by Neil George | September 11, 2009 7:32 am
Bonds are supposed to be for the big guys. You know, the mega financials, insurers, pension funds, and the like. But there is a corner of the stock market that continues to bring bonds within the reach of individual investors. The product they use is called a mini-bond.
Mini-bonds look just like stocks and trade just like stocks, mostly on the New York Stock Exchange (NYSE). But they are actually bonds, not that most folks, including your broker, ever really notice. And rather than being priced and traded like traditional bonds — with $1,000 face values traded in lots of tens of thousands or millions — these trade in more manageable quantities, with face values of $25 or less.
Now here is where I need to roll out some of the fine print on these bonds that look and trade like stocks These mini-bonds have rather scary acronyms given by the banks that put them together and brought them to the market. But, behind the forbidding facades are some very investor-friendly securities.
I’ll start with one type of mini-bond called Trust Preferred Securities (TruPS). These have been quietly trading for quite a while, yet haven’t been on most investors’ radar because they’re just not widely touted by anyone.
Behaving much more like preferred stocks, these securities arise from regular everyday companies, including big utilities and other companies, which essentially issue them to bank holding companies. The holding companies then package them up as trusts and issue them to investors in the markets, just like stocks.
The bank holding companies then use the funds to invest in bonds from the issuing companies. Those bonds typically have intermediate to longer maturities, and the cash flow from the bonds is what pays dividends on the TruPS.
The process creates the advantage for the issuing company of being able to treat the TruPS stock as equity for its balance sheet without having to register the issue with the SEC, while the IRS lets the company treat the dividends as debt that allows it to reduce its tax liabilities, just like regular bonds.
So the investor benefits from the steady dividends and the advantages and security of owning a bond, and the company gets access to cheaper after-tax capital.
There are a plethora of these issues as well as other varieties of these easy-to-buy bonds with acronyms like PINEs (Public Income Notes), QUIBs (Quarterly Interest Bonds) and more.
But what makes them all similar is that they’re issued to investors in sums typically amounting to $25, with calls by the issuing company at their issuance price – again typically $25. The key then is to understand the credit of the issuing company, know the current price of the TruPS, know the yield to the call price as well as the call dates.
The result is that you and I can put together a group of these bonds from a variety of industries that pay us quite well, with yields running for most from 7% to over 14%.
And even better, even though these mini-bonds trade like stocks on the NYSE, they tend to be very steady in price, even when the stock market is in a tizzy of trouble. This is mostly because nobody in trading rooms or hedge funds knows about them. And that’s perfect for us.
One more thing to note: Because they are brought to the stock market by banks, some of the mini-bonds can have their names shortened and can actually have the name of the bank bringing them, rather than the company behind them. So, don’t get spooked — just look behind some of the names on the stock tables to find the real issuing company.
Which mini-bonds to buy now? Here are some of my favorites.
I’ll start with an easy one from the giant US telecom company: Verizon (VZ[1]). The A-rated issuer has a TruPS trading under the symbol of PJL[2] on the NYSE, with a dividend of 7.625% due in 12/01/30.
Trading pretty consistently either just above or just shy of the $25 range, the yield is running currently at around 7.5%. I see this paying you a steady and solid dividend rate that trumps the dividend from the common stock and the regular bonds by a whopping margin.
Next is an issue with a bit more in yield from another telephone operator with regulated phone lines based in the Kansas side of Kansas City in Overland Park. Embarq has its 7.1% due 06/01/36 TruPS, which trades on the NYSE under the symbol of FJA[3].
The bond trades with a bit more volatility than the Verizon TruPS, yet is also advancing in price more than the Verizon issue. FJA trades in the upper teens, giving us yield at a great value. The result is a current yield for FJA of over 9.3%, payable every June and December. A newer issue, this mini-bond is not callable until June of 2012, which would be a huge gain for you at the current price.
Verizon isn’t the only baby-bell to go to the NYSE for some of its bond issuance. Qwest (Q[4]) has had a pile of challenges, but still maintains an impressive chunk of telecom assets in a crucial section of the U.S. market.
I see the credit prospects for this utility being good enough to invest in the company’s TruPS, trading under the symbol PKH[5]. The bonds are the 7.75%, due 02/15/31. They continue to trade positively — in the mid-teens. These mini-bonds are callable like the others at $25, so we have only upside price potential. The yield therefore is a big one: currently over 12%.
Last up in my examples of these stocks that pay you comes from my favorite airline holding company: AMR (AMR[6]).
The holding company for AMR has a PINE trading under the symbol AAR[7], paying 7.875%. Trading around $13-$14 apiece, these mini-bonds are generating another huge yield of over 14%.
And while many might question the stability of owning a bond from an airline, note that AMR continues to pay its bills, and has continued to prove that it can rollover credit lines and bonds and has continued to have ample access to new leases and other new lines of credit. That’s the key: I personally stress test every company I recommend, and AMR passes with flying colors.
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