Duke Energy Corp. (DUK), Ford Motor Co. (F) and General Electric Co. (GE) are enticing a growing number of individuals to buy their debt through investments pitched as higher-yield alternatives to checking accounts and money funds.
These and other companies that sell the debt, called floating-rate demand notes, are exploiting frustration with money-market funds paying an average 0.03 percent as of May 29 and bank savings accounts at 0.13 percent. The notes, which usually require a minimum deposit such as $500 or $1,000 and offer checks to access the money, are paying 1 percent to 1.6 percent.
The notes help companies diversify their funding, which is skewed to securities such as commercial paper and bonds bought mainly by institutions. For retail investors, they provide less protection than an insured bank account or a money fund that holds debt from many issuers. The notes aren’t secured.
“It looks like these programs are a much better deal for the company than they are for the individual investor,” said David Sekera, corporate bond strategist at Chicago-based research firm Morningstar Inc. (MORN) “These programs don’t appear to pay enough extra spread over money-market funds to compensate the investors for the credit risk and lack of diversification.”
Issuers generally can change payout rates weekly. Duke Energy, a Charlotte, North Carolina-based utility, and Ford Credit, the company’s finance unit, promise to pay at least 0.25 percent more than the average money fund rate. Fairfield, Connecticut-based GE doesn’t guarantee a minimum.
“I like to call them a bond with a checkbook,” said John Heffernan, director of the PremierNotes program at Duke Energy. “The unique thing about this is we’re selling them directly to the investors.”
Duke Energy started offering floating-rate notes to individuals about a year ago, marketing them first to employees and through billing inserts to customers before advertising in newspapers, Heffernan said in an interview. The amount of debt outstanding through the program increased 59 percent to $126 million as of March 31.
The finance arm of Peoria, Illinois-based Caterpillar Inc. (CAT), the world’s largest construction-equipment maker, had about $550 million outstanding in the floating-rate demand notes as of December. Detroit-based Ally Financial Inc. (ALLY), the auto-finance company, had issued about $3 billion outstanding in a similar product as of March 31.
Caterpillar’s notes are available to the general public. Ally’s generally are offered to its employees, retirees and immediate family members, as well as those at General Motors Co. (GM) and the Chrysler group of companies, said spokeswoman Gina Proia.
“Looking for CD or Money Market Rates? You can do better,” according to the marketing on GE’s Interest Plus website. The notes are issued by GE Capital, the finance unit of the industrial and financial-services company. GE has been offering the notes to individuals since 1992. It had $8.7 billion outstanding as of March 31, compared with $5.6 billion at the end of 2008.
“The real benefit of this product is flexibility,” Russell Wilkerson, a spokesman for GE Capital, said in an interview. “It allows customers to come in without a sales fee and exit at any time without a penalty. That supreme flexibility and an attractive yield is the strength of the offering.”
If a corporation selling these notes defaulted, investors’ money would probably be tied up in bankruptcy court and they might lose a significant portion of their investment, Sekera said.
While the investments let investors write checks against them and access the money daily, they aren’t insured by the Federal Deposit Insurance Corp. against losses and there are restrictions. Duke Energy requires that checks written or online transfers total at least $250.
The notes, unlike traditional bonds, don’t have stated maturity dates and aren’t tradable in a secondary market. Buyers must rely on the company issuing them to get their money back.
People “tend to use it like a savings account or a money- market account,” Brad Reynolds, chief investment officer for LJPR LLC, said of Ford Credit’s Interest Advantage notes. Investors who are also employees of the companies may be inadequately diversified if there are credit problems with the issuers, said Troy, Michigan-based Reynolds, who works with clients who invest in the notes.
Money-market funds by comparison pool assets from a variety of sources.
“A money market fund is a diversified, professionally managed, highly transparent portfolio consisting of high- quality, liquid assets and governed by all the investor protections of a mutual fund,” Rachel McTague, a spokeswoman for the Washington-based Investment Company Institute, a lobbying group for mutual-fund companies, said in an e-mailed statement.
The staff of the Securities and Exchange Commission has been drafting two proposals aimed at reducing the risk money- market funds may pose to financial stability. The first would strip funds of their traditional fixed $1 share price, substituting a floating value. The second would impose capital requirements and restrict redemptions.
Duke Energy and GE Capital both said they are transparent about how the products work and that it’s the responsibility of individuals to determine what investments are right for them depending on their risk tolerance.
Ford Credit, a unit of the Dearborn, Michigan-based automaker, prominently discloses how its notes differ from bank accounts or other guaranteed products, said spokeswoman Margaret Mellott. The company had about $4.7 billion outstanding in its demand notes at the end of 2011.
Some of the companies issuing the notes generally can’t sell commercial paper to money-market funds because their short- term debt isn’t top-rated, said Peter Crane, president of Crane Data, which tracks money markets.
Moody’s Investors Service on May 22 raised the unsecured credit ratings of Ford and its finance unit to investment grade from junk status. Money-market funds generally can’t hold the company’s short-term debt, which was raised to P-3, the lowest level of investment grade, from Not Prime by Moody’s. GE’s short-term debt is rated first tier by Moody’s and S&P, while Duke Energy’s is rated P-2 by Moody’s and A-2 by S&P.
Investors should look up the ratings for the different companies offering these programs and check both the short-term and long-term ratings, said Morningstar’s Sekera. While the probability of a large corporation going bankrupt is low, the failure of companies such as Enron Corp. and Lehman Brothers Holdings Inc. are evidence that it’s possible, he said.
The average yield for 90-day nonfinancial commercial paper rated P-2 by Moody’s and A-2 by S&P was 0.60 percent for the week through June 1, according to data compiled by the Federal Reserve. The average for higher rated 90-day nonfinancial commercial paper was 0.21 percent.
Duke Energy and GE Capital have internal committees that can reset the rates paid on the accounts weekly. Ford Credit updates the rates weekly to reflect money-market rates plus 25 basis points and may pay greater than that “at its sole discretion,” according to the notes’ prospectus. Mellott, the spokeswoman, declined to comment beyond the prospectus on how the company sets its rates.
Duke Energy currently pays investors 1.2 percent for accounts less than $10,000 and as much as 1.6 percent for those with more than $50,000. GE Capital and Ford Credit paid a rate of 1 percent for investments of less than $15,000 and as much as 1.1 percent on amounts greater than $50,000 as of June 4.
Income on the notes is treated as interest and taxed at ordinary income rates.
If the rate is set by the company rather than an index, it’s harder to determine the value of an investment, said Richard Saperstein, managing director at New York-based Treasury Partners, which is a unit of HighTower Advisors and advises corporations and individual investors.
“Clearly they are playing off of consumers’ interest in eking out a little bit better return on their money than they can get from bank accounts or money-market funds,” said Barbara Roper, director of investor protection for the Consumer Federation of America.
Even though the risks are disclosed in the notes’ prospectuses, investors may still confuse the products with money markets or guaranteed accounts because of the features they offer, Reynolds, the investment adviser, said. “It looks like a duck, quacks like a duck and swims like a duck.”
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