Saybrook Capital LLC has raised capital commitments of $135 million for a fund thatlooks to capitalize on deteriorating credit quality in the municipal bond market.
"The next several years hold substantial investment opportunities in the distressedmunicipal bond arena," Jeff Wilson, a co-manager of the new Saybrook Tax-ExemptOpportunity Fund II, said in a prepared statement. "Credit quality continues to erodeacross several sectors - airlines, energy, health care, multifamily housing,hospitality, and tobacco."
The new fund, whose closing Saybrook announced last month, will invest in tax-exemptbonds in various stages of distress, including default, in cases where the debt can berestructured and stabilized. It closely resembles a smaller fund with only $45 millionin capital commitments that was launched by the Santa Monica, Calif.-based firm in 2000.
As mutual fund companies reduce the number of credit analysts on staff, their ability tofocus on small, distressed bond deals becomes more limited, said Jon Schotz, a foundingpartner of the firm and co-manager of the fund.
"We saw a need in the marketplace because there is no liquidity, particularly for dealsunder $100 million in size," Schotz said during a telephone interview yesterday. Headded that Saybrook, which also functions as a financial advisor, has substantialexpertise in representing various parties in some high-profile bankruptcy workouts, likethat of Orange County, Calif., in 1994, Pacific Gas & Electric Co. in 2001, and UnitedAirlines in 2002.
"A lot of the fund companies hate something that's bankrupt," Schotz said. "Bankruptcyis something we like."
One big advantage the Saybrook fund wields over traditional municipal bond mutual fundsis that it is organized as an investment partnership that allows it to take back equityin a workout. Municipal bond mutual funds are often prohibited from doing so byprospectus and are thus more limited in the type of remedies they can seek.
"It gives us more flexibility, which makes it easier to reach a resolution," Schotzsaid.
The fund managers typically seek to acquire controlling positions for bondrestructurings. They then negotiate with the public agencies that issue the bonds,sometimes introducing new management, pursuing foreclosure, proposing workouts throughbankruptcy or debt restructuring, or a combination of those approaches.
One of the fund's drawbacks is that distressed municipal bonds offer very littleliquidity.
Not all municipal bonds are sold by highly rated states or cities. Often, publicagencies are able to sell municipal bonds on behalf of corporations, which can carry lowratings.
During the 1990s, almost $10 billion in municipal bonds went into default, and the pacehas since picked up due in part to an unprecedented number of corporate bankruptcies,according to Saybrook.
But the new fund is drawing from many of the same institutional investors that investedin the company's first fund, who were attracted by its tax-exempt income.
Because of Saybrook's expertise, the recent spate of corporate bankruptcies may bepromising. The market sometimes suffers from misconceptions about the impact corporatebankruptcies or downgrades can have on municipal bond issues, according to the company'smarketing materials.
"The high volume of municipal bond defaults, the lack of liquidity in the distressedtax-exempt securities market, and the increasing scrutiny of financial reporting andfund valuation practices leads Saybrook to believe that the fund is well positioned toidentify and capitalize on investment opportunities," says a statement on the firm's Website.
In addition to being an investment bank, Saybrook manages two real estate funds -Saybrook Community Capital, which provides capital to large homebuilders for theacquisition and development of residential land, and Pacific CityHome, which offershomebuilders capital to develop quality median-priced urban homes.
