A 14.34% YTM Opportunity in James River Coal Company Bonds (CUSIP: 470355AG3)

 

By: The Financial Lexicon

(March 23rd, 2012) On Thursday, Standard & Poor’s (S&P) cut the corporate credit rating on James River Coal Company bonds (JRCC) from ‘B’ to ‘B-.’ Along with the corporate credit rating cut, S&P also cut the ratings on James River’s (JRCC) senior unsecured debt as well as its convertible notes. The $275 million of senior unsecured debt was cut from ‘B+’ to ‘B,’ and the convertible notes were cut from ‘CCC+’ to ‘CCC.’

In the press release, S&P also announced that in the event of a default, it believes the recovery rate on the senior unsecured debt would be in the 70% to 90% range versus a recovery range of 0% to 10% on the convertible notes.

What’s interesting about James River Coal Company’s senior unsecured debt is that the entire $275 million comes from just one CUSIP. This April 1, 2019 maturing, 7.875% coupon note with various call and put features has the following CUSIP: 470355AG3. If S&P believes the senior unsecured debt will have a 70% to 90% recovery rate should James River Coal Company default and the senior unsecured debt is all found in one CUSIP, then investors who believe S&P’s prognosis for debt recovery have a very easy way to keep track of whether an investing opportunity presents itself in JRCC debt or not: Simply watch that one CUSIP.

At the moment, James River’s senior unsecured note, CUSIP 470355AG3, is asking 72 cents on the dollar (14.34% yield-to-maturity before commissions). If you believe S&P will be correct with its prediction, the market is currently offering an investment opportunity with much more upside than downside risk.

If you purchase the notes at 72 cents on the dollar and the company defaults, under S&P’s recovery scenario, the potential return will range from a loss of 2.78% to a gain of 25.00% (excluding commissions). Furthermore, any interest received on the investment before default will increase the potential return. Naturally, given the call features on the note, an early call would change the potential return. And, of course, should James River Coal Company not default on its debt, you will own a note with a 14.34% yield-to-maturity.

Perhaps you are wondering how JRCC’s note reacted to S&P’s downgrade. Friday’s action saw both the high and the low on this corporate note remain in the range in which they have been trading over the past several days (around 74 to 75 for the high and 71 to 72 for the low). Perhaps the most notable reaction was in the total trade count, which was 108 trades on Thursday, the day of the downgrade, and then just 18 on Friday, the day after the downgrade. To put this into perspective, in the five trading days prior to the downgrade, JRCC’s senior unsecured note had total trade counts of 25 (on 3/15), 18 (on 3/16), 39 (on 3/19), 42 (on 3/20), and 43 (on 3/21).

On a closing note, I would like to point out that CUSIP 470355AG3, first settling on 10/13/2011, should not be confused with CUSIP U47008AA2, which first settled on 3/29/2011. James River Coal Company’s 8-K filed on October 14, 2011 explains the exchange offer that took place converting U47008AA2 to 470355AG3.

About “The Financial Lexicon”

I am an investor/trader with nearly nine years experience in the financial world. I have experience investing in and trading equities, options, and a variety of fixed income and alternative investment products. I also write for SeekingAlpha.com.

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