How much money Paulson has made in Lehman... (LBHI)

In the past, we have discussed Rule 2019 in the bankruptcy of Accuride. To recap, Rule 2019 is summarized as thus:

"Rule 2019(a) requires that unofficial committees or ad hoc groups disclose, inter alia, (1) the nature and amount of their claims or interests; (2) the date of acquisitions of their claims or interests acquired in the year prior to the filing of the bankruptcy case; (3) the amount paid; and (4) any subsequent sales of claims or interests."
On April 26, the Supreme Court's Chief Justice, the Honorable John Roberts, sent a letter to John Boehner, the Speaker of the House of Representatives, and Joe Biden, VP and President of the Senate detailing amendments to the bankruptcy code; specifically: Bankruptcy Rules 2003, 2019, 3001,4004, and 6003, and new Rules 1004.2 and 3002.1. It is expected these measures will not be held up in Congress and the new rules will go in effect in December.

For our intents and purposes, we will focus on the changes to Rule 2019. For those that are interested, I have embedded the document sent by the Chief Justice detailing each of the rule changes:

Breaking the new rule down, in essence, any "group or committee that consists of or represents, and every entity that represents, multiple creditors or equity security holders that are (A) acting in concert to advance their common interests, and (B) not composed entirely of affiliates or insiders of one another" OTHER than appointed committees under 1102 or 1114 (i.e. Official Creditor Committees) must disclose:
  • The name and address of each forming entities and for who the group is acting on behalf
  • Name and amount of claims against / equity ownership in the debtor
  • The date (by quarter and year) of purchase (unless acquired a year before Chapter 11 petition)
Why is this important? In past situations, funds have argued that this transaction detail is proprietary and could hurt their business. Litigation and objections arose, which are costly, and less focus was put on rehabilitating the debtor. By shifting the "date" to a quarterly basis, super secretive techniques of distressed funds (i.e. asking Joe Beggans at JPM or any other distressed trader at dealers on the Street to make you a market) will stay under lock & key.

With that said, a debtor trying to expose a distressed debt fund's purchase of claims at a massive discount from the original holder is really a strong arming negotiation tactic to exhibit to the Court the misaligned incentives of creditors and emerging debtors.

The most recent example of a Rule 2019 disclosure came in the Lehman Brothers case. In the annex below, you will find the holdings and trades (buys and sells) made by the Ad Hoc Group which consists of Calpers, Canyon Capital, Fir Tree, Gruss, Owl Creek, PIMCO, Paulson, Perry, Taconic and a few other creditors (Elliot and King Street are no longer members).

Let's take a look at Paulson's disclosures. We are sticking to LBHI now:
  1. Total Senior Unsecured Claims held as of April 13, 2011 = $4,006,220,219. This number nets buys and sells throughout the transaction history.
  2. Total Purchased Claims ~ $7,006,727,733. Sold claims ~ $3,000,507,555
  3. Capital Spent for Purchases ~ $928,475,080. Average Price Paid ~ 13.2 cents on the dollar
  4. Capital Raised on Sales ~ $637,112,472. Average Sale Price ~ 21.2 cents on the dollar
  • Current Position = Claims * Market Price = $4,006,220,219 * 26 cents on the dollar ~ $1,041,617,257
  • Capital Raised (see above) = $637,112,472
  • Capital Spent (see above) = $928,475,080
  • Current Position + Proceeds from Sales ~ $1,678,729,729
In other words, according to my calculations, Paulson has made
approximately $750,000,000 on the Lehman Bankruptcy (LBHI alone).

Distressed Debt Investing for the win? I think so. It is going to be interesting to see what, if any, effect this new ruling has on ad hoc and unofficially credit committees. One thing I am interested to hear is whether this will apply to steering committees in bank facilities.

One final note: You will notice a new addition to our right side rail: "Distressed Investing Resources" and our first static page: "Bankruptcy Dockets" On that page (after I add all the active dockets this weekend), you will find an easy resource to go to most of the major bankruptcy's dockets (and won't have to pay PACER as you will be going through the claims agent's site which I find easier to navigate anyways). Enjoy!


Random Request: Job Posting

We have three or four posts lined up for the next few days. Before we get to that, I came across a job posting I was curious about. Here it is:

Research Analyst / PM
New York based buy-side investment management firm ($2.0 billion in total assets) seeks an experienced Research Analyst / PM to assist in the managing of equity & fixed income investment portfolios. The Analyst / PM will work in accord with an exceptional team of investment professionals (with both fixed income and equity expertise) in order to identify individual equity & fixed income securities as well as constructing investment portfolios.

The ideal candidate will have several years (5+) of previous buy-side equity & fixed income Research Analyst / PM experience with significant product knowledge across the fixed income and equity sectors. Candidates with prior experience analyzing financial services companies will be given priority. In addition, the individual will possess exceptional analytical, written, and verbal communication skills.

Essential Skills:
  • Previous buy-side research / portfolio management experience – 5 years minimum Extensive product knowledge covering equity & multiple fixed income asset classes
  • Exceptional analytical, written, and verbal communication skills Ability to thrive in a team oriented environment
Desired Skills:
  • Significant knowledge of the financial sector including banks, insurance, REITs etc.
  • Ability to interact with clients and accurately convey the underlying investment strategy
  • Build / Maintain relationships with industry professionals on a global scale
  • Detailed understanding of financial statement analysis, credit spreads, rating agencies, and other fixed income valuation tools / resources
  • MBA / CFA
If your firm posted this or you know which firm this is, could you please email me at hunter [at] distressed-debt-investing [dot] com (I will, as usual, keep complete discretion with the info) ... Thanks!



Distressed Debt Analysis: NewPage

NewPage has been discussed in distressed circles for quite some time now. In fact, if I am not mistaken, it has the most investment write-ups on the Distressed Debt Investors Club:

  • In April 2010, a member recommended going long the 2nd lien floaters
  • In September 2010, a member recommended going long the 1st liens
  • And a few weeks ago, a member recommended going short the 10% 2nd liens
With that said, and given such a rich capital structure, distressed debt investors have spent a significant amount of time on the credit over the past few months. And that focus increased over the past few days as rumors swirled about a possible restructuring around the corner culminating with news on the wire last night and today that Newpage is working with advisors (Lazard, FTI, and Dewey & LeBoeuf) to evaluate alternatives.

Further, it was reported that Apollo and Avenue Capital hold more than $400M of NewPage's aforementioned 2nd liens. For reference here is a chart of the 10% 2nd liens going back to May 2008:

From looking at my runs, by far the most liquid bonds are the 11.375% 1st liens and these 10% 2nd liens.

NewPage is the largest coated paper producers in North America. Cerberus purchased the company in 2005 and currently own ~80% of the company. The balance is owned by management and Stora Enso Oyj which divested its North American operations to NewPage in late 2007.

According to its most recent 10K, coated paper products represent 80% of 2010 net sales at NewPage. Coated paper is the used in media and marketing applications such as glossy advertising brochures, magazine covers, company annual reports, catalogs and textbooks. Look around at your desk and you will see numerous examples of coated paper. The remaining 20% of sales comes from supercalendered paper (inserts and flyers), newsprint and specialty paper.

As one can expect, the coated paper products market has faced both cyclical and secular declines in the past few years. With that said, industry capacity has been taken out over the past few years as demand has fallen and rising raw material and operating costs (energy) have made a number of plants across North America unprofitable. Because of back integration (they produce ~95% of their pulp requirement), NewPage is the low cost producer in North America.

It is estimated that utilizations of plants across North America are running in the mid 90s. Supply is fairly tight right now. Contributing to this, in October 2010, the International Trade Commission voted unanimously that imports of NewPage's principal product (coated paper) from China and Indonesia (15-20% of the market) and harmful to U.S. producers and workers. This allows the Department of Commerce to impose duties on imports. Industry trade group, RISI, expects coated paper to increase $67/ton in 2011 and $56/ton in 2012. Supporting this, NewPage announced a $60/ton increase on coated free sheet products starting June 1.

As on can expect in a paper / packaging company, operating leverage is magnificently high in this business. The company's EBITDA nearly doubled in 2010, and given where pricing is today plus a slight increase in volumes, Newpage should be able to double EBITDA in 2011 (from 2010 levels) in spite of higher raw material costs. This trend would continue into 2012 assuming RISI's price expectations come to fruition.

For comps I am going to use Sappi and Verso paper, both well known names in the high yield universe. Sappi trades at 5.3x 2011 EBITDA and Verso trades at 5.6x 2011 EBITDA. Assuming conservative multiples of 5.0x, 5.5x, and 6.0x versus the expected $500M of EBITDA Newpage should generate in 2011 gets us to a valuation of Newpage between $2.5-$3.0B. Without completely oversimplifying things, this is what I come up with:

So on a back of the envelope calculation, the 2nd liens are worth between 56-105. At today's price of 57-58 that looks pretty compelling for these reasons:
  1. In our low case I used a 5.0x multiple versus 5.3x and 5.6x for Sappi and Verso respectively
  2. I used a fairly conservative EBITDA number. Goldman Sachs' credit analyst Joe Stivaletti pegs 2011 EBITDA at $574M and Banc of America's Roger Spitz is using $525M for normalized EBITDA
  3. Assuming a restructuring and the 1st lien getting adequate protection in the form of post petition interest, run rate interest in a restructuring for NewPage will be between $200-$250M. With capital expenditures in line with previous years, NewPage (on $500M of EBITDA) could generate between $150M - $225M of free cash flow per year. Given $1.030B of 2nd lien debt, this translates into 15-22 bond points. This number increases assuming EBITDA continues to rise in 2012
  4. In line with the above, given how hot the bank debt market is today, it wouldn't surprise me to see NewPage refinance its entire first lien structure at a 7-9% handle saving the company $40-$70M pre-tax dollars a year
  5. The company has non cash flowing operating assets it can sell to generate additional proceeds. Further, cash proceeds ($100M) from already announced sales will flow to the balance sheet over the next few quarters
So all in all, with very little downside and tremendous upside NewPage's 2nd lien looks like a very interesting investment opportunity. The 1st liens look well covered as well and are attractive for risk averse investors at a healthy 12%+ yield. I personally think a 1/3 1st lien, 2/3 2nd lien position also looks interesting to hedge one self against a rapid drop in coated paper products. The biggest risk I see here is Cerberus offering to exchange 2nd lien debt into 1st lien debt (street estimating ~$500M of first lien capacity under various indentures). Instead of capturing the upside of a strong 2011/2012 pricing cycle, investors would be stuck in a fixed instrument with a longer maturity profile.

We will continue updating and fine tuning our analysis as more facts emerge in this fascinating distressed debt case.



Michael Burry Speech at Vanderbilt: Transcribed

Earlier in the week, we posted notes from Michael Burry's speech at Vanderbilt. We saw the video and thought it would be a good exercise to transcribe the video. Note: I have been informed that the video does not capture large portions of the speech. Be forewarned and enjoy!

Michael Burry at Vandebilt

Michael Burry: Soon … though my attention … my activities inside the capital, I thought of myself as a value investor. Soon, my attention was caught by this growing importance of the housing sector. The amount and type of leverage, the generation's old acceptance and assumption that prices always went up, and the very broad societal participation, greater than sixty percent, owning homes.

This all called out to me. This was not just a case where a few early adopters made a lot of money, or a few venture capitalists acted badly. The entire economy depended on home price appreciation. The slope. Home Price Appreciation. Consumer spending, jobs, securities markets, all of it.

Soon, I would see financial Armageddon with housing at the trigger point. Now, in predicting how and when the collapse would occur, my focus was again on the actions of our government and the response of the private sector. This was much in keeping with my studies a decade earlier in Chicago.

Let's consider that history. The idea of an American Dream being related to home ownership has been around for nearly a century. Nearly every modern president promoted it, in one way or another, with a named program. The government helped returning G.I.'s after World War II buy homes, and the government was the first to securitize mortgages in the early 70's. Private securitized mortgages followed shortly thereafter, thanks to Lew Ranieri. President Reagan would sign the secondary mortgage market enhancement act, which, among other things, allowed insurance companies and pensions to invest in these securitized mortgages. A short time later, Reagan signed a law that made these types of products much more tax efficient.

To be clear, securitization of mortgages means that there is virtually no limit on the amount of mortgages that can be originated by an institution. They just get sold through to Wall street to investors. But all this was considered harmless. It was a good thing for the American Dream, to almost all concerned, for decades.

The desire to satisfy this dream, though, needed a tool. Something that would make home loans themselves much more affordable for those without the income, credit, or assets, to afford one. Let's step back to 1982 again. The Depository Institutions Act legalized adjustable-rate mortgages for the very first time. These adjustable-rate mortgages were teaser-rate mortgages, and would, in various forms, be the primary mortgage product at the heart of the collapse of our economy two-and-a-half decades later. But, adjustable-rate mortgages did not take off immediately. They really did not take off until additional regulatory and legislative changes in the 1990s, early 2000s, jump started the market for affordability products in the mortgage space.

Specifically during the 90s, the Community Reinvestment Act, of 1977, was reinterpreted several times. By Robert Ruben, the treasury secretary at the time, and Bill Clinton, the president at the time. The general point was to increase pressure on banks to make more loans to less credit-worthy customers, and they did. Sub-prime issuance bloomed about five to six times during the 1990s, and there was a mini-crisis thereafter.

Bill Clinton had a name for this drive, as all presidents did. His name was the National Home Ownership Strategy. Then, in 1999, the Gramm-Leach-Bliley Act repealed the Glass-Steagall Act of 1933, and officially removed the increasingly leaky separation between the activities of Wall street banks and depository banks.

This freed banks to experiment and to expand into new lines of business. None were fateful in the experiment with derivatives and sub-prime asset-backed securities. The private market therefore gained the capability to mount a massive response to all the government's efforts to stimulate housing. We all remember 1999 very well, but, in fact, our global village underestimated many, many risks throughout the 90s, as is typical of a generally good economic time. And we had to deal with: stock market crash, Enron, 9-1-1, World Com, and eventually war.

The Federal Reserve stepped in, cutting the discount rate of charge lenders from 6% to roughly 1% in order to stave off recession. Other key short-term interest rates followed. Not at all coincidentally, from 2001 to 2003, we saw American home prices, which had largely moved in line with household income over the decades, suddenly accelerate up and away from the household income trend line. Home prices had good reason for such deviation. From 2001 to 2003, rapidly declining short-term rates, to lows not seen since the aftermath of The Great Depression, induced a boom in adjustable-rate mortgages. A homeowner's dollar went farther in that teaser-rate period, and so home prices rose unnaturally. Risk would be low as long as home price appreciation was strong under this paradigm, thanks to refinancing options.

It was a positive feedback loop with the full blessings from the U.S. Government. In fact, amidst early fears that the housing market was getting ahead of itself in 2003, Fed. Chairman Allen Greenspan assured everyone that national bubbles in real estate simply do not happen. As I surveyed the national trends in housing at that time, I wondered where their common sense ought rule against the application of precedent to the unprecedented.

Mr. Greenspan went on to advise, in 2004, that they were under-utilizing the new types of adjustable-rate mortgages. In 2005, he __ specifically the technologies by sub-prime lenders to get sub-prime borrowers into homes. Tragically for all of us, The Federal Reserve actually had authority to block any lending activity it deemed deserving of such treatment, but it had absolutely no will to do so.

In any event, by 2003, the mortgage rates stabilized at 40-year lows, and importantly, plain vanilla adjustable-rate mortgages had already come into widespread use. This was a big problem for public lenders with a growth mandate. They needed to stimulate more loan volume despite stable mortgage rates and inadequate income growth. At this point, if home prices were to rise significantly, they would have to float almost entirely on the back of the type and quality of mortgage that credit provided to the buyer. Critically, interest rates alone would no longer determine affordability.

In my letter to investors at the time, I termed this 'credit extension by instrument', and it took our housing market into a new paradigm. It was the private market's time to overreact. The instrument chosen for sub-prime borrowers, by lenders in 2003, was a relic of the 1920s. The interest-only adjustable-rate mortgage.

Lenders, by implementing a mortgage product they had long avoided, showed for all to see that they were more interested in growth than they were in maintaining credit standards. They were no longer interested in checking excess credit risk at the door. By fall of 2004, I noted from my investors that Countrywide Financial, a very large, national mortgage lender, reported sub-prime mortgage originations of 158%, year over year, despite a 20% decline in overall originations. Evidence was there for manifest. Banks were chasing bad credits, inclusive of housing speculators. The only question was, “How far could they go?”

Ominously, fraud jumped. The point at which the provision of credit was most lax, in my mind, would mark the point of maximal price in the asset. I imagine the top in the housing market would be marked by a mortgage in which home buyers of sub-prime quality were enticed to buy, with teaser-rate monthly payments near zero. I was very aware lenders would take this to the nth degree. Banks to securitization. Any loans that the banks did not want to keep, they could sell through Wall street to investors who were simply ravenous for yield.

Importantly, because sub-prime mortgages were being turned into securities, there were mandatory regulatory filings. This is how I educated myself on the sector. At times, I felt I was the only one reading these things. By summer of 2005, these documents revealed that interest-only mortgages had taken a substantial share in the sub-prime market. Just a year or so later, after they were introduced to that market. More than 40% of sub-prime originations were passing through Wall street on their way to investors. This was up from 10% a year earlier. Simultaneous Second Lean Mortgages ramped up significantly. This was not disclosed in every document I read.

A stated income option available to borrowers inspired a new vernacular: the liar loan. In some mortgage pools, 40% of sub-prime loans were for second or vacation homes; condos in Miami. Yet, as late as 2005, Moody's and S&P, so crucial to the securitization process, Moody's and S&P being the ratings agencies everybody watched, they were not reacting at all.

The top would soon be fast upon us. As a sub-prime, interest-only, adjustable-rate mortgage started to touch maximum sales channel penetration, we saw the introduction of yet another, more extreme, teaser-rate mortgage called the Pay Option ARM, or Cash Flow ARM. In this new type of mortgage, never before seen in a widely standardized format, the borrower could basically pay next to nothing each month. The unpaid interest would simply negatively amortize into the growing mortgage balance. Rampant cash out refinancing had already made the home a magical ATM for most Americans. And now, housing had its credit card.

This was what I had been waiting for, peak credit. Such a mortgage product would only exist as long as home price appreciation was an essential assumption, and home price appreciation was not long for this world, precisely because these mortgage products existed. Some of these mortgages started making their way into the sub-prime channels, too. I knew this because by 2005, as early as 2005, I could see these mortgages being packed into Alt A securitizations. I read those too. Those are between sub-prime and prime. Not all of these, though, were sold … not as many as you would thing were actually coming through this way, though. Most of them were not being sold through the street.

I noticed something else. Incredibly, Washington Mutual and Countrywide, again two national giants in home loans, began to load their own balance sheets with these Pay Option Adjustable-rate Mortgages. Facing yet another slow down in loan volume, these companies saw the negative amortization feature as a way to show loan growth in a slowing market. Yet these companies, in doing so, expressed confidence in home price stability in the event of a slow down in loan origination. Of course this is what the ratings agencies, the Federal Reserve, Congress, the President, and all the president's men believed, as well.

I disagreed. I saw absolutely no chance of home prices going sideways, or stabilizing for any significant length of time. Once home price appreciation was no longer a given, these new types of mortgages would simply disappear. Home prices, starved of peak credit, would fall and fall steeply, as mortgage and financing options crumbled away. The crisis, in my view, would start in 2007, by which time the teaser-rate on the vast majority of these new types of mortgages would expire or reset for a population of homeowners trapped in mortgages they could no longer afford. And on the way down, housing would take consumer spending, jobs, everything, with it. A positive feedback loop of a very damaging variety was set up.

So, seeing the economy on the verge of collapse, I did the logical thing. I sucked the profit from it.

[Audience laughs]

Specifically, I set out to buy credit default swaps on subordinated tranches on sub-prime, residential mortgage-backed securities. And that's where I lost my investors, too.

[audience laughs again]

In fact, in doing so, I gained a new level of insight into how Wall street really works. I called different Wall street firms, banks with which I had prior relationships due to my trading of distress debt. I asked them to trade in this market with me. Initially, I found no takers. This was in March of 2005. The whole effort was complicated because it was important to me that this security, this instrument that I like to use to short the market, would be standardized such that if I bought a credit default swap from one dealer counter party, I could easily trade that credit default swap to another dealer counter party. We spoke, won off contracts, were full of contract counter party risk, but I would not tolerate it.

Nevertheless, by May of 2005, standardized contracts were on the cusp of becoming of reality. In May of 2005, May 19th of 2005, we agreed to our first trades, shorting the sub-prime mortgage market. We worked on these soon-to-be standardized contracts a bit, and the first days of June 2005 were the first trades that officially went through. We would ultimately use nine different Wall street dealer counter parties. To be clear … well, first I would say Leeman and Bear I avoided, for obvious reasons, even back then.

[audience laughs]

Goldmann-Sachs featured very prominently early on. They were a very anxious crew. To be clear, these credit default swaps that I'm buying, that would rise in value as mortgages were written off, and the value of these tranches fell. Goldmann-Sachs, in the spring of '07, appeared to us to want to make it's trade bigger. They wanted a bigger piece of the big short. A lower price, therefore, would benefit Goldmann-Sachs, and that's how Wall street works.

In late June of 2007, credit spread began marching higher, and then it just took off once Goldmann was on my side for the trade. Then it was AIG's turn to complain about Goldmann's marks. Later, it would incredibly be reported that more than 60 trillion dollars in credit derivatives were in effect at the peak. Now hyperbole, we'd say that is more than the gross product of the world. But it's roughly equal, and who really knows what the gross product of the world is?

How could that be? How could it even get close to the gross product of the world? Credit derivatives on an underlying asset could be worth multiple orders of magnitude more than the asset itself is worth because all asset-backed derivative securities settle in cash, pay as you go. That was the secret sauce of the Doomsday Machine. And so the crisis unfolded with the market providing a signal far too late. Even so, Fed. Chairman, Ben Bernanke, treasury secretary, Fred Paulson, continued to underestimate the situation.

I was appli... just like that, apaplicted. Secretary Paulson now claims that even if he knew what was going to happen, he couldn't have done anything about it. Now that may be true. After all, he would say, “I just joined the treasury in 2006.” But he came from the top CEO job at Goldmann-Sachs. And once treasury secretary, he wasn't so impotent. He orchestrated the once-unthinkable government takeovers of AIG, Fanny-May, Freddy-Mac. Absolutely unthinkable, the bailout of Wall street. He was anything but an impotent tool. He had a running start unlike any other. But if he truly felt that way, this is an absolutely devastating commentary on how our government works.

In fact, as books and articles on the crisis proliferate, it becomes clear that nearly every failed institution, and nearly every relevant department of government, there's someone with insight that is every bit as good as mine, and in many cases, better. However, none … zero … were in the top job. That our CEOs, Governers, our Presidents, and our Charimen did not see this coming and adequately prepare their constituencies, is an inditement in the manner in which we choose and enable our leaders. But such would not be the conclusion in 2008. Broadly speaking its the hedge fund's fault. By the second half of the year, with the government targeting hedge fund managers with punitive subpoenas, the global attack on so-called speculator and evil hedge funds. The nationalization of Fanny, Freddy, AIG, etc, and their liabilities. Very importantly, their liabilities, which were now a special-purpose vehicle of the government.

I worried about the future of a nation who would refuse to acknowledge the true causes of the crisis. In my view, a historic opportunity was lost. America had instead chosen it's poison as it's cure, and a second greatest nation would never be born. Today, I expect the government to continue easy-money policies into the next presidential term. Past the meat of the foreclosure crises, and past the corporate and public refinancing humps that are upcoming. With junk bonds, junk bonds incredibly, again at all time highs. Quantitative easing seems to be working, for now. This is an invalid validation of what America is doing.

This is, in fact, a Pyrrhic gamble. We continue to debase our currency. Bernanke says he's not printing money. I, again, I disagree. As it stands, I get an email every day from the Fed, saying, “We just bought another seven, eight billion of treasuries.” Monetizing the debt. I don't know, that's pretty clear to me.

In fact, this program, QE2, not Queen Elizabeth, Quantitative Easing, QE2, it's scope and breadth raises a severe question of the treasury's needs. The government's borrowing of money for the purpose of injecting cash into society, bailing out banks, brokers, and consumers, is a short-sighted easy decision for a population that has not yet learned that short-sighted, easy strategies are the route to long-term ruin.

We never quite achieve the catharsis necessary to stoke a deep reevaluation of our wants, needs, and fears. Importantly, the toxic twins. Fiat currency, and the activist Fed remain firmly entrenched, even more so with the financial reforms last year. In fact, the Federal Reserve, having acquired new powers of regulation, has insisted that nothing in the field of economics or finance was of any help in predicting the crisis, period. No more comment.

It's a worthless conclusion. It guarantees we'll make the same mistake, again and again. So I have a problem with leaders. I should note, I've been overwhelmed with these mistakes they've made. We need better leaders. But, very frankly, this isn't going to happen. A problem cannot be solved if it can never be acknowledged. And it will never be acknowledged. Taxes need to be raised, spending needs to be cut, loop holes need to be shut, if we are to have any hope of returning to a stable base.

Certainly, home ownership should not be a policy of the U.S. Government, and the banking system needs substantial reform and even bank breakups. Glass-Steagall needs a second run, in a strong form. And those 22 and a half million public workers have no business unionizing agianst the taxpayer. The list of things that will happen compared to things that should happen, goes on and on. As citizens of these United States, we should carefully consider what 1 trillion means. All personal income taxes collected in a year do not add up to 1 trillion dollars. By 2020, interest expense on our international debt could very well exceed 1 trillion dollars. When you consider our 1.7 trillion dollar deficit, consider the treasury's inlays are only a little over 2 trillion.

It's quite a loss margin. 2 trillion also happens to be a little less than the amount of bank and government debt now held at our overly-bloated Fed. 2 trillion seconds is 64 thousand years. And what's minimum wage again? Our country's math is scary big, and simply speaking, it does not work. Speaking of math not working, how many of you are checking that math? Pretty sure, 64 thousand years. So arguments on blooming economic recovery must be considered along the fact that all this debt and all the money being printed is very much a real bill, a real tax on our future. It is a debtor's prison for our children. It is not yet come due today except for savers and those on a fixed income. As such, I recommend sober analysis on the part of the individual. This is paramount. We must remember that entire societies do run the wrong path for a very long time. They do run aground. There's nothing wrong with breaking from the social norm to assure good outcomes. Common sense must rule when it comes to career paths and life choices. Though the situation seems to call for it, it is not a time for a responsible individual to tolerate any level of blind faith directed toward any man or woman. It is not a time to follow. So all that said, I might recommend opening a bank account in Canada.




Distressed Debt Investors Club Idea: Denver Convention Center

Every few months, I post a recent research idea from the (newly redesigned) Distressed Debt Investors Club, a site where event driven and distressed debt analysts and portfolio managers share and discuss relevant investment ideas. Members must be approved based on an investment idea they submit for review. For more information, please visit the site or the various posting on the blog.

With that said, this idea , submitted a few weeks ago, is a bit off the run from the traditional First Datas, Lehmans, and other more prevalent distressed ideas. I think you'll enjoy it.

Denver Convention Center 5% Notes due 12/2035, CUSIP 249189CF(6)

Stressed municipal bonds may be one of the few remaining areas of compelling value. Accordingly, I suggest the purchase of the Denver Convention Center 5% Notes due 12/2035, CUSIP 249189CF(6). The notes last traded at 77% of par representing a YTM of 6.96% and a YTC of 10.49% based on a par call at 12/1/2016. Relative to treasuries, this represents 156% and 421% of the reference treasuries. For a variety of reasons, I believe this is a rock-solid credit that deserves to trade in-line to slightly above Treasuries. For reference purposes, the average “A” rated municipal bond has historically traded in-line with treasuries reflecting the much-superior tax characteristics of municipals.

Investment Thesis
The Denver Convention Center is a 1,100 room hotel in downtown Denver (surprise) that also serves as the nearest lodging for the city’s premier convention center. The hotel opened in 2005 and encompasses about 1.2 million square feet. It was built at a cost of about $300 million and is managed by Hyatt. The property we should be concerned about is really only the hotel because your debt service comes from the hotel and your mortgage is on the hotel and not the convention center itself. The equity in the property is effectively owned by the City of Denver, so you have a strong AAA equity sponsor with a long-term perspective on the value of the hotel (both in terms of cash flows to the city as well as the value of the hotel to the city’s overall economy).

In evaluating the credit, I looked at three sources of value. First, there is the underlying hotel itself on which you have a mortgage. The hotel also benefits from a property tax waiver, which should mean that the property gets a higher multiple than peers on a per room basis (though not on an EBITDA basis since property taxes are not generally added back to get to EBITDA). Second, the city has agreed to make an annual allocation payment from certain sales and excise taxes for the benefit of the hotel’s creditors. Third, there are several restricted cash accounts such as debt service reserves that are being held for the benefit of the creditors. In order to value the bond, we approached the hotel valuation as representing the residual after the restricted cash for debt service and the allocation payments from the City of Denver, which is a AAA credit.

While the restricted cash does not represent an asset producing cash flow for debt service, it is a claim that would be readily available to creditors. Including only the accounts that are identifiable for the benefit of bondholders – the senior debt service fund, the debt service fund, the senior special debt service fund, and the redemption fund – gets us to $41.5 million of restricted cash set aside for creditors. In considering the credit, we have included the value of this cash but ignored the other $37.8 million of restricted cash that has been set aside for other uses such as future capex. In reality, some or all of this other restricted cash could be used to reduce operating expenses for the hotel and free up additional hotel cash flow for debt service should it prove necessary.

The allocation payments, known as Economic Development Payments, are considered a “moral obligation” of Denver City and come from specific tax revenues. The city has covenanted that the Mayor will include the Economic Development Payments in his budget and these have traditionally been seen as non-negotiable allocations by cities because their exclusion would effectively shut the city in question out from raising additional allocation-backed debt. For this reason, allocation backed bonds have historically been considered very safe instruments and tend to take on their issuer’s credit rating. The allocations that the city has agreed to make will grow from $8.75 million in 2011 to $11 million in 2018 and then continue at $11 million until 2040. To value these allocations, we first calculated their duration (12.8 years) and then chose the reference bond (20-year UST). We valued the allocations at a yield equal to 100% of the reference treasury based on a small premium to the Denver GO credit, which is currently trading at 90% of the reference treasury. On this basis, we believe that the allocation payments have a present value of approximately $173 million.

To value the hotel itself, I looked at a variety of comparable companies, including H, HST, MAR, HOT, and IHG on an EV/EBITDA basis. The average trailing EBITDA multiple is 15.5x, suggesting that the Denver hotel is worth about $375 million. On a per room basis, private market transactions have been taking place at about $300,000 per room, which means that the hotel would be worth $330 million. Given the hotel’s excellent condition (recently built), its property tax waiver, and its substantial meeting, restaurant, and common spaces, we think this is a conservative value per room. Using the average of these valuation metrics, we come to a value for the hotel of about $350 million.

The face value of debt outstanding is $344 million excluding the unamortized premium and the market value at 77% of par is $265 million. Subtracting the $173 million of value attributable to the annual allocation from Denver as well as the $41 million of restricted cash for the benefit of creditors implies a value of the debt attributable to the hotel of $130 million at face value and $51 million at market prices. This represents a LTV of 37% at face value and 15% at market prices and you have a first mortgage on the hotel and underlying land. I believe this should be considered an investment grade mortgage credit of “A” or “AA” and that the appropriate interest rate is somewhere around 110% of treasuries. If we look only at the cash flowing allocation asset and ignore the restricted cash accounts, the implied leverage against the hotel is 49% at face value and 26% at market value. I believe this would also be considered an investment grade mortgage credit but of “BBB” or “A” quality and that the appropriate interest rate is somewhere around 120% of treasuries.

Including our valuation for the allocation payments, hotel mortgage, and restricted cash, we believe that a valuation based on a yield of 110% of the reference treasury is appropriate for this credit or a YTM of 4.9% and a price of 101% of par. This represents 31% price upside to our purchase price of 77% of par. In order to invest in this bond as a credit investment rather than a rates investment, we suggest swapping debt from fixed to floating paying about 4.2% for a 20-year swap, which has a similar duration to the Denver hotel debt. This leaves us with a 2.8% spread to collect over the remaining term of the bond (all of which we believe can be captured through price appreciation) and similar price upside based on the bond’s credit.



Michael Burry: Notes from Vanderbilt Speech

One of our favorite investors of all time, Michael Burry, who I personally have been following for quite some time, gave a speech tonight at Vanderbilt University entitled: "Missteps to Mayhem: Inside the Doomsday Machine with the Outsider who Predicted and Profited from America’s Financial Armageddon". Distressed Debt Investing was there (we have our tentacles everywhere) and are pleased to bring you notes from the speech. Enjoy!

As indicated by the lecture’s title most of Dr. Burry’s material was a blow-by-blow account of how and why the housing bubble occurred and how he profited from the resultant crash. To put his presentation in context, it is worth noting that the audience was comprised of people from many different academic and professional backgrounds. As such, much of the content was already familiar to those who’ve read Michael Lewis’s The Big Short and/or his Vanity Fair article. I assume the Distressed Debt Investing community is familiar with these works so my notes are focused on things I thought were not discussed in those works and interesting anecdotes that provide insight into his thought process.

To begin I was impressed with the turnout. I’ve heard that Vanderbilt’s Chancellor series is popular, but I was surprised that the approximately 500 seat lecture hall was well beyond capacity with at least 100 people sitting in the aisles or standing along the walls. The audience was very diverse with several doctors (Burry was a Vandy med school graduate), a priest and a fairly even mix of students and professionals.
  • Dr. Burry began by semi-joking that of all the top fifty finance people he’s met, none were as smart as most of his med school classmates
  • He was attracted to investing because he was evaluated on performance not whether or not he looked people in the eye or was socially adept
  • Being looked down on by more credentialed professionals is a hallmark of most trailblazing success stories, noting how John Bogle openly criticized him in a Forbes article
  • He has always been attracted to “ick investments”
  • Aside from being short $1.8 bln notional of sub-prime CDS he was also short $6.6 bln of corporate CDS in names including AIG, Wamu, Countrywide, Fannie and Freddie
  • Due to Wall Street marking against him and his growing investor unrest he was forced to sell his corporate CDS and side pocket his subprime bets
  • When he was first buying protection on sub-prime CDS he was making a psychological bet on the first real defaults, which he expected to soon start, causing the broader mortgage market to collapse. By late ’05, when defaults actually started occurring EVERYBODY should have seen what was coming
  • Instead technical factors—most notably the deep CDS offer from synthetic CDOs and correlation traders—pushed the mortgage basis even tighter
  • He really went after Goldman noting that e-mail have subsequently been disclosed that revealed GS orchestrated a short squeeze “to cause maximum pain” to existing shorts in order to pile on the trade themselves at better levels
  • Paulson and Bernake grossly underestimated the problem. He is amazed that Paulson didn't realize the extent of sub-prime exposure given his tenure at Goldman
  • He notes that many people at different government agencies saw the crisis coming—even more so than he did—but weren't listened to
  • He expects easy monetary policy into the next presidential term
  • QE “seems” to be working but is really just a big gamble
  • QE2 brings the governments motives into question
  • The “Toxic Twins”: fiat currency and an expansionary Fed will be a disaster
  • Glass Stegall needs a 2nd go
  • We are building a debtors’ prison for our children. Legacies are a fatal burden in a fast changing world
  • Don’t tolerate blind faith, figure things for yourself
  • Open a bank account in Canada
  • When asked how to improve the mortgage industry he said that the first step would be eliminating the government’s stance that they should incentivize home ownership. People are smart enough to make their own rent/buy decisions. He would also require originators to hold 50% of their production on their balance sheets.
  • He was very reluctant to reveal details of what he is investing in now
  • He has bought some farmland, but for very specific factors including currency (didn't really expand on this)
  • He has funded some venture capital type investments in Silicon Valley; noted that Silicon Valley is the only place where pure capitalism exists today
  • There are opportunities in small caps because they have lost sponsorship at most sell-side firms
  • Doesn’t think large caps are as cheap as others do
  • Hard to determine when people will lose faith in USTs
  • You don’t have to be the smartest analyst, he was 50th percentile at best in his med school class; you just have to be most dogged
  • Read every line item until you get it



2 Year Anniversary

2 years ago yesterday, on April 2nd, 2009, I started this blog with a post entitled: "What is Distressed Debt Investing?" After nearly one million page views, over 500,000 visitors, 6,000 RSS subscribers, and the onset of the Distressed Debt Investors Club, there is only one thing to say: Thank you...

  • Thank you to all those that send me emails with suggestions for posts, changes to the site, etc
  • Thank you to all that have contributed articles or content for posts
  • Thank you to all members of the DDIC for helping me build an incredible community
  • Thank you to all other bloggers and writers that have helped me hone my craft
  • And thank you to all my readers that make this experience as worthwhile as it is
I have many, many big things planned for the sites over the next few months that should make us bigger and better with more and more content everyday. Here's to hoping another great 2, 5, and 10 years in the future.

Thanks again,



University of Chicago Booth's Annual Distressed Investing and Restructuring Conference

In past years we have highlighted the amazing distressed conference put on at the University of Chicago Booth School of Business. This year, the 6th Annual Distressed Investing and Restructuring Conference looks to be another great event. Not only is the morning keynote being given by one of Distressed Debt Investing's favorite, Howard Marks, but there is a fantastic series of panels (including one focused on the AbitibiBowater bankruptcy) and panelists including Chris Sontchi (bankruptcy judge in Delaware) and many fantastic buy side and restructuring shops. These events are a great way to meet others across the variety of specialties distressed investing has to offer and always prove to be incredibly informative events.

We will have very extensive notes following the conference. The event will be held April 15th at the University Club of Chicago. If you are already attending, please shoot me an email.



Notes from the Harvard Business School Turnaround Conference

We mentioned to readers a few weeks ago about the 13th Annual HBS Turnaround Conference. Representatives from Distressed Debt Investing were in the audience. Here are some of our take-aways/notes from the conference:

  • Distressed investing is very cyclical and professionals operating in this space should be aware of where they are in the cycle. In the last 20 years there were three opportunities where there were large cap opportunities in distressed: 1990 (fall of Drexel), 2002 (Enron), 2008-2009 (Great Recession). And after EACH of those periods, a violent snapback followed in the market in terms of recovery.
  • What is happening in the market now is that when it comes to refinancing pre-recession over levered LBOs the bank debt is effectively in the money and it is being refinanced with secured high yield bonds (with fixed coupons vs LIBOR based rates) maturing not in 2012 but in 2017
  • This has caused many people to say the oft-iterated “Wall of Maturity”/massive amount of maturing debt has been pushed out with these recent refinancings and we are okay. But are we? The unsecured bonds from the original buyout are the fulcrum under current valuations – can these be refinanced? No. They could not be and have not been refinanced in the recent HY issuance boom. (Equity is wiped out)
  • In effect what the speaker is saying is that these large cap opportunities for distressed investors still exist and will present themselves in the next couple years – because smaller, more junior pieces of the cap structure were not refi’d and probably will not be capable of being refi’d, the LBO’d companies will have to be restructured, presenting opportunities for distressed investors
  • As the distressed "opportunity set" gets smaller (at least until borrowers hit the sub- and mezz-debt wall), distressed investors are getting "back to basics." This means creating value in small to mid cap companies through operational improvement and optimization
  • Stages of a Distressed Cycle: 1) Doing Nothing -> 2) Credit: Fear is Your Friend -> 3) Credit / PE: Back to Basics -> 4) Warm & Sunny
  • First Stage: Doing Nothing. Patience is a virtue – single hardest thing for an investor is to do nothing – he just goes home early from work when he’s in this stage. But Wall Street doesn’t work that way because it is transaction driven. On the other hand, investors get paid to make money, not do deals.
  • Second Stage: Fear is Your Friend. You can buy a lot when things get bloody. With that said, one issue for hedge funds is that duration of investment timelines don’t often match the amount of time it takes for a distressed play to pan out (i.e. one, two-year lockups are difficult to deal with when sometimes you have to ride out the storm before an investment pans out)
  • Third Stage: Back to Basics. The speaker believes this is where we are presently where distressed investors go back to what the majority of distressed investors focus on in most time periods - small/medium size companies
  • Fourth Stage: Warm & Sunny. This is the period that most people make mistakes: When people overpay and EV will eventually become less than amount of debt and companies are going to become insolvent – insolvent b/c they can’t refinance.
  • Companies become insolvent because they can’t refinance
  • Discipline is central (hallmark of investing).
  • Investors always chase yesterday’s performance which causes mistakes
  • Europe is interesting right now because bank shakeout has yet to occur but will happen. And there are complexities there. The risks are many w/ legal, currency, cultural etc. but if you can buy really cheap, there is a margin of safety that can protect you against some of these risks
  • In a world of extraordinary liquidity, big focus on Europe. European banks forced selling at pretty depressed prices. Basel will cause lots of deleveraging and asset sales.
  • With that said, certain prop desks used to be much bigger competitors, especially with the ability to source deals and investment opportunities. Now they are a much smaller operation.
  • There are a lot of financial professionals with the quanitiative skills to identify balance sheet issues and structure a solution -- but far fewer with the operational skill set required for day-today turn around mangement.
  • With record inflows, where are the opportunities: "Looking at $1bn company, 40 distressed guys show up. Prefer to have 3 other guys with two looking for jobs."



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.