Sunday, November 30, 2008

Long Term Bonds in Trust Certificate Form/Grantor Trust Legal Opinion

After coming to a realization late yesterday that I had been sitting on too much cash, and being eternally thankful of my blissful ignorance on that point until now, I started to actually contemplate whether stocks or corporate bonds would be a better use of that cash now. I  was not thinking about an index fund for the total bond market that might pay me a tad over 4% but the long bonds in TC form.  Alan Abelson mentioned in his column in this week's Barrons that he was positive, at least to the extent that he is capable of enjoying that feeling, on AT & T common which I do not own but have considered buying back after selling in the high 30s. The perma bear then mentioned that an income investor might be drawn to AT & T bonds yielding up to 7%.  One of the TCs that I have discussed is JZJ, which contains a senior bond of AT  & T currently yielding 9.45% at its closing price of  $16.86 last Friday. JZJ Stock Quote

I have also mentioned that this bond has enhancement features in the event of a debt downgrade, .25% for each notch as I understand it, and I further discussed the possibility of a call and redemption at the $25 par value as soon as the corporate credit market stabilizes. I own JZJ and JZE, both containing the same AT & T senior bond, but JZJ is a tad better in that the guarantee is higher at 6.375% versus 6% for JZE. Since the debt has been upgraded since the original issuance of these TCs, the rate has floated down to the minimum guarantee for both of these TCs. Both just went ex interest so I may add to one or the other based on price. It makes no sense for JZE to be selling at 17.75 and JZJ at 16.86, since both are identical except for the better guarantee provided by JZJ, which would rationally call for a higher price rather than a lower one, and the date for the first call option. JZJ is callable now by the owner of the call warrant.

Relationships: Trust Certificates for the Same ATT Bond
I mentioned in the JZE post referenced above that I had a limit order hit at 12.5 for that security. This doubled my guaranteed rate to 12% for the life of the bond, maybe higher in the event of debt downgrades. If it was not called and the underlying bond was permitted to mature in 2031, I would realize another 4% per year annualized representing the spread between my cost and par amortized over the life of the bond.  That is what started me to think about this issue more.  I will likely live to 2031. Is a stock likely to give me over 16% annualized every year for the next 23 years? This is a eureka moment.  The answer is no way.  What is my risk if I held to maturity?  One answer is inflation risk but that risk is eliminated except for what I and others would call lost opportunity cost by holding until maturity. That is, if the value of long bonds plummet as they did in the late 1970s and early 1980s, I lose the opportunity of buying long bonds at cheaper rates and higher yields that I would be receiving for the AT & T  bond. I will accept that risk. The second risk has to do with credit. Will AT & T go bankrupt before 2031? This is just not knowable now but I doubt it. If it looks like it is starting to go down the path of GM, and assuming my mental condition is still more or less still functioning, I could just sell it then. After thinking some more about this issue, I am going to increase my long bond positions as opportunities present themselves. 

Another one that I might add to is the Prudential bond in the TC JZH.  I bought some at 9.75 and I will add some more at some point. JZH Stock Quote I discussed this one in a prior post. TRUST CERTIFICATE JZH: PRUDENTIAL SENIOR BOND I gave a link to the prospectus in that post. I found out a few minutes ago that the link works fine using safari on one of my IMACs but a computer using Windows and Internet Explorer gets the same document with a lot of lines through it. Weird. This one matures in 2033 and yields 14.35% at the last price of 10.35, plus around 5%+ annualized from the amortized spread assuming payment at maturity. Pru may be a more questionable long term hold to 2033 for me but again I am starting to alter my thinking some. I was thinking about trading this one when the market recovered and people became more comfortable with life insurance companies. Now, I am saying to myself, and possibly I may even pay attention, that there is no way that stocks will give me a 20% annualized return for 25 years.

A few other investment grade bonds, providing similar yields, fall into the same category as JZH, JZE and JZJ but I have not discussed all of them.  Others discussed would include the AON TCs, and the Duke JBI at lower prices than today  TRUST CERTIFICATES JBI DUKE .

But, the real question mark is do I sell a more troubling senior bond like the one from Phoenix Insurance, PFX, selling at around 7 and change, even if it jumped to 15 sometime next year or hold, hoping that the company survives until maturity in 24 years and pays me the $25 par value plus 24% per year in current yield based on the today's price. PFX Stock Quote - Phoenix Cos Inc New Stock Quote - PFX Quote - PFX Stock Price That is a much  harder question to answer. My tentative answer is to buy, possibly on further weakness, another 100 shares and hold 200 until it makes it back to 15 or so, then sell 1/2, and then keep the other 100 until maturity, playing with the house's money, one of my favorite terms along with the phrase "double down" when the dealer has a four showing and I have 11. If it looks like PNX is going to sink into oblivion, then I take the loss on the 200 and say bad boy-don't do that again. I have several like this one and I have only mentioned PFX. Industrial REITS; WB, TARP & LNC/PNX SENIOR BOND (PFX)

One facet of Trust Certificates that I have not mentioned is the legal opinion which is contained in all of them. They all say basically the same thing.  It is the opinion of counsel that the trust is a grantor trust that is not subject to taxation at the corporate level but this is not free of doubt. I do not know what that means. The individual holding the trust certificate is taxed on the interest received of course and it will be included on the 1099 received from the broker. I suspect, but do not know, that if there was any problem with the legal opinion contained in the prospectus, it would have already come up. Some, who know me, will say that I spent a career reading crap more complicated than this document and I would agree with that assessment. But I have no background in grantor trust tax issues and I am not about to spend one second trying to acquire one. A typical statement is found on page 32 of the prospectus for JZH referenced above.

After posting this one, I thought I would add a personal comment. I said that I would likely live until 2033. This is an optimistic opinion, similar to the one that I have that the U.S. will always find a way to muddle through even the most severe crisis. On life expectancy, it is probably best to assume a long longevity particularly when you come from a family like mine. Both of my parents are still alive and as some readers know we can trace ancestry back to 1634 when Joseph first came from Bristol England to Virginia and lived 81 years before dying in 1696. While it has been said that the subsequent generation lost the fortune Joseph built drinking and gambling, they did share a similar long life. The life expectancy had to be less than 40 years back in Joseph's time.  So, in doing financial plans now for me, I am going to assume 90 is highly probable.  

I am not a financial advisor but an individual investor trying to navigate my way through a difficult market. In these posts, I am acting as an unpaid financial journalist and an occasional political commentator.   I am also aggregating financial news stories that I view as important and providing any reader of these posts, assuming there are more than a couple, with links to those articles, sort of a filtered, somewhat intelligent, free search engine.  Any discussion made by me of particular securities  is not a recommendation to buy or to sell.  Trade at your own risk.  Consult with your financial advisor prior to making any purchase or sale. I will try to identify my sales too but it may take a few minutes after I implement them to create a post explaining my reasons.  The sale may before or after the post.  Before buying or selling any stock, even one recommended by a trusted financial advisor,  please research it and make up your own mind which is what I always try to do.  Research would include reading reports, reviewing financial records, earnings estimates, sec filings and prior earnings releases and news.  In this post, and all others by me, I am merely describing my reasons for purchasing  or selling securities, and the potential pitfalls that I identified prior to purchase or the reasons for a sale.  The securities mentioned in this and all posts written by me may not be suitable for others based on their unique financial position and risk profile.  Always read the prospectus before buying a Trust Certificate, bond, preferred stock or other bond or bond like investments.    

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