Ford deferred dividends on preferreds – Feb 2010

Trade Summary

Based on our analysis as detailed below, we believed there was a high likelihood that Ford would take some corporate action that would include a resumption of dividends or a call for redemption, or a tender offer.

The trade was initiated with the possible three outcomes:

I) The company would initiate the dividend and pay the accrued. Based on the current yield where we expected Ford junior debt to trade we thought we would make 2pts net of the accrued dividend payment. Expected outcome 1.5 pts
II) The company would call these for cash + accrued dividends if the stock went up high enough ($15 +). Expected outcome 7+pts
III) The company would flush these for added stock + accrued. 8+ pts

Due to the risk reward profile of the trade, it was our biggest position in the book by LMV. We also thought that Ford would do something with the preferred within two quarters from when the trade was initiated.

The position setup was via stock on a lighter delta (20-40 delta, depending on stock price levels) to ensure the fact that if the stock ran we crossed par at approx 1 – 2pts over parity. The balance of the hedge was done via short dated OTM puts options to ensure we would pick up delta on the way down, thus allowing us to trade some gamma.

The position had been coming in primarily due to a weak tape and Ford credit drifting wider. However, through all of this we continued to believe, as was relayed by the company, their intent to reduce debt and as part of this, apply one of the three outcomes to the preferred stock.

On June 30th, Ford announced they were reducing $3.8B VEBA trust debt and also re-initiating the preferred dividends and paying back the accrued. We made about 3.6pts that day, for a net of 2pts since the position was initiated.

We feel that at some point they will want to take out the preferred stock but are closely monitoring the situation as to when is best to re-initiate the position.

Background details
In January 2002, Ford issued $5B of 6.5% convertible trust preferred stock, of which only $2.9B remained outstanding today following an earlier tender offer. The indenture states that Ford has the right to defer quarterly dividend payments for up to 20 consecutive quarterly periods.

However, the company would have to pay all dividends then accrued and unpaid (at a 6.5% annum compounded quarterly) at the end of the deferral period. After six quarters, the owed dividend totaled $5.08 per preferred share. Ford also would not be able to pay any common dividends until the company was current on the trust preferred stock. Ford’s first deferred coupon occurred on April 15, 2009. The company’s reason for doing so was that it needed to conserve cash due to the unprecedented drop in auto sales that ultimately drove both GM and Chrysler into bankruptcy.

However, six quarters later, Ford is in much better financial shape. The company generated $1.5B of free cash flow in 1Q 2010 and expected to post a similar amount for 2Q. Although the company never stated its intentions about the preferred dividend, management’s public statements, our conservations with investor relations and management, and our experience with corporate actions led us to believe that Ford would either reinstate the dividend or tender for the securities within a short time frame.

In March 2010, at JP Morgan’s high yield conference, Ford VP Neil Schloss stated, “So as we generate cash …. we will pay back debt and the trust preferred dividend will be part of that.” In April 2010, we met with Robert Shanks, Ford’s controller, at the Merrill Lynch auto conference, who told us that the company has “thoughts and plans around that [trust preferred] but nothing to share [today].”

In a follow-up call with investor relations, Shawn Ryan, head of fixed income IR, said management is well aware of the trust preferred dividend issue and it is high on their priority list of things to address. Additionally, in April 2010, Ford paid back $3B of its credit revolver early in a sign that the company was executing their debt reduction plan.

Another hint that Ford would address the dividend soon was that July 15, 2010 would have been the sixth quarter of missed dividends. It is customary language in preferred stock indentures that a sixth missed dividend would allow preferred stock holders to elect two directors to the board. This was the case with two earlier series of Ford preferred stock and many other companies including Dana Holdings (an automotive supplier) 4% convertible preferred stock.

Although this language was not in the 6.5% Ford trust preferred indenture, we felt that missing more than six preferred dividends would carry a certain stigma within the preferred community.
Ford also has a history of tendering for its convertible securities so we thought this was a possibility as well. Almost exactly 3 years ago, Ford tendered for the same 6.5% convertible trust preferred stock and was only partially successful. In July 2007, Ford offered 2.8249 common shares plus a premium of $14.25 in stock for each trust preferred share. Of the $5B issue, only $2.1B preferred shares were tendered, leaving $2.9B outstanding. In a more recent case, Ford launched a tender offer in April 2009 for its 4.25% senior convertible bonds where the company offered to pay a cash premium to induce the holders of $4.9B principal amount outstanding to convert the preferred into common stock early.

Feb 12, 2010

The Ford 6.5% preferred bonds have deferred the dividend since the 12/31/08 dividend payout. The company has missed 4 dividends through today. Ford can defer coupon payments for up to 20 consecutive quarters, after which they must pay the cumulative amount of dividend at a 6.5% annual rate compounded quarterly on each missed dividend. Ford must pay all cumulative dividends if they call the preferred. There are $2.9B outstanding ($50 par) and each coupon is 0.81c, so Ford owes about $47m per quarter.

I spoke to Brian Jacoby, credit analyst for Goldman, who said that he sees Ford resuming the trust preferred dividend some time in 2010. This is because Ford’s business is doing much better and the company has $25B in cash which is earning close to 0%. The 6.5% compound interest on coupon makes this security very high cost of capital compared to what they are earning with their cash. If Ford lets the dividend continue to accumulate, the company would owe over $1B by the end of the 20 quarters. It makes sense for Ford to resume the dividend soon.

Ford will not comment on their plans. I have spoke to IR and heard them on conference calls say that “at this point we aren’t saying anything from a standpoint of what we will do with that security as we go forward.”
Brian compared the Ford preferred situation with companies who had switch to paying coupons with pay in kind securities at a 2% higher rate than cash during the crisis. Many of these companies have switched back to paying cash coupons.

The next record date for Ford will be 3/31/10 so we think that a resumption of the dividend will be announced soon if Ford decides to go that route

Feb 16, 2010 – discussion with IR

I spoke to Dave Dickenson 1-313-621-0881 of Ford about the preferred dividends. He said the company has not made a decision to resume the dividend. Additionally, there was a rumor that the Ford family owns a significant percentage of the issue. However, Dave said he didn’t think this was the case and the bloomberg holdings page confirms that the Ford family does not own much of it. The institutional holders list owns 86% of the issue.

March 2, 2010 – Ford comments at investor conference

The takeaway is the as Ford generates operating cash, they will look to reinstate dividends.

And then we have just one question for you, you guys have a preferred given you have held out for some quarters accounting dividend I think was cancelled a couple of years ago none lot of money compared to liquidity you have at the auto company, why not reinstate those as you’ve signed a confidence?

: I think if you look at our capital strategy today there is a lot different instruments. Its not just simply unsecured debt and common stock which is how was in the grow days, and so when we look at the need to improve our balance sheet clearly the dividends on the trust preferred will be one of those items that we will consider as part of the key there. The key to restate the dividend, the key to paying down our debt is going to be generating operating cash flow in the business right and we are starting to see that at least the last two quarters of 2009 at still a very depressed industry. So as we generate cash we are going to reinstate other things,we will pay back debt and trust preferred dividend will be part of that.

: And then could you prioritize you top three uses of liquidity at the Motorco [ph].

: No.

: That’s a pay down debt, this is a debt [ph].

: Pay down debt is the fixing the balance sheet and generating positive cash flow — two go very well together.

April 7, 2010 – I asked the Ford Controller about the preferred dividends at investor conference. Below is the transcript.

I asked Ford about preferred dividends at their presentation. This was the exact question and response:

Ray Lam – AM Investment Partners – Analyst
Ray Lam, AM Investment Partners. The Company deferred dividends on the trust preferred securities about a year ago. Have you thought about when you might want to reinstate that? And are you also considering other options including calling them or exchanging them for the stock?

Robert Shanks – Ford Motor Company – VP & Controller
Yes, I mean we don’t have anything to say about that today. We clearly did that for cash conservation. We can’t defer indefinitely. As part of our overall plan on fixing the balance sheet clearly we have thoughts and plans around that, but nothing to share today.

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