100-Year Bonds: With All This Uncertainty?

Last Updated Aug 24, 2010 2:11 PM EDT

Yesterday Norfolk Southern, the large and successful railroad, issued $250 million of bonds due in 100 years, paying a yield of about six percent. The company is an investment grade credit, although of lesser standing, and that's just what the rating agencies think today. But institutional investors bought them like crazy, leading Norfolk Southern to more than double the issue from the $100 million announced earlier. With all the uncertainty in the economy today, not to mention all the good and bad things that could happen in the railroad business over the next 100 years, who would invest good money in such a thing, even at a high interest rate?

I'm not declaring that investing in these bonds is a bad idea, or a good idea for that matter, or that Norfolk Southern won't be around in the next century.

Instead I call this to readers' attention mostly because it's a unique and interesting capital market event (interesting to me, anyway). Garden variety corporate bonds are issued for 10 years, and maybe 20 or 30 years for long-lived enterprises such as utility companies.

The Norfolk Southern goes way back, starting as the City Point Railroad in 1836, spanning all of 11 miles from Petersburg to City Point on the James River, according to the website of the Norfolk & Western Historical Society. Along the way it acquired and merged with perhaps 100 different roads, large and small, the most recent being a combination between the Norfolk & Western with the Southern Railway. (Train buffs are pretty serious about this stuff, so I'm inclined to think the details are accurate.) So it's already been around for nearly 200 years, and made it through the War Between The States.

More recently Norfolk Southern has been doing pretty well, too, earning net income of $392 million in 2Q 2010, compared to $375 million back in the strong economy of 2Q 2006. The road hauls a lot of coal, so Great Recession notwithstanding, the company is earning more than it did when they first issued the 100-year bonds in 2005.

Picture to follow: Locomotive Y3 #2041 at Island Yard, Lynchburg, Va. (photo by Walter Dunnam - 1940's)

And other century bonds are not unheard of -- Disney issued $300 million worth, priced to yield 7.55 percent, in 1993. (They were dubbed "Sleeping Beauty bonds" by the financial press.) Other venerable institutions such as Coca-Cola, Federal Express, the Massachusetts Institute of Technology and Ford Motor Company have sold them as well.

A Washington University business school case informs us further :

The Disney bonds were the first 100-year bonds to be issued since 1954, when the Chicago & Eastern Railroad (a subsidiary of Union Pacific) issued 5% bonds due in 2054. [Corporate rates were in the mid-threes then.] However, the award for longest lasting liability went to the Canadian Pacific Corporation, which was paying 4% on a 1000-year bond, issued by the Toronto Grey and Bruce Railway in 1883, and due to be repaid in 2883!
Norfolk Southern issued ultra-long bonds five years ago, and the bonds brought to market yesterday are actually a re-opening of that earlier issue. Other companies have issued 50-year bonds in recent memory, such as the Tennessee Valley Authority in 1992, and Ford, Boeing, Texaco and Conrail in 1993.

The flurry of issuance around 1992 and 1993 was a response to a drop in yields on Baa corporate bonds to between seven and eight percent from a local high of about 10 percent in early 1990.

The 1993 Disney bonds have a 30-year call provision, meaning that Disney can buy back the bonds in 2023. And they will, if they can refinance the bonds at a lower rate. In a sense, then, the Sleeping Beauties are not 100-year bonds, but rather 30-year bonds with something optional after that. The Coca-Cola bonds, however, had no call provision, so those bonds will pay, or at least have agreed to pay, about 7.5 percent for the entire 100 years.

Norfolk Southern has given itself even more leeway, from what I can tell, because the prospectus says they can call the bonds at any time at par, plus a premium based on market interest rates.

So who's buying? Insurance companies, mostly. They have to find bonds with very long terms, to provide reliable income base on life insurance policies. Since life expectancies are getting longer, the insurers need the longest paper they can find, and the Norfolk Southern bonds provide that as well as a yield premium. They attractive to pension funds as well.

The latest yields on Baa corporate bonds are about 5.5 percent, so the century bonds are offering a premium of maybe a half a percent. But can that be anywhere near enough? Consider the Ford 50 and 100-year bonds from just five years ago. The Financial Times reports:

Investors who bought Ford's century debt at a higher rate in an issue from 1997 saw their bonds fall to less than 15 cents on the dollar when the US car industry was in crisis over the past few years... They have since recovered, but still trade at less than 90 cents on the dollar.
At the time Disney issued its long-long bonds, skeptics pointed out that amusement parks don't last forever, citing the several different parks at Coney Island in Brooklyn that have come and gone. To the insurance companies, I guess it's mostly about the bond mathematics. But what if it were GM that had issued those 100 year bonds back in 1997?