Z-Score Creator Says Distressed Debt to Slide Further (Update2)
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By Shelley Smith
April 29 (Bloomberg) -- Distressed debt investors should wait before buying as soaring default rates will depress prices, according to Edward Altman, creator of the Z-Score formula that calculates a company’s probability of bankruptcy.
“It’s too early for the distressed industry to pile into defaulted assets,” Altman, a 67-year-old professor of finance at New York University’s Leonard N. Stern School of Business, said at a conference in Hong Kong yesterday arranged by FinanceAsia and AsianInvestor. “Defaulted assets will not go up in value as long as the default rate is escalating.”
More than $1.3 trillion of losses and writedowns at financial institutions worldwide, combined with the deepest global recession since World War II, have weakened companies’ ability to pay debt. The U.S. speculative-grade default rate will reach an all-time high of 14.3 percent by March 2010 after leveraged buyouts push European corporate defaults to a record 14.7 percent this year, Standard & Poor’s forecast this month.
Bonds are termed distressed when they yield at least 10 percentage points more than similar-maturity government notes. Distressed debt managers typically seek to profit by buying assets at below their face value, providing high-yield financing that could give rights to equity opportunities to restructure companies before selling them at a higher value.
Tightening Spread
The extra yield investors demand to hold speculative-grade, or junk, corporate bonds rather than government securities fell 3.11 percentage points to 15.47 points this year after rising to a record 21.93 points Dec. 15, according to Merrill Lynch & Co.’s Global High-yield Corporate Bond index. Junk bonds are securities rated below BBB- by Standard & Poor’s and Baa3 by Moody’s Investors Service.
U.S. distressed debt returned 17.4 percent this year compared to a loss of 4.7 percent in the same period last year, Merrill data show.
The supply of new distressed debt has increased fourfold to $2 trillion since the end of 2007, creating opportunities for patient investors who conserve capital, according to Altman’s presentation.
Hedge funds are reeling after they lost 19 percent on average last year and investors withdrew $155 billion, the worst performance since Chicago-based Hedge Fund Research Inc. started keeping records.
Fourfold Increase
“You can lick your lips and say ‘look at those opportunities,’ but they will also be there in six, nine and 12 months,” Altman said. “Look at the supply and demand dynamics: half as much money chasing four times as much distressed debt.”
Chrysler LLC, which was downgraded to one level above default by Moody’s on April 21, faces bankruptcy if it is unable to restructure its debt, according to a person with knowledge of talks with lenders. The U.S. has reached an agreement with the banks to forgo $6.9 billion of the Auburn Hills, Michigan-based automaker’s debt in return for $2 billion in cash, the person said yesterday.
“We really are seeing a complete mismatch between the supply of credit and not many people around to buy those credits from companies that have got themselves into trouble and need financing,” Robert Appleby, who helps oversee about $2.4 billion as chief investment officer for Hong Kong-based ADM Capital, said at the conference. “It’s now a very interesting time for providing companies with new forms of capital and making sure those investments are structured correctly.”
General Motors Corp.’s bondholders are baulking at the automaker’s offer to exchange $27 billion in debt for equity, according to a statement issued by an ad hoc committee of the Detroit-based automaker’s investors yesterday.
GM’s $3 billion of 8.375 percent bonds due in 2033 last traded at 9.2 cents on the dollar to yield 89.2 percent, according to Trace, the bond-pricing service of the Financial Industry Regulatory Authority. Moody’s withdrew its rating on the company on July 15. |
