Double Blind

Asset backed securities have a bad name in finance, mainly because the assets backing them tended to be mortgage related products.

I wrote about this earlier.

Just because something is called an asset-backed security doesn’t mean you should treat the investment as toxic.

So now that I have made an investment at the opening today, I can write about it (and be warned – after I write about purchasing something it is guaranteed to tank). One example of such an asset-backed security is PYG, which is an exchange traded trust. The trust has one asset backing it – senior unsecured bonds of Sprint-Nextel corporation, maturing in 2028. The bonds themselves yield 6.875%. The trust was created (using some financial wizardry) to yield 7%, and sell for $25 per unit of par value.

There were approximately 1.7 million units of this trust created, and the asset backing them (the bonds) has a par value of approximately $43.3 million. So the trust is taking in roughly $3 million a year in interest income, and distributing it back to trust holders in two payments per year.

The trust was trading today at around $12 a unit, with a current yield about 14-15%, and valuing the entire trust at $20.4 million dollars if you were to buy the whole thing.

The value is that the underlying assets are trading at $32.5 million, which means that by purchasing the trust instead of the underlying asset (Sprint bonds), you are essentially purchasing debt of Sprint-Nextel Corporation at a 37% discount under the market value.

Presumably illiquidity is the reason why this discount is so high.

Two risks that remain deal with liquidity (the trust is very thinly traded) and the underlying corporation (Sprint Corporation isn’t exactly gushing cash, but they are making positive cash flows). If Sprint goes under, the bondholders are first in line in any liquidation, so chances are there would be some sort of recovery greater than 50% of par value. For example, the market capitalization of their equity is currently 20 billion, while the amount of their debt outstanding is approximately 23 billion, which makes me suspect that this will be a winning fixed income investment. Sprint has enough cellular infrastructure to be worth at least 12 billion to a potential acquirer in the event of a (unlikely) bankruptcy.

This entry was posted on Thursday, September 25th, 2008 and is filed under Finance. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.