Explaining “Payroll Certificates” as pitched by Oxford Bond Advantage

Checking out the "guaranteed by law" income pitch from Steve McDonald

By Travis Johnson, Stock Gumshoe, March 4, 2015

Steve McDonald made some friends in the world of Gumshoe a few years ago, when his income-focused advisory The Bond Trader was doing pretty well.

He moved on from that to a service with a similar strategy for the Oxford Club folks called Oxford Bond Advantage, and he’s now pitching that newsletter by tantalizing readers with the idea that you can get “Payroll Certificates” that are “obligated by law” to pay you.

So that sounds pretty good, right? Let’s dig into the details a bit. He sums it up pretty nicely in the intro to the ad:

“If you’re concerned about retirement, forget relying on Social Security… stocks… real estate… banks… or annuities. These specific companies are obligated by law to pay you at least$56,744 once you enroll.

“Hi everybody, I’m Steve McDonald and I hope you’re sitting down…

“Because what you’re about to see will change the way you look at money forever.

“It’s one of the only money sources in the world where it’s mandated by LAW that you get paid.

“For lack of a better name, I call them ‘Payroll Certificates.'”

That’s probably enough for many of you to hazard a guess as to what he’s talking about, but don’t spoil the surprise — we don’t want everyone to hear the idea and get bored and wander off… (OK, here’s a hint — it rhymes with “shmorporate fronds”).

And the “Payroll” bit is because he describes it as kind of like being on the payroll of a company, without doing any work…

“You won’t lift a finger for them, and yet… they’ll still pay you just as if you did work for them!

“Best of all, it has nothing to do with the employee payroll. Employees can get their wages slashed at any time… but our payouts are set in stone!

“Collecting money from a ‘Payroll Certificate’ takes only a few minutes a week at most.”

And he throws in a couple examples, using the old copywriter’s trick of talking about what you get, but not what you have to invest in order to get that return…

“Some companies, like Genworth Financial, pay up to $5,618 to holders of ‘Payroll Certificates’… Others, like Dell, pay as much as $2,257.

“Even $6,236 from a company like Barrick Gold….

“There are dozens of companies that offer these opportunities.

“Getting started with just eight companies can net you $56,744.”

McDonald is appealing to the risk averse for the most part, and he makes that clear:

“Take It From Me – This Is the Only Way to Stop Worrying About Your Money

“Whether we’ve met before at a conference… or you know me through my weekly videos… or even if this is the first time you’ve seen my face…

“There’s one thing we both have in common:

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“We absolutely HATE losing money!”

And he throws in some examples of people who are much smarter than you or I, and who are cutting their risk exposure… though he doesn’t exactly say that they’re buying “payroll certificates.”

  • “Famous bull investor Jeremy Siegel of the Wharton School is predicting our ‘first correction’ in 2015.
  • Credit Suisse, one of the world’s largest banks since 1856, is predicting a 2015 correction.
  • Warren Buffett has drastically sold off his shares in Kraft, Intel, and Johnson & Johnson.
  • Billionaire John Paulson, the man who foresaw the subprime mortgage crisis, says he’s selling off his U.S. stocks.
  • George Soros has dumped millions of shares of JPMorgan Chase, Citigroup and Goldman Sachs as of late January.
  • Jim Rogers expects a correction, adding, ‘that’s the way the markets have always worked.’
  • Bill Gross, the legendary PIMCO guru, claims ‘The good times are over’ and expects assets to fall this year.”

All of that’s probably true, though it doesn’t necessarily mean anything particularly specific for us as individual investors. Bill Gross is a bond guru, George Soros has certainly bought lots of stuff just like he sells lots of stuff, Warren Buffett has sold some major holdings but also poured lots more into others, including IBM, John Paulson hasn’t had a particularly good year since 2009 if my memory is correct… the list goes on.

Does it mean anything other than “many folks are nervous that the bull market will eventually end, and it’s been going on longer than average?” No, not really. Lots of folks are hedging their bets after five+ years without any big corrections (and the S&P 500 has doubled in five years, meaning stocks did well better than average for that time period — and some sectors are even more ebullient, with the Nasdaq up 150% and biotech up about 300% in those years, plenty of reason for folks to be itchy about taking profits or hedging).

More from McDonald…

“These things I call Payroll Certificates are one of the few ways you can invest confidently – knowing with 100% certainty exactly how much you are set to collect in cash payments each year and month.

“It’s one of the only investments that can hand you upward of $56,744 in income, no matter what’s happening in the stock market! …

“There is NO limit to how many of these checks you can receive.

“You can take baby steps with just one company and collect around $4,740 to $9,806.

“You can start modestly, as I recommend, with eight companies and collect $38,721.

“Or you can really get aggressive and sign on with 12 or 13 companies and clear $91,000.”

So again, nothing in there about what kind of investment would be required to “take baby steps” or “start modestly” … If you have ten million dollars to invest, I can get you a risk-free $91,000 every year, easy as pie (that’s a return of less than one percent, for those who don’t want to do math), but for the smaller investors among us (including me) collecting $38,721 sound pretty awesome… assuming that we can do it with our much-more-modest investable cash.

Then he gives an example that finally mentions how much we have to invest…

“Collect up to $6,236 From Barrick Gold

“Last year, my followers collected a Payroll Certificate for this exact company.

“When I first showed it to them, it promised that, if you invested $13,837, you would receive guaranteed cash payments totaling $5,074 – made in 13 separate payouts over time.

“After you receive those 13 deposits, you get your original $13,837 back.

“Plus, an extra predetermined bonus of $1,162.

“In total, then, you put in $13,837. And you get back $20,073.”

So that’s pretty good… and yes, we’re well past hinting and word evasion now, there’s little point in keeping the “secret” any longer: Steve McDonald, in this teaser pitch for his Oxford Bond Advantage, is pitching — don’t be too shocked now — investing in individual corporate bonds.

Which does indeed give you a predictable cash flow, because bond coupon payments (the amount they have to pay to bondholders, usually in two payments each year) are set when the bond is created, and because you know that (assuming the company doesn’t go bankrupt) you will get back the original principal of the bond from the borrowing company at maturity. And these bonds are legal agreements, so yes, you are guaranteed by law to get the coupon payments… unless that gets legally changed, as through some kind of (usually bankruptcy-related) change to the bond agreement.

The reason he doesn’t use the word “bonds” is both because it’s a hard sale to make — many bond-focused newsletters have gone under because it’s not a very sexy or marketable idea, lending money to corporations, and there weren’t that many such services to begin with — and because just about every single pundit on the face of the earth is expecting interest rates to climb, which should make bonds a weak investment, possibly a disastrous one.

That’s a broad perspective, though — even if interest rates rise and the value of many bonds falls, not all of them will fall precipitously, and corporate bonds are not just a pure play on interest rates and currencies the way sovereign bonds (like US Treasuries) typically are, they’re also a play on corporate profits and the ability of a company to pay back its lenders. Companies whose fiscal standing improves considerably could see their bonds become more valuable even in a rising interest-rate environment, because their perceived credit rating improves, though that’s not the norm… and, of course, the fact that “everyone” expects a rising rate environment well into the future doesn’t mean it will come to pass. Everyone expected rates to rise considerably in 2007, too, and in 2011, and in 2013. The bull market in bonds has been far, far longer and more consistent than the bull market in equities.

McDonald is pitching corporate bonds for the most part, and the examples he gives are fairly lowly-rated bonds — because that’s where the sexy stuff comes in, if you can buy $1,000 in principal value (that’s how most bonds trade among individual investors, in lots of $1,000 or $10,000 of principal) for $800, and the bond is paying a coupon of $60/year (meaning it had an original yield of 6% on the $1,000), then your $800 is actually earning you a 7.5% yield because you bought at a discount to principal… and, perhaps more importantly, you get the principal back in the end. So in ten or 20 years (or however long it is until the bond matures), you get $1,000 back from the company as the principal of the loan is repaid. That’s a 25% “at maturity” bonus (your $800 back plus another $200 to repay the full principal amount — the company doesn’t get to repay you at a discount even if that’s how the market values the bonds).

That’s just an example with easy numbers, McDonald provides a couple other examples of “Payroll Certificates” that are currently available:

“With DynCorp, you put in $13,935 and you get back $18,675.
“With Jones Group, you put in $10,320 and you get back $19,170.
“With Comstock, you put in $9,945 and you get back $19,751.
“Now, it’s important to note, you don’t have to invest $9,000 or $10,000 in these.

“You can get in for as little as $600 or so.”

I checked the bonds currently outstanding/trading for those companies (I use the bond market data center at FINRA for this, most brokerage websites are pretty bad at showing bond data). Here’s what I found at current prices:

DynCorp’s major outstanding bond has the CUSIP 26817CAB7 (a CUSIP number is what you use to identify a particular bond — like a ticker for stocks, it’s what you would use to research the bond or, in most places, place orders with a broker). It is rated as Junk (CCC+ from S&P), which means the ratings agency considers it to be “Currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments.” Given the current yield environment, you really have to go down to these low-rated bonds to get a chance at a substantial yield or real capital gains.

That particular bond matures in 2017, so you have about two years until it is repaid at $1000. It bottomed out at about $800 late last year, but last traded around $920. So that’s a 8.5% “kicker” when you’re repaid, and it pays a coupon of $103.75/year so the current income yield is about 11%. There are probably five payments remaining, so the total return, including all the coupon payments and the return of principal in July of 2017 would be about $1,520, or a profit of $600 in 2-1/2 years.

Why is the return so high on something that’s “contractually obligated” to pay you a high yield? Because Dyncorp is a highly levered company in a somewhat unpredictable industry (defense and aviation, for the most part), and investors are demanding a high yield because of what they must perceive as an above-average likelihood that the company will default on its debts and go into bankruptcy. I just browsed their recent presentation to a leveraged finance conference, and they say the industry continues to be uncertain, they’re doing (and saying) the right things about paying down their debt balances, but this particular bond represents a large portion of their debt, well over half of the debt, and it’s due to be repaid in July of 2017. Depending on what the environment is like for refinancing debt when that runs around, they may start to feel the pressure of that impending maturity over the next year or so.

So the calculus for these kinds of investments involves understanding the company’s operating prospects and the likelihood that they’ll keep generating enough cash to pay the coupon until maturity, having some consideration for how easy or difficult it might be for them to refinance at maturity (ie, issue new bonds so they can repay their existing bondholders — most of the time at least some of the debt, if not all, is effectively “rolled over” to new lenders), and, perhaps most importantly for junk bonds, making some risk assessment that you’re comfortable with about how likely the company is to go bankrupt before maturity and whether they own assets that are valuable enough to repay bondholders if they liquidate.

And sometimes, companies that still seem like they can be viable operators after the debt is cleared get a decent deal in bankruptcy court and the bondholders essentially just end up owning a company that continues operating, but which is far less valuable than the bonds had been (just ask anyone who owned A&P bonds a few years ago, for example — $1,000 in bond “face value” might have seemed appealing to buy at $600, but after the company went through bankruptcy that bond was turned into equity that’s probably now worth far less than $100 (probably more like $3, but I haven’t checked — that equity also might not be publicly traded, it isn’t for A&P now, which adds further to the difficulty of selling).

So that’s the downside risk, and corporate bonds — particularly junk bonds — are often quite illiquid, so you can’t count on being able to sell your bond at a good price if you think things are deteriorating. Diversification is at least as important for corporate bonds as it is for stocks, partly because of that lack of liquidity and the general lack of coverage of corporate debt in the financial press (at least, the financial press that’s focused on individual investors). I don’t want to overstate the default risk of corporate bonds — even for junk bonds, most of them are repaid and don’t default… but if you buy just a couple bonds as an individual investor dabbling in debt, one of them going south will clobber that portion of your portfolio. Bonds are far less likely than stocks to fall abruptly in value, and even less likely to not repay the principal at maturity, but that doesn’t mean it’s impossible… particularly if you’re dabbling in the riskiest part of the bond market, these high-yield bonds that look so appealing with a discount to maturity value and a double-digit coupon yield.

If you’re curious, I didn’t look into all the details of the other ones, but the “Comstock” one is almost certainly Comstock Resources, which is an oil company whose 2019 bonds (CUSIP 205768AJ3) are now trading down to 60 cents on the dollar with an effective 23%+ annual yield to maturity. There are a lot of small energy stocks who’ve been downgraded to “Junk” status and are trading at huge yields, largely because they’re levered companies that depend on the sale of oil to make their coupon payments and, well, we’ve all seen what oil did over the last six months or so. If oil recovers sharply, perhaps many of them will be fine… but if it doesn’t, the pundits are widely predicting a big wave of bankruptcies among the smaller oil stocks. Comstock has about a billion dollars in debt and a market cap now of only about $250 million, so it’s getting closer to being effectively “owned” by the bondholders already.

McDonald undoubtedly thinks the risk is overstated, at least for the “Payroll Certificates” he recommends — here’s how he puts it:

“Remember, the only major risk to your money is if the company offering the Payroll Certificate goes completely bankrupt.

“But I’ve NEVER had one of these companies default and refuse to pay out. Not once. Not ever.”

From the general gist of the ad, it appears that McDonald is recommending a lot of bonds that are not investment grade, meaning they’re down below “medium credit quality” with a rating of BBB or worse (that’s what folks call “junk bonds” — which doesn’t mean they’re necessarily bad investments, just riskier than “blue chip” or steadier, less-levered companies who can borrow much more cheaply, and whose bonds therefore yield much less). And he’s focusing on those with maturities coming fairly soon, to reduce both credit risk and interest rate risk (when a bond matures you are repaid the principal), so it looks like he’s restricting his recommendations to maturities that are perhaps five years out or less.

And he does leave us with one hint about a “buy now” bond that he likes (the letter implies that he likes or has recommended several other examples, but this is the only one he doesn’t name), so let’s see if we can wrap it up by identifying that for you. Here’s what he throws out by way of clues:

“In fact, I recommend you collect a quick $1,522 from this aluminum company right now.

“This $1,522 Is Waiting for You

“First of all, this company is in outstanding financial shape.

“Profits are up 232% year over year.

“It’s recently made Nasdaq’s ‘hot performers’ list.

“And with my guidance, you can easily collect $1,542 from this company.

“It’s easy…

“To initially get started, you’ll need just $1,021.

“You’ll then collect $522, split into 10 separate payments.

“When the payouts are done, you’ll get your full $1,021 back.

“In total, then, you put in $1,021. And you get back $1,522.

“That’s a predetermined return of 54%.”

He doesn’t specifically say that this “quick” return will be over five years, but I’m assuming he’s talking about a bond with about five years left to maturity (10 payments, most bonds pay twice a year), so that means the yield is in the neighborhood of 10% a year (it could be a much lower-yielding bond that pays once a year and has a coupon of about 5%, but that seems unlikely).

Alcoa (AA), the biggest and strongest aluminum company in the US, is rated down at the bottom of investment grade/top of “junk” grade, and their yield going out to 2018 is less than 3%, so we know it’s not them. There other other aluminum-related companies that also have debt maturities in the 2019-2021 timeframe, including Park Ohio (PKOH) and Kaiser Aluminum (KALU), but most of them have yields far, far lower than 10%… and some are junkier, like the bonds of Exco Resources (XCO), and trade at a big discount to principal that doesn’t match the clues.

Aleris comes fairly close (2020 maturity, 269279AE5) and trades right around principal but has a yield of just about 8%, so that’s too light. Century Aluminum (CENX) is probably the best match among fairly major companies, but doesn’t match exactly, either. The best match for yield is probably Noranda Aluminum’s 2019 11% bond (CUSIP 65543AAD6, stock’s ticker is NOR), though that doesn’t match the earnings growth hint… that Noranda bond was trading at a bit over $1020 six months ago, so perhaps the copywriters are using some pretty stale recommendations in generating their teaser hype (wouldn’t be the first time).

So… no definitive answers for you, but some thoughts to chew on — my best guess for what he’s touting now for the aluminum bond is that Noranda debt, which should have nine or ten coupons remaining at an 11% yield and is trading right at the principal value.

The possible outcomes are that the bond goes up in value because NOR’s finances improve (most of the aluminum stocks are getting crushed right now after the sector got downgraded by Merrill Lynch, bringing down NOR as well as CENX and AA), which would let you sell at a profit or hold and keep getting the 11% coupon; the bond goes down in value because of weak finances or outlook for the industry (which is what happened, gradually, over the last six months) but still stays strong enough to pay the coupons and repay your principal in 2019; or the company goes bankrupt and the value of the bond becomes much less certain (if they have to actually liquidate, or convert bonds into equity of a refinanced company, etc.), something which doesn’t usually happen rapidly or unexpectedly but certainly can surprise investors and make it hard to take a small loss on the way down to prevent larger losses.

Because of the high yield and the junk status of the bond, this is not primarily an interest rate play — it’s much more dependent on the perceived risk of default (roughly described by the credit rating) than it is on the competitive rates of “safe” 5-10 year bonds. If the 10-year note benchmark goes from 2% to 3.5% over the next few years, that’s not likely to impact a high-yielding security like this very dramatically (it should impact investment grade corporate debt, which is priced much closer to US treasury rates, much more substantially). That means you’re investing in company fundamentals to a greater degree than you are investing in interest rate expectations or inflation prospects, so knowing the company well and diversifying will be key for those who want to own high-yield corporate bonds, whether or not you wish to call them “Payroll Certificates.”

Interested? I’ve found myself tempted by corporate bonds from time to time, but I am not terribly confident in my strengths as a credit analyst and I haven’t built a corporate bond portfolio — my inclination is to avoid most fixed income assets right now just because rates are so low, but that doesn’t mean investing in junk bonds can’t work just fine for a lot of people, particularly those who need more income from their portfolio, even if it’s not necessarily sexy or fast-moving enough to sell a lot of newsletters. Let us know what you think with a comment below.