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Author: joelcorley Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 42  
Subject: Re: Bonds Now! First Post Date: 5/19/2010 3:17 AM
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Prophet43M,

You wrote, The site does not include a definition for a junior bond. My belief is that "Junior" and "Subordinated" effectively mean the same thing. Whether the term is Junior or Subordinated, the bonds claim is below that of the senior bond in the class.

I've read a number of prospectus that refer to their bond issues as senior subordinated debentures. Based on your interpretation, that would be a conflict in the language; but it seems to be pretty standard wording in the prospectus I've read.

My understanding about the term "Subordinated" is simply that it signifies these claims are behind something else. What is not necessary defined by the term - you have to look elsewhere for that; but you can expect that something is ahead of the claim for that instrument.

The terms Junior and Senior with respect to debt seem somewhat arbitrary marketing spin; but they seem to be intended to convey the the obligation's relative security position: Senior unsecured is ahead of most other unsecured; Junior is behind...

Also, First, secured debt is one class of debt while unsecured debt is a completely differnt class of debt. Both secured and unsecured debt can have senior and subordinated sub-classes. An example of a senior SECURED loan would be a first mortgage. An example of a subordinated SECURED loan would be a home equity or "second" mortgage loan. There are other examples.

I don't think that's quite the right interpretation. "secured" and "subordinate" are attributes of a particular obligation. In theory you could zero, one or both of these attributes. However, the two are not completely unrelated.

Regardless of the seniority of any unsecured bond, its claim on an asset held as collateral is always inferior to any secured claims on that asset. However, just like in residential mortgage, you could theoretically have a secured debt who's claims have been subordinated to a lender with a senior secured interest. Of course in general, I haven't had any interest in secured debt, so beyond my past home mortgage liens, I've not actually bothered to read any of these types of instruments so I don't have any idea what's typical or not in the commercial markets.

And, Further, secured debt is not necessarily safer than unsecured debt.

I think that depends on whether or not the secured obligation is a non-recourse loan. In general I don't believe corporations benefit from no-recourse statutes in the various states; but it can always negotiate one as part of the financing. For recourse secured loans, any obligation that goes unfulfilled by the sale of the collateral would eventually become an unsecured claim in bankruptcy - the remaining debt doesn't just go away, they effectively become just another unsecured creditor for the balance owed. That makes their position fundamentally more secure even if the lender is not able to recover 100% of the obligation through the sale of the collateral - they should be able to recover at least as much as any other unsecured lender.

Also, Secured debt has a claim on SPECIFIC assets which may be 100% of the assets as well as the accounts receivable of a corporation but that is typically not the case from most large corporations and it is certainly not true for the typical larger corporation whose unsecured bonds trade on the bond market that we are typically evaluating here on this message board and the the bond and fixd income message board.

Yes, in general we don't evaluate secured debt on any of these boards. You would need to start a board that evaluates things like CDOs or CMOs - not that I've found a place to buy or sell those that wouldn't require a "serious capital commitment". Corporations do take out mortgages on buildings, plant and equipment. Those commercial loans tend to be packaged up and resold like most residential mortgages. Of course the fad in recent decades has been to have some REIT or other capital-intensive business (such as GE Capital) to buy the property and then have them lease it back to you in a long-term lease arrangement. Supposedly this has some tax advantage over a mortgage that I've not bothered to fathom; but I think it mostly just helps to keep liabilities off of the balance sheets. It's so commonly practiced, no one bothers to complain about it.

Finally, Regarding risk, during the recent credit crisis and ongoing commercial real estate dislocations, several REITS have "turned in the keys" on hotels and offices where the specific securing asset's LTV was significantly underwater and the bank would not negotiate a work out. The bank lost on those deals and the REIT walked away healthier b/c they reduced balance sheet debt while reducing reducing balance sheet assets by a lower number while not subjecting the corporation to a potential bankruptcy. In short, as you know, the safety of a secured loan is only as good as the LTV of the underlying collateral.

Fortunately for those REITs, their loans must have been non-recourse or were limited to the assets of some insolvent subsidiary. If the loan was not non-recourse, the lender could sue for the outstanding balance, obtain a judgment and then file for a seizure order. Corporations and individuals are both subject to this process ... though in many states an individual can claim a certain set of assets as part of a "personal exemption".

Hopefully that covered most of your OT post... :-)

- Joel
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