Old Fashioned Yield With National Rural Notes

Includes: NRC, NRU
by: Rubicon Associates

I have long been a believer that if you like a company or a company is solid, you should be willing to take exposure to that company lower in the capital structure. I keep this in mind when looking at newly issued securities.

Among the corporate bonds issued today was National Rural Utilities Cooperative Finance Corp. (CFC or NRUC). National Rural Utilities Cooperative Finance Corporation (NRUC) is a member-owned cooperative association, non-bank financial institution, exclusively serving rural electric and telecommunication utilities. NRUC was organized in April 1969 by rural electric cooperatives (RECs) to provide an economical alternative to federally subsidized funds from the Rural Utilities Service (RUS) of the U.S. Department of Agriculture. NRUC sold $800 million in three and 10- year debt at 80bps and 115bps above treasuries, respectively. ( WSJ on NRUC issue)

Lets do the math:
3-year treasuries are at 0.30%, putting the three-year yield at 1.10%.
10-year treasuries are at 1.93%, putting the 10-year yield at 3.08%

Now, these are not ordinary unsecured notes, these are what is known as collateral trust bonds, which provides that collateral will consist of mortgage notes of distribution system members, cash and permitted investments. A distribution system member is a member of CFC that derives at least 50% of gross operating revenue from sales of electricity to consumers. The principal amount of collateral on deposit with the trustee must be at least equal to the aggregate principal amount of collateral trust bonds outstanding. Prospectus here.

Okay, bottom line is the bonds are secured by assets of CFC, which is why they are rated A1/A+. Unsecured debt of CFC is rated A2/A. Subordinated notes are rated A3/BBB. Rating agency reviews can be found here: NRUC Moodys (pdf) and here: NRUC - S&P (pdf).

Both the secured and unsecured debt of the company were positions within a portfolio I managed, and aside from a few hiccups along the way (remember the telcom bust?) the credit was stable - especially considering that this is a finance company, not a utility (people often seemed confused on this issue, don't know why).

Remember my earlier statement "if you like a company or a company is solid, you should be willing to take exposure to that company lower in the capital structure", well that holds true here as well. CFC has two exchange traded subordinated notes - (NYSE:NRU) and (NYSE:NRC).

The charts below give a snapshot of where they are trading:

While NRC has a marginally higher yield, I currently prefer the NRUs as they haven't gone ex-dividend yet and they are currently trading at a lower premium (I try to stay lower when issues are callable as both of these are).

While liquidity is not staggering, they are easy enough to position, and at nearly 6 percent, they are certainly worth inclusion in an income portfolio. Keep in mind that these are notes and pay interest, not dividends, so there are tax implications.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.