Insights series / 23 August 2021
3 opportunities for distressed debt managers today
2020 turned out to be a underwhelming for distressed strategies. The opportunity was staved off by multi trillion-dollar government grants and loans, which became available to businesses very quickly. Impressive central bank asset-purchasing programmes were also quick to roll out, equating to $1.5bn of bond buying per hour globally, according to Bank of America.
The Covid-19 opportunity may have been over before it really began, but market participants are raising war-chests and biding their time.
There are now a record-high 79 distressed debt funds in North America and Europe, and as at Q1 2021, special situations and distressed debt comprises 40% of total private debt assets under management (‘AuM’), up from 16% in 2009. The largest distressed debt fund is currently seeking $15bn of assets, according to Preqin data.
For these managers, the opportunity has merely been postponed: as the economic cycle progresses, the next recession, and with it, the next downturn in the credit cycle, beckons.
To this end, we look at the top opportunities distressed debt managers have in their sights today.
1. Covid-19 long-tail opportunities
Market participants have noted that if the stress post-pandemic is anything like that which followed the Global Financial Crisis (GFC), high-yielding deals will continue even five years after it “ends,” as the aftermath of such an economic event causes a long tail of attractive opportunities available to those looking for them.
As such, the aftermath of Covid-19 has the potential to transform balance sheets, with an ever-increasing amount of distressed lending taking place. It’s worth noting that distressed debt opportunities tend to do best after a crisis rather than in the middle of one, when prices are volatile. For example, some distressed debt hedge funds notched up gains of 36% in 2009 and 23% in 2010.
Managers such as Connection Capital, a UK-based distressed debt manager, have gone on the record, reiterating this point, adding that government action has so far disguised the problems rather than eliminating them.
No doubt, these problems will continue to come to the fore as time goes on.
2. The usual opportunities do persist
There are still companies that have become overly indebted, retain large-scale brand recognition and have a fundamentally sound businesses model that make them interesting to distressed debt managers.
One interesting case study in 2020 included car hire company Hertz, a business whose debt burden had grown to an unsustainable level. The company had spent the years prior to the pandemic investing heavily in upgrading its business, so it had less capital than its rivals to ride out lockdowns and tourism coming to all but a complete stop.
In March 2021, Hertz revealed it was snapped up by distressed debt manager Knighthead Capital Management LLC and partners, in a $4.2bn restructuring plan with the managers expected to slash debt and buy up to 100% of the shares in the company.
According to credit rating agencies, there are plenty of companies in a similar boat to Hertz, though the opportunity is more pronounced amongst firms who are unable to access the bond market.
3. Less liquid or niche deals are a potential source of opportunity
Managers see another way to invest in the distressed opportunity, by searching for less liquid deals or stressed rather than distressed opportunities – which could be key to delivering on target 15%+ gross IRRs.
There is less competition for such assets after all, so returns will be higher, as the main fray takes place in the more liquid parts of the market.
Opportunities here persist too, Arena Investors is recently reported to have already deployed almost all the $520m they raised in 2020 for their special opportunities fund. They targeted industries dislocated by the pandemic, including real estate loans where banks "feared to tread,” and much more niche opportunities like litigation finance.
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