Vultures are preparing to feast

Hedge fund managers are rubbing their hands at the prospect of a rapid increase in loan-to-own opportunities as covenant breaches are predicted to rise, according to the latest research.

A significant number of over-leveraged buyouts are expected to crumble in the next two to three years and create a surge of distressed investment opportunities.

In a survey commissioned by accountants Grant Thornton and law firm Latham & Watkins of 110 senior lending bankers, CLO managers, hedge funds and private equity executives in the UK and Europe, more than half predicted at least 10 percent of leveraged buyouts will be acquired by distressed debt investors in the next two years.

A quarter predicted more than 20 percent of buyouts will be purchased by distressed investors during this period.

To put this in context, 60 percent of respondents estimated at least 20 percent of buyouts have too much debt on the balance sheet.

Mark Byers, head of restructuring at Grant Thornton, said “With deal flows also predicted to fall next year, it is highly likely that distressed investing could make up an even greater proportion of overall opportunities in the next 18 months.

He said for those with the ability to move quickly, assign a sensible value and assess a distressed investment's turnaround prospects, this environment could be a lucrative opportunity.

But there is still reluctance in the vast majority of buyout firms to explore these opportunities. Just 28 percent of executives are planning any change of strategy in light of the recent turn in the credit markets.

Hedge fund managers are gloomiest about private equity's prospects with 41 percent of respondents expecting a fifth of buyout credits to breach covenants in the next three years.

CLO managers and banks, where just five and seven percent of respondents respectively, are most optimistic. The expect breaches of more than 20 percent of credits are likely within three years.

Survey respondents also painted a bleak picture for future buyouts, with an overwhelming 94 percent expecting a decline of at least 10 percent in deal volumes in 2008.