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.