Why I'm Against Baby BDC Bonds
David Merkel | Nov 25, 2012 12:56AM ET
After reading Jason Zweig’s good piece, “and can be found here . Here are the main headings:
- The Notes will be unsecured and therefore will be effectively subordinated to any secured indebtedness we have currently incurred or may incur in the future.
- The Notes will be structurally subordinated to the indebtedness and other liabilities of our subsidiaries.
- The indenture under which the Notes will be issued will contain limited protection for holders of the Notes.
- There is no existing trading market for the Notes and, even if the NYSE approves the listing of the Notes, an active trading market for the Notes may not develop, which could limit your ability to sell the Notes or the market price of the Notes.
- If we default on our obligations to pay our other indebtedness, we may not be able to make payments on the Notes.
Unsecured holding company debt can be weak, because with some subsidiaries there may be regulatory limits or private limits to upstreaming capital to the holding companies. That puts financial holding companies in a weak position, because when financial conditions get bad liquidity can get very tight.
And with business development companies [BDCs], which own and finance small-to-medium sized businesses, there is a lot of idiosyncratic risk including:
- Your downside is 100%, but your upside is capped.
- BDCs tend to be speculative investors.
- Many of the assets held are subject to third-party security interests, which lessens the rights of unsecured lenders to the holding company.
- BDCs, life REITs, have to pay out 90%+ of taxable income in order not to face corporate taxation. That forces BDCs to continually go to the credit markets for financing. But what if the market is no longer favorable for a year or two?
- BDCs are placid weather vehicles, and more so the bonds. One might be better off holding 30% Treasuries and 70% BDC stock. At least you have more downside protection, and more upside.
So put me in the camp of those that have no interest in BDC debt. It is a weak instrument, and regardless of what the rating agencies say, they are not investment grade risks.
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