According to a Debtwire report released this month, the North American distressed debt market will be characterized by continued volatility throughout 2017, with the oil & gas sector presenting the most attractive opportunity for investors. Financial services, industrials and real estate were also identified in the report as being ripe for investment in the coming year.

Downward allocation trends

2016 saw a lower year-over-year asset allocation to distressed investing, with 50% of respondents stating that they had increased their allocation to distressed debt, compared to 68% of respondents in 2015. This downward trend was explained mainly by concerns over general market conditions and the slow pace of economic recovery, both of which pushed investors to hold onto their capital.

Looking ahead, 43% of respondents indicated that they expected to allocate equivalent amounts to distressed debt in 2017 relative to the previous year, while 21% suggested they would decrease their allocation. Meanwhile, only 36% of respondents anticipated an increase in allocation.

M&A at the fore

In line with the previous year, strategic M&A was identified by 35% of respondents as the primary driver of market activity. As companies struggle to grow organically in a time of sluggish economic progress, respondents expected an increased emphasis on consolidation, synergy optimization and mutual growth benefits through strategic M&A.

The oil & gas sector was identified as being a likely active area for M&A due to the fall in prices within the sector. Indeed, 51% of respondents anticipated allocating more capital to oil & gas companies in 2017, while only 10% planned to decrease allocations. Of those companies expecting to increase their allocation in this sector, 27% of respondents predicted their allocations would increase between 26-50%, while a further 22% of respondents anticipated their allocation would increase between 1-25%.

Interestingly, 26% of respondents pointed to capital expenditures as the likely primary force behind primary issuance in 2017, more than doubling expectations from the previous year, when only 12% of respondents anticipated they would lead. Expectations regarding the role of refinancing (17%) and dividend recapitalization (7%) mirrored last year’s results, while leveraged buyouts are predicted to play a markedly smaller role in the year ahead, declining from 32% in 2016 to 15% in the coming 12 months.

An optimist perspective

Although the global macroeconomic climate has tempered certain investors’ appetite for distressed debt, others see opportunity in light of current market conditions, as economic uncertainty, slow credit markets and volatile commodity prices have created enticing investment opportunities in undervalued companies.

The author would like to thank Brian Peebles, Articling Student, for her assistance in preparing this legal update.

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