L/S Credit HF Analyst - Q&A


I'm a long-term lurker, infrequent poster on another account. Q&A. Have been reflecting a lot lately on "giving back" and WSO has been huge to me. More interested in talking credit / markets than "my path" or "recruiting" because I only got my jobs via recommendations. 2 years at BB trading floor, been at credit HF for 2.5 now. Spent most of college working 40+ hours for a very thoughtful small family- office PM/former AM PM/II-ranked ER guy. Owe him everything as he forced me to be a real student/historian of the markets. In short about me to get the ball rolling - Credit HF with flexibility across the capital structure / across instruments long/short. Industry generalist - 90% of my time - NA-Domiciled B/CCC HY/Loans/CDS - Other 10% - equities of issuers, deep discount BBB/BBs, EU/EM issues - Because of work experience / family-office PM, it's been commented on by a few people I'm relatively more macro/market-history aware than your average junior analyst - Investor Styles/Personalities I Admire (no particular order): Black/Harris/Rowan, Bass, Druckenmiller, Burry, MBIA-era Ackman, Auerbach, Beal, Burbank Thoughts on Credit/Markets/HFs/Life: 1. I think HY-spreads have hit tights for this cycle, but think non-commodity exposure has room to run. Spreads closed Friday ~750 for HY, ~625 ex-commodities. My target spread would be high 400s for ex-commodities. My HY total return forecast for 2016 in late-2015 was 8%-10%. 2. If I had to guess today, probably shading lower-end. I'm still quite bullish, but shocked how much HY has become an asset class filled with closet oil traders. We're due for a pullback from here though - oil fundamentals don't seem to be getting much better and have to assume banks are a bit more aggressive with redeterminations this spring. This run up was a little overdone. 3. Was actually forecasting a low/mid single-digit S&P return which i still like. 4. Biggest things that worry me at the moment? China, reflexive behavior from Main Street looking at asset prices. Brexit seems unlikely to me, I'm generally more positive on the Fed than most people, I think asset prices moving off of oil is generally stupid and a pretty decent buying opportunity. 5. Biggest lesson to pass on: It's important to like what you do, and who you do it with. But more important is that the other people like the work you do and like being around you too. That solves so many problems in life you wouldn't believe. 6. General impression is that HFs across the board seem to be overrated. But of course, "we're the ones that actually add value". I really enjoy the work though.


Comments (75)

Mar 20, 2016 - 11:40am

Thanks for this AMA!
Have a few questions, hope you have time to answer.
1. If you were about to start your internship in a credit what would your reading list be (and generally what's helpful to know)?
2. How difficult is it to move to a with a different strategy (L/S Equity or Macro)? Is it impossible?

Mar 20, 2016 - 5:03pm
  1. As an intern, the bar for knowledge is much lower. Know your accounting and know how to build to FCF both on an unlevered and levered basis.

For reading:

  1. Distressed Debt Analysis by Moyer
  2. Investment Banking is good just to get the technical skills down
  3. Most Important Thing by Marks

  4. I wouldn't say impossible, but I'll have some eyebrows raised if I wanted to join a FX / rates HF at this point. I could probably move over to L/S equity or be security selection at a global macro fund. I've seen both those moves. If I recall correctly, a major global macro HF is now being headed up by the former distressed debt PM (someone help me out here). If I ever wanted to move to Europe/Asia and if I knew a useful language, I could probably do it there as well and technically be EM.

Mar 20, 2016 - 5:36pm

In your reply you mentioned that the bar is a lot lower for an intern compared to a FT (which is to be expected), but could you possibly comment on some of the topics or skills that are required to be competent in this space? I am very interested in the L/S Credit universe, and wanted to learn as much as possible about the technical aspects of the job. It would be great if you could give a list of books/resources/materials that would help make someone successful in your space. Thanks so much!

Mar 20, 2016 - 12:20pm

Thanks for doing this. I've met with a few L/S credit funds in the last year and one thing that has interested me is the wide range of structures & processes they have.

  1. How concentrated is your fund?
  2. How many analysts and how many credits are each responsible for?
  3. Typical holding period?
  4. Any ABS exposure?
  5. Are your positions more macro driven of bottom up?
  6. Basic overview of your investment process?

If you aren't comfortable answering any of these publicly no worries. I'm used to asking questions while being pitched on a fund.

Mar 20, 2016 - 5:37pm
  1. 25-30 issuers are the bread and butter but notionally we have a lot more. PM is fond of basket trades and small starter positions.

  2. I feel like 10-15 names in the book are really mine, constantly looking at new names.

  3. We think about our 1Y returns, but have the ability to wait if we think we need to wait. There's a position we love that we're convinced will take 2-3 years to really play out.

  4. Nope, but I've pitched CLO equity as an idea.

  5. When I pitch my PM ideas, I feel they're more macro driven. But very bottom-up in terms of philosophy. Open door policy in terms of ideas though - I can pitch him almost anything and he'll at least tell me why not.

  6. Receive name from PM - my PM typically knows what he wants me to do and he just wants me to say yes/no and why.

  7. Build simple historic cash flow model just to get the numbers down, capital structure, structure chart
  8. I like to read the last few years worth of Debtwire (this is a credit market news website) articles and transcripts in chronological order typically over a beer / coffee at home sometime in the process. Helps me understand what people are really worried about / thinking about / capital structure chatter that won't be in filings.
  9. Read filings - 10Ks/10Qs/presentations/compensation section of proxy. If he wants to short it, I typically research like a long and vice-versa.
  10. From here will usually adjust my model for segments / etc. I'll usually have a shrewd idea of what the issues are, will start reading sellside stuff to see if there's any color.
    6.. Start building out a simple forecast to see what really matters for this business
  11. Honestly from here, it sort of depends on the situation - is there a regulatory risk? If so research that. Is there activist / M&A risk? A major industry issue? Repeat until I have my answer.
Mar 20, 2016 - 1:20pm

Hi! Thanks for doing this! My questions:

  1. How quantitative is your position? Does it require any programming skills? If yes, what do you use it for?
  2. Do you mainly read broker research and make your investment recommendations based on this or you prefer/are encouraged to do your own analysis from scratch?

Thanks again!

Mar 20, 2016 - 5:06pm
  1. I know accounting? No programming skills unless you count Bloomberg API.
  2. I personally enjoy reading from SEC filings from scratch. I never take broker research as a basis for my recommendation but I read it for consensus view/counterpoints/things I might not have considered. Also for industry data.
Mar 20, 2016 - 5:35pm

Thanks for doing the AMA, appreciate it.

I'm particularly interested in your "student of markets" comment. Do you mind providing more color to this?

Perhaps to give a more close-formed specific question on this:
- Do you look at historical prices in the credit universe you are covering and attach major news, prevailing trends to inflections in price to sharpen your intuition on what future news releases, trends will mean for future prices?
-What sort of economic data do you use? BoPs, GDP, prince indices?
-Do you incorporate any statistical analysis? Or do you feel that there are people that focus on analyzing credit from a heavy statistical perspective (e.g. machine learning) that its not worth attempting? If so, do you feel you are missing out on something that could potentially give you greater insight (chicken and egg I know, but just want to hear your thoughts).

Thank you,

Best Response
Mar 20, 2016 - 5:55pm

I say "student of the markets" in that I was encouraged to read a ton, but also respect market cycles and look at previous HY-credit selloffs. I'm much more myopic about "macro" if you will as it was always focused back on the HY credit market.

The modern high-yield credit market as we know it today was founded in the late 80s. The biggest thing I focus on for "macro" was the credit boom and bust cycle - you lend and get a yield, underwriting gets sloppier/financing gets more aggressive, default/debt restructuring, so on so forth.

HY Credit on a macro basis is focused mainly on the late 80's S&L crisis, '01 Telecom/Tech crisis, '08 subprime. The unique sell-offs are the '97 Russian/EM crisis (which I haven't spent as much time on) and S&P downgrade / European debt crisis issues from '11 / '12. The first set were all fundamental issues that faced pretty large default cycles. The other two I mentioned caused HY to blow out but ultimately rally back as the defaults were relatively low vs. the first four.

I mentally keep an eye on when bonds were issued just due to the underwriting quality at that time. For 2015/2016 so far, I've been much happier with the quality of underwriting versus 2013/2014 vintage bonds.

Using your close-ended points:

  1. Just simple credit spreads going back in time, default rates, spread dispersion, stuff along those lines. I don't trade on these trends, it just gives me a sense as to how the market might be feeling. In '14 dispersion was fairly low throughout the year.

  2. I like looking at payrolls, 5Y B/E, consumer spending, GDP, U6 not in any statistical way but just as a sense as to where we are. I've been confused by the selloffs we've seen in HY credit as of late as a lot of the economic indicators seem okay.

  3. No statistics. I'm sure I'm biased but I don't think HY/distressed credit can be quantitatively traded. Illiquid market, heavy price movements. The more things drop the more event risk begins to pop up.

Mar 20, 2016 - 6:46pm

Thanks for doing this, SB'ed!
1.) What is your bonus structure (all cash?) and do you have any kind of equity or carry in your fund?
2.) What qualitative and quantitative variables drive your bonus? I understand in credit it's not always a P&L that drives comp but certainly a variable.
3.) What do you think people in your field can generally expect their bonus as a multiple of base salary to be, assuming AUM growth and performance are not declining?
4.) What do you think is/are the most interesting sector or sectors now in HY and why?
5.) How much of the AUM are you guys holding short now? How does this compare to the historical average?
6.) What's the org structure like at your shop - how many PMs, analysts, junior support (if any)?

Mar 22, 2016 - 5:47pm

Thanks for doing this. Can PM my questions as well if too personal to answer in forum setting.

1) How often do you build out full three statement models?
2) What would you say is the most difficult analytical challenge you face from an excel/modeling standpoint?
3) How do you come up with a defensible EBITDA multiple and Enterprise Value?
4) Can you share any experiences you've had meeting with management teams?
5) What are some of the tougher professional situations you've found yourself in? How did you handle them?

Mar 22, 2016 - 11:53pm
  1. Suspect I never will at my fund

  2. I've learned to at least come to a back-of-an-envelope PV10 model which was annoying the first time you do it but gets easier as you do it more. I dislike modelling pharmas and insurance co's, not because it's hard, but because it truly feels like random assumptions.

  3. Comps generally, but we're paranoid about accounting policies as that can really skew things - one of my best shorts was a company that essentially capitalized what many in the industry were booking as a COGS which really skewed their EBITDA up. I've done a lot more distressed situations where we're trying to understand how long a company can last or busting the bull thesis.

  4. My best memory actually was with the family office PM. In a commoditized industry he was trying to figure out what the supply/demand picture looked like - there are ~50-100 factories in this industry and he hired a consultant to get him a list of them. In the past he'd ask the CEO which factories were shutdown/open and the CEO would guffaw and say "I can't remember the status of all 40 of my plants - maybe if I had a list of them." When the CEO used this answer, the PM whipped out a highlighted list of the plants the CEO owned. CEO was surprised, and then told us the status of each of their plants (operating/not operating). This was semi-public information (you could theoretically cold-call / go look at each plant) but still an interesting story.

Besides that, I enjoy meeting management teams. But I'm always very wary of them - they sell their business the best, and they're typically trying to screw you over as a bondholder as their interests are aligned with the equity (usually anyways).

  1. This fund has been great to me - there's one incident but I'll save that for offline.
Mar 23, 2016 - 12:51am

Thank you for your time. I am starting my MBA soon in hopes of breaking into investment management and could use your insights.

  1. As a generalist, could you talk about the resources you use to learn about a new industry? How long does it take you to get comfortable?
  2. I have been recommended the Moyer book by many mentors of mine. Could you comment on the Valuation book by McKinsey, compared to the Investment Banking book (by Rosenbaum)?
Mar 25, 2016 - 3:10pm
  1. Depends a lot on the industry - a lot. I'll admit when under the gun I'm more looking at the "investment" rather than "the business" if you will.

  2. Valuation by McKinsey is fantastic, it's one of the first books I read during my time in college, but it's not the most practical book. Investment Banking by Rosenbaum is the closest to what i've seen for the "industry standard".

The difference between McKinsey / Damodaran and Rosenbaum is McKinsey / Damodaran is how you "should" do it, Rosenbaum is how most people on the street are doing it. And remember, the markets are a Keynesian beauty contest - it doesn't matter if you've "solved" the value of the company because no one else has that model (unless you're Ackman and try to convince everyone).

Mar 25, 2016 - 3:18pm

Sorry Pt. 1 got cut off.

It depends a lot on the industry because some companies also have some "economies of experience" if you will. If you understand one E&P name or one mining name inside out, it's pretty easy to understand the rest of the industry. Retail is somewhat similar once you get your key metrics down.

Tech or healthcare or industrials I find are much harder because there are no economies of scale. Using big tech names for a second, just because you understand Apple (consumer hardware) doesn't neccessarily mean you understand Google (advertising).

If it's the former, I really try to understand the business inside/out. If it's the latter, I'll admit I try to understand the bare basics.

I think Ackman made the joke once about return on invested brain damage - that's probably the #1 lesson I've taken away from him.

Mar 25, 2016 - 7:34pm

Thank you so much! This is very insightful, particularly point #2.

Apologies for my ignorance (or for not having read Moyer), is ability to interpret covenant a valuable skill in credit investing? I could use your advice on preparing for both equity and credit research.

Mar 23, 2016 - 1:47pm


Are you a HY par bond guy or true distressed analyst? What is the most interesting distressed situation in your opinion right now?

Algeco Scotsman - what a disaster, gunna be a fun fight

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
Mar 23, 2016 - 7:10pm

Some quick hitters:
-Where do you see the credit investing industry going? Do you think passive investing has a place in this arena?
-Do you think the investors in the HY space will essentially become the market maker given the regulation that disallow principal investing? How will this impact the industry dynamic?
-Can you elaborate on the one incident for the fund?

Mar 23, 2016 - 9:31pm
  1. I think credit derivatives, if they can ever wash the stink of 2008 off themselves, have a long way to go. TRS on iBoxx allows you to put on so many more interesting views that would create more liquidity, and not restricted necessarily by underlying bonds. Besides that, moving CDS on names to be centrally cleared. I think leveraged loans could be a better instrument if liquidity improved but LLs were never meant to be a traded instrument in the first place. ETF growth has been huge and can sometimes whip around bonds.

As for passive investing - i think in an ideal world there's space for it. If you buy "the HY market", you essentially get a 8% coupon/year. For six years you would lose 0.7% per year (1% defaults, avg. 30% recovery) due to defaults and in the 7th year you lose 7% (10% defaults, avg. 30% recovery, end of the cycle). Now the game is to avoid the 7th year...but even then your total returns are still positive. Grossly simplified, but would you rather own that, or the S&P? What about if you were smart enough to time the market and get out before the big 7% loss?

  1. I don't think so - I think the format HY practitioners see today sort of works but we'll see smaller banks step into HY. The big boys will always trade the big liquid issues (Valeant, Sprint) as it's easy to get that risk on/off in a hurry. As for smaller issues, the guys like Imperial, CRT, Jefferies, RBC will trade those but like small-cap equities, understood that these issues are more illiquid. Just my $0.02. Inter-buyside investor trading directly could potentially happen but I feel there are a lot of hurdles that have to be jumped through there.

  2. Nope - it was a personnel issue but we'll leave it at that.

Mar 25, 2016 - 3:57am

Do you feel that you have job security? What would it take for you to get fired? For example, if you werent able to source any good ideas for a year, would that be a major concern for you and your management?
Secondly, how do you see yourself progressing through the ranks? Do you feel its possible for you to reach a VP equivalent level?
Thanks again

Mar 25, 2016 - 3:14pm
  1. I'm very lucky it's a top-down structure. The philosophy of the fund is that junior people shouldn't be on the hook for idea generation because we don't have good experience for what might make a good investment, but we're experienced enough to bust a faulty bullish / bearish thesis the PM might have.

As an example, PM wanted to short a tech company because "it looks like this segment might face future obsolescence." After a week of research, I had enough evidence that said "it might seem that way, but it simply isn't the case because this company is doing X to mitigate."

  1. We're a small enough fund that titles really don't matter much. It's essentially PM and analysts.
Mar 25, 2016 - 5:53pm

The first point sounds great, but in regards to the second point, what are your plans for the future?
Work your way up? Jump to another fund? How long would you have to work to get promoted? Are you concerned that there might be no salary progression as you will remain an analyst in the upcoming couple of years?

Thanks again for answering.

Mar 25, 2016 - 2:48pm

Great thread, got a few questions

-Does you fund/you ever take any more macro views on credit as a whole through index/index vol?

-Thoughts on credit ETFs? You mentioned this briefly, but do you think they will retain their popularity through a default cycle or are they more dangerous due to the underlying bond's low liquidity? Basically the Icahn vs Fink debate.

-Any more thoughts on the credit cycle and HY markets over the next year or two? Specifically with regards to energy/metals&mining as that's where the action is.

-What's your take on liquidity in the markets currently versus a few years ago? Pretty large debate about bond liquidity and it seems like more of the indicators (bid/ask spread, depth, price impact, volumes etc.) don't show a huge deterioration, but anecdotally pretty much everyone seems to say that liquidity is terrible at this point.

Mar 25, 2016 - 3:58pm
  1. No but I've been more of a proponent for it - in fairness I'm not close to trading so I don't exactly know the feasibility but using the CDXs or ETFs or TRS to adjust your long exposure/short exposure in a hurry seems like a better idea than adding/subtracting to your current book where liquidity/portfolio diversification could be an issue.

I've thought about this a lot and get annoyed by the question/misinformation out there so have some patience:

So what is liquidity? Is it being able to trade a large block quickly? What if you were able to trade a large block quickly but would have to take a price discount? Now if the market is falling, things go bidless quickly, but believe me, if iShares wants a trade done, I've seen enough from the other side of the table to know that a trader would show them a bid - a low one but iShares would hit it. So that's our first answer here - I think if iShares wants a trade done, they can get the trade done, but it'd be probably a point/two lower than ETF investors would like.


So iBoxx who runs the HYG, the most popular HY ETF has some cash set aside, and from my conversations with them, "a credit line whose amount we can't (won't?) disclose. Are they going to maintain their popularity - hell no, they'll be mo traded by macro tourists and main street and rightfully drop like a rock. But are they philosophically "an issue"? Now I'm showing my age but I wasn't around during the crisis, but there's a lot of stuff out there that I'd be shocked to see go "bidless". But bonds are a tradeable instrument - settle in 2/3 days. Liquidity doesn't seem insanely poor here. I think HYG could handle it.


BKLN is slightly different - they actually hold a decent amount of HY and have the same credit line. BKLN however deals with loans - which CAN take forever to settle. But BKLN has $4Bn of assets, maybe 10% HY which can settle in 2-3 days, and credit lines. You can plug in your own assumptions here - i think BKLN is scarier but still not that scary.

If the day comes were BKLN is under pressure, there's a ton of stuff out there I'd rather play instead.

  1. The average credit cycle, as mentioned above is ~ 6/7 years. But a few things have happened that leave me to believe this one could go out longer - namely the current energy crisis and 2011 S&P downgrade/Europe issues. The markets climb a "wall of worry" - assuming our metaphorical wall is 70 feet high, you scale 10 feet a year, the S&P downgrade/energy issues maybe knocked you down 10ft - 20ft. It's why I think we'll see the default cycle in 2018/2019. With that being said, the market is smart enough to "see the defaults coming" - spreads troughed in late 2007 but 2009 was the biggest default year . If I had to put 10 silver bananas on it, I'd say a 2019 default cycle peak, 2018 spread blow out. I think we've already troughed this cycle for spreads (Summer '14).

I actually don't cover mining/metals at all but intuitively, the capital malinvestment in China seems to have propped up on all these economically infeasible projects.

For energy I'm very torn. The issue I face at the moment is that there is plenty that looks cheap, but there's no reason to buy it if that makes sense. Like it'll be dead money ex the coupons clipped which can be substantial but the market will also trade off as coupons are clipped. But almost no HY E&P business makes sense at these levels.

  1. I think people are used to the street taking B/S risk that just doesn't exist anymore. I suspect liquidity is poorer just judging by the layoffs/cuts I've seen across the street, but I can't comment on pre-crisis / post-crisis liquidity because I just wasn't there.

Mar 26, 2016 - 2:15am

Thanks for the thread. Great over all input. One comment I will make is on the illiquidity side. I'm not sure what size bonds/loans you trade but for me, in the middle market (150-500mm tranche size) I will see loans and bonds go for months without a trade. Dec - Feb saw things getting bid down daily with no fundamental change just no buyers. Trades will say they just keep down bidding to find a buyer but with so much outflows and limited CLO issuances the supply/demand dynamics have been out of whack. So to your point out there is always liquidity just depends on price, maybe a point or town down, I'd say that yes there is always a price but from what I've seen that gap is substantially larger than a point or two, more like 5-10+. I would personally define that as a illiquid issue. Yes you can sell so its liquid, but as substantial discounts. Fortunately, March has had a lot of inflow and new CLOs so the bids are coming up, but this highlights the illiquidity issue. For similar size bonds, especially the stressed / distressed names, if you want liquidity the gap downs can be as high as 20+. So between months of no trades and large declines in bids without fundament change, I'd personally say the illiquidity issue is a real one. Maybe your are in larger flow names to which I have limited to no experience but at the lower levels I think the argument has merit.

Mar 27, 2016 - 2:09pm

Great color on the ETFs - one thing I'd disagree with is on HYG's ownership. I think its gotten very institutional and will get so more and more. Major bond shops are increasingly using it to park their cash / equitize cash, and more massive asset managers are focusing on income product dev (to address global demographics) which more and more I see these things using more ETFs / more fixed income ETFs like HYG (which leads the pack).

Mar 28, 2016 - 10:47pm

Main player is tough. Do you mean the players that get their hands dirty with distressed PE?

The big distressed PE-situations - Cerberus, Centerbridge, Apollo, Oaktree always seem to be sniffing around.
But the big credit funds - King Street, Anchorage, Silver Point are all great credit guys as well.

Mar 27, 2016 - 1:54pm

Thanks for posting. Why do you think spring redeterminations will be any different than the recent past? I think banks are incentivized to avoid owning oil assets and so they'll help HY energy / shale kick it down the road. I think banks are focused on equity financing for loan repurchases for now as a way to reduce their exposure, for instance. Maybe the first wave of revolver full-draw-then-file events will change that tone. But I don't see the gain for banks if they tighten conditions and add more pain.

I think you're right about oil fundamentals not getting better from here, which is why I think a good base case is oil stuck in the $20s/30s and we're sitting here at YE'16 wondering when that situation will improve, all while the contagion into manufacturing/industrial economy got worse (its already a downward spiral in both US and globally) which continues to drag services (that PMI is already rolling over), and no catalyst to get out of this S&P earnings recession, certainly no revenue growth...tough to see anything HY with a 400 handle in that scenario.

I don't think risk assets moving on oil is stupid, I think its that oil is moving on the dollar, and the dollar is moving on the China / EM / Fed feedback loop, and every risk asset especially S&P and HY is then asymmetric to the downside with respect to this loop. The main asymmetry is in China, on a number of fronts (social, geopol, crash landing), but mostly because they either deval vs USD 10-20% overnight at any given point or aggressively resume such deval which last knocked 20% off of equities and every fundamental angle says China needs to deval, whether instantly or gradually is the debate. CNY is 21%+ of the USDTWI, by far #1, so this scenario keeps oil heavily pressured, and that I think is a likely base case.

Thanks for sharing any further thoughts. Good thread.

Mar 28, 2016 - 11:04pm

I'm taking it more from a reflexive angle.

I think a lot of the market at the moment believes that banks won't push anyone into bankruptcy or anything, and I agree with that statement. But my impression is that the banks will take more of their chips off the table this time around - I felt a lot of the redeterminations last year were relatively "sweetheart"-like but I think they're less "sweetheart"-like this time around. When that happens, you revisit your liquidity assumptions/coupon stream, and maybe take a coupon/half a coupon out. You don't need a bankruptcy for the market to puke on a few of these E&P names.

There is 0 gain for the banks to do this, but I have heard from restructuring guys that regulators are breathing a bit down the necks of some banks and telling them to derisk a bit.

Why do you like look at PMI? I personally monitor unemployment/U6 which has lost some of its momentum. Consumer spending which I also really like seems...okay-ish. But no one has much confidence in it.

When I say stupid, I say in the narrow mindset of non-EMM HY. Deutsche recently flagged that the correlation of non-EMM HY to oil prices is ~0.66. This is the tough part of HY - because it sometimes feels so immune to everything else (can this company raise pricing or not) you can get blinders on for these other factors moving around prices. What you're saying makes sense and goes back to what I flagged earlier in this thread - I'm quite comfortable in figuring out the '08 / '01 fundamental debt selloffs, but corporate debt levels actually look relatively reasonable compared to '07/'00 levels. But extraneous shocks from '97 and '11/'12 are different beasts where I have a few blind spots.

So I guess here you're flagging the USD, and ergo the Fed as being the major driver of volatility. Pushing back here though, I have some faith in Yellen to not hike rates to cause this type of vol. but your argument says it's not really in Yellen's hands but China's which I hadn't neccessarily heard. I knew it was bad in China, but my impression it was a more run of the mill economic downturn rather than an aggressive crash like you're implying.

Apr 15, 2016 - 7:16pm

Just coming back to this, and thanks for the thoughtful reply.

Based on what I've been reading in the last few weeks, turns out you look completely right about both regulators coming down on banks to tighten things up (zerohedge is all over the Dallas Fed on this one) and redeterminations look pretty brutal. Also, I saw some companies did suddenly and fully tap their revolvers very recently.

I think the 'this rally is over' crowd has missed a paradigm shift, if they're wrong - the Fed doesn't move but for another token nod in December. That's not a world where the dollar is rallying, the PBOC is freaking out and oil is in the $20s.

Mar 30, 2016 - 12:30am

Not sure where the borrowing base redetermination price deck ended up this season but the real difference now for oil-weighted E&Ps is the flat futures curve. Before you (management) could have gotten away Goldilocks drilling schedule for your undeveloped assets. Now with futures curve flat at $45 WTI the realized prices (differential-adjusted) don't justify PV-10s for ~75-100% of people's acreage outside of the Permian. Thus the "net investment" column in reserve reports is a fucking joke -- who's going to give any of these guys money when even first lien lenders are nervous. For now let's also ignore capital allocation motives when bond cash yield > well IRR.

Besides the above, interest coverage ratios found in unsecured E&P indentures are limiting factors now that hedges are rolling off (LTM cash settlement on hedges is counted as EBITDA). While sure you may have permitted lien capacity resulting from the $1+ billion borrowing you had at $100 WTI when you issued the bonds (secured capacity is floored at greater of i) borrowing base at issuance or ii) borrowing base today)...this is irrelevant if you can't issue debt because the 2.25x interest coverage ratio prevents you from doing anything but unsecured-for-second-lien exchange. But no bondholder is going to bite because a) you are undercollateralized and just giving up what will be unsecured notional voting principal b) likely giving up voting rights and exposing yourself to payment subordination via intercreditor agreement IN ADDITION to lien subordination or c) the 10-k already has negative shareholder equity (bankruptcy court insolvency test) which could result in some form of equitable subordinated.

On the macro front, competitive devaluations are nearing their limits and to prevent a prolonged, undoubtedly more severe repeat of the August fiasco the Fed will continue to project higher rates to put us somewhere between EM and EUR/JPY. We are walking a tightrope trying to balance the sale of EM-held USD assets and promoting capital inflows from the NIRP developed world.

Global USD reserves (treasuries, SPX) were upwards of $10 trillion before the commodity cycle burst, and EM is liquidating USD-assets to plug budget gaps or dollar pegs. The real tail risk here isn't dollar-up/WTI-down but the potential of a CNY-denominated seaborne oil market. To elaborate, the US can effectively run an infinitely large deficit because we can print more USD and the essential opex/capex commodities are priced in USD; other countries have to run a surplus to get dollar denominated assets so they can fund those purchases. If this relationship were to change...well nothings safe but guns and gold.

Mar 30, 2016 - 9:56pm

Does anyone know where I can find content similar to this post here: http://www.distressed-debt-investing.com/2012/02/capital-structure-arbi…

I know how to do all of the equity and credit analysis but no eff'ing clue how to trade the bonds.

Disclaimer for the Kids: Any forward-looking statements are solely for informational purposes and cannot be taken as investment advice. Consult your moms before deciding where to invest.
Apr 18, 2016 - 11:30pm

So story:

Friend and I are both long something with bonds from the low 60's now in the 70's. We both think the bonds are par instruments. He works at a large big-bad fund with every resource in the world, sector specialist. I'm at my humbler shop. We were just comparing notes.

I'm happy our fund owned the "low print" in the low 60s while he got in in the high 60's - he asked how I got comfortable with X assumption, Y assumption, Z assumption without his resources.

My response was this: How much did assumption X / Y / Z really affect his valuation? Maybe it gets to 90 instead of 100, but either way you should be buying.

Being at a small shop is sometimes a blessing - my PM is a yell away and I'm at the point where he trusts me enough to put on a trade on my work. At a bigger shop, I might have to report to my sector head who reports to the PM so a slide deck or something might have to be put together and a lot more going on before the trade gets put on.

Was the incremental work and information he got worth 6 pts?

I love understanding things inside out - but how much do you really need to know for some ideas?

Mar 31, 2016 - 7:26pm

Hi thank you for doing this.

Can you elaborate more on shorting credits?

I have heard that shorting company bonds are harder because there are less borrow and liquidity, do you agree?

Don't you have to cover interest payments when you are short credits (negative carry?)? If so, how do you manage to make money on shorting credits while covering 5-7% coupons?

Is it fair to say that shorting HY or Distressed bonds usually aren't that feasible for L/S credits strategy (given the above consideration on negative carry)

Lastly, I was surprised to find out that credit guys gets compensated more than equity guys, can you explain why this is? I have also heard the saying (paraphase) "you have to be good to make money in fixed income, but you have to be FUCKING good to make money in equity". Why is this?


Apr 15, 2016 - 7:22pm

Someone correct me if I'm wrong but L/S credit strategies are usually rel-val based, so the coupon isn't an issue, its the convergence/divergence you're playing. In the opp credit world, you can make money shorting low coupon IG bonds trading above par that look set to break and you can't imagine why they haven't already (borgata), or as part of cap arb (short a bond, long something else) or special sit where you're working off of a hard catalyst and the coupon is bearable if you're right, like not getting paid to begin with. Take all that with a grain of salt (not a practitioner) but I can say with authority yes liquidity matters.

Apr 15, 2016 - 11:24pm

thanks Mortimer, everything you said were conceivable and I would have guessed them as well. Except the part you said that L/S credits strategies are usually RV, that would take care of the coupon covering conundrum, didn't think of that. Would like other's take on it as well.

Apr 16, 2016 - 1:34am

You are correct in having to cover the interest. I personally find this to be pretty "scary". We don't do shorts but from speaking with friends I believe generally you will do a pair trade where you will go long a high ranked security (say first lien) and short an unsecured. The interest from the first lien will offset the unsecured so you don't pay the carry. Also, some shops will us CDS (credit default swaps) to short bonds. Not my area of expertise but that is what is done.

Apr 16, 2016 - 9:51am
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