Credit Impairment: We're Not Talking Score!

November 8, 2017

Over the past 15 years there has been a substantial increase in recommendations for Non-Conventional Investments (NCI) for retirees and income beneficiaries.  NCI's are non-traded securities, offered both publicly and privately, e.g. Real Estate Investment Trusts and Limited Partnerships, Equipment Leasing, Promissory Notes, Oil and Gas, and Tenancy in Common offerings.  Virtually all promise distributions at rates substantially above current interest rates supported by collateral that will maintain value or appreciate over 6-10 years. The merits and risks of NCIs will be the focus of future blogs, but one rarely discussed risk, "Credit Impairment", warrants discussion.

 

Many asset types carry value despite being illiquid.  Liquidity pertains to an asset's ability to be converted to cash without penalty or discount from market value and it affects credit.  Many assets such as owned real estate, private businesses, fine art, stocks & bonds and mutual funds qualify as "collateral" for credit extensions like home equity loans, margin, inventory loans, auto dealer floor-plans etc.  This is because possession of the collateral is easily obtainable and the asset can be turned into cash with no substantial loss in reasonable time.

 

Due to their financial & ownership structures, and leveraging, NCIs are assets that cannot be liquidated or turned into cash.  Nearly all are leveraged meaning the underlying asset cannot be foreclosed upon even if the investment interest can be. No lender is willing to become a limited partner or co-tenant to collect a defaulting debt.  In short, an NCI interest does not qualify as collateral.  This impairs credit availability otherwise available on conventional assets. There will be no collateralized or equity loans and no margin extensions for NCI assets with profound consequences.  Budgeted and unplanned for expenses will necessarily be funded through liquidation of growth equities.  The greater the concentration of NCIs in a portfolio, the greater the stress on volatile growth equities which by mid retirement will be problematic in the event the projected income stream from NCIs fails to materialize or cash needs exceed projected distributions.

 

And finally, except in rare circumstances, the present value of NCIs is substantially less than investment, book, or carrying value. NCIs have no liquidity or credit availability even when performing.  Any division of assets that includes NCIs may find them particularly unsuited to one of the parties despite the valuation.   

 

 

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Frederick W Rosenberg JD

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