Solar Bonds Pay Up to 5.75%. What's the Risk?

Solar Bonds Pay Up to 5.75%. What's the Risk?

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On Facebook I saw an ad promoting a Solar Bond that paid up to 5.75%. Intrigued, I clicked over to learn the details. The good news is that the bonds are offered by Solar City, a legitimate, publicly traded company that is a leader in installing solar panels on houses and businesses. The company chairman is publicly traded on the Nasdaq at SCTY. Its chairman is Elon Musk of Tesla and SpaceX fame.

On Facebook I saw an ad promoting a Solar Bond that paid up to 5.75%. Intrigued, I clicked over to learn the details.

The good news is that the bonds are offered by Solar City, a legitimate, publicly traded company that is a leader in installing solar panels on houses and businesses. The company is publicly traded on the Nasdaq at SCTY. Its chairman is Elon Musk of Tesla and SpaceX fame. Mr. Musk is a bold visionary who exceeds at extracting an enormous amount of capital from investors with Herculean bets on the future. His track record at generating profits at the companies he is associated with is less impressive as neither Tesla or SpaceX are profitable at their core businesses - yet.

Their general model is for the company to pay for the cost of the installation and then lease the equipment back to the homeowner over a twenty-thirty year period. The savings that the homeowner generates on their electricity bill pays for the lease and often leaves some left over, providing an electricity credit to the homeowner. Government subsidies of up to 30% of the installation cost also help to make the installation more affordable for Solar City and the homeowner.

The company is offering several different bond terms. The current terms and their rates are listed below:

1 Year:   2.00%

3 Year:   3.00%

5 Year:   4.00%

10 Year: 5.00%

15 Year: 5.75%

These rates are for bonds purchased directly from the company via an online ordering system. I haven't tried the system so can't vouch for how hard or easy it might be to register and order. Investors can also purchase them through a broker but the rates are slightly lower.

These bonds are not FDIC insured and if the company goes bankrupt, bondholders could lose interest or even principal. Interest is typically paid semi-annually (twice per year) although it may vary according to bond type.

Should You Invest in Solar Bonds?

As of April 15, 2015, the best risk-free rate on an FDIC insured CD according to BestCashCow is close to 2.30% APY.  The rate on a five year Treasury Security is 1.31%. The five year muni bond average is a bit worse according to Bloomberg at 1.26%. The ten year yields show a similar spread. Solar City's offering is akin to a high yield bond, otherwise known as a junk bond. Now, the name doesn't mean the bond is junk, but it is risky. An examination of the company's income statement and balance sheet will illustrate the risk.

Solar City's 2014 annual report shows that the company had a net loss of $375 million versus a net loss of $96 million in 2013. Why the loss? The company had an operating profit of $79 million with a 30% operating margin. It's not a great margin but at least  they generated an operating profit. Their operating expenses, especially Sales and Marketing were responsible for the widening loss.  One way to look at this is that Solar City is in expansion mode and is paying heavily now to get as many panels on customer homes as it can. Once it does this, it will have a recurring revenue stream for the next 30 years, as consumers are not going to rip up the panels.  Sounds good. The only problem is that 30 years is a long time. New technology may arrive and make these panels obsolete. Or the utilities may change the way they buy back excess electricity from the homeowner. As a bondholder, you will have to be confident that no matter what the changes, the company will have enough cash over the time period of the bond to pay you interest and also principal.

The balance sheet shows the company has about $700 billion available in cash or cash equivalents to pay the bills. Looking at cash flow, the company used up $1.3 billion in cash last year, the biggest amount being used for payments for solar energy systems that will be leased.

You can see the entire SEC filing here:

http://investors.solarcity.com/secfiling.cfm?filingID=1564590-15-897&CIK=1408356

The company is a bet on whether it can successfully deploy and lease these solar energy systems in a way that generates enough positive cash flowing going forward.

Conclusion

Solar City is a promising company, but it is also a risky one with no history of profits. It could succeed spectacularly or it could also just as spectacularly crash and burn. Whether you invest and how much you invest depends on your risk tolerance.

If you are willing to stomach the potential of losing your investment and want the higher yield, then this might be an investment for you. The shorter term bonds obviously offer less risk.

If you want to be as assured as possible (is there really ever any assurance in life?) that you will receive your interest payments and principal back then this is probably not an investment for you.


Suze Orman Is Giving Bad Advice About Municipal Bonds

Suze Orman Is Giving Bad Advice About Municipal Bonds

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By and large, I think Suze Orman is great. She provides a great service in telling people with little in way of assets how to preserve them. But, I watched her recent presentation on PBS as part of their fundraising effort, and she was giving one piece of advice that is just dead wrong in the current rate environment.

On Suze Orman’s PBS special, she was telling her audience (the US middle and lower classes) that they should be buying 5 year municipal bonds with any money that they have available and want to safely park for the next five years.

While this advice is ordinarily very good counsel for those in the highest Federal and State tax brackets (not Suze Orman’s audience), it makes little sense at all in the current rate structure.  And, it absolutely makes no sense for Suze’s target audience.

Here is why:  A AAA-rated insured NY municipal bond which matures in 5 years is going to trade at 1.20% at the moment, if you have a broker who can find you one.   The fully taxable equivalent for someone who lives in NY City and pays 39% tax (Federal, State and NY City) is about 1.96%.   For someone who is in a lower tax bracket, the fully taxable equivalent will be lower.  An AAA-rated municipal bond in other high state-tax States like Illinois, California, Massachusetts, Georgia or New Jersey is going to trade roughly at the same level.  In States with low taxes, or no taxes, like Florida or Washington, you may be able to find a high quality 5 year municipal bond trading close to 1.50%, but in no case at the moment is a holder going to a fully taxable equivalent more than 2% on a safe municipal bond.

On the other hand, a fully FDIC-insured 5 year Jumbo CD issued by CIT bank currently pays 2.27% APY, and several online banks are offering 5 year CDs with rates as high as 2.25% APY.  Those rates are available nationally, but depending on where you live, you may find higher rates on BestCashCow that are offered in a branch by a local banks and credit union near you.

Unlike a municipal bond, the purchase of a CD – online or otherwise – ordinarily involves absolutely nothing in the way of a transaction fee (hidden or otherwise).  More importantly, while an investor may think that they do not need access to their money for five years, it is very possible that life circumstances can change and they could need to access it.  In the current interest rate environment, an investor could lose significant principal on a new municipal bond purchased today if rates rise (which is something Suze Orman realizes and her reason for cautioning against bond funds at the moment).  With a CD, that investor would only face an early withdrawal penalty, expressed in terms of interest although it may affect principal in the event of an extremely early withdrawal.   The CIT Bank and Synchrony Bank penalties for earlier withdrawal on a 5 year CD, for example, are only 12 months and 6 months, respectively.

Suze Orman’s advice is generally very good.  But, in recommending municipal bonds, she is wrong because she is not aware of the current bond and CD rates.  You can always remain up on the rates by checking them here.


JP Morgan Chase's Callable Step-Up CD is to be Avoided

JP Morgan Chase's Callable Step-Up CD is to be Avoided

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TD Ameritrade is currently syndicating a 6 year callable step-up CD issued by JP Morgan Chase. The CD represents perhaps the most transparent "heads I win, tails you lose" offering available, and should be avoided.

The JP Morgan Chase CD being syndicated by TD Ameritrade has a maximum maturity of 6 years, paying 1% for the first two years, 2% for the next year, 3% in years 4 and 5, and 5% in year 6.  The note - however attractive it may appear at first glance - is callable anytime after 6 months and therefore should be absolutely avoided.

More likely than not, if interest rates remain low, JP Morgan Chase is going to call the note within the first two years.  If interest rates, however, were to begin to revert to historically normal levels over the next two years, JP Morgan can continue to pay note holders rates which may very well be below market rates at that time into years 3 through 5, calling the CD at any point should it be offer a rate than begins to become close to a normal rate of return.

Since JP Morgan Chase has the call option, the entire proposition is in their favor, and while I have often advocated that investors look at structured notes that involve their effective sale of a call option, those notes always involve the receipt of higher interest rates in the near term in return for the sale of the call (often as high as 10 or 11%).  In this case, JP Morgan is giving depositors a 1% interest rate for the first two years - a rate which is even worse than the best cash rates today!   See and compare the best cash rates here.

To boot, these types of syndicated structured notes are not liquid, and cannot even be redeemed early by paying an interest penalty the way that ordinary CDs can.  Rather, purchasers of these notes who want out early will essentially be relying on TD Ameritrade (or a subsequent broker) to go out and get the market price (i.e., take whatever anyone is willing to pay for the CD).

Even a depositor who wants to bet that rates are not going to rise over the next 5 years and is willing to lock into a rate for that time would be better off buying a 5 year CD.  The current best rate on a 5 year CD is 2.32%.  Exclusive of tax consequences, $100,000 invested in that CD will produce $12,150 over the next five years versus the JP Morgan Chase product which will produce $10,386 if not called earlier.  The 5 year bank CD, unlike the JP Morgan product, can be redeemed early by payment of an interest penalty fee.

A still more logical choice in this current environment in light of the reality that rates are likely to go up at some point over the next two years is to either stay in cash, or to invest in a two year CD.  One of the most interesting 2 year CDs available today is a RampUp Plus CD offered by CIT Bank, currently paying 1.35%.  These CDs offer not only better fixed rates than the JP Morgan Chase callable CDs over the next two years, but enable depositors a one-time rate increase if rates should rise over that period.  (The RampUp products were recently named a Best Bet for 2015 by BestCashCow.com.)

Under any circumstances, there are plenty of good CD options available, even in the current rate environment.  The JP Morgan Chase product currently being syndicated by TD Ameritrade should be avoided.