The ongoing credit crunch has led to a huge number of high-yield real estate debt funds trying to cash in on the distress: There are now close to 70 such funds, and they are attempting to raise US$40 billion. Some are veteran investors that have operated in real estate debt for 20 years or more, but many others are newcomers. The funds use different strategies, usually including some combination of CMBS, mezzanine, preferred equity, whole loans, B-notes, RMBS and, increasingly, originating new loans.
There were a lot of reasons to dislike riskier credit in the second half of last year. The subprime mortgage fallout, tightening credit markets, an increasing backlog of postponed new issues in the high yield space and growing concern over the economy were enough to make even the most seasoned distressed investors re-evaluate their portfolio strategies.
The bursting of Japan’s bubble economy and the ensuing Asian crisis of 1997-98 created an entirely new asset class in Asia: distressed debt. Companies that were once healthy and viable filed for bankruptcy, creating a large investing landscape for specialised investors. Distressed debt arises when a company is experiencing financial difficulty, and has defaulted on its debt obligations. To align the capital structure with repayment capability, the company must reduce debt by either restructuring its balance sheet or by liquidating some of its assets.
In contrast to how hedge funds evolved elsewhere, and in particularly in Asia, in Latin America the dominance of fixed income and debt markets explains the creation of many macro and multi-strategy funds, in detriment of other strategies, including equity long/short.
Financial distress arises when a company has too much debt and too little cash flow. The company must seek to reduce this debt burden by either restructuring its balance sheet or by liquidating the assets used as collateral. Distressed debt is any payable that has been issued by such a company. The asset class includes bank debt, fixed and floating rate public debt, convertible bonds and private debt including trade claims. Investors in the asset class take advantage of the significant fall in price of these claims in the event of financial distress.