Description

Summary: This is a relatively straightforward idea but is very low risk and good for 5% gross return over the next month or so (so a good IRR for very little fundamental risk). 

Trade: Buy PG&E pre-petition debt either outright or hedged with (pari passu) match-dated new issue debt to lock in the gross return.  I'll use the 6.05% due 2034 (ISIN: US694308GE15) for illustrative purposes below but a list of 6 bonds which all benefit from the same package of consideration are listed below. 

Return Calculation (for the 6.05% due 2034): 

• Each pre-petition bond is entitiled to: 
  • (i) Pre-petition interest + post-petition (statutory) interest; plus
  • (ii) 0.5 new 4.55% PCG Utility Bonds due 2030; plus
  • (iii) 0.5 new 4.95% PCG utility bonds due 2050
• Valuation of each element: 
  • (i) Interest => 6.2pts (assuming a 30-Jun-20 exit date). Comprised of 2.5pts of pre-petition interest + 3.7pts of staturoty interest; 
  • (ii) 4.55% PCG Utiltiy Bonds => 58.5pts. PCG issued Investment Grade bonds earlier this week.  These IG bonds are pari passu with the 4.55% bonds.  The 2031 maturity IG bond issued earlier this week is trading at a spread of 190bps.  Using 190bps to value the 4.55% bond derives a value of 117 and you receive 0.5 bonds.  117 x 0.5 = 58.5 
  • (iii) 4.95% PCG Utiltiy Bonds => 62.7pts.  Per above there was also a 2050 maturity IG bond issued this week.  These are trading at a spread of 210bps.  Using 210bps to value the 4.95% bond derives a value of 125.5 and you receive 0.5 bonds.  125.5 x 0.5 = 67.75  
• Aggregating the above arrives at a value of 127.4pts
• Current Trading Price: 121pts 
• Gross Return: 5.3% (127.4/121 = 5.3% return)

Timing 

•  PCG will emerge from Chapter 11 bankruptcy before the end of this month and the new bonds will be issued at emergence
  • The bankruptcy court approved PCG's plan of reorganization on Friday 19 June => as such any process risk is now gone
• PCG's Utility Bonds have been rated investment grade - they will enter the IG Index next month 
• The new bonds should reprice to the same spread as the current bonds outstanding 
  • All bonds are pari passu and the IG bonds described above are match-dated maturities to the new bonds that will be issued 
  • If repricing does not occur there would be a kink in the PCG credit curve which would be very unusual for an Investment Grade issuer (i.e. it would get arbitraged away or traded away by real money holders selling expensive securities to buy cheaper identical securities) 

Why Does The Opportunity Exist?

• Process Risk => PCG has been in Chapter 11 for almost 1 1/2 years.  During the Chapter 11 process there has been actual or percieved process risk which has made it difficult for investment grade buyers to buy PCG debt (even after the package of securities one would receive - as described above - was confirmed earlier this year).  Post court confirmation of the PCG plan on Friday this risk has now gone but many IG buyers will likely wait until the new bonds are issued to buy them 
  • This is an unusual bankruptcy insofar as the company will emerge with Investment Grade debt.  This creates an opportunity as IG buyers are not typically looking at bankruptcy dockets
• Complexity => The process has gone on for a long time and has been complex.  Similar to the point above IG buyers are not following BK dockets or looking to invest in companies pre-emergence with significant amounts of bankruptcy process complexity.  Once the company emerges and the new bonds are issued the complexity is gone - the company will again be a utility with investment grade bonds (comparable to Edison International) 
• Valuation => Until the PCG IG bonds were issued earlier this week there was also a question re: what the value of the new bonds would be.  Post the IG issue this is now known as there are directly comparable bonds trading in the market

List Of Bonds

• Each of the pre-petition bonds below are entitled to the same package of new IG bonds described above (i.e. 0.5 of each of the 4.55% due 2030 and 4.95% due 2050 for each 1.0 pre-petition bond held) but will be entitiled to different amounts of interest (interest calculated based on pre-petition interest entitlement using coupon plus number of days owing plus statutory interest for the post-petition period)
  • PCG 6.05 03/01/34 
  • PCG 5.8 03/01/37 
  • PCG 6.35 02/15/38 
  • PCG 6 1/4 03/01/39 
  • PCG 5.4 01/15/40  
  • PCG 5 1/8 11/15/43 

Catalyst

• Emergence from bankrutcy and issue of new bonds => likely before end-June 2020
• New bonds go into Investment Grade Index => the month after issue (July 2020)
• Investment Grade buyers buy the new bonds (or sell existing bonds and switch into new bonds to capture the spread differential) => as soon as the new bonds are issued (otherwise there will be a pure arbitrage which is material in size)