The Truth About Medium Term Notes

Includes: BAC, CIT
by: Bernard Thomas

There is a disturbing article from Bloomberg News this morning regarding CIT Internotes. It appears as investors did not know what they were buying and investment advisers either did not know what they were selling or misrepresented the investment. From my nearly two decades of experience with medium term notes, I can state that most investors do not fully understand the structure of most medium term note structures, including Internotes can say the same for most advisers as well.

Let's review what an Internote really is.

Internote (or Ford COBRA or GMAC Smartnote):

Senior Unsecured Note: No MTN (issued via weekly programs) is secured by specific assets. They are all general obligations of the respective issuer.

Illiquid: Weekly MTNs are issued in small sizes. Typical deal sizes range from 5mm to 20mm bonds. These would be considered good trade sizes in the institutional (real) bond market, never mind deal sizes. Bids to sell are often difficult to obtain and may be lower than were a similar (and equally senior) global issue is trading.

Survivors Options: Most issuers now include minimum holding periods of six months or one year. This means the investor must own the bonds (purchased either in the primary or secondary market) for the minimum holding period. If the investor dies before the minimum holding period passes, the survivors option may not be exercised. If the bonds transfer to heirs before the survivors option is exercised, it will be exercisable upon the death of the heirs. Most trusts are ineligible to exercise survivors option. Check with the issuer before purchasing.

Internotes and other small MTNs carry the same credit risk as any other senior unsecured corporate bond. Investors and advisers should be familiar with the credit story of each issuer before purchasing any corporate bond, including MTNs with survivors options.