Over the past six months, distressed-debt investors have been waiting for a tidal wave of bad debt to wash their way. But the surge, which was supposed to have started this year and swell to $1 trillion in the next four years, has yet to appear. Its absence has left many firms that started distressed funds last year — including Alvarez & Marsal, Cerberus Capital Management, Citadel Investment Group, GLG Partners, Oak Hill Advisors and Sankaty Advisors — waiting like stranded surfers.
Much of this wave will be fueled by massive amounts of high-yield debt that can no longer be amended and extended. Legions of highly leveraged companies have put off doomsday by rolling out maturities, thanks to strong equity markets and low interest rates. “Many people have raised capital with one sole mandate, which is to invest in distressed,” says Peter Lupoff, founder of New York–based Tiburon Capital Management, which invests in distressed debt as one of three strategies. “These funds are forced to spend money at exactly the wrong time, because they’ve got an extremely narrow focus.”
Nevertheless, Kingman Penniman, chief investment officer of KDP Asset Management in Montpelier, Vermont, says a ground swell of debt is still coming — and it’s getting bigger. But it will also take longer to arrive. “When you look at 2012 and 2015, you see the aggregate amount in refinancings has actually increased by about $16 billion, to a total of $1.16 trillion,” Penniman says. This year, $35 billion is coming due, but that will soar to $418 billion in 2014, he reckons.
High-yield investors who are earning 10 to 12 percent annualized yields (down from 50 percent-plus last year) say they’re unfazed by Armageddon scenarios. “As far as the wall of debt goes, I’m not worried because so many companies have done proactive financing,” says Margaret Patel, who manages $1 billion in high-yield bonds at Boston-based Evergreen Investments. “People who have a liquidity wall coming are companies that went private and took on too much debt and can’t grow,” she adds.
Dwayne Moyers, CIO of Fort Worth, Texas–based SMH Capital Advisors, which manages $1.4 billion in assets, including high-yield bonds, is also optimistic. “We’re seeing a very conservative attitude from corporations,” he says. “Most have been pushing out debt obligations and many have called debt or made tenders. We see that ongoing.” Moyers says he is buying debt rated below BBB and emphasizing shorter-duration maturities to take advantage of the steep yield curve.
Investor enthusiasm has caused high-yield bond spreads over Treasuries to tighten. From January through late April, they came in by 87 basis points (although early last month the market widened by almost as much because of sovereign debt problems). “The big question from a technical perspective is whether cash starts leaving the system over the next few weeks while primary volume begins to pick up with new LBO paper,” Peter Toal, head of high-yield capital markets, Americas, at Barclays Capital in New York, said last month.
Make no mistake: An onslaught is coming. “Highly leveraged companies, particularly leveraged buyouts, have had little access to capital markets due to their excessive leverage,” says Jason Mudrick, CIO of New York–based hedge fund Mudrick Capital Management. “It is this wall of maturities that will cause defaults to rise as these debts move closer to maturity. Even this debt has traded significantly higher as investors misprice the default risk in their search for yield.”
Spreads reflect this. Year-to-date through May 11, Ba-rated credits are 10 basis points wider, B credits are 31 basis points wider, while lower-rated CCC credits are actually 32 basis points tighter.
This kind of pricing has caused at least one veteran to cash out. “For a distressed investor, when CCC bonds are going for 90 cents on the dollar,” he says, “you should be doing a lot of divesting.”
Many wait for the bottom to resurface, but patience is hard to come by. “For the investor that wants to own the fulcrum security in a company that’s going through a restructuring where there’s an equity-like return, there’s virtually nothing to do right now,” says Tiburon’s Lupoff. “We see the likelihood of it. But the reality is that it’s now May and we’re talking about 2011. That may as well be a decade from now.”
