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Mid-market lender expects distressed debt opportunity to rise

A growing swath of troubled corporate borrowers that need to restructure their liabilities may create opportunities for investors that specialize in distressed debt, says the head of credit at Charlesbank Capital Partners.

A growing batch of troubled corporate borrowers need to restructure their liabilities, creating opportunities for investors that specialize in distressed debt.

Charlesbank Capital Partners, which runs a platform that lends to middle-market borrowers, closed its third credit opportunities fund on $1.5 billion in January. The vehicle targets strategies including secondary credit, special situations and distressed debt investing.

Among those strategies, Charlesbank head of credit Sandor Hau anticipates distressed debt, or buying debt at a discount and building a position with the goal of owning the borrower after a restructuring, will be particularly active in the short term. Fueling this climate are tight credit conditions in the middle market and more companies facing near-term maturities, compressed margins and elevated debt loads.

Hau talked to PitchBook about why distressed debt could pile up in 2024. This interview has been edited for length and clarity.

PitchBook: Among your core strategies, which do you expect to drive your deal pipeline this year?

Hau: We expect distressed debt investing is going to become more active in the next 12 months. There will be more ... restructuring transactions for middle-market companies.

Leverage has increased for certain companies, which also have debt that will mature. And not everyone will be able to find a capital solution. Given those situations, we think defaults will go up.

How has leverage changed for middle-market borrowers?

There are many high-quality businesses that have debt maturities within the next two to three years, and there will be hundreds of billions of dollars in debt that are coming due.

Meanwhile, many high-quality businesses have elevated debt levels now as their margins have come down. Many companies that previously have had around 4x EBITDA now see their leverage rise to 5x or 6x.

As long as their leverage is elevated, a pure-play direct lender who focuses on performing credit may not want to lend to a company that has a 5.5x debt to EBITDA, even as that business may still be a high-quality business.

Many distressed debt investors expected higher interest rates and bank failures last year to lead to rich pickings for attractive distressed debt assets. But that didn’t happen. How do you think this year will be different?

The number of debt maturities coming due in the short term are bigger than before, and the leverage is still elevated.

So 2023 and 2024, what’s the difference? We’re closer to debt maturity, mathematically. That is part of the catalyst. Maybe [the cycle] is extended a little bit more. Maybe it doesn’t come for another six months. That’s a macro prognostication question.

But from a fundamental analysis perspective, when we look at the market, we clearly expect defaults to go up within the next couple of years.

If the company has leverage at 7x or 8x, not many lenders are going to provide debt for it. At that point, the company’s sponsor has to decide whether to put in more equity; otherwise, the company will restructure and let debt holders take over.

Private equity firms are gonna save a lot of their companies. I think it comes down to: Can they save every single one of them? Sponsors have to focus on companies that they believe will have the highest return.

Featured image by Eoneren/Getty Images

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