Is a wave of distress finally about to wash ashore? It would be about time. After reaching peak fundraising levels in 2017 and 2019, the past couple of years have seen some investors seemingly give up on the likelihood of substantial distressed dealflow.
Our fundraising data shows distressed strategies accounting for just 18 percent of the private debt fundraising total last year, down from 20 percent the previous year and 30 percent two years ago.
But for those still waiting for that wave, the past couple of months have brought fresh interest. In March, the UK’s Financial Times reported a meeting of what it described as “top banking regulators” – specifically the US Federal Reserve Board, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency. They collectively described risks in the leveraged loan market as remaining “high” despite some marginal signs of improvement in creditworthiness.
They observed volatility in certain sectors hit hard by the pandemic, including commercial real estate, and noted red flags in deal structures, such as high leverage, aggressive repayment reschedules and deal terms allowing companies considerable leeway to take on fresh debt. Levels of debt rose considerably during the pandemic, including at businesses with low ratings. Reading the report, you would question the ability of all these firms to successfully repay that debt.
Not surprising therefore that participants in the private debt market are beginning to catch a whiff of something in the air. In our March 2022 issue, David Conrod of capital raising and advisory business FocusPoint reflected on the prolonged impact of covid-19, supply-chain shocks, inflationary pressures and the tapering of Fed policies. He believes that they add up to that long-awaited wave of opportunity and calculates that the addressable market for distress has risen 3.7x between 2007 and the end of last year.
Of course, we have seen this kind of optimism before. It’s no coincidence that some fund managers formerly associated with distress have been aligning themselves more closely with the flexible “special situations” tag in recent years. Some have even wondered whether we’ve entered a new paradigm in which “pure distress” is effectively a thing of the past. The coming months may lay these questions to rest.