For one thing there are loads of non-bankrupt companies whose debt trades below par, and this doesn’t imply less than full recovery nor does it imply that their equity is worthless!
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Look I’m not an equity guy or a credit guy, but these passages, from latest @matt_levine newsletter, strike me as kind of obviously wrong.pic.twitter.com/RaaoXuC36b
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But even for bankrupt companies it is totally rational for debt to trade below par and the equity to trade above zero, because the equity has much more optionality (if the restructuring goes well the best that the creditors can do is full recovery, the rest goes to shareholders)
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Similarly while it’s true that distressed debt investors are more focused on the downside I don’t think that’s a difference in temperament. Rather it’s a rational response to the potential outcomes.
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If you’re buying debt at 40 cents the absolute best you can do is a 150% return and the worst is you lose everything. If you buy equity you can still lose everything, but your upside is unlimited (or at least, limited at a much bigger number than 150%)
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So of course equity investors are more focused on the upside —that’s where most of the value from holding the equity is! Bond holders stop caring about the upside as soon as there’s enough money to repay the debt because that’s where they stop participating.
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I’m not saying anything profound here, and there is zero shade thrown at Matt Levine, who continues to be the single best newsletter writer in the world, just thought this was neat to think about.
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Yeah I spend majority of my time thinking of and avoiding the downside
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Would you say that's the result of being in EQUITIES tho? or of being an equities PROFESSIONAL? I feel like Matt's using retail noobs as the only equity investor type here, and that's not accurate. Plenty of pro equities folks worry primarily about the downside.
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There is a price for the debt that implies the equity is worthless. If the debt is below par and the case is about to be resolved, that could imply the equity value is zero. I was a debt PM at equity firms; the mindsets of debt & equity investors are as Matt says, different
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All I mean is, say the outcomes are 60% recovery, 90% recovery and 120% recovery each with 1/3 chance. Then the debt will trade at 83 (probably a bit less) but the equity will be non zero, even though there is a 2/3 chance that shareholders will be wiped out.
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