Irrational World of Distressed Debt Leaves $15 Billion Idle

It was a flashpoint in the world of distressed investing: Sanjeev Gupta’s infamous metals empire was falling apart as Greensill Capital imploded.

As turnaround specialists sought to grab debt of one of his key assets on the cheap, a single U.S private-equity firm swooped in to buy up the lion’s share -- at full price.

While the supply-chain saga has sparked a lobbying scandal in the U.K. political establishment, for troubled credit creditors it shows the everyday challenges of deploying the $15 billion lying idle in distressed funds. Thanks to a central bank-fueled financing bonanza, even borrowers on their knees have leverage over the big-guns of high finance.

With developed economies recovering, deals are rare and hard-won. Faced with vanishing ways to profit from distress, once-adventurous traders are joining banks in the loan market or competing with insurers buying debt of publicly-rated companies.

Industry practitioners are taking a glass half-full view on all this, but there’s no question the distressed debt community is downsizing lofty ambitions forged in the pandemic downturn.

“The market is irrational,” said Galia Velimukhametova, who manages Pictet Asset Management’s $400 million Distressed & Special Situations Fund. “The opportunities’ set has shrunk -- but you can still cherry pick and position for when the euphoria will settle.”

Irrational World of Distressed Debt Leaves $15 Billion Idle

The existential challenge distressed debt investors face may not be new after a decade of easy-money policies that encouraged companies to refinance debt at reduced costs. But the swift rebound from the depths of the pandemic has taken many by surprise.

Stimulus-inspired growth has pushed global default rates back to 2018 levels and the number of traded distressed bonds to pre-pandemic levels.

“We are now bearish on distressed, as the landscape may prove challenging for capital deployment given the substantial decline in defaults and levels of outstanding distressed debt,” wrote Jens Foehrenbach, chief investment officer of Man FRM, in a report published on Thursday.

Industry players point to opportunities for those willing to dig a little deeper. Some are lending to small to mid-cap borrowers, filling a void left by retreating banks.

Others are crowding into junk bonds, joining hordes of yield-starved investors. Returns on speculative-grade corporate debt, at about 2.5% so far this year, pale in comparison to the gains distressed debt investors are used to.

For example, when German luxury retailer Douglas GmbH refinanced $2.8 billion dollar equivalent of debt last month, it attracted significant demand from distressed debt investors and private credit funds, according to people familiar with the deal.

“There has definitely been a lot of money raised within credit opportunities strategies which is also flowing into selected public high-yield transactions right now,” said Murad Khaled, head of EMEA leveraged finance capital markets at Bank of America Corp.

‘More Niche’

When he’s not buying baseball-card companies, Mudrick Capital Management founder Jason Mudrick is scouring the $3 trillion market for leveraged credit in North America, where he’s been helping finance leveraged buyouts for smaller companies.

“Just because the largest distressed investors can’t find anything to do doesn’t mean there’s not a lot going on -- there’s just not a lot going on where they’re looking,” Mudrick said. “The more niche parts of the market are definitively presenting more lucrative opportunities.”

He’s actually expanding in Europe with the takeover of a credit hedge fund previously run by CVC Credit Partners, and will announce a new hire in the region in the next few months.

There may even be chances left to jump into Gupta’s sprawling debt complex, with his Australian businesses seeking new loans.

Among other targets traders are eyeing up: Abu Dhabi-based defaulted healthcare group NMC Health Plc. They’re circling $6.4 billion of debt tied to NMC Health’s administration ahead of a deadline in one month for creditors to back a restructuring plan, according to people with knowledge of the situation.

“European funds are nibbling into emerging markets while they wait for another two or three quarters for European companies to show the real picture,” said Pictet’s Velimukhametova.

End of Euphoria

The adversity that distressed funds long for may ironically be the result of the European economy really picking up steam, forcing policy makers to consider withdrawing aid.

Some at the European Central Bank may push to begin scaling back the 1.85 trillion-euro ($2.2 trillion) pandemic bond purchase program in the third quarter as the economy is likely to stage a strong rebound. The result -- higher debt costs -- may be felt most acutely at companies with the biggest debt burdens.

“Leverage is racking up and is often understated when you take into account often generous Ebitda adjustments,” said Duncan Priston, the co-head of European credit at distressed debt firm HIG Bayside Capital. “We expect to see a pickup in restructurings and defaults in the second part of the year as governments start phasing out economic support.”

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