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Vaselkiv on Opportunity in Bankruptcies

Jason Stipp

Jason Stipp: I'd like to move down to the portfolio level now. You have recently found some opportunities in companies that are coming out of bankruptcy. And I think that, certainly, there is a lot of attention on investors' minds on downside protection, and it would seem on the face of it that these could be much more touch-and-go or risky situations.

For those companies that you have invested in, that have been coming out of bankruptcy, how do you get comfortable with them and the risk that potentially you could be taking on there?

Mark Vaselkiv: I think as people have studied the high-yield market for the last two years, the dominant focus has been the default rate and where the expectations for defaults were headed. We've been pleasantly surprised to see defaults come down significantly.

One of the benefits of the high-default rate is actually that companies went into bankruptcy reorganizations with too much debt, and a lot of those obligations and liabilities were significantly pared back. So as the companies now finish their Chapter 11 bankruptcy processes, they are coming out in much better shape financially.

I think one illustration, Jason, would be Lyondell Petrochemical which went into Chapter 11 with over $20 billion of debt and are coming out, they have exited, with less than $7 billion in debt. That makes a very profound difference in terms of the potential for the company going forward.

So, we're seeing many similar stories of good businesses that had bad balance sheets, and now they are good businesses with better balance sheets.

Stipp: Would you say that you are seeing then potentially more opportunity in some of these bankruptcy or special situations now in the current market environment than maybe you had seen in the past?

Vaselkiv: Yes. And that's a little bit of a difficult skill set to acquire because usually a traditional high-yield manager will focus on higher-quality companies rather than companies operating in distressed situations. But there has been so much of it in the last year that we've really devoted a significant amount of resources to understanding these companies.

Clearly, the largest name in the high-yield market for many years is General Motors. Obviously, it went through a reorganization process, but we see things getting better at GM. We're seeing an early recovery in the auto industry. And if you peel back the layers of that company, you really see a business that is going to be in better shape over the next couple of years, and we're finding in many respects that's a diamond in the rough.

Another company would be CIT Group, specialized financial services company, and they also exited from Chapter 11 with a lot less debt. And from our standpoint, it's now a very attractive franchise and an asset. In many cases, our equity analysts and portfolio managers are also looking at these situations. So while we are investing in the debt of companies like CIT, T. Rowe Price portfolio managers on the equity side are buying the common stock.

Stipp: Some companies then coming out of bankruptcy, you mentioned, are looking like they are in a better situation now. A lot of other companies that maybe didn't enter bankruptcy did feel the pinch of the credit crunch and the crisis, and then as liquidity started to come back, they were able to roll over some of their debt.

But some folks have been saying for some of these companies they've really just kicked the problem down the road a little bit, there is concerns about another maturity wall coming up in 2012, 2013.

Do you feel like there is going to be an issue for high yield in a couple of years when some of the debt that they were able roll over recently starts to come due again? Is it just going to be the same problem all over again?

Vaselkiv: I think there is clearly a number of very significant companies in the high-yield market that still are not out of the woods and mostly these are in leveraged buyout stories. The private equity world really in many respects created the amount of extreme leverage that we see in our market. And many of those LBOs have been substantially fixed, but a handful still remain where the jury is out, and without very substantial improvement in the operating fundamentals of these companies, they're just not going to be able to grow into their balance sheets, and ultimately a debt restructuring will be in order.

But I want to emphasize, that's not the end of the world when a company has to do that. Debt can be pared back. It's a very rational process that occurs either in court or out of court. And as we've been talking in this conversation, many times that creates opportunities. So, even though some of those companies may have to go through default situations, ultimately that may be very good for some creditors if you are positioned appropriately in the company's securities and the capital structure.

Stipp: Well, Mark thanks so much for joining me today and for your insights on the market. I appreciate speaking with you.

Vaselkiv: I enjoyed the conversation, Jason. Thank you.

Stipp: For Morningstar, I am Jason Stipp. Thanks for watching.