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My brokerage sent me an invitation to participate in a private placement to purchase 15 mo notes which offer 8% annualized return, however they they intend to redeem and reissue the notes every 3mo. (At which point you can opt out or reinvest.) They have done this consistently for about 4yrs now (7.5 to 8% return for each offering).

The firm has over 2 billion consolidated capital and debt is 6% of capital. Also their S&P ratings are BBB-.

Commission is low (1 dollar per 1000 invested.)

Since they are private, the only info I have is the S&P report and their "statement of financial condition".

Like many brokers I know there is risk that their trading company could hold highly leveraged positions which could potentially melt down in a highly volatile market, or their accounting results could be fabricated. Are there red flags I should be look for here when evaluating the risk vs return ? I am new to private placements and I'm considering investing about 20% of my portfolio (instead of US treasuries)


thanks. SD
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(SuperDigital):....Since they are private, the only info I have is the S&P report and their "statement of financial condition".

Like many brokers I know there is risk that their trading company could hold highly leveraged positions which could potentially melt down in a highly volatile market, or their accounting results could be fabricated


Higher risks come with higher yields. OK, so you understand that. Good.

I am new to private placements and I'm considering investing about 20% of my portfolio (instead of US treasuries)

Now THAT might be a bit much, for one issue/issuer.

Switching from Treasuries to Corporates might be worthwhile, for a higher yield. (Though, consider state tax advantages to the treasuries, and you might not be that far off anyway.)

But for moving as much as 20% to corporate bonds, you want diversification, for credit risk.

(As always, my advice is guaranteed to be worth what you pay for it. And your mileage may vary.)

Bill


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My brokerage sent me an invitation to participate in a private placement to purchase 15 mo notes which offer 8% annualized return, however they they intend to redeem and reissue the notes every 3mo. (At which point you can opt out or reinvest.) They have done this consistently for about 4yrs now (7.5 to 8% return for each offering).

Question 1 - Why would they do this (renew a 15 month 8% with a new 15 month 8% repeatedly every 3 months)?

Question 2 - If the interest rate they can get rises to 8.25% at some point, why would they do this?

Question 3 - Why does the S&P rate them at BBB- if they have such consistent ability to pay their debt? What do they know that we do not?

Question 4 - Why does your brokerage have to "sell" this to you? If it is so good, wouldn't it already be snapped up by their best customers? (Are you one of their best customers?)

Question 5 - What is the priority of this debt?

Question 6 - When they reissue every 3 months, are the amounts increasing or remaining about the same? If they are increasing, can you be sure that they aren't using this ever increasing debt to remain afloat?
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Question 1 - Why would they do this (renew a 15 month 8% with a new 15 month 8% repeatedly every 3 months)?

Per FAQ they intend to do this to give the client added liquidity. I assume if their credit rating dropped they would extend beyond 3mo as capital would be more expensive to borrow.

Question 2 - If the interest rate they can get rises to 8.25% at some point, why would they do this?

Not sure I understand your point, why would they want to pay out a higher rate of return of 8.25%, this would cost them more money ?

Question 3 - Why does the S&P rate them at BBB- if they have such consistent ability to pay their debt? What do they know that we do not?

They do not have much debt vs. assets. but I think there trading firm is higher risk than most traditional businesses.

per S&P
Weaknesses:
�� Business concentration in options market trading
�� Earnings are highly volatile
�� Low equity market volatility can significantly reduce earnings

Question 4 - Why does your brokerage have to "sell" this to you? If it is so good, wouldn't it already be snapped up by their best customers? (Are you one of their best customers?)

The offer is limited to a select pool, and yes I do quite a bit of business with them. I know historically owner shuns working with traditional bankers. Also the faq claims they do not want to spend extra fees on investment banking and the offer helps builds relationship with their retail clients. (obviously if they default the outcome will be very different..)

Question 5 - What is the priority of this debt?

"senior unsecured obligations and will rank equally with all other unsectured indebtedness"

Question 6 - When they reissue every 3 months, are the amounts increasing or remaining about the same? If they are increasing, can you be sure that they aren't using this ever increasing debt to remain afloat?

no it has consistently been 50 mill ea offering.

Also, thank you Bill for the advice to limit exposure when considering an individual issuer. I will take this into account.
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Since you seem to understand the risk, I guess I'd ask whether you've looked for what else is out there in the BBB- junk short term range? The 3-month cycle seems to offer some protection—you're betting they won't go belly up in 3-months and can reassess (not like GM 50 year maturities). But S&P doesn't think much of their credit worthiness, so I'd at least want to compare.
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<<Question 1 - Why would they do this (renew a 15 month 8% with a new 15 month 8% repeatedly every 3 months)?>>

Per FAQ they intend to do this to give the client added liquidity. I assume if their credit rating dropped they would extend beyond 3mo as capital would be more expensive to borrow.


But if they are concerned about cost, why aren't they selling 3 months at 7.5% (instead of 15 month at 8%)? [unless 15 month money costs the same as 3 month money, but at this risk level, there must be some premium for an extra year of money]

<<Question 2 - If the interest rate they can get rises to 8.25% at some point, why would they do this?>>

Not sure I understand your point, why would they want to pay out a higher rate of return of 8.25%, this would cost them more money ?


No, I am saying if prevailing interest rates go up, they may opt not to payoff after 3 months and rather wait the 15 months.

<<Question 3 - Why does the S&P rate them at BBB- if they have such consistent ability to pay their debt? What do they know that we do not?>>

They do not have much debt vs. assets. but I think there trading firm is higher risk than most traditional businesses.

per S&P
Weaknesses:
􀂃 Business concentration in options market trading
􀂃 Earnings are highly volatile
􀂃 Low equity market volatility can significantly reduce earnings


To determine safety, it would be instructive to understand how the money is being used. If they are using the extra $50M for capital to invest, then the question is - why do they need an extra $50M to trade if they already have $2B in capital? If they have yields better than 8% on their $2B, let's say 18% yield in total, and they use this additional $50B to "juice" the yield, then they are only adding 0.25% in total yield overall. Doesn't quite seem worth it to me. So the question is - why are they doing this? what profit does it gain?

<<Question 4 - Why does your brokerage have to "sell" this to you? If it is so good, wouldn't it already be snapped up by their best customers? (Are you one of their best customers?)>>

The offer is limited to a select pool, and yes I do quite a bit of business with them. I know historically owner shuns working with traditional bankers. Also the faq claims they do not want to spend extra fees on investment banking and the offer helps builds relationship with their retail clients. (obviously if they default the outcome will be very different..)


That's true. If they default, there are no more clients anyway, so it doesn't matter who is a good client and who is a bad one.

<<Question 5 - What is the priority of this debt?>>

"senior unsecured obligations and will rank equally with all other unsectured indebtedness"


And in what form is the other $120M of debt (6% of $2B consolidated capital)? And what does "consolidated" mean in this case - how much of the capital is really theirs and is there any other debt in an external construct that may have claim?

<<Question 6 - When they reissue every 3 months, are the amounts increasing or remaining about the same? If they are increasing, can you be sure that they aren't using this ever increasing debt to remain afloat?>>

no it has consistently been 50 mill ea offering.

Before I invest, I would want to know why they do this when they already have $2B in capital.

Commission is low (1 dollar per 1000 invested.)

By the way, I've never paid a commission for a private placement in my life. All the ones I have done were equity, and perhaps it is different with debt, but it still doesn't seem quite "fair" to me.
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Mark,

You raise many good points. Unfortunately, the published financial info is limited so some of the questions can not be answered. They indicate they are raising the money in order to loan it to other clients and for "general expenses". Also I noticed that the interest rate is only 5.5 to 6.0 % to buy securities on margin, so unless they were expecting substantial trading fees they would be losing money with the 8% notes. And as you point out with such a large stash of cash why would they need an additional amount that is quite unsubstantial in comparison to total equity. Also, as someone earlier asked, I am in a high tax bracket in a high tax state (CA). I think I will start looking a t-bills (this will be my first purchase). Thanks for the assistance folks. SD
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"I am in a high tax bracket in a high tax state (CA). I think I will start looking a t-bills (this will be my first purchase)."

Have you looked at California Munis? Munis are often a good choice for high tax bracket folks, and state specific ones will avoid state taxes as well. You probably won't beat 8% tax equivalent, but you can probably beat Treasuries, even with investment grade munis, and you might get the equivalent of 8% with "high yield" (junk) munis, which historically have been less prone to default than corporate junk, though current budget deficits at state and local levels make me less sanguine.
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SD

My biggest question is why are they offering to pay you BB- rates if they are a BBB- company? They aren't doing it because they are nice.

jack
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Yes Jack, understood.

Regarding CA muni's they make me very nervous. Alot of counties here are bleeding red ink. If and when real estate and corporate taxes begin to drop things could get ugly. Not worth the premium in my opinion.

Although I have owned the Vanguard CA muni money market fund. However total return ended up below that of a taxable money market.

thanks
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"Regarding CA muni's they make me very nervous. Alot of counties here are bleeding red ink. If and when real estate and corporate taxes begin to drop things could get ugly. Not worth the premium in my opinion."

Hence my proviso that history of safety with munis may not be replicable in the future.

Not sure why we keep pretending Treasuries and insured CDs are "safe," either.
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My biggest question is why are they offering to pay you BB- rates if they are a BBB- company?

Because these are restricted securities, and can't be traded. They're probably also not registered with the SEC, so to compensate the investor for the loss of liquidity the rate is higher. (This is also the premium the borrower pays for not registering the securities normally.)
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yes you are correct, there is a boldfaced disclaimer that states they are not registered with the SEC, tradeable, or protected by applicable laws.
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