DistressedHard

3 min read · 626 words

What the seat actually does

A distressed seat buys claims on companies that cannot pay their debts as written. The instrument is usually a loan or a bond trading far below its face value, and the question is not whether the business is good but how much of that face value the claim will actually collect, and after whom.

The document is the analysis. Two lenders to the same company can end up with entirely different outcomes because one of them signed a different set of covenants, sits at a different subsidiary, or holds security over an asset the other does not. Reading that carefully is the work; a view on the industry is the easy part and rarely the part that decides it.

• Buying a claim — a loan or bond at a discount, expecting to recover more than the price paid.
• The fulcrum — the layer of debt that gets converted into ownership when the company is restructured, and therefore ends up controlling it.
• Special situations — a solvent company with a solvable problem: a covenant breach, a maturity nobody will refinance, an asset that has to be sold.

A day, and where it goes

• The stack. Every layer of debt, what it is secured on, which entity issued it, and what each layer is priced at — because those prices say what the market thinks the fulcrum is.
• The documents. The credit agreement, the indenture, the intercreditor agreement. See reading a credit agreement.
• Liquidity. How many weeks of cash are left, which is the clock everything else runs against.
• The other holders. Who else owns this layer, because a restructuring is a negotiation and a majority is what carries it.

What it is measured on

• Recovery against price paid, per claim, which is the only number that describes the trade.
• Time. A recovery of eighty on a claim bought at fifty is a different investment over one year and over four.
• Whether the outcome was the one analysed. Being right about the company and wrong about the ranking is the characteristic failure here.
• Position concentration, because these books are small in names and large in each.

What it touches on this site

• The transactions — the whole restructuring desk, especially distressed exchanges, debt-for-equity swaps and Chapter 11.
• The order of payment — who gets paid, which is the whole of this seat set out once.
• The plain version — what happens to bonds in a restructuring.
• When it goes wrong — 2020, where a majority of lenders moved themselves ahead of the rest, and 2001, where one clause held out against a whole restructuring.

How it goes wrong

• The document allowed something nobody expected. Assets moved out of reach, or new debt was put in front — both written into agreements that had been signed years earlier in better times.
• The process takes longer than the thesis. Legal timetables are not the investor's to set.
• Being outside the majority, which means being a spectator to a negotiation that decides the outcome.
• The claim was not what it appeared to be — issued by a holding company with nothing in it, or guaranteed by an entity that owns nothing.

Concepts to master

• Seniority is structural as well as contractual. Debt at an operating company sits ahead of debt at its parent whatever either document says about ranking.
• A covenant is an option granted to the borrower — the question is always what it permits, not what it forbids.
• Price and recovery are two different estimates, and the gap between them is the trade.
• Credit spreads widen long before a default, and reading that is a separate skill. See credit spreads.