After reading Jason Zweig’s good piece, “Should You Bottle Up Your Money in ‘Baby Bonds’?” I said to myself, “But what does the prospectus look like?” So I went to EDGAR, and pulled up the prospectus for Fifth Street Finance Corp’s 5.875% Senior Notes due 2024.
Please understand — I get squeamish with the unsecured bonds of exotic financial companies. Losses on the bonds of financial companies when they fail tend to be far worse than those of industrials or utilities. That is a major reason why financial bonds typically yield more than similarly rated non-financial bonds. They are more risky.
So, looking through the deal summary terms, we learn:
The structural protections here are weak. You are lending to a financial holding company where many of the assets are pledged to other creditors. More on that in a moment.
The risk factors for a business development company like Fifth Street are significant, and can be found here, all eighteen-plus pages of them. But the risk factors of the debt are more significant, and can be found here. Here are the main headings:
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:
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.