Quote from Daal:
I can concede that buying C was a mistake, not because they are risky, I still stand that they are safe, since the bloomberg article doesnt mention that the government doesnt have the legal authority to 'haircut' bonds(I dont think you will see Geithner going to congress to ask for the authority to shed bank debt, since no US bank would be able to raise debt without a FDIC guarantee likely for years)
What they can do is to ask for debt to equity swap, which you can say no. Regarless I'm going to short a bit more C today in this rally to further protect the position, Whitney says she still not a buyer of C, so the hedge could easly make money. This will get my short to 1/3 of the bond
The reason it was a mistake is because I'm currently looking for bargains in the junk bond market and I'm finding some issues that are absurd. Take International Lease Finance Corporation(subsidiary of AIG, a tip from bill gross), the 2010 bonds yield 33% YTM, the company is hugely profitable, has access to the fed CP facility, has an inventory of $17b of airplanes that can be sold in order to generate cash yet because its AIG people are selling first and asking later. That fact that the company is connected to AIG raises the chance of survival since back in Sep AIG loaned about $1.7B to help the liquidity of ILFC. Even if ILFC were to go bankrupt, since they got tons of airplanes the bond recovery will be high, likely 100%. And they could get bought out since the company is still very much profitable
And I'm seeing bonds like that over and over again. Goodyear is another one I'm looking at. I'm thinking of strategically buying bargain corporate bonds up to 15% of my networth to get me more comfortable in taking shorts
These could be interesting plays, but let's be a bit more realistic on the risk here. Any finance company's current profits (i.e. backward looking) are irrelevant - what matters are its future cashflows. So IFLC should be analysed for 09 and 2010 cash earnings, not 2008 paper/GAAP earnings. I am not saying they won't make money the next 2 years, just pointing out that your investment case should focus on that and not on their last year earnings. Lots of homebuilders had great earnings in 06 after all, but 07 and 08 weren't so pretty.
Second, their collateral will collapse in value. Aeroplanes are big ticket items heavily dependent on financing. If we get an extended recession/depression, plane values will collapse, eroding the collateral for the bonds. This needs to be accounted for in any investment analysis. If a firesale occurs, then half the world's airlines will be bust and firesaling planes at the same time. The collateral will follow a similar trajectory to the Baltic Freight index last year and your margin of safety evaporates.
As for Goodyear, their main customers are having the biggest industry bust since the 1930s, so much if not all of the yield is simply compensating for the very real risk ("certainty" may be a more accurate term) that the auto sector goes up in smoke.
I agree that corp bonds are more value than stocks, so a spread play on the capital structure could prove profitable despite the huge short-squeeze risk, just keep your size down because the stocks can go up 100-200% in a week on air, making the "spread" far more risky than a simple bond outright position. Are you earning multiples more $$$ with a bond/stock spread compared to a pure bond long, per unit risked? I am not so sure. A bond risk is max 100%, a bond/stock spread max risk is 400 or 500% (like the VW voting/non-voting stock "arbitrage" that turned out to be more risky than a 2:1 margined long in FNM). Yes that's probably quotational risk rather than risk of permanent capital loss, but only if it's a small position. Even a 1% short becomes a 5% position in a short-squeeze.
As for bond outrights, just like Asia 1998, UK 1974, Nasdaq 2002 or USA 1932 I expect they will first get to bargain prices, and then collapse another 50-80% from there. Historic bear markets always sucker in value players before they make their biggest move down. Bill Miller was first, Marty Whitman second, Buffett third, now Gross will go. The credibility of all value players must be destroyed before it becomes time to make any investments.
(they have gone bankrupt twice in the past)