncertainty. In situations like this I like to step back and look at things behaviorally. Who are the "sellers" at this point? Aunt Jenny who just got around to looking at her Oppenheimer funds statement from 2013, soon-to-be unemployed institutional PMs with career risk, and Reuters bloggers who get paid by the click. Who are the buyers? Distressed debt hedge funds who live for opps like this. Of these two constituencies, which one is putting up real money and thinks they have an edge?
    Feb 11 01:30 PM | Likes Like |Link to Comment
  • Puerto Rico And Municipal Credit Default Swap Trading Volume 2010-2013 [View article]
    Thanks for this, Donald, which sheds light into what's become a cloud of misinformation about this alleged "impending" PR default. It's not clear what those trafficking these rumors really mean by a "default." Default to me is non-payment of interest and principal when due. This can either mean that the issuer can't pay (insolvent), or (as in the case of many of the headline muni bankruptcies) simply chooses not to pay because some other alternative (like Ch. 9) looks more attractive.

    PR can't do a Ch. 9, so that option is off the table. The question, then, is whether or when it's in the interest of the PR govt to stop paying some of all of its obligations. I could very easily see a time down the road when they switch gears and play hardball with the GO bondholders to negotiate some kind of restructuring of the debt, exchanging the old GO debts coming due for new notes payable in the future. But with GOs trading at .50-.60 on the $, that leaves a pretty big margin of safety for haircuts. At this stage of the game, PR has absolutely no incentive to stiff their creditors. They can still access capital--albeit at extortionary rates--and will suck it up and pay the gig until this all blows over and they can refi into something in the 7-8% range where the junky credit should have been all along. COFINA's should be fine, and although the coverage on the revenue bonds is thin, they've been given control over rate increases and should be able to squeeze out their debt service.

    They've got some big structural probs. So do Spain and Italy, and look at where their sov debt is trading now... But they don't want to default (people underestimate the significance of this...)--and thus won't--until it becomes in their advantage to do so. And even then, we're talking about a fraction of the $70 Bill headline number. Regardless of whether they default momentarily or manage to kick the can down the road a couple more years (my own prediction), the risk/reward on the debt looks attractive at these prices. "Heads" (they stabilize the markets and balance the budget) and you make 50-75% upside, "tails" (they stop paying debt service and negotiate a 50% haircut), you lose nothing. At a tax free 8-8.5%, I'd rather own the 2nd lien COFINA's than any junk corporate in the market right now.

    My 2 cents, FWIW. Only time will tell.
    Feb 11 10:18 AM | 1 Like Like |Link to Comment
  • RadioShack: Forget The Stock, Shack Up With The Bond! [View article]
    Haha, you give us too much credit for our intelligence!

    Something's def going down with the capital structure at RSH, though. First, you've got the new financing (hugely detrimental to the unsecured bondholders, who'd be better off with a quick plunge into Ch.11 and would emerge with a share in the new equity). As it is, the longer the company burns cash, the lower the potential recovery. Second, you've got this hedge fund coming in and taking a big interest in the equity. That can't be because they really think the equity is money good; no one is that dumb. It can only be a chess move to potentially head the equity committee as an impaired class to put pressure from below against the 2019s and other unsecured creditors. "Changing hands" always implies a buyer and a seller, so the significant fact about the 2019s is that they're changing hands at much lower prices. Someone sees the writing on the wall.

    I own some of the 2019s, but as part of a capital structure arb trade, and I'm increasingly pessimistic about recoveries. Rather than them leading anything (they can't force a Ch. 11 unless or until a payment is missed), my guess is the forces are aligning to squeeze them out.

    We'll know more about the only thing that matters--rate of cash burn--when earnings come out.
    Feb 4 04:19 PM | 2 Likes Like |Link to Comment
  • Report: RadioShack to close 500 stores soon [View news story]
    Closing the worst 500 stores is a great plus...unless you have to keep paying the leases on the shuttered stores.
    Feb 4 03:26 PM | Likes Like |Link to Comment
  • RadioShack: Forget The Stock, Shack Up With The Bond! [View article]
    Meh, I don't know about this investment thesis. If they filed a prepack Ch. 11 tomorrow, yes, it's likely that the 2019s would be the fulcrum security and stand to have a decent recovery in bk (while being equitized at the expense of, or to the dilution of, the current equity holders...). So in that sense you're right that it's better to own the bonds than the equity. If I were running the 'Shack, that's what I'd do--try to take a major controlling position in the equity and use that leverage to cram down a restructuring on the unsecured bondholders, and then use Ch. 11 to cancel all the executory contracts and leases on the underperforming stores. Otherwise, outside of Ch. 11 they're going to have to eat a big chunk of the leases on the 400 stores they're closing.

    However, people rarely do what's rational, and it's likely they'll lurch onward for another 6-9 months before burning through all their remaining cash (and any hopes for recovery on the unsecured 2019s). I would only buy the unsecured debt if you plan to hedge it by shorting the common. Otherwise, you may clip a few coupons but still find yourself with negligible recoveries in a bk as all the inventory is pledged to the senior secured bank loans.

    Big jump yesterday could just have been short covering--on days of major vol, longs typically sell and shorts cover. You see this behavior often in heavily shorted stocks on big down days.
    Feb 4 03:24 PM | Likes Like |Link to Comment
  • Assessing The Q4 2013 Dividend Of Western Asset Mortgage Capital [View article]
    Hey Scott,

    We agree 100% on the trade-offs involved. Hedging book is costly, and that has to come at the expense of NIM. For better or worse, WMC has chosen to go a different, more aggressive route than AGNC and MTGE, who (IMHO) made exactly the wrong move of closing out losing positions at the bottom and putting on hedges when they were most costly.

    In the interest of generating conversation, rather than picking nits, you seem to make two inferences that I think are arguable. One is strategic and conjectural, the other empirical.

    With respect to WMC's strategy in the coming year, if they were going to take the pedal off the floor and lighten up on leverage or add swaps, the time to do so is long past. Their strategy is aggressive as heck, no dispute there, but I think their view is that we've seen the worst of the vol, and that the best path through the mreit malaise is to hold the high divvy at any cost to NAV, betting that after a few quarters investors will come back in at a premium. Paying out all the gains on swaps at once--with a headline number--also has the attraction of scaring the shorts into covering. Issue some new shares, hold the cash, and be willing to accept some serious turbulence with NAV if rates begin to back up again. Love it or hate it, that seems to be the gameplan.

    The second quibble regards your point about WAC (weighted average coupon) and the conclusions you draw from it about the dangers of cutting the divvy. You say "These two factors, WMC's higher proportion of 30-year fixed-rate agency MBS but basically the same WAC, lead me to believe WMC should have dividend distributions that are equal to (or at the most slightly above) what AGNC and MTGE have distributed over the past few quarters (generally speaking)." Your point, in a nutshell, is that because WMC's WAC isn't *that much* greater than AGNC's, that the dividend is too high and will need to be trimmed.

    Here's the problem with that reasoning. Relying on WAC here is misleading, if not wrong, and while it can tell you some very broad things about earnings power, it's important to keep in mind that WAC<>realizeable YIELD. You can have a pool of lower coupon 3s or 3.5s specials purchased at a discount to par and prepaying at 3-5% (WMC's bread and butter) that might have a higher expected YIELD than a generic pool of 4s and 4.5s purchased at a premium and prepaying at 25-30% (the space where AGNC and MTGE have migrated). Put differently, yield isn't linear to coupon. You can see this by looking at a stack chart of prices on 3s, 3.5s, 4s, 4.5s, 5s, etc. (insofar as the off the run coupons still trade). The price tends to increase a little as you move above the current coupon and then begins to level out very quickly, That reflects the fact that people aren't willing to pay significant premia for higher coupons because they know they'll get their money back sooner. Otherwise, if you think about it, if yield were perfectly linear to coupon, people would always buy the highest coupon they could find.

    So the move you've observed on AGNC's part to shift into higher coupon 30s isn't to increase yield, it's strictly to lower duration. They're accepting a LOWER expected yield on those 4s and 5s (as well as the 15s) in exchange for a lower duration (and less price vol).

    Sorry to bore everyone to tears with the details, but it's just to say that your inference from WAC is problematic. The real story comes from NIM.

    A rash prediction: if vol remains low (at no point does TSY10 break above 3.15% in the next quarter), they raise the divvy to $.85 next qtr...

    Happy holidays and GLTA :)
    Dec 26 10:35 AM | 3 Likes Like |Link to Comment
  • Assessing The Q4 2013 Dividend Of Western Asset Mortgage Capital [View article]
    I’m sure many people appreciate the clear, detailed analysis you present. Thanks for this. But your own analysis of WMC’s earnings power answers the question of why it can trade at a premium to the rest of the space. Regardless of how its WAC looks relative to AGNC and MTGE, it is running a more aggressive portfolio with a larger duration gap. The story behind the diff is in the NIM. If you look at WMC versus its peers in terms of EARNINGS POWER, it’s easy to see why it deserves to trade at a premium to the others. It is raking in the spread income.

    Why "unsustainable"? Spit-balling NIM of 2.28% (3.42% average portfolio yield-1.14% cost of funds) * 9 times leverage=20.52% + 2.28% on the portfolio itself=22.8% earnings on a going forward basis. **Assuming no changes to portfolio from 9/30**, I see no problem whatsoever for them to easily cover the current regular dividend of .80 per share in spread income. By way of contrast, both AGNC and MTGE have reduced leverage, migrated down into 15s, and put on the brakes through additional hedges, and thus the successive divvy cuts. They’ve sacrificed NIM to stabilize book.

    The flip-side of this, which is the *real* danger of WMC that you barely touch on, is that this makes WMC’s NAV much more volatile. If rates begin to back up again aggressively, they’re going to be slammed much harder than AGNC or MTGE with all those low coupon 30s.
    Pick your poison. The $1.55 or whatever special is an accounting gimmick—no argument there. But if you want raw earnings power at the cost of running a bigger duration gap (this used to be AGNC’s game, for which everyone loved them…), then WMC is best in class and, IMO, deserves to trade tighter than AGNC, NLY, etc.

    My 2 cents...

    Disclosure: long WMC and MTGE
    Dec 24 04:22 PM | 6 Likes Like |Link to Comment
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