Visiting the ‘junk’ yard is a risky way to buy bonds
Dear Mr. Berko:
Please tell me what junk bonds are and how one recognizes them. How many different junk bonds are out in the market? Ifve never owned a junk bond but a friend of mine, whose advice I trust, told me that “now is the time to go junk!” I would like to invest $30,000 to $35,000 in three or four junk bonds, but my friend won’t provide me with names because he would feel bad if one of the bonds he named for me went bad. So would you please name some short-term junk bonds that have a decent potential for survival? I can afford the risk, and I promise not to hold you responsible if the bonds fall in price.
B.W., Jonesboro, Ark.
High-yielders, trash, junkers, crazy corporates, beasties, garbage can debt, coke (not the cola) bonds and damaged debt are just a few of the colorful nouns used by the Street to describe a type of extremely risky bond that most of us know as junk bonds. These bonds have other popular names, but that graphic language is not fit for this paper.
A junk bond is issued by corporations (cities, states and nations, too) that have a high probability of default. These bonds might default because the business of the underlying company (and Ifm not going to pull punches) may be going down the royal crapper. When that happens, the underlying company can’t pay its interest obligations or its accounts payable and may seek protection in bankruptcy court. These bonds have skyscraper yields with current returns between 10 percent and 35 percent, but if they default, there’s little chance that you will get your investment (or even part of it) back.
The most common way to identify a junk bond is by its Standard & Poor’s rating: AAA is the highest-quality bond, AA is very good quality, A is good quality, BBB is medium quality, BB is lower-medium quality and anything below BB is considered junk. The ratings B, CCC, CC and C connote declining degrees of junk quality. The D rating indicates that the bond is in default. The NR, or no-rating, may indicate that the bond issuer does not want to pay S&P, Moody’s, Fitch or Duff & Phelps analysis fees, which can be as high as $500,000, to assign their bonds a rating. All U.S. Treasury bonds are NR.
Meanwhile, analysts guesstimate that the U.S. junk bond market totals about $620 billion (Europe’s junk market is $66 billion) and growing. Most of us have heard of Michael Milken, who was the undisputed “King of the Junk Bond Market” in the 1980s. In fact, ’twas Bear Stearns under the guidance of Milken that underwrote the initial public offering of the world’s first junk bond, Texas International, in 1977.
Here are a few statistics to consider before you decide to “go junk.”
1. Companies with bonds that have fallen to junk status have a one-in-four chance of going bankrupt within 10 years of their downgrade.
2. After the Internet bubble collapse, 197 companies with junk ratings went bankrupt.
3. No company has ever regained its AAA rating status after receiving a junk bond rating.
4. The combined bonds of GM and Ford account for 13 percent of the junk bond market.
I didnft know how many U.S. companies have bonds with junk ratings. So I asked around and got three interesting factoids:
1. About 95 percent of all issued bonds are junk rated.
2. There are about 60,000 different corporate bonds in the market.
3. Approximately 57,000 of those bonds have a junk rating.
So you have a lot from which to choose. And because you asked for short-term junk bonds, here are three.
œ Durra Automotive Systems 9 percent due 2009. These bonds trade at $640 per $1,000 face value and have a 14 percent current yield. The common stock (DRRA) trades at $3.50 and this $2.5 billion revenue company might be profitable this year and next. If the bonds pay off at maturity, you will enjoy a $360 capital gain per $1,000 bond.
œ Sbarro 11 percent bonds due 2009. These bonds trade at $960 per $1,000 face value and have an 11.5 percent current yield. Sbarro went private in 1999 and is 100 percent owned by the family (Tony Sbarro, Bobby Sabitino, Tony Missano, Dom Portanova, etc.). With over 1,000 locations and about $640 million in revenues, this Melville, N.Y., company should be in the dough.
œ Remy International 9.375 percent due in 2012. The Remy bonds trade at $770 per $1,000 face value and have a 12.1 percent current yield. Remy, formerly known as Delco Remy, is a 6,800-employee company with over $1 billion in revenues and $56 million in profits last year from global sales of auto, marine and truck parts. If Remy bonds pay off at face value in 2012, you will have a $230 capital gain per bond.
Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at firstname.lastname@example.org.