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Wednesday, May 27, 2009 11:32:14 AM
Valuing the liability side of a going concern is very different than one in bankruptcy. Debt may trade at a premium or discount for a healthy firm, but nearly always trades at a discount for one in Ch 11 (or 7).
The $1.8 billion dollar spread reflects a discount caused by uncertainty of receiving payment. Risk arbs generally seek a 25 percent annual rate of return. Needless to say, common and preferred shareholders are expecting a huge windfall from litigation because shareholder's equity is negative $1.3 billion. If litigation is successful, the debtholders can only receive their claim amount plus post-petition interest if WaMu is deemed "solvent" like Texaco, Manville and A.H. Robbins were in their cases.
If debtholders believed in a huge payoff from as much as the stockholders, then lowers classes of debt would be selling closer to par. Based on the spreads today, the expectation is this case gets resolved in about 18 months to 2 years.
Stockholders need to pray for quick settlements rather than large verdicts. The appeal process will take years.
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