Expected returns in this latest go-around through the corporate credit cycle are not likely to be as high as when defaults peaked in the early 90s, according to conference participants. Historically, the greatest returns for investments in distressed debt have come at the times of greatest supply, said Marc Lasry, managing partner of Avenue Capital. But while the supply of distressed debt may be at an all-time high, return rates have yet to reach the levels experienced in the early 90s. According to data from Credit Suisse First Boston, overall default recovery rates in the early 90s were roughly 37%, compared to recovery rates of only 27.6% for the 2000-2001 period.
The extraordinary supply of distressed paper and extension risks are among the factors affecting the latest returns. Default rates have soared to roughly 10% and are expected to remain high for the rest of 2002, many speakers predicted, noting that the plethora of fallen angels account for much of the supply. In addition, John Stark, principal and ceo of Water Tower Capital, noted that the concept of extension risk has affected returns. A decade ago, there were high interest rates, high oil prices and a shooting war, but this situation was redeemed when interest rates and oil prices came down and the Gulf War ended, he explained. Today, interest rates are already low and oil prices may be high, but the war on terrorism has no ending in sight.
The business environment has changed dramatically as well. There are many companies plagued by complicated corporate structures and account fraud issues, noted Marcia Page, principal of Varde Partners. Stark supported this notion by referring to a cliché that has come to sum up the difference between this latest corporate cycle and the last. "In the early 90s, you had good companies with bad balance sheets," he said. "This time around, you have bad companies with bad balance sheets."