Credit Value Partners LP, is a distressed debt value based hedge fund. The fund recently outlined why they see many opportunities in the space currently. Below is a summary.
Stressed and Distressed Loans are an attractive asset class in this environment
1) A high-returning alternative to corporate equities
- Underlying investment target (U.S. and European Companies) is essentially the same as for public equities
- Historic investment returns on Distressed Loans have significantly exceeded those for equities1
- Historically, attractive total returns and current interest income
2) Providing better downside protection and lower volatility
- Investing in the most senior portion of a company’s capital structure, secured by the company’s assets
- Investing in companies at distressed prices and depressed valuations
- Recoveries on secured loans in bankruptcy are far superior to those on equities
1) A Natural Default Cycle is Underway: Corporate distressed debt investing cycles have historically been created by high levels of LBO related debt defaults. LBO debt maturities are coming due in record volumes over the next three to five years. At the same time, the average non-investment grade company is highly leveraged with greater than 5x debt to cash flow. This combination alone is likely to create high levels of defaults and a large distressed investing opportunity.
2) Credit Tightening Typically Leads to Higher Defaults: The European Sovereign Debt Crisis has recently and materially infected the U.S. High Yield Bond and Leveraged Loan markets. Borrowing spreads for non-investment grade companies at 12/31/11 were 28% higher than they were at 6/30/11, and new issue volumes for high yield and leveraged loans have fallen significantly, especially for single-B rated issuers. Unless this situation reverses itself, speculative grade companies will find it difficult to refinance their loans and bonds as their existing debt matures, leading to even higher levels of defaults.
3) The Sovereign Debt Crisis is Increasing the Odds of a Recession: As credit availability contracts, we are more likely to see a resumption or “double dip” of the 2008/9 recession. Recessions usually lead to lower corporate earnings, resulting in even higher debt multiples, which would likely cause default rates to trend even higher.
