Distressed debt / special sits investing - On the job

BuyFixAndSell's picture
Rank: Baboon | 162

Hi there,

I am currently in the process of making up my mind regarding post-IB analyst opportunities. While there is an abundance of information on PE as an exit, the info on distressed debt or special sits is more limited.

Can someone shed some light on some of the following questions?

1) Is someone from an M&A background at a huge disadvantage to someone from RX / LevFin background, or is M&A also a good foundation for a DD role? If so, how can you make up for that disadvantage?
2) Can someone comment on day-to-day hours on the job? Ie, do you have to come in really early, or are we talking more 8.30/9ish? I assume the evenings won't go much longer than 9/10
3) For someone with a solid M&A modeling knowledge, are there any must read guides that will bring me up to speed on all I need to know for DD interviews? I have already read Moyer as well as the HL "Buying and selling the troubled company" but feel like I need more hands-on info regarding modeling that is required on the job
4) Is there a real difference between distressed debt and special sits investing? I feel like some funds use it interchangeably
5) How much different is a DD investing job at a say Baupost, Anchorage, Monarch and KKR / BX / Oaktree special sits type investing roles?

Thanks a lot!

Comments (31)

Oct 3, 2016

Has been a while, but I thought I might give it another try.. Any insights?

Thanks!

Oct 3, 2016

Also interested

Oct 5, 2016

I'll bite.

  1. The Art of Distressed M&A: Buying, Selling, and Financing Troubled Companies
  2. Nomenclature is irrelevant. Funds do some combination of passive investing and distressed-for-control. Special situations should imply passive (NPL portfolios, lease financing, patent monetization, ect) but the term is often used in the context of corporate securities.
  3. All those funds fall under the value investing umbrella (with control preference being the variable). Expanding on #4, some example "special situations" funds are Lone Star and Varde, which both tend to buy non-traded financial assets at a discount to NAV. Another style would be more legal-oriented corporate securities investing (Aurelius is a prime example) with their value-add being expertise in how a judge/jurisdiction will treat fact patterns leading up to bankruptcy.
    • 5
Oct 6, 2016

Thanks a lot houstonbound89, your insights are much appreciated. I'll also have a look into this book, seems good at first look!

SB for you!

Any other thoughts are much appreciated.

Apr 12, 2017

Bump, especially Q4

Apr 12, 2017

I'm at a value shop that does distressed when we think the opportunity set is good (see last year). I actually don't understand pure distressed funds as I don't understand how one could do distressed well at all points of the market cycle but that might just be me.

1) I would think not in a big way. There would be a learning curve involved for sure. I think enough of the skill set is transferable so that if you show you are "smart enough" a can see a lot of PMs/teams willing to take the leap of faith.
2) I don't think it will be much different.
3) I think hands on experience is vastly superior than any book you can possibly read. I'm sure you read the Moyer book well but if you read it again after 2 years you will probably see how the book mentions something extremely important in passing in a single line at times.
4) Yes very different. I think the previous poster answered well.
5) I don't have the background to answer this well as I only comprehend what the first half of the list you provided likely does.

    • 2
Best Response
Apr 13, 2017

At a long-only distressed fund you can crushed if your market timing is off, particularly if you are sitting on paper that is subject to lien or payment subordination and the firm value tanks immediately prior to bankruptcy.

Some funds have lock-ups and the flexibility to go long and short various parts of the capital structure in a normal market. This works for relative value trades (i.e. one tranche is rich relative to another), capital structure arbitrage (cash yields vs synthetic), and long positions with offsets (buy bonds on their way down while simultaneously shorting the equity). Many of the most interesting opportunities arise outside of market selloffs. Consider the Caesars bankruptcy trade: some funds bought the first lien term loan (not deeply distressed) then used negotiating leverage under its credit agreement to put company into bankruptcy after buying CDS on the junior tranches, which catapulted returns. Furthermore, if an investor in Caesars had a fairly accurate estimate of when a default event would be triggered under the CDS they could have even issued short-dated CDS then used the proceeds to purchase long-dated CDS (i.e. a self funding trade). The short-dated CDS would pay out nothing if the contract expires (i.e. during a technical default but not an ISDA triggering event) while the long-dated CDS could pay out $0.80/$1.00 of notional insurance amount.

If you're at one of the few shops with broad mandates and lock-ups, trades like the above become available and in many ways are far better risk-adjusted returns than simply being long value equities / discounted debt. Also, many of these trades are largely uncorrelated to the market so fund performance is dependent on the outcome of several hedged, idiosyncratic events rather than the direction of the SPX.

    • 11
Apr 13, 2017

thank you for the interesting info, SB'ed.

Observe. Learn. Share.

Apr 13, 2017
houstonbound89:

At a long-only distressed fund you can crushed if your market timing is off, particularly if you are sitting on paper that is subject to lien or payment subordination and the firm value tanks immediately prior to bankruptcy.

Some funds have lock-ups and the flexibility to go long and short various parts of the capital structure in a normal market. This works for relative value trades (i.e. one tranche is rich relative to another), capital structure arbitrage (cash yields vs synthetic), and long positions with offsets (buy bonds on their way down while simultaneously shorting the equity). Many of the most interesting opportunities arise outside of market selloffs. Consider the Caesars bankruptcy trade: some funds bought the first lien term loan (not deeply distressed) then used negotiating leverage under its credit agreement to put company into bankruptcy after buying CDS on the junior tranches, which catapulted returns. Furthermore, if an investor in Caesars had a fairly accurate estimate of when a default event would be triggered under the CDS they could have even issued short-dated CDS then used the proceeds to purchase long-dated CDS (i.e. a self funding trade). The short-dated CDS would pay out nothing if the contract expires (i.e. during a technical default but not an ISDA triggering event) while the long-dated CDS could pay out $0.80/$1.00 of notional insurance amount.

If you're at one of the few shops with broad mandates and lock-ups, trades like the above become available and in many ways are far better risk-adjusted returns than simply being long value equities / discounted debt. Also, many of these trades are largely uncorrelated to the market so fund performance is dependent on the outcome of several hedged, idiosyncratic events rather than the direction of the SPX.

I would second being able to move across the capital structure as highly valuable. There are a lot of trades you can also construct similar to what the poster above described. We've done strategies where we've gone long the long dated bonds and short some near dated maturity bonds to construct our position in some dicey names.

We are currently in a trade where we're long the bond of a company, have some equity, an also some call options to reflect our view that the company is cheap but very risky and could move lower in value but likely not as low as impairing our bonds but could also very likely be sold due to market position and cash generation so we have some option upside + change of control in our bonds. There are currently two activists in the name both urging the company to sell itself.

    • 5
Apr 16, 2017

I also own RentaCenter

Apr 14, 2017

Another noteworthy opportunity within the pari passu unsecured long short universe are bonds issue by Nova Scotia subsidiaries formed as unlimited liability companies. This structure provides tax savings by funding all of the US-domiciled parent corporation's debt offerings at the Nova Scotia sub then the sub makes an intercompany loan to the parent (interest paid to Nova Scotia sub is tax deductible from parent's perspective). The catch is that the Nova Scotia sub does not have to pay taxes on the interest income paid by the parent. To receive this benefit, the US parent allows itself to be liable for the full amount of cumulative loans provided by its Nova Scotia sub in addition to any guarantees on any third party debt (the so-called "double dip").

This was the structure / trade that brought GM down. Many of the same funds in Caesars started buying CDS on the pari unsecured notes issued by parent (1.0x claim to face value) at the same time as taking a long position in the Nova Scotia sub bonds (2.25x claim to face value). As these details are often overlooked, the parent and Nova Scotia subsidiary bonds traded at parity leading into bankruptcy.

    • 3
Apr 16, 2017

markets are relatively illiquid. its a very cyclical business. you price the asset based on valuation methods mainly looking at things like tangible assets (land, equiptment, inventory, proprietary technology, patents) there is no formula for pricing distressed securities.

over the past few years, banks may have one or two traders focusing on distressed securities, in a downturn, they may up the staff if they see fit.

There was a post yesterday asking what the "next big thing" will be. just because a few guys who don't even work in banking say distressed debt is the next "private equity", doesn't mean its gonna happen.

If you have a serious interest in distressed debt, there are some buy side firms (vulture funds) that focus on this. oaktree capital, etc. I would focus my efforts on the buyside rather than the sell side in a field like this.

Apr 16, 2017

I have to pick rotations after I return from training and thought this might sound interesting. I think credit prop may be more what I am looking for, but I need good backups.

Apr 16, 2017

Interesting - i always assumed that most people in distressed debt were from the banking side rather than the trading side - the vulture funds you talked about - whats the normal route to get into something like that

Apr 16, 2017

i only have experience with distressed securities trading, not banking. i try and stay away from anything that has to do with the banking side, that business makes me nauseous....

anyway. vultures funds are basically a hybrid hedge fund/private equity fund that buy up distressed securities. (thats a generalization) so basically you would break into vulture funds the same way you would private equity or hedge funds out of banking or sales and trading. I dont really know the specifics of their recruiting, but get a list of the firms, and try and make some contacts their, idk?

Apr 16, 2017

Would you consider David Tepper's fund a vulture fund, or are they more multi strategy?

Apr 16, 2017

Just out of curiosity, is there any benefit to going to law school for distressed debt investing? I'd assume there is some legal analysis required, but is that usually done by a retained law firm?

Apr 16, 2017

I have a little experience with distressed debt post-Lehman, including the bankruptcy process and the PE bidding process (the firm I work for is a HF but we made a couple of bids on select assets during 2009). Personally, I think distressed debt is one of the most interesting niches in finance because of the potential to get involved in a controlling stake in a company while retaining some of the most interesting aspects of public markets. Whether it's for you is for you to decide, but I would highly recommend picking up the distressed debt book by Stephen Moyer on Amazon. It's not cheap, but it's probably the best book on the subject out there. If you read it, you're going to have a strong gut reaction one way or the other -- "This is really interesting" or "Meh, not for me."

http://www.amazon.com/Distressed-Debt-Analysis-Str...

Apr 16, 2017
Ravenous:

I have a little experience with distressed debt post-Lehman, including the bankruptcy process and the PE bidding process (the firm I work for is a HF but we made a couple of bids on select assets during 2009). Personally, I think distressed debt is one of the most interesting niches in finance because of the potential to get involved in a controlling stake in a company while retaining some of the most interesting aspects of public markets. Whether it's for you is for you to decide, but I would highly recommend picking up the distressed debt book by Stephen Moyer on Amazon. It's not cheap, but it's probably the best book on the subject out there. If you read it, you're going to have a strong gut reaction one way or the other -- "This is really interesting" or "Meh, not for me."

http://www.amazon.com/Distressed-Debt-Analysis-Str...

I agree with everything here. DD is def one of the most interesting things you can be doing in the world finance and I compare to playing a game of chess...it requires a lot of intellectual horsepower to do well in the space IMO.

However, I cant actually comment on the quality of experience you'd be getting by focusing on NPLs/REOs given that I doubt you would be working with actual distressed companies.

Apr 16, 2017

I am at a midwest ~$500MM distressed debt firm with an NPL and REO strategy.

Dealing with NPLs and REO and depending on strategy, you are basically a "Real Asset" Private Equity Analyst. "Rewarding" is based on ones perspective but I like it.

You will likely be purchasing across a broad range of NPLs with a large mix of it being real estate. In the last month I have looked at a golf course, retail, office, hospitality, a chicken farm, several dairy farms, sawmills, land, and small middle market companies.

As far as a good place to start I would say it is as good as any REPE analyst role. Acquisitions Analyst is usually more sought after than Asset Management. It is also as bad as one, meaning that there is a tendency to get pigeonholed in RE, but it is also very easy to spin experience into LBO or most other PE firms. I think that there is an advantage to actually gaining skills on the distressed side, versus vanilla REPE or REIT work.

"As an acquisitions analyst, is this a good place to work to gain experience and help break into IB?"

Depending on the firm strategy, you will be creating pitch books and gaining strong excel skills, so sure. There are quite a few restructuring analyst jobs from what i can see.

That said, I wanted to do IB before but do not see why I would now. The pay is strong and the hours are good, so it seems like a waste unless I was interested in corp dev or something.

Feel free to ask any specific questions.

Apr 16, 2017

1) A lot of times, an organizational chart in an OM or prospectus shows which sub debt is located and whether subs are guarantors/non guarantors. When it's not available there, for bonds, you'd have to check the indenture to see which subs guarantee which pieces of debt. Sometimes it's just hard to find though, you can get some information in footnotes of sec filings or management presentations (For example, Sear's corporate structure was a mystery for the most part until they released a presentation that laid out all the entities). In terms of profitability, if there are guarantors, see the consolidating statements.

2) Tough to find information on these sometimes. Sometimes in the footnotes of sec filings or presentations. Sometimes IR can provide some info on these as well

Apr 16, 2017

Lol I love how, whether for career or investment purposes, people always try to time their entry into the distressed space. Like more so than normal...

Distressed will always be around, even during an economic boom (which we're definitely NOT having). Maybe a better question to ask yourself is, do you like Distressed? Why do you like it more than other areas? etc.

Apr 16, 2017

there will always be boom and bust, distressed will always be around.

its not nearly important to be in a "hot sector" at the beginning of your career than being in a hot sector 10-15 years in ;)

Apr 16, 2017

Hi everyone,

Could you tell me what is the required background to work in the distressed funds industry?
I have heard about degrees in finance and law. Personnally I graduated in Finance and I am on my way to get a master degree in Tax & Law. Is it suitable?

Thanks in advance

Apr 16, 2017
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