Most of us strive to stay well clear of bankruptcy courts, loans gone bad, and properties in foreclosure. But for a certain class of savvy investors, known as “distressed debt” investors, such situations of crisis have the makings of lucrative opportunities.
It was these opportunities, as well as the unprecedented economic conditions that have created them, that 11 outstanding distressed debt investors gathered to discuss at the McIntire School of Commerce’s annual Fall Forum, held Oct. 15, 2010, in Old Cabell Hall. The Forum, titled “Distressed Debt Investing in Today’s Corporate and Real Estate Markets,” was presented by The McIntire Center for Financial Innovation and sponsored by UBS, PNC, and Simple Alternatives LLC.
“This year’s Fall Forum provided an outstanding opportunity for professional investors, members of the investing community, UVA alumni, and students to gain significant insight into the world of distressed debt investing,” said David C. Smith, Professor of Finance at the McIntire School and Director of McIntire’s Center for Financial Innovation. “These are the investors who come in and fix companies and properties that are broken or badly damaged by past financial misfortune. They are an integral part of a healing economy.” Smith noted that this year’s Forum qualified for 3.5 continuing education credit hours for CFA Institute members.
Broadly speaking, “distressed debt” refers to the financial obligations—commonly, corporate bonds or bank debt—of companies that have either filed for bankruptcy or are at serious risk of doing so. When a company or property becomes distressed, the holders of its debt may react by selling the debt at a discount. For distressed debt investors, such a sale may represent the opportunity to snap up a bargain, if the existing company claimants are eager to get out and in need of cash. Distressed debt investors buy the claims, and hold them until some sort of workout or restructuring is devised. Often, distressed debt investors receive new equity in the distressed company in exchange for the claims they own. In this way, the investors may end up owning the troubled company, and can set about turning it around.
The conference began with the remarks of keynote speaker Bruce Richards, Chief Executive Officer and Co-Managing Partner of powerhouse global credit manager Marathon Asset Management.
Richards was keen to point out that the key to success in the distressed debt sector is relentless, rigorous analysis. “You have to do your homework,” Richards said, explaining that Marathon has “SWAT teams” of analysts who go through the financial statements of possible acquisitions “line item by line item.” More, he said, it’s critical that distressed debt investors understand not only the company of interest, but also the industry in which the company operates, and the particular court in which it may file for bankruptcy.
Richards also acknowledged the bonanza that the recent financial crisis created for distressed debt investors, as sound companies were rendered insolvent by shocks to the financial system, rather than by fundamental flaws in their business strategies, incompetent management, or the obsolescence of their products or services. Still, he told the audience, until economic growth picks up, debt investments “will continue to outperform” equities.
Richards’ talk was followed by a panel discussion of the corporate distressed debt market, featuring expert commentators Michael Alexander (McIntire ’99), Senior Vice President and Investment Analyst at Marathon Asset Management; David Hilty (McIntire ’90), Managing Director at Houlihan Lokey Howard & Zukin; Phillip Schaffer (McIntire ’77), Managing Director and Portfolio Manager of Katonah Scott’s Cove Management LLC; and John Shippee (McIntire ’85), Principal at Intermarket Corporation. The panel was moderated by Carney Hawks (McIntire ’96), an Original Partner with Brigade Capital Management.
The panel discussed such topics as the critical role that financial restructuring firms such as Houlihan Lokey Howard & Zukin can play in finding value in troubled companies; why restructuring tends to be dominated by small firms; and how the distressed debt market can be monitored, given that there’s no formal credit market index.
Panel members also had the opportunity to react to criticism of the distressed debt investment industry, and to discuss some of the benefits that distressed debt investors offer to target companies, other debtors, and the economy in general. Such benefits, they said, include the improved payment rates of all creditors; lower rates of liquidation, allowing businesses to keep running and workers to remain employed; and injecting more liquidity into the market.
“We’re really not ‘vultures,’” Hilty said. “We don’t want to liquidate companies, but to rehabilitate them—our interest is in seeing companies thrive.”
Unease in Real Estate
The Forum’s second panel featured a discussion of current and likely conditions in the market for real estate-related debt. The panel was composed of David Chattleton (McIntire ’00), Executive Director in Morgan Stanley’s Real Estate Investment Banking Group; Allen de Olazzara (A&S ’81), Founder, Chairman, and CEO of America’s Capital Partners; Jeff Johnson, Managing Principal of Reunion Office Holdings; and Robert White (McIntire ’87), Founder and President of Real Capital Analytics Inc. Robert Harper (McIntire ’00), Managing Director in The Blackstone Group’s real estate private equity group, acted as the panel’s moderator.
Asked to consider what the next few years will likely hold for commercial real estate, the panelists were not optimistic. Although the situation is no longer the “cardiac arrest” scenario of three years ago, Chattleton said, default rates in the commercial real estate sector remain high, and recovery in the sector seems to be stalled. More, White pointed out, lenders remain risk averse, and although the commercial real estate market has to some extent stabilized, it’s not “out of the woods” yet.
Though the panelists agreed that current market conditions may be conducive to certain distressed debt investment opportunities, they voiced only tempered optimism when it came to predicting rapid or robust growth in the U.S. economy. When asked which country would likely lead the world out of the current global recession, the panelists offered China and India as the most likely candidates, citing concerns over employment and consumer demand in the United States. “It’ll be an interesting next few years,” Chattleton said.