Adding Short/Medium Maturity Income Security Information

We have began to get our listing of short maturity dated baby bonds and preferreds together and it can be found here.

While the baby bond listing will not be complete for a while we thought we should get it out and published–even incomplete as we are continually referring to the term preferreds.

A Rising Tide Lifts All Boats

Folks that publish on line are always just an article or two away from being made to look like a fool.

I made my first common stock investment in 1971–I wasn’t old enough to even sign the legal papers at the brokerage firm-had to have mom do it-she hadn’t owned a stock in her life.  It was a big purchase $50 (I thought $50 bucks was big back then).

I have read and studied on a non stop basis since that time–that is 47 years ago.

I learned quite a few years ago that I wasn’t a great investor when it came to common stocks-lots of buying high and selling low–a common issue with most individual investors.

12 years ago we started to dabble in income securities–primarily baby bonds and preferred stocks.  We liked them.  At that time it was not difficult to garner a solid 8% or so with little risk to capital.  Why would I buy common stocks when I could get 8% on a preferred or baby bond?  Sure the SP500 had an average 9.8% return over the last 100 years, but we would be absolutely thrilled with a 8% return year end and year out.

With that we quit buying common stocks–sure once in a while we lose our mind and buy something, but it isn’t very often.

In 2008 we wrote our first article on Seeking Alpha.  This was 2 years after we started publishing the 1st “Yield Hunter” website in 2006.  Talk about a crude site–that was before Google Docs and other tools were available.

Somewhere around 2009 or 2010 via email Brad Thomas and I had some communication and shortly thereafter we had a few phone conversations.  To make a long story short he wanted to partner on Seeking Alpha and other places.  He had been blown out of the real estate business during the recession and I think that he was looking for a new career.  I had a very active real estate appraisal business and I had no intention of trying to start a new career (in particular at my age–56 then).  My intention of running my little website was to learn and help other newbies learn.  There was no way that I was going to try to pass myself off as an expert–I was learning from lots of folks about income investing–after all these years I know quite a bit-BUT THE LEARNING FROM OTHERS NEVER STOPS!

A Rising tide lifts all boats.  For quite a few years REITs went up and up.  If you owned a REIT–any REIT, you made money.  If you wrote about REITs you were a hero.  Readers bowed to you at the alter of Seeking Alpha.  You launched lots of subscription websites with costs of up to $200/month.  You wrote for Forbes, you announced yourself as a publisher and share holder in themaven and continually attacked those with differing opinions.

Most of all you determined that everyone else was stupid and know nothings.  Markets didn’t understand REITs, forget that those you called a SWAN were now down 20, 30 or 50% and you refused to acknowledge that ‘the market’ knew anything.

Arrogance of publishers is deadly–IF WE EVER ACT LIKE WE KNOW IT ALL PLEASE LET US KNOW OTHERWISE.  We don’t!! We plan to learn all we can from readers, reader comments and income security forums all around the web.  Almost 65 and still learning.

I’m a caring guy and I feel sorry for Brad Thomas, he doesn’t ‘get it’.  We hope we never act like him.  We hope he realizes that investing isn’t all about being a salesman-we hope he reforms his ways.

We Personally Own These Monthly Payers

We wanted to take a minute to review some of our personal holdings that we have been highly satisfied with and most of which have been owned for years.

We are/have been high on the Gladstone Companies term preferred stocks which they have been issuing for 10 or 15 years.  They have always performed exactly as intended.

This doesn’t mean that we are positive on the individual Gladstone common shares, but we only have to be ‘so-so’ on the individual issues to own the term preferreds.

Here are some we own and may go to overweight positions, in particular if they sell much lower.

NOTE THAT FIDELITY MAY NOT ACCEPT ORDERS ON THESE ISSUES

Gladstone Capital 6% 2024 Term Preferred (NASDAQ:GLADN).

Gladstone Capital is a BDC and as such is covered by the leverage rules for senior securities, which includes preferred stock which means they must have 200% asset coverage ratio.  The company has been around since 2001 and recent financials have been acceptable–not great–not terrible.  Mandatory redemption in 2024.  We bought this on the OTC Grey market when issued in 2017.

Gladstone Investment 6.25% 2023 Term Preferred (NASDAQ:GAINM).

Gladstone Investment is a BDC and earnings recently have been better than average for the company.  They have $566 million in investments.  Mandatory redemption in 2023.

Gladstone Land 6.375% 2021 Term Preferred (NASDAQ:LANDP)

Gladstone Land is a farmland REIT (1 of 2 farmland REITs).  The company has performed ‘ok’ in a tough business right now as any farming related land company has had to navigate low commodity prices–thus low rents.  Gladstone Land concentrates on owning land for fruits and vegetables instead of corn and soybeans (like Farmland Partners) and thus has not had quite as tough a time as FPI.

Being a REIT there is NO leverage rule that applies, thus the issue may contain more risk.

Gladstone Investment 6.75% 2021 Term Preferred (NASDAQ:GAINO)

Same as the above Gladstone Investment.  Note that the shares are now redemption eligible as they became redeemable 12/31/2017.

For us owning these securities is simply a way to receive a decent (not huge) dividend while having a relative certainty of return of capital in the not distant future.

 

CPI Runs Hotter Than Expectations

As mentioned yesterday the CPI release this morning could rile the markets a bit and that is the case as the number came in a bit hotter than consensus.

The CPI came in at up 2.1% which actually is just in the upper end of the consensus range, but above the overall consensus of 2%.  Certainly this is above expectations, but honestly it isn’t a real big deal.  The big deal is just in the direction–not the number itself.  In the end it is not what we think but instead is how the markets react.

The DJIA implied opening was around up 150 points, but after the release of the number the implied open was down 300–a 450 point swing.  Cooler heads are now prevailing and the loss has moderated.

The 10 year treasury was trading around 2.82% prior to the number release, but is now trading around 2.88%–below the short term upper band of 2.90%.  We will watch this during the day to see if we are going to breach the 2.90% on a closing basis today.

It is likely we will have a bit of downward pressure on income securities today but we will not change any positions, because we try to simply be correctly positioned (correctly positioned is defined as understanding securities we own and the reaction of prices to higher interest rates and accept the level of risk inherent in particular positions).

The Calm Before the (Potential) Storm

Tomorrow with the release of the CPI at 8:30 am CST we could see a breakout of the 10 year treasury yield. To us a breakout will be a close for the day above 2.90% and of course only a stones throw from the 3% mark.

The expected range on the CPI is 1.9% to 2.3% and we can expect this breakout to occur if the reported rate is above the top end of consensus.

Investors need to once again be positioned correctly–we know we sound like a broken record.  “Correctly” means understanding the loss of capital that comes with higher rates and perpetual securities.

Of course if investors want to change positioning there are just 35 minutes left to do it prior to the CPI release.

On the other hand maybe the number tomorrow will be soft in which case the 10 year treasury will temporarily fall back to the 2.80% level.

Ouch – Spark Energy F-to-F Tumbles

While we own only 2 perpetual preferreds personally and 1 is a fixed-to-floating rate issue there is still pain from time to time.

1 of our holdings had a big seller– Spark Energy 8.75% fixed-to-floating perpetual just dropped by a buck.

Guess they wanted out pretty bad.  Given that the shares represent 1% of our holdings for us there is modest pain, but it does show what can happen to these high yield issues with thin trading.

While we don’t build our personal portfolios with a bunch of high yield issues (quite the contrary) if you look at the partially invested High Yield Portfolio you can see that a hit like the above mentioned can take a chunk quickly.

New Purchase Made in the High Yield Portfolio

We have added a full position to the Enhanced High Yield Income Portfolio of the 8.625% Resource Capital Fixed-to-Floating rate preferred (NYSE:RSO-C).




This purchase brings this particular model up to 43% invested so we will need another 4-5 issues to finish up construction of this model.

Here are the reasons we have purchased this security for this model.

  1. The issue is fixed-to-floating rate meaning at a point 6 years in the future there is interest rate risk coverage.
  2. The issue is from a commercial mortgage REIT which helps diversify the energy heavy preferreds bought previously.
  3. Resource Capital has recently (15 months ago) drafted a plan to divest residential mortgage businesses as well as non core businesses and has executed the plan leaving them with substantial cash on hand.  Impaired assets were sold or marked to market and are for sale.
  4. The commercial real estate portfolio RSO owns is primarily senior floating rate loans.
  5. RSO was able to issue a convertible note at 4.50% while paying off convertible notes with coupons of 6 and 8%.

While we believe this issue, like all perpetuals, is susceptible to loss of capital as interest rates increase, we are willing to incur that risk to own a high yield security. Reasonable higher yield preferreds are in somewhat short supply, but given the improvements in performance coming from RSO we think this issue fits right in.

Midday Report

After hitting near 2.90% overnight the 10 year treasury has settled in to a trading range of 2.84-2.87%.  We are assuming that investors are awaiting the CPI release on Wednesday before trying to drive rates over 2.90% on the way to 3%.  It must be remembered that once rates are stable it takes a few days before investors are willing to tip toe back in–if we get a Goldilocks CPI report we would expect rates to be stable for another week and maybe we will gain a 1/2% in average capital gain on issues we own.  Of course we have only lost 3/4-1% on most the the issues so it is unlikely we can have significant bounces.

With interest rates remaining under control the average preferred/baby bond is up 1 cent–with most issues up or down 10 cents or less.  There are a few larger movers.  Colony Northstar (CLNS) has 3 issues moving 2-3% higher as they had been too severely punished for a decent REIT with high coupon preferreds.  CLNS, like Ashford Hospitality (AHT) is simply an unloved issue.

Of course everyone knows that equity prices are way up with the DJIA up another 400 points–a bit of irrational exuburance for the day.

REITs are down almost a percent again.  The retail related issues we are watching closely are mostly flat.  KIMCO (KIM) is flat at this moment at $14.19 after being as low as $13.75–current yield is 7.90%.  Realty Income (O), the cause of continuous fighting over on Seeking Alpha, is down 46 cents trading at $48.44 giving a current yield of 5.25%–a point at which we normally would be interested, but not this time.  Tanger Outlets (SKT) is just barely positive at $22.88 for a current yield of 5.99%.  Whitestone REIT  (WSR) sold off early today (must be because we just bought shares last week) going as low as $11.75 before recovering to now be at $12.11.  The sell off was caused by an investor presentation released by the company which can be found here.  We skimmed the presentation and didn’t find anything worthy of a selloff in it–but there are enough investors willing to try to read between the lines which means there are sellers based on nothing at all many times.

Utilities are flattish and MLPs are up a percent or two based on higher energy prices.

 

Monday Morning Kickoff

So another week is gone and for many investors it was an exciting time and obviously for many it was a panic time.

Interest rates traded in a fairly wide range as the movements in the stock markets drove rates down to 2.75% for part of a day (a flight to safety), but by and large rates (10 year) moved in the 2.82% to 2.89% area. We would expect pressure on rates to continue with the lower end being 2.80% and the upper end being 2.90%–for now at least as we await further economic data.

On the economic data front the most important number coming out next week will be the release of the CPI (consumer price index) on Wednesday, February 14. Year over year change is estimated at 2% with a range of predictions of 1.9% to 2.3%. Given that the FED is focused on inflation any deviations outside of this range could move markets–in particular in the interest rate complex.

After a big week of run-off of the FED balance sheet a week ago the FED actually increased the size of the balance sheet in the last week by $1-2 billion–more or less a rounding error. A week ago we wrote on what we think the outcomes of ‘quantitative tightened’ will be and it isn’t good if the FED goes down that path without adjustment on the way. The bottom line is they can run-off assets on the balance sheet or they can raise interest rates–but not both.  We shall see.

Preferreds took a bit of a hit of 6 cents on the average share (of course averages don’t tell the whole story).  We were disappointed that even the short maturity term preferreds and baby bonds moved a bit lower as the ‘spillover’ from the constant equity poundings finally drug them a bit lower.  We opined this may be coming as it always does when there are multiple day downdrafts in equities.  Of course we have been in a ‘Goldilocks’ market so long our expectations are likely a bit high.

We have 223 issues trading under $25 compared to 219 last week so with the minor price pressure and the modest change week to week in issues under $25 we may be moving to a more stable period.  If interest rates stay in our expected 2.8 to 2.9% during the coming week we may see a modest bump up in prices this week.

A few new issues traded through their 1st full week such as Fidus Investment (NASDAQ:FDUSL)5.875% baby bonds trading at $25.05 while the Jernigan Capital (NYSE:JCAP-B) 7% perpetual preferred fell a buck on Friday to trade around $23.







Sotherly Hotels (NASDAQ:SOHO) announced a new baby bond issue with a very short maturity of 3 years and a pretty decent coupon of 7.25%. A quick review of SOHO’s financials show a reasonably strong, yet small, lodging REIT. This issue is high on our list to purchase this week, both in model portfolios as well as personal portfolios.

In addition to the Sotherly baby bonds we are looking for 2 issues for the  high yield income portfolio which should get that portfolio oever 50% invested–additionally we may add some of the KIMCO common shares (NYSE:KIM) simply because we believe there is some decent capital gains that may occur with KIMCO, but we would rather miss a purchasing opportunity than to buy it too early.  For us a $14/share price (or slightly under) would be a good purchase price.

Tonight (1 am CST) the DJIA is up 175 points on the futures while the 10 year treasury is trading with a higher yield in the 2.89% area.  Hopefully we will see the 10 year treasury trade down in yield during the course of Monday as we think the next potential breach of the 2.90% area will be with the release of the CPI on Wednesday.

Good luck to all as we likely enter another exciting week.

Adding Color to the Medium Duration Income Portfolio

Expanding on our earlier announcement on the new Medium Duration Income Portfolio.

We know from history and logic that bonds and term preferred stocks are more stable in price as there is a ‘date certain’ for redemption or maturity–the longer the date in the future the  redemption/maturity date is the more volatile the share price will be as interest rates move.  This means that even if interest rates rise the share price reaction will be just a tiny fraction of the movement in a similar coupon issue of a perpetual preferred which has no state maturity and may well be outstanding for decades and decades.  If the price is way above $25 or way below $25 as the redemption/maturity date approaches the share price will move closer and closer to $25.

In the past we have composed portfolios of the above types of securities and they have performed very well.  They have paid a reasonably good income stream while maintaining relatively level share prices–this helps us sleep very well at night.  We currently maintain 2 portfolios similar to these on the dividendinvestor.com website.  The longest running portfolio we have constructed in this manner can be found here and has returned about 6.5% annually.

Now it should be obvious that the investor will not ‘get rich’ owning a similar portfolio and that is not the point of the portfolio.  The point is a reasonable return with low volatility which allows a retired person to sleep well at night.

A key to the portfolio is that the general economy remain fairly strong–not in recession.  The issues in the model are NOT investment grade and thus you have to watch the issuer of these securities to make sure financials are NOT going ‘south’ on a sustained basis.  A weak quarter or two is generally not a large concern, but a steady 6 quarter slide would be a cause for concern.

A few words on the starting issues.

Gladstone Capital–a BDC (business development company) has generally performed well.  Being a BDC which is also a closed end fund they are required to have asset coverage of 200% or more which adds a level of safety.

Eagle Point Credit–a specialty finance company which owns a portfolio of CLO’s (collateralized loan obligations) which has performed very well in recent quarters.  While we are not fans of CLO’s and similar instruments ECC is a closed end fund and subject to the 200% asset coverage requirements.

RiverNorth Marketplace–is a non traded mutual fund which owns a portfolio of loans secured from peer-to-peer lending sites.  We are not huge fans of peer to peer lending as the credit risk seems to be higher from our personal experience.  Given the short maturity of the term preferreds we believe shares will perform just fine in spite of what we believe will be marginal performance of their loan portfolio.

To expand further on peer-to-peer sites (ie Prosper).  Originally borrowers would ‘apply’ for loans and ‘lenders’ (you and I) would bid on the loans.  Initially the credit quality was highly suspect  and we didn’t believe the sites were doing a very good screening job on the ‘borrowers’.  After poor performance the sites tightened credit screening and loan performance improved.  Then a few years ago ‘bulk buyers’ of loans came into the market place which changed how these sites operate.  Instead of bidding for loans the bulk buyers are allowed to short circuit the bidding process and instantly do the loan. This means (in our opinion) that the bulk buyers are allowed to buy the best loans–by best we mean the highest credit quality with extremely solid credit histories.  We have not checked RiverNorth portfolio in extreme detail, but we are guessing the quality of loans is better than what we have personally experienced.

Personally we had invested thousands of dollars into loans when Prosper initially launched the site.  Because of issues with their credit screening we experienced losses of 8% for the first couple of years.  After improvement our returns went higher and now are at 4.86% annually since inception.  This was more a trial of the site than a search for yield and we have now been reducing our holdings (as the loans mature we have withdrawn) and are down to around $500 now.

Arbor Realty Trust–a commercial mortgage REIT with good financial performance in the last couple of years.

Sotherly Hotels–a small lodging REIT that has had decent FFO (funds from operations) recently

We think investors in these term preferreds and baby bonds need to at a minimum pay attention to the quarterly earnings reports to ensure resources are adequate to fund dividends and interest payments–BUT if the economy softens subtantially investors have to use more intuitive feelings to determine whether to buy or sell these securities.

 

 

Added Medium Duration Income Portfolio

We have started the Medium Duration Income Portfolio which can be found here.

We will add some color to this model during the course of today.  Populating this model is easier than other portfolios as many of the issues that will be in the model are issues we personally own and thus are familiar with them.

Nate that we have the new Sotherly hotel baby bond in the model, although it is not yet trading we will be adding the issue when it does start trading.

The idea of this model is that we reduce volatility and risk by owning only issues that will mature in the next 2-5 years.  Additionally we maintain a pretty fair income stream, lower than perpetual preferreds, but higher than the 10 year treasury or CDs.

Sotherly Hotels Prices Baby Bonds

4:30 PM CST

Sotherly Hotels (NASDAQ:SOHO) has priced their new baby bond issue with a coupon of 7.25%.

Additionally in this case if the company decides to redeem the debt after 2/15/2019 and prior to maturity they will pay a premium of 101%, plus accrued interest

While we are not fond of lodging REITs this issue has some possibilities as it has a maturity date in 2021.  The combination of a 7.25% coupon with the very short maturity date means we need to strongly consider a purchase of this security.

The pricing term sheet for this issue can be found here.

The issue will trade under the ticker SOHOK.  This issue will not trade OTC grey market prior to issuance.  The issue should trade in the next couple of days–watch your broker for the loading of the ticker into their quote system.

We will post when we see the issue start to trade.

Mid Day Report

12:15 pm CST

Well we have an orderly pounding of stocks going on with the DJIA down 600 as I write.  To look at the bright side of things the drop in stocks is supporting lower interest rates as the 10 year is off a few basis points from this mornings high.  I guess it is at this time we are happy we are not common stock holders–off course we have endured the pain of watching common stocks fly higher the last few years as we have had to be happy with our 7% coupon issues.

In spite of interest rates falling a bit midday preferreds, baby bonds and other interest rate sensitive securities are falling by a dime.  This is simply the weak hands tossing the baby out with the bath water.  Most seasoned income investors will ignore this ‘noise’ at this point in time.  Falling by a dime is not meaningful.

REITs are hanging tough and are flat on the day–given the hammering they have received in recent months being flat is a victory.

Utilities remain at a point just above their 52 week lows.  We recently updated the dividends for utilities on the dividendinvestor.com site and as we updated we noted what low current yields most issues still had given the share price depreciation lately.  We aren’t going to incur the market risk for just a 3% dividend.

MLPs are off more than 1% today, but these are not too sensitive to interest rate wiggles, but crude oil is off a buck and this is what is driving MLPs.  We note that the Alerian MLP ETF (NYSE:AMLP) is now at a current yield of about 7.5%.  We may have an interest in a small position if it becomes slightly more attractive.

We could have a very interesting end to the market day today–way up (from current lower levels) or maybe a plunge of a few hundred more Dow points.

We didn’t get our 2nd portfolio launched yesterday as we hoped – simply a case of running out of time.

Interest Rates Remain Elevated

Watching the 10 year treasury today I think it should be obvious to all observers that rates will remain above 2.80% for the foreseeable future. With the 10 year at 2.88% at this moment, after being as high as 2.89%, we think that rates will stay in a 2.80% to 3% range for the the next few weeks. The 10 year will only fall below 2.80% if there is another broad equity market selloff which sparks a flight to safety.

The jobless claims number this morning at 221,000 certainly helps to put a floor under interest rates and until we see some ‘softer’ economic numbers you should expect higher rates and thus lower prices on perpetual preferreds.

We will see how much runoff the FED allowed in the last week at 4 pm today as they release the balance sheet info. As we wrote early in the week we think this is a critical piece of data relative to putting a floor under interest rates–reduced demand at a time of larger supply.

Long dated perpetuals and bonds are off in price today which is expected, but key to us personally is that they move lower in an orderly fashion so as not to spook investors which would cause a panic rush out the doors.

Nustar Reduces Distribution, Announces Merger and Announces Earnings

Nustar Energy (NS), of which we just purchased debt, has announced a merger with their general partner.  Additionally they reduced their distribution from $1.095/unit to 60 cents/unit.  Lastly they announced fairly soft earnings–a small loss.  Actually earnings are an improvement on earnings from the year ago quarter.

We don’t believe any of these items should have a material affect on the baby bonds we bought yesterday, although there could be a ‘knee jerk’ reaction lower.

We need to study there items closer to see if there is a material affect on our holdings.  We will try to get this done in the next day or so.