2009 - What a Year for Distressed Debt!

What a year for distressed debt. By every metric known to the credit investing community, 2009 was a blockbuster year:

  • CCC index up over 100%
  • Year-to-date inflows of HY funds over $20B
  • LSTA Leveraged Loan Index up 52%
  • Pilgrims Pride Sub Notes: up 105 points to 111 (yes, you read that right)
  • Spansion Senior Notes: up 101 points to 108
  • Bon-Ton Senior Notes: up 80 points to 92
  • Post-re org stocks, like Dana or Solutia, that were widely held by various distressed funds up 5-10x from their lows.
And it continues - ResCap bonds are up 20 points in the last few days.

What I think is the most telling statistic: CDS Auction Settlement Prices and where bonds are trading today...

As a quick primer: When there is a credit default swap (CDS) outstanding on an entity, and a default occurs, Markit will run an auction to determine the settlement price for an outstanding CDS contract. If you have bought protection on an entity, you will be paid par less the settlement price (i.e. if the settlement price is 10, you would receive 90 points on your notional). And if you are a seller of protection, you would pay up those same points.

Now, why do I think this is important? I believe filing of bankruptcy causes certain lenders and investors in high yield and leveraged loans to sell their holdings for "uneconomic" reasons. In other words, forced selling. This may be anything from CLOs that need to empty some baskets to insurance companies that bought paper at par in the primary, and cannot own defaulted securities. In that, I would think that while the event of bankruptcy may not be the "low" on a particular security, many times it will be an event that forces some sellers out and provides a catalyst for future capital appreciation.

Let's look at the data. Using Markit's incredible site, which details date and settlement price for various auctions both in CDS and LCDS land (I am going to solely discuss CDS this time around), I can get a sense for where a security is trading when a default occurs. There are some limitations to this of course (i.e. the bond may not of been trading exactly where the auction price went off for hedging or unique reasons), but it will be pretty close. I have listed the company name, auction date, auction settlement price, and the year end bond price (ball parked according to dealer runs and TRACE) for the on-the-run bond in the capital structure. Going in chronological order from Markit's site (note - I have not included all bonds on the list, specifically predominantly European issuers, CIT [too recent], and a few other bonds [most are up dramatically as well]):

Yes. You read that right as well.

379% percent return average return. (306% if you exclude the Tribune bonds).

Will this strategy work in the coming year? I think it will, but I doubt to the tune of 2009. 2009 was such a great year for distressed debt and debt investing, but the math alone makes it hard to justify another return like this. Here's to hoping its one-half, or even a quarter, or even a tenth of 2009's return...


Anonymous,  1/05/2010  

Is the CDS auction settlement price an estimate of the ultimate recovery to the bond so that if the settlement price is 10 and you receive 90 on the notional, then you are expected to make up the last 10 on the actual bond so that you are made whole? If that is roughly correct, why not use the trading price of the bond at the time of default as the market's estimate of the bond's ultimate recovery instead of conducting an auction to determine the settlement price? Thanks.

Anonymous,  1/05/2010  

interesting study there Hunter, thanks. this site kicks so much ass. thanks for your work.

Anonymous,  1/05/2010  

so basically this study says that if you bought bonds of companies when they declared bankruptcy in 2009 you would have returned 379%??!

Anonymous,  1/06/2010  

is your start date for the return calc the bankruptcy filing date or the CDS auction date?

Anonymous,  1/07/2010  

Quick question - which brokers have the best inventories of distressed bonds for sale? I use Fidelity to buy distressed corporate bonds and its OK, hit and miss - somedays there are lots, other days nothing at all - but I have no idea how things are at Schwab or Morgan Stanley. Anyone care to comment?



LM,  1/13/2010  

Dear Hunter, I am not sure how you get that the CDS auctions are a good estimate of where bonds trade (or at what price you could actually source them) - they are not. CDS auctions are far from that.

If you would take the suggestion of one of the gentleman here to calculate with actual prices, your returns would be lower, and in my view still overstated as desks will qoute prices that dont necessarily have a 'real' ask.


hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.