OSBCP - Old Second Bank Corp Preferred

[NoCalledStrikes]

Here is a blog post I wrote yesterday on a small little arbitrage play.  It won't make you rich, but I think it could work well for loose cash in an IRA.

 

http://www.nocalledstrikes.com/

 

HOW TO MAKE 26% ANNUALIZED WITHOUT REALLY TRYING (TOO HARD)

APRIL 23, 2014

How to make 26% annualized:

 

1. Find a small bank which suspended its preferred stock’s dividend during the credit crisis.

2. Make sure the dividend was cumulative and will pay interest on the dividends in arrears while you wait for it to resume payments.

3. Make sure the bank will have the resources to payback the dividends it missed.

 

Here is our candidate:

 

Old Second Capital Trust I, 7.80% Cumulative Trust Preferred Securities (Nasdaq: OSBCP)

 

Old Second Bank is a small bank holding company serving the western Chicago suburbs.  Like many banks it was unprepared for the financial crisis of 2008/9, needed TARP money, and got overextended.  At its nadir, it suspended payment of its preferred stock effective June 2010 and became subject to Federal Reserve  supervision.

 

The preferred is redeemable by the bank at $10 plus all outstanding dividends at anytime prior to 2033.  At $10/share, OSBCP yields 7.8% or 19.5 cents per quarter.  Since last paying its dividend in June of 2010,  the preferred will have missed 16 payments by June 30, 2014 for a total of $3.62 ($3.12 in dividends and $.50 in interest on the missed dividends).

 

So why buy the preferred now?  Well for starters, the bank is doing better now and is no longer under a Federal Reserve consent decree, so it can pay dividends again. Second, the bank recently issued new common stock with the stated goal of “We plan to use the proceeds of this offering to pay the accrued and unpaid interest on the Trust Preferred Securities”.  While no date has been announced for the dividend payments to resume,  my calculations use the next available payment window of June 30, 2014.

 

The math:

 

Purchase price 4/23/2014:  $12.98

 

Dividends to be received on June 30th, 2014: $3.62

 

Absolute Return on investment = $.64/$12.98 = 4.93%

 

Annualized return on a 67 day investment = 4.93% * (365/67) = 26.8%

 

Assumptions: I am assuming the preferred will trade at $10/share once the back dividend is paid and the regular dividend schedule resumes.  Most likely, it will actually trade a little below $10 once the dividend is first paid out and then start to trade a little above $10 once yield investors see a reasonable safe bank preferred paying 7.8% interest.

 

Taxes: You will want to do this in your IRA our else as the $3.62 dividend is fully taxable as ordinary income.

 

Risk:  The largest risk is that the bank delays paying off the suspended dividends for another quarter.  While we would continue to earn the 7.8% rate while waiting; our annualized return will suffer. Also, this issue is thinly traded.  Use a limit order and be patient else you could get a really bad price when buying or selling.

 

The prospectus:  http://www.sec.gov/Archives/edgar/data/357173/000104746903022390/a2113714z424b1.htm

 

Disclaimer: I own OSBCP and may sell it at anytime.

 

 

[oddballstocks]

Ok, I spent a little time looking at this, it's interesting.  It looks like they took the $64m raised and applied it to the Preferred Series B.  They're also repurchasing that stock.  A dividend was declared, and all unpaid dividends were paid up on April 21st.  Of the $64m do you have any idea how much was used by this?

 

On the Capital Trust I, looks like it'll take $10m to pay all accrued interest, and ongoing dividends will be about $530k per quarter.  Do you think they can handle that?  Their earnings aren't the greatest quality, but they did about $630k this most recently quarter.  Maybe they will pay out almost all of their income as a preferred dividend, I'd guess they'd want to defer this another quarter or two.  OREO and NPA are both coming down, it looks like they're reversing some loan loss provisions as well.

 

The company is heading in the right direction.  I have to say I loved the CEO's comment that their community banking strength is what's pulled them out of this mess.  Clearly time has pulled them out, their loans and deposits have declined and expenses have gone through the roof.  An improving economy has earned off their bad assets, bad assets are what was killing them, they still appear to be poor bankers.

[NoCalledStrikes]

I am definitely in it only for the preferred. It's 80% efficiency rating is nothing to brag about, nor is the 50 million loss the Treasury department took when selling its tarp shares last year.

 

From January:

 

"The $2 billion company plans to sell up to $70 million of common stock, it said in a regulatory filing Friday. It plans to use the money to buy back a third of its outstanding Troubled Asset Relief Program shares, pay the $12.3 million in accrued interest on those shares and pay off $15.7 million in unpaid interest on trust-preferred debt, it said." The buy back would take about 25 million for a total of 53 million in planned spending.

 

BTW, yesterday's news release confirms the dividend was paid:

 

"On April 21, 2014, the Company paid the accumulated unpaid interest on trust preferred securities and terminated the deferral period.  The interest will not be immediately paid by the indenture trustees to the holders of such trust preferred securities.  Instead, the indenture trustees will hold the interest payments in irrevocable deposit accounts.  The interest will be paid by the trustees on the next applicable payment dates under the indentures to the holders of the securities on the record dates set forth in the appropriate indenture."

 

I'm not worried about it missing the q3 dividend, but I don't plan to hold it until 2018 to find out how it does in the recession of 2017.

 

 

 

 

[Hielko]

I'm not so sure about the opportunity here. Is an 8% yield on the prefs really that high for a not so great bank?

[NoCalledStrikes]

I'm not suggesting you hold onto the 8% preferred for 5 years, but I've had a good run of buying suspended preferreds and selling them after they make good.  Its possible the preferred only trades at 9.80 for a month after the dividend is made good, but I am not aware of any bank preferreds trading with a coupon above 7% in our current interest rate environment trading below their preference value ($10 in this case) for an extended period of time.

 

 

[randomep]

 

Well just wanted to say I learned something thanks. I have no guts to do this type of thing though.

 

Congrads on starting your blog, I see this is your first entry. Hope you keep it up long term. Lots of people start and then peter out after a half year or so.....

 

 

[randomep]

Well just wanted to say I learned something thanks. I have no guts to do this type of thing though.

 

Congrads on starting your blog, I see this is your first entry. Hope you keep it up long term. Lots of people start and then peter out after a half year or so.....

 

 

[NoCalledStrikes]

Thanks Randomep.  I'm glad you enjoyed it.  I plan to write up my portfolio as a way to better analyze what I own and am pursuing.

 

 

[benhacker]

I think you should be careful here.  There is a real possibility of a repayment and then re-deferral on this I believe.  If you want to step out into illiquid and dinged goods, the yield here is not that interesting, so I'm not sure the price is out of line.

 

One example offhand I could offer (I have not position) is CSBQ preferred, coupon is 10%, below par slightly.  Very illiquid.

 

I don't follow either closely (or own either), but just a word of caution... not everything even in today's rate environment is worth par.

 

Ben

[Palantir]

Great idea,...weekend homework.

[NoCalledStrikes]

Thanks Ben - Your point is valid. I appreciate your feedback that is why I wrote the post to get perspective.

 

In my experience only high coupon, non-cumulative, issues never make par, but if trading dries up in OSBCP completely like it it apparently has at Cornerstone where CSBQP hasn't traded in a month(!), then OSBCP will not trade at par either and this could trade at $9.50 for months which negates the whole annualized argument. 

 

Old Second is not a stellar bank by any means and I should not have called it reasonable safe earlier, its profitability is a function of the economy and would likely re-suspend the dividends in a downturn; but its preferred does offer some protections. Its cumulative, it pays interest on its arrears, it has a 5 year limit, and most importantly is a trust preferred (subordinated debt) so it is senior to the Tarp preferred.

 

I will probably scale down my small position to a smaller position while liquidity is still high to factor in the possibility that I may have to hold this longer than I care to.

 

[Daytripper]

I tried to put in a really low-ball bid on a few shares and got a message from Ameritrade that stated "Opening transactions for this security must be placed with a broker. Please contact us."

 

Hmmm.....You have to pay the brokers rate to get a warning that it is illiquid. Anyway, I passed on my small order.

 

And thank you for an excellent analysis on the stock!

[NoCalledStrikes]

FYI - IB just sent me a notice for  OSBCP@NASDAQ (Name: OLD SECOND CAPITAL TRUST I PFD) announced a cash dividend with ex-dividend date of 20140701 and payable date of 20140630. The declared cash rate is USD 3.6206.

 

As is typical for large distributions the ex-d date is after the data you actually get the dividend which always sounds weird but really just means you need to hold through the payable date to get the dividend.  This is what happened with the GPT-PRA in January as well.

 

Daytripper - Whenever TD Ameritrade makes me call in to place an order for a low liquidity stock that they won't let you buy over the internet, they always give me the internet rate.  It is a nuisance however.  Every time I do it I think I should consolidate my accounts, but then a stock comes up like AWLCF which is available at TD Ameritrade but not IB.  Since they never read me a warning message or tell me why it is not available online, I think it may be for fraud prevention method more than my own protection since causing a spike in a low liquidity stock would be a way for hackers to effectively transfer money from one account to another.

[abitofvalue]

thanks for the idea.

 

What is going on with the repurchase? It appears that the company is repurchasing Preferred Stock at 94.75% of Par.  if the dividend was coming through, why would the seller sell for such a discount and give up the dividends? It appears that the sellers are waiving rights to dividends in arrears when they do this.  Any thoughts?

[NoCalledStrikes]

OSBC has two preferred's, the original OSBCP is not being repurchased.  The other "B" preferred is not publicly traded and is the TARP preferred of 70 million notional value.  The Treasury sold it at a massive discount (about 1/3 face) last year and lost 50 million.  The folks how bought the TARP last year at 30 are doing just fine by selling at 94.75.  The management bought 2.5% of the TARP from the treasury as well.  One could argue that they should be required to tender at the same discount as the purchasers or one could argue that is too sweet a deal and they should be the last to exit but a potentially higher price. In either case, the management of this company comes out with a sweet deal (what a surprise- NOT!)

 

OSBCP is a trust preferred which means it is a preferred share of a trust that owns the bank's subordinated debt, and not a direct preferred of the company itself.  This puts it higher in the debt structure over the TARP preferred.  Back in the day, this was a clever trick to sell debt which looked like equity.

 

I think the only exit strategy this year for the preferred "B" TARP holders is this tender. So if you want to collect your 300% gain and move on, you would take the discount and the cash. There would be worse problems to have than that one:)  I take it as a positive that 2/3 of the holder said they would rather stay than take a lower price.

 

Since doing the original write-up, I am concerned that OSCBP may trade at a discount to par for an extended period as it is relative liquidity is a current phenomena, so the annualized rate calculation in my example is obviously going to be lower if this only trades at 9.60 or 9.70 after it pays the special dividend on July 1. 

 

[abitofvalue]

OSBC has two preferred's, the original OSBCP is not being repurchased.  The other "B" preferred is not publicly traded and is the TARP preferred of 70 million notional value.  The Treasury sold it at a massive discount (about 1/3 face) last year and lost 50 million.  The folks how bought the TARP last year at 30 are doing just fine by selling at 94.75.  The management bought 2.5% of the TARP from the treasury as well.  One could argue that they should be required to tender at the same discount as the purchasers or one could argue that is too sweet a deal and they should be the last to exit but a potentially higher price. In either case, the management of this company comes out with a sweet deal (what a surprise- NOT!)

 

OSBCP is a trust preferred which means it is a preferred share of a trust that owns the bank's subordinated debt, and not a direct preferred of the company itself.  This puts it higher in the debt structure over the TARP preferred.  Back in the day, this was a clever trick to sell debt which looked like equity.

 

I think the only exit strategy this year for the preferred "B" TARP holders is this tender. So if you want to collect your 300% gain and move on, you would take the discount and the cash. There would be worse problems to have than that one:)  I take it as a positive that 2/3 of the holder said they would rather stay than take a lower price.

 

Since doing the original write-up, I am concerned that OSCBP may trade at a discount to par for an extended period as it is relative liquidity is a current phenomena, so the annualized rate calculation in my example is obviously going to be lower if this only trades at 9.60 or 9.70 after it pays the special dividend on July 1.

 

thanks - this is helpful.  I realized they were different securities but it appears they are also paying interest / divs on the TARP holders preferreds.  Anyway the fact that 2/3 of those guys are staying on is a good sign too.  Seems like a good deal if you could buy the TARP shares last year.  Wonder who the buyers tend to be given their lack of liquidity - i imagine it's P/E or institutions that do direct investing with a long horizon (insurance companies, pension funds etc.)?  Any ideas?  pretty sure an indiv couldn't buy it so was just wondering who buys it.