During this era of ultra-low interest rates, investors are faced with a difficult conundrum. When searching for yield among bonds, do you increase the duration and decrease the credit quality of your portfolio, or do you follow the advice so often given nowadays and focus your buying on corporate bonds with shorter terms to maturity? If you are nervous about interest rates heading higher over the near- to intermediate-term, there is a good chance you have focused on corporate bonds with just a few years to maturity. After all, corporate bonds are known for offering higher yields than Treasuries, and there are plenty of decent corporations with bonds to choose from. Here are five such examples:
AT&T's (NYSE:T) senior unsecured note (CUSIP: 00206RBB7) maturing 2/13/2015 has a 0.875% coupon and is asking 100.932 cents on the dollar (0.474% yield-to-maturity before commissions).
Rio Tinto Finance's (NYSE:RIO) senior unsecured note (CUSIP: 76720AAA4) maturing 3/20/2015 has a 1.125% coupon and is asking 100.944 cents on the dollar (0.734% yield-to-maturity before commissions).
PepsiCo's (NYSE:PEP) senior unsecured note (CUSIP: 713448CA4) maturing 8/13/2015 has a 0.70% coupon and is asking 100.603 cents on the dollar (0.486% yield-to-maturity before commissions).
Bristol-Myers Squibb's (NYSE:BMY) senior unsecured note (CUSIP: 110122AS7) maturing 8/1/2017 has a 0.875% coupon and is asking 99.356 cents on the dollar (1.013% yield-to-maturity before commissions).
Caterpillar's (NYSE:CAT) senior unsecured note (CUSIP: 149123BZ3) maturing 6/26/2017 has a 1.50% coupon and is asking 102.292 cents on the dollar (1.00% yield-to-maturity before commissions).
As a collective whole, these corporate bonds have maturities ranging from roughly two-and-a-half years to just under five years with yields ranging from 0.474% to 1.013%. With the Fed indicating it is on hold for a few more years, it is understandable why some investors would be tempted to park their cash in short-term corporate bonds. But before you buy any of the aforementioned bonds, don't forget to take a look at a part of the fixed income market that seems to have been forgotten in recent years: certificates of deposit (CDs).
Since December 2008, the amount of money in "small-denomination time deposits," also known as CDs, has plunged. According to the Federal Reserve's "H.6 - Money Stock Measures," the amount of time deposits issued in amounts of $100,000 or less at commercial banks and thrift institutions fell from $1.378 trillion in December 2008 to $666.5 billion on September 24, 2012. The 51.63% drop in small-time deposit assets indicates that retail investors are not favoring certificates of deposit (CDs) the way they once did. If you are a retail investor who began to ignore CDs in recent years in favor of, say, investment grade corporate bonds, you may want to reconsider.
It turns out that yields on shorter-term bonds in many parts of the investment grade corporate bond market are actually lower than those of FDIC insured brokered CDs with similar maturity dates. When bank deposits are paying more than corporate bonds, it is time to reconsider purchasing those corporate bonds, no matter who the issuer is. For investors who believe that deposits in an FDIC insured institution are a safer bet than corporate bonds, here are a few CDs that may be of interest. They are each currently being offered in the secondary market and have similar maturities and higher yields than the corporate bonds mentioned above.
Goldman Sachs Bank's (NYSE:GS) certificate of deposit (CUSIP: 38143AJ22) maturing 10/3/2016 has a 1.35% coupon and is asking 99.806 cents on the dollar (1.40% yield-to-maturity before commissions). It pays interest semi-annually, is non-callable, and has a conditional put for the death of the holder.
American Express Centurion Bank's (NYSE:AXP) certificate of deposit (CUSIP: 02587DLC0) maturing 10/4/2016 has a 1.35% coupon and is asking 99.75 cents on the dollar (1.414% yield-to-maturity before commissions). It pays interest semi-annually, is non-callable, and has a conditional put for the death of the holder.
Discover Bank's (NYSE:DFS) certificate of deposit (CUSIP: 254671GT1) maturing 10/5/2015 has a 1.05% coupon and is asking 99.56 cents on the dollar (1.201% yield-to-maturity before commissions). It pays interest semi-annually, is non-callable, and has a conditional put for the death of the holder.
GE Capital Retail Bank's (NYSE:GE) certificate of deposit (CUSIP: 36157EDN1) maturing 4/13/2015 has a 1.05% coupon and is asking 99.876 cents on the dollar (1.10% yield-to-maturity before commissions). It pays interest semi-annually, is non-callable, and has a conditional put for the death of the holder.
I know the yields on these CDs aren't stellar, but when compared with the yields being offered on the corporate bonds mentioned above, it makes more sense to choose the CDs. If you are interested in parking some cash in certificates of deposit, keep the following in mind:
- If the bank issuing your FDIC insured certificate of deposit goes under, you will have to decide whether to reinvest the proceeds after the FDIC returns the face value of your CDs. Therefore, if you are worried that you will not be able to find corporate bonds of decent credit quality with the types of yields mentioned earlier in this article, you will have to weigh whether the risk of a CD is worth it. I am not particularly worried about being able to find three to five year corporates yielding 0.50% to 1.00% (like the ones previously mentioned) at any point in the future. So if I were choosing between the types of CDs or corporate bonds highlighted in this article, I would choose the CDs.
- Be aware of any call features on the CDs you purchase. The CDs I mentioned in this article are all non-callable, but there are plenty of other CDs that are callable.
- Remember that if the bank issuing your CD fails, the FDIC will return to you the face value of the CDs plus any accrued interest. If you purchase a CD at a price over 100 cents on the dollar, and the bank fails, the FDIC will not pay you back your entire initial investment. It will only pay the face value of the CD plus any accrued interest.
- Liquidity for secondary market CDs is a risk I have often heard associated with selling a CD prior to maturity. While I have never had a problem getting what I considered acceptable bids on a brokered CD, other investors could have different experiences depending on their brokers. I would like to note that even during the heart of the financial crisis in 2008, I was able to sell at respectable premiums to par the CDs of several banks most people have probably never heard of. Meanwhile, during the same time period, finding respectable bids in the secondary corporate bond market was often quite a challenge.
The advantage in yield that FDIC insured CDs currently have over many investment grade corporate bonds is certainly something to keep in mind the next time you are looking for a place to park your cash.
Please be aware that prices in the over-the-counter U.S. bond market may vary depending on the broker you use. I discuss this in my article, "Are You Paying Too Much For Your Bonds?" The current prices may also differ greatly from those listed at the time this article was written. For more information on any of these notes, including additional call or put features, please contact your broker or read the indenture.
Also, please do your own due diligence on the financial profiles of the companies mentioned in this article. Only you can determine if taking the counterparty risk of purchasing individual bonds is suitable for you.
Disclosure: I am long BMY, T, RIO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am also long PepsiCo and Goldman Sachs bonds.