Distressed debt investors are finding too many other players in their sandbox, crowding their space and taking some overdue distress out of the distressed market. Speaking at the Strategic Research Institute's Annual Distressed Debt Investing Forum in Las Vegas last week, investors bemoaned the lack of investment opportunities because of the increased competition from new players, especially hedge funds.
Scott Victor, founding partner of SSG Capital Advisors, a boutique middle-market investment banking firm, said the large amount of capital means that good distressed opportunities are fewer and more difficult to find. "There are many situations that get recapped because there is a tremendous amount of capital," said Victor. "Those of us in the distressed and turnaround markets hope and pray that there will be a recession. But there is a ton of money and a lot of deals are getting done to keep companies out of Chapter 11 that should be in Chapter 11. In '01 it was difficult to get financing done for anything but healthy companies. Now it is very different."
Private equity firms cited hedge funds as increasing competitors. Some criticized them for being too aggressive and not doing enough due diligence on many deals. One area that hedge funds are increasingly competing with other lenders is the second-lien finance market. This area has grown rapidly and the lack of rights on some of these deals, such as covenant rights, alarms some investors. "The broadly syndicated second-lien market has grown substantially. Many of these loans do not contain the rights that we would customarily expect to see," said John Brignola, managing partner and co-founder of LBC Credit Partners.
Hedge funds are not the only players to invest aggressively in new, riskier areas of the market. Brignola said collateralized loan obligations are gobbling up second-lien paper. The fierce competition is also causing traditional lenders to do riskier deals. "Two years ago, you saw more hedge funds helping out on deals. This year, traditional lenders want to be more involved in riskier deals," said Ryan Esko, director at AlixPartners, a turnaround and restructuring firm.
Some expressed concern that some hedge funds may not survive the distressed cycle. "There is a danger that institutions like hedge funds are not equipped to go through the entire distressed cycle," said Maria Boyazny, principal at private equity firm Siguler Guff & Company. "It will be interesting to see how the cycle unfolds with a different set of players."
Increased liquidity means that many companies hold too much debt and creditors may not get the returns they had hoped for. Esko pointed out that because companies are highly leveraged, it is more difficult for companies to maintain value for all creditors. "In a quick fire sale, companies were able to maintain more value for all creditors four years ago. But with the higher leverage, a much higher value must be realized and creditors with second liens and further down the capital structure will be feeling the pain in a fire sale," he said.
