H&R Block - Compelling Swap in Bonds

I have been following (and writing) on the H&R Block story recently (some would say mildly obsessed), but I felt that there is a compelling trade to be done and I can't keep it to myself.

What is this trade?  SELL HRB 5.125% due 10/30/2014 and BUY HRB 7.875% due 01/15/2013.

Lets Take a look under the hood:

SELL HRB 5.125% 2014

Recap:  Z+407, G+430 at par (3.55 ModDur)

BUY HRB 7.875% 2013

 Recap: Z+464, G+480 at par (1.95 ModDur).

Come out of a $400MM deal into a $600MM deal;

Pick 57/z, 50/g;

Shorten 1.75 years, 1.6 ModDur

put in 5pts

MUCH BETTER COVENANTS

Why does this trade exist?

2013 Details(HRB 2013 Prospectus):

• $600MM deal size;
• Unconditionally guaranteed by H&R Block, Inc;
• $101 CoC (below investment grade by EACH of the agencies);
• Coupon steps (from issue coupon, cumulative, 200bps max): 25bps if Ba1/BB+ (50bps combined); 50bps if Ba2/BB (100bps combined);75bps if Ba3/BB- (150bps combined);100bps if below B1/B+ (200 bps combined).
• Limitation on liens -subsidiary, principal property (greater of $250 million or 15% of the total consolidated stockholders’ equity carve-out);
• Governed by NY Law.

2014 Details (HRB 2014 prospectus):

• $400MM deal size;
• Unconditionally guaranteed by H&R Block, Inc;
• make-whole +20;
• NO COC
• NO INTEREST RATE STEPS
• Limitation on liens -subsidiary, principal property (greater of $250 million or 15% of the total consolidated stockholders’ equity carve-out);
• Indenture dated as of October 20, 1997

2013s trade wide to 2014s and have much better investor protection.

H&R Block - Thesis is Intact - BUY equity and HRB 13s.

As I mentioned Tuesday, HRB bonds were strong and the stock should follow suit.  Well, while the equity was down on Tuesday (less than 10bps, but still) I still like the thesis and the trade.  Bonds continued strong today with the 14s trading at par, so a minor equity dip doesn't scare us off.

I think the fundamentals warrant a higher price (not saying this is a gem of a company - given OptionOne and their RAL problem, just that the company is currently undervalued) and momentum is on my side.

Also, still a better buyer of 13s relative to 14s in the senior debt.

HRB - Bonds Up, Equity Next?

Anyone catch the name of the rocket carrying HRB's bonds to the moon?

Check it out:

Block 14's at PAR!

Howzabout a graphic:

Today the climbed to par.  Yeah, about a 15% return on this pig since 10/21 - yep 10 days!

The print:

Oh yeah, not to leave the 13's out:

Last decent size print on the 13s was $103.81, a 5.99% yield.  Hate the premium, but a better buyer of 13s at these levels.  Bigger deal, bigger spread - gotta put $4 into the trade on swap or pony the premium outright.

I'll admit I was on the wrong side of this one, believing that their OptionOne exposure might kick 'em in the chops.  A trader friend of mine told me to look at it from a long view, but did I listen?  No.

And the equity:

Bonds are telling you to get long the equity.  The senior part of the capital structure has outperformed, and when trading over par, they say there is indeed equity value.

H&R Block, Inc. (H&R Block) has subsidiaries that provide tax, banking, and business and consulting services. The Company’s Tax Services segment provides income tax return preparation, electronic filing and other services and products related to income tax return preparation to the general public primarily in the United States, and also in Canada and Australia. It offers the H&R Block Prepaid Emerald MasterCard and Emerald Advance lines of credit through H&R Block Bank (HRB Bank). Its Business Services segment consists of RSM McGladrey, Inc. (RSM), a tax and consulting firm primarily serving mid-sized businesses.

Wednesday Bonds

Credit did well today with both IG and HY turning in positive advance/decline ratios of approximately 1.1x.  New issue flow was muted and secondary activity kept pace with yesterday, but not much more.

 

BAC continued to be in the headlines today as folks pondered the whole FRBNY/PIMCO/BLK repurchase story.  Wells' earnings did nothing to help their beleaguered peer.  At first bonds started to claw tighter, but couldn't keep the momentum going and slipped deeper down the well.

Looking at the BAC 5.625% 7/20:

How do you think this will fare tomorrow when folks have read - and knee-jerked to -the WSJ story stating:

The federal regulator overseeing Fannie Mae and Freddie Mac hired a law firm specializing in litigation as the agency considers how to move forward with efforts to recoup billions of dollars on soured mortgage-backed securities purchased from banks and Wall Street firms. 

The Federal Housing Finance Agency, which in July issued 64 subpoenas to issuers of mortgage securities, bank servicing companies and other entities, is working with Quinn Emanuel Urquhart & Sullivan LLP, a Los Angeles-based firm that specializes in business litigation, to coordinate its investigations.

Since the financial crisis, 400-lawyer Quinn Emanuel has avoided building a banking clientele, making it a top suitor for plaintiffs pursuing banks. The firm has represented MBIA Insurance Corp. in several lawsuits against top U.S. mortgage banks alleging that the insurer was fraudulently induced to cover losses on mortgage-backed securities. Those cases are ongoing.

Yeah, gonna be fun for BAC holders again. On the fly, I would say BAC holders can feel fortunate they don't own H&R Block paper.  H&R Block CDS rose to 768 from 722 on Tuesday and continued to bleed out today. A credit strategist focusing on U.S. banks said the company could face the same issues as Bank of America because of a legacy portfolio of mortgages from Option One Mortgage Corp., which it agreed to sell in 2008.

The HRB 5.125% '14 opened weak at $92ish and rolled over during the day to land around $89. Oh, did I mention the downgrade?  Yeah, hope those tax receipts are huge - best of luck (honestly though, the company's on the hook for the mortgages even though they were sold, but they have decent enough cash flow to cover a good chunk - but if the repurchases are larger than expected - POW).  Might look at these as a value play soon - wait for them to shed more points.

Moving on....

With the dollar down, risk on trade happening today, govvies did pretty well, all things considered.  Tomorrow 2yr, 5yr and 7yr get announced for auction next week.

Curve steepened a bit in 2-10s and flattened some in 10-30, the net being marginal.

Tomorrow: we get jobless claims (455k expected, 462k prior) and Philly Fed (1.40 expected, -0.7 prior), claims last week were a disappointment - wouldn't be surprised to see modest bounce - and Philly Fed forecasters are looking for uptick, just might get it.
Does it feel like a bubble to you?  Me neither.