Large bank debt is frequently a sign of weakness. Safe Bulkers (SB) vs. AGNC.

Large bank debt due shortly is frequently a sign of weakness.  I’m comparing two of the stocks that I’ve been analyzing the most: Safe Bulkers (SB) and American Capital Agency Corp. (AGNC).  Both are high dividend stocks.  SB yields about 7.4% and AGNC yields a whopping 19%.  See how each of them deals with their short term debts.

Safe Bulkers (SB) looks like it is financially sound.  Safe Bulkers (SB) has $28.6 million in short term debt as of Q1 2011.  Short term debts were $8.2 million in 2006.  It has $53.2 million in total current liabilities.    Total current liabilities were $172 million in 2006.  Short term debt is on a slight uptrend, but total current liabilities are in a five year downtrend.  Safe Bulkers has an annual net income of about $109 million.  It can pay down the debts it owns with the money the business earns and continue to pay its high dividend (even in the beaten down dry-bulk shipping market; shipping rates have plummeted since 2008).  The same can’t be said of AGNC.

American Capital Agency Corp. (AGNC) is not financially sound because it is leveraged 7-9 times and like a bank it is borrowed short (through repurchase agreements due in 30-180 days) and lent long (agency securities).  AGNC has $21.9 billion in short term debt according to the company’s latest quarterly report.  The company’s total current liabilities is virtually the same as its short term debts.  AGNC has an annual net income of about $288 million.

You can see the huge difference between AGNC’s short term debt and net income due to their leverage.  I expect the company’s net income to decrease in the next year or so due to rising short term interest rates.

The point is that AGNC does not payback its short term debts with the money it earns.  Its dividend payment is also in jeopardy.  It issues more stock to raise capital and it rolls over its debts.  The music stops when the financial institutions refuse to rollover its short term debts (credit crisis) or they charge higher rates for short term borrowings (rising interest rates).

I will not invest in banks, mortgage REITs, and insurance companies for this reason.  They are too opaque and difficult to understand their asset values.  The details of the business operations are also difficult to understand.  Don’t be charmed by their siren’s song of a whopping dividend yield or you may find a portion of your dividend portfolio smashed upon the rocks when the interest rate yield curve inverts.

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Large Bank Debt Frequently a Sign of Weakness. Financial difficulties are almost always heralded by the presence of bank loans or of other debt due in a short time. In other words, it is rare for a weak financial position to be created solely by ordinary trade accounts payable. This does not mean that bank debt is a bad sign in itself; the use of a reasonable amount of bank credit —particularly for seasonal needs—is not only legitimate but even desirable. But, whenever the statement shows Notes or Bills Payable, the analyst will subject the financial picture to a somewhat closer scrutiny than in cases where there is a “clean” balance sheet.

The postwar boom in 1919 was marked by an enormous expansion of industrial inventories carried at high prices and financed largely by bank loans. The 1920–1921 collapse of commodity prices made these industrial bank loans a major problem. But the depression of the 1930’s had different characteristics. Industrial borrowings in 1929 had been remarkably small, due first to the absence of commodity or inventory speculation and secondly to the huge sales of stock to provide additional working capital. (Naturally there were exceptions, such as, notably, Anaconda Copper Mining Company which owed $35,000,000 to banks at the end of 1929, increased to $70,500,000 three years later.) The large bank borrowings were shown more frequently by the railroads and public utilities. These were contracted to pay for property additions or to meet maturing debt or—in the case of some railways—to carry unearned fixed charges. The expectation in all these cases was that the bank loans would be refunded by permanent financing; but in many instances such refinancing proved impossible, and receivership resulted. The collapse of the Insull system of public-utility holding companies was precipitated in this way.

Published in: on May 9, 2011 at 4:23 pm  Leave a Comment  

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