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Always shop for price, even with junk bonds


Dear Mr. Berko:

My broker and friend has advised me to buy $50,000 of a 5.75 percent California tobacco settlement bond with a current tax-free yield of 7.4 percent. This bond comes due in 2047, and I would have to pay $39,000, or $780 per $1,000 face value. The bonds are rated Baa3, which is just above junk status, but he says a large number of tax-free bond funds own large positions in these bonds. This money is coming from a 3.5 percent CD that comes due next week.

J.G., Punta Gorda, Fla.

Dear J.G.:

The Golden State (California?) Tobacco Securitization 5.75 percent bonds trade at $68 and have a current yield of 8.4 percent. Similar bonds issued by Illinois, New Jersey and Ohio trade at similar prices with similar yields. Though this good broker and friend may be giving you good advice, I’m not sure he is giving you a good price. I can purchase those 5.75 percent California Tobacco bonds all day (except on holidays, Saturdays and Sundays) for 68 cents on the dollar.

A website I access to verify municipal bond prices and trades is http://investinginbonds.com, and you can use it, too. Just input the bond’s CUSIP number, and all sorts of useful data you might want will pop up. I checked that site today and saw numerous buy and sell transactions ranging from 67 cents for larger purchases of $25,000 or more to 71 cents on the dollar for smaller purchases. So with a $50,000 face-value purchase, I believe this bond can be bought for 68 cents on the dollar, or $34,000.

I wonder if your good broker and friend who wants to sell you this bond for 78 cents on the dollar is aware that his price ($39,000) may be a tad exorbitant. Please ask him: “Is this really the best price you can get for me?”

These are risky bonds, because they are backed by a 1998 master settlement agreement (MSA) with Altria (Philip Morris), R.J. Reynolds and Lorillard rather than the issuing states. The bonds originally sold at 100 cents on the dollar a dozen years ago and have crashed in price because MSA payments haven’t met expectations. Payments are pegged to cigarette consumption, which has fallen 32 percent since 1998, from 22 billion packs to 15 billion packs in 2010. However, this decline has been largely offset by some very aggressive price increases.

The bond’s high 13 percent taxable equivalent yield mitigates the risks, and I’m more comfortable owning a tobacco bond with a Baa3 (junk) rating than a taxable corporate with a 13 percent yield. Moody’s and Standard and Poor’s downgraded these bonds last November to Baa3 (top-of-the-line junk), but I’m always suspicious of Moody’s and S&P’s ratings. These are the same crooks who ascribed AAA ratings to the mortgage-backed bonds issued by Goldman Sachs, Merrill Lynch, Lehman Bros., Bank of America, Bear Stearns, etc., which then collapsed months later.

That notwithstanding, quite a few tax-free mutual funds have large positions in the tobacco bonds. Oppenheimer’s Rochester Municipal Bond Fund owns more than a billion dollars’ worth of tobacco bonds. Pimco’s Total Return Fund owns 25 percent of the Buckeye Ohio 5.88 percent issue due in 2047, which currently trades at 68 cents on the dollar, yielding a swell 8.7 percent.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or email him at malber@adelphia.net. ©2011 Creators.com

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