Some Takeaways from Citi's Distressed Desk

Last week, Citi held their annual credit conference, an event I have attended for many years and always have thoroughly enjoyed. I would love to spend time writing a post on keynote speaker Michael Milken's fantastic keynote speech at lunch but thought it would make sense to spend time on some takeaways from commentary by Citi's distressed desk.

Scott Balkan, the head of the desk, kicked off with some insightful comments about the current positioning and state of the market. He noted that distressed funds across the board had a specific predisposition to safer trades. He used the analogy of two distinct trades (I'm paraphrasing the numbers below):

• Trade A: Security trades at 10. Three outcomes: 12, 15, 18
• Trade B: Security trades at 10. Three outcomes: 5, 12, 100

Scott noted that funds are reluctant to consider trade B and risk loss of capital despite the enormous upside in the tail scenario. I've touched on this topic before when discussing convex versus concave investing strategies.  Because of this dynamic, Scott noted that options (tail events to the upside), are more than likely mis-priced in the market and therefore present opportunities for the diligent investor.

Citi conducted a survey with their clients earlier in the year regarding positioning, cash balances, etc. On of the more interesting takeaways from the survey was very fund funds think their cash position is below average. But at the same time very fund funds think the current opportunity set is above average. No respondent said the opportunity set was very high. For me this is somewhat hard to reconcile.

One of Scott's final points was that most investors are fine being late. This corresponds with investors being predisposed to safer trades. The hardest investment to put on in any market is the falling knife. And because, across the board, funds are ultra focused on short term performance, funds are avoiding that falling knife. Another opportunity for diligent investors.

Citi's desk analysts then presented a number of ideas in the current market place. I will say the presentations across the board were fantastic. While I will not relay what securities the analysts discussed or which way they were positioned (ask your Citi sales coverage), the situations discussed included (but not limited to):

• Ambac
• AMR
• Sharp
• OSG (OSG had filed that morning! Everyone perked up started talking notes when they analyst began speaking)
• TXU

Overall, as usual Citi put together great ideas for distressed investors to chew on in a very difficult investing environment. Scott Balkan did note the desk is doing simply enormous volume and as I know a number of the distressed analysts personally, they deserve the volume given their quality of research, market color, and commentary. Great stuff.