End of the road

Is the distressed pendulum swinging? Investors have recently been looking towards Germany for distressed debt investing—but, according to some in the space, the smart focus for bad debt investing is the US. By Aaron Lovell.

According to participants at a recent private investing conference in London, market players are looking away from Germany and towards the US for bad debt investing.

In Germany, once a market known for large companies saddled with NPLs, good investments are becoming increasingly scarce, according to Sid Shamnath, an investment manager with hedge fund Titanium Capital. Meanwhile, another conference attendee suggested that distressed debt plays could soon be plentiful in the US.

Bill Maldonado, chief executive officer for alternative investments at HSBC Halbis Partners, part of the international banking group, said his firm continues to see good distressed debt deal flow. He pointed to the large volume of below-grade debt issued in the US, something that could spell trouble as increasing interest rates and inflation could put the squeeze on companies that would stay afloat in better market conditions.

According to Standard and Poor’s most recent distressed debt report, trouble in the speculative debt sector in March inched up only slightly when compared to the same month last year. Averages for the year remained less than those seen in 2005 and 2004 and well off the numbers seen in 2000 and 2001. Corporate earnings and downgrade activity indicated that there could b e small changes to the amount of default activity. The report is in line with S&P predictions, indicating that the ratings agency expects global distressed activity to incrementally increase this year.

Still, the unemployment rate in the US and the yield curve both indicated there could be a stronger increase in default activity. The rating firm noted that the automotive, telecommunication and transportation industries were the sectors showing the highest propensity; on the other hand, the media, entertainment, restaurant and retail sectors all posted the most credits to their bad debt.

It may be too early to test HSBC’s strategy; Maldonado has said he expects defaults to increase towards the end of 2006 and into early 2007. HSBC is putting its money where its mouth is: the banking giant hopes to increase its investments in bad loans to $1 billion over the next 18 months.

A number of private equity firms and hedge funds are looking at putting money to work in the distressed space. Buyout shops like The Carlyle Group, Kravis Kohlberg Roberts and The Blackstone Group are eyeing hedge and bad debt vehicles, while established players like Matlin Patterson have been raising capital for the inevitable fall. Veterans have even been leaving the likes of Oaktree Capital Management, Och-Ziff Capital Management, The DE Shaw Group and Angelo Gordon to start their own shops.

While the fundamentals suggest a increase in opportunities, how long investors have to wait around remains to be seen.