Foothill Capital establishes fund to invest in troubled bank loans.

Foothill Capital establishes fund to invest in troubled bank loans

Foothill Capital Corp. has set out to raise $100 million for a fund to invest in troubled bank loans.

These are loans which have not yet gone bad but were made to companies experiencing financial difficulties.

If the company succeeds in raising the money, it will be one of the few players in the increasingly crowded corporate restructuring area to focus its attentions on bank debt.

"This is a difficult market, if any exists, and they're making a market for what was not done before," said Barry Rubens, CEO at Santa Monica-based California Research Corp.

One potential obstacle to creating such a market is that banks would have to take write-offs on the problem loans they sold, Rubens suggested.

With Merrill Lynch Capital Markets as the placement agent, Foothill began soliciting potential investors last November and expects to have the fund fully raised by the end of the year, said Dennis R. Ascher, vice president of the company and its parent, The Foothill Group, Inc.

The long lead time can be attributed to the newness of the product. "We have to educate people because the product is not well known and institutional investors are not familiar with the mechanics of the fund or the size of the market," Ascher said.

"We're buying live bank debt, still paying interest, and not that of companies in bankruptcy," said Don L. Gevirtz, chairman of the board and CEO of The Foothill Group, Inc.

The fund will look for commercial and industrial loans secured with accounts receivable, machinery and equipment or inventory, and occasionally real estate, Gevirtz added.

Even with the security, Foothill expects to be able to pick up the loans with a discount anywhere from 30 percent to 70 percent because of the probability of the borrower going bankrupt, Ascher said.

If a company goes bankrupt, the security may be inadequate if its value had declined. However, the lender stands a decent chance of collecting at least a part of its loan, even if the terms of the loan are restructured.

Foothill expects to buy such debt from the likes of Security Pacific and Bank of America as well Grant Street Bank, the institution to which Mellon Bank has spun off its bad loans.

Competitors in this field are T. Rowe Price and Trust Company of the West, but none of these firms set up a fund which focuses exclusively on distressed bank debt.

The life of the fund will be seven years. Foothill will collect a 2 percent management fee, Gevirtz said. Individual loans the fund would consider buying range between $3 million and $15 million. After being repaid the fund could reinvest principal but would pay out to investors any interest or realized capital gains, Ascher said.

Foothill Capital expects to benefit from its experience buying these kinds of loans for two existing funds which also made other investments.

Based on that experience, it anticipates a return in excess of 30 percent, Ascher said.

Rubens, as well as several other industry sources, expressed a vote of confidence in Foothill's ability to pull it off. "They're visionary, always one step ahead of the pack, and if they're doing it, there's probably money in it," he said.

In a study Foothill Group commissioned, it was estimated that the total market value of distressed securities and bank debt and trade claims in default is about $200 billion, with a book value of $300 billion, while there is so far only $5 billion under active management by investment firms dedicated to this area.