We Love It and You Might Too

Ok, we’ll admit it right up front.  Sometimes we are lazy and don’t check our investments for days on end.  There are also months where we might make only 1 buy or 1 sell of a security.  We have written before that it is our goal to NOT trade unless we have a real reason to do so.  We have staked out that position based upon our individual circumstance.  In our household we both continue to work at least 1 full time job and many times that job turns into 7 days a week.  We are comfortable with our minimal trading and 7% annual return target and each investor needs to define their goals and then find a way to realistically make them happen.  For us to try to trade continually would probably be a disaster since we simply don’t have the time to monitor our positions.

We have noticed that there are a fair number of income investors that are very active traders.  I believe they do this for a couple of different reasons.  1st off if they are totally retired they may be bored and active trading helps to fill the day while hopefully providing some added returns to there account.  2ndly, in a trending market one can truly pick up an extra 1%, 2%, 5% or more in return over the course of a year.  Is there anything wrong with trading actively?  Absolutely not!!  The best way to invest is the way that fits your situation and gives you the return that you desire.

So we return to the topic of this note – “We Love It and You Might Too”.  We are simply referring to our 2015/2016/2017 Moderate Duration Income with Zip Portfolio (such a lousy name).  We love this model and very much have used it as a basis for our own personal investing. Recall that this model was put together in August, 2015–just over 18 months ago.  The holdings are either baby bonds or term preferreds since we are looking to avoid “interest rate risk”  and thus we avoid perpetual preferreds.  Thus far the portfolio has shown a return of 13.54% (about 9% annualized) which we consider excellent for the modest risk inherent in the portfolio (at least during times of trending interest rates and stable U.S. economic performance).  Starting with a value of just over $80,000 the portfolio now is nearing $91,000 in value. There have been 8 sales from the model and 9 purchases–just about 1 transaction per month. Most of the sales have been caused by either issues being called or by the need to “capture” profits on one of the “zip” items held (for this model we define the zip items as simply either REITs or MLPs which give us the potential for added return).

Digging a bit deeper we can anticipate that readers question whether a portfolio with so many baby bonds from business development companies (BDCs)  is safe.  Our answer is that it is a reasonable risk as long as the general economy stays healthy.  Remember that BDCs are closed end funds and this means they must have an asset coverage ratio of 200% of their debt–this helps mitigate risk with an added level of safety. If the economy was to move toward a recession, which there is no sign of now, we would likely move toward some higher quality baby bonds.

In summary we simply love this model portfolio and believe it can be a base for many investors like ourselves.  Maybe you toss in a couple perpetual preferred to the base to juice yields a bit.  Maybe you use a higher percentage of REITs or MLPs to again help juice the yields–but always mindful that the higher the reward the higher the risk. No portfolio is right for everyone, but at this point in our lives this one works well.

To get more information on preferred stocks and exchange traded debt (baby bonds), screen them, set up your own portfolio and receive email alerts, go to www.preferred-stock.com now.

The Coming Interest Rate Hike

We thought it was time to revisit the topic of the coming interest rate hike.  Certainly it is likely there is a rate hike coming, but when it will happen no one knows for sure.

Earlier this week we watched Chair Yellen testify to congress and at first it seemed that she wanted to raise rates in March, but in the end she didn’t give me, or any markets, confidence that she really meant it.  Of course they are data dependent, but if they don’t raise when they have the chance with good economic data when will it happen?  This the same sad story we have witnessed for multiple years already.  We saw inflation tick higher in January by a “hot” .6%–much of the rise driven by food and energy, but as Yellen acknowleged in her testimony food and energy are large parts of the average consumers budget.  Employment is reasonable, both from a job creation point of view as well as unemployment rate, although wages remain somewhat stagnant, but let’s face it if we are to wait for each and every data point to be perfect then we just as well concede that near ZIRP (zero interest rate policy) is here to stay.  Let’s get the Fed Fund rate up in March by another 1/4%!!!

Yellen also testified this week that she would begin to let the balance sheet “run off” when interest rates are normalized (not certain she defined “normalize”).  The Fed holds over $4 trillion in assets on their balance sheet as a result of “QE” (quantative easing)–prior to 2008 when the 1st QE program began the normalized balance sheet had assets of $800 billion–only 20% of what it is today.  Every month $40 billion in debt that the FED holds matures and instead of simply letting the balance sheet fall naturally they turn around and reinvest the proceeds–a perpetual QE program.  Month after month after month more opportunity to lower the balance sheet has passed by. If the Fed intends to wait until interest rates are normalized before beginning to reduce the balance sheet we simply should admit that it isn’t going to happen—–EVER.

So we simply hope that the FED will raise rates in March–it is the least that can be done.

Here is the problem.  The markets have almost written off the odds of a March hike.  The current odds of a March hike is pegged at 17%.  Wow!!  This means either A) there will be no rate hike or B) there is going to be a lot of blood spilt in the next couple of weeks.

The bottom line is this–it doesn’t matter for us whether the Fed raises rates or not–we are positioned for a rate increase to the extent that we reasonably can be–meaning quite a few shorter duration securities.   If there is a major hit because of a surprise rate hike we will simply have to deal with it when/if it happens.  Keeping dry powder at the ready is always best in times of uncertainty (at least for us).  For those with a potful of perpetual preferreds you might want to say an extra “Hail Mary” at bedtime tonight–or at a minimum simply understand that a 2-10% hit is coming your way.

Energy Retailer Just Energy Corp. Sells a Juicy Fix-to-Floating Issue

Canadian energy reseller Just Energy Corp. (NYSE:JE) has sold a new 4 million share fixed-to-floating rate preferred offering with an initial fixed coupon of 8.50%.

Just Energy is a reseller of both electricity and natural gas in most of Canada and in 14 U.S. states.  JE does not produce energy, but simply is the seller to 2,000,000 customers.  The company was formed to take advantage of the deregulation of energy suppliers that has occurred in many states and Canadian provinces.  Deregulation gives consumers the choice of who is their energy supplier.  The company was formed in 1997 and has annual revenue of over $4 billion.

This new preferred stock issue will have a fixed coupon rate of 8.50% until 3/31/2022 at which point it will begin to float at a rate of 6.48% plus the 5 year mid market swap rate, plus ½%. Typically the floating portion is based on 3 month Libor, but in this case a different metric is used. The best source we have found for the 5 year mid market swap rate is here.  The key rate we focus on when evaluating fixed to floating rate issues is the fixed base portion of the floating rate. 6.48% is an excellent base rate and ensures that future coupon payments will remain fairly high.

Potential investors should be aware that there is a likelihood that your broker will withhold 15% of your dividend for Canadian withholding.  While we believe they would be incorrect in doing so you will need to check with your broker to determine your own circumstances.  Additionally we have noted in the past that some brokerage firms attempt to charge an added fee for purchase of a foreign stock. Again this should not be tolerated by the investor as standard trade fees should be applied.  

This issue is now trading on the OTC Grey market under the ticker of JENGF and is trading around $25.60.

Details of this new issue can be found here.

To get more information on preferred stocks and exchange traded debt (baby bonds), screen them, set up your own portfolio and receive email alerts, go to www.preferred-stock.com now.


Adding a mREIT to 2 Portfolios

In what we believe to be a 1st for the model portfolios we have added shares of mREIT New Residential Investment Corp (NYSE:NRZ) to 2 of the models.  This decision was made as shares traded sharply lower as the company did a stock offering of 50,000,000 shares.  We should also note that we follow many investing message boards and our awareness of this potential “bargain” was highlighted by the wise men and women on the Silicon Investor–1 of many sites we follow. Honestly we have made better decisions in investing by paying attention to message boards (and NO-not Yahoo message boards) for over 10 years as the cumulative amount of wisdom imparted by seasoned investors can’t be bought—sometimes it is their wisdom that is valuable and sometimes it is simply “ideas” that are floated.

We have added 500 shares to the 2015/2016/2017 Blended Income Portfolio.  This portfolio has had plenty of cash available and we were able to buy shares early today for $15.30 share.  Additionally we have added 3oo shares to the 2015/2016/2017 Moderate Duration Portfolio with Zip–these shares are almost the perfect “zip” for this portfolio and it raises the current yield on this relatively conservative portfolio to 6.68%.  NRZ just raised their dividend from .46/quarter to .48 for a current yield of 12%.

We have been hesitant to own shares in mREITs in the past because of the complexity of their business models, but we think we have a good handle on the business of NRZ.  In general it is fairly straighforward.

NRZ is a REIT which is primarily an owner of Mortgage Servicing Rights (MSR’s).  MSR’s are purchased from mortgage originators and New Residential receives a fee for servicing these mortgages.  Servicing involves receiving payments, disbursing interest and principal, insurance and taxes.  For this service they receive a fee and from the originator.  In addition to MSR’s NRZ has a modest portfolio of residential mortgage backed securities as well as a portfolio of consumer loans.  Each of these businesses has specific risks, but in the end the risks are minimized as long as the general economy fairly healthy.

The 50,000,000 share offering that the company just sold was to finance a purchase MSRs on $97 billion in unpaid mortgage balances.  They are paying about $950 million for the MSRs which is a typical price (normal pricing is around 1% of unpaid mortgage balances).  This will give them MSRs on almost $600 billion in unpaid mortgages. With a relatively solid economy we see little current risk in owning NRZ.

For investors interested in NRZ you can find an informative presentation on the company website here.  

Additionally one should read this recent article on Seeking Alpha which adds some color to NRZ.

We are hopeful we will hold this investment for a long time, but when and if we get a whiff of recession we will have to exit.

Disclosure – we have also purchased for our personal account.


Interest Rates Flat Through January

January has been a reasonably good month for income investors as the 10 year treasury ended the month at the same place it started, 2.45%.  Even though interest rates remained flat the average price of a preferred share or baby bond continued to climb from December prices.  The average share ended the month at $25.68 which is a gain of about 1% on the month.  In what has been a typical pattern for years any interest rate move such as the Fed Funds increase in December spur price movements that are initially much greater than are justified, but prices adjust as time goes by.  Recall that even before the December Fed Funds rate increase interest rates had anticipated the move and the 10 year treasury was at 2.5%.  The average preferred stock had fallen by 4% although high quality low coupon issues had fallen by as much as 6-10%.  A  seasoned, patient investor, would have anticipated that prices would adjust higher as the overreaction corrected itself.

So where do rates go from here?  The Federal Open Market Committee is meeting right now and will be announcing interest rate decisions on Wednesday afternoon.  There will be no change in rates Wednesday and we agree with most that a rate hike in March is likely given the information available at this moment.  Recall that in December Yellen announced that 4 rate hikes were likely in 2017–we disagree and think given what we know right now 2 is more likely.  Last week 4th quarter GDP was announced at 1.9%, after the 3rd quarter was at 3.5%–the consensus was 2.2% so already we are slipping from consensus.  Friday will give us a look at employment which is very important in the interest rate outlook and this announcement could be a market mover.  Of course the wild card in any market is what the Trump administration does with policy and we are unable to factor this into our outlook.  Assuming all data in February comes in at close to expectations we think the 10 year treasury may move somewhat higher (10-20 basis points) in late February in anticipation of a 1/4% Fed Funds increase in March.  This is somewhat meaningless to us as we have  set our path with purchases of only shorter maturity issues or high yield issues and this won’t be changed.

In summary we believe that rates will remain flat for the next 30 days, but factors outside the norm (the Trump administration) may be responsible for movements that can’t be anticipated by anyone.  We have to invest based upon what we believe will happen and simply deal with any special events caused by government when they happen as we can’t foresee what these will be.


BDC Hercules Capital Calls 7% Baby Bonds

Quality business development company Hercules Capital (NYSE:HTGC) has called for early redemption of their 7% baby bonds (NYSE:HTGZ and HTGY) effective 2/24/2017.  These 2 issues became callable on 4/30/2015 and 9/30/2015 respectively and had maturity dates in 2019.  The company has sold a large ($230 million) convertible issue with a 4.375% coupon to fund the redemption.  The redemption cost will be in the $115 million area–they will be using the balance of the proceeds from this offering for general corporate purposes.

Unfortunately, in a continued squeeze on income investors (and us in particular) we hold these bonds in all of the model portfolios as well as in our personal holdings.  Fortunately our positions are relatively small so the loss of a quality 7% holding won’t be hugely hurtful, but just the same every time we lose a 7% coupon issue it makes it more difficult to attain our modest 7% annual goal with a good level of safety.

Here is what we are going to do right now.  We will let the Hercules holdings simply be called in February, but we will make a couple of immediate purchases with cash on hand as we have had a buildup of cash as dividends/interests roll in and other issues are redeemed.

In the 2014/2015/2015 Short/Medium Duration Portfolio we will be adding shares of the Hercules 6.25% baby bonds (NYSE:HTGX).  While obviously we are giving up .75% by buying these baby bonds as compared to the bonds being called at least we are getting the funds deployed.  BE AWARE that the HTGX issue is callable on 7/30/2017 and we are paying $25.35 for our new shares.  Because it is callable soon there is a risk that we may have to replace it in the summer. We are willing to take that chance since we have little risk of loss (maybe 20 cents per share) and we really want baby bonds of this quality company.  As cash builds up it is most important to get these funds invested as our cash earns nothing.  Recall that this portfolio is designed to have shorter maturity instruments with a target return of 7% annually.  It is not designed to garner capital gains.  Since 10/2014 the portfolio has returned a low stress 15.42%.  Currently the portfolio has a cash balance of $12,671 which is too high on a total portfolio value of $98,108.  With this purchase we move the cash position down to $4,977.

In the 2015/2016 Moderate Duration Income with Zip Portfolio we have added 200 more shares of the Arbor Realty Trust 7.375% Senior Notes (NYSE:ABRN).  When this issue was originally bought for the portfolio only 100 shares were bought, which is kind of  a light position.  Given the companies performance in the last year (which has been respectable) it is reasonable to add some shares.  Please note that this issue (ABRN) is callable starting in May which again gives us a 20 cent or so risk by owning these shares.  This portfolio has $12,544 in cash so this will now be taken down to $7,400.  This portfolio was built to be primarily short maturity issues with a REIT or MLP (or 2) added in for potential capital gains.  In 17 months there is a gain of 12.24% which was helped by a gain booked in Independence Realty Trust (NYSE:IRT), which was later repurchased at a lower price as well as a gain that was booked on Stag Industrial (NYSE:STAG).

With these changes in the 2 Short/Moderate Duration portfolios we remain relatively well positioned for our 7% target–although it is becoming more difficult all the time.  We will see where the Fed takes interest rates in the months ahead as this may be helpful for these 2 portfolios.