Are there any ways to find the intrinsic value of a bond/TL?
Prepping for liquid credit shops — wondering if there are any way to find the intrinsic value of a credit facility? For example, if a bond is trading at 80, are there any way to build my thesis that it’s trading at a discount and it should be 90? Understood that in equity you can do a DCF but curious about a credit facility (keep thinking debt paydown % thru waterfalls but that doesn’t give intrinsic price of a facility directly)
Thanks!
To determine the intrinsic value of a bond or term loan (TL) for liquid credit shops, here are some approaches based on the most helpful WSO content:
Discounted Cash Flow (DCF) for Debt Instruments:
While DCF is commonly used for equity, it can also be applied to bonds or credit facilities. You would discount the expected cash flows (interest payments and principal repayment) using an appropriate discount rate. The discount rate should reflect the risk profile of the bond or TL, which could be derived from the yield of comparable instruments or the issuer's credit rating.
Market Comparables:
Similar to equity valuation, you can look at comparable bonds or credit facilities in the market. Analyze their yields, spreads, and trading prices relative to their credit quality, maturity, and covenants. If the bond is trading at 80, but similar instruments with comparable risk profiles are trading at 90, this could support your thesis that the bond is undervalued.
Credit Metrics and Recovery Analysis:
Covenant Analysis:
Review the covenant package of the credit facility. Stronger covenants can provide downside protection, which might justify a higher intrinsic value. For example, if the bond has restrictive covenants that limit additional debt issuance or asset sales, it could reduce risk and support a higher valuation.
Subjective Discount Rate:
As highlighted in WSO discussions, the discount rate is subjective and varies by investor. If you believe the market is overestimating the risk (and thus applying a higher discount rate), you could argue for a lower discount rate, which would increase the intrinsic value of the bond or TL.
Market Sentiment and Liquidity:
Sometimes, bonds trade at a discount due to temporary market dislocations or liquidity issues rather than fundamental credit concerns. If you can identify such situations, you can build a thesis that the bond should trade closer to its intrinsic value once the market normalizes.
By combining these methods, you can build a robust thesis for why a bond or credit facility trading at 80 might be intrinsically worth 90.
Sources: Private Credit Resources and Prep, DCF Modeling Course ~ Pre-training text.pdf, https://www.wallstreetoasis.com/forum/investment-banking/how-to-prepare-for-restructuring-technical-questions?customgpt=1, Walk me through a DCF, Relationship among Cap Rate, IRR, Discount rate and NPV
Bond and loan pricing is a DCF the only thing you need to debate is the discount rate and whether it gets paid or not, and if not what the recovery is
DCF against recovery and see risks that might impact that recovery
otherwise, if no operational/legal issues, you may be simply looking at a bond being repriced in the secondary market based on the increase of Treasuries which are used as a benchmark for the cost of assets in the economy, including the bond/loan if it has no proper benchmark and is fixed
Start by valuing the overall business (DCF, trading multiples, etc.) and assessing how much value is available to creditors. Valuation is always somewhat subjective.
Beyond that, I would look at a few things:
If a bond trades at 80, your thesis for 90 could be that the market overestimates default risk, underestimates deleveraging or demands an excessive spread.
Ultimately, you need to combine the above to get a view, but as always there is no answer thats 100% clear.
I personally just guess what things are worth
that's my quant
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