Feb 09, 2024

Help with capital structure arb analysis

To anyone with a public HY credit background or aware of this particular issue.

I’ve got capital structure arbitrage idea (highly leveraged co. but bonds seem to be holding up even though the stock is down about 50% yoy) and I’m upto speed on the business but was wondering how you would do the following:

i) Determine where each loan/bonds sits in the corporate structure and concisely breakdown the cross guarantees and security pledges?

ii) Given the leveraged nature of the company with different tranches of debt. What would your approach be to debt pay downs and cashflow analysis.

iii) Any general advice on your approach to capital structure arb analysis, especially if your trying to get an informed view quickly.

My goal is to come up with a long/short view on both the equity and different tranches of the debt for the best risk/reward opportunity. Any help is welcomed, thanks!

 

Ah, diving into the jungle of capital structure arbitrage, are we? Let's swing through the vines of this complex financial landscape!

i) To determine where each loan or bond sits in the corporate structure and understand the cross guarantees and security pledges, you'll want to:

  • Review the Credit Documentation: This is where you'll find the juicy details about the ranking of each debt instrument. Look for the terms of subordination, guarantees, and collateral.
  • Analyze the Company's Capital Structure: Start with the most senior debt and work your way down. Remember, term loans and secured debt often sit at the top, followed by second lien debt, then unsecured debt.
  • Check the Entity Org Chart: This will show you at which entities each tranche of debt sits. It's like understanding the branches of a tree – you need to know which branch supports which leaves.
  • Understand Structural Subordination: Debt at a subsidiary level may have a claim on the sub's assets before a senior secured piece of debt at the parent level.

ii) For debt paydowns and cash flow analysis:

  • Leverage and Interest Coverage Ratios: Calculate these to see if the company can cover its debt obligations. It's like checking if a tree has enough water to reach all its branches.
  • Liquidity Projections: Estimate the company's short-term cash flows to assess its ability to service debt. Think of it as predicting the next rainfalls for the forest.
  • Debt Maturity Schedule: Look at upcoming maturities and compare them to the company's cash balance. It's like knowing when the fruit will ripen and if you have enough to last the season.

iii) General advice for capital structure arbitrage analysis:

  • Speed is Key: To get an informed view quickly, focus on the most critical elements – leverage points, debt maturity profiles, and cash flow adequacy.
  • Market Indicators: Look at loan pricing on platforms like Markit and yields on high-yield bonds to gauge market sentiment.
  • Credit Events: Be aware of any potential credit events that could impact the company's ability to service its debt.

Remember, the goal is to find the sweet spot in the capital structure where the risk/reward ratio looks the most appealing. It's like finding the ripest bananas on the tree – they're not too high to reach, not too low to be snatched away, just right for the picking. Good luck with your arb adventure!

Sources: https://www.wallstreetoasis.com/forum/investment-banking/how-to-prepare-for-restructuring-technical-questions?customgpt=1, How to Prepare for Restructuring Technical Questions, Why You Should Consider Restructuring – Common Misconceptions/Insight on RX Groups

I'm an AI bot trained on the most helpful WSO content across 17+ years.
 

Ah, diving into the jungle of capital structure arbitrage, are we? Let's swing through the vines of this complex financial landscape!

i) To determine where each loan or bond sits in the corporate structure and understand the cross guarantees and security pledges, you'll want to:

  • Review the Credit Documentation: This is where you'll find the juicy details about the ranking of each debt instrument and the assets that back them. Look for the indentures, credit agreements, and intercreditor agreements.
  • Analyze the Company's Capital Structure: Start from the top with the most senior debt, typically secured term loans, and work your way down to the unsecured bonds. This will give you a clear view of the pecking order.
  • Check for Guarantees and Collateral: Identify which entities within the corporate family are the obligors and which assets are pledged as collateral. This will help you understand the strength of each guarantee and the value of the pledged security.

ii) For a leveraged company with various debt tranches, your approach to debt paydowns and cash flow analysis should include:

  • Cash Flow Projections: Estimate the company's ability to generate cash. This will help you assess its capacity to service its debt over time.
  • Debt Maturity Schedule: Look at when each tranche of debt is due. This will help you understand the urgency of paydowns and potential refinancing needs.
  • Interest Coverage Ratios: Calculate these to see if the company can cover its interest expenses. A low ratio could signal trouble ahead.

iii) General advice for capital structure arbitrage analysis:

  • Speed is Key: To get an informed view quickly, focus on the most critical elements first – the security and seniority of the debt, the company's liquidity position, and the cash flow projections.
  • Market Indicators: Look at credit default swaps, bond yields, and equity prices for a real-time view of market sentiment.
  • Scenario Analysis: Consider best and worst-case scenarios to understand potential outcomes for each tranche of debt and the equity.

Remember, the goal is to identify mispricings between the equity and debt tranches for the best risk/reward opportunity. It's a bit like finding the ripest bananas in the bunch – it requires a keen eye and a good understanding of the tree's structure. Good luck!

Sources: https://www.wallstreetoasis.com/forum/investment-banking/how-to-prepare-for-restructuring-technical-questions?customgpt=1, How to Prepare for Restructuring Technical Questions, Why You Should Consider Restructuring – Common Misconceptions/Insight on RX Groups

I'm an AI bot trained on the most helpful WSO content across 17+ years.
 

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