Exchange Traded Debt – Why do Companies Issue Debt?

Recently I wrote about exchange traded debt.  These securities are perfect for income and retirement investors, because they provide the safety of bonds, but the yields of preferred stock, and liquidity of equities.  It’s the happy medium for investment.

Why do companies issue debt?  To finance their operations.  Most of the time, they issue bonds as a form of debt.   Companies issue debt to finance operations, and that debt is usually in the form of bonds. The advantage of debt is the regular interest payments the company must make to holders, and that debt holders have top position in the event of bankruptcy. They are first in line to receive back principal.

Now, while there is a market for bonds, but they can be difficult to trade, they trade without much liquidity and often in $10,000 bunches.

Until recently, the next step down was preferred stock, a stock-bond hybrid that pays dividends in the 5% to 9% range. It has an advantage in being behind debt for principal recovery but ahead of common stock. It tends to trade in a limited range, but often lacks liquidity as well. Preferred stock dividends also only get cut after common dividends, so that’s another advantage.

Recently, a new form of security came around that snuggled in between those two issuances in the capital stack. ETD is next in line to bonds, and if it happens to be senior secured ETD, then it may even be in first position. Exchange-traded debt pays interest, so it does get taxes as ordinary income, rather than at the 20% qualified dividend rate. However, ETD tends to be much more liquid.

Here are two ETDs that I think are good additions to a retirement portfolio, and you can use them in place of bonds in your asset allocation.

Entergy Louisiana 6% First Mortgage Bonds (NYSE:ELB) are secured by a first mortgage lien on all of the company’s property, so it’s backed by real estate. Entergy is a $14 billion electric public utility in Louisiana.

The common stock has strong free cash flow, pays a 4.1% dividend, and the company carries $6 billion in cash and long-term investments. It’s $12 billion in debt is easily serviced by cash flow. The 6% yield is perfect for income investors, especially considering the solidity of its real estate holdings.

Note the current price is $25.36 and the company can redeem the Notes at $25 beginning next March. It doesn’t mean they will, just be aware of it, so you don’t get caught owning some above the redemption price.

Best of all, S&P rates this debt at “A-” — meaning it has “Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances.”

The other choice is debt tied to one of America’s greatest brands, one that is still a stalwart in the stock market.  Stanley Black & Decker 5.75% Jr. Subordinated Debentures (NYSE:SWJ), is rated as “BBB+” — meaning they have “more than adequate capacity to meet their obligations” according to S&P, although they are somewhat subject to economic conditions.

I’m not terribly worried considering the company has been around this long, through all kinds of economic turmoil. The effective yield is 5.99% as the ETD trades at $24.95, right about par.

About Lawrence Meyers

lawrence meyersLarry is regarded as one of the nation’s experts on alternative consumer finance. He consults for hedge funds and private equity via his Council Member status at Gerson Lehman Group, and as a member of Coleman Research Group’s Executive Forum. He also consults for Credit Access Businesses and Credit Services Organizations in Texas. His Op-Eds and Letters to the Editor have appeared in over two dozen major newspapers. He also brokers financing, strategic investments, and distressed asset purchases between private equity firms and businesses of all stripes. You can reach him at [email protected]

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