Notes from Chicago Booth's Annual Distressed Investing and Restructuring Conference

We were fortunate enough to have the organizers of Chicago Booth's 6th Annual Distressed Investing and Restructuring Conference take notes for us. Enjoy!

MORNING KEYNOTE:

Howard Marks, Chairman, Oaktree Capital Management

• Dean Harry Davis, who taught Howard Marks, introduces Marks with a discussion about the importance of Art and Study and how those themes run through Marks’s career.
• Marks gives an overview of the distressed investing space and the current cycle. He notes that while thousands of people can do similar analysis the difference lies in the art of interpretation.
• Marks walks through the history of each distressed debt cycle, noting that each cycle is similar to past cycles: unwise extension of credit combines with economic weakness to offer plentiful opportunities in the distressed debt space.
• The cyclical pattern is the same with tight post-recession credit conditions leading to solid credit quality, which then leads to strong returns, which then pushes more money into the space allowing for poor quality issuance, which eventually produces high defaults and a period of risk aversion.
• The second half of the talk was a case study of Favorite Brands with Marks explaining how to analyze the capital structure and why Oaktree bought at every level of the capital stack.
• In terms of fund management while having an ability to take positions in large size trades gives an access to unique opportunities, having a lot of assets under management is not always a good thing in terms of efficiency and client management. Quality of investments is the key.
• He also noted that an investor must make conservative assumptions, but not so conservative that it prohibits putting money to work.
• Prospective Commercial Real Estate opportunities will depend on whether financial institutions face the reality of the buildings' prices going down from their original levels and how regulators treat loans.
• Basel II will require European investors to face value drops and this may lead to distressed investment opportunities there.

Legal Panel

Moderator: Donald Bernstein, Davis Polk & Wardwell LLP

Panelists:

Douglas Baird, University of Chicago Law School

Ashley Keller, Bartlit Beck Herman Palenchar & Scott

Damian Schaible, Davis Polk & Wardwell LLP

Christopher Sontchi, US Bankruptcy Judge, District of Deleware

• Chapter 11 was designed to provide legal mechanisms to restructure companies but more recently has been used more by the investors than management. Panel discussed how the Chapter 11 process has been transformed with regular players who use it as a way to source investments.
• Discussion of reorganizations versus 363 sales. At times, reorganizations are the best solution as a 363 asset sale at a certain period in time may not provide the best price. Yet, the reorganization process does not consider the fact that debt is being traded and there are no clear-cut rules on how the court should deal with investors having different incentives and positions in various parts of the capital structure.
• In recent reorganizations, there has been increased importance of "gifting" where senior creditors give junior creditors some value to be able to come to an agreement.
• Credit bidding has become an important trend and it provides a good option in situations of market failure (example of Delphi where the only bid was 15% of the DIP financing amount). Discussion of whether Philly News will be precedent setting.
• The role of CDS protection holders in the restructuring space has become an important topic. Their incentives differ from other distressed investors because of the ability to get paid when CDS is triggered by a credit event such as bankruptcy.
• The revival of capital markets activity with covenant-lite loans and PIK-toggle loans is coming back in vogue. This should lead to plenty of bankruptcy work.
• There seems to be a lot of loan amendment activity, as well, which may indicate more distressed opportunities down the road.
• Issues with deal sourcing in the current environment due to high demand from distressed investors and new players in the space.
• A great number of current activities in the space are from hedge funds which lead to prolonged periods of negotiations when it comes to handing over the keys to the company.
• Another side of the coin here is that should credit markets freeze, we are to expect a severe drop similar to Q2 2008.

Private Equity Panel

Moderator: Darin Facer, AlixPartners

Panelists:

Duncan Bourne, Wynnchurch Capital

Ron Glass, GlassRatner Advisory & Capital Group LLC

Paul Halpern, Versa Capital Management

Michael Oleshansky, Industrial Opportunities Partners

• Some panelists thought that the downturn would have gotten a lot worse before getting better
• One panelist noted that they never expected creditors to be as patient as they have been (relating to the many amendments and extensions)
• It was also mentioned that some investors thought that interest rates would have faced more upward pressure by now
• The panel also discussed the importance of implementing operational changes in the portfolio companies The panel spoke about ways they are sourcing deal flow and specific sectors / industries they are looking at.
• Current environment is also a good one for monetizing private equity investments due to active capital markets.

Investment Banking Panel

Moderator: Nat Gregory, Professor, University of Chicago Booth School of Business

Panelists:

Dan Aronson, Lazard

Mona Baruah, Rothschild

Jeffery Finger, Miller Buckfire

Andrew Turnbull, Houlihan Lokey

• Much of the discussion centered on the question, “Is the recent distressed cycle done?” Panelists contrasted the low-level of deal-flow today versus the hectic period of 2008/2009
• Lack of deal-flow mainly attributed to the improvement in the global economy, the prevalence of covenant-lite loans during the recent credit boom, and the flexibility of debt holders
• In light of decreased activity in the space, panelists mentioned that some banks are pushing their related capital markets platform (specifically, negotiating amend & extends and sourcing new capital for struggling companies)
• Panelists predicted that the high level of covenant amendments might result in another distressed cycle in the 2013-2015 timeframe (when a maturity wall of ~$600bn will come due)
• Many companies (despite having pushed out their maturities) will still be underwater and will eventually have difficulty refinancing sizeable issues
• Panelists also discussed the popular topic of distressed municipalities and the general consensus was that many municipalities are facing real distress
• Panel worried about how fast credit spreads have tightened, how quickly banking activity has returned to near 2007 levels. The financing business cycle has been compressed by massive U.S. stimulus programs, leaving open the possibility of a fairly quick return of frothiness in underwriting, then to another credit crunch.

Distressed Investing Panel

Moderator: David Small, Grosvenor Capital Management

Panelists:

Eric Baer, Chicago Fundemental Investment Partners

David Miller, Elliott Associates

David Trucano, Centerbridge Partners, LP

Michael Watchorn, PIMCO

• Panel began with each investor discussing strategy and talking through an investment. Names discussed included Quebecor World, Delphi, Tribune and an unnamed finance company.
• Panel then turned to the current location in the distressed cycle. They worried about how fast credit spreads have tightened and how liquidity returned so quickly. Panel is generally cautious on fixed income assets and particularly sovereign debt.
• They turned attention to the shift to the increasing sophistication of investors in bankruptcies and how the smaller sophisticated claim holders can obtain higher returns.
• The panel turned to sourcing opportunities. It was emphasized that in determining new opportunities investors should look for businesses owned by unnatural owners.
• Panelists agreed on the companies facing commodity pressure (both agricultural and oil) will face hard times in the next two years.
• Another source of opportunity will likely be Europe due to both fiscal crises and changing financial regulations.
• Panelists discussed whether it is better for young investors to be generalists or specialists, with the panel divided on which is best. One consistent theme was repetition and muscle memory and an emphasis on being part of lots of investments.

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Notes from the HBSCNY Distressed Investing Roundtable

Last week we posted a quick note on the HBSCNY distressed debt round table. Well, our spies have performed, and now we some notes from the event. Enjoy.

Panel:
• Eric Edidin, Managing Partner, Archer Capital Management (“EE”)
• Jed A. Hart, Senior Managing Director, Centerbridge Partners (“JH”)
• Tiffany Kosch, Managing Director, H.I.G. (“TK”)
• Victor Khosla, CIO and Managing Partner, Strategic Value Partners ("VK")
• John Reiss, Partner, White & Case ("JR")

JR opened by pointing out the enormous uncertainty and asked panel about their firms and what they were doing:

VK opened by saying they manage $3.3 billion and have 165 people globally (they have some CEO and CFO types that they can drop into operational roles, if necessary). He said they are not US centric and see lots of opportunities in Europe. They have 60 people in London and Frankfurt. They are salivating over the opportunities.

TK said that her group overall manages about $3.5 billion. She invests the Bayside Fund. They are also in London, Germany, and Paris. She said that Europe had greater dislocations and, thus, offered more opportunities. It wasn’t a contagion – it hit all at once. She commented that they look at deals like PE investments (not trades) and they focus on enterprise value and the potential optimal capital structure.

JH said that Centerbridge was formed 3 years ago by people from Angelo Gordon and Blackstone. They have about $7.5 billion of which $3.2 billion is control and about $4.0 billion is non-control focused (can’t reconcile the missing $300 million). They are currently only in NY and have 35 investment professionals. They are looking at non-control distressed investments. They are focusing on credit investing on a control or non-control basis.

EE said that Archer is a Hedge Fund that focuses on middle market. They primarily focus on secondary purchases, but do have some direct lending capacity (for DIP/Exit/Bridge). He said it’s a great time to be a capital provider. Noted that this cycle is different from prior cycles due to changes in Code and changed dynamics (shortened exclusivity, lack of DIP). Also the health of the primary investor is different (harder for them to inject additional capital). Expects cycle to be different.

VK noted that any investments made prior to Lehman bankruptcy (September) are hurting and it will take time for those to return to cost. He mentioned that they had purchased First Lien loans of a German company for $0.50 on the Dollar. The company will soon blow through covenants. He mentioned something about debt being priced at 2x EBITDA. Noted that Europe is less efficient since fewer experienced investors and less money chasing deals. Pointed out that there was still tail risk. If the economy gets worse, if the borrower has had fraud, etc. He said he manages these types of risks (although not overall economy) by having some diversification.

TK said they her firm tries to look at companies differently from others so as to create an advantage. She gave an example of a company that needed cash. She purchased the 2nd lien from a hedge fund. The company was losing $35 mm in EBITDA. They put in an executive who quickly was able to stop the burn and bring to break-even. The company was complicated (screwed up balance sheet, fraud claims, etc.) but it was resolvable. She said they need to look at lots of deals (reading lots of credit documents) to identify opportunities.

JH said they are focusing on cyclical versus secular declines. They identified a world class construction company with tremendous operating leverage that was suffering a cyclical decline in the building market. The company had been LBOed in 2005. Now had BEV of 25% of 2005 cost. PE firm walked away. Expected that his cost will end up being 1x EBITDA when the market recovers (thus >100% potential returns). They look for situations where they will get >100% through getting equity participation.

EE stated that they are trying to be market neutral. They have a sourcing effort where they look to private deals, call on PE firms and private companies. They were able to get great returns by loaning money to a company that had GECC as their lender. GECC wouldn’t extend the lines, so Archer lent money secured by the receivable of customer (Eastman Chemical). Had 20% IRR on project, and they purchased a CDS on Eastman from Morgan Stanley that cost only 1% (leaving their credit risk with MS). Seeing arbitrage opportunities in bankruptcy (like WaMu, and arb on liquidation/litigation). Can buy Chrysler Financial bank loans with 30% IRR (not part of Chrysler bankruptcy, in run-down mode).

JH said that they try to build a portfolio of companies that WILL DEFAULT. Looking for near term defaults. The increased speed of the process makes these investments attractive. Thinks Chrysler would have gone Government’s way regardless (not a good party to challenge).

TK said she spends a lot of time reading credit docs (remarked about not expecting to need a legal degree). Looking for shorter time frame. Look to avoid bankruptcy, which is a costly process, and negotiate out of court restructurings. Invested with a firm that services ATMs for banks. Since they hold cash for the banks to resupply the ATMs, the banks DID NOT WANT A BANKRUPTCY. She mentioned that there are a lot of people who think they can do the business and think they know companies because they read docs; but they respond “no” when asked if they’ve spoken with the companies themselves or their customers.

VK said that his firm does event driven investing. They buy in expectation of default. If the restructuring can’t be done outside of court, then they are not afraid to go through process. Typical time frame is 2 years with multiple upside.

JR mentioned that White & Case is finding that strategic investors (corporate) are willing to play the distressed game now, while PE firms are less willing.

TK said that she only sees strategics in 363 sales. She noted that many more PE firms are attempting to invest in the distressed space, but they have problems (their analysts are used to running models with stable or rising earnings – they are NOT used to projecting a period of deterioration in margins – which is typical in distressed/bankruptcy).

The panel discussed Europe. There have been big changes. In 1996-98 one of them had a bad experience in France where labor was put ahead of the secured lenders. They note that the UK is doable and similar to the US. Germany changed four years ago and now doable. The Netherlands is okay. France, Spain and Italy are not good spots for this type of investment (local laws not predictable/friendly).

Incredible stuff on the distressed debt market. If anyone else attended and can shoot me their notes, it would be greatly appreciated!

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