Small Block

Capital Deployment Risk

Positions where the deployer bears loss, priority, leverage or counterparty risk.

Derivatives

  • Credit Default Swaps (CDS)A contract in which one party pays periodic premiums to another in exchange for a payment if a named borrower defaults or another specified credit event occurs, shifting that borrower's credit risk without transferring the debt itself. Federal law lists credit default swaps among the contracts that are swaps under the Commodity Exchange Act, and treats one as a security-based swap, regulated by the SEC, when it is based on a single security, loan, or issuer or a narrow-based index.
  • Interest Rate SwapsA contract in which two parties exchange interest payments on a notional amount, most often fixed-rate payments for floating-rate payments, used to hedge or take on interest-rate exposure. Federal law lists interest rate swaps among the contracts that are swaps under the Commodity Exchange Act; swaps the CFTC designates must be cleared through a registered clearinghouse, except where one party is not a financial entity and is using the swap to hedge or mitigate commercial risk.
  • Options ContractsA contract giving its holder the right, but not the obligation, to buy (a call) or sell (a put) an asset at a set price on or before a set date, in exchange for a premium paid to the seller, who bears the obligation. Options on securities, certificates of deposit, or securities indexes are securities under the Securities Act of 1933 and the Securities Exchange Act of 1934; options on rates, currencies, commodities, and similar interests are generally swaps under the Commodity Exchange Act, which excludes securities options and options on futures contracts.

Debt, by priority (most senior first)

  • Secured First-Mortgage Liens and Senior Secured LendersA lender whose loan is backed by a first-priority mortgage or deed of trust on real property, giving it the first right to the property's value on default. In bankruptcy, its claim is a secured claim up to the value of its interest in the collateral and an unsecured claim for any shortfall.
  • Senior DebtDebt that has the first claim on a borrower's cash flow and, if secured, its collateral, ahead of subordinated debt and equity; for the lender it carries the lowest loss risk in the capital stack and the lowest pricing. Its priority over junior creditors rests on lien position and subordination agreements, which bankruptcy enforces to the extent they are enforceable under nonbankruptcy law.
  • Bridge Loan Providers and Refinancing ProceedsFor the lender, short-term capital whose repayment depends on the borrower closing a refinancing or sale; if the takeout fails, the lender is left with a matured loan and a borrower who may not be able to pay. Federal ability-to-repay rules for residential mortgages do not apply to temporary or bridge loans with a term of 12 months or less.
  • Mezzanine Debt and Subordinated NotesDebt that ranks below senior loans but above equity, often unsecured or secured only by a pledge of the borrower's ownership interests, and priced higher because the lender is repaid only after senior lenders. In bankruptcy, the subordination agreement that sets this ranking is enforced to the same extent it is enforceable under nonbankruptcy law.
  • Subordinated Lenders and Private Credit FundsNon-bank lenders, often pooled investment funds, that make loans ranking behind senior debt by agreement in exchange for higher yields. Such funds are commonly 'private funds', meaning issuers that would be investment companies but for the Investment Company Act's section 3(c)(1) or 3(c)(7) exclusions, and their contractual subordination is enforced in bankruptcy to the extent it is enforceable under nonbankruptcy law.
  • Unsecured Corporate Debt Holders and NotesBonds, notes, or debentures backed only by the issuer's general promise to pay, with no lien on specific property. In bankruptcy, a creditor's claim is secured only up to the value of its collateral, and in a liquidation general unsecured claims are paid from the estate only after claims with statutory priority; publicly offered issues are generally issued under an indenture qualified under the Trust Indenture Act of 1939, which protects each holder's right to receive and sue for principal and interest when due.

Structured and blank-check vehicles

  • Multi-Series Asset CellsA single legal entity, such as a series LLC or protected cell company, divided into separate series or cells that each hold their own assets and liabilities, intended to keep one cell's creditors from reaching another's assets. These structures are created by state law, and whether a court outside the forming state will respect the separation is not settled by any federal statute.
  • Real Estate Mortgage Investment Conduits (REMICs)A real estate mortgage investment conduit: a pool of mortgages, usually held in a trust, that issues regular interests taxed like debt and a residual interest that bears the pool's taxable income. A REMIC itself is generally not subject to federal income tax; its income is taxed to the holders of its interests.
  • Special Purpose Acquisition Companies (SPACs)A special purpose acquisition company (SPAC) is a shell company that raises money in an initial public offering, typically holds the proceeds in trust, and has a limited time to merge with an operating company or return the money. SEC rules define it as a company whose business plan is to conduct a primary offering outside Rule 419 and complete a business combination within a specified time frame, which keeps it outside the escrow rules Congress directed for penny-stock blank check companies.

Cash and distributions

  • Escrow DepositsMoney a neutral holder keeps on behalf of the parties until set conditions are met, such as a closing, or, in mortgage lending, funds a servicer collects to pay the property's taxes and insurance. For federally related mortgage loans, federal law limits how much a lender may require a borrower to deposit into an escrow account at settlement and each month, and requires an escrow account for taxes and insurance on certain first-lien consumer loans on a principal dwelling.
  • Fixed Priority DistributionsA payment order, set by contract, under which each class of capital is paid in sequence, with senior classes paid in full before junior classes receive anything; investors in later classes absorb losses first. When a deal enters bankruptcy, agreed subordination among creditors is enforced to the extent enforceable under nonbankruptcy law, while the statute itself sets a default order of distribution in liquidation.

Tax credit recapture

  • New Markets Tax CreditsFor the investor, the new markets tax credit can be taken back: if, within the 7-year period beginning when the investment is issued, the entity ceases to be a qualified community development entity, stops using the proceeds as required, or redeems the investment, the investor's tax is increased by the credit recapture amount.