Monday, May 12, 2008

Junk Bonds and Junk Food: You Don’t Want to See How They’re Made. (FORD junk bonds and FORD Interest Advantage)

I read a book this winter (when I was laid up from surgery, I think I read a hundred books) called The Omnivore’s Dilemma. It was a good, scary read about big agriculture and the food business. One part that particularly struck me was a section on the corn industry and the main product from corn, something called high fructose corn syrup (HFCS). The author’s point was that HFCS was in a whole variety of foods, and universally applied as an ingredient (from our primitive desire for sugar and fat). I went on the McDonald’s web site and found that HFCS is in a wide variety of McDonald’s foods, from the obvious, like soda and sauces, to some not so obvious, like Big Macs (buns and sauce), salads, Egg McMuffins, and croutons. The ingredients list is a scary place, but it’s good to know that McDonald’s honey is actually just pure honey, and the orange juice is orange juice. It’s a little disheartening to know that a Chicken McNugget has somewhere around 44 ingredients.

So what’s this got to do with personal finance? I think we shall call this blog “Read Your Ingredients”. I like chicken. To me, a nice piece of free-range or Amish chicken, some olive oil, a bit of sea salt, and maybe some fresh rosemary. Three nice ingredients. Not 44, not butane (an ingredient of Chicken McNuggets). I know what I’m getting. And no offense to McDonald’s: I really like their coffee (and the honey is pretty good too), but this got me thinking, particularly after this sub-prime debacle, do our clients understand what ingredients they are getting in their investments out there?

The example that jumps out at me is the Ford Interest Advantage. The Ford Interest Advantage was formerly called the Ford Money Market Fund until the SEC made Ford Credit rename it. (By the way, don’t mix this up with the Interest Income Fund in the Ford 401(k) plans, which are a totally different animal). The Ford Interest Advantage acts like a money market fund, and pays a handsome rate of interest. For example, as of 05/06/08, it was paying as much as 3.76% on accounts with balances over $50,000. The average money market mutual fund was paying about 2.03%, so that’s a pretty good deal, until you read the ingredients.

The Ford Interest Advantage is a floating rate demand note issued by Ford Credit. According to the FIA prospectus:

“Key factors to consider before investing include:

  • Your investment is not a bank account and is not insured by the Federal Deposit Insurance Corporation or any other insurance.
  • The Notes are not an investment in a money market mutual fund and are not subject to the requirements of the Investment Company Act of 1940 (including requirements relating to diversification and quality of investments).
  • The Notes are not obligations of or guaranteed by Ford Motor Company, the Agent Bank or anyone else.
  • The Notes are unsecured obligations of Ford Credit and only Ford Credit’s assets that have not been sold or securitized are available to pay the principal of and interest on the Notes. It is possible for you to lose some or all of your investment in the Notes, including accrued interest, if Ford Credit is unable to pay its debts, becomes bankrupt or seeks creditor protection.
  • The Notes are not transferable.
The Notes will rank equally and ratably with all other unsecured senior indebtedness of Ford Motor Credit Company LLC (parent company only). At March 31, 2007, Ford Credit had outstanding debt of $135 billion on a consolidated basis.”

So is this sodium benzoate or butane? The reality of the situation is that the Ford Interest Advantage is low-paying short term junk bond. This might not bug me too much, except Ford Credit just issued another $1billion of bonds in the open market at a coupon of 12.00%. That means to me that the ‘smart’ money is getting somewhere around 12% from Ford Credit, mainly because they think the risk deserves that rate, while another group of bondholders are getting 3.76%, with the same level of risk, albeit in a cash-like investment (you could, for example, write yourself a check from your Ford Interest advantage account dollar in dollar out), but is a 68% liquidity premium really justified???????????? So let’s compare apples to apples, or at least Granny Smiths to Golden Delicious. Ford Credit has a bond maturing on 6/16/08, that would yield 5.27%; so once again you are giving up 150 basis points in return for the ability to access your money at anytime during the next 30 days……… it worth it? If you require that much liquidity, safety should be your primary concern, head and shoulders above anything else.

I’m not slamming Ford, goodness knows I’ve been working with Ford for years and understand the company and its wonderful employees well. I’m just reading that ingredient list and seeing that 3.76% is made of the exact same things as Wall Street’s 12%. Everything has a price, Big Macs and Investment Returns. Why pay 50 dollars for a Big Mac when everyone else is paying 5?

Then there’s that last line of the above quote: “Ford Credit has outstanding debt of $135 billion…” That’s a lot of cars.

You decide for yourself. For my money, if I’m buying junk, I want junk rates. Don’t trick me into thinking your fast food is health food. Safety, get a bank account. They’re insured. And even the bank’s fine print warns you: deposits are insured only up to $100,000.

Leon LaBrecque