Explain \"buying debt\"
 

I read this paragraph:

"Just about everybody thought Lampert was crazy in 2002 when he began buying up Kmart debt at around 40 cents on the dollar after the retailer filed for Chapter 11. Crazier still, Lampert loaded up more as the price sank to 20 cents, eventually boosting his total investment to $700 million."

And I simply do not understand what "buying debt" means, at least in this context.

I've Googled 7 ways to Sunday and can't find an explanation.

Can someone give me a rundown of "buying debt," and, if you're so kind, apply it to the article segment I quoted.

Thanks guys

Re: Explain \"buying debt\"
 

It's a more complicated form of lending someone money. Basically though, you're lending someone money.

In your example, he bought $1 of face value debt for $0.40. This means he bought a promise to be paid $1 for $0.40.

Re: Explain \"buying debt\"
 

well it could mean 2 things:

1) buying the liabilities of the company from creditors (literal creditors. like wholesalers that provide kmart inventory via accts receivable)

2) buying the corporate bonds (if the company is not in bankruptcy...if it is, i don't know if corporate bonds still trade or if they stop trading until the creditors work out what % they get and what is left for bondholders? and then are the bonds sold to people who could buy them?)...in this case, buying debt in terms of bonds may be evaluated as "kmart issued a bond with a 1k face value. it is now trading at $200 (aka 20% or 20 cents on the dollar). therefore buying that debt may be doing so when it is overly cheap."

i think it is the latter.

Barron

Re: Explain \"buying debt\"
 

In this case it's 2, though 1 does happen, usually through specialized debt collection agencies. Corporate bonds do continue to trade through bankruptcy, with their value varying based on the expected outcome of the bankruptcy.

Re: Explain \"buying debt\"
 

[ QUOTE ]
In this case it's 2, though 1 does happen, usually through specialized debt collection agencies. Corporate bonds do continue to trade through bankruptcy, with their value varying based on the expected outcome of the bankruptcy.

[/ QUOTE ]

thanks, clears that right up!

whats the relative price volatility of corporate debt after a chapter 11 files? i'd think it would rise significantly.

are there options on corporate debt? thats a good way to bet on bankruptcy i think if it were feasible, buy OTM puts on the debt if you think there is a larger than priced in chance the corporation will file chapter 11.

how would those options trade? i would assume that as the probability of bankruptcy becomes not insignificant, those options start to price in that extra volatility. but if you get in early enough, i would think that you would make a ton on the rise in implied volatility.

is this analysis correct? did i miss something?

are these types of bets available? do you know anyone or have you had experience w/ those types of situations?

sorry to just ask questions w/o serious research but if you know that would save me the trouble and i'd be much obliged.

thanks,
Barron

Re: Explain \"buying debt\"
 

[/ QUOTE ] are there options on corporate debt? thats a good way to bet on bankruptcy i think if it were feasible, buy OTM puts on the debt if you think there is a larger than priced in chance the corporation will file chapter 11.

[/ QUOTE ]

Yes. They're called credit default swaps. All the big investment banks make a market in them. It's a non-transparent, very lightly regulated market making it nearly impossible to know who owns them, who has written them, or whether or not the writer of the option will be willing and able to perform in the event of a credit default. They trade over the counter and don't go through an option clearing house, so it's really the wild west.

In the benign credit environment of the recent past, writing credit default swaps has been like free money. Hedge funds have approached them like insurance, belieiving that if they write CDS on a large number of creditors, the premia from the issuers who don't default will cover their obligations against the few that do after recovery. They certainly have super sophisticated models to assess value at risk, but it's really a grand untested experiment. My feeling is that adverse events in insurance happen more or less randomly. For example, if a neighbors house 3 blocks aways accidently catches on fire, there's no reason to think my house will accidently catch fire. But when an economy turns down, financial distress begets financial distress. The primary element of randomness that makes insurance work is violated. It's going to be interesting to see how it plays out in the next downturn.

CDS do add to volatilty. Delphi is a good example. Before Delphi defaulted a couple of years ago, the notional value of the CDS written on Delphi debt far exceeded the par value of the Delphi debt outstanding. Perversely, when Delphi finally filed for bankrtupty, the value of Delphi's bonds actually spiked. Did they spike because the debt had suddenly become more valuable upon the bankruptcy filing? No, they spiked because many of the writers of the credit default swaps bought the bonds in the open market at a discount to par rather than risk having the credit default swaps assigned to them at par.

Re: Explain \"buying debt\"
 

Thanks guys, you've answered my question and more

Re: Explain \"buying debt\"
 

LOl at buying sub prime Kmart debt for .40 on the dollar!

Ive collected on a huge amount of "bought paper" and 40% is a ridiculous price....something closer to 5-7% is the norm, 7% being very high.

Especially since charged of retail credit cards usually liquidate (successfully recovewred) at less thn 15% over a year and usually cap off at about 20% (on a really good batch)

Ive never heard of this guy before but seriously, 40% is a huge rip off, and I dont buy this one bit. There would be 0 ways to make money on this unless he wqas buying A tier credit stuff.....which isnt sold...the banks sue those people.

The bought paper is usally just debtors that have moved, some have filed bankruptcy, or refused to pay the bill in the past.

Google "buying charge offs" or something like that and you'll see what I mean. I know one place "chargeoff clearinghouses" used to sell portfolios per state and credit teir.

If you really want to make money doing this then buy some credit card portfolios for like 5% yhen have an attorney send out demand letters and offer letters to settle for 40-50% of the debt. You have to be licensed as a collection agency as well to take ownership over the debt. Or buy fewer, but larger debts and just have an attorney in the area sue the debtors with assests, and write off the ones that dont. Theres money in this...but you have to know a decent amount about risk management.

You'll also need some good skiptracers because the majority of the contact information you get with these accounts will be outdated.


If anyone is really serious about this PM me for more infomation.

(sorry for the spelling mistakes....im in a hurry)

Re: Explain \"buying debt\"
 

The guy in question is renowned investor Eddie Lampert. He came out pretty well on this "ripoff"

http://money.cnn.com/2006/02/03/news...pert/index.htm

Re: Explain \"buying debt\"
 

The OP is talking about corporate debt. You seem to be referring to consumer loans.

Re: Explain \"buying debt\"
 

This is obviously a reference to buying Kmart bonds that are trading in the market at 20 cents on the dollar. This is clearly not a reference to trade debt, as somebody suggested, since that stuff doesnt trade easily.

Re: Explain \"buying debt\"
 

[ QUOTE ]
whats the relative price volatility of corporate debt after a chapter 11 files? i'd think it would rise significantly.

[/ QUOTE ]

This depends entirely on the pre-filing capital structure of the entity, and whether in a reorganization, you're above or below the cramdown/pivot security.

Re: Explain \"buying debt\"
 

Realize that in a lot cases when people buy debt of bankrupt companies the debt is being bought with an eye towards the equity that will be received upon reorganization, and the analysis is going to be a lot different. This hold's true in Lamperts case with Kmart, by buying the debt he was really buying the stock in the company at a valuation that proved to be very very low. This is because when a company reemerges from bankruptcy the old common stock is usually cancelled and worth zero, and the bondholders receive the stock in the new company.

Say you have a simple example: There is $1,000mm of debt outstanding for a certain company that is now in Ch 11, it's all one class. The plan of reorganization has been approved and states that for every $100 of debt you hold you will receive $40 in cash plus one share of stock in the new company.

If the bonds are hypothetically trading at 60 then that implies a value of 20 for the stock to be received(because the cash is worth par). And if there is $1,000mm outstanding of old debt then the implied valuation of the equity is $200mm. For anyone buying this debt the analysis is going to be totally an analysis of the value of the equity of the company, as the cash is going to be worth face value. So if you think the equity is worth $400mm, then that would make the bonds worth 80 cents and you might buy. But that is the kind of analysis being done.

Re: Explain \"buying debt\"
 

[ QUOTE ]
[ QUOTE ]
whats the relative price volatility of corporate debt after a chapter 11 files? i'd think it would rise significantly.

[/ QUOTE ]

This depends entirely on the pre-filing capital structure of the entity, and whether in a reorganization, you're above or below the cramdown/pivot security.

[/ QUOTE ]

what is a cramdown/pivot security? is that the security that is in between the first lein creditors and the bondholders? probably not since that is a guess outta my ass but i am curious as to how that goes down.

no pun.

thanks,
Barron

Re: Explain \"buying debt\"
 

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
whats the relative price volatility of corporate debt after a chapter 11 files? i'd think it would rise significantly.

[/ QUOTE ]

This depends entirely on the pre-filing capital structure of the entity, and whether in a reorganization, you're above or below the cramdown/pivot security.

[/ QUOTE ]

what is a cramdown/pivot security? is that the security that is in between the first lein creditors and the bondholders? probably not since that is a guess outta my ass but i am curious as to how that goes down.

no pun.

thanks,
Barron

[/ QUOTE ]

the more senior securities can force the plan of reorg to go through even if the more junior securities are against it. that's called a cram-down. "The Vulture Investors" is a great book that shows how all this goes down.

Re: Explain \"buying debt\"
 

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
whats the relative price volatility of corporate debt after a chapter 11 files? i'd think it would rise significantly.

[/ QUOTE ]

This depends entirely on the pre-filing capital structure of the entity, and whether in a reorganization, you're above or below the cramdown/pivot security.

[/ QUOTE ]

what is a cramdown/pivot security? is that the security that is in between the first lein creditors and the bondholders? probably not since that is a guess outta my ass but i am curious as to how that goes down.

no pun.

thanks,
Barron

[/ QUOTE ]

the more senior securities can force the plan of reorg to go through even if the more junior securities are against it. that's called a cram-down. "The Vulture Investors" is a great book that shows how all this goes down.

[/ QUOTE ]

To expand on this, in a plan of reorganization, if a senior class of security votes in favor of a plan that gives them an impaired recovery, they can force the more junior securities to accept the plan; this is the cramdown. If you're above the cramdown you are money good (generally), if you're the pivot/cramdown security you generally get equity in the reorganized entity, and if you're below the pivot security you'll be either totally de-equitized or significantly diluted under the reorg plan. Generally, investing in distressed securities tends to have a strong bankruptcy/event/process angle to it, as opposed to the more trading oriented strategies it sounds like you employ.

Re: Explain \"buying debt\"
 

Andy Beal (the banker) made a chunk of his money buying debt. I forget from whom. IIRC, he bought it for like 10-20 cents on the dollar. 40 does seem really high, as another poster stated.

Re: Explain \"buying debt\"
 

[ QUOTE ]
The guy in question is renowned investor Eddie Lampert. He came out pretty well on this "ripoff"

http://money.cnn.com/2006/02/03/news...pert/index.htm

[/ QUOTE ]

If this was retail Kmart credit extensions via credit cards or instore credit then yeah 40% is a joke and this isnt true....however after reading more of the posts, I take it this is a bit different than the OP described?

I had assumed by the way I read the OP he was referring to commercial debt of their credit departments. If this was something more like corporate liens changings hands or higher end protfolios then I can see that. I havent read any of the linked pages but I assume he had some sort of an established financial investment or risk management company?

Its an interesting industry to say the least....but there's a lot of red tape and lawyers the farther away you get from retail debt acquisition.

Re: Explain \"buying debt\"
 

liv, why don't you just read the article [img]/images/graemlins/wink.gif[/img]

Re: Explain \"buying debt\"
 

[ QUOTE ]
Andy Beal (the banker) made a chunk of his money buying debt. I forget from whom. IIRC, he bought it for like 10-20 cents on the dollar. 40 does seem really high, as another poster stated.

[/ QUOTE ]

Gramma made some money this way too.

Re: Explain \"buying debt\"
 

[ QUOTE ]
liv, why don't you just read the article [img]/images/graemlins/wink.gif[/img]

[/ QUOTE ]

I spend too much time reading collection articles as it is [img]/images/graemlins/smile.gif[/img] I also dont have access to 2p2 at work.

I know what the OP is talking about now. Definately big profit....but you need a big foot in the door and a hell of a lot of startup cash, not every joe with money can do this.

Re: Explain \"buying debt\"
 

[ QUOTE ]


[/ QUOTE ] are there options on corporate debt? thats a good way to bet on bankruptcy i think if it were feasible, buy OTM puts on the debt if you think there is a larger than priced in chance the corporation will file chapter 11.

[/ QUOTE ]

Yes. They're called credit default swaps. All the big investment banks make a market in them. It's a non-transparent, very lightly regulated market making it nearly impossible to know who owns them, who has written them, or whether or not the writer of the option will be willing and able to perform in the event of a credit default. They trade over the counter and don't go through an option clearing house, so it's really the wild west.

In the benign credit environment of the recent past, writing credit default swaps has been like free money. Hedge funds have approached them like insurance, belieiving that if they write CDS on a large number of creditors, the premia from the issuers who don't default will cover their obligations against the few that do after recovery. They certainly have super sophisticated models to assess value at risk, but it's really a grand untested experiment. My feeling is that adverse events in insurance happen more or less randomly. For example, if a neighbors house 3 blocks aways accidently catches on fire, there's no reason to think my house will accidently catch fire. But when an economy turns down, financial distress begets financial distress. The primary element of randomness that makes insurance work is violated. It's going to be interesting to see how it plays out in the next downturn.

CDS do add to volatilty. Delphi is a good example. Before Delphi defaulted a couple of years ago, the notional value of the CDS written on Delphi debt far exceeded the par value of the Delphi debt outstanding. Perversely, when Delphi finally filed for bankrtupty, the value of Delphi's bonds actually spiked. Did they spike because the debt had suddenly become more valuable upon the bankruptcy filing? No, they spiked because many of the writers of the credit default swaps bought the bonds in the open market at a discount to par rather than risk having the credit default swaps assigned to them at par.

[/ QUOTE ]

While you're correct that one way to bet on banruptcy is to buy a CDS, you're way off on the spike in delphi prices being attributed to sellers of CDS buying up bonds at a discount. Delphi was mostly "cash settled" where bonds/loans were not delivered to be paid back at par but rather an auction was held to determine the accepted recovery rate and coverage was paid back based upon that. (I am sure some were physically settled still but not anywhere near the gross notional amount of CDS outstanding)

Also, it's important to note that there are many "tear-ups" when there is a Credit Event so that most dealers (and some client side as well) net down position pretty well and only a small fraction of outstanding CDS coverage is actually settled when a credit event occurs.

Also there are practically zero private investors who have CDS. Lastly while CDS are still mainly unregulated - the Fed and FSA have taken a big interest and require regluar reporting on CDS from the major broker dealers who in turn have asked clients to comply with various iniatives to add control to the market. As for no clearing house - check with DTC on that- the DTCC wharehouse will hold almost all (live) CDS trades (more than half of all current trading is confirmed through there and it is a Fed and FSA mandate to get the % clearing through DTCC (a part of DTC) to be at a very high rate.

Re: Explain \"buying debt\"
 

didn't read the rest of the thread, but "buying debt" is just a fancy way of saying "buying bonds"

Re: Explain \"buying debt\"
 

[ QUOTE ]
didn't read the rest of the thread, but "buying debt" is just a fancy way of saying "buying bonds"

[/ QUOTE ]

Um. Not anymore. You can buy bank debt and senior loans directly now from many large banks. This is dramatically different from buying bonds, but OP was confuzzed.