Distressed Investors Dusting Up for Restructuring Bout

After spending a long time twiddling their thumbs, it’s time for some action for distressed investors. Or at least that’s one way to read a crowd of about 60 that gathered for a morning discussion about distressed investing Tuesday at the New York Society of Securities Analysts.

Starting from the premise that it’s only a matter of time before the next round of bankruptcies hit, panelists pointed to the rising debt issuance to back leveraged buyouts as a sure sign of trouble ahead. And the type of debt being issued is just as creative, often more flexible, than the covenant-lite, PIK-toggle parade of bonds that supported the LBO tide of the mid-aughts, they said.

Justin Smith, an attorney at covenant deciphering firm Xtract Research LLC, said that indentures of credit agreements have added “flexibility” to the debt that borrowers can incur, to the point that investors—or lenders—should know that “the capital structure of today is not the capital structure of tomorrow.” For instance, an ability to extend maturities with only 50% of the lenders’ vote or the right to prepay loans at a discount are some of the features being included in intercreditor agreements. Although the panelists said an understanding of the nuances of debt indentures was among the so-called “lessons learned” from the unraveling of the 2009 credit markets, they said that little has changed and investors are often found “scrambling” for the intercreditor agreement when a dispute between holders of different parts of a capital structure emerges.

Another indicator that a new round of restructuring situations is simmering is not so much the daunting wall of maturity or supply of corporate debt, but the demand from investors to keep that wall moving forward, said Andrew Milgram, managing partner of hedge fund Marblegate Asset Management.

Collateralized loan obligations, or CLOs, sucked up much of the bank debt issued to fund the LBOs of 2005 to 2007, but these vehicles have a finite reinvestment period of five or six years, so there may be a vacuum in loan demand over the next year, he said.

Some of the sectors in which panelists expect to see restructurings include trucking and health services, said Varun Bedi, of Tenex Capital Management, a private equity firm that focuses on middle-market situations in which it can apply its operational turnaround skills. Bedi said that these are “highly fragmented” industries with plenty of bad management, which is ripe for significant margin improvements. At Marblegate, they are looking at shipping, secondary film finance, single property commercial real estate and gaming. The fund “gets very involved” in its investments that are also in the mid-markets.

Derek Pitts, a managing director at the financial restructuring group of Houlihan Lokey, also cited gaming, shipping and real estate as candidates for restructuring, and an oddball sector: general obligation bonds issued by municipalities. Admittedly a very obscure corner of the debt. But if investors take their time to dig it up, there are some situations ripe for restructuring, he said.

Another curious development that Pitts said he’s been watching is investors, flush with cash, calling on the services of restructuring firm such as Houlihan to try and put more capital into a situation they are already involved in. “They call up and say they’re interested in being a part of the solution,” which often means getting a sturdier position in the capital structure.

Now that’s getting ready for some action.