What does it mean to Buy Debt?

nastynate's picture
Rank: Chimp | 7

I am a bit of a noob to the i-banking world (I'll admit it), but am gradually getting the hang of industry lingo. Say an investment firm buys another company's debt at a discount. First, what does this mean to buy the other company's debt? Also, I understand that buying the debt at a discount often occurs because the company who currently has the debt wants to dump it and must sell it at a discounted price if it wants to get it off its hands. However, hows does buying the debt at a discount affect the eventual return. Obviously the return has the potential to be greater, but how does face value, maturity, etc. work? Sorry if this seems elementary to some of you.

Comments (24)

Jul 30, 2008

as far as you are concerned

debt = bonds
equity = stock

Jul 30, 2008

Buying debt means you're loaning money. When companies issue debt, they sell bonds. Investors buy these bonds (buy the company's debt), which is effectively loaning the company money. The return you get from loaning this money is called the yield. Bonds define a fixed payout, so if you pay less for this future payout, you're getting a higher yield on your money.

Before you worry about lingo it'd probably be more worthwhile to learn about basic concepts like discounted cash flow.

Jul 30, 2008

Not to be a jackass, but a google search should answer these questions, or use investopedia.

www.sharpeinvesting.com

  • Anonymous Monkey
  •  Jul 4, 2016

Welp, you're a jackass.

Jul 30, 2008
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Jul 30, 2008

Actually, I don't think he's referring to buying bonds in the primary or being part of the participation in a debt syndicate, like you guys are suggesting. He's asking about buying funds or investors who buy bonds on the secondary at a discount and what that does to yield, at least that's how I read the question. So to answer it, take for example you have a bond who has an annuity or coupon at a fixed rate with a certain face value (i.e. 100). Any discount that the bond is trading at to par equates to more yield for you, since you're essentially purchasing the bond at a cheaper face value, collecting the coupon and then at the bond's maturity, you're receiving the full face value of the bond at par. More applicable to my situation in private equity, buying back portfolio company debt that is trading at a discount in the secondary market (whether it be bank debt or bonds) can reap big rewards in two ways - allowing unfriendly banks to unload their position at the current fair market value, and provide a higher yield than one would normally get by holding the same bank debt at par. You also have the advantage of insider information for the company, although you give up voting rights, so the only advantage you have is being able to justify purchasing the debt in the first place.

Jul 30, 2008

The main debt they are talking about is a securitised group of loans made to individuals or companies (if you are talking about all this credit crisis stuff). Basically, 1000 people owed the bank their mortgages, but because nobody knows how many of those people will default (i.e. not pay their mortgages) the credit rating on these securitised groups of loans has been a problem.

This package of loans (securitised debt) is typically packaged up by investment banks then sold on to investors. As the credit crisis has hit, this secondary market of people willing to buy these loans has collapsed (for sub-prime loans) and the price has cratered accordingly.

When Merrill sold off their loans for a $3bn write-down today, they were washing there hands of a big chunk of securitised loans that they just wanted to get rid of. The price they sell the loan at (I think it was like $7bn instead of $10bn) has no effect on how much those underlying people owe to their mortgages. It is simply a valuation put on the loans (value of mortages adjusted for default rate).

  • rottenapple
  •  Jul 31, 2008

Collateralized debt obligations

Jul 31, 2008

The government should not be in the business of promoting homeownership. No need for Fannie or Freddi, nor should there have ever been a need. Shut the doors and let things be.

Renters typically live closer to work. Fannie and Freddie allowed Americans to move to suburbia. In the new economy, you need to be flexible and mobile. Owning a home is a boat chain around your neck.

Jul 31, 2008
ANT:

The government should not be in the business of promoting homeownership. No need for Fannie or Freddi, nor should there have ever been a need. Shut the doors and let things be.

Renters typically live closer to work. Fannie and Freddie allowed Americans to move to suburbia. In the new economy, you need to be flexible and mobile. Owning a home is a boat chain around your neck.

Suburbanization is one of the greatest economic and ecological disasters in the history of man.

We have irreparably destroyed some of the finest farmland on Earth so that we can pave it over with minimalls and McMansions whose inhabitants have to commute on 1950s-built highways intended to handle 1/8 the traffic.

Jul 31, 2008

This is why i need to be in banking.

Jul 31, 2008

Excellent point ivoteforthatguy. Not to mention creating generations of alienated, isolated Americans who are culturally inept.

As for this being a prize for the banks, it depends on what is actually in this junk. I still don't believe that the housing market has bottomed. With interest rates raising (at least until June, when the Fed pulls the carpet out from underneath QE2), less buyers will be in the market. Take a look at this article from Bloomberg Businessweek. Investor purchases are up, and first-time buyer sales are down to 29% from 40%. First-time buyers are needed to enter the market so existing home owners can move up to a McMansion (and drive new home sales). Inventories are slightly down but I think this is again the result of higher investment purchases, and not real demand.

If home prices continue to fall this junk will continue to be worthless. More homeowners will be owing more than the house is worth and will have no incentive to keep the property. Case-Shiller has been trending down as well for a few months. If the banks want to profit they will have to figure out which properties will pay, and then buy securities holding those properties, which I don't see happening if they have to buy $150 billion of this doo-doo.

Jul 31, 2008

Glad I didnt get raped for my statements.

I really think it is bullshit how the government favors homeowners vs rents. I realize that homeownership adds a lot to GDP, but when you think of the costs associated with having millions of little towns, miles of roads, and a less mobile population, it looks like a wash.

My parents own a monster house which they will never be able to sell. I grew up in one economic class and then saw technology put my family into another class. Had my parents been renters, they could have adjusted more swiftly or downgraded to reflect their new economic reality. Unfortunately this was not the case.

Me, I would rather rent and bank the rest. Being mobile and close to work is ideal for me. I value my time too much to commute. I don't want to be stuck in an area when jobs move. I want to have the smallest carbon foot print available.

I honestly think that we will see a drive towards this. Not only have banks gone back to where they used to be with mortgage lending, but they have gotten even more restrictive. Add to that, people are scared shitless to own a home. Millions of Americans have watched their credit get ruined also.

Look at Michigan. Jobs are not coming back there yet you don't see people moving. North Dakota can't fill jobs. Immobility of the labor force. Yeah yeah, North Dakota fucking blows. But you know what blows more than ND? Being out of work for 2 years in Michigan.

Jul 31, 2008
ANT:

Glad I didnt get raped for my statements.

I really think it is bullshit how the government favors homeowners vs rents. I realize that homeownership adds a lot to GDP, but when you think of the costs associated with having millions of little towns, miles of roads, and a less mobile population, it looks like a wash.

Owned homes do not add to GDP. Homes owned by banks, which people occupy and dutifully pay the note on...add to GDP. Until we start being honest with ourselves about this, no steps can be taken in the right direction. The illusion of "The American Dream" starts with this fallacy.

ANT:

My parents own a monster house which they will never be able to sell. I grew up in one economic class and then saw technology put my family into another class. Had my parents been renters, they could have adjusted more swiftly or downgraded to reflect their new economic reality. Unfortunately this was not the case.

Your parents and people like them, do not fall into a voting block. They are just decent people trying to thrive and survive. Where this was once the definition of the vast majority of the American public. Today, it is only those who unionize (in some manner of speaking) and lobby, that aren't ignored.

ANT:

Me, I would rather rent and bank the rest. Being mobile and close to work is ideal for me. I value my time too much to commute. I don't want to be stuck in an area when jobs move. I want to have the smallest carbon foot print available.

It's comments like these that get people labeled as tea baggersor worse yet...anti-social.

Just consider the subtext.

ANT:

I honestly think that we will see a drive towards this. Not only have banks gone back to where they used to be with mortgage lending, but they have gotten even more restrictive. Add to that, people are scared shitless to own a home. Millions of Americans have watched their credit get ruined also.

Agreed. But since none of the chief contributors to the crisis (I'm talking bout the con men and their all too willing to get taken, victims) have gotten adequately penalized. What's the incentive not to go back to doing dumb shit? I don't see any.

ANT:

Look at Michigan. Jobs are not coming back there yet you don't see people moving. North Dakota can't fill jobs. Immobility of the labor force. Yeah yeah, North Dakota fucking blows. But you know what blows more than ND? Being out of work for 2 years in Michigan.

Better yet, look at Cleveland. In the 30's it was the fastest growing American city, reaching almost a million in population. Today it's less than 300K. For the record, I'd love to live in North Dakota. I may even be able to use the 1st and 2nd Amendment at the same time out there. Now how many states can stake that claim and pull it off completely?

Jul 31, 2008

I'll be renting for a long damn while. Unless I can finance a house that comes close to break-even on the rent yield, not going to buy.

Jul 31, 2008

Agreed! I would also pull my mortgage calculator and rationally think if I can pay it in the next 10-20 yrs adjusted to CPI.

ivoteforthatguy:

I'll be renting for a long damn while. Unless I can finance a house that comes close to break-even on the rent yield, not going to buy.

Jul 31, 2008
Midas Mulligan Magoo:

This means that at the predicted 5 to 10 cents on the dollar acquisitions, they can still make their money back tenfold...if they can just find some takers.

Who in their right mind would take the other side of that bet? Fool me once shame on you but fool me twice...

More importantly why would someone absorb that risk at this present moment? If China increased the value of their currency against good 'ole Ben Frank I can maybe see us moving forward, even that is a far stretch of the imagination.

...What recovery?

good post

Jul 31, 2008

These notes are still secured by first rights to the property, right? I think we're forgetting what we're working with here.

I'd buy them at 90-95% discounts, hell I'd probably buy them at 75% discounts. I'd buy a few single family homes and a few townhomes. If they continute to pay the mortgages - GREAT, if not I'll get them booted and have positive cashflow properties. Except for the time and effort to kick out the current owners this is a huge Win-Win.

While I agree with everyone about renting being a better option for most, I would jump all over these kids of discounts

twitter: @CorpFin_Guy

Jul 31, 2008

Bump - Anyone? Appreciate any guidance or insight that can be offered.

Jul 31, 2008

On the public company side, I wonder how much of the rationale is just geared towards improving operating earnings profile via incurring the one-time charge.

Also interested in other people's thoughts on this.

Jul 31, 2008
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