investing

FDIC-backed bonds: Too safe?

Highlights
  • "Unlike a CD, you can sell the FDIC-backed bond on the secondary market."
  • "You pay a premium for safety and that premium is very costly."
  • Yields on FDIC-backed bank bonds have dropped over the past few months.

Fixed-income investors who insist on a government-backed guarantee, but want a better yield than Treasuries, may find certain bank bonds tempting. The caveat, as always, is whether the price for security is too steep.

Among the alphabet soup of programs announced by the federal government as it tries to spur lending and investment is the Temporary Liquidity Guarantee Program, or TLGP. One facet of the program puts an FDIC guarantee on senior unsecured debt newly issued by banks, thrifts and some holding companies.

The debt must be issued on or before June 30, 2009, and coverage is limited to bonds with maturities of 30 days to three years. The guarantee ceases June 30, 2012, even if the bond's maturity exceeds that date. If the institution fails, or its holding company files for bankruptcy during that period, your investment is fully protected. Investors can buy bank bonds through brokerages, but should inquire to be sure that they carry the FDIC guarantee.

"This is an offering to provide liquidity to a bank," says David Barr, FDIC spokesman. "It's different than taking deposits and it's not like savings bonds or Treasuries. These are corporate bonds that banks use."

Alternative to CDs
Marilyn Cohen, president of Envision Capital Management in Los Angeles and a fixed income portfolio manager, says she likes these bonds for consumers who are looking for an alternative to CDs.

"They have to compare them because there are some CDs that are paying a higher rate than the FDIC-insured bonds. But, unlike a CD where if you need your money [early], you take an early withdrawal penalty, you can sell the FDIC-backed bond on the secondary market. If it has performed and interest rates have fallen then you can make a profit. If rates rise, you'd have a loss since the price of the bond would have dropped. You have a different type of liquidity than you do with CDs," Cohen says.

Banks have issued more than $250 billion in bonds with the FDIC banking. Bank of America leads the pack with more than $33 billion issued. JP Morgan Chase is close behind at $30 billion.

To compare, JP Morgan issued three-year bonds Nov. 26, 2008 under the program at 3.125 percent, according to data from Thomson Reuters. At that time, a Treasury of similar maturity was paying 1.38 percent. A two-year bond issued by JP Morgan Feb. 19, 2009 pays 1.65 percent. A similar Treasury issued that day pays 1.01 percent. Bank of America issued one-year bonds Dec. 19, 2008 with a yield of 1.7 percent; a Treasury would have paid 0.74 percent. Even with the preferential tax treatment, Treasuries lag behind these bonds.

Premium for safety
While the spread may appeal to risk-averse investors, it may not be good enough for most others, says William Larkin, a fixed-income portfolio manager with Cabot Money Management in Salem, Mass.

"You're not going to get enough return. You pay a premium for safety and that premium is very costly. A lot of people are reacting to the market downturn; they had a stock allocation but now they've gone to money markets, CDs and some of this FDIC paper. The problem is they're not looking realistically at what their money needs to earn to support their cost of living. That scares me.

People should be allocating assets. If you take a hit, don't react by going into a bunker trade, and I consider this a bunker trade. You need to say, 'OK, what's my new allocation? I had too much in stocks and I couldn't handle the volatility.' The stock component is the only thing that can pull you back from that hole,” Larkin says.

If individual stocks make your stomach churn, Larkin recommends exchange-traded funds. Similarly, if individual bond issues aren't right for you, he suggests ETFs that allow you to buy different parts of the yield curve, such as short-term corporate bonds.

Yields on the FDIC-backed bank bonds have dropped over the past few months -- as have other no-risk investments such as high-yield CDs. Nevertheless, CDs deserve a look as the high-yield variety still offer very decent returns in this environment, complete with the FDIC backing within the current $250,000 limit. As of this writing, more than a dozen institutions listed in Bankrate's high-yield tables are paying 2.5 percent or better on one-year CDs. If you can lock up your money for two years, you'll find some yielding 3 percent; three-year CDs are pushing just a bit above 3 percent.

The FDIC is considering extending a guarantee to high-grade, secured lending with maturities between three and 10 years.

advertisement

          Connect with us
Product Rate Change Last week
1 Year CD 0.90%  0.02 0.88%
2 Year CD 1.02%  0.01 1.03%
5 Year CD 1.59%  0.01 1.60%
 
View Rates in your area Search
advertisement
CD & INVESTING NEWSLETTER

Learn the latest trends that will help grow your portfolio, plus tips on investing strategies. Delivered weekly.

CDs and Investment

How can I pay myself first?

Dear Dr. Don, You often advise readers to "pay yourself first." It sounds like a fine idea. But I'm wondering how that actually should work. I'd like to know how much or what percentage of my income should be set aside... Read more

advertisement

Blog

Sheyna Steiner

Investing: Sometimes less is more

A sixth grade class played along in an investing throw down among college-level clubs and easily beat all their returns.  ... Read more

Partner Center
advertisement

Connect with us