Our Take: Opportunity in Distress
Investing in distressed companies is providing traders, portfolio managers and research analysts with some hot job prospects.
For more than a year, well-known institutions on both the buy- and sell-side have been quietly raising capital for new funds that seek bargains among "distressed" issuers - those going through a bankruptcy or restructuring. While such plays exist even in the best of times - think of the auto parts sector in 2005-06, or the airline sector just about any time in the last 30 years - the pickings tend to be relatively slim then. It's during economic downturns, when corporate borrowers are defaulting left and right, that bottom-fishers really go to town.
Such a period seems to be upon us now. And distressed-investment proponents are seriously gearing up to take advantage.
Distressed Assets Balloon - Who Will Sift and Manage Them?
"The noose is starting to tighten around a host of struggling companies," The Wall Street Journal declared recently in a page-one story inspired by the Chapter 11 bankruptcy filings of the Sharper Image and Lillian Vernon. The bankruptcies reflect more than just soft sales figures. Already awash in nonperforming loans from their mortgage, credit-card and auto lending businesses, banks are much less willing to finance corporations than they were a year ago. That's a major reason why the default rate among risky corporate borrowers, after posting record lows during 2007, is widely expected to soar this year. Moody's forecasts the global speculative-grade default rate will climb from 1.1 percent at the end of January to 4.8 percent by January 2009, and warns that a "significant" U.S. recession could push the default rate above 10 percent.
The Journal quotes bankruptcy expert and NYU Professor Edward Altman's estimate that $220 billion of high-yield corporate bonds, leveraged loans and other non-bank debt will default during 2008-09. That's a lot of distressed assets for bargain-hunters to analyze and perhaps manage through an extended workout process. They have plenty of cash to put to work: Private equity fundraising designated specifically for distressed investments zoomed 300 percent last year, topping $48 billion, according to Dow Jones.
One investor moving that way is Lehman Brothers Private Equity, a fund of funds that had its initial public offering on the Euronext Amsterdam stock exchange in July. The Lehman fund said 31 percent of its capital and 60 percent of new commitments since its IPO have gone into funds that invest in distressed debt and restructurings. Hedge fund groups that recently initiated or expanded distressed-investing strategies include GLG Partners, Oaktree Capital Management and Octavian Advisors.
Some distressed-debt funds are even focusing on mortgage assets, currently the most feared sector of the financial markets. Funds like the newly launched Oxford Opportunistic Mortgage Fund (run by Oxford Management Capital, in Houston) could become a landing spot for some of the legion of mortgage bond traders and researchers laid off by investment banks. The Oxford fund made its first deal this week, acquiring a $5.3 million pool of mortgages, according to the news site FINalternatives.
On the sell side, Wachovia Securities last month hired Jeremiah Keefe from Deutsche Bank as head of distressed debt, a new position supervising a team of distressed-debt traders. Wachovia is "building out a comprehensive suite of distressed debt and corporate restructuring services," and indicates Keefe's team is in hiring mode. Another sell-side firm, boutique investment bank Duff & Phelps, recently launched a special situations M&A practice for deals that involve "significantly underperforming" or distressed companies.
Restructuring and turnaround specialists are adding heads too. One such firm, New York-based Miller Buckfire, has doubled its professional staff in the past three years, according to The Wall Street Journal.
Many of these players are featured on the program at an annual Distressed Investing Forum, which takes place next Wednesday and Thursday in New York.