Special Corporate Bond Situations

Note: Darnell L Williams is an investor and does not own or work for any financial or investment advising institution. His interest here is to educate the public in the area of savings and investment. He strongly believes that it is everyone in the community’s responsibility to educate and train the public in their area of expertise. That way, no one in the community can be scammed.

Bankruptcy, A Special Situation: Part 6

Every time I go into a new brokerage firm and tell them about my junk bond investments, I can count on them telling me how much more risk I am taking than if I would invest in Common Stocks. Remember what I told you about risk You can make far more money in the stock market than you can in the Bond Market. But you are being paid to take on the risk. In any given company, if they were to file for chapter 11 or chapter 7, generally, this is how the money would be rewarded to investors by the Federal Court System. But no matter how the judge rules, stockholders are almost always last.

1. Federal Taxes paid
2. State Taxes paid
3. Local Taxes paid
4. Employee Payroll paid
5. Mortgages including Mortgage Corporate Bonds settled
6. Bond Senior Notes paid
7. Bond Junior Notes paid
8. Debentures paid
9. Expenses such as Utilities, rents, leases, and, vendors paid
10. Preferred Stock holder will get paid according to the contract
11. Common Stockholder gets what is left.


People do have the potential to make money in special bond situations when corporations file for bankruptcy; chapter 11 or chapter 7. If you notice, the last people to get money after bankruptcy is the common stockholder. Most of the time, the money runs out before it gets to the common stockholder. On December 29, 2008, GM Common Stockholders had zero equity in the company. The stock is worthless if the company would go out of business. But if you are a mortgage bond holder in the company, chances are, you will get your money back. Chances increase that you will get little to nothing as you go down the list of securities. If you are worried about bankruptcy, you as an investor would want to read the Indenture, the contract between the bond holder and the company, before investing. Your broker should be able to provide you with a copy, you can email the company for a copy, or it may be available on the internet.


Since most investment funds and managed brokerage accounts have GM stock in them, maybe that is why congress will not let them file Chapter 11. The stockholders will be wiped out. Many of our pension funds, colleges, and institutions will take another big hit. Instead, the Federal Government bought Preferred Stock. This stock gives the Feds 8% interest but the company does not fold if GM does not pay it. If they would have bought bonds from GM and they do not pay interest or principal, the company could be forced into bankruptcy.


On Sunday, January 4, 2008, John Luciew of the Patriot News write a story, "How to invest depends on who you are." He interviewed Certified Financial Planner, Stacey Gibble Barrick. She said, "Corporate bonds – issued by companies needing to raise money to, say, build new plants – are riskier because companies can go out of business, meaning the bonds are worthless. For this reason, their rates of return are generally higher, currently around 10 percent, Barrick said." She claims that prices of most corporate bonds have plunged, denting their overall yields. That is why she cautions investing in this sector. From what you have read in my lessons, does what she say make any sense? No, it does not because we have learned that stockholders have the highest risk since they are last to be paid in bankruptcy. That is why stockholders carry the most risk. If a company goes out of business, the bondholder has a better chance of getting paid vs. the stockholder. In 95% of the time, the stockholder never receives money after bankruptcy. If they do, the bondholder is paid in full. You can buy corporate bonds, lock in a yield and never sell the bond.


So why would a certified financial planner mislead people? Because they make money when you buy stocks and when you sell stocks. They can turn over your account many times and make money on commissions. If you buy bonds, you may buy one time in several years. That means that they get little or no commissions. Remember they have to eat, buy homes, and send children to college. So they have a conflict of interest when servicing the public. That is why you have to take your financial situation in your own hands.


Special Situations

A special situation might be where an investor would look for Mortgage Bonds at a deep discount. In the early 1980s, I bought a TWA Mortgage bond with a lien on a 747. I bought the bond at $200 per bond. Within 2 years, the 747 was sold and I got $1,000 for every bond that I held. Several years ago, I bought Senior Notes of Calpine Corporation, an Electric Utility at 50 cents on the dollar. They went chapter 11, about two years later. They reorganized and I exchanged my bonds for the new Calpine Common Stock. Later I sold the common stock at a profit. In the early 2000s, I bought Weirton Steel Corporation at 25 cents on the dollar. I was lucky enough to get my money back in interest before it went Chapter 7 and the bonds were worth zero. So there is a danger of investors being wiped out in the bond market as well. But the danger is not as great as it is with Common Stock.


Play the Market Using Convertible Bonds

Another safer special situation is investing in Convertible Corporate Bonds. They are bonds that can be converted from bonds to stock based on what is stated in the Indenture. If you want to invest in the Common Stock of a company, it might be wise to check to see if they have Convertible Bonds. With Convertible bonds, you can benefit from the increase in price of the stock while getting the benefit of collecting interest off the bonds. I did this with an Aircraft producer in the mid 1970s. I bought the convertible bond on a Monday at $1,000 per bond. On Friday, I sold them at $2,000 per bond. I doubled my money in appreciation and made five days interest on top of that. If the stock would have stayed at the same price, I would still have made interest on my money until I sold or until maturity.


What We Learned

We have studied 6 lesson on Corporate non-investment grade Bond. What we have learned;

1. To pick an investment broker with a large Bond Inventory (more in later lessons)
2. To go into the bond inventory and find bonds of companies with the proper Standard and Poor’s rating that fits your investment needs.
3. To look for these companies that we are interested in by writing the company, looking information up at the library, and asking the librarian for help finding the Standard and Poor’s financial information on the companies and industry.
4. To look up information on the companies by way of the internet.
5. To figure out how much we can make on the investment over time.
6. To figure out your cost per transaction.
7. Look for convertible bonds first before buying the common stock.


Before you get started on your way to investing, try a few transactions on paper and follow your investments while you set up your IRA account at the brokerage firm of your choice.