oec2000

Also, just wanted to point out that SGP Pfd is mandatorily convertible into common - just in case anyone is thinking of buying it.

Eric, could you please email me your spreadsheet at [email protected]? Thanks.

I agree fully. I am narrowing my focus to companies where I can definitely quantify the risks and fully comprehend the business model. In the situations where you can do this, wouldn't it make more sense to just go long the stock or calls, as in FFH or ORH? Btw, is Derek Foster the guy who retired on something like $1,500 a month? Wonder how his strategy is coping with the dividend cuts we are seeing everywhere?

(that's my answer to the guy who says that by writing the put I miss out on being able to buy GE at $5 if it gets there). So, let's say the shares are at $5 and I decide that I really want to own the stock. Well, one thing I could do is just take the $1 loss by buying the put back at $2 and essentially I'd be at roughly a cost basis of $6 for the stock. Still much better than if I'd initially paid $9. What I said was to scale into the position - "plan your purchases such that you would end up having an average cost no different from what you would have achieved by selling the puts." So, you would not be stuck with stock at a cost of $9 on your full position if the stock does fall to $5 or lower. The key is that if the stock does not fall below $9 and the mkt bottoms and GE recovers to $20, your upside is not limited. The reason I'm advocating this approach is because of where mkts are today (stocks already down 70-80%) and the "risk" that mkts could be very close to the bottom - to me, managing the upside risk is as important as managing the downside risk. Also, by trading the common, you are not exposed to volatility spikes that might be expected if GE were to fall to $5. The option strategy can work, I agree, but has too many moving parts and requires higher maintenance. It's probably fine if you can initiate your put at very good prices but these opportunities are transient and easy to miss unless you are glued to the screens all day.

Is this possible? How would one go about it? In Derek Foster's example it sounds like he bought back his original put position once it was in-the-money (the volatility premium was therefore largely gone), and then replaced it with another round of at-the-money puts at a time when volatility was very high. If volatility was 33% of strike when he wrote the replacement puts, then that would produce the kind of numbers to give him about a $4 per share gain (the initial premium). He doesn't quite explain it that way, but it makes sense. It's possible but in order to get a net credit on the switch, he would have had to extend the expiry - the 45 put will have to be for a further out month. But, you cannot always save your position this way - it depends on how much the price has dropped and how much further out you can go.

Crip, Thanks for the advice. Looks like you have convinced me to go. Any advice on planning/making arrangements for the trip, what to do when there - to get the most out of attending - would be appreciated. Cheers, oec

I don't know if you saw my post about hedging. I did and thought it was a smart way to pay for your FFH calls because it addresses two points I raised - risk mgmt (the FFH calls reduce your FFH risk) and selling expensive (or mispriced) options. The problem with Phoenix's strategy is that there is limited upside for him if the mkt bottoms here. I have also been buying the cheap FFH calls (which have been getting even cheaper!) to limit my downside and using the balance of the cash, which I would otherwise have had to use if I had bought FFH common, to buy pfds yielding 20-30%. So, say I bought the 250 FFH calls for $50; then used $200 to buy WFC.PR.L yielding 20%. By Jan 2011, assuming WFC is still around and did not stop the dividends, the $200 should have accumulated to more than $280. Anything I can recover/earn from the FFH call is icing on the cake. If your risk tolerance is lower than mine, you can buy the 12% ORH.PR.A pfds instead. There's more - whipped cream on the icing - if the pfds trade back closer to par, there is a capital gain on the pfds to boot!

Also, once NB is wholly-owned, they have more flexibility in "dividending" out surplus capital to holdco. The net impact on holdco cash will likely be somewhat less than the cash required for the buy out.

I have decided that my market prediction skill is simply not good enough for this climate. What?! And, you didn't make this disclosure when you made the mkt capitulation call? Phew, am I glad I didn't act on your call. ;D (Sorry, just couldn't resist making that dig - but we need all the humour we can get in these dismal markets.) I have been looking at selling puts as a way to generate some $$ while waiting for the prices to drop. If the price does not drop, the premium is cash in the pocket a t a time when cash is king. If the price drops, the net price paid is lower than if the stock had been purchased initially. Any thoughts on this strategy? My 2 cents: 1) Generally speaking, the drawback of selling options is the poor risk/reward economics - i.e. your downside is more than your upside. At a time when many stocks are 70-80% off their highs, are trading below intrinsic value and have very favourable risk/reward characteristics (on a 5-yr timeframe), you have to ask yourself whether you want to limit your upside while still exposing yourself fully to the downside. 2) It depends on how is the rest of your portfolio positioned? If you are already significantly long stocks and would benefit from a mkt recovery, then selling the puts to get some income (best case) or average down on your existing stocks at lower prices, then the strategy is probably OK if you can find generously priced options. If you have very little exposure to stocks currently, you would be better off scaling gradually into stocks. You can, for e.g., plan your purchases such that you would end up having an average cost no different from what you would have achieved by selling the puts. This way, you retain some upside if the mkt bottoms out right here. 3) The other disadvantage of trading options is that timing is crucial. Say you sell GE $5 puts because you think $5 is a good entry level for GE. You collect $1.30 for the 2010 LEAP. Then GE drops below $5 over the next 3 months but then recovers to $10 by Jan 2010. You will make $1.30 but you will have missed the opportunity to buy GE at $5 even though you were perfectly correct in your price predictions. My personal preference is to use options as a risk management tool (which usually translates into buying options) although there are times when I do sell options when I fell they are grossly mispriced (e.g. when FFH options were selling for 8-9% with less than a month to expiry in Sep 08). You might find it useful to try both alternatives on a small scale just to get a feel for which works better. I know there are other members on this board who appear to be more prolific options traders then I am. They might see some flaws in my thinking.

How about, "You know it's capitulation when you feel like it's decapitation?"

Anyone know why printing the AR is not being allowed from Adobe? Time for you to get the kindle - then you don't need to print out. No, I am not long AMZN. ;)

Stubble Jumper, To get back to you on the WFC.PR.L, (sorry, so many opportunities to look into) you were correct about the conversion ratio - the Ls convert into about 6.5 WFC shares, i.e. $150 conversion price. Not much use unless we are planning to hold till 2030. Nevertheless, I like the converts because they are not callable - useful when collecting 20% p.a. On HBC.PR, thanks for the recommendation. I was lucky enough to hold off buying until it went below $9 = 20% yield. Thought you might be comforted to know that Harris insiders bought these at significantly higher prices - not large quantities, to be fair. Skimmed through their 10-Q also and they appear to be in good shape. oec

With the Citi deal the govt is requiring other preferred holders to convert their shares to common too. Although other large banks may not be in the same situation as Citi, it's possible some...perhaps many, would take the same path. Depending on the conversion terms, it could be good, or bad for pfd holders. If the conversion is at face value it could be a windfall, which is doubtful and if it's at some prior trading price of the common and pfd, then it is probably not good. Conversion at a current price would be close to a wash. The market must believe many other banks are going to have to convert their pfds into common like C, and/or suspend pfd dividends. Ericd, As implied in my earlier post, I think the Citi model is likely to be followed in future by others. However, I do not see conversion to be a problem for current buyers of pfds at these distressed levels. (See how the C pfds performed after the conversion announcement.) The reason is that the conversion terms have to be set at a level that gives pfd holders an incentive to convert - otherwise, why would you convert and give up your seniority and liquidation preference of $25? Remember that conversion is optional and cannot be forced. So, there should be a premium on conversion at the time of announcement which pfd holders can lock in by shorting the common. That's why the arb trade on Citi was worth 50-100%. Holding a basket rather than using an ETF gives you more control and that's why I prefer the basket route. Firstly, you can buy only the Trust pfds if you want to minimise the conversion risk. (The banks can, of course, offer to convert the Trust pfds - but the terms would have to be much more attractive.) Secondly, my strategy has not been to pick the pfds paying the highest yields but those trading at the largest discounts to par. Because the conversion price is the same for all pfd classes, the pfds at the biggest discount to par will have the greatest upside. Thirdly, if I buy pfds at 10-15% of par (increasingly common these days), even if the dividends are suspended and no conversion is offered, as long as the bank survives, returns to health and resumes dividends after 10 years and the pfds revert to trading at par, my annualised return would still be between 21-26%. To summarise, there are 4 possible outcomes" a) C, BAC and WFC all fail - low probability outcome, imo. Loss would be 100% - but if this happened, even BRK would probably drop 50%! b) Dividends suspended for 10 years, no conversion. 21-26% annualised return. c) Conversion. Immediate gain. d) Pfds continue to pay dividends. 20-30% annual return for a very long time! (WFC.PR.L is not callable by company - I could collect this 20% return in perpetuity - while sitting on a beach in the Caribbean. I may have to figure out how to survive into perpetuity though! ;))

http://www.fairfax.ca/Assets/Downloads/AR2008.pdf I get a nice warm and fuzzy feeling reading it! ;D Makes me want to go out and buy more LEAPs - oops, too late, markets are closed for the week.

Netnet, 1) C arb - I missed the best part of the arb trade that was available on Fri am as pointed out by Cman because I am out on the West coast. Nevertheless, I was able to do the arb Fri pm as well as on Monday. (I had to improvise the arb by shorting the C 2010 2.50 call because TD would not let me short sell the common.) Based on the original Citi announcement, I assumed that the M and P pfds would convert into 7.7 C shares ($25 par value divided by $3.25 conversion price). A few days later, C threw a curve ball by announcing that the conversion would be subject to exchange factors which effectively reduce the no of shares by 5% to 7.3. Last Friday, the common/pfd spread varied between 50-100%. Today that spread has narrowed to about 6-7%. So, if you had done the arb on Fri, you could unwind the positions now for a 40+% profit. 2) Yes, I'm naked long the C.PR.U which, I should point out, is a cumulative Trust Pfd. It is senior in ranking to the other pfds and even the TARP pfds. They are are effectively backed by junior debt securities isued by Citigroup and their dividends are funded by interest received on the debt. So, unless Citi is prepared to default on its debt payments, these pfd dividends shoudl be safe. (Citi does have a right to defer payment for a maximum of 40 quarters on the debt). Unless you think that the govt is prepared to let C go under (if they are prepared to throw almost $200b at AIG, I don't see why they would not do the same with Citi), these do look attractive at 30% yield today. 3) Agree that I should treat C arb and ORH separately. 4) Retractibles. In Q4 08, there was this ridiculous opportunity to buy BNA.PR.B at prices between $14-19 and then surrendering them at the end of each month for retraction at about $21.50. You had to take the risk of BAM going bust during the month. I considered the risk to be low but in any case I bought out of the money BAM puts for insurance. BNA.PR.B now trades at about $20.50 so you could still do the arb but for a much smaller gain. (Very low volume though.) Right now, I am buying FBS.PR.B and BSD.PR.A - not so much for retraction (although the retraction rights offer a layer of protection - BSD retraction has been suspended for now though) but as a discounted and lower risk way to get exposure to Cdn banks and income trusts. oec

Is it time to load up (SELL) on naked puts ? Given where mkts are, the risk/reward characteristics of going long are, imo, much better. There are so many potential multibagger opportunities - it doesn't seem logical to me to enter a trade where your gain is limited to a fraction of the risk and capital you'd have to tie up to sell the put.

I am wondering whether it is worthwhile to go for the meeting this year. Haven't been before and am put off by the thought of the crowds and queues. Besides, the meeting looks like it will be well covered. Would appreciate advice of those who have been there.

Unfortunately, the government doesn't seem to have a playbook. They are reacting and sending mixed messages to investors i.e. suspending FRE & FNM preferreds outright and now splitting Citi's. I actually think the Citi plan is a smart plan. Firstly, it strengthens C's balance sheet without fresh govt capital infusion. Secondly, the preferred holders have been forced to take a haircut in a way that does not make them feel so bad (unlike the FNM/FRE situation). Thirdly, it sets the stage for C to raise funds in future by way of rights issues. The thing is that they are learning from their mistakes as they go along and I think they are finally beginning to show signs of a more coherent policy with the Citi plan which, unlike the BS/LEH/FNM/AIG plans, does not seem to be a reactive last minute desperation plan. The C plan, imo, clarifies three things: 1) The govt will continue to support the TBTFs (Too Big To Fail). By taking common equity, the govt has now aligned its interests with other common equity owners. When its support was purely in pfds, common equity owners could never be sure whether they would be wiped out. 2) Going forward, govt support will be on less onerous terms so as give the weakened institutions a chance to rebuild their equity. The earlier terms were too tough and self-defeating. The govt's goal is to save the financial system, not to maximise returns on its investment. The best way to do this is to pass on its low cost of borrowing to allow the institutions time to earn themselves back into health. The faster the financial system gets back into order, the faster the institutions can go back to raising private capital and the faster the govt can get its money back. Acceptance of zero-yield common equity shows that the govt realizes this now. 3) The govt will encourage/coerce private capital to share some of the burden of support. By assuring investors through its equity investment that C will not be allowed to fail, it will make it easier for C to raise capital in future by way of a govt underwritten deeply discounted rights issue which private investors will be motivated to take up so as not to be diluted; at the same time, they will not be deterred by the fear of C going under. If my analysis is right, it makes the case for investing in pfds even stronger because every fresh addition to common equity enhances the position of the pfds, not to mention that pfd shareholders are now ahead of the govt. I hold the following basket of pfds: C.PR.I (for the arb trade) C.PR.U (18% yield on cost, 26% yield today) WFC.PR.L (18%, 20%) BML.PR.H (30%, 20%) RBS.PR.P (36%, 48%) HFC.PR.B (30%, 30%) HBC.PR (20%, 20%) (Thanks, SJ!) ORH.PR.A (12%, 12%) My positions are somewhat aggressive but my exposure is less than 10% of overall portfolio. I am prepared to raise exposure to max of 20% if more compelling opportunities appear. Please tell me if you think I'm crazy!

It is at 6,763 today, down 42.5%, nine years after the peak. You overlook the fact that the Dow hit a new peak in 2007. In any case, comparisons with past cycles have no real predictive value. The sample size is so small that trying to draw a pattern is meaningless. Besides, a simple peak to trough computation does not take into account the degree of overvaluation at the peak so it has no real fundamental basis. The Mkt cap/GDP ratio metric is, imo, a better indicator - but even it is limited by sample size. Alertmeipp is right to point out that we are playing the wrong game. Smarter people than us - namely Buffett and Watsa - realise that they cannot call the bottom. Why should we think that we can? The goal should be to buy 50 cent dollars and to buy even more if they become 30 cent dollars. This is a staregy I think I can cope with. Calling the bottom is too hard for me.

We probably aren't done yet as I haven't seen any big headlines about private equity tripping covenants. From some of my sources I have spoken with, some of these shops are getting damn close to not being able to service some pretty staggering amounts of debt. If this recession gets any deeper, you might see some massive defaults. Interesting take. Question is who are the holders of all this PE debt? How thses defaults affect the public mkts will depend on who is affected by this fallout. It's probably fair to assume that the banks are not major holders, apart from those loans they were unable to place out before the crisis unfolded so we can hope that this will not set off another round of bank sell-offs. I would imagine that PE debt defaults would have to be settled in a more orderly manner (i.e. negotiated restructuring, chapter 11, etc) because the very nature of the assets preclude the lenders from carrying out indiscriminate selling a la margin debt. If this is the case, the impact on public mkts may be less dramatic. Besides, the debt holders may already have taken the mark-to-market hits in which case the actual defaults only confirm what the mkt have already priced in. Finally, on the BX conference call, they spoke about taking advantage of the distressed debt mkts to buy back PE debt at huge discounts and thus make the deals less leveraged. So, to the extent that PE funds still have undrawn capital, they could use this to improve their deal economics. It's complicated but unless the banks are hit in a major way, the fallout could be more limited than you think, especially if the holders of these debt are not highly leveraged.

They sold more than $400b nominal of CDS. Extrapolate from FFH's gains on just $20b of CDS and you get a sense of what went wrong. Best part is that the clowns who ran their Financial Products division in London that sold these CDS got paid their millions in bonuses before these losses were recognised. Cheers.

I would ask the question to those who are not interested in FFH at current prices (or roughly at book value): You should not automatically draw the conclusion that anyone who raises questions about FFH does not like the stock and is critical of mgmt. I like the company and management, bought the stock yesterday and today, but also hope to see underwriting results approach mgmt's 100% target. I don't see anything inconsistent with this. Consider the alternative question: If we think that mgmt can achieve a 10% return on float, and assuming that the average duration of the float is 2 years (meaning that a 103% CR equates to a 1.5% p.a. cost of float), should we, as shareholders, prefer to see FFH underwrite more aggressively (say, to 105% or even 110% CR target) so that they can have more float on which to make more money? To me, it boils down to the margin of safety that we require and I feel that 100% CR gives more margin. The second point is that normalised CR affects the market perception of the "riskiness" of earnings and hence the valuation multiple it accords to the stock. (In other words, higher CRs may result in higher earnings but a lower share price. There is no question that Prem and his team have done an excellent job overall. But, does this mean that shareholders cannot question why they are unable to meet their own CR target? Someone else on this board made the valid point that FFH did not back out the FX effect on CR when the USD was weakening. I can't speak for everyone else but my goal in raising questions about uw is not to criticise mgmt but to try and better understand the business. The level of CR that is achievable and realistic is material to how I evaluate my potential returns from FFH. Id’ rather have 100%+ of ratio and a big book of invested funds out there than be able to report 95% and have funds that have returns in the negatives… Fair enough but is it wrong for me to want to have 100% CR COMBINED with good investment returns. The point is that mgmt gives the impression that this is possible - why would you, as a shareholder, not want it?

Millsman, I wonder why you say that Prem has missed the bond mkt top and stock mkt bottom. They did sell their govt bonds at good levels and close out their equity hedges very close to the Nov mkt bottom. I was not particularly bullish in guessing their BV prior to the results release but even accounting for the recent decline in stocks, I can't get to your $230 figure. It still seems to me that $260 is about the right level - before ICICI revaluation. Their continued underwriting losses are more frustrating and I can see why you might be concerned. While it is true that their investment acumen has more than offset their 2-3% historical cost of float, the issue is why/how mgmt has not been able to meet their own target of 100% CR despite their repeated assertions that they will reject unprofitable business to do so. If it is simply a mgmt issue, than I have confidence that this is solvable. However, if it is a structural competitive issue - i.e. they do not have a sufficiently strong competitive edge to maintain a reasonable level of business if they hold the line on premium rates - it might be a more difficult problem to solve. My inability to figure out what is the underlying cause is what bothers me. The other thing that I cannot get my head around is the impact of USD strength on underwriting performance. Given that FFH reports in USD, I would have thought that non-USD liabilities would become smaller on translation into a stronger USD, not bigger. (I admit I have not read their results announcement in full yet so I might be missing something here.)

How do you use the retraction features? You just tell your broker? Yep. Just call and tell them you want to surrender your preferreds for retraction. I use TD Waterhouse and I have had no problems with their reps with these instructions. You should read the prospectus and the presecribed retraction form - sometimes, you have choices/options that you will have to give the broker.

I also hold Harris Preferred Capital Corp HBC-, and WFC-L (thanks OEC!!!!!). SJ, you're welcome! At the rate it's falling, I thought I'd better accept the thanks before you change your mind. ;) I'm buying today, fwiw. On the Canadian side, the preferreds of split share corps are beginning to look very interesting again. Many of them are trading at significant discounts to underlying NAV and redemption values in 3-5 years in addition to paying healthy yields. Added plus is that many of them have retraction features that should provide some short term arbitrage opps. I'm normally not a "fixed income" investor but the potential returns now available in preferreds are, imo, equity-like with better protection. I can't remember another time when one could potentially lock in such high returns for very long periods. Someone with experience in the early 1980s might have a better perspective.