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Update For Bond And Preferred Stock Basket Strategy As Of 8/28/15

|Includes: NGHC, Windstream Holdings, Inc. (WINMQ)

My Vix Asset Allocation Model is close to flashing a Trigger Event, which is a major occurrence in that Model. Volatility data goes back to 1/1/1986 for the S & P 100 and 1/1/1990 for the S & P 500. Since 1/1/1986, there have been only 3 prior TEs: Spring of 1987; October-November 1997 and August 2007.

Only two more readings in the VIX above 26 are necessary before the VIX returns to below 20. I have already started to write an Instablog discussing it.

I developed mechanical rules for this Model over 8 years ago that created two basic safety valves. I did not want to start or to terminate a Stable Vix Pattern too soon.

To terminate a Stable VIX Pattern, I have to find a Trigger Event, a descriptive phrase that is analogous to being slapped in the face a few times and then having someone throw a big bucket of ice cold water on you.

The TE requires at least 7 to 10 days of elevated VIX readings over 26 coming out of a long Stable Vix Pattern. If two of those days are over 30, then the TE has to be declared after either 7 or 8 days of 26+ readings. This mechanical requirement has an important rationale. Every investor has a tendency to allow emotions and rationalizations to guide investing decisions. The Model was formulated based on the historical evidence, and its mechanical rules can not be changed until future history changes them.

Anyone interested in the Model can change it of course. Any material change would not be supported by the historical evidence.

I would note that the DJIA volatility index did manage to close below 26 last Thursday and Friday, while the VIX barely closed over 26.

Quotes as of Friday 8/28/15 for all Volatility Indexes:

VXD: 25.31 -0.20 (-0.78%) DJIA

The S & P 100 volatility index also closed below 26:

VXO: 25.52 -0.63 (-2.41%)

The S & P 500 volatility index closed over 26:

VIX: 26.05 -0.05 (-0.19%) VOLATILITY S&P 500

Historically, those two volatility indexes are more stable than the VIX which is a broader index. The most unstable major indexes historically would be the Nasdaq 100 and the Russell 2000:

VXN: 28.75 +0.29 (+1.02%): CBOE NASDAQ 100 Voltility

RVX: 26.74 -0.33 (-1.22%): CBOE RUSSELL 2000 VOLATILITY

For me, once the Trigger Event occurs, I am in my Unstable VIX Pattern mode; and it simply does not matter how long that pattern continues. The Stable Vix Pattern playbook is substituted when the Model flashes its emergence and not before.


My last update for my bond and preferred stock basket strategy was published here: Update On Bond And Equity Preferred Stock Basket Strategy As Of 8/14/15 - South Gent | Seeking Alpha

The following table includes only exchange traded securities. I do not have a table showing my existing $1,000 par value bonds bought in the bond market such as the one discussed in Item # 1 below:

Given the long period of abnormally low rates, I have lost a considerable number of exchange traded bonds and preferred stocks to issuer redemptions. The pickings are really slim now. The dollar value probably hit a high near $150K after the 2011-2012 built up from zero after Lehman's failure. I have also actively traded exchange traded bonds.

For example, at the end of my Gateway Post for Trust Certificates, a category of exchange traded bonds, I have a large number of trading snapshots: Trust Certificates: New Gateway Post (trading snapshots=+$28,971.16, all in small lots and frequently in odd lots)

I briefly discuss the categories of exchange traded bonds in this Update: Update For Bond And Equity Preferred Stock Basket Strategy As Of 7/31/15 - South Gent | Seeking Alpha

1. Bought 2 Winstream 7.75% Senior Unsecured Bonds Maturing in 2020 at 91.375:

As with other recent junk bond purchases, the first move after my purchase was down. This bond closed last Friday at $87.56, so I am already in another hole. For most past of the past week however, the bond was trading slightly higher than that close during the turbulence last week. A 90 price was hit just before that closing price.

Snapshot Of Order Confirmation:

This order confirmation shows that I had to pay the seller $53.82 in accrued interest. The current yield is 8.485%.

The yield to maturity is 9.935% per year until the 10/15/2020 maturity date. The YTM assumes that Windstream makes all interest payments and survives to pay the $2,000 principal amount at maturity.

This is a link to the FINRA data for this bond. FINRA Page A prospectus is linked at the FINRA page.

I did flip this bond and another one back in 2011, selling both at premiums to par value. Snapshots of those small trades are in the Appendix below.

Accounting for Accrued Interest:

I have at best a lay understanding of this accounting issue derived solely from source material found on the internet and the accountant employed to handle my trust accounts. I prepare my own personal returns and have always done so.

I will receive the accrued interest that I paid to the seller when I receive the next semi-annual interest payment.

Since my brokers invariably include the accrued interest paid to the seller in my 1099, and I always check to confirm that fact, I need to make an adjustment for that amount in my Schedule B. Accrued Interest and Bond Premiums; Accrued Interest on Bonds; Item # 1 Tax Accounting For Bonds; Taxation of Bond Income

IRS Publication 550:

Publication 550 (2014), Investment Income and Expenses

The IRS asserts that a professional tax preparer should make this adjustment. IRS Course

This can become a bit complicated since the interest paid to the seller and the interest thereafter received from the bond issuer may occur in different years. It is my understanding that the accrued interest has to be deducted in the same tax year when the interest is received and included in the taxpayer's 1099. For this WIN 2020 bond purchase, I will receive an interest payment during 2015, so the accrued interest payment will occur in the same calendar year.

More Information on Windstream and the 2020 Bond:

This 2020 Windstream bond was trading at over 108 in 2013.

The most recent slide, as shown in the FINRA chart, started when Moody's downgraded WIN's senior unsecured debt to B2 from B1.

Fitch affirmed in its BB rating for the senior unsecured debt last February.

Windstream may call the 2020 bond redemption by paying the following amounts that depend on when that option is exercised:

Since I bought at a discount to par value, I am fine with Windstream redeeming this bond whenever it wants to prior to maturity. I am far more concerned with credit risk than interest rate risk given that the bond matures in slightly over 5 years. A significant rise in interest could increase credit risk however given the amounts that have to be refinanced in the coming years.

More Information on Windstream's Debt Reduction and Outstanding Maturities:

Windstream did reduce its leverage when it spun out Communications Sales and Leasing (CPAL) as described in WIN's recently filed 10-Q.

{Windstream Holdings has no debt. Windstream Services, a direct and wholly owned subsidiary, is the debt issuer.}

Sourced: Page 15 2015.06.30 10Q

CPAL did make a cash payment to Windstream of $1.035 billion that was mostly used to redeem $850M in Windstream's debt.

Sourced Page 19

Another 1.9 billion repayment is noted in the preceding snapshot but that repayment was funded by a draw on the bank credit facility.

Windstream called in April a 8.125% senior unsecured bond maturing with$400M in outstanding principal amount, paying $1040.63 for each $1000 in principal amount for that early redemption. Page 42 2015.03.31 10-Q

As a result of these transactions, long term debt did decrease from $8.7281 as of 3/31/15 to $5.6379 billion as of 6/30/15:

Sourced Page 18

There is one senior unsecured bond that will need to be refinanced before the 2020. The principal amount outstanding on the 7.875% 2017 is large at $1.1B. I considered buying that one, but it was selling at over par value with a YTM of 6.3%. 2017 Bond Detail I did not view the yield to maturity as adequate compensation for the risk.

As of 6/30/15, Windstream had a 19.6% stake in CFAL that it intends to sell opportunistically and to use the proceeds to retire debt.

Page 15: 2015.06.30 10Q

Windstream is still over-leveraged for a company in a declining business IMO.

I selected one of the shorter term maturities to improve the odds some of Windstream surviving long enough to pay off the bond at maturity. That becomes increasingly more dicey as the investor goes further out in time. The shortest term did not compensate me for the default risk. I pick up an additional 3.5% or so in YTM per year by going with the 2020 rather than the 2017. The Bond Ghouls are saying that WIN is likely to pay off that 2017, while WIN's survival to pay off the 2020 is more dicey however.

Recent Earnings Report: Early in the second quarter report, WIN announced a $75M stock repurchase program and a $.15 per share common dividend. Given the excessive leverage, the buyback can not be justified IMO. Moody's justified its debt downgrade in part on the share buyback announcement.

Windstream noted that it had paid down $3.2B in debt in connection with the REIT spin-off transaction, "which will provide approximately $170M in annual interest savings".

The company gave 2015 guidance of a 3% decline to flat revenues in 2015 compared to 2014. The GAAP loss for the quarter was reported at $111.2M. The GAAP calculation includes $57.3 in merger and integration costs and $341.8M in depreciation and amortization non-cash expenses.

WIN asserts that its "adjusted" free cash number was $141M. There has been a lot of criticism directed toward this adjusted free cash calculation over the years. (e.g. Accounting Wizardry)

SEC Filed Press Release; Q2 2015 Results - Earnings Call Transcript | Seeking Alpha

The company discusses risk incident to its operations starting at page 13 of its 2014 Annual Report. 2014 10K Risk factors are discussed starting at page 15 of the 2020 bond's prospectus.

2. Roth IRA: Bought 50 NGHCP at $24.6

Trade Snapshot: Email Notification

Quote: National General Holdings Corp. 7.5% Preferred Series A (NGHCP:NASDAQ)

Assuming a total cost per share of $24.6, the dividend yield would be about 7.62%. Money doubles in about 9.44 years unadjusted for inflation. Estimate Compound Interest

Prior Trade Taxable Account: Item # 1 BOUGHT 50 NGHCP at $24.3 (10/24/14 Post)

This security is a non-cumulative equity preferred stock that pays qualified dividends at the fixed coupon rate of 7.5% on a $25 par value. The issuer, National General Holdings (NASDAQ:NGHC), has the option to redeem the issue on or after 7/15/2019. This preferred stock will be perpetual until the issuer elects to redeem it. The issuer may redeem on or after 7/15/2019 when it is in its interest to do so.


A.M. Best rates the preferred stock at BB.

The prospectus contains a typical Dividend Stopper Clause, the legal mechanism for enforcing the preferred shareholders superior rights to common shareholders.

National General Holdings was formed in 2009 and is a speciality personal lines insurance holding company. Profile

National General Website

Investor Relations - National General

SEC Filings for National General

Key Developments Page at Reuters

The most important development in August was the concurrent issuance of a 7.625% subordinated bond and the public offering of 10 million common shares. National General Holdings Corp. Announces Pricing of Its Concurrent Offerings of Common Stock and 7.625% Subordinated Notes Due 2055 The common stock was priced to the public at $19 per share. The subordinated note will trade under the symbol NGHCZ within 30 days after the IPO's closing. NGHCZ is higher in the capital structure than NGHCP.

Prospectus for Common Stock Offering

Prospectus for 7.625% Subornated Notes due 2055 (optional redemption on or after 9/15/20; quarterly interest payments; risk factors discussed starting at page S-11; subordinated to senior indebtedness)

I am not sure whether or not this subordinated note is trading in the Grey Market. Last week I tried several times to buy two newly issued preferred stocks in the Grey Market without success. Bid and Ask prices are not displayed so you have to guess what price will induce a seller to part with that newly created security prior to when it starts to trade on the stock exchange. I just figure out what I am willing to pay and then place a AON limit order which I can do for 100 shares at Fidelity or a 50 share limit order slightly below the price that I will pay for 100 shares since I might get a partial fill.

The general idea with equity preferred stocks is to harvest several quarterly dividends and to escape with a profit. I did not start to fool with them at all until after Lehman failed and their prices were smashed to 50% or lower discounts to their par values.

I view equity preferred stocks with some disfavor for the reasons outlined throughout my blog for the past 7 years starting in October 2008 and more recently here at SA.

Recent Earnings Report: I view it important to review earnings reports even when I own only a bond or preferred stock issued by the company. I do not currently own National General's common stock and consequently my review of the most recent report was solely related to the credit worthiness of the company rather than assigning a fair value range for the stock.

For the 2015 second quarter, NGHC reported operating earnings of $35.1M or $.36 per share:

National General Holdings Corp. Reports Second Quarter 2015 Results

Risks: The company discusses risks incident to its operations starting at page 18 of the prospectus. One of the risks mentioned is phrased this way: "Our principal stockholders have the ability to control our business, which may be disadvantageous to other stockholders".

There are a number of investors who have issues with the principal stockholders. This preferred stock is selling at an unusually yield that may be due to what I would call the Michael Karfunkel discount.

Karfunkel family - Forbes

Mr. Karfunkel is an elderly gentleman who co-founded the American Stock Transfer and Trust Company in 1971, a stock transfer company, that was sold in 2008. He is a founder and Chairman of the Board of Amtrust (AFSI) and is also a founder of Maiden. It is the AmTrust connection that makes some queasy as I previously mentioned when buying 50 shares of its preferred stock. Item # 7 Bought 50 AFSIPRB at $24.79 I have sold that preferred stock.

National General started to pay a quarterly dividend of $.01 per share in the 2013 4th quarter and is now up to $.02 per share. NGHC Dividend History

If that cash dividend is eliminated, there is no legal impediment to eliminating the non-cumulative preferred stock dividend. An elimination of that common dividend would likely cause the preferred stock to crater in price in my opinion. Why would a company eliminate a 1 or 2 cent per quarter dividend? The dividend stopper clause does prevent National General from eliminating the preferred dividend for as long as it maintains a cash dividend payment to the common shareholders.

The lowly status of equity preferred stocks makes them subject to severe downdrafts in price during periods of market turmoil and financial stress. Many of the non-cumulative preferred stocks crashed in 2008, falling in many cases to the single digits, even when the issuer kept paying the dividends. The most recent severe decline occurred during the 2011 stock market correction. I noted in a August 2011 post a really bad day for several different types of exchange traded securities, having a higher priority than common stock in the capital structure. Item # 1 Fear and Enhanced Volatility in Certain Classes of Income Securities

I lump equity preferred stocks with bonds since their bond characteristics are more dominant than their equity features. Many of their equity features are undesirable including their potential perpetual terms without actually having an equity interest in the business and with interest rate risk being asymmetric with the issuer. I view equity preferred stocks as a disfavored asset class and will consequently attempt to trade them opportunistically.

The interest rate risk is asymmetric between the issuer and the owner of the preferred stock.

If interest rates rise, the issuer will allow the owner to keep the preferred stock which is declining in value. The investor has the option to sell at a loss, or to keep the security declining in value and consequently lose the opportunity to reinvest the proceeds in a higher yielding security.

These securities can become perpetual for an individual's lifetime when rates rise and then remain at a level sufficiently high enough that it is not advantageous for the issuer to exercise their optional call right.

If interest rates decline and the issuer can refinance at lower rates, then the issuer has the option after the call date to redeem the security and to pay only par value plus accrued dividends, providing the investor with cash that can only then be reinvested in a lower yielding security.

When bought near par value, share price appreciation is minimal, while downside price risk is retained by the investor rather than the issuer, due to two factors.

First, in a declining rate environment, where the issuer is likely to redeem the security when it is legally able to do so (generally five years after the IPO), the price will be unable to rise much above par value even under optimal credit conditions for the issuer.

Second, the downside risk to the investor is not capped due to interest rates rising. In a rising rate scenario, the issuer has locked a favorable rate to its advantage, possibly into perpetuity, while the owner of the fixed coupon preferred stock has only bad choices left.

In a BK, an equity preferred stock is likely to meet the same fate as the common stock.

The company discusses risks incident to its operations starting at page 23 of its 2014 Annual Report: NGHC 2014 10K

I took a snapshot of risk summary relating to NGHC' relationship with other connected companies:


1. Prior Trades Windstream Bonds:

7.75% 2020

Sold All Winstream Bonds: Two 2019s at 101 and One 2020 at 103.5 (the difference between 102.7 and 103.5 is the $8 brokerage commission which reduces the price sold in the trade confirmation)

$103.5 x. 10= $1,035 - $8=$1,027

Bond prices are quoted at 1/10th of the $1,000 par values.

Bought 1 Windstream 7.75% Senior Unsecured Bond Maturing 10/15/2020 at 98 (8/15/11 Post)

7% 2019:

Bought 2 Windstream 7% Senior Unsecured Bonds Maturing on 3/15/2019 at 96 (8/12/11 Post)

2. Prior WIN Common Stock Round Trips: I am no longer interested in WIN common shares. I did periodically buy and sell small lots when the quarterly dividend rate was $.25 per share. That dividend created a yield in excess of 10%, so any profit on the stock was just viewed as gravy.

2011 +$189.67

2013 Net Two Transactions = -27 cents

2014 +$78

Total Net Realized Gain= +$267.4

There was a reverse 1 for 6 split in May 2015 WIN Interactive Stock Chart That split occurred as a result of WIN spinning out "selected telecommunication network assets into Communication Sales and Leasing" (CSAL), a new REIT. WIN shareholders received 1 share in for every 6 shares in WIN. Subsequent to the 1 for 6 split, WIN set a $.15 per share quarterly dividend. Windstream Completes Tax-Free Spinoff of CS&L That REIT is currently paying a quarterly dividend of $0.60 Per Share.

It would be fair to say that my trading history in WIN securities has been irrelevant to me.

Disclaimer: I am not a financial advisor but simply an individual investor who has been managing my own money since I was a teenager. In this post, I am acting solely as a financial journalist focusing on my own investments. The information contained in this post is not intended to be a complete description or summary of all available data relevant to making an investment decision. Instead, I am merely expressing some of the reasons underlying the purchase or sell of securities. Nothing in this post is intended to constitute investment or legal advice or a recommendation to buy or to sell. All investors need to perform their own due diligence before making any financial decision which requires at a minimum reading original source material available at the SEC and elsewhere. Each investor needs to assess a potential investment taking into account their personal risk tolerances, goals and situational risks. I can only make that kind of assessment for myself and family members.