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Senior Secured Lending Funds

What are Senior Secured Loans?

Senior secured loans are a form of debt financing for private companies that are typically collateralized, or “secured” by a company’s cash flow and assets. Senior secured loans are used by companies to finance an expansion, fund an acquisition or for general operation purposes.

Three features separate senior secured loans from other asset classes: floating interest rates, security and covenants.


Feature 1: Floating Interest Rate:

Floating interest rate (also known as variable or adjustable rate) refers to any debt instrument, such as a loan, bond,mortgage, or credit that does not have a fixed rate of interest over the life of the instrument. Given that Senior Secured Loans are commonly grouped with other “fixed income” investments, such as bonds, the difference is how each investment performs in a changing interest rate environment.

In the case of senior secured loans, short term interest rates, typically tied to LIBOR[1], are utilized over the life of the
loan. These “short terms” are typically 3-months. In other words, the interest rate the borrower pays (the private company) on the loan will reset or “float” on a regular basis over the entire life of the loan. Conversely, traditional bonds pay a fixed rate for the term of the entire investment. The interest paid over the life of the bond does not fluctuate.

How does this affect the investment performance of each during a changing interest rate environment? In a rising interest rate environment, the senior secured loans economic value will generally increase due to the ability to increase the interest rate the borrower is paying, or increase the cash flow the lender is receiving. Conversely, the fixed interest rate bonds economic value will generally decrease, due to the fact that the income received from the loan will not fluctuate. As expected, should interest rates fall, the senior secured loans will generally decrease in economic value and the fixed income bonds will increase in economic value.


Feature 2: Security

Senior Secured Loans are “senior” because they usually comprise the most senior portion of a borrower’s capital structure[2] and are therefore the first to be repaid from a borrower’s cash flow – generally before bonds and equity. Loans are referred to as “secured” because they typically claim substantially all of the borrower’s assets (such as inventory, property and equipment and real estate) as collateral. Being senior on the balance sheet and secured by collateral means that these loans provide a more protected repayment stream to investors than investments that are unsecured or otherwise lower on the capital structure in the event of a default or bankruptcy. It does not however guarantee a full repayment of the amount borrowed, it only allows for the loan to be the first item repaid.

Feature 3: Covenants

A loan credit agreement – the legal document that binds the borrower to the lender, containing covenants that allow the lender to take protective steps should the borrowing company’s financial health begins to deteriorate. These covenants set boundaries for a borrower’s financial conduct and minimum standards for the borrower’s performance. While other bond instruments may also contain covenants, they are typically less numerous, less stringent and less restrictive than those typically found in senior secured loan agreements.

The covenants found in most senior secured loans allow the lender a “seat at the table” if you will. If at any time the borrower finds themselves in a position that may affect their ability to repay or maintain their payments, the lender has the right to come in and assist or take over multiple aspects of the company in order to potentially negate default. In some cases, default is inevitable, in other cases, the lender is able to provide temporary relief or assist management in finding a solution that enables the company to stay economically stable and valid.


Investment opportunities for Investors:

Senior Secured Loans are available to investors (subject to suitability) in several forms. In the traded market place there are Senior Secured Loan mutual funds and Senior Secured Loan exchange traded funds (ETF’s). In the non-traded market place there are business development companies (BDC’s), limited partnerships and closed-end funds.[3] The mutual funds, ETF’s and BDC’s are the three most common vehicles available for individuals to invest in senior secured loans. Each of these fund structures offers different risks, fees, strategies and investment time horizons.

Investors should speak to a financial advisor to understand the risks and consider their goals before investing.



Summary

Senior Secured Loans represent one option for investors seeking to diversify their income streams while maintaining a focus on capital preservation. Senior Secured Loans have notable attributes that differentiate them from other fixed income investments, and due to these attributes have a low correlation to more traditional asset classes.[4]
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Footnotes:
1. The London Interbank Offered Rate is the average interest rate estimated by leading banks in London that the average bank would be charged if borrowing from other banks. The LIBOR is calculated for 10 currencies and 15 borrowing periods ranging from overnight to one year. These values are published daily.
2. Companies finance their businesses in one of two ways –by borrowing money (debt) or by selling an interest in the company (equity). The combination of debt and equity form a company’s capital structure. When a company repays its obligations, the money typically flows from the top of the capital structure down, with debt holders paid back ahead of equity investors.
3. The BDC’s, limited partnerships and closed-end funds referred to here are subject to suitability and may only be sold by prospectus.
4. Traditional investments are stocks, bonds and cash. Correlation is a statistical measure of how two securities move in relation to each other, ranging between -1 and +1, with +1 implying perfect correlation, or that the securities move in lock-step with each other.
Disclosure:
Securities offered through Titan Securities, member FINRA|SIPC. Titan Securities is a registered Broker/Dealer.
Walt Parker and the registered persons associated with Investing Makes Me Sick.com are all licensed representatives of Titan Securities, doing business under the name of Investing Makes Me Sick.com. Investing Makes Me Sick.com and Titan Securities are not affiliated.
Risk Factors
An investment in the shares of a fund that invests in senior secured loans (a “Fund”) may involve a high degree of risk and may be considered speculative. The following are some of the risks an investment in the shares of a Fund may involve; however, investors should carefully consider all of the information found in the section of the prospectus of the applicable Fund entitled “Risk Factors” before deciding to invest.
• Because there may not be a public trading market for the shares of a Fund and the Fund may not be obligated to effectuate a liquidity event by a specified date, it is unlikely that investors will be able to sell their shares. While a Fund may conduct quarterly tender offers for its shares, in many cases, only a limited number of shares may be eligible for repurchase, and a Fund may have the ability to suspend or terminate its share repurchase program at any time.
• Investors may not receive distributions, or a Fund’s distributions may not grow over time. A Fund may pay distributions from offering proceeds, borrowings or the sale of assets, and each Fund may not establish limits on the amount of funds that such Fund may use from net offering proceeds or borrowings to make distributions. A Fund’s distribution proceeds may exceed its net investment income. Therefore, portions of the distributions that a Fund makes may represent a return of capital to investors for tax purposes.
• These Funds may have an investment strategy focused primarily on privately held companies. An investment strategy focused primarily on privately held companies presents certain challenges, including
the lack of available information about these companies.
• These Funds may invest in small and middle market companies. Investing in small and middle market companies involves a number of significant risks, any one of which could have a material adverse effect on
a Fund’s operating results.
• A lack of liquidity in certain of a Fund’s investments may adversely affect its business.
• These Funds are often subject to financial market risks, including changes in interest rates, which may have a substantial negative impact on a Fund’s investments.
• These Funds may borrow funds to make investments, which increases the volatility of the Fund’s investments and may increase the risks of investing in the Fund’s shares.
• These Funds may have limited operating histories and therefore may be subject to the business risks and uncertainties associated with any new business.

Investments involve a high degree of risk, may be considered speculative, and may result in the entire loss of the amount invested. Investments incur substantial fees and expenses which are borne by the investor. Securities and Investment Advisory Services offered through Titan Securities, member FINRA|SIPC. Investingmakesmesick.com and Titan Securities are not affiliated.

Contact:
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info@investingmakesmesick.com

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