The lending market has faced some significant changes as a result of the economic downturn; no longer footloose and fancy free with their money, banks are strictly screening potential borrowers in hopes of avoiding defaults on loans. But with prices rising and jobs disappearing, many people are in need of loans. This has led to an increase of investors becoming lenders themselves.
Peer-to-peer lending and hard money lending are two avenues commonly used by investors-turned-lenders. Renewable unsecured subordinated notes, such as those STEN Corporation began offering in April 2007, present investors with yet another option: lending to a lender.
STEN (NASDAQ: STEN), based in Minnesota and founded in 1976, is a business that wears many hats.
STEN primarily funds used vehicle purchases for credit challenged buyers
STEN's primary business is funding credit-challenged buyers' used vehicle purchases at independent lots in Arizona. They also provide vehicle inventory financing for the lot owners and operate their own sales lots. Other roles STEN plays include providing short-term consumer loans and payday advances, both online and in brick-and-mortar locations, in Arizona and Utah. Check cashing services are available at the Utah locations. Further, STEN "provides contract manufacturing services for medical companies at a facility in east Texas where it used to produce its own patented medical products before exiting that business several years ago," according to STEN's website.
STEN is a micro-cap stock with a market capitalization of about $7 million. "The stock gets no analyst coverage," according to columnist Chuck Jaffe of MarketWatch. "Morningstar considers it 'distressed,' which it defines as...'companies that are having serious operating problems.' Despite that designation, the Chicago firm gives STEN a 'B' grade for financial health and a B-minus for profitability. While the stock gets a D grade for growth, there's nothing in the balance sheet that makes any sort of default on the notes look imminent."
"A renewable unsecured subordinated note is a promise by STEN to pay principal and interest to the holder when due. By purchasing a note, you are lending money to STEN. The note represents STEN’s obligation to repay your loan with interest," according to STEN's website.
When the loan matures, investors can choose to be repaid and receive their investment back, along with the accrued interest. If the investor opts not to be repaid when the loan reaches maturity, the note is automatically renewed for another term, during which it continues to earn interest.
Notes are available for terms from three months up to 10 years. "The notes earn incrementally higher interest rates when the aggregate principal amount reaches $25,000, $50,000, $75,000 and $100,000," according to STEN's website. Interest is compounded daily, and payments are made into the account specified by the investor via direct deposit. Investors can choose to receive their interest payments monthly, quarterly, semiannually, annually or at maturity.
The minimum investment is $1,000; multiple notes cannot be combined to meet this threshold. As of publication, interest rates available ranged from 8.15 percent for a three-month note from $1,000 to $24,999 up to 17.35 percent for a five-year note of $100,000 or more. Investors may purchase multiple notes for different terms.
Investors whose IRA, SEP, 401(k), 403(b) or Keogh accounts allow investment in securities that are not DTC eligible can purchase notes using these accounts.
Interest on STEN loans can provide good returns, but at somewhat high risk
"There is no active secondary market for the notes. The notes are not negotiable instruments and cannot be transferred without the prior written consent of STEN. If you decide to liquidate your investment prior to maturity, you would have to request that STEN consent to a transfer or repurchase your note early," according to STEN's website. This request would incur a penalty equaling up to three months of simple interest for notes with "up to three months of simple interest for notes with three-month maturities calculated at the current rate and up to six months of simple interest for all other notes. The early repurchase penalty does not apply in the event of the note holder’s death or total permanent disability."
As with all investments, there is risk involved; in fact, STEN's prospectus for investors cautions that "an investment in the notes we are offering involves a high degree of risk."
"Because the notes are unsecured, subordinate to our existing and future indebtedness, and do not restrict our ability to incur future indebtedness, the notes may not be a suitable investment for you based on your ability to withstand a loss of interest or principal," according to the prospectus.
STEN is careful to clearly state that "you lack priority in payment on the notes, which rank junior to substantially all of our existing and future debt and other financial obligations," according to the prospectus.
The fact that the notes are subordinate means that, if STEN goes bankrupt, liquidates or dissolves, its assets would be available to make payments on the notes only after payments had been made on all other debt. This means that investors are risking losing interest or principal when investing in a note. This is another suitable time to invoke the investing maxim that investors should not invest more than they can afford to lose.
The notes are essentially "personalized, small-scale junk bonds," according to Jaffe. Further, he recommends that investors who plan to invest in unsecured subordinated notes "understand an issuer's business and believe in it. Under normal circumstances with corporate bonds, there's a credit rating to review, but STEN hasn't been rated by the major agencies."
Jaffe also writes that purchasing a note is basically making a subprime loan to a subprime lender. "In STEN's case—unlike subprime mortgage companies that have been in the news—the financing deals are secured by a depreciating asset, namely the car," he writes. "STEN has a system in place that dramatically limits its potential losses, effectively having a reserve fund from the dealers it works with; the dealers, in turn, put a locating device in each car, so that they can be repossessed if the buyer defaults."
The notes are offered through Sumner Harrington Ltd., and are solely the obligations of STEN. They are not insured by the Federal Deposit Insurance Corporation or the Securities Investor Protection Corporation. They are registered with the Securities and Exchange Commission.
