TROUBLED-DEBT PLAYERS RAISE RECORD AMOUNT DESPITE GOOD TIMES: DISTRESSED? NOT THIS MARKET

A strong economy plus low defaults add up to a lack of opportunity for distressed debt, right?

Somebody better tell the distressed-debt players. Investors in the debt of troubled companies raised $2.6 billion last year, a record amount, according to Wilshire Associates in Santa Monica, Calif.

And, while records are being broken, a distressed-debt fund for the first time raised more than $1 billion. Los Angeles-based Oaktree Capital Management took in $1.2 billion from investors last year for its Opportunities Fund II.

Its investors include the Olympia-based Washington State Investment Board, the Boston-based Massachusetts Pension Reserves Investment Trust, the Rhode Island State Investment Commission, the San Diego County Employees’ Retirement Association and the Flinn Foundation in Phoenix.

Other groups to successfully close distressed-debt vehicles were Wellesley, Mass.-based DDJ Capital Management, which raised $500 million; Greenwich, Conn.-based Contrarian Capital Management, which raised $250 million; New York-based Rothschild Asset Management’s Recovery Fund, $200 million; and Chicago-based PPM America’s Special Investment Fund II, $473 million.

The $31 billion Minnesota State Board of Investment is an investor in Contrarian Capital’s fund.

Wilshire Associates Vice President Tom Lynch cites three reasons for the record amount:

* Oaktree’s billion dollar fund;

* The institutionalization of distressed debt;

* The view by some investors that distressed debt can hedge exposure to buyout funds.

“More alternative investment allocations include distressed debt,” Mr. Lynch says.

The total is understated because some buyout partnerships, traditional junk-bond money managers and hedge funds have allocated portions of their portfolios to the sector, he says. “There is a lot of crossover, primarily from buyout funds that do distressed debt.

“High-yield managers do a portion of their investments in distressed debt and you have hedge fund managers which dominate t
he trading component,” Mr. Lynch adds.

Distressed-debt players acknowledge that this isn’t the most attractive environment for distressed-debt investing, but they are confident they will find opportunities.

“The timing is not good,” says Howard Marks, chairman of Oaktree Capital. “Now is a good time to anticipate. You have to raise funds in advance.”

Terry Blaney, head of alternative investments for the $34 billion Washington State Investment Board, is confident Mr. Marks will make the right moves.”He has been able to invest in thick and thin markets,” Mr. Blaney says.

But the investors are not standing idly by waiting for a recession. There are enough opportunities to keep them busy in the current economy, and many have permission to invest internationally, where there are additional opportunities.

The Rothschild Recovery Fund in January scooped up bonds from the Korean Development Bank at 75 cents on the dollar in the days before the International Monetary Fund agreed to lend the country $60 billion. The bonds rose to 90 cents in the days following the loan approval.

Looking ahead, though, the domestic distressed-debt market should improve. According to Edward Altman, a professor at New York University, default rates are at historical lows, which means fewer opportunities. Mr. Altman’s research calculates the default rates from 1995 through 1997 are 1.9%, 1.2% and between 1.5% and 1.8% (for 1997), respectively.

The historical default rate has been twice the current rate, says Kenneth Schlemmel, senior managing director with PPM Special Investments Group.

During this period of low defaults, new issues of high-yield debt — the riskiest type — have also hit an all-time high with a record $119 billion raised in 1997, Mr. Altman says.

“If the default rate returns to historical levels, which is twice what it is presently, and you apply it against new issues, you will have a huge market,” says Mr. Schlemmel. “There will be a lot of opportunities.&q
uot;

“If there is any reversion to the mean, it will be a staggering amount,” says PPM senior managing director Levoyd Robinson.

It is unlikely that distressed-debt players will force money into the market while they wait for the supply of distressed debt to pick up.

“We have five years to invest,” Mr. Marks says.

Probably the best indication that investors are confident that distressed-debt investors will be patient is the ease with which Oaktree and some of the others raised money.

“We didn’t do any marketing,” Mr. Marks says. “We had good repeat business from our existing customers.”

Crain News Service