Investing in Credit
First time post -- go easy...
How would you guys assess how to invest across the debt portion of the capital structure for a particular company, i.e., say you're given the information for the term loan, senior bonds, and high yield bonds for one issuer -- which would you pick to long, and would you ever pick one long and one short from the same issuer?
At a high level, my sense is you'd want to understand:
-Qualitative business model / company stuff - is this a well-positioned company, in a reasonable industry (not in secular decline), with a sustainable competitive advantage
-Seniority of the tranches in the cap str. (who gets paid out first)
-Pricing / Yield
-Distressed analysis - anticipated restructured holdings/ownership
I suppose if you modeled out cash flows and anticipated enough coverage on a more senior tranche, you could potentially long the more senior tranche and short the junior (w/ the expectation that the return exceeds the negative carry associated w/ higher interest rate on the junior piece).
I could be completely wrong - anybody have any thoughts?
Thanks guys
I think people will sometimes go long and short different portions of the capital structure- I think its called capital structure arbitrage- but I think this mainly happens in distressed situations, since the values would have to really get out of whack. I think people will also do this with CDS's and equity, using dividends to fund the premiums and so forth. I don't know anything about it really, but very interested to see if anyone has any resources. I could be completely wrong really. Would also like some reading material on this if anyone has any.
If I were looking for a company to both long and short, this is what I would do...
Look at companies which are distressed or look like they have a chance of defaulting. Then look at how much the debt would recover in the event of a bankruptcy. Look for a company that would pay off the senior debt (buy that) and that would not be able to pay off the sub debt in the event of a liquidation, restructuring, etc. (short that).
Lets say a company has 500mm of debt, and 250mm liquidation value. Simplifying things quite a bit (bankruptcy is messy and complicated) if the company has 250mm of senior debt and 250mm of sub debt, the company liquidates, the senior debtholders get paid out in full, and the sub debtholders get nothing.
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