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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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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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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End of conversation
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where the bond trades relative to par depends on prevailing rates and the bond coupon in addition to whatever default probability and recovery rate the bond might have. Callables are a good example of something that's almost always under par but doesn't imply equity is worthess
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Agree with you that debt can trade below par. But what I understood from that sentence is that theoretically the discount to par is an indication of default risk reflected in the higher rate investors require to be compensated
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What are they considering par here? Do they mean they think everything should price like sovereign?
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