BondsOnline Advisor

Big Corporates for Small Investors

by Stephen Taub

If you want to invest in corporate bonds, you have two choices-buy the individual security or invest in a mutual fund.

If you buy the bond, you can either buy a new issue or you can buy one in the secondary market. Trouble is, the minimum investment is high and the prices fluctuate every day on the open market.

Enter InterNotes, a relatively new but fast-growing solution for small investors.

InterNotes are bonds issued by investment grade companies, typically at $1,000 increments. This means just about anybody can afford them.

They are offered at par, so the yield on a purchase of semi-annual InterNotes will be the stated coupon rate. The bond equivalent yield on monthly or quarterly - pay InterNotes will be slightly higher than the stated coupon rate.

And you don't have to make an immediate decision. The same offering price is available for a full week. The paper is priced again the following week.

The yields are competitive too. Okay, you're not going to get the same deal as the institutions that plunk down $100 million at a time. But, they're still fairly close.

Jim Schaberg of InCapital LLC, which is the underwriter of InterNotes says individuals typically receive about 20 to 25 fewer basis points than the institutions. Not bad, huh?

Boca Raton, Fla.-based LaSalle Broker Dealer Services Division, part of ABN AMRO, is the underwriter of DirectNotes, a similar program.

You can also buy a variety of maturities, generally 3, 5, 7 and 10 years. This makes InterNotes ideal for a laddered strategy: you buy bonds at different maturities so you can smooth out the maturity cycle. For example, if rates rise, you can regularly reinvest the maturing paper at a higher yield.

And they are not generally callable.

"This has simplified the bond buying process," explains Schaberg. "It's very accessible."

General Motors Acceptance Corporation (GMAC) was the first company to issue InterNotes back in 1996 and recently exceeded $25 billion in outstanding SmartNotes, the name for its program.

So far, a little less than $100 billion of InterNotes have been issued and the market is growing at a $30- to $35-billion annual clip, says Schaberg.

The issuers are huge, household names. For example, currently InterNotes are being offered by the following companies: Bank of America Corp., CIT Group Inc., DaimlerChrysler NAH Corp., The Dow Chemical Co., GE Capital Corp., Household Finance Corp., PHH Corp. and Sears Roebuck Acceptance Corp.

Typically, the issuers devote about 20% to 25% of a total debt offering to this retail market. The appeal to issuers: It's an opportunity to raise money at a little lower rate and to diversify their investor base.

This is especially helpful when rates are rising since institutions will frequently put back the bonds to the issuing company. "This (InterNotes) is a very stable investor base," says Schaberg.

GMAC's maturity dates normally range from 18 months to 20 years. Payment options include annual, semi-annual, quarterly and monthly interest payment dates. SmartNotes offer both a "non-callable" and a "callable" format.
A survivor's option, or death put, is offered, which gives investors greater flexibility in the coordination of investment and estate planning needs. The survivor's option is a feature of InterNotes that allows the holder's estate to return (or "put") the bonds back to the issuer at par. In the event of death, with some restrictions and limitations, this feature is at the option of the estate.

Concerned that interest rates are poised to rise over the next few years after hitting a 45-year low?

No problem. InCapital recently trotted out Inflation-Protected InterNotes on behalf of Banc of America Securities.
Interest payments on IPIs are adjusted for changes in the Consumer Price Index. The bond will pay a monthly interest payment yielding 255 basis points over the All Urban Consumer Price Index (CPI-U.

You may be familiar with Treasury Inflation-Protected Securities (TIPS), which require investors to pay a tax on phantom income each year because of adjustments to principal, even though this adjustment is not received until maturity.
In contrast, the principal on Inflation Protected InterNotes is not adjusted so there is no phantom tax. Household Finance Corp. was the first corporate issuer of IPIs.

So, how does an investor buy one of these? Call your broker/dealer. However, if you want more information, check out either www.internotes.com or www.directnotes.com.

Stephen Taub is Contributing Editor to BondsOnline. Stephen has been covering financial markets for more than 20 years with Financial World magazine, Individual Investor.com, CFO.com, and others.