Distressed Debt

Distressed Strategy in Private Credit Fund

To effectively manage and navigate distressed situations in private credit, top firms implement from of the following key strategies:

Preventing a Distressed Situation

• Risk Management: Initiate strong due diligence and ongoing monitoring to assess and mitigate risks early.

• Diversification: Spread investments across various sectors, regions, and risk levels to minimize potential negative impacts from any single asset.

• Investment Committee: Ensure large or risky investments pass through rigorous committee reviews to balance risks with potential returns.

Navigating a Distressed Situation

• Expertise in Restructuring: Utilize in-house restructuring specialists to renegotiate terms or manage recovery processes.

• Active Management: Take proactive steps such as loan term renegotiations or direct management interventions to rehabilitate distressed assets.

Evolution of Distressed Debt

The distressed debt market has undergone significant changes, particularly since the financial crisis. Historically, distressed debt was largely traded on public markets where large investors could buy substantial portions of a company's debt to control or influence restructuring processes. This was enabled by active trading desks at large banks and by leveraged investment vehicles that were common pre-crisis but collapsed during it.

Post-crisis, the landscape shifted. The owners of distressed debt today are often long-term holders, such as those involved in collateralized loan obligations (CLOs). These structures are less inclined to sell their holdings, even in default situations, because they don't face the same liquidity pressures as previous market structures. They can self-regulate to some extent, diminishing the frequency and volume of distressed debt that becomes available on the market.

This shift means that trading opportunities in distressed debt are less frequent and shorter-lived. The brief but intense periods when trading does occur, such as during the initial months of the COVID-19 pandemic, require investors to act quickly and decisively.

Moreover, distressed debt investment has increasingly moved towards a private credit model. Here, investors often engage in consensual negotiations to provide rescue financing directly in partnership with private equity firms that own the distressed companies. This approach is less about battling in public debt markets and more about structuring proactive solutions that might involve complex layers of capital, such as first-lien rescue loans or preferential equity structures that attempt to deleverage existing debt while still providing returns akin to equity for the risk undertaken.

Overall, the market for distressed debt has become more strategic, less liquid, and oriented towards private negotiations rather than public market transactions. This evolution reflects broader changes in financial markets towards more stability and long-term holding strategies post-financial crisis.