Trash or Treasure? Finding Value in Distressed-Debt Investing

Panelist Profiles and Fund Strategies

• Laurence Scottlieb (Fundamental Advisors): Manages private equity and hedge fund vehicles focused on total return/value in municipal alternative investing; the firm is eight years old and spans nearly all municipal sectors except stable yield high-grade securities.
• Chris Piccillo (Solus Alternative Asset Management): Serves as CEO/CIO of a distressed-focused firm with over $6 billion in AUM across multiple vehicles, targeting stressed opportunities across the capital structure.
• Brian Reynolds (Chatham Capital): Founder of a fourth-fund vehicle with $1 billion AUM focused on first and second lien leverage lending, primarily for LBOs in the lower middle market.
• Steve Shapiro (Golden Tree): Leads a 15-year-old firm managing $23 billion in corporate credit, high-yield, leveraged loans, and distressed assets across offices in New York and London.

Energy Sector Analysis and Capital Mobilization

• The energy sector represents approximately 15% of the high-yield index, with about 5% of the sector trading at distressed values as of year-end.
• Panelists generally view the energy trade as "too soon" to enter, citing valuations justified by forward oil prices that are too high given the potential for oversupply.
• US rig counts have declined from 2,000 in 2011 to under 700, creating excess production, while future supply depends on volatility in Libya, Russia, Iran, and Iraq.
• Some panelists note better risk-adjusted returns in energy equities compared to debt, as debt is pricing in commodity recoveries that equities do not reflect.
• Capital mobilization for energy distress is active with dedicated funds, but panelists warn that "not all of it's going to work" due to a dearth of large-cap distressed ideas.
• Steve Shapiro's firm currently avoids the oil sector due to skewed supply-demand dynamics, noting the high-yield energy index recently touched 8%.

Alternative Investment Themes and Opportunities

• Municipal Focus: Lawrence Scottlieb identifies affordable housing and needs-based senior care as primary investment targets within the municipal sector, betting on the reframing of community services.
• Telecommunications: Chris Piccillo highlights cellular phone spectrum as a long-term theme, leveraging asset ownership to create value against the high costs of network infrastructure (2G to 4G transitions).
• Regulatory Disruption: Solus identifies opportunities in payday lending (specifically ACE and CNG) where companies have pre-emptively restructured to meet new legislation.
• Business Development Companies (BDCs): Panelists note BDCs are trading under book value (97 vs. 105) due to oil exposure, offering average dividend yields of 9.7%.
• Idiosyncratic Plays: Golden Tree is targeting eclectic, one-off opportunities such as the liquidation of GM units, Puerto Rico assets, and transitioning Yellow Page directories from print to digital.

Puerto Rico Distressed Debt Strategy

• Puerto Rico holds approximately $70 billion in debt across a complex capital structure including GEO bonds, the government development bank, and public corporations.
• The panel generally agrees the situation is "fixable" and supports allowing government-owned corporations to file for Chapter 9, arguing that a cohesive restructuring is superior to the chaos of creditors pursuing individual legal remedies.
• The 2016 Puerto Rico Recovery Act was struck down, creating a vacuum that prevents a unified restructuring rubric, leading to concerns over a chaotic, piecemeal resolution.
• Steve Shapiro's firm specifically likes the Cofina bonds backed by sales tax, distinguishing between wrapped and unwrapped bonds based on recovery potential.
• Panelists warn that PREPA (the electric utility) is not adhering to indentures or rational cost structures, creating a "domino effect" where fixing one area (e.g., power generation) impacts other debt tranches.
• Current pricing is estimated at roughly 50 cents on the dollar, which panelists view as having built-in protection relative to potential recovery scenarios.
• Section 2022 tax incentives are discussed as a mechanism to drive growth, potentially aiding a broader economic turnaround if combined with medical/pharmaceutical reinvestment.

Credit Cycle, Default Risk, and Market Liquidity

• Credit Cycle Positioning: Golden Tree and Chatham Capital believe the market is "deep into the credit cycle," citing underperformance of triple-C credits, increased leverage, and a rise in covenant-light structures.
• Default Rate Forecasts: While some panelists warn of underwriting quality deteriorating toward 2006 levels, others argue cumulative default rates will not reach Lehman crisis levels due to better borrower coverage ratios; they anticipate a rise to 4-5% default rates.
• Opportunity Size: Steve Shapiro projects a "robust distressed opportunity" over the next 12-24 months, specifically in the 75-80 cent range, driven by rising interest rates and credit upgrades.
• Interest Rate Impact: A 3-4% 10-year Treasury rate could force lower-rated borrowers to pay 10-12%, exacerbating free cash flow issues and crowding out marginal companies.
• Liquidity Deterioration: Broker-dealers are committing less capital, leading to wider bid-ask gaps and more violent price moves during volatility.
• Dealer Behavior: Analysis of Federal Reserve data suggests dealers often cut positions during distress rather than providing a cushion, acting as "first out the door" rather than buyers.
• Municipal Liquidity: The municipal market faces similar liquidity constraints due to regulatory capital constraints and a decentralized broker network, though deeply distressed credits have historically never been a liquid market.
• Yield Curve Signals: The panel notes the yield curve is currently positive (approx. 2%), whereas every recession in the last 50 years was preceded by an inverted curve, suggesting a downturn is not immediate but may be 1-2 years away.