Distressed Debt Specialists Sound Off In New Survey

Jan 12 2007 | 12:20pm ET

Housing will likely have a hard landing this year and consumer spending will also hit a rough patch, according to a recent survey of 106 distressed debt prop traders and hedge fund managers, conducted by distressed and high-yield data provider Debtwire. As new debt issuance dries up in 2007, hedge funds that participate in the space will find a tougher fund raising environment. And as competition heats up for lesser deals, hedge funds will make riskier bets resulting in attrition for some of the 1,000 funds this year.

Rough Going For Housing, Retail

According to the survey, almost one-third of respondents foresee a hard landing for housing while about half expect the sector to cool somewhat from current levels but not crash completely. Three-quarters of respondents expect there to be more defaults this year than there were last year.

Despite their predictions, traders seem cautious in their construction bets as 53% expected to be sector neutral while 26% are expected to be net long and the remaining respondents net short.

Last year, half of those surveyed that invested in retail allocated 5-10% of their portfolios to the industry and only one-fifth allocated 11-20%. This is set to change this year as 63% polled indicated that they expected an increase in distressed activity in the retail space. Respondents also see opportunities in healthcare, restaurants and paper/packaging and gaming.

As well, the besieged automotive sector should remain under the spotlights this year. “Even with a number of highly publicized bankruptcies in 2006, the auto sector should remain under significant pressure in 2007 given continued high raw material costs, modest consumer demand and legacy liabilities,” said Evan Flaschen, co-head of the financial restructuring group of law firm Bingham McCutchen.

Taking On More Risks

The lack of new distressed opportunities in 2006 led some hedge funds down the activist route, riling companies such as General Motors, Bally Total Fitness and WCI Communities.

Sixty-three percent of respondents believe that the run up in activist investing will continue this year, which could increase management’s efforts to enact restrictions on board-member elections and poison pills.

“Hedge funds have not been afraid to roll up their sleeves and pursue activist strategies in recent years in order to unlock value at underperforming targets, and they have done so with substantial success,” said Greg Nye, a partner in the Bingham’s financial restructuring group. “We expect more of the same in 2007, with a ‘seat at the table’ often translating to ‘a fist at the table.’”

Last year’s high-profile hedge fund blowups and other lesser-known liquidations make the majority of respondents think that hedge fund liquidations will increase in 2007, to the tune of more than 1,000 funds. What’s more, new distressed-debt fund managers will find it more difficult to raise capital this year, according to 44% of respondents.

While “convergence,” the trend of hedge funds raising private equity funds, is a headline-grabber, the survey seems to indicate otherwise. In fact, more than half of the respondents said their firms don’t have a separate private equity fund and are not considering raising one going forward. “While there might be a lot of talk about convergence, I think the issue is really about product diversification,” said Mark Rubin, a managing director at financial adviser Chanin Capital Partners.

“As investment firms seek to grow and offer different investment options, we will likely see more firms that manage both hedge funds and private equity funds but this won’t be a huge trend. What I see as a bigger development is the advent of hedge funds and private equity funds partnering on specific transactions like we are seeing in Delphi.”

The North American Distressed Debt Outlook 2007 was conducted by Debtwire, in conjunction with Bingham McCutchen and Chanin.

By Hung Tran

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