Where To Buy Debt Portfolios

This client update identifies the principal issues that private equity firms and their portfolio companies should consider and address with the help of counsel before any purchase of portfolio company debt by the sponsor or the portfolio company itself.

where to buy debt portfolios

Accordingly, if a sponsor is considering a purchase of portfolio company debt, it should be sure to consult with fund counsel to make sure that it does so in a manner that both complies with its underlying fund documents and carefully considers any conflict issues.

Most portfolio company credit agreements still permit the borrower and its subsidiaries and affiliates (e.g., the sponsor or a debt fund affiliated with the sponsor) to purchase term loans of the company, whereas the purchase of revolving loans and commitments is still generally restricted and in many cases prohibited.[1]

Set forth below is a high-level overview of common terms in credit agreements that may affect the extent to which a sponsor or its portfolio company purchases/repurchases its debt, and some of the implications doing so can have under these instruments.

If the debt takes the form of a security such as senior notes issued under an indenture (in contrast to loans outstanding under a credit agreement), the private equity sponsor or portfolio company should consider the following:

The purchase of portfolio company debt at a discount may trigger taxable cancellation of debt (COD) income to the portfolio company and may cause the purchased debt to no longer be fungible with the remaining debt (which may impact the ability to resell the debt into the market). The precise tax consequences depend in part on whether the debt is repurchased by the portfolio company itself, by the private equity fund or by a related entity.

Similarly, if the debt will be purchased by a different fund (even if by an affiliated fund), the purchasing fund will need to obtain its own contractual management rights in order to qualify the investment as a good VCOC investment.

[1] However, some (typically mid-market) credit agreements continue to prohibit any purchase of loans by the borrower or its affiliates (including the sponsor). In these situations, the affiliate or the borrower may be able to enter into a participation with a lender. If this option is not available, an amendment (which may require a 100% lender vote) would be required to permit a debt purchase/repurchase.

Correction: August 19, 2014An earlier version of this article misstated the value of a package of debt that McKellar and Associates Group purchased for 12 basis points. That comes out to about one-eighth of a penny on the dollar, not one-twelfth of a penny on the dollar.

Helping Communities Wipe Out Medical DebtTo help relieve the burden of medical debt on their residents as part of the recovery from the COVD-19 pandemic, communities across the country are using American Rescue Plan (ARP) funding to support efforts to buy and forgive medical debt. These communities work with partners to purchase medical debt portfolios from hospitals, health systems, and debt collection agencies and forgive the debt. Because medical debts are often available for purchase at pennies on the dollar, these efforts can translate into massive reductions in medical debt.In the programs implemented to date, individuals qualify if they are residents of the given locality and have incomes below a certain threshold or have medical debt in excess of 5% of their annual household income. Individuals whose debt is cancelled are notified by mail and do not need to apply. Communities that have used ARP funds to forgive medical debt include:

New Data on Medical Debt in CollectionsThe report from the CFPB documents trends in medical debt in collections that are listed on credit reports, with the data extending through the first quarter of 2022. Key findings include:

These are all reasons your clients are reaching out to you for answers and ways to capture more alpha in their portfolios. We believe emerging markets may be an unexpected opportunity for your clients as you consider rebalancing their portfolios. Our team sees current valuations as likely setting the stage for emerging markets debt to generate high income and strong total returns over the next 12 to 18 months, with adequate compensation for risk.

Emerging markets debt is significantly more diversified than it has ever been, with numerous new issuers from both sides of the credit spectrum. The category includes low-income countries from sub-Saharan Africa and wealthy oil exporters from the Persian Gulf. A more diversified issuer base translates into less idiosyncratic risk and more active management opportunities.

This certainly does not make emerging markets investments risk-free, and defaults do happen, but the incentive to pay the debt is very high. In fact, recovery rates after default are often higher than for corporate issuers because countries do not simply disappear as a company may. Once a recovery is in place, returns from emerging markets debt can be very significant as longer bond maturities can sustain price appreciation and countries strive to improve their credit fundamentals.

The specific case for emerging markets debt comes down to valuations and improving technical factors, while fundamentals are mixed. Many emerging markets issuers will continue to benefit from higher commodity prices, but some are exposed to higher import costs for food and fuel. Government revenues have been strong, but higher imported inflation is increasing costs for domestic borrowing as costs for external borrowing have risen.

Emerging markets debt is further along in its adjustment. Triggered by early signs of global monetary tightening, the emerging markets sell-off began in the fourth quarter of 2021, much earlier than in the sell-off in the broader credit market. That's one reason we believe emerging markets debt is closer to its bottom and better positioned for recovery than other asset classes. The rapid selloff in spreads and global interest rates has resulted in historically low dollar prices for emerging markets bonds. While this mostly supports distressed issuers that may be forced to restructure (minimizing any loss given default), it should also result in tighter spreads for healthy credits, given the lower dollar amount investors have to put at risk for each bond purchased.

While it's always hard to pick the exact bottom, we feel comfortable about the outlook for emerging markets debt returns for 12 to 18 months. We're now positioned constructively in our emerging markets portfolios and encourage you to consider increasing allocations to emerging markets debt in your clients' portfolios.

Available for sale (AFS): A catch-all for debt and equity securities not captured by either of the above definitions. These are securities that the bank may retain for long periods but that may also be sold.

The chart below shows a breakdown of bank debt and equity securities portfolios into these three categories. The size of each portfolio is scaled by the total assets of the commercial banking system.

1. Banks may face an imbalance between their access to deposit finance or other low-cost funding and their profitable lending opportunities. This could be the result of geographic factors, shocks to credit demand or to deposits, or other factors. In such cases, funding-rich banks may choose to invest in securities that reflect lending by other banks or by nonbank lenders (e.g., mortgage-backed securities issued by another lender), or direct debt issuance by nonfinancial firms (e.g., corporate bonds).

3. From a risk management point of view, holding securities may help the bank diversify or mitigate its risk exposures. Conversely, adjusting securities holdings can provide a straightforward way for banks to ramp up their level of risk in an effort to increase expected returns. For example, recent research argues that banks respond to expansionary monetary policy by lengthening the maturity of their securities portfolios, in an effort to boost yields.

4. Holding securities portfolios may help the banking firm perform other financial services. For example, broker-dealers maintain an inventory of securities to allow them to act as market makers, matching buyers and sellers in financial markets and providing liquidity to those markets.

A commercial debt buyer purchases portfolios of non-performing paper from finance companies. While consumer debt buyers dabbled in commercial accounts decades ago and continue to do so, the commercial debt buying profession can be traced to 1998 with the founding of TBF Financial.

Equipment lessors with small-ticket transactions were quicker to understand the value of commercial debt selling. Some lessors began selling their non-performing paper, after having first managed it in-house and handed it over to collections agencies for extended periods. By 2005, more lessors were using commercial debt buying services and most were doing so soon after charge-off, the prevailing practice that continues today.

Then the Great Recession changed everything. From 2008 to 2010, equipment lessors were dealing with a growing volume of non-performing paper, especially accounts connected with the real estate and construction industries. But the paper was not very collectible because so many lessees had failing businesses. Commercial debt buying and selling in equipment finance dropped dramatically after lessors tried to clean the defaults from their books. Volume began picking back up in 2015 and since then has been building gradually.

Interestingly, the recession piqued banking interest in commercial debt buying. Banks were dealing with an avalanche of defaults. Problems also emerged with business lines of credit secured by first mortgages. Foreclosures could take a year or more, the market for them was weak and bank reputations were being tarnished. Banks began selling their write-offs to save time and make quick money. 041b061a72