This topic was last updated here: Update For Exchange Traded Bonds And Preferred Stocks Basket Strategy As 6/3/16 - South Gent | Seeking Alpha
Fixed coupon exchange traded bonds and preferred stocks have what I call asymmetric interest risk between the owner and the issuer that clearly favors the issuer.
I discuss the asymmetric interest rate risk of exchange traded fixed coupon securities here: Update For Bond And Preferred Stock Basket Strategy As Of 9/10/15 - South Gent | Seeking Alpha
I discussed the interest rate risk and other material topics here: Update On Bond And Equity Preferred Stock Basket Strategy As Of 8/14/15 - South Gent | Seeking Alpha (scroll to following titles in the Appendix section: Interest Rate and Lost Opportunity Risks for Fixed Rate Coupon Equity Preferred Stocks; Credit Risks; Volatility Risk for Equity Preferred Stocks)
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. I will discuss some of those trades here. I do not have the time to discuss all of my bond market purchases.
There are generally three notable differences between exchange traded bonds and those traded in the bond market.
1. Par Values:
For bonds traded in the bond market, par value is $1,000. Pricing of the bonds are at 1/10th of par value.
Exchange traded bonds generally have $25 par values, though there are exceptions.
2. Accrued Interest:
Whoever owns an exchange traded bond on the ex-interest date receives the entire interest payment irrespective of when the bond was bought.
The purchaser of a $1,000 par value bond has to be accrued interest to the seller. This will generally require an accounting adjustment in Schedule B.
3. Call Protection:
An exchange traded bond generally restrains the issuer from redeeming the bond within five years after the IPO (though there are sometimes loopholes). And, most importantly, the issuer can generally redeem at par value plus accrued interest on or after that call date. The option to call at par value creates significant asymmetric interest rate risk between the issuer and owner in favor of the issuer.
If interest rates decline into the call date, and it is beneficial for the issuer to call at par value and refinance, then the owner has to reinvest the proceeds into lower yielding instruments. This has been commonplace over the past several years and would be equally applicable to equity preferred stocks.
If interest rates rise, and it is beneficial to the issuer to put its optional call right into hibernation, then the owners will be allowed to keep a bond falling in value.
The bonds sold primarily to institutional investors will generally shift interest rate risk in a more balanced way.
The standard "make whole" clause found in many $1,000 bond prospectuses is in effect a penalty for an optional redemption prior to maturity that becomes more severe as rates decline.
This is the make whole provision found in the 2023 Enbridge bond prospectus:
To get out from under a 4% senior note maturing in 2023, Enbridge would have to pay the owners "the sum of the present values of the remaining scheduled payments of principal and interest". Those sums are discounted to present value using the treasury rate for a similar maturity plus 25 basis points. The discount rate is extremely low which means the sum of all remaining interest payments and the $1,000 principal amount is reduced at a snail's pace.
The 5 year and 7 year treasury notes closed yesterday at 1.10% and 1.38% respectively. Daily Treasury Yield Curve Rates
If rates shot up, the sums were be discounted to present value faster but then would the issuer be interested in redeeming a 4% coupon bond maturing in 2023 given the coupon rate for a similar maturity replacement bond.
Basket as of 6/17/16
1. Sold 100 EMAPRB at C$12.62:
Snapshot of Trade (C$1 Commission):
Closing Price 6/32/2016: EMA-PB.TO: C$12.62 +0.16 (+1.28%)
I accounted for 100 of the 300 shares traded that day. It is a bit odd that an Old Geezer from Tennessee traded 1/3rd of an entire days volume.
Snapshot of Profit C$120
Item # 2. Bought 100 EMAPRB at C$11.4: Update For Exchange Traded Bond And Preferred Stock Basket Strategy As Of April 1, 2016 - South Gent | Seeking Alpha
I did hold the shares long enough to receive one quarterly dividend. Emera Approves Quarterly Dividends (" a quarterly dividend of $0.1393 per Series B First Preferred Share payable on and after May 16, 2016 to Series B First Preferred shareholders of record at the close of business on May 2, 2016.")
Security Description: EMAPRB is an equity preferred stock that pays quarterly and cumulative dividends at a 1.84% spread to the 3 month Canadian T Bill on a $25 par value. The issuer is Emera (EMA:TOR), a large utility company based in Canada that is in the process of acquiring Teco Electric in the U.S.: Emera to Acquire TECO Energy in US$10.4 Billion Transaction That purchase price included the assumption of approximately $3.9B in debt.
Emera Incorporated Announces Filing of Preliminary Base Shelf Prospectus and Registration Statement and Separate US$ and CDN$ Offerings of Senior Unsecured Notes as Part of the Funding for the Acquisition of TECO Energy, Inc.
I am somewhat concerned about the issuance of debt to fund the TECO acquisition. The dismal jobs report and its likely impact on the Federal Reserve was another reason for selling one of my Canadian preferred stocks that reset at a spread to the 3 month Canadian T Bill.
Recent Earnings Report: Emera Reports Q1 2016 Earnings
2. Bought 2 Enbridge 4% Senior Unsecured Bonds Maturing in 2023:
Rationale: This is a low expectation buy. I would be content to receive the 4% coupon and par value on 10/1/2023. This purchase is part of an ongoing build of an investment grade bond ladder focusing on maturities between 2019 through 2025 that now includes a bunch of TIPs purchased in the Roth IRA.
The bogeys for the corporate bond purchases include the following:
1. Investment Grade Ratings (an Icahn Enterprises bond, which was recently downgraded to junk, is an exception)
2. YTM's Greater than 4%
3. Purchased at Below Par Value
4. Available for Purchase in 2 Bond Lots and
5. Maturing between 1/1/20 and 12/31/2025 (easily allowing me to hold until maturity)
The 99.93 price shown in the snapshot includes Fidelity's commission.
|Moody's Rating||Baa2 (06/22/2015)|
Current Yield and YTM would be the 4% coupon rate.
Prospectus ("The notes will be direct, unsecured and unsubordinated obligations of the Corporation, issued under the Indenture and will rank equally with all other existing and future unsecured and unsubordinated indebtedness of the Corporation other than preferred claims imposed by statute. In addition, our business operations are conducted substantially through our subsidiaries and through partnerships and joint ventures. The notes will be structurally subordinated to all existing and future liabilities of these subsidiaries, partnerships and joint ventures." at page S-18)
It is conceivable that I could clip up to a $100 profit. This bond was trading near 105 in November 2014 and April 2015. There was then a steep decline to what looks like a double bottom around 87 earlier this year. I do not interpret that decline as being caused by an adverse change in interest rates but to a perception that developed about the credit risks of energy infrastructure companies in general. Some other energy infrastructure companies saw greater declines in their senior unsecured debt. An example would be the BKinder Morgan 4.15% maturing on 2/1/2024.
I recently discussed buying another Enbridge senior unsecured bond maturing in 2024.
I have nothing to add to that discussion and my previous discussion relating to this company when I purchased ENBPRA, a cumulative equity preferred stock.
Item # 2. Bought 2 Enbridge 3.5% Senior Unsecured Bonds Maturing on 6/10/2024 at 93.658: Update For Exchange Traded Bonds And Preferred Stocks Basket Strategy As Of 5/10/16 - South Gent | Seeking Alpha
Item # 1. Bought 300 ENBPRP:CA at C$12.39: Update For Exchange Traded Bond And Preferred Stock Basket Strategy As Of 2/29/16 - South Gent | Seeking Alpha
3. BOUGHT BACK 100 ENBPRF at C$13.45:
Closing Price Day of Trade (today): ENB-PF.TO: C$14.05 -0.13 (-0.92%)
Trading Range: C$13.38 to C$14.3 (top to bottom=6.43%)
I recently flipped a 100 share lot of this Canadian reset preferred stock after a one month holding period.
Item # 5. Sold 100 ENBPRF at C$14.56 Update For Exchange Traded Bond And Preferred Stock Basket Strategy As Of April 1, 2016 - South Gent | Seeking Alpha(profit snapshot C$196)- Item # 2. Bought 100 ENBPRF at C$12.58: Update For Exchange Traded Bond And Preferred Stock Basket Strategy As Of 2/29/16 - South Gent | Seeking Alpha
The Enbridge Inc. Cumulative Preferred Series F (ENB.PR.F:TOR) has a 4% initial fixed rate coupon, paid on a $25 par value to 6/1/2018. Starting on 6/1/2018 and for every five year period thereafter, the coupon will reset at a 2.51% spread to the 5 year Canadian government bond.
Based on the current fixed coupon rate of 4%, and assuming a total cost per share of C$13.45, the dividend yield is about 7.44%.
The current quarterly rate is C$.25 per share. The last ex dividend date was 5/12/16. Dividends, Securities and Tax Info - Enbridge Inc.
My next move in Enbridge securities will be to sell something, possibly this preferred stock again.
4. Sold 50 TCRX at $25.55: It is hard to make money on junky exchange traded bonds when bought near par value in a search for yield.
Profit Snapshot: $35.72
Item # 1. Bought 50 TCRX at $24.8: Update For Exchange Traded Bonds And Preferred Stocks As Of 1/21/16 - South Gent | Seeking Alpha
I still own the functionally equivalent TCRZ: TCRZ Stock Quote - THL Credit Inc. 6.75% Notes 12/30/22 (TCRZ:NYSE); Prospectus for 2021 Senior Unsecured Note
Item # 2. Bought 50 TCRZ at $24.75: Update For Exchange Traded Bonds And Preferred Stocks Basket Strategy As Of 1/5/16 - South Gent | Seeking Alpha
I made this comment when I discussed the TCRX purchase, the one that was sold:
"The most significant differences between the two THL senior secured bonds are that TCRX matures about a year earlier and consequently has an earlier optional call date
TCRX Matures on 11/15/21 with optional call on or after 11/15/17, Prospectus
TCRZ Matures on 12/30/22 with optional call on or after 12/30/18. Prospectus
Since I am using my IB account to make these odd lot purchases, it is conceivable that I may sell one profitably in order to buy an equivalent amount of the other when I can secure a better yield with the swap. There was a time during the Near Depression and its afterglow when there could be substantially different yields from functionally equivalent preferred stocks and exchange traded bonds."
That is what I intend to do. Wait for a better opportunity to buy back 50 of TCRX or to add 50 to the existing TCRZ position. My preference in a falling interest rate environment would be to go with TCRZ due to its later call and maturity dates.
Last Earnings Report: SEC Filed Press Release
A list of investments starts at page 7 of the last filed 10-Q.
5. Paired Trade-Sold 2 Seagate Technology 4.75% Senior Unsecured Bond Maturing on 6/1/2023 at $83.838 and Bought 2 Seagate Technology 4.75% Senior Unsecured Bonds Maturing on 1/1/25 at $79.125:
Paired Trade Snapshot:
Profit Snapshot for 2023 Bond: +$45.59
Item # 5. Bought 2 Seagate Technology 4.75% Senior Unsecured Bonds Maturing in 2024 at $80.99: Update For Exchange Traded Bond And Preferred Stock Basket Strategy As Of 5/16/16 - South Gent | Seeking Alpha
Plus Interest: $7.91
Total Return (one month)=+$53.5 or 3.29%
The taxable amount of interest received since my 5/12/16 purchase is calculated in the Appendix section below.
YTM for 2023 Bond at Proceeds Price of 83.638=7.846% (7.804% without the broker's commission)
Current Yield 2023 Bond at 83.648= 5.68%
Substituted 2025 Seagate Bond YTM and Current Yields:
YTM for 2025 Bond at Total Cost Price of 79.325= 8.158% (8.196% before commission at executed price of 79.125)
Current Yield at 79.125= 6%
YTM and current yields are calculated with the commission cost of $2 per bond. YTM assumes that Seagate survives to pay the principal amount at maturity. The Bond Ghouls have some concerns about that occurring.
A YTM of 8.158% for a BBB- rating bond maturing in 2025 is just way out-of-line with other BBB- rated bonds maturing that year.
Yields as of 6/14/16:
2025 Arrow Electronics 4% 3.482% at 103.8
2025 Associated Banc 4.25% 3.88% at 102.62
2025 AutoNation 4.5% 3.853% at 104.9
2025 DDR 3.625% 3.685% at 99.46
2025 Healthcare Realty 3.875% 3.811% at 100.47
2025 Sychrony Financial 4.5% 3.761% at 105.52
I would call the foregoing cluster of yields in the 3.5% to 4% to be the Bond Ghouls benchmark for accurately rated BBB- bonds.
Rationale: My thinking was that it was worth the extra current yield and YTM to go out another 18 months when in my small ball playing mode.
And, the OG looks at the $79.125 and notes that it is closer to zero than $83.838, and less money is used to buy a functionally equivalent bond maturing on 1/1/2025.
The longer maturity date would work in my favor when and if interest rates remain near where they are now and Seagate does not default between the two bond maturities.
A. Calculation of Taxable Interest for Seagate 2023 Transaction:
When I bought this bond, I paid $43.81 in accrued interest to the seller.
Shortly thereafter, I received a semi-annual interest payment of $47.5 which will be on my 1099.
My accountant will deduct in schedule B the $43.81 in interest paid to the seller, along with other accrued interest payments, using one line item in that schedule (e.g. "Accrued Interest Paid to Seller")
When I sold the bonds, I received $4.22 in accrued interest from the seller.
Received from Seagate on 6/1/16 +$47.5 (semi-annual payment)
Minus Accrued Interest Paid to Seller -$43.81
Plus Accrued Interest Received from Buyer +$4.22
Taxable Interest= $7.91
B. Categories of Preferred Stocks and Exchange Traded Bonds (excludes principal protected senior unsecured notes that have all been redeemed)
I have snapshots of net trading gains for the following exchange traded bonds and preferred stock categories. The net trading gains were in small lots.
Trust Certificates: New Gateway Post= $28,971.16
Baby Bonds - South Gent | Seeking Alpha= +$7,571.73
REIT Cumulative Equity Preferred Stocks= +$6,496.18
Aegon Hybrids: Gateway Post= +$4,512.81
ING Hybrids = $2,117.96
Non-REIT Fixed Coupon Equity Preferred Stocks = $2,337.47 (snapshots now at the end of REIT Cumulative Equity Preferred Stocks Post linked above)
Synthetic Floater transactions are included in the Trust Certificate category.
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".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