Senior Secured Debt Can Be Profitable For Investors Invest

It was 2009 and General Motors Co. (ticker: GM) had just declared bankruptcy. Financial carnage ensued.

GM shares fell to zero. The people who owned it lost everything. Those who invested in regular GM bonds tried to collect something and pocketed a few cents – about 20 cents on the dollar. Even when the company was resurrected, those who had old stock could not trade it for new stock.

A single group of people was able to collect almost 100 percent of the money they had invested in the business.

“Senior secured debt holders got 100% of their money back. They were the first in line, ”said Michael Brady, president of Generosity Wealth Management in Boulder, Colorado.

Senior secured debt holders are invested in debts tied and secured by something solid as collateral, such as the very buildings that house a business or accounts receivable. And because it is considered a “senior” debt, it takes precedence over all other debts, which means it must be paid off first.

“This debt has to be settled before anything else can be settled,” says John Foard III, senior wealth advisor at Hobart Financial Group in Charlotte, North Carolina. “This (GM) was a great example of how these notes are designed to work.”

There are several ways to add senior secured debt, also known as bank loans or leveraged loans, to your portfolio. They are available in the form of traded stocks, exchange-traded funds, mutual funds or non-traded space, Foard says. Senior secured debt adds diversity to a portfolio and, during periods of rising interest rates, is generally more stable than traditional fixed income investments.

“The yield generated is between 5 and 7 percent. You can’t get that kind of yield in bonds right now,” Foard said.

You can buy the stock, thought of as the liquid version – or the illiquid version, which you typically have to hang on to for five to eight years.

There are benefits for everyone. The liquid, or stock, version can be sold out fairly quickly, but typically offers a lower return, in the range of 4-6 percent versus 6-8 percent for the illiquid version or non-traded bundles of tickets. The illiquid versions eliminate some of the panic selling that can occur with worry or panic, Brady explains.

Also, illiquid debt in the non-traded space pays a higher dividend because taxes are paid later, Foard says, which means they have less income when taxed.

But make sure the companies that are loaned out under these programs are heavily vetted, Foard says. “It’s going to take homework on the part of investors or relying on a solid consultancy firm.”

While the yield is generally higher, illiquid secured senior debt is an investment for accredited investors who can stay in place for at least five years. “There are penalties for getting out of it earlier, and there is no guarantee that they will buy back your shares either,” Foard said.

Investors should also limit their exposure. “During retirement, if you have to sell something, you don’t want to be subject to fees and penalties and get stuck,” says Foard.

Make sure it is grouped favorably. Senior secured debt is typically used by companies to finance expansions or acquisitions, so investors should make sure that the bundled deal is favorable – for example, that it is a $ 20 debt. million dollars for a company worth $ 100 million, instead of a debt of, say, $ 80 million.

“From a leverage point of view, you want to make sure that you are working with the loan company that will look out for your best interest and only lend between 30 and 50% of the size of the company,” he said. declared Foard. . “Because if you were to liquidate to sell their assets to get your money back, and you had to do that on a fire sale, you still want to be able to get back at least 100 percent of your money as a minimum, if you can. “

Investors in the space are expected to hold the debt of several companies. “My recommendation to clients is to buy a packaged program in which you have a few hundred different businesses that money is loaned to at any given time, with an average term of three years to inflate that payment back to that business. , and if one or two of them go wrong, you know, you don’t destroy the whole portfolio, ”Foard says.“ So it’s diversification of risk using a packaged program. ”

Investors looking to take a position may better choose a large credit company like Blackstone Group (BX) to review companies offering debt.

But how do individual investors get access to Blackstone, a company that works primarily with institutions and foundations? One solution is to work with an affiliate group, says William Saunders, wealth manager at Equity Concepts, based in Richmond, Virginia.

“One of the best groups in this space is Franklin Square Capital Partners. You can work with and access any of the advisers who have a relationship with Blackstone,” Saunders said. “Another big name you hear a lot in this space is The Carlyle Group.”

CION Investment Corp. and two mutual funds – Oppenheimer Senior Floating Rate Fund (OOSAX) and Easton Vance Floating Rate & High Income Fund (EVFHX) – are other players in the senior corporate debt arena, Brady said.

Diversify your businesses as well as your ratings. “You wouldn’t want to have just 20 different companies. Most mutual funds or business development companies – a closed-end investment company that invests in small and medium-sized businesses – can own 1% to 3% of one company.

“Keep a ratio of mostly A ratings, with only up to 20% B ratings, because B may be more aggressive, but also seen as ‘junk’ ratings with a higher likelihood of defaulting on debt,” says Brady .

Determine your level of risk. “The downside with senior securities is that there are liquidity issues; money is locked in longer than traditional fixed income securities, you can’t just sell it, ”says Saunders. “You give a loan to a business and they can’t pay the money back immediately; it’s not like a traditional bond that trades on the open market. It’s private security – you loaned someone money. “

Always keep in mind that you are buying debt, which can be risky, and relegate it to a small percentage of your portfolio.

“Compared to a stock, it’s not volatile at all,” says Brady. “Compared to a money market or a CD, it’s super volatile.”

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