My Favorite Safe Way to Earn Huge Interest Payments
By Dr. Steve Sjuggerud
September 17, 2007

I love times like these...

As investors, we actually wait and hope for times like now... times when investors panic and create big profit opportunities. Now is a rare moment. We must take advantage of it.

Thanks to the "credit crunch," we have the opportunity to basically buy a dollar bill for 87 cents... You can't do that every day... And while we wait for the day we can sell our investment for its full dollar of value, we'll get paid 8%+ a year in interest!

The Three Best Gold Investments Right Now Simply sign up to receive, DailyWealth, and we'll immediately e-mail you this latest research report... Absolutely FREE:

The opportunity is in what are known as "senior secured loans."

Senior secured loans are good loans... The term "senior" means that they're paid off before any other corporate debts. And the term "secured" means an actual specific asset backs the loan. They generally either mature or roll over in 90 days, so they're short-term in nature.

In the event of a corporate liquidation, senior loans are the highest in the food chain, ahead of the company's shares and debt. In other words, holders of senior loans get paid first. Like I said, these are good loans, at least for investors like you and me...

As you might imagine, the default rate for these loans is very low. I don't believe there has been a single default in the senior loan market in 2007. Looking ahead, investors will likely demand strict terms from borrowers. So we probably won't see defaults in senior loans spike up significantly, like we did in the dot-com days.

Back in the dot-com bust, the default rate on senior secured loans hit its all-time high... It touched 8%. When that happened, investors in senior loans panicked, and the prices of senior loans fell to 97 cents on the dollar.

Right now, the default rate on senior loans is zero. However, thanks to overzealous banks calling in their loans, senior loans fell to 93-95 cents on the dollar. It's unbelievable.

Buying at 93 cents on the dollar is a great deal. But the story has an even better twist for us, a way for us to push our cost down to 87 cents on the dollar...

What I'd like to buy is a senior loan fund... a fund that holds literally hundreds of senior loans at any one time. Plenty of them exist. But if you dig deeper, you'll find that there are about a dozen closed-end funds that specialize in senior loans.

For the 12 months ending on June 19, 2007, the actual values of the senior loans these funds hold have barely moved. Of course, that's what you'd expect – these safe senior loans are worth 100 cents on the dollar. They're only 90-day loans, and they don't fluctuate much in value. In a basic sense, if you hold the loan to maturity, you'll get your 100 cents. Pretty simple.

But the SEC – the investment industry watchdog – has added an interesting wrinkle...

Even though the senior loan funds might plan on holding to maturity, the SEC requires the funds get a price quote from an independent pricing service for their holdings every day.

Even with this stipulation, prices only fluctuated 1% above or below their average value for the 12 months ended June 19. Then the credit crunch came...

The banks forced hedge funds to sell their senior loans. All of a sudden, there were way more sellers than buyers. So the independent pricing services marked down the net asset value (NAV) of senior loans to 95 cents... even 93 cents on the dollar. And that's where we are today.

The markdown by the independent pricing services also had an unintended effect. It scared the heck out of investors in senior loan closed-end funds.

Mom and Pop America, who were sold these senior loan funds as "high-yielding CD alternatives," suddenly saw the net asset values of their senior loan funds dropping daily.

Mom and Pop didn't understand why. And they didn't bother to ask. They simply decided, "This is no CD, and it's time to get out." So they sold these funds en masse. That selling pressure drove these funds to trade at a discount to their already depressed net asset values.

On top of the 7% haircut from the independent pricing services, Mom and Pop America have driven prices down another 6.5% below that. When you look combine these two, you see that we can buy at like 87 cents on the dollar. Look at the Eaton Vance Senior Income Trust (EVF), for example.

This is the exact type of investment I recommended in my newsletter Sjuggerud Confidential. I just picked a different stock. (The one I recommended is a 100% pure senior loan fund. The Eaton Vance Fund above is about 90% pure.)

You can find a list of the senior loan funds and their discounts in Barron's over the weekend. They're listed as the "Loan Participation" funds. You can get them at The Wall Street Journal's website, wsj.com, if you subscribe, where they're in the Markets Data Center section. Or you get them online for free at www.etfconnect.com.

As the credit crunch eases, I believe we'll get back to 97-98 cents on the dollar, at least. Ideally, within a year's time, we'll sell our dollar for close its full value, and we'll have earned 8%+ a year in interest - for a total profit of more than 20%.

It may take longer than a year. But even if that's the case, chances are excellent we'll still get our 20% gain within two years, mostly in interest alone. Remember, we will be collecting the 9% interest here. Two years of 9% interest is 18%.

While we do have a few risks (as I outlined in my newsletter), we're able to buy in so cheaply, at such high dividend yields, they're risks worth taking. We'll collect our 8%+ in annual interest (paid in monthly dividends) and, ideally, the value of the funds will rise from 87 cents on the dollar to back-to-normal levels.

If it weren't for the credit crunch, this idea never would have come along...

Good investing,

Steve

Editor's note: Steve Sjuggerud is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.

Sign up today to read more investment ideas from Steve Sjuggerud.