European Distressed Debt Market

Today, Bloomberg posted an article on Oaktree Capital's intent to purchased distressed debt investments in the EU as opportunities for distressed debt in the United States are slim to nil"

"March 3 (Bloomberg) -- Oaktree Capital Management LLC, an $82 billion investment firm, plans to purchase more distressed assets in Europe as a price rally eroded the return outlook for U.S. corporate debt, according to Chairman Howard Marks.

'The better opportunities lie in Europe because banks have some purification job to do on their portfolios, and in mid-cap deals and also in debt related to commercial real estate,' Marks said in an interview in Berlin yesterday. 'We indicated to our investors in 2008 that a return before fees of more than 25 percent is possible. Today, you can’t get that level of returns from traditional U.S. distressed debt.'"
As I have done in the past, I will layout a graph of the number of traced distressed issuers traded over the past year:

As one can see, the index has effectively grinded tighter on the whole since QE2 was hinted by Ben Bernake in the late summer of 2010.

In past cycles, distressed debt returns have held up a few years after default spike. But looking back in history, one can see that not only has annualized returns dropped, but the length of the "comeback" if you will has gotten shorter. For example, distressed produced fantastic results over 6 years in the period following the 90/91' recession (through 97'). In 2003, distressed had a fantastic year as well, and was followed by strong returns in the following 3 years. That being said, these returns were no were near the length or the magnitude of the previous cycle. Why is this?

In my estimation, there is simply a whole lot of capital in the distressed debt world. Bonds may not fall far enough and are snapped back at a precariously fast rate. And admittedly, we should have had more defaults in the 2008/2009 period, but massive fiscal and monetary stimulus turned off that spigot quickly. Of course, some players, like Oaktree, made absolute bank from the cycle: The fund that Howard Marks began marketing in 2007/2008, returned 31% gross to investors - and they are returning the capital because a lack of opportunities.

Now, to get back to the original point of this post, Howard Marks thinks the European distressed debt market offers a better opportunity set than the US. While my mandate professionally does not allow me to invest in non-dollar denominated assets, the potential risk/reward does look better than the distressed market domestically. Here are some things to consider:
  1. Research analysts estimate that banks in the EU will have to shed more assets than US banks: Typically, and as played out by this cycle, public distressed securities rally over the course of a few years then banks and other financial institutions begin to shed assets that will probably sell at a more reasonable valuation. Banks can get away with this because historically they marked to model and did not have to take capital charges for unrealized losses on the balance sheet. Domestically, banks will begin to sell off their CRE loan portfolio (and equity positions) - This morning Sam Zell noted, regarding CRE: "...because of zero interest rates, there is an awful lot of assets that in another arena would have already been REO. And so the result is, there is very little supply. The banks are feeding their distressed assets into the market very slowly, so the supply of new stuff is low." But then Zell went on to say that capital domestically is sky high and that prices probably will not drop to make real juicy returns (here's the video: http://www.cnbc.com/id/15840232?video=3000008432&play=1). In Europe though, banks are under significantly more pressure due to a variety of issues (cross ownership of sovereign bonds for instance). Net / Net more "forced" sellers in Europe, especially considering Basel III implementation
  2. The amount of capital chasing distressed debt in Europe is less than that in the United States: I do not have figured in front of me, so you will have to take my word for it. The list of dedicated distressed debt funds in Europe numbers about 40, whereas in the United States its a little less than 300.
  3. Complexity. In the EU, bankruptcy leads itself more to liquidation than restructuring. Furthermore, while cross-nation rehabilitation rules have been somewhat standardized, the fact remains that many of these rules have not been tested in an actual restructuring proceeding. In my opinion, complexity leads to more opportunity
When looking at dealer runs for European distressed debt I am greeted by a list of opportunities I have never heard of. In the coming weeks, I am going to try to find 2-3 managers playing in the distressed space in Europe and conduct an interview with them (if you know of any, please contact me). To me, when the competition is less, and their are more forced sellers, good things are bound to happen for your investors.

I will do my best in the coming months to add to my coverage of the EU distressed debt market - if you would like to help, contact me at hunter [at] distressed-debt-investing.com


Anonymous,  3/06/2011  

Avenue and DK have dedicated Europe funds.

Anonymous,  3/06/2011  

Octavian Advisors runs dedicated distressed money exclusively focused outside the US.

Anonymous,  3/07/2011  

Personally, I think you should focus on dedicated european groups instead of american shops with a satellite office. I think you get a more local perspective that isn't influenced by the home office. European distressed is different. You have a spectrum of legal approaches.

Suggestions for UK based distressed trading managers:
Ian Cash at Alchemy
David Nazar at Ironshield
Paul de Rome at EQT Credit

BTW, keep up the great work! One of the most thoughtful blogs around.

Anonymous,  3/14/2011  


distressed debt shop dedicated to Spain and Portugal.

private health cover 3/15/2011  

Interesting information, I think that it is good to know about this. Nice post.

Anonymous,  4/12/2011  

In our Team we believe the best opportunities in European distressed debt are in the small / mid cap segment. This segment historically offers better yields than the large caps segment. Main reasons for that are the lack of liquidity and coverage - large distressed players generally focus on situations where they can put significant amount of capital at work, the liquidity is better but returns are smaller...

The small / mid cap segment also provides for opportunities later and longer in the cycle - large distressed situations are addressed first and quickly - you cannot hide a billion dollar default... smaller situations take longer to be dealt with. Commercial banks are the main players in that segment and it take a long time for them to clean their books (first they need to provision, but for that they need to make profit etc..) - capital constraints / regulation is going in the right direction and is forcing banks to deleverage.

The refinancing wall will hit small / mid cap corporates much harder than the large caps who have access to refinancing alternatives (HY / equity markets)

Only problem with small / mid cap segment is that it is not scaleable - funds are small (you cannot put a lot of capital at work)

Carolyn 4/23/2011  

Excellent blog! Keep up the good work.

Do you know of any good bond screeners for Europe?

In terms of ideas for distressed debt, I recommend the Cytos Biotech convertible bond - 2.875% of 2012 - CH0029060735 - with a 20% YTM and in a hard currency - Swiss Francs.

ciao ciao


Anonymous,  10/11/2011  

You hit the spot with the 3 points listed re European distressed CRE.

Some additional thoughts, until now lots of (€zone) lenders managed to escape big losses with pretend and extend approach...German mortgage banks in particular. Furthermore, most of those have set up bad banks and still feel the need to load their balance sheet..

I just came across your blog. Great job!

Anonymous,  12/28/2011  

Good blog, don't forget that a lot of European distressed credit has USD debt outstanding so not the whole world of European distressed is off limits for you


hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.