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While AT&T's (T) common stock pays a great dividend it is also subject to earnings and cash flow risk in addition to common stock market risk inherent in owning any common issue. Investors looking to gain exposure through T's debt have some options and in this article, we'll take a look at the Variable Corporate Backed Trust Certificates issued by AT&T in 2003 (JZJ) to see if it could be right for your income portfolio.

We'll start by defining exactly what JZJ is. JZJ is a third party trust preferred security which basically means that a trust was formed to issue shares to the public and use the proceeds to purchase the debt of AT&T, in this case the 8% Senior Notes due 2031. This essentially means that by holding JZJ you are holding AT&T debt in a roundabout way. The trust receives interest payments on the debt and then funnels them back to holders of JZJ to make its semiannual distributions. In this way, JZJ holders receive interest income as though they owned the debt outright.

JZJ was issued in $25 shares and the interest received on JZJ is currently $1.78125 annually received in equal increments in May and November of each year. At the issue price this was good for a yield of 7.125% and with shares trading at a premium of only eight cents the current yield is still 7.1%. Thus, JZJ is a very high-yielding issue from a seasoned debt issuer that produces very steady cash flows to service its debt.

In the opener I stated JZJ is variable and what I meant by that is JZJ actually can change the interest distributions that are made based upon certain criteria. Basically, the interest distributions can be increased or decreased due to changes in the credit rating of the underlying security, the Senior Note due in 2031 in this case. At the time of issue the credit rating of the underlying issue was BBB/Baa2 and based on my research the current rating is actually higher at A-/A3. However, the interest distributions have not been changed due to this increase in credit rating so JZJ is still paying $1.78125 annually as of now. The variable nature of this issue likely won't come into play but I wanted to mention it in the off chance that it does at some point in the future; you just need to be aware this clause exists.

Unfortunately JZJ isn't eligible for the favorable tax treatment that dividends receive because distributions from JZJ aren't dividends, they're interest payments. Thus, holders of JZJ in a taxable account are unfortunately going to be subject to higher tax liabilities from their distributions than they otherwise would be if JZJ were distributing qualified dividends. In a retirement account this shouldn't matter but if you're holding JZJ in a taxable account it could mean that Uncle Sam takes enough of your distribution that the after-tax yield in JZJ is no longer acceptable. This is something that will be particular to each individual investor and must be decided on a case by case basis.

Finally, JZJ is trading past its call date. AT&T can actually call JZJ anytime it likes at this point and in fact, in 2010 a partial call of this issue was conducted. You can still buy JZJ just as you always could but the partial call reduced the outstanding size of the issue. I mention this because AT&T may decide tomorrow that it wants to eliminate JZJ and call the remaining portions of the issue. Of course, it may decide to keep it until maturity; this is a risk of owning virtually any debt issue. If AT&T decides to call the issue it will do so at a price of $25 per share so in that event, holders that go long today at $25.08 will be subject to a capital loss of eight cents per share. No one knows when or if this issue will be called but it is something to keep in mind if you are thinking of getting long JZJ.

Overall, JZJ offers investors, particularly those holding it in retirement accounts, the chance to gain access to AT&T debt that pays a great interest rate on an investment grade issue. If you can move past the semiannual distributions and the unfavorable taxation rate JZJ could be the jolt of high income your portfolio needs.

Source: A Safe 7.1% Yield From This Dow Component