Illiquid Insights
In past cycles, distressed investors took advantage of market panic and high defaults to acquire debt at massive discounts, and reap big gains.
But structural shifts across the credit markets have made this a harder play to run.
Why distressed debt is disappearing:
Private credit is swallowing up the market
LMEs are replacing restructurings on the public side
Read the full breakdown below.
The Landscape Has Changed
Traditionally, restructuring was the only option when companies ran into financial trouble.
This gave funds like Oaktree, Cerberus and Apollo ample opportunities to acquire debt at steep discounts, execute restructurings, and reap big returns.
But the rise of private credit and LMEs has given companies new ways to address debt burdens.
This means there are fewer opportunities for distressed investors to go around.
Private Credit’s Takeover
The boom in private credit has created a massive, new pool of capital separate from publicly traded credit.
Today, there is over $500B of dry powder in private credit, which lenders are eager to deploy.
The direct lending market, now the same size as the broadly syndicated market, has directly reduced distressed opportunities:
Private debt doesn't trade on the secondary market, meaning less debt is available for distressed funds to acquire
Lenders will take equity ownership, and manage the turnaround / sell the company, rather than sell their debt to third parties
Special situations private lenders are providing higher yielding debt like 2nd lien, HoldCo and rescue loans, which give stressed companies more options
The LME Revolution
On the public credit side, the market has been transformed by Liability Management Exercises (“LMEs”).
LMEs are coercive transactions used by borrowers, like removing collateral, issuing or exchanging debt, or other modifications, to manage debt liabilities.
LMEs surged in popularity in 2020 during the pandemic, and have since become even more widespread.
Today, LMEs outnumber payment defaults by ~20%.
Companies use LMEs to raise new capital, extend maturities, and preserve optionality for equity holders.
This development has come at a cost to distressed investors.
LMEs are now the first move for struggling companies, directly displacing the traditional restructurings that distressed investors depend on.
Shifting Strategies
The distressed opportunity set is changing, and managers are adapting.
Most funds are repositioning from distressed to opportunistic, greatly broadening their mandate.
Opportunistic entails expensive capital for companies with limited options. This can range from 2nd Lien and HoldCo loans to rescue financings and preferred equity solutions.
The shift reflects the evolution of distressed, from a narrow restructuring focus to a broader, flexible approach.
Distressed debt is not dying, it’s evolving.
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