More on ING Prime Rate Trust and Loan-Participation Funds

First, I’d just like to say just because I’m talking about a certain stock or bond doesn’t mean I’m recommending it or going to go out and buy tomorrow. I love learning about new areas of investing, and right now my focus is on increasing the yield on my cash funds for short-term time horizons. Accordingly, I’ve been reading the articles I mentioned in my previous post on ING Prime Rate Trust. First let’s break this down a bit to my level of understanding.

What’s going on? Corporations need money for their operations. Each corporation is given a credit rating by a company like Moody’s, sort of like the Equifax for businesses, as to how credit-worthy they are. Obviously, the higher the risk for default, the higher the interest rates they are charged. Banks loan money to these corporations, and one type of loan is called a floating-rate loan, in which the rate adjusts like an adjustable rate mortage with an index rate, like the LIBOR. Then loan-participation funds like ING Prime Rate Trust (PPR) invest in a diversified portfolio of these loans, focusing on those with less than investment-grade credit ratings.

How much is it paying? According to this latest press release, PPR declared a “3.85 cents per share monthly dividend on August 31, 2005 for the 31 days of August, payable on September 22, 2005 to shareholders of record on September 12, 2005.” The last trading price was $6.95 on Friday, so that would be an annualized rate of (0.385×12)/6.95 = 6.65%. Not bad. Of course, you can also make or lose money based on the share price.

How do I buy it? You buy it through a brokerage, just like a stock. So you’ll have to pay commissions to buy and sell. Per the last paragraph, if you buy the stock by 8/12, you’ll get your monthly dividend on 9/22. So $5,000 of the stock would get you $27.70 a month in dividends. Note that dividends are usually taxed at lower rates than the interest you’d get from a bank CD or ING Direct, so it’s slightly more appealing.

How risky is it? This is the biggie. I have a hard time judging this. From the Official ING Funds site:

Investment in the Fund involves the risk that borrowers may default on obligations, or that lenders may have difficulty liquidating the collateral securing the loans or enforcing their rights under the terms of the senior loans.

Changes in market interest rates will effect the yield on the Fund?s Common Shares. If market interest rates fall, the yield on the Fund?s Common Shares will also fall… substantial increases in interest rates may cause an increase in loan defaults as borrowers may lack the resources to meet higher debt service requirements.

According to the Forbes article,

The bank debt is, by and large, “senior,” in the sense that in a crisis it would be paid off before junk bonds from the same issuer… “The recovery rate for senior bank loans is 70 to 80 cents on the dollar in a bankruptcy,” says Margolin, versus 25 cents for junk bonds. Page of Eaton Vance says the long-term default rate on these loans is in the 2.5% range but was higher during the dark days of 2001 and 2002.

On the other hand, the MSN article notes:

The objectives of these so-called loan-participation funds, says Nuveen managing director Ted Neild, are to produce yields midway between those of stable-value funds and high-yield bonds, but to do so with much less volatility than a typical junk-bond fund produces.

Launched in 1988, ING Prime Rate is by far the oldest loan-participation fund. Over the past five years to Dec. 2, it has returned an annualized 2% on NAV, according to Morningstar, while regular mutual funds that specialize in junk bonds have lost an annualized 1%, on average. ING Prime Rate has never lost more than 2% on NAV in any single year.

I know I haven’t done the best job explaining all the pros and cons, but I think it gives you a flavor of this investment alternative. I’m not buying any of it right now, but I still find it interesting. I’m also researching FDIC-insured bank certificates of deposit (CDs) for 1-2 year lengths.

Find more in Investing | 9/3/05, 11:05am | Trackback