Updated at 7:41 p.m. ET with news of Magnum Hunter's bankruptcy
Just how bad are the assets in Third Avenue Management's Focused Credit Fund? They are bad enough that one has to wonder if it is even fair to call them assets.
For example, Magnum Hunter Resources (MHR) filed for bankruptcy Tuesday, soon after Third Avenue had shed its position in the Texas-based oil and gas company. Magnum has a debt-for-equity restructuring deal that has won the support of nearly 75% of its debtholders, The Wall Street Journal reported.
Third Avenue announced on Friday it was freezing redemptions as it looks to liquidate its fund.
To be fair, the fund's prospectus states the fund might look to make investments in bankrupt companies and that those holdings could be difficult to sell. Also, the fund is a high-yield and distressed fund, so by definition the holdings are not going to be pristine. Even so, this fund took "slumming it" to new levels.
Real Money spoke to several asset managers over the last few days about the Third Avenue Management fund. The consensus is that while some illiquid assets may have been appropriate to put in the high-yield fund, the amount of illiquid assets in this fund was plainly irresponsible.
Furthermore, mutual funds are expected to price daily. How was Third Avenue Management able to price this fund if it admits in its prospectus that its holdings may not be able to be sold "at the value the fund places on them."
In reviewing some of the top holdings of the company, I was reminded of one of the best pieces of business advice I ever received: "Don't accept anything in your business life that you wouldn't accept in your personal life."
At the time, I was a recent college graduate working in the credit and collections department of an equipment financing firm. A deal went bad and an executive vice president made us study the file to see what went wrong. As we looked at the deal knowing that it had already gone bad, the department's mistakes were readily apparent: The credit file on the client was thin, the Dun & Bradstreet report only registered the client's name, contact information for the firm varied across lease documents, and there wasn't a clear description on what equipment was being leased. If it had been my own money on the line, I wouldn't have offered the client financing.
Fortunately, the losses on this one deal were small, but if that negligence had been more common in the department, the firm would have faced serious problems.
Which brings us to the holdings in Third Avenue Management Focused Credit Fund. The assets in the fund now are difficult to liquidate as most of the more pristine pieces have been sold off. Even so, investors should still wonder why some of the weaker remaining assets were ever allowed in the fund.
A sample of some of the fund's top holdings shows its weaknesses.
Altegrity Inc. -- Debt in this private company accounts for 7.5% of the holdings in the Third Avenue Management fund. The top results for the company in a Google search are articles about it filing for bankruptcy earlier this year. The company's Web address, which is listed not on the search results but on the company's Wikipedia page, produces a 404 error. A deeper look into the Google search results shows the company is going by the name Corporate Risk Holdings. Let's not forget to mention that Altegrity was the firm that vetted Edward Snowden. How can investors ever expect to receive coupon payments from a company that barely registers in Google search?
Hercules Offshore (HERO) -- This Houston-based ocean driller filed for Chapter 11 bankruptcy in August citing low oil prices as one of the main reasons for their financial woes. The company proposed that its bondholders swap $1.2 billion in debt for control of the company. Hercules Offshore announced that it emerged from bankruptcy in November but it is still operating in a climate of low oil prices.
Liberty Tire Recycling -- In April, this Pittsburgh-based company completed its financial restructuring, in which the company's existing bondholders exchanged their unsecured notes for second-lien notes and equity. Also of note, last November, the company had a massive tire fire at one of its centers in Kentucky. The recycling center was on a property that wasn't zoned for recycling and the center is now vacant.
As of June, Moody's assigned a rating of Caa2 to the company, which is just three notches above Moody's lowest rating.
"Liberty Tire's very high leverage even after the March 2015 out-of-court debt restructuring (adjusted debt-to-EBITDA including Moody's standard adjustments over 8.5x), weak EBIT-to-interest coverage and the difficulty in matching used tire collections with profitable and sustainable recycled tire applications raises the likelihood that more meaningful adjustments to the operating model and/or the capital structure will need to be made in the next 12-18 months," Moody's said in a statement released in June.
CHC Group Ltd. (HELI) -- This Canadian-based helicopter services company has been a somewhat unlikely victim of the prolonged low prices in oil and gas. However, it provides helicopter transportation for offshore companies. Earlier this month, the company held an extraordinary meeting of shareholders where the shareholders voted to approve a 30:1 reverse stock split. The purpose of the reverse split was to increase the trading price of the company's shares so that it could "regain compliance with the $1 minimum trading price requirement for continued listing on the NYSE," the company said in its recent 10-Q filing.
New World Resources (NWR) -- In 2014, New World Resources, an Amsterdam-based coal producer, embarked on a debt restructuring plan in which some of its creditors became shareholders. However, the company is still burdened by low coal prices and it requested government assistance last week, according to reports from Reuters. The request was denied.
