Distressed Investing Is Back. These Trades Are Defining the Game

Russia

Having saved up cash for years, hedge funds were ready to pounce when missiles started flying into Kyiv in February. Wall Street banks avidly sourced declining bonds for their clients and investors poured into bets using both debt and derivatives — despite debate over the ethics of profiting from a humanitarian disaster.

Some of the derivative plays paid off almost immediately, while bondholders at the time of Russia’s sovereign debt default in June are in for a long and tangled process of sorting out their recoveries.

Twitter’s Hung Debt

The debt that Elon Musk lined up to finance his acquisition of Twitter helped crowd bank balance sheets to the tune of $43 billion near the end of the year. Interest rate hikes and inflation made it hard to unload as the typical buyers sought to avoid risk.

While some banks looked to sell the debt before the end of the financial year, others are inclined to hold until markets improve. For the banks, both options sting, and will affect their approach to risky lending next year, said Jamie Weinstein, portfolio manager and head of corporate special situations at Pacific Investment Management Co.

“Banks that are absorbing losses on hung debt are less likely and less willing to make new financing commitments,” Weinstein said — meaning troubled companies may be shut out of the market altogether.

Crypto Crash

Though the wave of distress among crypto firms involved little liquid debt, it still sent the restructuring industry aflutter.

For lawyers and advisers, it was race to master new subject matter in time to capture business. For investors, it served as a warning about just how fast asset values can disappear once the first domino falls.

A spate of crypto companies sought bankruptcy protection this year as slumping token prices triggered a cascade of distress and exposed a web of interdependence within the industry. When Sam Bankman-Fried’s FTX exchange filed for bankruptcy in November, the move soon forced lender BlockFi Inc. to follow suit. Voyager Digital earlier attributed its July bankruptcy to the failure of crypto hedge fund Three Arrows Capital, and crypto miner Core Scientific in a Dec. 21 bankruptcy filing cited as a cause the July bankruptcy of Celsius, one of its largest hosting customers.

New Rules

Ongoing litigation tied to long-standing disputes over aggressive distressed financing maneuvers delivered potential wins for the underdogs.

A New York state judge gave life to claims from a group of lenders alleging that clothing company Boardriders Inc. breached contracts when it got new funding from Oaktree Capital Management and others. Judge Andrea Masley declined a request to dismiss the claims, suggesting they may have to have some merit.

That and a similar decision in a case regarding mattress seller Serta Simmons may have a chilling effect on the exploitation of loose debt terms that benefits some investors at the expense of others. Though each situation is unique, these decisions cast some doubt on the legality of such maneuvers.

The rulings “have had an impact on how people are thinking about this on all sides,” said Pimco’s Weinstein. “Whatever the playbook was before, some people are thinking that maybe it needs to be different.”

Carvana & Cooperation

Accordingly, camaraderie seemed to come into style as some lender groups instead banded together and pledged to negotiate as a whole with company management.

Such was the choice of holders of nearly $4 billion of Carvana Co.’s debt. A group led by Apollo Global Management Inc. and Pimco signed a pact designed to avoid the kind of fights that sometimes drag out in court.

“You essentially are locking arms with your co-holders and saying, ‘we’re not going to do anything that isn’t available to the rest of the group,’” said Damian Schaible, co-head of restructuring at law firm Davis Polk & Wardwell.

The fallout from financing deals at companies like Envision Healthcare Corp. and Incora — where favored lenders helped shift assets away from creditors — has lent appeal to the concept of creditor cooperation.

“You haven’t heard about them much at all for the last several years,” Schaible said, “but debt investors have started reverting to considering co-op agreements to protect themselves from this new threat of a private equity sponsor working with 51% of lenders to do something terrible to the other 49%.”

Bloomberg News provided this article. For more articles like this please visit bloomberg.com.

Read more articles by Eliza Ronalds-Hannon