Investors generally look to fixed-income assets for potential risk-adjusted income. And in today’s rising interest rate environment, investors may be looking at floating-rate assets to help protect their portfolios.
Once the discussion turns to these assets, investors must consider default risk. Default risk is the risk that the borrower will be unable to repay all their interest and all of their principal. If the borrower files for bankruptcy, investors could lose the potential income stream from interest payments, and may not recover their principal. While default rates remain low by historical standards, investors should consider focusing on assets that offer an additional layer of default protection.
For example, senior secured loans enjoy a senior position in the capital structure. They are generally secured by a borrowers’ assets like property and equipment. In the unlikely event of default, these loans have the first claim on the borrower’s assets, making them the least risky investment in the capital structure.
Historical capital recovery rates illustrate this point. Over the last three decades, capital recovery rates have generally been correlated with priority of claim. The higher the priority, the higher the average rate of recovery.
Recovery rates for senior secured loans have been historically much higher than those of more-junior and unsecured loans.
At Resource, we are always looking to provide innovative solutions that meet the needs of today’s investment environment. Fixed-income investors searching for new ways to generate income as rates rise may want to consider senior secured assets to potentially help preserve principal.