The BCM Bond and the Creation of a Liquidity Event

Bond Overview

Bonds have a long history in the Financial Landscape, primarily thought of as a relatively sleepy type of investment it caught fire in the 1980s through the advent of “Junk Bonds” driving the use of Leveraged Buy Outs to an extreme never witnessed before. Simply put, a bond is a fixed income instrument that represents a loan made by an investor to a borrower. Bonds are debt instruments and represent loans made to the issuer. Governments (at all levels) and corporations commonly use bonds in order to borrow money. Governments need to fund roads, schools, dams, or other infrastructure. Similarly, corporations will often borrow to grow their business, to buy property and equipment, to undertake profitable projects, for research and development, or to hire employees. 

The bond market often called the debt market, fixed-income market, or credit market is the collective name given to all trades and issues of debt securities and  broadly describes a marketplace where investors buy debt securities that are brought to the market by either governmental entities or corporations. The bond market is among the largest asset markets in the world—almost twice as large in terms of notional value as the stock market. The bond market includes debt securities issued by governments and corporations, both domestic and foreign. Bonds may also be structured with fixed or variable interest rates and may or may not be convertible into equity. Bonds are typically thought to be less volatile than stocks since they pay regular interest and return principal upon maturity. 

By far, the two (2) largest classes of Bonds issuers are Municipalities issuing Municipal Bonds and Large Corporations issuing Corporate Bonds. While the Bond Market remains large and robust the number of new issues has dropped, and many Bond Departments of Investment Banks have slowed down appreciably. The reason for this is clear. Municipalities whose taxing powers are being squeezed can no longer support projects financed through Bonds as they have done in the past and due to the general state of the economy, most companies are looking to cut expenses and pay down debt rather than put on additional, new debt. 

BCM Bonds

Bach Capital Management is pleased to announce the creation of a new type of Bond called the BCM Bond, that gives Owners of low to non-income producing appreciating assets the ability to use Bonds to create liquidity without the credit risk and/or interest risk that typical Bond offerings face. Assets acceptable for use in BCM Bonds include but are not limited to:

  • Land
  • Precious Metals
  • Precious Gems
  • In Ground Assets including but not limited to Oil, Gas and Minerals
  • Fine Art and Collectables
  • Carbon Credit Offsets and Nutrient Credits

BCM Bonds are designed to be in One Hundred Million ($100,000,000 USD) Dollar increments with a Ten (10) year Bond Term paying a tax advantaged six (6%) percent with an inflation adjustment in the event inflation rises throughout the Bond Term. The collateral level of the asset to the bond size is set to a Two (2) to One (1) ratio so that for every One Hundred Million ($100,000,000 USD) Dollar BCM Bond, Two Hundred Million ($200,000,000 USD) Dollars of collateral is required. In addition to that initial collateral ratio, Bach Capital Management as Fund Trustee of the Bond Proceeds adds to the collateral throughout the Bond Term through the annual purchase of US Treasuries in the amount equal to the annual Bondholder interest payment. 

These US Treasuries and their respective dividends are added to the overall collateral of the Bond thereby increasing the collateral ratio throughout the Bond Term. This ensures that the Owner of the asset and the Bondholders are fully protected in a manner not seen in any other type of Bond Offering and the Bond Principal will be paid in full at the end of the Bond Term.The Owner of the asset retains ownership of the asset throughout the Bond Term. The asset is pledged to the Single Purpose Vehicle (“SPV”) the Bond is created around and at the end of the Bond Term the pledge is terminated and the asset is under full control of the Owner once again who can then repeat the process. 

Index Options                                                                     

To ensure that the Bondholders receive a tax advantaged Six (6%) percent yield throughout the Bond Term Bach Capital Management employs an Index Option only methodology in order to ensure an above market tax advantaged  return along with complete portfolio integrity. Although there are both equity options and index options, only index options allow you to set the required rate of return in as risk free an environment as possible. 

Although similar in concept, equity options and index options have significant differences. An equity option is a contract between two (2) parties that gives the owner the right to buy (in the case of calls) or sell (in the case of puts) the underlying asset at a specific price until the expiration date. The “asset” in regard to an equity option is an actual stock or ETF that is exchanged between the two (2) parties after the option is exercised. When a standard call is exercised the owner receives one hundred (100) shares of the underlying security at the contract’s strike price. Equity options are the most common type of option and are listed on most of the actively traded stocks or ETFs in the market today. Equity options contracts can be weekly, monthly or quarterly. 

Similar to equity options, index options have strike prices, expiration dates and can be calls or puts. However, since the underlying asset is an index rather than a stock or ETF the “asset” that gets delivered at expiration is cash. An index is just a number designed to measure the value of a portion of the stock market and therefore cannot be delivered. At expiration, the difference between the value of the index and the strike price (assuming it is in the money at expiration) determines how much cash is delivered. Options are listed on many of the popular indices such as the S&P 500, NASDAQ 100 and Russell 2000. Unlike equity options, index options expire on the last business day of each calendar quarter. 

Additionally, Index Options unlike equities, ETFs and equity options allow companies to take advantage of the 60/40 rule, lowering the tax bite for short-term holdings. According to Section 1256 of the Internal Revenue Code, certain financial contracts, including Index Options, are classified as “Section 1256 Contracts” and are treated differently than other products when the holding period is less than one year. Specifically, these products are subject to the “60/40 rule,” under which 60 percent of the gain (or loss) on a trade is treated as a long-term gain (or loss), regardless of how long the contract is held in a portfolio. The remaining 40 percent is treated as a short-term gain (or loss). 

Given the wide discrepancy between short and long-term capital gains tax rates, the impact of this 60/40 rule can be very significant. Long-term capital gains are taxed at either zero (0%) percent, fifteen (15%) percent or twenty (20%) percent depending upon an individual’s taxable income. Short-term capital gains are taxed as regular income, subject to marginal tax rates reaching up to thirty-seven (37%) percent in 2021. This can lead to a significant tax advantage for income generated by Index Options versus income generated by equity trading and/or equity options as illustrated by the following example. 

Suppose that a successful index option trade netted $100,000 and the investor is in the highest marginal tax rate of thirty-seven (37%) percent and the highest long-term capital tax rate of twenty (20%) percent. With the 60/40 rule, $60,000 of that profit would be taxed at the twenty (20%) percent long-term tax rate, requiring a payment of $12,000, the remaining $40,000 would be taxed at thirty-seven (37%) percent marginal tax rate requiring a payment of $14,800. The total tax paid would be $26,800 or 26.8%. A similarly successful trade made with equity trading and/or equity options not qualifying for IRS 1256 Tax Status would be taxed fully at the marginal tax rate of thirty-seven (37%) for a tax payment of $37,000, a difference of $10,200 representing 10.2% of the total trade.

Liquidity Events

There comes a point in time where all owners of low income performing or non-income producing appreciating assets consider a liquidity event for that asset. There currently exists only two (2) methods to achieve this liquidity event, monetization and sale. Neither approach meets the needs of the owner of the asset. Monetization typically will result in a low Loan To Value amount of liquidity made available and when coupled with regular interest payments can dramatically reduce the liquidity initially provided. With regard to selling the asset to create liquidity, most owners do not want to give up a long term appreciating asset for a lump sum payment that does not reflect the true value of the asset. 

The purpose of the BCM Bond is to create liquidity events for the Owner of the low income performing or non-income performing appreciating assets that truly meets ALL of the needs of the owner. With a BCM Bond, the Owner of the asset receives a lump sum payment equal to twenty (20%) percent of the bond size from the bond proceeds after the sale of the bond. Thereafter the Owner receives three (3%) percent interest payment from the SPV on an annual basis for the term of the bond. This annual liquidity event is based upon the value of the asset not the size of the Bond itself, 

Given the issuance of a One Hundred Million ($100,000,000 USD) Dollar BCM Bond, the Owner of the appreciating asset can expect to receive the following amount as  liquidity events over the full Ten (10) year Bond Term:

  1. Twenty Million ($20,000,000 USD) Dollars from the bond proceeds immediately following the sale of the bond offering by the Investment Bank/Broker Dealer.
  2. Six Million ($6,000,000 USD) on an annual basis throughout the term of the bond. Inasmuch as these payments are generated through the Index Option Dividends these dividends are tax advantaged in the same manner set forth above.

Accordingly, the Owner of the asset can expect to receive Eighty Million ($80,000,000 USD) Dollars over the Ten-Year Bond Term representing an annualized Eight (8%) percent tax advantaged yield. 

Finally, and most importantly, the payments received through BCM Bonds, unlike monetization are not loans and no interest payments are required. These monies can be used for whatever purpose the owner chooses. Furthermore, unlike a sale, the owner gets the liquidity and still maintains ownership of the asset. It is clear that the methodology outlined above is far superior to anything else offered in today’s financial marketplace.

Please feel free to reach out to us at  [email protected] for more information and see how your low income and/or non income producing appreciating assets can be used to create liquidity events for you. 

Michael Bach
CEO & Founder
Bach Capital Management