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Distressed Buyers Take Wait-and-See View Amid Euro Crisis Cloud

Europe’s sovereign-debt crisis and concern about a double-dip recession in the U.S. have distressed-debt investors split on whether to buy the riskiest securities amid an expected rise in defaults, according to a survey of 100 asset managers and traders.

Common shares were rated the most appealing investment opportunity by 37 percent of those surveyed and least attractive by 34 percent, Debtwire’s North American Distressed Debt Market Outlook 2012 showed. Investors are taking a “wait-and-see” approach while reassessing their appetite for risk in the face of economic instability and political and regulatory changes, according to the survey.

Europe is seen as the most “dangerous cloud” over the markets, with 69 percent of those surveyed naming the region’s two-year-old crisis as the most significant factor affecting distressed investing and trading volumes. That’s a 10 percent jump from last year’s outlook as European finance ministers push bondholders to provide greater relief for Greece.

“If you go back a year, there was perhaps more hedge fund confidence that they were going to be able to figure out and master the European problem and profit from it,” said Timothy DeSieno, a New York-based partner at Bingham McCutchen LLP, which co-sponsored the survey. “There are a few heads hanging these days having realized the governments have gone to such extremes that they’ve beaten hedgies back more than they might have expected a year ago.”

Hoarding Cash

A euro zone default would cause an increase in U.S. default rates, according to 34 percent of investors, while 31 percent said it would result in a double-dip recession. Among the riskiest European sovereign debt, 42 percent of respondents put Ireland as the most important component of their strategy, followed by Greece and Spain.

“No matter where I go in the world, or which emerging markets conference I’m at, the agenda is largely taken up with Europe and what’s happening there,” DeSieno said in a telephone interview. “CFOs are trying to hoard cash and make conservative investment decisions, and prepare for what might be a massive repeat of illiquidity.”

After the European debt crisis, respondents said the likelihood of a U.S. recession is the second-most significant factor that will affect distressed-debt investing in 2012, with “bursts of good news on the employment and housing fronts” failing to quell fears. More than half of respondents agreed that the U.S. economy will be better served by a newly elected administration.

Dodd-Frank Looming

With implementation of the Dodd-Frank Act looming, the clearing requirement for standardized trades was cited by 45 percent of respondents as poised to have the most impact on credit-default swaps markets, up from 8 percent a year ago.

The financial-services sector continued to hold the most interest for respondents in the wake of such collapses as MF Global Holdings Ltd. and PMI Group Inc., followed by real estate, with 37 percent targeting the property sector from 22 percent in 2011.

“We don’t expect to see an influx of bankruptcies in 2012,” said Scott Seamon, New York-based counsel at Bingham.

A majority of participants see debtor-in-possession lending maintain a “backseat status,” while almost half expect to take part in activist strategies this year, “in an effort to stir the tranquil pot of still eerily low default rates,” according to the survey.

Defaults will exceed 2.1 percent this year, according to 68 percent of those surveyed. Moody’s Investors Service estimates the speculative-grade default rate in the U.S. will rise to 2.8 percent by the end of this year, from 1.8 percent at the end of December.

“I think default rates are going to stay relatively low especially in the first half of the year,” said Mick Solimene, a Chicago-based managing director at Macquarie Capital, co-sponsor of the survey. “We’ve got a relatively light maturity wall in 2012.”

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