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Update For Exchange Traded Bond And Equity Preferred Stock Basket Strategy As Of 10/7/15

|Includes: Global Indemnity plc (GBLI), MS

This basket was last update here: Update On Bond And Preferred Stock Basket Strategy As Of 9/29/15 - South Gent | Seeking Alpha

I still believe that interest rate risks are in a heightened state for fixed income investors, as previously discussed here: An Analysis Of The Risk/Reward Balance For Intermediate And Long Term Treasuries - South Gent | Seeking Alpha (3/18/15)

However, with inflation and inflation expectations remaining abnormally low, interest rate risk has currently become less important than other bond risks including currency, credit and country risks.

Inflation expectations are currently low: 5-Year Breakeven Inflation Rate-St. Louis Fed; 10-Year Breakeven Inflation Rate-St. Louis Fed

That number can easily be calculated as follows simply by subtracting the real yield from the nominal yield:

Daily Treasury Yield Curve Rates (non-inflation protected nominal yields)


Daily Treasury Real Yield Curve Rates

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.

Basket as of 10/7/15:

Three of the losers today were securities that pay the greater of a minimum coupon or a float over the 3 Month Libor rate. I added to one of those earlier today, MSPRA, and the other two were the equity preferred floater GSPRD and the Synthetic Floater GYB. The Trust Certificate KTN, which has a $25 par value and was bought at less than $14, can fluctuate significantly in a narrow range on very light volume. Today's volume was 2,202 shares trading in a range between $30.1 to $30.7: Structured Products Corp. 8.205% Credit-Enhanced CorTS Interactive Stock Chart

This basket topped out near $150K but had shrunk to less than $40K due to issuer redemptions and profit taking a couple of months ago. Update For Bond And Equity Preferred Stock Basket Strategy As Of 7/31/15 - South Gent | Seeking Alpha

Over the past few weeks, I have been adding to this basket some in small amounts based in significant part on the foregoing considerations.

Another consideration is simply a desire to generate tax free income in my Roth IRA accounts, when the money market accounts, which fund the purchases, generate nothing as a practical matter.

Deflationary risks have increased over the past year due to the declines in commodity prices, the parabolic rise in the USD which lowers import prices (WSJ), the recessions in several important economies (Brazil, Russia, Canada), the slowdowns in many others with China being the most important, and the persistent sluggishness in the Eurozone and Japan.

Over the past 12 months through August 2014, the government's CPI index was up only .2% on a non-seasonally adjusted basis. Consumer Price Index Summary


S & P recently upgraded my Compass Bank bond from junk to investment grade:

Moody's has a Baa3 rating according to FINRA: Bond Detail

My current yield on that bond is 7.607%. The YTM is 8.738%:

Stocks, Bonds & Politics: BOUGHT 1 Compass Bank 5.9% Subordinated Note Maturing in 2026 at 76.75 (7/11/12 Post)

Current Position-1 Bond:

The 75.75 price may have been due to institutional dumping occurring after the issuer's offer to buy was oversubscribed; and one or more owners decided to jettison what had been bought in anticipation of selling the bonds back to the bank. BBVA Compass Announces Tender Offer Result-May 3, 2012 This bond is thinly traded and possibly the only way to liquidate a position was at a much lower price.


1. Bought 50 GBLIZ at $24.12 This is a new exchange traded bond.

Trade Snapshot ($1 COMMISSION):

I also bought 50 in my Roth IRA where I turn this taxable bond into a tax free one.

Security Description:The Global Indemnity PLC 7.75% Subordinated Notes Due 2045 (GBLIZ:NASDAQ) is an exchange traded junior bond issued by insurance company Global Indemnity PLC Stock Price (NASDAQ:GBLI) based in Ireland.

Investor Relations: Global Indemnity plc

The current yield at a total cost of $24.12 per share is about 8.03%.

Par value: $25

Maturity Date: 8/15/2045

Issuer Optional Call Date: On 8/15/2020 or on any interest payment thereafter at par value plus any accrued and unpaid interest.

The optional call date creates asymmetric interest rate risk in favor of the issuer. Update For Bond And Preferred Stock Basket Strategy As Of 9/10/15 - South Gent | Seeking Alpha (scroll to "1. Exchange Traded Bonds and Preferred Stocks: Asymmetric Interest Rate Risks")

I discuss the asymmetric interest rate risk in the Appendix to this post:

Interest Payments: Quarterly

Ranking: "The Notes will be our subordinated unsecured obligations and will rank (NYSE:I) senior to our existing and future capital stock, (ii) senior in right of payment to any future junior subordinated debt, (NASDAQ:III) equally in right of payment with any unsecured, subordinated debt that we incur in the future that ranks equally with the Notes, and (iv) subordinate in right of payment to any of our existing and future senior debt. In addition, the Notes will be structurally subordinated to all existing and future indebtedness, liabilities and other obligations of our subsidiaries." (emphasis added).

I simply call that ranking a junior bond which clarifies in my mind its inferiority to all senior debt and superiority to common and equity preferred stock.


A.M. Best rated this subordinated bond BBB-. Senior unsecured debt is rated by Best at BBB. A.M. Best Assigns Issue Rating to Global Indemnity plc's New Subordinated Note Offering

SEC Filings for Global Indemnity

Tax Issues: While I am not sure, it appears to me, based on a review of these publications, that Ireland will not withhold a tax for interest payments made to a U.S. citizen.

The actual practice may depend on whether the broker claims U.S. tax treaty benefits for a customer.

I bought 50 shares in a Vanguard Roth IRA, and that broker has been good in doing whatever is necessary to claim tax treaty benefits in the past.

I have run into a few situations where other brokers did not claim treaty benefits; and I was taxed at a higher rate than permissible under the U.S. treaty with a foreign country.

I quit using Schwab, for example, to buy stocks domiciled in France, since that broker did not make the necessary mass email filing to reduce its customers tax rate from 30% to 15%.

I also ran into a similar problem with Fidelity filing the necessary paperwork for some Swedish companies which resulted in a 30% tax rate when the treaty rate for a dividend was 15%.

If there is a tax withholding for the GBLIZ interest payment in that account, I will need to consider jettisoning the position when I can do so at break-even or better. Foreign taxes are not recoverable when the security is owned in a retirement account:Claiming Foreign Taxes: Credit or Deduction?

Worldwide Corporate Tax Guide - Ireland, Republic of - EY - Global

Article 11 Tax Treaty: Tax Treaty with Ireland/pdf

Recent Earnings Report:

Sourced: SEC Filed Press Release and Form 10-Q

The current E.P.S. consensus estimate is for $1.35 this year and $1.2 next year: GBLI Analyst Estimates

The company discusses risks incident to its business starting at page 31 of its 2014 Annual Report: Form 10-K

2. ADDED 50 MSPRA AT $19.48:

Trade Snapshot ($1 Commission; snapshot off Webtrader Application rather than confirmation page):

This preferred stock is near its 52 week low of $18.78: Morgan Stanley Non-Cumulative Preferred Series A

Volume was unusually heavy and picked up during the day as the stock fell in price, which indicates selling pressure to me.

The previous close was at $19.72 and the intra-day low, achieved after my purchase, was at $19.25. It is not unusual for a preferred stock to experience weakness after an ex -dividend date, and this security went ex dividend for its quarterly distribution on 9/28/15.

Closing Price 10/7/15: $19.43 down 1.47% (Volume=337,992/average volume=63,184)

My last transaction was to sell 50 shares at $21.2, realizing a $214.09 profit:

The profit snapshot is in the Appendix section below. So I bought back that 50 share lot in my new IB taxable account.

That sell transaction was in a Fidelity account, which no longer permits orders for this security during regular market hours as one of its numerous and extremely asinine restrictions. This one can only be bought with a market on close order:

My last substantive discussion here of this security was in this October 2014 Instabog: Equity Preferred Floating Rate Stocks: Added To MSPRA At $19.87 - South Gent | Seeking Alpha I will be dragging and dropping some of that discussion and editing it where appropriate.

Security Description: The Morgan Stanley Non-Cumulative Preferred Series A (NYSE:MS.PA) is an equity preferred stock that pays non-cumulative and qualified dividends at the greater of 4% or .7% above the 3 month Libor rate on a $25 par value. Prospectus

The current coupon is the minimum 4% rate, which is likely to remain the applicable coupon for two or more years. At a $19.48 total cost per share, the yield would be about 5.13% currently.

If a non-cumulative preferred dividend is legally eliminated, it is just gone. The non-cumulative dividend can not be eliminated unless the issuer first eliminates a common share cash dividend.

If a cumulative preferred dividend is legally omitted, it has to be paid before common shareholders can receive a cash dividend. A common share cash dividend must be eliminated before the issuer can defer a cumulative preferred stock dividend.

An increase in the minimum 4% coupon will occur when the 3 month LIBOR rate is over 3.3% during the applicable computation period. If that rate was then 5%, the coupon would then become 5.7% and the effective yield would increase to 7.32% at a constant total cost per share of $19.48.

The 3 month Libor rate will be anchored near zero for as long as the Federal Reserve continues ZIRP: Chart: 3 Month LIBOR based on U.S. Dollar

An equity preferred stock will be senior only to common stock. The prospectus does contain a standard "stopper" provision that would prevent Morgan Stanley from paying a cash dividend to the common shareholders and eliminating the MSPRA dividend. (see pages S-2 to S-3; S-14 to S-15). Once the common dividend is eliminated, there would be nothing legally that could stop MS from eliminating the MSPRA dividend.

I believe that this security is currently rated at Ba3 by Moody's and BB by S & P, both junk ratings.

Morgan Stanley is currently paying a small common stock dividend. Once that dividend is eliminated, MS could eliminate the non-cumulative equity preferred dividend. MS Dividend History

However, as a practical matter, it would be unwise for MS to eliminate the MSPRA dividend to preserve capital. If you were an institutional client, what kind of message would such an elimination send to you?

For an investment bank, dependent on customer confidence in its financial viability, the only practical course would be to pay the preferred stock dividend until the company does a Lehman Brothers, IMO.

A failure to pay prior to a bankruptcy filing could easily cause that result as clients flee. MSPRA went ex dividend for its quarterly distribution on 9/28/14. MSPRA is being priced by the market below other equity preferred floaters that pay the greater of a 4% coupon or a lower spread to the 3 month Libor than MSPRA.

I have included in the links below the yields of floating rate preferred stocks from other issuers at their mid-day prices today:

SunTrust Banks Non-Cumulative Preferred Series A (NYSE:STI.PA): $21.88/4.3%

Zions Bancorp Non-Cumulative Preferred Series A (ZB.PA): $21.75/4.7%

Santander Finance Preferred S.A. Non-Cumulative Preferred Series 6 (NYSE:SAN.PB):$22.9/4.43%

The MSPRA has a higher current yield and a better float provision than those three floaters.

I have owned all of those in the past.

According to Quantumonline, the MSPRA is rated Ba3 and BB. The Zions' preferred stocks are rated lower at B1 and BB-. The Suntrust preferred has the highest rating in this bunch at Ba1 and BB+. All of them are rated in junk land.

Prior Trades: I have a net realized gain of $1,624.96 trading this security, always in small lots.

Snapshots of those trades, and references to discussions of them, can be found in the Appendix below:

Rationale and Risks: The main advantages of this type of security are as follows: (1) the security pays qualified dividends when purchased in a taxable account and (2) provides a measure of deflation/low inflation and problematic inflation in the same security.

I will frequently add some floating rate securities when buying potentially long term exchange traded bonds which I have been doing lately.

The deflation/low inflation scenario is addressed by the minimum coupon, while the protection for problematic inflation involves the LIBOR float activation. By buying at a discount to par value, I juice the yield in both scenarios.

With the Jihads being practiced by central banks against savers worldwide, short term rates are likely to remain low, irrespective of the inflation rate until the central banks start to raise their short term benchmark rates, with the U.S. Federal Reserve being the most important and the leading practitioner of financial repression.

When and if central banks allow rates to rise, and assuming inflation has become a problem too, then this kind of security could start to increase its coupon in response.

I really view this kind of security as providing some protection against unexpected and problematic inflation.

With CPI inflation currently trending well under 2%, and the 3 month LIBOR likely to stay below 3.3% for an extended period of time, then this security becomes relatively unattractive given its 4% coupon compared to other higher coupon equity preferred stocks issued by Morgan Stanley.

The minimum yield on MSPRA is about 5.13% at a total cost of $19.48.

I could have bought a MSPRG that pays non-cumulative and qualified dividends at the per annum fixed coupon rate of 6.625% on a $25 par value. Prospectus MSPRG and MSPRA are in pari-passu (same place in the capital structure)

The last trade in MSPRG when I placed the MSPRA was at $26.02:

MS-PG: 26.02 +0.03 (+0.11%) at 1:07PM EDT - Nasdaq Real Time Price

The current yield at that price is about 6.37%.

Current Yield Spread Differential: 1.24% per annum

Another issue with MSPRG is that it might be called on or after 7/15/19. The call price would be $25. If that was done, the actual yield would be about 5.86% due to the loss in value impacting the yield.

Yield-TO-Worst Yield Spread Differential (assumes MSPRG called on 7/15/19): .73%

I would emphasize that MSPRA at its current discount to par has more share price appreciation potential than MSPRG which is selling now at a premium to its $25 par value. The appreciation in MSPRG is in effect capped by the optional call right. Why would MSPRG go up more in value? It would reflect the desirability of its coupon in a declining rate environment. But that increases the odds that the issuer will call the security at par value.

Current Yield Spread Between the Fixed Rate and Floating Rate Security Is Analogous to an Insurance Premium:

Is the extra current yield from a Morgan Stanley fixed coupon preferred stock worth it to the investor? The additional yield could be as low as .73% per year with a MSPRG redemption on 7/15/19 to 1.24% with no redemption.

I look at this spread as an annual insurance premium paid for unexpected inflation. Am I willing to pay .73% or 1.24% per year in order to have the unexpected inflation protection of the floater?

Each investor can decide that issue for themselves.

Inflation certainly does not look like a problem for the foreseeable future, but investors probably told themselves the same thing back in the early 1960s.

So what are the odds that inflation and interest rates will rise significantly from current levels, causing the fixed coupon security to go down in value and the float provision of the floater to be activated as the relevant coupon amount?

If the 3 month Libor rate was 6% during the relevant computation period, MSPRA's coupon would become 6.7% rather than 4%, and that coupon would be applied to a much lower cost per share. At the $19.48 per share total cost, that 6.7% produces a current yield of about 8.6% while the current yield of MSPRG bought at $26.02 remains constant at 6.37%. And, would MSPRA then have a higher price per share than MSPRG? I would say so without any reasonable doubt.

I would expect MSPRA to be selling somewhere near its $25 par value in this hypothetical, while MSPRG would likely IMO to sink below $20. So that is what I mean by labeling the current yield spread between those two securities as an insurance premium which may be lost like all of the insurance premiums that I have paid for auto, health and home insurance, or become valuable depending on the largely unknowable future (the house burns down)

In effect, the investor is paying an insurance type premium in accepting a lower rate now for MSPRA than a fixed coupon preferred stock from the same issuer. Both have identical credit risks. If that premium is close to 1.5% or less, then I will consider adding the floater, particularly since I started to invest during a period of problematic inflation and am consequently very sensitive to its dangers.

For MSPRA, the 3 month LIBOR rate would have to rise above 3.3% during the applicable computation period to trigger a higher coupon than 4%. That is not likely to happen anytime soon. If short term rates stall below 3.3% and intermediate and long term rates rise, then the 4% minimum coupon will not look too good and this security probably would go down in price more than a MS fixed coupon preferred.

Historically, before the current extended period of financial repression, a 4% or 5% three month LIBOR rate was not uncommon. (move left cursor all the way to the left to get data going back to 1986: 3-Month LIBOR)

MSPRA will at least produces a current real rate of return of about 3.5%, before taxes, based on the currently forecasted inflation rate embodied in the ten year TIP price.

I discuss the advantages and disadvantages of this kind of security in Advantages and Disadvantages of Equity Preferred Floating Rate Securities. Given the many disadvantages, I view non-cumulative equity preferred stocks issued by financial institutions with some disfavor.

While these securities are classified as part of a firm's equity, I view their bond characteristics to be more dominant than their equity features. From an individual investor's viewpoint, the equity features of MSPRA include the qualified dividend, the non-cumulative feature, and the perpetual term of the security.

Unlike common stock, however, the owner of MSPRA does not have an equity interest in the business, and its owner really only has the dividend.

Non-cumulative equity preferred stocks issued by financial institutions are hyper-sensitive to perceptions about the firm's creditworthiness.

During the Near Depression, it was common to see this type of security, with a $25 par value, sell at less than $10 per share. (e.g. Bought BMLprg at $8.8; Bought 100 ZBPRA at $7.8).

Generally, I would expect the senior unsecured note owners to recover less than 25 cents on the dollar in a BK.

Owners of more junior securities, including trust and equity preferred stocks, will most likely be wiped out completely. The Lehman equity preferred shareholders were left holding a worthless pieces of paper. Lehman had a floating rate equity preferred stock that was traded on the stock exchange (formerly under the symbol LEHPRG).

I started to invest in some of these securities during the Near Depression when they could be purchased at greater than 50% discounts to their $25 par values. The downside risk is zero as shown by what happened to those unfortunate souls who owned LEHPRG, a Lehman equity preferred floater, that is now worthless of course.

An equity preferred stock is only superior to common stock. It will be junior in the capital structure to all bonds. Given that low priority, the non-cumulative dividends paid by most of them, and the highly leveraged balance sheets of financial institutions issuing them, there will be no recovery in a bankruptcy for an owner of an equity preferred stock. Investors realized that would be the likely outcome and will behave irrationally when there is a whiff of a possible financial collapse. (a 75% chance of bankruptcy when a rational number would be less than 10%).

This type of security can be extremely volatile in price, as shown by my trading history, and by a long term chart. MS.PA Interactive Stock Chart This stock fell to below $8 during the Near Depression period. I first bought shares at $12.88.

The decline in MSPRA's price after Lehman's failure was not irrational, but was borderline irrational when I first bought MSPRA in May 2009.

Periodically, these stocks will hit an air pocket. I am just use to it.

I discuss an example from August 2011: Item # 1 Fear and Enhanced Volatility in Certain Classes of Income Securities I was able to buy Santander's floater at $13 during that one, and still own those shares.

A few weeks later, yet another downdraft, and I picked up HBAPRG at $16.18 (HSBC's US operation). Bought 50 HBAPRG at $16.8

One of my earlier discussions about embracing their volatility in a trading strategy is discussed in a May 2009 post. Embracing Volatility as A Risk Management Tool In the Sub-Asset Class of Equity Preferred Stock

So, volatility and risk are just known hazards. Know what you are buying, its history and characteristics.

My last purchase of the common shares was discussed in this post: Bought 50 MS at $14.98 (9/5/12 Post)

With inflation quiescent, and the 3 month Libor rate a long way from triggering an increase in the 4% coupon, the equity preferred floaters are relatively unattractive now. I buy them as part of bond strategy due to their sensitivity to rising rates.

In the last analysis, I do not see the 3 month Libor rising over 3.3% for several years, but the market may be wrong in predicting low inflation numbers into the distant future, as reflected in the current break-even spreads embodied in the 10, 20 and 30 year TIPs. It is certainly conceivable that problematic inflation will return much sooner, causing the FED to raise the FF rate much higher and quicker than currently anticipated by the TIP pricings.

Given the low coupon for the foreseeable future, I have adopted a trading mentality for these securities. Snapshots of realized gains in this category can be found in the Gateway Post for Equity Preferred Floating Rate Securities=+$13,377.97.


Morgan Stanley Non-Cumulative Preferred Series A (MS.PA:NYSE)

1. The largest gain was on a 100 share lot purchased in 2009: Bought 100 MSPRA at $12.88 in May 2009-SOLD 100 MSPRA at $21.43 (January 2010); and Bought 50 MSPRA at $15.7 (May 2010)-Sold MSPRA at $18.50 (July 2010)

150 Shares +$962.87

2. Item # 1 Bought 50 MSPRA at 19.71 (January 2011)-Item # 4 Sold 50 MSPRA at 21.03 in Roth IR (3/14/11 Post)

50 Shares +$58.47 Roth IRA Account

3. Item # 5 Added 50 MSPRA at 19.54 (2/2/11 Post)-Item # 5 Sold 50 of 200 MSPRA at $22.04 (3/5/13 Post); Item # 2 Bought 50 MSPRA at 19.71(12/20/11 Post)-Item # 3 Pared 50 of 250 MSPRA at $20.8 (1/22/14 Post)

100 Shares +$147.66

4. Bought 50 MSPRA at $19.25-ROTH IRA (September 2013)-Sold 50 MSPRA at $20.22 April 2014

150 Shares +$71.86 Roth IRA

5. Added 100 MSPRA at $18.9 (March 2012)-Sold 100 MSPRA at $20.21 April 2014

100 Shares +$116.98

There have been two sell transactions this year:

6. Item # 1 Bought 50 MSPRA at $16.6 (9/27/11 Post)-Sold at $21.2-No Write Up

50 Shares +$214.09

7. Sold 100 of 200 MSPRA at $20.91 (3/2/15 Post)-Item # 3 Bought Back 100 MSPRA at $20.24 (10/4/14 Post)

100 Shares + 53.03

Total Realized Gains: $1,624.96

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. A failure to perform due diligence only increases what I call "error creep". Stocks, Bonds & Politics:ERROR CREEP and the INVESTING PROCESS. 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.