Wall Street’s Rules of Risk Have Changed

“Six months ago, if you’d have told me I could refinance $850 million worth of subordinated debt at 10%, I’d have looked at you like you were crazy…the demand for its debt is a sign of confidence.”

Wall_Street

There’s finance and then there’s FINANCE.

There’s debt and then there’s DEBT.  In this case subordinated debt.

The above quote is from the Chief Financial Officer of Clear Channel, Richard Bressler, the radio conglomerate I worked for.  It’s a company with a debt load of $21 billion, a debt rolled up in just a few years.  To put this into perspective it took the bankrupt city of Detroit about 40 years to go this deep underwater.  Of course all debt is not bad debt. Some debt is good debt.  Just like good and bad cholesterol.

Bressler certainly knows a lot more about managing money, paying and refinancing debt than I do and I would never argue against his opinion on things.  I do, however, find his quote from the Financial Times fascinating because money today is so cheap and I always understood high interest rates to be a lack of confidence.

When you go to a bank today and deposit money, on a good day, the bank may give you .5% on a CD (Certificate of Deposit).  A good day is when you get a few tenths of a point interest on a Money Market account.  What you are doing is “loaning” the bank your money and they are paying you back in interest to use this money and loan it out to someone else though a car loan or home mortgage, for example.

This is where my fascination comes in.

First some definitions.  Please follow along.

Subordinated debt is a loan that ranks below other loans when it comes to claims on assets or earnings. So in a case where a company files for bankruptcy, subordinated debt would not get paid out until the senior debt holders were paid in full.  It’s an orderly lining up of debt holders, like at a deli counter, where the first person in line will get their sliced bologna and the 100th person in line may be out of luck.  This makes subordinated debt riskier than senior or unsubordinated debt.  The higher the risk…the higher the interest rate.

Securities can be bonds, which evidence ownership of debt obligations.  Here’s how it works.  Let’s say you invest or loan a company $100,000 at 10% over 10 years, each year the company would pay you $10,000. Over 10 years you’d get $100,000 in total interest and at the end of the 10-year term you’d get your $100,000 back.  The risk is if the company goes bankrupt you would lose future interest payments and you may lose all or a portion of your original investment or loan.  High reward.  Huge downside.

I pay my bills and have an excellent credit score.  If I go to the bank to take out a mortgage the bank would research the risk of loaning me money, get my credit score and would give me a very favorable or low interest rate as a reward for years of managing money correctly.  The opposite would also be true.  If I had a history of not paying my bills the bank would consider me a risk and if they loaned me money the interest rate would be high.  The bank would be showing a lack of confidence in me.

Subordinated debt always comes with a higher interest rate because of greater risk and the investor being farther down the line, using my deli example.

Still how is a 10% interest rate showing confidence?  Just asking.

  1 comment for “Wall Street’s Rules of Risk Have Changed

  1. Hans von Balkovsky
    June 13, 2014 at 12:04 am

    Let’s just hope that Clear Channel is not too big to fail.

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