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Thursday, 2-Oct-2014 22:47 Email | Share | Bookmark
Horizon Kinetics Second Quarter 2014 Commentary - Nasdaq.com












If the maturities on those borrowings are short (and, unlike the historical norm, there is much less availability of long-term high-yield lending to match the extended workout periods ordinarily required for private equity) and if interest rates rise, then the refinancing risk is entirely on the private equity investor. The bond buyer, assuming the company remains solvent, is going to get a higher coupon; the private equity investor is going to pay the higher coupon. The maximum risk one can take in bonds is the risk of being the borrower (as opposed to a lender). The lender, such as a bond holder, can legally enforce homepage payment by a troubled borrower, can force bankruptcy if necessary, and has dominating influence in bankruptcy proceedings, where the weakest interested party is typically the common equity owner. Paradoxically, private equity investors are making themselves, effectively, large-scale borrowers in that the institutions that place or pledge equity with the private equity firms as limited partners, by putting themselves in the position of providing a small amount of equity collateral to back the substantial borrowing of the deals, are essentially issuers of a) low-quality debt, or b) debt that can become low or lower-quality quite rapidly. In both cases, this debt is subject to refinancing risk during a period that is an historic bottom in interest rates. It is astonishing that institutions and asset allocators that are very mindful of duration risk are actually taking the greatest duration risk they have ever taken (although, to be precise, it is not duration risk in the conventional sense, so much as it is really refinancing risk). It is a different kind of risk than in bonds. There may be select institutions that understand the underlying refinancing risk; however, we surmise many are unaware. <br>News source: http://www.nasdaq.com/article/horizon-kinetics-second-quarter-2014-commentary-cm373765



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