UnThreaded | Threaded | Whole Thread (12) | Ignore Thread Prev Thread | Next Thread
Author: joelcorley Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35342  
Subject: F-S Date: 1/31/2010 3:17 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 22
Fools,

I've heard several people talk about buying F-S. I've thought about buying F-S, even before Cramer told the world what a great deal it was. But I've had misgivings about F-S's value. And I've been in the market for exactly this type of offering for a while now. So when kahunacfa and rog56 mentioned it in that previous thread, I thought I'd post my musings about F-S as a potential investment. What follows is partly a rambling review of the security and part analysis. Any conclusions are my own.

-----------------------------------------------------------------------

I have to say F-S is a rather unique hybrid fixed income vehicle and an interesting topic in its own right. I've been tempted to purchase shares in the past but have always been too concerned about either the associated risk or the relative pricing of the offering. The latter keeps me from buying even today. But the complexity of the hybrid itself makes it a little difficult to establish a fair price relative to other Ford offerings.

The key characteristic of F-S is that it's a capital trust preferred, meaning it is preferred shares of a capital trust that holds junior debt. In the case of any qualifying capital trusts, dividends of the debt must be suspend-able for at least 20 consecutive months. Unlike most direct (US) corporate preferreds, dividends continue to accrue despite the suspension. But like most direct corporate preferreds, to suspend dividends, Ford must concurrently suspend dividends on all equal or subordinate securities. (Meaning they can't pay dividends on common or direct corporate preferreds until these dividends have been paid.) These are typical characteristics of qualified capital trusts used by bank holding companies to raise equity.

That this is a capital trust issue, which is usually issued by bank holding companies makes me believe it must have been set up with an eye to spinning off Ford Credit as a separate bank holding company. Certainly the F-S prospectus spends a lot of time discussing Ford Credit's activities and market position; but I doubt that's speculation I could verify.

The par value of F-S is $50/share. It is past its call date; but it doesn't mature until 1/15/2032. And though it's past its call date, the actual redemption price doesn't fall to par until 2012. The current redemption price is $50.65. (It was $50.98 for 2009.)

What makes F-S a hybrid preferred is the indivisible inclusion of a common stock warrant with each share of F-S. The warrant is exercisable at the holder's option any time after 1/15/2007 - this is pretty unusual as most equity hybrid preferreds are mandatory convertibles, which usually makes conversion provisions differ from warrant or option contracts. If you exercise the F-S warrant, you must tender your shares. In exchange, Ford will provide you with 2.8249 shares of F. Fractional shares are not actually redeemable. They will result in a return of principal. If you actually redeemed one share at a time, Ford would issue you 2 shares of F and $14.60 in change.

F closed Friday at $10.84, placing the intrinsic value of the warrant at $30.62/share. Or $36.28/share if you're willing to do the paperwork for each share individually and spread the redemptions out over time. (I assume no one is really willing to do that.)

In addition, there is the accrued and unpaid dividend. The annual dividend is $3.25/share; but the deferred dividends also accrue interest, so the present value of the deferred dividends should be $3.33/share as of 1/15/2010, or a few cents more today. That brings the intrinsic value, based on the warrant and accrued unpaid dividends, up to $33.95/share.

From what I gather from the prospectus, Ford actually must pay the accrued dividends if you exercise the warrant, so if you bought F-S Monday and faxed in a notice to exercise and gave instructions to sell the resulting shares of F immediately to your broker, $33.95/share is about what your holdings would fetch.

At first blush the current share price of $42.11 doesn't compare favorably to the $33.95 of intrinsic value. However your fair value calculation still needs to consider a risk-adjusted rate of return on future dividends, assuming you're holding the security.

Also warrants are almost identical to call option contracts, so there is also some non-trivial time-value to the warrant which I've not calculated... But I can look up a LEAP contract for Ford for 2012. An ATM contract at $17.50 (our effective strike price is $17.70) is going for about $1.11/contract. You could remove the extra 20 cents of intrinsic value; but then you'd need to add probably another 50 cents to a dollar of time value to the warrant. I'll call it $1.75; but maybe someone else will run it through the Black–Scholes model for a more precise figure?

Anyway, adding the value of the warrant increases the estimate of F-S's present value to about $35.70/share with nothing really in that number for discounted future income. Friday's share price effectively reflects an excess $6.41/share premium for that projected income. That might actually be reasonable, but you have to bear in mind that the value of the warrant and the value of the income stream are mostly independent variables - you generally can't have both outcomes. This suggests buyers are buying F-S today mainly for the return of the expected income and are adding in some principal value for the time-value component of the warrant. (The inherent time-value of the associated warrant was why Ford was able to sell F-S near par with a coupon of 6.50% in 2002, despite its deteriorating credit. Without the underlying value of the warrant, the debt would have needed a coupon in the 8's or 9's or it would have had to be discounted severely.)

So I'd say the real value of F-S depends on where Ford's common stock goes from here. I'm reluctant to put too much optimism into that though. Oh I think F will survive for probably another decade - I'm banking on it through the purchase of other Ford debt. But I'm not yet sure how strong Ford's performance will be going forward.

Despite the recent run up, I honestly have no idea how much longer you'd have to hold F-S before the share price got above the strike price of $17.70. For that reason, I have no idea when the underlying warrant component will increase the price above par.

Also Ford has other trust preferred issues that are not suspended. (They're holding senior debt, not junior.) F-S's current YTM is 8.04% with a current yield of 7.72%. That compares to PJE, which has a YTM of 9.57% and a current yield of 9.37%.

So let's look at F-S another way. Let's discount F-S's yield by the apparent accrued dividends ($3.33) and the value of the warrants ($1.75) - these are items that we can price separately from the underlying debt. Of course these quantities effectively raise the securities effective redemption value for comparison purposes - not lower its price. The result is a higher YTM of 8.96%. Current yield of course remains unchanged - the reality is that current yield is undefined, so using it for comparison is at best inappropriate.

Other Ford issues yielding more than 8.96% are PJE, XVF, KVU, DKL, XKN, PIJ, TZK, and even FCZ. FCZ is a direct and senior debt obligation of Ford. That probably makes it the highest yielding exchange-traded Ford obligation you can currently buy with its YTM at 9.06%. FCZ's security interest is on par with F-A, which has a YTM of only 8.10%. Admittedly PJE, XVF, KVU, DKL, XKN, PIJ and TZK are third-party trusts - organized by a third party to hold Ford-issued debt obligations. Potential default or malfeasance of such a trust probably worries some; but their underlying securities are senior to F-S, so at their worst I'd consider the two comparable risks if Ford defaults.

Based solely on these comparisons and assuming you've decided to buy Ford's debt anyway, I'm not sure why you'd choose F-S. At a minimum, I'd think you'd need to see F-S's YTM rise by 50 to 75 basis points to make them comparable. And from an income / cash flow perspective, F-S just doesn't make sense compared to the alternatives.

BTW, If you're thinking about looking at the yield curve for these preferreds, don't bother. Most of them mature in 2031 or 2032. (A fact that's troublesome in itself.) A couple are longer dated; but PJE matures in 2031 and F-S matures in 2032.

And for completeness, I should also point out that according to Finra TRACE, some of Ford's senior debt has traded hands recently with YTMs as high as 10.785%. Of course the preferred market does seem to offer slightly better liquidity; but today buying one of those bonds might be preferable to buying a preferred or exchange-trade-debt offering ... assuming you can actually catch any listed by your broker and you have the necessary powder.

All and all, most of Ford's other offerings seem better priced than F-S at the moment.

- Joel
Who currently holds XKN, KVU & PIJ.
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
Author: hockeypop Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29952 of 35342
Subject: Re: F-S Date: 1/31/2010 9:09 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
- Joel
Who currently holds XKN, KVU & PIJ.


Excellent! Thank you! Questions.

1. If interest rates rise and you consider Ford "at risk" even in ten years, does that not put your cost to sell at something like 50% to 0 as compared to what it can be purchased today, especially with P-S, but even in some of these others. Might you need to sell before 2032 or so?

2. As others point out, there IS the value of buying when others see trouble, but I'm not sure this isn't just trouble.

3. What percentage of a portfolio do you put in investments like this?

Again, thank you!

Hockeypop

Print the post Back To Top
Author: brewer12345 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29953 of 35342
Subject: Re: F-S Date: 1/31/2010 9:35 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 1
A point of clarification: FCZ is not a Ford Motor Company senior unsecured. It is a Ford Motor Credit Company senior unsecured. FMCC appears to me to have a better credit profile and liquidity than its parent (Ford Motor), but there are no contractual restrictions that I am aware of that limit the amount of cash that Ford Motor can take out of FMCC.

Print the post Back To Top
Author: joelcorley Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29955 of 35342
Subject: Re: F-S Date: 1/31/2010 3:04 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 1
Oops.

OCD: In the case of any qualifying capital trusts, dividends of the debt must be suspend-able for at least 20 consecutive months.

That should be 20 consecutive quarters, not months. To be a qualified capital trust, the bond issuer must be able to suspend dividends for at least 5 full years. I've seen (and currently own) some trusts that allow up to 10 years.

- Joel

Print the post Back To Top
Author: joelcorley Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29959 of 35342
Subject: Re: F-S Date: 1/31/2010 4:03 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 2
hockeypop,

You wrote, 1. If interest rates rise and you consider Ford "at risk" even in ten years, does that not put your cost to sell at something like 50% to 0 as compared to what it can be purchased today, especially with P-S, but even in some of these others. Might you need to sell before 2032 or so?

Of course it depends. I currently think the odds of Ford actually filing for bankruptcy any time in the next 22 years to be below 50%; but it's difficult to say what will happen over such a long time frame.

And yes, I suspect I will have to sell before my holdings mature. Unless Ford manages to improve to the point where it can refinance some of these obligations ... or it happens to be in a great position around 2031, I think it will have a difficult time actually repaying all the underlying principal that is schedule to come due then.

But that's 22 years out and the market for Ford's preferreds has been surprisingly liquid, so I'm hoping that during some point Ford's credit quality will improve to the point that I'll be able to exit with a tidy capital gain. If that doesn't happen, I'll probably still be able to sell the securities for something near what I paid and I'll have taken in 10+%/year in dividends. Of course if Ford's prospects go south really fast would I be in serious danger of taking a loss.

Fortunately, Ford's looking fairly good right now. There's a lot of talk about GM and Chrysler being better position because they managed to shed so much debt in the bankruptcies. But the problem I have is that I don't think GM or Chrysler have learned a thing in this. They still have much of the same poor management that led to the crisis and they've lost a lot of owner and dealer loyalty along the way. Despite their relatively clean balance sheets, I don't think I would ever consider personally holding long-term debt from either.

On the other hand Ford has been facing their problems. Their management, their financing and their product problems. The results are mixed; but if Ford keeps moving in their current direction, I think they have a fair chance at becoming a great car company again. If they don't, well at least I should have their dividends for a few years.

Also, 2. As others point out, there IS the value of buying when others see trouble, but I'm not sure this isn't just trouble.

I think I've already answered this one. I think Ford is already past the worst. I could be wrong. Time will tell.

Finally, 3. What percentage of a portfolio do you put in investments like this?

Currently Ford debt is 5.4% of my investable assets - assets held for investment in both taxable and tax-favored accounts. I'm probably a little too heavily invested in Ford right now - 5% is about as far as I should have taken it, but prices change and I don't think it was quite that high a percentage at year-end.

I started shifting to buying debt in 2008 when credit markets collapsed. I didn't get the best of deals on everything; but a few purchases were spectacularly good with a 4x return on capital.

Currently 56% of my investable assets are in some type of debt obligation. That is actually down somewhat over the past 2 months as I've liquidated two positions. I'm currently holding some cash as I've expected some kind of retrenchment that I've hoped would be another minor buying opportunity.

My big play over the past year or so has been to buy Bank of America debt. BAC debt is currently a whopping 37% of my investable assets, most of that is split between CFC-B and CPP. Of course on average those holdings have capital gains of over 50% and they still have a current yield of >8%. I need to thin that out; but I still think BAC debt is one of the better values out there - I'm just feel I'm too heavily invested in for my own good.

- Joel

Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
Author: joelcorley Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29960 of 35342
Subject: Re: F-S Date: 1/31/2010 4:08 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 1
brewer12345,

You wrote, A point of clarification: FCZ is not a Ford Motor Company senior unsecured. It is a Ford Motor Credit Company senior unsecured. FMCC appears to me to have a better credit profile and liquidity than its parent (Ford Motor), but there are no contractual restrictions that I am aware of that limit the amount of cash that Ford Motor can take out of FMCC.

That's actually an interesting point. Ford Motor Credit has a credit rating one tier above Ford Motor Co. - which should mean FCZ should actually fetch a better price than F-A. Of course people and firms that have invested in lenders in the past have been shying away from their debt.

It seems likely that FCZ is probably still suffering from that association, despite its better credit rating.

- Joel

Print the post Back To Top
Author: brewer12345 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29961 of 35342
Subject: Re: F-S Date: 1/31/2010 4:15 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Personally, I am tempted to go long FCZ and short F-A. Hard to believe there is really a significant difference in credit profile, as would be suggested by the price difference between the bonds.

Print the post Back To Top
Author: joelcorley Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29965 of 35342
Subject: Re: F-S Date: 1/31/2010 5:57 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 1
brewer12345,

You wrote, Personally, I am tempted to go long FCZ and short F-A. Hard to believe there is really a significant difference in credit profile, as would be suggested by the price difference between the bonds.

I know this may sound like a novice question, but could you explain the rational behind that position?

I realize FCZ is likely to move up relative to F-A. You're hoping to make a profit off of a narrowing spread between the two related securities. I looked into doing this last year and decided it probably wasn't that great a deal, especially given my broker's margin rates. Maybe I needed to change brokers? Or maybe I just didn't have enough assets?

The brokers I've used reserve any proceeds from a short sell, meaning you can't actually use that cash to create a long position. However you can borrow against it through your margin account. That means that even though the two positions are offsetting, you wind up paying margin interest on the outstanding long position. The reserved cash gets no interest. That means you're racing the clock hoping the market closes the spread before you blow any potential gains on interest.

Is this pretty much how it works for you? Do you get a decent margin rate? Or do you have so much in assets that your broker pays you enough interest on your short reserves to offset your most of your margin interest? Or is it some other kind of deal?

OK, maybe I understand your motivation in the position. I guess I'm really interested in the mechanics.

- Joel

Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
Author: brewer12345 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29966 of 35342
Subject: Re: F-S Date: 1/31/2010 6:01 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
It is as you described WRT margin usage. The trade looks attractive, but the difference in the price of the securities must be significantly wider than it is to make it worth it to overcome the frictional costs.

Print the post Back To Top
Author: brucedoe Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29967 of 35342
Subject: Re: F-S Date: 1/31/2010 6:04 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
joel

What an informative post!

brucedoe

Print the post Back To Top
Author: JustMee01 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29971 of 35342
Subject: Re: F-S Date: 1/31/2010 10:55 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 1
Joel,

Excellent post.

You wrote:

"Ford Motor Credit has a credit rating one tier above Ford Motor Co. - which should mean FCZ should actually fetch a better price than F-A."

This disparity has been in play for quite a while now, and really makes no sense. Under Ford's capital structure, Ford Credit is unencumbered by the parent company's debt. In essence, FC debt is senior in priority to automotive debt. Hence the higher credit ratings, since Ford Credit itself is a modestly leveraged, cash flow positive bank that has no real problem servicing its own debt.

"It seems likely that FCZ is probably still suffering from that association, despite its better credit rating."

In some ways I'd agree. But, what I think you're missing is that there are a lot of equity investors that grabbed Ford preferreds as a proxy for common given the risk associated with common. They bought because they had some income to sweeten the pot. Most of those people just haven't done the homework and don't even know what the third-party trusts or FCZ and FCJ are. They can find information on F-A and F-S more readily and thus they buy it. There's also an element of momentum that's driving the shares and F-S especially is trading more like equity than debt. That momentum hasn't filtered down to the other shares because the herd has more difficulty locating it...

People should also look at strategic considerations when evaluating F-S or F-A for that matter. Ford is trying to clean its balance sheet. A tender is a significant possibility for any of Ford's debt. The last time F-S was tendered, Ford paid cash to cover the difference and provide a gain for anyone that converted. They may repeat that strategy. It's a good way to reduce the debt load without consuming cash, and could be in play again. That's speculation of course, but speculation has been moving common and S for a while now.

The final point is one that I freely admit that I'm unequipped to answer. I can only offer the question. You suggest that the conversion warrant value could be estimated by looking to LEAPs. I don't think a LEAP can even come close. How can the value of what is essentially a 20 year option be estimated by comparison to a LEAP? By comparison, a LEAP is a very short term contract, and time value of the two should be radically different. But I knwo diddly about options.

At the risk of being redundant, Great post, Joel.

Peter

Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
Author: BenHacker Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 29974 of 35342
Subject: Re: F-S Date: 2/1/2010 1:11 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 2
"Maybe I needed to change brokers? Or maybe I just didn't have enough assets?"

Joel,

In theory, shorting as described makes perfect sense, in practice, as you have astutely noted, it rarely does.

Getting a 'borrow' on the short with safety, and at a rate of interest is difficult in practice. Typical brokers don't play in this space so both their margin rates and their inventory of shares to borrow is anemic or worse.

I have found only one broker (at <$1m accounts) that can handle it at effective cost.

IBKR.

I would go so far as to say that IBKR (with the exception of bond invetory which has been dramtically improving and is expected to continue) is hands down the absolute best broker.

Margin rates are 1.25% (not a typo) or lower last I checked, and they allow you to earn a rebate on the shorted shares (earn interest).

I don't normally short, but have shorted some 3x ETFs through IBKR and I've done a ton of exchange traded multi-class share pair trades like the one in this thread over the past year each working well. The risk is always that you can get called out of your short at any time, so make sure you use IBKR's handy tool to check for short sale inventory (counts the number of lenders for the shares, as well as total shares available to short, AND the rate at which you borrow).

In practice, shorting via pair trading is a bet on pricing deltas AND on the time it takes to converge the trade because almost all pair trades run a negative basis after the costs, etc.

http://www.interactivebrokers.com/en/p.php?f=shortableStocks...

Cheers,

Ben - long IBKR (through a partnership... tiny position) and I have one personal account with them as well.

Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
UnThreaded | Threaded | Whole Thread (12) | Ignore Thread Prev Thread | Next Thread
Advertisement