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The return of distressed debt opportunities – how to stay ahead of the curve

20 October 2020

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Our recent webinar addressed exciting trends in distressed debt, which is set to be a key opportunity in the wake of the global pandemic.

As the financial markets continue to adjust to the profound impact of the COVID-19 pandemic and shutdown measures, volatility has become the norm and the sense of uncertainty prevails. This economic turmoil is testing the resilience of the private lending industry, and accelerating the race for distressed debt opportunities.

In a recent webinar hosted by Intertrust Group, distressed debt was a point of focus, with the crisis expected to cause a surge in defaults and insolvencies. A live poll held among the audience revealed that 60% expected to see an increased allocation to distressed assets, followed by private debt (25%) and private equity (15%).

The panelists weighed in on the secondary market opportunity for distressed assets and how the landscape differs from the previous global financial crisis. Cliff Pearce, Global Head of Capital Markets at Intertrust Group, said: “The 2008 crisis was born out of a credit issue, a broken banking system. This crisis isn’t born out of that – but the more prolonged it becomes, I fear the consequences will be similar to those in 2008. Effectively, governments can’t keep stepping in to bail out or mask the underlying problems, manifesting themselves in payment defaults.”

Riding the waves

Commenting on the difference in cycles from a global perspective, Cliff added: “We saw very quickly that volatility hit the markets, which then came back and stabilized. Asia, which obviously got hit first, has now been through various cycles and is seeing more reconditioning there. Chinese airlines and lessors, for example, are now starting to be active again. This can give hope for other economies.”

Tony Longi, Chief Operating Officer at Newport Global Advisors, explained: “During a credit cycle, there are always pockets of distress that tend to be industry-driven. When we have shocks to the system, like we had during the global shutdown in March-April, then we have distress that really hits all sectors, usually caused by dislocation of liquidity to the marketplaces. When liquidity gets drawn out, those opportunities for distressed debt investors are prime, especially if you have capital ready to deploy and you understand how to deal with distressed credit.”

Daniel Hunter, Partner at Schulte Roth & Zabel LLP, commented: “We are seeing a distinct drive for yield. Massive amounts of dollars were raised for private equity funds but there is still an enormous amount of dry powder. We are now seeing real distress across the travel, hospitality and energy sectors. If you are a distressed manager, the good news is those opportunities exist; the bad news is that there are quite a few hedge funds, credit funds and private equity fund managers fighting over those pools.”

Embracing opportunities

Asking the audience for their views on how LPs are viewing the risk/reward profile of distressed debt opportunities, 69% believed this to be favorably, compared to 31% who said unfavorably.

Jeremiah Loeffler, COO-Credit of Crestline Investors, agreed with the audience’s sentiment, adding: “In the direct lending space, we have definitely seen investors show a strong appetite. We have open fundraising on all three of our strategies right now and are still closing investors in the midst of this turmoil, which is indicative of their appetite for getting into the risk reward in the credit markets today.”

When asked how recent Central Bank policy responses have impacted the ability to find real opportunities, compared with the credit crisis of 2008, 67% of the audience believed it to be harder in the short term. A fifth (20%) believed these had resulted in clearer opportunities and a minority (13%) found it harder in the medium-to-long term.

Formulating a plan

Finally, a look at the competitive challenges that managers could face ahead of diversifying into the private credit distressed space, revealed the need for managers to demonstrate a high understanding of the assets, have a competitive edge and know where to add value.

Cliff at Intertrust Group commented: “As you move into a sector that you haven’t been in before, having the expertise to underwrite that opportunity properly is going to be key. If you are a private equity fund, having immediate liquidity at your disposal, for example, in the form of a fund finance facility is going to be vital as well. Understanding the assets so you can price them correctly and work them out, is going to be paramount.”

Daniel at Schulte Roth & Zabel LLP concluded: “I think that, like anything in life, you must distinguish yourself and set yourself apart as a manager. There are already a lot of people out there with enormous depth in credit – so if you do want to make a name for yourself, knowing where you add value is extremely important.”