I believe the FSA baby bonds will have a challenging time rising in price to the point that they have a 9 or 10% yield from the present 11% simply because they were delisted by AGO. Hopefully, AGO will make a offer to buy at some discount from par in the future that is considerably higher than where they are today, but still a good deal for AGO’s balance sheet. Other alternatives would be a stock or convertible bond exchange.
I think the best way to demonstrate what I call the “pink sheet penalty” is by comparing 2 baby bonds that are owned by the same company, AT&T. The first is traded on the NYSE with the ticker ATT while the other has the ticker KTBC and is traded on the pink sheets. KTBC came with AT&T’s acquisition of Bell South and was subsequently delisted which AT&T had the legal right to do. Both have a par value of $25 and both have been rated in a like manner by Moodys/S&P as A2/A. At Friday’s close the price for ATT was $26.21 and provided a yield of 6.01%. KTBC, on the other hand, closed at $22.12 and had a yield of 7.91%. I rest my case.
What happened to the financial markets was a once in a life time event. I took a gamble that the market would respond favorablyafter the fear dissipated. I decided to stay away from stocks as well as preferred stocks and solely invested in exchange traded debt issues. I then decided to concentrated in banks or their subsidiaries that had an international exposure and were unlikely to fail simply because they were so large. I then decided not only to invest in the senior unsecured issues, but also the subordinated debt issues which I knew carried a lot more risk. Since I was so heavily concentrated in finanancials I now have started to "deleverage" by plowing back the income stream into utilities which have yields around 6%, but are far less volatile. I think one has to be careful about chasing yield. For example, the junk bond funds have done very well as an asset class, but the only one I own, Fidelity Capital and Income has experienced a yield decline to about 7.5% which tells me it's time to get out. I'm selling it the first day the market has a 1 to 1.5 percent decline.
What you say is correct. The pink sheet penalty I was referring to has more to do with the reduced marketability of a security that comes from a decrease in the availability of information at the time the trade is made. That's why many brokers, including my own that will only permit limit orders. In addition, many pink sheet listed securities are fairly small in trading volume and this also makes prices very volatile. Pink sheet securities, however, can be attractive if one has studied the trading characteristics of the securities and does not invest to heavily in one security. As a general rule, I limit my purchases of these securities to no more than 1 or 2 percent of my portfolio and so far have limited them to investment grade securities. I do not own any stocks that are listed on the pink sheets only debt issues.
1. AGO knew full well that the FSA bonds would decline because this happens when delisting occurs and buyers are deprived of information on a timely basis as the NYSE provides.
2. AGO in my opinion anticipated a sell off would take place because marketability is always reduced when delisting takes place especially for small issues. All of the FSA issues are small. FSAD and FSAE each have only 4 MM units outstanding while FSAH has 9.2 MM units outstanding. This is small potatoes for a bond issue.
3. The cost savings from delisting is only a small piece of the savings and is a red herring. The big savings comes from the mark to market accounting as required under GAAP. On June 30 the closing prices for the 3 issues resulted in a total balance sheet improvement of 177.8 million which I calculated. AGO did not give specifics on the FSA mark to market accounting adjusted which the baby bonds were only a part of, but the GAAP accounting adjustment is stated on page 13 of their presentation.
4. There was a huge disproportionate savings in favor of AGO to the cost that has been borne by the bondholders.