By Leslie Kramer
Investors eyeing the distressed debt sector have a myriad of issues to sift through to mine the gems they are hoping to find. Finding the value in underlying assets, getting a price where sellers are willing to move and targeting various tranches in the deal structure are some of the issues expected to be discussed at today's "Distressed Debt Investment Strategies: What Does the Future Hold?" panel.
Arne Kluewer, Frankfurt, Germany-based partner at law firm Clifford Chance, noted that billions of dollars will need to be refinanced over the next few years and lenders must decide if they want to extend loans, allow borrowers time to refinance or enforce the terms and security of the loans. "This creates the potential for arbitrage scenarios in which borrowers will start buying back debt at a discount--to the extent that that debt is trading at a discount and is available," he said.
Some investors, holding debt in the form of loans or a securitized product, are assuming that borrowers will eventually pay up, especially if the underlying assets come back. "From the borrowers' side, the opportunity is to buy back their debt, but from the lenders side...the strategy is risk mitigation," Kluewer noted. Lenders may also choose to invest in the asset itself by entering into debt-to-equity swaps. Additionally, third-party investors may look to buy the debt at a discount or buy the underlying asset at the current market price. "There are legal challenges and market challenges to that, but those two approaches will surely be discussed," Kluewer said.
In the European commercial mortgage backed securities market, there is about E130 billion of CMBS outstanding and in the next 15 to 18 months there will be about E10 billion of underlying loans that will reach maturity, said Paul Severs, partner, at London-based law firm Berwin Leighton Paisner. Between now and 2013, another E90 billion will reach maturity, so either the vehicles are going to need to be restructured or there will be sales of collateral. "Because of the way the capital structure works on a lot of these deals, there will be pressure to sell the underlying asset, be it an office building, retail park or shopping malls," he said. Sellers will then be faced with the question of whether to sell at the bottom of the market or hold onto the asset with the hope that the asset value comes back in the next two to three years. "That is a problem for everyone: Will credit spreads tighten and yields on properties tighten, creating some value again?" said Severs.
Kluewer said one issue in the market is that some investors are not willing to sell their bonds at market price, preferring to hold them until the underlying assets increase in price and increase the value of their investment. Speaking generally about finding a price in the market, Severs said: "My experience is that the sellers are not selling at the prices the buyers are willing to buy; there has been some trading, but asset values have not stabilized."
Carolyn Aitchison, managing director at GSO Capital Partners, said that a topic she will be focusing on during the panel is investing in AAA- rated CLO securities in light of the rating agencies' methodology changes and underlying loan portfolio performance. Defaults and the amount of CCC-rated securities are increasing in the underlying leveraged loan portfolios in CLOs, and that is causing cash flows to be diverted from the lower tranches of CLOs to more senior tranches, including the AAA securities, as some transactions are seeing prepayments, she said. "We think as a result, AAA CLO securities are actually an interesting potential hedge from a credit perspective in a portfolio, because as defaults increase in the underlying loan portfolios, the returns on the AAA CLO securities potentially improve as the duration shortens," she added.