Takeaways from SVP's Recent Investor Conference Call

Victor Khosla's Strategic Value Partners is one of the more well respected funds in the distressed debt universe. It's Strategic Value Restructuring Fund has returned over 13% annually since inception (September 2002) with less than 50% correlation with both the S&P 500 and Merrill Lynch High Yield Bond Index. They are fantastic investors that play up and down the capital structure, with a focus on senior tranches both domestically and internationally.

Last week, SVP hosted its Quarterly Market Call. While I will not post the presentation, here are some takeaways from the discussion:

• The three fold pressures facing the market right now are: 1) A slow down in the general economy in both the United States and Europe 2) The EU Sovereign Crisis 3) Japan - It's in a recession. Because of these pressures, we've seen a sort of mini crash in the equity markets
• This equity mini crash has extended to the high yield market with significant spread widening in both high yield and bank debt driven by substantial outflows
• With a weaker secondary market, primary markets have all but dried up
• With that said, the distressed market is down substantially more than you would expect given the underlying moves in the equity markets. This goes across senior, sub, and equity structures of the distressed universe
• This compares to the high yield and leveraged loan market being down essentially in line with expectations given the equity moves
• SVP compares recent price moves to the distressed cycle of 1998 (post LTCM / Russia default) which was not nearly as bad as the 2002 and 2008/2009 cycles. With that, SVP warns the market are "still playing out"
• SVP notes that while the distressed market has broadened (see my earlier post: http://www.distressed-debt-investing.com/2011/08/having-fun-yetpart-ii.html), this market needs to be navigated carefully given all the headline macro risk
• Emerging opportunities in the US: Shipping, infrastructure, commercial real estate debt, some large cap distressed names
• In Europe: lots of supply and lots for sale and few buyers

This squares exactly what I've seen in the past few weeks. I got a listing of big moves in the past month in bank debt land as of last week. Here are some notables:

• Quiznos Second Lien: Down 69 points
• Cinram First Lien: Down 43 points
• Buffets Term Loan: Down 28 points
• Lightsquared Term Loan: Down 25 points
• Marsico Term Loan: Down 20 points
• Idearc Exit Term Loan: Down 20 points
• Etc. Etc.

In the U.S., I do agree that shipping is shaping up to be an interesting opportunity (tomorrow's post). The large cap distressed names continue to leak as redemptions seemingly hurt those credits the worst (most liquid, overly concentrated in a number of high yield funds). And the primary market, effectively shut down save for a few bank loans that got launched before the mini crisis, isn't helping things either (i.e. the option for a hail mary capital raise to extend maturities is deeply out of the money right now).

Many distressed investors have been spending lots of hours working through some event driven opportunities that have popped up. Specifically, PMI is one that many people are working / wading through (both bonds trade 26/27 context). The CDS curve is a fun one on that one:

Sep11 8/12

Dec11 44/48

Mar12 56/60

Jun12 61/65

1yr 63/67

2yr 66/68

3yr 67/69

4yr 68/70

5yr 69/71

7yr 69/71

10yr 69/71

The numbers on the right are expressed as points up front for those interested. To buy protection for the Dec 2011 contract, you would have to put up 48 points initially and then pay a 500 bps running spread. The recovery market for PMI right now is 21/25. The PMI Group is in the on the run CDX HY Index (Series 16).

So, things are definitely MUCH more interesting than they were 2 months ago. It really does feel like night and day. One of these days, I am going to do a comprehensive review of Howard Mark's fantastic new book "The Most Important Thing". Chapter 9, entitled "Awareness of the Pendulum" is probably one of the greatest chapters written on investing since Chapter 8 in Intelligent Investor. In the book, Marks writes:

"Thirty-five years after I first learned about the stages of a bull market, after the weakness of subprime mortgages (and their holders) had been exposed and as people were worrying about contagion to a global crisis, I came up with a flip side, the three stages of a bear market:

• The first, when just a few thoughtful investors recognize that, despite the prevailing bullishness, things won't always be rosy
• The second, when most investors recognize things are deteriorating
• The third, when everyone's convinced things can only get worse"

To me, it felt like the melt down in August was the investing public moving from the first stage to the second stage. I do not believe, in the aggregate, we are at the third stage. Maybe in certain pockets and sectors (i.e. shipping / tankers - seriously, when was the last time you heard ANY good news about the tanker industry), but definitely not in the aggregate. That is why you have to selectively pick your spots focus on the opportunities where risk of permanent capital loss is the lowest, fear is rampant, and thus expected return (given the risk) is the highest.