For several years leading up to the big Credit Crunch of ’08, experts and pundits alike were pointing to hedge funds focused on the distressed market as the next group in line to clean up.
Yet time and again it never seemed to really happen; through the subprime crisis in the summer of ’07 and through the first round of the credit crunch, expectations were that buying up virtually every kind of distressed security would be an easy, no-brainer windfall.
Boy was that an understatement.
Of course, 2008 wasn’t great for distressed guys either, but as the rest of the world focused on trying to keep ahead of the game in ‘09, distressed-focused shops were out there grabbing loot.
Stuart Kovensky, co-COO of New Jersey-based Onex Credit Partners, a distressed debt shop, told attendees at an AIMA luncheon last Thursday that the opportunities this year have been “fantastic”.
“In 2009 we bought debt at fantastic prices – because people had to sell,” noted Kovensky, who along with financial newsletter notables Dennis Gartman and Scivest Capital’s John Schmitz participated in a panel discussion on what’s next for the economy, financial markets, and, of course, hedge funds.
In terms of the amount of distressed debt available at bargain-bin prices, “the sponge – the cash out there – wasn’t big enough to absorb it,” Kovensky said.
The reasons are fairly obvious: starting with the U.S. housing market collapse, which in of itself has generated distressed opportunities, and expanding into other areas as the U.S. and global economies recoiled.
In turn, the amount of defaults and accompanying opportunities to take on unwanted, undervalued, unloved debt have skyrocketed, said Kovensky, who with Gartman and Schmitz tackled everything from the end of the leverage-driven era to why the profit cycle and economic cycle have zero correlation.
Among Kovensky’s firm’s crowning achievements, he says, was buying Las Vegas Sands’ Tier 1 debt at 38 cents on the dollar, backed by the company’s real estate assets. Their year-to-date returns: up more than 48% — more than souble the 22.58% average through September, as measured by Barclay Group in the snapshot above.
But according to Kovensky, the party is already over. While deleveraging is still clearly underway, fire sales are less common as companies find different ways to restructure their debt.
While that still spells opportunity, “it won’t be anything like this year.”
Chapters 22 and 33
There may be opportunity in repeat offenders this year though. A new study by distressed debt guru, professor Ed Altman of NYU (see related posts) says that the number of companies that emerge from bankruptcy only to go back into it (via “Chapter 22”) is growing. According to data cited by Altman and colleagues Tushar Kant and Thongchai Rattanaruengyot even find some companies scoring the mythical hat-trick of bankruptcies (or so-called “Chapter 33”).
Altman concludes that his ubiquitous Z-Score can be used to predict the likelihood of a company slipping back into a coma.
This suggests that the party may not be quite over for distressed debt funds. In fact, Onex last week unveiled that it is planning an IPO of Kovensky’s fund, called the OCP Credit Strategy Fund, giving retail investors the chance to buy a piece of the longer-term payoffs it hopes to achieve.
You blinked – and you missed the distressed debt party. But the after-party is looking like it could be fairly sweet too.