Q&A: 30 Year-Old Breaking In, Part II - From tiny M&A boutique to Distressed Debt

It’s been a few years since my last post and things have taken an interesting turn. I left the small advisory boutique after a year, moved to a HY/distressed trading desk where I worked as a desk analyst for 2 years, and then moved to a small HF, where I've been for the last year. Still based in London. Things have been busier than ever lately, and since the distressed debt space is becoming more visible again, I thought it'd be good timing to host a Q&A. Happy to answer any questions relating to career path, investment process, market views, lifestyle, etc, to the extent that I can.


 

Probably a very basic question, but I’m an analyst at an M&A boutique. What would you say is the best way to break into the distressed space from my current position?

 

Hi Jack,

I worked a few years in high yield research and debt/restructuring advisory and I'm thinking about my next move. Distressed debt has always been of interest to me and I'm wondering what a typical day would look like in distressed debt investing. Also, what do you think are your exit opportunities after a few years at your HF ?

thanks a lot

 

From my experience, HY AM is definitely a popular exit for traditional distressed guys. Long/short credit hedge funds used to be a popular exit too for colleagues who got fed up over the bull market with Avenue, AG, etc. - generally less manpower intensive -> higher AUM per head, better work hours, and less touching the hairy RX situations. However...this is becoming much much less so the case as 75-80% of the big long/short credit sleeves of hedge funds are bleeding profusely (as I'm sure you've seen the likes of KS, York's Credit HF, BlueMountain, SouthPaw). Startups like Tresidor and Aptior have difficulty getting off the ground/scaling up and the likes of Diameter and Bybrook - the big success stories in the L/S Credit fund style - are few. So nowadays a lot of guys I think are just happy to stay in traditional distressed where the AUM keeps flowing from LPs.

Understand you can't disclose your HF fund positioning, but curious as to what situations you're finding topical these days/really like. Pre-Corona a lot of the distressed situations seemed picked over and presented few solid investable opportunities (Like everyone and their mother piled into Steinhoff back in 2018). Wondering if it's still looking at more of the usual suspects (same pre-corona distressed names) at lower prices, or instead looking more at some high quality businesses/corporate credits that have since traded down into Double Digit+ yields/IRRs upon corona (names that prior were maybe a little yieldly but definitely not a distressed coverage name).

 

What are the key things you look at when modeling distressed firms?

Does your HF only play in the debt space or also touches equity in event-driven stuff?

Do you sometimes try to get a chunk of debt being syndicated to benefit from the OID or in emergency fundraising currently?

And a question for lifestyle an easy one- favorite neigbourhood in London.

 

It would be great if you could provide more insight into the desk analyst position. It's a gateway role used by a lot of guys to break into the credit HF space but doesn't get a lot of attention on these boards. I had a few questions on that side of things:

1) How many names did you cover and was it sector specific or driven more by what's in vogue?

2) How much time do you devote to a name? Is it a 1-day quick analysis where you throw together a cap structure, a few comps and a recovery analysis or do you actually build out a full model, dive into the covenants and talk to sell-side research and management?

3) How do the economics of the desk work? I'm guessing the bank allocates a certain amount of RWA to the desk and you guys have a P&L target for the year? How much of that target is flow vs. prop?

4) How do your economics work? I'm guessing the traders get all the upside as it's their book but do you get linkage to the P&L from your ideas or is it just base + bonus and a pat on the back?

5) How tolerate are the desks around mark-to-market losses? Let's say you pitch a bond at 80 that you think will recover to par. It prints a shitty quarter and falls 20 points to 60. Eventually, say 6 months later it recovers to par. Do you get a tap on the shoulder at 60 or are you judged on how your case actually plays out? I can see getting canned if you were long Thomas Cook/Debenhams at 90 and your case was wrong but getting canned over mark-to-market losses seems a lot harsher.

Thanks!

 

Fewer and fewer desk analysts roles at the banks over the years as they do not really do prop any more. Too high a capital charge. Most of the desk analysts in credit are there to support the new issues business at the I Banks. GS SSG still does stuff. RBC just hired Adam Saverese who ran the liquid side of SSG and still does mix of prop/execution. The European banks come and go from the business all the time. UBS/CS has shut down and reopened their distressed desks numerous times over the last 20 years.

Then you have the desk guys at the commission shops like Cantor, Odeon, Imperial, Cowen, Stifel, Guggenheim trying to make money in secondary market, but they have no origination so until recently when HY trading had dried up and all the volume was in loans, those places were bleeding money in FI. In those places the job of a desk analyst is to support a sell order (put lipstick on a pig and try and dump it on a customer so the sales guy can get his monthly commission. If you are there for long your reputation will not likely be good on buyside. If you can do if for 1-2 years, make some big funds some money and or not blow them up, you could land a job at a client if they think you are smart. You are at least in the loop with buyside

 

Thanks for this - do you believe in the fulcrum security investment philosophy?

Can you share a case study / example of a credit with upside you spotted and how you arrived at that conclusion?

 
Most Helpful

Figuring out the Fulcrum security is largely the old days of distressed (pre 2008) given the enormous growth in loan only cap structures and the amount of secured debt, particularly for sponsor owned companies. The DIP is the most strategic place in the cap structure in BK and is since the 2008 GFR is almost exclusively done by 1L lenders since no DIP loan that impairs their collateral can be approved over the objection of existing secured lenders who are entitled to adequate protection (Section 364(d)(1)(b)).

Most companies do not one a priming fight on day 1 of the BK and will take the 1L lenders DIP rather than fight in most cases. Junior creditors can try to offer cheaper terms, but rarely win a priming fight. The best they can to is get some of the more onerous terms removed from between the interim DIP order and final order. Finally most companies file with a Restructuring Support Agreement with the majority of the senior lenders laying out the terms of the restructuring prior to filing (pre arranged BK). In a prepack, voting on the Plan or Reorganization is solicited prior to filing, often as an alternative to a failed out of court consent solicitation.

IF you want to do distressed/BK, right, learn BK law and understand credit docs. The buyside doesnt really train guys and so unless you were at restructuring firm you wont know how BK works or how to read a doc. Even then,unless you were a more senior associate or above you were mostly down int he weeds modelling, not learning BK law and process.

 

Thanks for this - not sure I fully understand, are you saying Fulcrum security is an outdated concept? and this is now replaced by DIP financing? If so why is this the case - is DIP classified into the same voting category as 1L lenders?

 

It is an outdated concept for two reasons, One, most capital structures are loan only and two, the 1L creditors are generally in control the process as explained in my previous post unless the junior creditors are going to buy them out or can effect a "cram up" and treat them as unimpaired. However, that still will require the ability to prevent them from being the DIP lender and winning a priming fight which is not easy.

If you are interviewing for distressed jobs asking about how a firm identifies the Fulcrum security is a canned question that signals a lack of understanding of the BK process. I would ask about something more nuanced about cram ups or cram downs, or roll-up DIPs that demonstrate a better understanding of BK. But read up on it first, do not get over your skis and try and sound more knowledgeable than you are.

 

How do companies taking uni-tranche debt change either your opportunity set or how you view distressed opportunities? What are the incremental benefits or risks here?

Broad question but what are your views on current credit and equity markets - where are you seeing the best distressed opportunities besides energy?

How does what you do day to day inform you or help with your personal PA? Do you do any personal investing in performing credit or distressed?

What are some things don't you like about distressed investing?

Any tips for quickly analyzing capital structure and finding the best opportunity within the stack? What's your personal process for this when looking at a new situation? And what additional resources would you recommend reading to become good at this?

 

Unitranche debt is essentially a type of Senior-Subordinated debt structured as one tranche with different payment priorities. A unitranche loan is a First Lien loan done on a single credit agreement which spells out the payment priorities between First Out and Last Out lenders (there is no lien subordination as in a 1L and 2L, but lien subordination is not payment subordination. Lien subordination is with respect to collateral enforcement remedies in an Event of Default, it is the inter-creditor agreement that spells out payment subordination. In the case of a unitranche the credit agreement also functions as the inter-creditor between the First Out and Last out Lenders).

Section 510 of the Bankruptcy code mandates the enforcement of pre-petition subordination agreements and the courts routinely uphold inter-creditor agreement priorities. If you are a FILO lender (First Lien Last Out) and there is insufficient value in the payment waterfall after the First Outs are paid you would need determine whether a plan to cram up and or refinance out the First Outs and taking control of the process is economical. Distressed Energy related to E&P is the absolute worst place to put your money. Shale E&P companies have not and cannot generate sustained positive FCF. They couldnt do it when oil was $90-$100 bbl and could not do it at $50-$60 and cannot do it now for sure. The geology of shale and its rapid decline rate makes maintaining and growing production very capital intensive. Capex is typically 1.25-1.5x EBITDA and then add interest on top of that and it becomes very ugly from a FCF perspective. M&A does not solve the geology problem and all the lowering the LOE and G&A costs through drilling efficiencies and cost cuts were wrung out of these companies over the last 5 years. Yes they are now cutting capex claiming they can sustain produciton, but shale E&P CEOs are the biggest fruadsters there are.

I am not going to speak on specific names I am involved in. But there were very attractive opportunities in the BBB/BBB-/BB space in March where you could buy the debt of well run companies with strong balance sheets in the 60s-70s. Most are now gone with Fed liquidity. Now is the time to be discerning and patient and wait for the next leg down. Cannot have 30mm people out of work and not have a recession.

Read the Weil Bankruptcy Blog. Learn Bankruptcy and Credit (how to read docs and understand capital structure priorities ). The finance is the same and anyone who has a finance background can do the modeling. Also you can take my class.

As for capital structure, most capital structures are pretty simple today. If you are going to look at the complex ones where there are multiple silos of debt you need to understand credit priorities as it relates to structural seniority/subordination, Guarantor/non-Guarantor subs, and the amount of secured and structurally senior debt that can be issued at the different credit boxes.

 

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