Two Bonds That Won't Bite

02/23/2011 12:43 pm EST

Focus: BONDS

Marilyn Cohen

President & CEO, Envision Capital Management, Inc.

Debt from Ford and Sallie Mae should perform well as interest rates rise, writes Marilyn Cohen of Bond Smart Investor.

Did you hear the one about the man who jumped off a 50-story building? When he got to the second floor, he said, “So far, so good.”

That’s the way I feel about the high-yield bond market right now. The Merrill Lynch High Yield Benchmark yield is 6.976%. The all-time low was 6.863% in December 2004, reports The Wall Street Journal.

Nevertheless, if you want junk bond exposure and haven’t purchased our high yield recommendations, then take another look at Ford (NYSE: F).

Ride the Credit U-Turn
We have talked about Ford’s change of course since last year, from its near-death experience in 2008 to its most impressive turnaround in process.

Any Ford bond that fits the maturity distribution in your portfolio and your yield parameters can, and should, be purchased. Even though prices are up and yields are down, we still like—no, love—the Ford story.

Don’t go crazy and buy 20-year bonds. That is too much interest rate risk.

But as far as the credit quality risk, this is one junk bond issuer that looks like it will actually make it back to investment grade bond status. Buy any Ford issue six years or shorter.

Ford has announced that it will reduce its debt load by another $3 billion by redeeming all of its outstanding 6.5% cumulative convertible trust preferred securities on March 15. The conversion, which will result in a first-quarter charge of up to $60 million, will cut annualized debt costs by about $190 million. Ford reduced its debt by $14.5 billion in 2010.

“We are committed to continuing to improve our balance sheet to lay a solid foundation for a strong and profitably growing business in years to come,” CFO Lewis Booth said.

Ford (NYSE: F) 5.625% notes due Sept. 15, 2015 (CUSIP: 345397VQ3) are priced at 105.125 for a yield 4.38% to maturity. Rated Ba2 by Moody’s and BB- by Standard & Poor's, the notes are non-callable.

A Bet on Rising Rates
With interest rates moving up, you’ll notice all of our bond recommendations are with maturities of seven years or shorter. Stay in front of the curve! That means, stay in short-term maturities or short-term funds. Interest rates are going higher (baring a terrorist event or the Eurozone imploding).

SLM Corp. (NYSE: SLM)—the old Sallie Mae—has an issue that will actually benefit you if 10-year interest rates rise rapidly.

You are guaranteed a minimum 4% coupon. If interest rates rise, you’ll receive 80% of the yield of the 10-year Treasury, no matter if you are one year away from maturity. So, if the 10-year US Treasury yield goes to 7%, your yield is 5.6% (7% X .80 = 5.6%). These bonds are hard to find. However, they are still around and do trade by appointment. Ask your broker for them and put in online bids. These bonds last traded on Feb. 11 at 95.

SLM Corp. (NYSE: SLM) floating notes with 4% minimum coupon due July 25, 2014 (CUSIP: 78442FCT3) are priced at 95 for a yield 5.68% to maturity. Rated Ba1 by Moody’s and BBB- by Standard & Poor's.

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