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Any distressed debt investors here?


muscleman
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It looks like almost all of the discussions are stock ideas. I wonder if there are any debt investors?

If you are a distressed debt investor, and if two securities have the same ranking and same price, would you buy a longer dated one or a shorter dated one or it may not matter as once the distress is removed, both may trade around par?

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In the JCP case, many investors favored the 2016 bonds because they figured that JCP can at least survive till then.  The investor favor the longer duration less since they don't know how JCP will do in the long run.  That's probably too little info to make a generic response.  Obviously, longer duration bonds are more susceptible to interest rate movements. 

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it depends.  sometimes the longer dated ones will trade cheaper due to more perceived risk, but being cheaper can reduce your risk if it is so cheap it trades near a recovery rate. 

 

For instance, JCP's situation is mentioned.  I did the opposite of what was mentioned.  I bought the 100-year 2097 maturity, because it was trading cheaper, which in my view provided more protection.  Additionally, in the event it survives, there is more upside. 

 

I bought in the low to mid 70's.  It is now trading in the low 80's.  This is a <1% position for me, bought about a year ago.  I didn't do a ton of due-diligence on the situation, but was more so following the due diligence of the other large investors publicly investing in both the debt and equity. 

 

The equity is a crap-shoot in something like this; its not worth playing unless you have real control and/or insider knowledge.  The bonds to me were worth it given the real estate and given it likely would pay out coupons prior to any bankruptcy reducing my cost basis to a point were significant loss was not likely.

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it depends.  sometimes the longer dated ones will trade cheaper due to more perceived risk, but being cheaper can reduce your risk if it is so cheap it trades near a recovery rate. 

 

For instance, JCP's situation is mentioned.  I did the opposite of what was mentioned.  I bought the 100-year 2097 maturity, because it was trading cheaper, which in my view provided more protection.  Additionally, in the event it survives, there is more upside. 

 

I bought in the low to mid 70's.  It is now trading in the low 80's.  This is a <1% position for me, bought about a year ago.  I didn't do a ton of due-diligence on the situation, but was more so following the due diligence of the other large investors publicly investing in both the debt and equity. 

 

The equity is a crap-shoot in something like this; its not worth playing unless you have real control and/or insider knowledge.  The bonds to me were worth it given the real estate and given it likely would pay out coupons prior to any bankruptcy reducing my cost basis to a point were significant loss was not likely.

 

I assume the liquidity is pretty good for this 2097 bond? What would you do if the liquidity is very low? For a short dated bond, at least I can wait until it expires and pay me the par. For a long dated bond, maybe I have no choice but to hold it for the next 20 years?

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I assume the liquidity is pretty good for this 2097 bond? What would you do if the liquidity is very low? For a short dated bond, at least I can wait until it expires and pay me the par. For a long dated bond, maybe I have no choice but to hold it for the next 20 years?

 

I purchased a par amount in the 5 digits...if you need liquidity for a multimillion trade you may want to look at it closer

 

Also my 2 largest holdings over the last 2 years representing over 30% of my portfolio were in stocks where I owned over 100% of the average daily volume...so I am not stranger to liquidity and it is not large concern of mine. 

 

There was enough liquidity that the bid/ask wasn't super-wide and I could get my trade through at my limit price though.

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A few added things to bear in mind.

 

The bond is distressed. (1) You need to be sure in your credit analysis; if XYZ bankrupts there isn't going to be a payout on maturity. (2) Buy at 40-50 & you have the aces; at 55-80 institutions hold the aces. Know the limits on the typical institutional FI Investment Policy Statement.

 

Know what game you're playing. Buy a 5yr, 6% coupon at 50; & your cash yield is 12% - if it actually gets paid. If you are not intending to put the bond up as collateral to buy something else & earn a positive carry; why are you doing it?

 

We've been in distressed bonds & prefs on 5 separate occasions & done very well by them, but it was because we also bring a CFA skill-set to the table. Level the playing field.

 

SD

 

 

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I love distressed debt. My best investments have all been distressed debt and prefs. Not seeing too much that is appealling in that area right now, would love to hear if others are finding distressed ideas.

 

As a couple of case studies, I would be happy to share a few situations where I've made money, and one where I broke even in distressed debt.

 

I purchased strategic hotels preferred shares at $2 ($25 par value) in 2009. It was the end of the world, and nobody would ever be able to refinance any debt ever again. I did a little bit of research (the Four Seasons Punta Mita is off the hook, I didn't have the cohones to try deducting the trip as an investment expense) and concluded that their assets covered their debt and the prefs. The debt was individual mortgage non-recourse, and mostly wasn't due in the near term. I unwound the position at prices from ~$4 (one of my biggest mistakes ever was selling a big chunk after the double) to ~$22. They eventually paid out par.

 

But that was in 2009, when everything was on sale. My next biggest success was buying American Airlines debt at the time of its bankruptcy. I bought the trust preferred securities just after the announcement for $4 and change, again it was debt with a $25 par value. They paid out $25 plus interest in 2013 in the form of preferred shares which I immediately liquidated. The value here was in buying right away, as the debt traded up after the distressed funds got their teeth into it and the previous holders had mostly puked it up. Also, to make the thesis go around you had to assume the company had franchise value. I felt the value of their non-tangible assets (ie slots at La Guardia/DCA, rights to fly to Brazil, dominant position in DFW) had value beyond the price of the planes they used to fly the routes. A great hedge would have been a Delta/United long, as those companies would have benefited big from a AMR liquidation.

 

I was a bit hesitant about the politics, as I had bought similar GM securities after its bankruptcy. While they turned out not bad, I felt the political situation transferred value from debtholders to other stakeholders, so I get concerned about companies that are big enough to matter politically.

 

Distressed debt isn't all roses though. I purchased Holloway REIT (in Canada) convertible debentures at a steep discount. They were converted to shares in a way that made me whole, although just barely, and there was significant opportunity cost to not having that money invested elsewhere in a market full of bargains.

 

I'm not sure now is a great time for distressed debt investing to be honest, as a company that couldn't raise equity right now is probably not a sustainable business. Of course, if there is a bankruptcy of a decent but overleveraged company, there is an opportunity for a quick revaluation in this market, which speeds up the realization of value.

 

I'm not a CFA (but I play one in my portfolio). I don't think that's totally necessary, but distressed debt isn't for people who aren't comfortable reading long dense sets of documents. I too would be very interested in hearing about SD's successes.

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We got into distressed investment because investments failed, & we hadn't the brains yet to sell early or recover our cash before entering the swamp; we also blew up a few times before we learnt. We hold a CFA designation, were trained in credit by the US Fed, & have spent some time as a corporate treasurer; assume that you are playing against a GS in this space.

 

If you don't intimately know IPS risk limits, the exit procedures, duration, convexity, etc. - you're the one wearing milk-bone undies in the pack of wolves.

 

Long time ago Canada hit the debt wall, & medium term coupon rates were routinely 14%+. Canada's were routinely stripped into IO & PO tranches in the secondary market, & longer dated zero-coupon PO's routinely sold at compound yields of 25-30%. We loaded up & simply let everything mature. We had realized that while sovereigns cannot go bankrupt (they just print more money), it is not a problem if you live in the sovereign - & are not buying anything from abroad (FX devaluation). We also hold a degree in Economics, amongst others.

 

Paul Martin & Jean Cretien arrived, the economy was grown, budget deficits turned into surpluses, & surpluses were used to pay down debt. Debt was refinanced at lower coupons, & debt paid down extremely rapidly. Mid-term yields fell dramatically & all our Canada's went to massive premiums. Because we had the sense to ride the yield curve & go with long dated zeros on very high coupon bonds, these were the first bonds repurchased - & our 20-25yr terms shrank to 5 years or less.  Punch card stuff.

 

At the time the $C was ridiculed as the Canadian Peso, & frankly was worth about as much. There was no cash in the economy, mortgages routinely were at 17-20% - if you could get one, & anyone doing this strategy was considered 90% in a mental institution. Very similar to many parts of Europe, in the last 5 years or so.

 

Not all distressed bonds are the same.

 

SD

 

 

 

 

 

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I'm not a CFA (but I play one in my portfolio).

 

Clearly not, as you broke a major rule of referencing the CFA designation.

 

(I'm just teasing. This is one of the stupid things that the CFA tests cover.)

 

  :D I probably should write those exams, but my new baby is limiting my extra time. Then I could (eventually) refer to myself as a CFA charterholder. (Or, apparently more correctly, add the letters CFA to the P.Eng behind my name). One of the other reasons I haven't is my current job (which I really enjoy) wouldn't qualify for the experience part, so even if I wrote the exams I wouldn't qualify.

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Bizaro what did you miss with the holoway reit? If the exact same situation would happen, would you buy it again? and if not what would be the reason. Or was it just sheer bad luck in something that you couldnt foresee.

 

I went back through my records, and Holloway was a better investment than I thought it was. I bought the debentures at $0.60 per dollar, at the end of 2010. I thought it was probable Royal Host/Geosam would rescue them and the debentures would eventually pay out par.

 

However, approximately 1 year later the company swapped their debt for equity at the recently weighted average trading price, as was their right according to the prospectus. This was the downside case in my analysis, so I was disappointed. However, that worked out to one share for every 6.5 cents of par value. After the exchange closed I sold my units immediately at 5.5 cents, for a recovery of $0.85 per dollar, which is a significant percentage gain on my $0.60 purchase price. I also received a few interest payments.

 

Interestingly, the units are currently trading at a split adjusted 11.25 cents, so I should have kept them.

 

 

 

 

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Bizaro what did you miss with the holoway reit? If the exact same situation would happen, would you buy it again? and if not what would be the reason. Or was it just sheer bad luck in something that you couldnt foresee.

 

I went back through my records, and Holloway was a better investment than I thought it was. I bought the debentures at $0.60 per dollar, at the end of 2010. I thought it was probable Royal Host/Geosam would rescue them and the debentures would eventually pay out par.

 

However, approximately 1 year later the company swapped their debt for equity at the recently weighted average trading price, as was their right according to the prospectus. This was the downside case in my analysis, so I was disappointed. However, that worked out to one share for every 6.5 cents of par value. After the exchange closed I sold my units immediately at 5.5 cents, for a recovery of $0.85 per dollar, which is a significant percentage gain on my $0.60 purchase price. I also received a few interest payments.

 

Interestingly, the units are currently trading at a split adjusted 11.25 cents, so I should have kept them.

 

Here is my thesis for a distressed bond. Can you please take a look?

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/prhta-bonds/

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Spent a year working at a distressed debt hedge fund. If you have the patience and attention to detail to comb through 1000's of pages of credit docs  there can be ripe pickings at the right time. In many ways it's "easier" than equity investment because you by definition must focus more on downside than upside!

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Spent a year working at a distressed debt hedge fund. If you have the patience and attention to detail to comb through 1000's of pages of credit docs  there can be ripe pickings at the right time. In many ways it's "easier" than equity investment because you by definition must focus more on downside than upside!

 

Would you be able to share one or two examples of work you were involved in, or hypothetical investments you were aware of as potential case studies for members here?

 

Also, I'd be very interested in hearing what you learned from the experience. What are the most common mistakes? What sources of upside/downside are most frequently missed, etc?

 

Thanks for anything you are able to discuss.

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Spent a year working at a distressed debt hedge fund. If you have the patience and attention to detail to comb through 1000's of pages of credit docs  there can be ripe pickings at the right time. In many ways it's "easier" than equity investment because you by definition must focus more on downside than upside!

 

Would you be able to share one or two examples of work you were involved in, or hypothetical investments you were aware of as potential case studies for members here?

 

Also, I'd be very interested in hearing what you learned from the experience. What are the most common mistakes? What sources of upside/downside are most frequently missed, etc?

 

Thanks for anything you are able to discuss.

 

I'd also be interested. One thing I'm additionally curious about is how these ideas are sourced. How did you guys get these ideas coming across your desk? How did you decide, among the many  thousands of debt securities, preferreds, warrants, etc. available, what was worth looking into? What's the sorting mechanism? I don't have much experience in that world.

 

Thanks in advance.

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Would you be able to share one or two examples of work you were involved in, or hypothetical investments you were aware of as potential case studies for members here?

Sure thing.

1. Smurfit Stone Bankruptcy in 2008/2009. Large manufacturer of various types of paperboard products. Overlevered in an overcapacity cyclical industry. Term loans traded down to the 50's (going off memory here) but marginal production capacity was not in the "high cost" end of the industry, and there was reasonable coverage in even a downside scenario. Based on mid-cycle earnings (we used EBITDA) estimates and multiples (I think we used 5x-5.5x), and knowing that DIP financing was available, we viewed this as a dislocation and achieved 20%+ IRR buy buying when others were scared.

 

2. CLUB (Town Sports Holding) in 2009. Stock was trading below $2 implying equity market fears that a "debt event" could impair the equity value. A close read of the debt covenants and basic modeling of the business suggested that a covenant breach was unlikely. Looking at the business (literally mapping + visiting locations) suggested that the company's footprint (leasehold + RE ownership) was unique among fitness centers in key geographies and would be extremely difficult to replicate--this indicated that either the company would be able to weather a storm for a while or would be a juicy acquisition. We assessed that the company would survive, not trip covenants, and would likely benefit from operating leverage benefits as the economy recovered and the boxes/ individual clubs hit scale. Worst case lose $2, reasonable base case stock goes to $6. 3/1 outcomes with a higher chance of the "3" was a good investment. FWIW I thought this business was trading rich relative to IV over the past year.

 

Also, I'd be very interested in hearing what you learned from the experience. What are the most common mistakes? What sources of upside/downside are most frequently missed, etc?

 

 

Learned a ton. Was introduced to buffet. Learned that fuzzy thinking & institutional incentives distort investing at even great investment funds. Learned that great returns could be achieved by simply "hitting in the fairway" / "avoiding the rough." Rarely was our analysis hugely complicated--but always thorough, logical, and clearly presented. At the time I thought this last part--presenting things clearly--was just red tape. But over the years I've learned that this is the most important thing. Communicating a thesis clearly so that a smart person with limited context "gets it" requires that you have a thorough understanding of the crucial levers of value. If you can't explain it, you probably don't understand it. Finally, I learned that being a successful equity investment requires that you understand capital structures well. Since debt is senior to equity--it is necessary for the debt to perform for the equity to have value. This doesn't mean you have to read an entire credit document, but it does mean you need to understand the good & bad things that can happen when financial leverage, operating leverage, and business conditions interact. Sorry, rambling! I learned a ton...

 

I'd also be interested. One thing I'm additionally curious about is how these ideas are sourced. How did you guys get these ideas coming across your desk? How did you decide, among the many  thousands of debt securities, preferreds, warrants, etc. available, what was worth looking into? What's the sorting mechanism? I don't have much experience in that world.

 

Thanks in advance.

 

We sourced frequently through banking relationships & contacts at other funds. In the leveraged loan space at the time the # of participants in the ecosystem was small. Most importantly though we targeted "equity like" returns which means that pretty much everything with a headline yield (or YTW) below our hurdle wasn't worth looking at--in other words, you're not going to hit IRR hurdles investing in a 6% note at 95.

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Here is my thesis for a distressed bond. Can you please take a look?

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/prhta-bonds/

 

I looked through at it and am afraid I don't have much to add. I probably won't buy it for 2 reasons.

1) I don't have the ability to understand US/Puerto Rico politics. It's just too far out of my circle of competence.

2) As a Canadian I don't benefit from the tax free nature of municipal bonds, which puts me at a cost of capital disadvantage to everyone else in that market.

 

It does seem like the type of thing that is very likely to be inefficient, so I'm sure there are opportunities. I don't trust the legal system in the US for things that are political and unknown, which seems like the biggest risk factor here to me. If they can take away the petroleum tax what else can they take out of the asset coverage?

 

With most of my distressed investments, I felt like the law was pretty clear and what should happen.

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Here is my thesis for a distressed bond. Can you please take a look?

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/prhta-bonds/

 

I looked through at it and am afraid I don't have much to add. I probably won't buy it for 2 reasons.

1) I don't have the ability to understand US/Puerto Rico politics. It's just too far out of my circle of competence.

2) As a Canadian I don't benefit from the tax free nature of municipal bonds, which puts me at a cost of capital disadvantage to everyone else in that market.

 

It does seem like the type of thing that is very likely to be inefficient, so I'm sure there are opportunities. I don't trust the legal system in the US for things that are political and unknown, which seems like the biggest risk factor here to me. If they can take away the petroleum tax what else can they take out of the asset coverage?

 

With most of my distressed investments, I felt like the law was pretty clear and what should happen.

 

Thank you for the insights.

Please share with us your distressed debt ideas if you come across one. :)

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  • 2 months later...

I have had success in the past buying distressed and high yield (YTM >15%) busted exchange traded convertible debentures that are traded on the Toronto Stock Exchange. The Financial Post provides a list of these debentures that is updated daily. Link is below...

 

http://www.financialpost.com/markets/data/bonds-debentures.html

 

As well, various value investors play in this market - like Francis Chou, Peter Pucetti at Goodwood, Saj Karsen etc. Here is one rec form Karsen I own...

 

http://www.barelkarsan.com/2013/07/pinetree-capitals-debt-in-free-fall-now.html

 

Also Snyder Brown has a good write up on the Fortress Paper 2016 converts currently trading at about $54.

 

https://www.hvst.com/posts/13799-snyder-brown-capital-management-q2-2014-letter

 

 

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I have had success in the past buying distressed and high yield (YTM >15%) busted exchange traded convertible debentures that are traded on the Toronto Stock Exchange. The Financial Post provides a list of these debentures that is updated daily. Link is below...

 

http://www.financialpost.com/markets/data/bonds-debentures.html

 

As well, various value investors play in this market - like Francis Chou, Peter Pucetti at Goodwood, Saj Karsen etc. Here is one rec form Karsen I own...

 

http://www.barelkarsan.com/2013/07/pinetree-capitals-debt-in-free-fall-now.html

 

Also Snyder Brown has a good write up on the Fortress Paper 2016 converts currently trading at about $54.

 

https://www.hvst.com/posts/13799-snyder-brown-capital-management-q2-2014-letter

 

Thank you! I will take a look at this.

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  • 1 month later...

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