I have long-term bonds with GM that pay between 6.5 percent and
8.25 percent and go out 20 and 25 years. These investments were
to generate retirement income and amount to about 8 percent of our
holdings. With all the bad GM press recently, it has been suggested
that we take the loss and get out. What are your thoughts concerning
-- Doug Diminished
Tough call. There isn't a definitive answer.
I'll try to help you find the answer that is right for you. First,
recognize that there is a difference between GM bonds and GMAC bonds.
It's possible that General Motors Acceptance Corporation (GMAC)
could be spun off and continue on its own as an investment-grade
finance company. Since you said you own GM bonds, I'll limit my
discussion to GM Corporation bonds.
Corporate bonds trade at a spread to U.S. Treasury
securities based on the corporate bond's credit risk as measured
by one of the rating agencies. The big three credit rating agencies
are Fitch IBCA, Moody's and Standard & Poor's. The ratings classifications
differ between these companies, but the idea of classifying credit
risk is the same. For convenience, I'll use Standard & Poor's
ratings classifications here.
The highest credit rating is AAA. Bonds rated from
BBB to AAA are considered investment grade. Bonds rated below investment
grade, BB or lower but not in default, are "high yield"
bonds. Bonds that were originally issued at investment grade and
later downgraded to non-investment grade status are called "fallen
GM bonds at this writing continue to have an investment-grade
rating, but are trading at spreads to U.S. Treasuries that are wider
than the spreads on most "high yield" corporate bonds.
It is very common for an issuer tainted with headline risk to trade
at much wider spreads than lower-rated credits.
An argument against selling is that the increased
credit risk is already priced into the bonds and you might as well
hold on, hoping to avoid recognizing the losses as GM takes steps
to improve its profitability and credit rating. GM isn't expected
to burn through its cash stockpiles in the near term, so there's
not an immediate need to act. You bought the bonds for income and
there's no reason to expect that income will cease any time soon.
An argument for selling these bonds is that GM is
holding on to an investment-grade credit rating by its fingertips
and, since bond ratings tend to lag financial results, more bad
news is possible, triggering another sell-off. If GM loses its investment-grade
credit rating, any portfolio managers that still own the name and
are limited to investing in investment-grade debt will have to sell
the bonds, pushing GM bond prices even lower. This argument has
you taking your licks now and moving on.
If you decide to sell the bonds, you should work with
your investment professional and tax adviser to manage the tax impact
of the sale and to find appropriate replacements for these securities
in your portfolio. Your letter reads like you were chasing yield
and got burned. Look to diversify your holdings away from a point
where you're holding 8 percent of your wealth in any one company.
It doesn't have to be all or none. You can dial down
the risk by eventually selling some of the bonds. Assuming that
the bonds were purchased close to par, the sale of the higher-coupon
bonds would minimize the current principal loss.
Note: A thanks and a tip of the hat to Jeff
Matthias, a bond portfolio manager for American Family Mutual Insurance
Company in Madison, Wisc., for his help in understanding the credit
issues and current markets in these bonds.