On Sears Debt Issuance, and RGA Long Case

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On Sears Debt Issuance, and RGA Long Case

I have great readers.  Two questions tonight on very different topics:

I’ve really enjoyed reading your blog ever since I came across it (via Simoleon Sense, I think?). I think your perspective as a bond manager is especially neat. When I was doing some research on Sears I saw something odd in the most recent 10-Q and I was curious to see what you thought about it. It seems like the company sold $250M in bonds to its own pension plan back in 2010:

Senior Secured Notes

In October 2010, we sold $1 billion aggregate principal amount of senior secured notes (the “Notes”), which bear interest at 6 5/8% per annum and mature on October 15, 2018. Concurrent with the closing of the sale of the Notes, the Company sold $250 million aggregate principal amount of Notes to the Company’s domestic pension plan in a private placement. The Notes are guaranteed by certain subsidiaries of the Company and are secured by a security interest in certain assets consisting primarily of domestic inventory and credit card receivables (the “Collateral”). The lien that secures the Notes is junior in priority to the lien on such assets that secures obligations under the Domestic Credit Agreement, as well as certain other first priority lien obligations. The Company used the net proceeds of this offering to repay borrowings outstanding under a previous domestic credit agreement on the settlement date and to fund the working capital requirements of our retail businesses, capital expenditures and for general corporate purposes. The indenture under which the Notes were issued contains restrictive covenants that, among other things, (1) limit the ability of the Company and certain of its domestic subsidiaries to create liens and enter into sale and leaseback transactions and (2) limit the ability of the Company to consolidate with or merge into, or sell other than for cash or lease all or substantially all of its assets to, another person. The indenture also provides for certain events of default, which, if any were to occur, would permit or require the principal and accrued and unpaid interest on all the then outstanding notes to be due and payable immediately. Generally, the Company is required to offer to repurchase all outstanding Notes at a purchase price equal to 101% of the principal amount if the borrowing base (as calculated pursuant to the indenture) falls below the principal value of the notes plus any other indebtedness for borrowed money that is secured by liens on the Collateral for two consecutive quarters or upon the occurrence of certain change of control triggering events. The Company may call the Notes at a premium based on the “Treasury Rate” as defined in the indenture, plus 50 basis points. On September 6, 2011, we completed our offer to exchange the Notes held by nonaffiliates for a new issue of substantially identical notes registered under the Securities Act of 1933, as amended.

I feel like that’s a bit odd, but I couldn’t find much about it either way. I assume you’ve pretty much seen it all with bond placement, so I figured you’d be a good person to ask – is that normal? Or is that something you see when a company has a hard time finding buyers for its debt? My gut says the latter since you’re basically jacking up your pension fund’s exposure to the company’s health and creating some agency issues, but maybe that’s just naivete on my part…

Anyway, love your blog, you’re putting something great out there (and not too many folks can say the same).

Aye, Miguel Barbosa, I know him.  We had dinner together in Chicago 1.5 years ago.  A great guy.

As for the odd Sears bonds, often companies with liquidity difficulties take the desperate step of issuing company securities to the pension plan.  You will note that most of the demand for the bonds came from external parties, and then they used that price to issue another $250 million to the pension plan.  To be perfectly above board, if I had been doing it, I would have done the deal for $1.25B, with a protected $250M order from the pension plan.  External investors should know the total size of the deal.

I’m not a pension actuary, but I do know that there are limits on what can be bought by pension plans of affiliated securities.  It is not considered to be a good practice — it is a form of leverage, and good companies don’t do it.  It would make me more skittish on Sears from a credit perspective.  Doing this is a red flag.

Aside from that, Eddie Lampert has harmed the interests of bondholders before, when he bought KMart.  Why should you be docile for someone who does not respect bondholders?

Here’s email #2:

I know you’re a big fan of RGA. How do you get comfortable with the tail risk potential from pandemics? What would downside be for the stock in the event of a pandemic?

I look forward to hearing your input.

That’s a good question.  In late 2004, I attended the Casualty Actuarial Society Annual Meeting in Montreal.  That was the first time I heard about H1N1, and the threat it might pose.  I owned for clients two pure-play life reinsurers at the time, Reinsurance Group of America Inc (NYSE:RGA) and (spit, spit) Scottish Re, so the potential problem concerned me.  After a lot of research, I held onto my reinsurers, here’s why:


  • People are a lot healthier now than in 1918
  • We are better at screening visitors from areas where avian flu exists.
  • The 1918 virus was unusual in terms of its ability to spread to humans and its virulence
  • Fewer people sleep on the ground with the birds that they shepherd.
  • Chickens and pigs are usually more separated now than previously.
  • Also humans don’t have as much contact with pigs.  Confinement raising may be cruel to animals, but it protects human health, in addition to being economic.


  • No one alive has any immunities to the avian flu.
  • Flu shots and Tamiflu are worthless with respect to the avian flu.  Don’t get vaccinated.  It is close to useless.  I have never gotten vaccinated.  They can’t predict what strains will be virulent six months in advance.

Now, nothing is impossible.  There is risk here, just as there is risk of large meteorites hitting earth every 100 years or so.  Those are risks I have to live with, unless I have special information, which I don’t.

More disasters don’t happen than do happen.  As Ecclesiastes 11:3-6 says:

If the clouds are full of rain, They empty themselves upon the earth;
And if a tree falls to the south or the north, In the place where the tree falls, there it shall lie.
He who observes the wind will not sow, And he who regards the clouds will not reap.

As you do not know what is the way of the wind, Or how the bones grow in the womb of her who is with child,
So you do not know the works of God who makes everything.

In the morning sow your seed, And in the evening do not withhold your hand; For you do not know which will prosper, Either this or that, Or whether both alike will be good.

Worrying about large disasters is fruitless.  Far better to try to be productive, than to try to time disasters.  Productivity is something we can control under ordinary circumstances.  Disasters are something we are subject to, and are very hard to avoid, so unless you are one of the favored ones with inside knowledge, aim to be productive  — it is the far better choice.

Full disclosure: Long RGA (double-weight)

By David Merkel, CFA of Aleph Blog

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