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Subject:  SLM’s Indexed-Coupon Bonds Date:  9/26/2012  4:37 PM
Author:  trader2012 Number:  34413 of 36324

Since summer of 2009, I’ve been saying that “the low-hanging fruit has already been picked”, and it has. But them with a tall ladder shopped for bonds the rest of that year and then did the same in 2010 and 2011. Earlier this year (2012), I said there was nothing worth buying. But I’ve still managed to add as many new position as last year. After Bernanke’s Sept 13th announcement, I said again that bonds had now gotten too expensive to be worth shopping for. But I added four new positions this week. So, obviously, I’ve been right, and I’ve been wrong. Bonds have gotten increasingly expensive. But a determined bond-buyer can still find things in the trash heaps that could and, maybe, should be bought.

One of the trash heaps I’ve ignored so far are 'Indexed-Coupon' bonds. I have no idea whether that is their proper name, and I don’t care enough to look it up. If the term isn’t descriptive enough, then here’s a sample of them. Rather than the bond having a fixed-rate coupon, or stepped-rate coupon, it has a variable-rate coupon that is tied to an index or an economic report.

-Floating/Variable Coupon - Monthly Reset, 12 mo % change in CPI-U+ 225bps, reset mo, but in no case <0%. 1st cpn 5.67%
-Floating/Variable Coupon - Monthly Reset, RATE = [(CPIT - CPIT-12) / CPIT-12] + 230BP
-Floating/Variable Coupon - Monthly Reset, 12mo%change in CPI-U+230bps, reset mo, but in no case<0%. 1st cpn 6.47%
-Floating/Variable Coupon - Monthly Reset, MNTHLY CPI YOY + 200BP

The formulas are clear enough. But calculating what the coupons might be for dozens of such bonds would be a pain in the butt, nor does E*Trade do the calculations for you when you pull the “Bond Offering Detail” (where you would generally find Qty, Price, Minimum, Settlement, YTW, YTC, TYM, CY, etc.) However, when you download the output of a bond-scan (which is a brokerage feature ET offers only to longer-term accounts), the present coupon is calculated, though the 'Offering-Yield' isn’t (for obvious reasons). However, having downloaded the bond data into a spreadsheet (as every competent bond-investor is going to be doing anyway, so they can run their comparatives), it’s no biggie to calculate the YTMs.

What you’ll discover, if you run such an exercise with SLM’s bonds, many of which are indexed-coupon bonds, is that many of the YTMs are very fat compared to those of comparable maturity. Intrigued, I ran the next step in the exercise, which was to calculate tax-and-inflation-adjusted YTMs, and, predictably, much of the advantage of the typically, higher yields of indexed-coupon bonds over their comparable-maturity, fixed-rate coupon peers went away, to say nothing of the likely volatility of the coupon-rate (which could work in your favor, or not). But if you’re looking for bonds around five years from maturity and offering a nominal YTM of around 6.25% and aren’t already at full-weight for exposure to SLM’s debt, you might want to repeat this exercise on your own. (The standard disclaimers of Caveat emptor! apply to this post, of course.)

Much to my surprise, when I tried to repeat this exercise using data from Zions Direct (who does allow any account to download the output of a bond-scan), the 'temporary-coupon' was not calculated, and the YTM (as at E*Trade) was reported to be "Flat", which, obviously, it is not. In short, if you didn't have the luck to have gotten yourself grandfathered into E*Trade's software, you've been cut off from easy access to this subset of bonds. You can do the needed calcs by hand. But it's probably not worth your effort. Bond-shopping only becomes viable when you have the means to quickly process at least five hundred bonds at a time (i.e., the maximum, one-page output of a bond-scan) in order to find the very few that merit further investigation. Obviously, that's not fair. All investors should have equal access to data. But that's how things are. Grandfathered accounts have an edge not found elsewhere.

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