August 31, 2017

Digging deeper into bearer and registered bonds

Let's review some critical terms.
Bonds represent loans that investors make TO companies. Bonds are written, binding promises. Companies use bonds to specify the amounts of money they will repay on specific dates. Bonds usually specify interest rates, the schedules of interest payments and the collateral that companies pledge in case they fail to fulfill their promises. Bondholders are usually 'first in line' in case of corporate bankruptcy.
Notes are bonds with shorter terms, generally ranging from 6 months to five years. There are a few 'notes' in my database with terms as long as 25 years. Very short-term notes were often issued without coupons. In the article that follows, assume that everything I say about bonds also applies to notes.
Coupons are small demand warrants usually attached to bonds. Coupons are worthless until specific dates, but on those dates, they immediately become payable for interest. Other than their names and small sizes, bond coupons bear no similarity to ordinary coupons that today's retail stores give to their shoppers to entice purchase. 

Back in July, I wrote about the most obvious differences between registered bonds and coupon bonds. From the 1880s until the 1940s, most medium-and large-sized railroad companies tended to offer both types of bonds whenever they borrowed money. While the differences seem obvious, it is important to understand why companies issued both types. Prior to the 1880s, most companies issued only coupon bonds. After the 1940s, registered bonds became the issuance of choice. The Tax Equity and Fiscal Responsibility Act officially stopped the issuance of domestic bearer bonds in 1982.

In truth, coupon bonds and registered bonds bonds were actually designed to deal with two different features of loans. Registration involved the security of investment principal, whereas coupons dealt with the payment of interest. Viewed from that perspective, registered bonds and coupon bonds were not quite opposites. Let's look at the differences.

Registered bonds are meant to give security of ownership. Registered bonds are registered in the names of individuals or companies who legally own bonds. Only those specific registered owners are legally entitled to redeem bonds at maturity.

It is important to understand that the true opposites of registered bonds are not coupon bonds, per se, but bearer bonds.

Bearer bonds represent no specific ownership. They are not secure. Whoever possesses bearer bonds can redeem them. There is no implied concern about whether ownership is legal. The differences between registered bonds and bearer bonds represent the differences in who will receive funds at the time of redemption.

Having said that, we must question who is entitled to receive interest payments in the period between purchase and redemption. Legal owners or bearers? Who should be responsible for initiating interest payments? Companies or bondholders? Is interest going to be paid throughout the terms of bonds? Or is interest going to be allowed to accumulate until the time of redemption?

These questions give rise to different approaches and this is where coupons come in.

Coupon bonds push the responsibility for collecting interest to bondholders. Whoever possesses coupon bonds must purposely redeem their coupons for interest, usually twice per year. If bondholders lose coupons or wait a long time before cashing them in, the problem is theirs alone. Viewed from the perspectives of companies, every lost or non-redeemed coupon represents profit.

With rare exception, coupons are bearer instruments. That means that whoever possesses coupons may redeem them. Legal ownership is a matter of concern for the legal system, not for companies.

The vast majority of corporate bearer bonds were issued with coupons, hence the reason that 'bearer bonds' are almost synonymous with 'coupon bonds.'

Bonds issued without coupons. The vast majority of registered railroad bonds were issued without coupons. In most cases, companies would have paid interest on registered bonds only to registered owners.

There is a question, however, whether all companies assumed the responsibility for sending interest payments to bondholders. Did some wait until bondholders requested payments? The text on registered bonds is rarely explicit on this point. Most registered bonds merely say they would make payments at the office of the railroad company or at the office of its agents. Theoretically, bondholders would have been paid through their brokerage accounts, but looking through the lens of time, it is unclear who was responsible for initiating those payments.

It is also important to understand that not all registered bonds were issued without coupons. Some registered bonds were, in fact, issued with coupons. Registered coupon bonds are fairly common among U.S. Treasury bonds, but they are quite rare among collectible railroad bonds. For those reasons, it is easy to understand why most collectors – and many companies – considered registered bonds the opposites of coupon bonds.

As I hinted above, companies and investors might prefer a third method for paying and collecting interest. What if interest is not paid during the terms of loans? What if interest is paid only at the time that companies redeem their bonds?

This is, in fact, the method the U.S. Government uses to pay interest on its savings bonds and short term Treasury Bills. While used more frequently in later years, some very early railroad companies took this approach, too.

Such bonds are issued without coupons and are usually called zero-coupon bonds or 'zeros.' Interest is paid only upon final redemption. Some zero-coupon bonds are sold at face value and allow interest to accumulate over the terms of loans. Interest is not paid periodically, but only when bonds are redeemed. For example, companies will need to pay investors $1,500 each to retire 10-yr, 5%, $1000 bonds. (5% interest on $1000 is $50/year; over ten years, delayed interest payments total $500. In this scenario, interest does not compound.)

Instead of accumulating interest over long periods, companies generally prefer to repay only the face value of zero-coupon bonds at the time of redemption. Consequently, investors must build in their own desired interest rate by purchasing zero-coupon bonds at discounts from face values. For instance, investors willing to settle for 5% non-compounding yield on their money will pay no more than $666 for a 10-year, $1000 bond. (If investors want their money to compound, they will probably lower their offers to less than $614.)

Both kinds of zero-coupon bonds are known among railroad bonds.

How are bonds distinguished in my database? Up until now, I have usually described bonds as either coupon bonds or registered bonds. I recently examined all 8,400 bonds in my database and pushed as many as possible into slightly more elaborate categories. The vast majority are described as:
  • bearer coupon bonds
  • registered bonds (typical bonds issued without coupons)
Long-time readers will notice a few new descriptive categories when I had enough information to determine their types:
  • bearer zero-coupon bonds
  • registered coupon bonds
  • registered zero-coupon bonds
(Don't freak out! There aren't many bonds in these new categories.)

How did I decide whether a bond started life as a bearer or a registered instrument? The key lies in simple, two-word phrases that appear on most bonds:
  • ... 'or bearer' ...
  • ... 'or holder' ...
  • ... 'or assigns' ...
  • ... 'or order' ...
Bearer bonds are the easiest to recognize. A large number were simply issued 'to bearer.' Most bearer bonds, however, have text that shows that bonds were initially issued to companies or prominent individuals followed by the phrase, 'or bearer.' A few companies used the phrase 'or holder,' but the meanings appear to have been entirely synonymous.

Because bonds were commonly written for terms of thirty to well over a hundred years, companies always assumed that bondholders would change through time. Consequently, we can understand the need for phrases like 'or bearer.' While 'or bearer' is not always obvious, some variation can usually be found somewhere on every bond that once had coupons attached.

By contrast, the vast majority of registered bonds left an empty space or line for bondholders' names, followed by the phrase, 'or assigns.' Legally, the word 'assigns' means 'assignees,' and carries the implication of legal transference of all rights.

I personally doubt that assigns was always interpreted using today's meaning.

To complicate matters further, some companies used the phrase 'or order' in place of 'or assigns.' According to current legal definitions, if a document is payable to an identified person 'or order,' it is not payable to a bearer. (See Legal Information Institute at the Cornell Law School.) Consequently, I define 'or order' like 'or assigns.' That does not mean I believe the definition was always accepted that way, nor that every company used the phrase in the same manner.

One final point. Although investors usually had justifiable preferences for one format over the other, they could later change their minds. They could register their bearer bonds or they could trade their registered bonds for bearer bonds at any time. My next blog article will discuss the flexibility of bonds types.

August 24, 2017

What are collectibles 'worth' when they don't sell?

I consider the question of unsold items everyday because it affects my catalog. However, it indirectly affects all dealers and all collectors, in every type of collectible, in every specialty.

Although you may not notice it, I adjust my prices constantly, primarily on the basis of recent sales. However, non-sales also enter my equations. Why did something NOT sell? Should I lower my estimates based upon recent non-sales?

As you might guess, it depends.

It depends, of course, on where item have failed to sell. A non-sale on eBay means almost nothing. A non-sale in a well-attended European auction might signal a sea-change.

Collectors' personal issues control checkbooks. Let's face it; it is a universal truth that life gets in the way. Collectors will get into arguments. Collectors will have monetary problems. Collectors will experience competing needs for money or illnesses or vacations or hail storms or broken computers. These events happen to everyone, but, statistically they don't happen to everyone at the same time. But, sometimes they do exactly that and there is no way of knowing that it has happened. Moreover, life can get in the way for only one or two collectors and their absense might make all the difference in the non-sales of key items.

Lack of eyeballs. No matter what is being offered, sales depend on collectors learning about offerings. Generally speaking, the more people who know about upcoming sales, the greater the number of examinations of inventory. Ideally, the greater the number of looks, the greater the number of sales. That all sounds very simple.

Even if an auction house sends out large numbers of catalogs or eBay touts very large numbers of members, it doesn't mean a thing if offerings fail to reach the right kinds of eyeballs.

Inappropriate audiences. The reality is that eBay sellers are never going to sell thousand dollar items to buyers who never spend more than a hundred dollars. And auction house are never going to sell $50 items when they send catalogs to buyers who routinely buy $50,000 collectibles. Sellers need to match their buyers to their offerings. And vice-versa.

Price. The underpinning assumption of capitalism is that sales depend on price. The accepted rule is that lower prices result in more sales. But that only works to a point. Unrealistically low prices can stymie sales if they cause collectors to worry about the threat of hoards lowering the value of their existing collections. Witness how absurdly eBay prices have adversely affected the sales of practically all collectibles.

Unrealistically high prices can also have a long-lasting effect on sales. Once collectors get turned off by high prices from certain houses and dealers, they may never buy from those outlets again, even if prices subsequently drop.

Risk. In my opinion, the issue of risk in hobbies like ours is the least understood and the most under-researched factor that affects sales of collectibles. I generally consider the impression of risk to be even more important than price. Simply put, every interaction between sellers and buyers affects the impression of risk and the flow of money. Obviously, customer service is a gigantic concern. The more sellers can lower the impression of the risk of purchase, the more likely collectors will buy.

Basically, the more sellers can focus on the qualities of the items they are selling, the more they can positively manipulate the comfort level of their potential buyers. Sellers automatically lower risk when they show good pictures of the exact items they are selling. They lower risk when they give precise information about problems, availability, scarcity, color, smell, feel, texture, age and so forth. There is nothing earth-shaking here; I'm simply talking about David Ogilvy's mantra, "The more you tell, the more you sell."

Sadly, many amateur sellers try to use senseless hype to sell their collectibles. They fail to realize that hype usually works to their detriment among collectors. Do such sellers really think words like "WOW!", "Unbelievable!" and "L@@K" have any positive effect on would-be buyers? If so, why don't they see such drivel in the catalogs of Christie's, Sotheby's, Spink, Heritage and Stack's Bowers? Maybe because it doesn't work? Maybe because hype increases the impression of risk among collectors?

Each of these topics is an article – or book – in its own right. And each affects how I answer the question of, "What is a collectible worth if it doesn't sell?" But here is my general approach.

Non-sale on eBay. I pay little attention if something does not sell on eBay. In fact, unless certificates are extraordinary, I don't even look. And I NEVER adjust prices up or down based upon non-sales on eBay.

Non-sale from low-priced auction houses. I have not encountered any such auctions in a long time. I fear all low-prices auction houses have fallen victim to, or moved their operations to, eBay.

Non-sale from mid-priced auction houses. If minimum-bid prices are reasonable, and descriptions and photos are good, I try to get some feeling from my correspondents about the issues of eyeballs and audiences. If their audiences are good and they are reaching adequate numbers of collectors, then non-sales are probably indicative of weak markets. If the same items fail to sell after a couple attempts, then I definitely lower price estimates 10% to 20%.

Non-sale from high-priced auction houses. I generally assume those kinds of houses enjoy good penetration (eyeballs) in good audiences (good matches with inventory.) At first blush, it would seem most non-sales would result from general high prices. However, it is also possible that some, if not many, non-sales actually reflect an over-valuing of rarity. I have found in conversations with correspondents that many who routinely buy expensive certificates buy only those certificates that fit their specialties. For them, rarity outside of their specialties is not particularly compelling. It is for that exact reason that certain highly rare items may appeal to only limited subsets of collectors. Once a few such collectors acquire rarities for the sake of rarity, there may be few if any more buyers on the sidelines.

I also find high-priced auction houses tend to focus heavily on autographed certificates, and those items follow cycles of interest different from otherwise ordinary certificates. It appears that highly specialized collectors tend to focus on collecting only those autographs of the highest quality. They may well delay buying second- and third-tier items while waiting for better quality autographs to appear.

For these reasons, I usually wait for typical items to go unsold three or four times before I lower my price estimates. It is not unusual to see items of ordinary rarity go unsold several times and then suddenly sell at prices measurably higher than had been rejected several months before.

On the other hand, I often lower price estimates quickly for unsold rarities when historic price behavior suggests they are not remarkably desirable. As I have argued many, many times, desirability is vastly more important for sales than rarity.

The conclusion? I definitely adjust prices based upon non-sales. It seems perfectly obvious to me that if items go unsold several times at one price, then they are not worth that price.

August 23, 2017

Faked issuance

While it doesn't happen very often, last week I encountered two certificates that had been fictitiously issued. One had been sold on eBay and another had been sent in by a correspondent.

In both cases, they were ordinary unissued certificates that someone had filled in just for fun. Probably children. And probably with no malicious intent.

Nonetheless, both certificates ended up being sold as real issued certificates. And both buyers will probably chalk up their oversights to inexperience. But I look at the question from twenty years down the road. I almost guarantee those spuriously 'issued' certificates be sold again, some time in the future..

Like I said, I do not encounter many of these certificates with faked names and details. Usually only one every two or three years. But they are out there. You will need to look for several telltale signs to avoid purchasing one by accident..

Faked issuances are almost always created by children and most are not recent creations. The handwriting usually looks like it was created by a child. The writing often looks strained and lacks the free flow typical of someone who spent years filling out certificates and working in an office. The slant of the writing typically shifts backs and forth from left to right.

No embossed seal. Very early certificates lack embossed corporate seals, but other details of those kinds of genuine certificates are exceedingly hard to fake. After the 1840s, most stock certificates show embossed corporate seals. Unless someone is an extreme pro, there is no reliable or cheap way to fake embossing. Beware of any certificate lacking that feature! If you can't see an embossed seal in a photograph, and the certificate otherwise appears questionable, simply ask the seller.

All of the handwriting looks the same. Genuine certificates typically show handwriting from two to four people. A clerk usually filled out most of the details (shareholder name, handwritten share value, numeric share value, serial number and date) and then it was signed by a president, a treasurer and sometimes a transfer agent. While some presidents and treasurers signed certificates in advance of legitimate issuance, their signatures never look like they came from the same hand.

The surnames of two to three crucial character names (president, treasurer, shareholder) are commonly the same. Vanity usually leaves evidence.

The entire certificate looks like it was filled out with the same pen. That almost never happened with genuine certificates.

The ink is blue or red. There is no hard and fast rule about ink color, but the vast majority of legitimate issuances were written in black ink by hand using a fountain or quill pen. The older the date on the certificate, the more likely that the original black ink has aged to brown.

Some details are usually missing. Faked issuances commonly lack a serial number, a numeric share value or a date. I have never encountered a faked issuance that lacks names, however. (There's that issue of of vanity again!)

Ball point pens. As I mentioned, most faked issuances capable of tricking collectors are not new. However, some are written in ball point pen and yet dated in the 1800s. (Ball point pens did not become popular until Christmas, 1950.) Be very cautious of any certificate written in ball point pen if it displays any other problems.

Strong preference for stock certificates. To date, I have never encountered a spuriously-issued bond, transfer receipt, subscription form or the like. That is not to say they are not out there, but it is obvious that unissued stock certificate remainders have always been easier to find. Still, the same warnings apply.

Date-related inconsistencies. Children (and even older individuals who haven't grown up) are not normally going to study railroad history in advance of their little games, so their handwritten dates will usually disagree with other known facts. Names will be wrong, of course, but companies were almost always defunct at the time of fictitious dates. You can also compare the serial numbers of questionable certificates with genuine serials recorded in my online database. Unless a professional forger is faking issuance for ill intent, faked serial numbers have little chance of coinciding with known date/serial number combinations.

Finally, check your own vanities and desires at the door. Never think you've seen everything and can't be tricked. Please remember that the more you want something, the easier you can fall for a con. So, step back and try to soften your desires for a minute. Does something not feel right? If so, that is the exact time to take a second look.

Still feel invincible? Then I beg you, in the strongest possible way, to read...

Salamander: the story of the Mormon forgery murders

...available in paperback from Amazon, Alibris, Abe Books, and elsewhere. (ISBN 1560852003). I consider this book a MUST-READ for every collector of paper documents.