Institutional Investor's Alpha Magazine - May 2008 - (Page 45)

Distressed Debt who co-founded Brookville Capital in August 2002 with Abraham Gulkowitz and David Reiss, says the play will be a little different this time around. The insatiable demand for structured credit over several years through mid-2007 led to an explosion in bank loans to inferior borrowers — that is, those who don’t meet investment-grade standards. These loans were repackaged into collateralized loan obligations, in which contractual subordination transformed the majority of the capital structure into investment-grade securities even though the underlying loans were still rated as junk. Cheap terms and plentiful supply encouraged leveraged-buyout sponsors and other highly leveraged companies to rely on bank debt for a large slice of their capital. According to Dealogic, a London-based research ﬁrm, annual leveraged loan volume in the U.S. soared to about $1.14 trillion in 2007, from $304 billion in 2002. The expansion not only cut the supply of subordinated bonds but also pushed them further down the capital structure, so that in future reorganizations bank debt will be less likely to pay out at par. As a result, distressed-debt investors today are focusing on bank debt rather than subordinated bonds that may end up with less negotiating power and an even smaller piece of the reorganized pie. Gulkowitz says that in the recessions of 1989–’90 and 2000–’01, senior subordinated bond recoveries averaged 25 to 30 cents on the dollar, but he foresees much worse numbers in the current downturn. Michael Fineman, co–portfolio manager and senior research analyst at Third Avenue Management, a New York–based money manager with $25 billion in assets, points out that the latest batch of leveraged buyouts, including those of Univision Communications and First Data Corp., were ﬁnanced with “covenant-lite” bonds that give holders few, if any, remedies until payment default occurs. “The hammer that distressed investors bank on to get to the table has been eliminated or reduced,” he says. Third Avenue is best known for its $16 billion mutual funds business, but it also manages $1 billion in alternativeinvestment strategies, including distressed debt. Fineman joined the company in late 2005 after stints in restructuring work at hedge fund Sanno Point Capital Management and at Ernst & Young Corporate Finance, both in New York; before that he held research and investment banking positions at Goldman, Sachs & Co. and Alex. Brown & Sons (now part of Deutsche Bank). Changes in bankruptcy law that took effect in October 2005 will come into play in a big way, for better or worse, for the ﬁ rst time during this cycle too. With the former law, bankruptcy judges allowed some companies to operate under Chapter 11 protection longer ABUNDANT VOLATILITY OPPORTUNITIES. OPTIONS ON THE CBOE VOLATILITY INDEX (VIX®) NEW! OPTIONS ON THE CBOE NASDAQ-100 ® VOLATILITY INDEX (VXN) NEW! OPTIONS ON THE CBOE RUSSELL 2000 ® VOLATILITY INDEX (RVX) Traders consider CBOE volatility indexes to be premier measurements of market volatility. Now, in addition to the hugely popular Options on VIX, CBOE provides expanded opportunities for trading volatility on benchmark equity indexes. Introducing Options on VXN (CBOE Nasdaq-100 Volatility Index) and Options on RVX (CBOE Russell 2000 Volatility Index). Trading volatility has never been easier. Enjoy the ride. Trade volatility at CBOE. To learn more, visit www.cboe.com/volatility. ACCEPT NO SUBSTITUTE. Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options (ODD). Copies of the ODD are available from your broker, by calling 1-888OPTIONS, or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606. CBOE ®, Chicago Board Options Exchange ®, CBOE Volatility Index ®‚ and VIX®‚ are registered trademarks of Chicago Board Options Exchange, Incorporated. All other trademarks and servicemarks are the property of their respective owners. Copyright 2007, Chicago Board Options Exchange, Incorporated. All rights reserved. MAY 2008 • INSTITUTIONAL INVESTOR’S ALPHA • 45 http://www.cboe.com/volatility http://www.cboe.com/volatility

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - May 2008

Institutional Investor's Alpha Magazine - May 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Send in the Clones The Good Guys: Outside the Box Cover Story: Welcome to Oz Interview: The Tipping Point Regulation: When Sentinels Go Astray Strategies: Taking Credit Research Center: The Hedge Fund 100 Book Excerpt: Shoot the Messenger Alpha Bytes: VaR Enough? Unhedged: Commentary: Not Your Father's Activist

Institutional Investor's Alpha Magazine - May 2008

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