This week we welcome Dominique Mielle, former Partner and Senior Portfolio Manager at Canyon Capital and the author of the new book, “Damsel in Distressed.” Ms. Mielle currently serves on the boards of ReadyCap, a mortgage REIT (2021 to present), Studio City International, a casino in Macau (2018 to present), Tiptree Inc., a specialty insurance (2020 to present), Digicel Group, a wireless operator (2020 to present) and Osiris Acquisition Corp (2021 to present). She was also a director (and the audit committee chairperson) for PG&E during its fifteen-month bankruptcy process and emergence (2019). We hope you enjoy her insights.

PETITION: Hi Dominique. Let’s get right into it. Throughout your book, you talk about the overconfident, alpha male personality that dominated the hedge fund industry throughout your career. Unfortunately, that hasn’t seemed to change much at the Partner/PM level. Have you started to see any shift towards more diversity in the hedge fund industry at the junior level? How do you encourage diversity in a space that has historically been known as a boys’ club?

Dominique: There are two issues here. First, there is not enough diversity at the junior level on the investing side. That’s a pipeline and recruiting problem. Second, the few women or minorities you may find among lowly analysts rarely make it to the top. That’s a recognition and promotion problem. Both need fixing. Hedge funds must believe that diversity will affect the bottom line positively – through performance, and by attracting and retaining institutional investors. Fairness and equality are not going to cut it as incentives. Think of it this way: people are still the primary resource of hedge funds. Can you name another industry that restrains sourcing to 30% (if that) of the available output? That said, I’m not an expert on diversity and inclusion or HR, just a casual observer. How I personally encourage diversity is by writing about it. I use my words, as they say in kindergarten.

PETITION: You were involved in a number of U.S. airline restructurings in the early 2000s. To say that you dove deep into the inner workings of airline financing would be an understatement. We’re now seeing a number of airline filings, particularly in Latin America. Systemic shocks caused both periods of airline distress—the former being 9/11 and the latter being COVID-19. What similarities and differences do you see between the current airlines bankruptcies and those that occurred in the early 2000s?

Dominique: My involvement was primarily in U.S. airlines. It’s telling that COVID-19 did not induce any filing in the U.S. to my knowledge, except a small cargo airline. There are two fundamental differences between then and now. The first is that the industry in 2001 was saturated, commoditized and only making money occasionally. There were too many airlines. The landscape changed dramatically post large consolidations between Northwest and Delta, United and Continental, American and US Airways and the liquidation of countless smaller airlines. It paved the way for a much more profitable and shock-resistant industry. The second is the systematic intervention of the Fed and the Treasury Department to support both the bond market, where airlines largely finance themselves, and the companies directly, through grants and loans. These were either not available back in 2001, too small, or too late in the game. And that’s the difference between filing and making it through the storm. My sense is that the Latin American airlines do not benefit from similar help. So, one must look outside the American market now. But that means doing away with the well-oiled Chapter 11 machine and the protection of section 1110. Airlines are always interesting to me because the business is prone to going bust – highly sensitive to GDP on the revenue side, with a large fixed-cost structure including one huge volatile input (oil) and hefty ongoing cap-ex. At the same time, they hold assets that are wonderful for creditors – aircraft are liquid and tradable with long depreciating lives, and let’s not forget routes, gates, and frequent flyer programs. Twenty years ago, that dichotomy was not well exploited, and there was a ton of money to be made on the latter. The cat is out of the bag, if I got that colloquial right. I tried to buy AMR EETC last year as a retail investor – they traded wide for a split second and tightened right back.

PETITION: It’s fairly common knowledge that, in 2008, Lehman Brothers went bankrupt and JPMorgan acquired Bear Stearns for $2/share. Washington Mutual was another major failure during the financial crisis, but it seems to fly a bit more under the radar in the history books. Canyon had invested in Washington Mutual prior to its collapse. Can you tease out for our readers exactly how WaMu played out and how you navigated the situation?

Dominique: WaMu was a large casualty of 2008. Same old story of subprime mortgage overexposure. It was rumored that JP Morgan wanted to buy it so there was a play for investors to bet on a decent price for the company. Up until the conference call announcing the deal officially, we thought that this was a real M&A with a willing buyer and seller. We were ready to pop the champagne. What transpired is that it wasn’t — post the credit downgrade, you had a run on the bank. The situation was dire and the demise quick: closure by the OTC, forced receivership by the FDIC, auctioned off to the highest bidder, which turned out to be indeed JP Morgan…at 16 cents a share or thereabout. A shotgun wedding.

PETITION: We know you’re familiar with the 2009 study by Bing Liang and Christopher Schwarz, which concluded that the primary objective of hedge fund managers is to hoard assets. As the performance of many hedge funds has continued to deteriorate in recent years, this seems to still hold true. Why, then, do pensions, endowments, etc. continue to allocate to these hoarders? Are there not other, better-performing options that fall within the “alternative investments” bucket?

Dominique: There are good and bad reasons. A good reason is diversification. Alternative managers are part of a well round institutional portfolio. The question is whether this diversification is well priced. Another reason is that the CIOs of these pensions and endowments are usually paid a bonus to outperform the index. The surest way not to beat the index is to be fully invested in it. Since some hedge funds will outperform on any given year, it keeps them trying to guess. And one more: investment recommendations at the institutional level are now largely outsourced to a third party who is not incentivized to take risks. Consultants tend to pitch the same large names to everyone, and their allocations are too sticky. Would emerging managers be a better alternative option? Some research say it is. But there’s little upside and a truckload of risk in recommending an up-and-coming fund to select clients only.

PETITION: You spearheaded the growth of Canyon’s CLO business and grew it to a $3.5b business in five years. What attracted you to that business? How difficult was it to get started in this space without the clout or connections that you may have had in other areas? Feel free to enlighten our readers about the meeting you held during your first trip to Japan.

Dominique: As an investment product, I loved that it’s data rich. You can run scenarios. You can stay up all night doing models – you know that old joke. I loved how robust the product is. The default rate for CLO bonds is minuscule. I think there are less than 12 issues that ever defaulted in some thirty years. Equity is hard to kill; even through 2008, most CLO equities return 8%-13% if you held on. The mark to market was vile. But if you could stomach it, easy peasy. The structure is just very clever, very self-healing. As a manager, I loved the puzzle of it all – arranging different pieces of the capital structure along with optimizing the asset side. It was a hard business to start because it’s volume driven. You don’t make much fees on one deal. You have to be a repeat issuer but also be mindful of timing (which in my mind is 80% of success). The key to a large business in my days was to get Japanese institutions into the AAA layer. That part felt like a visit to the DMV. It took five attempts and a two hour wait with a scheduled appointment to get my California ID. Every visit, I thought I had the right credentials. That I was talking to the proper supervisor. That I was going to crack the system and finally get somewhere. It’s spirit-sapping. But once you get it, you’re welcome everywhere. In my first meeting in Tokyo, I went through a 45-minute presentation while the investors were asleep – not intermittently dozing off mind you, drooling-at-the-mouth-asleep - and when they woke up, the interpreter kindly informed me that they thought Canyon was a bad investor. Ergo, no cigar. That was that.

PETITION: In recalling your experience during the dot-com bubble, you wrote: “My most humbling experiences were to listen to my hairdresser, dental hygienist, or OB-GYN describe how much money they made in stock picking.” That sounds a hell of a lot like what we’ve been experiencing in 2021. Everywhere we turn, there’s another story about a retail trader living in his mom’s basement who made a 1000% return on GameStop, XYZ crypto, or even a god d*mn JPEG. Is there any reason for us to think this time is different, or is it just a matter of time before it all comes crashing down?

Dominique: Try arguing EBITDA multiples when your hair is wet, your mouth open or you're butt naked. It feels the same today – the market part I mean. I don’t know how to analyze crypto or tech, but I do know AMC. I’ve covered it and invested in it for decades, through the transformation from multiplex to megaplex that resulted in bankrupting most of the industry and led to consolidation, the Apollo LBO, the IPO, the Wanda acquisition etc. And it ain’t worth what the screen says based on fundamental valuation. But that’s the key right there, the new paradigm that retail traders have introduced into the stock market. There’s a new premium in town: the premium that comes with having fun, being part of a community, screwing the system, cooperating on stocks. It’s real. It’s widespread. And it can last.  

PETITION: You’re active on Twitter, and you’ve been making your rounds on various podcasts since your book was published. It’s clear that retail investors and social media can have a substantial impact on distressed situations, such as Hertz and AMC. What impact do you foresee retail investors and social media having on the world of distressed debt moving forward?

Dominique: This is the continuation of the previous question. It’s not just moving a stock up and down like a yoyo: retail trading can have a permanent effect on a capital structure. It can prevent a filing like in AMC. It can render a Chapter 11 debtor solvent as in Hertz (it’s not the only factor, but certainly a large one), which is exceedingly rare. Name a large case in twenty years other than General Growth Properties and PG&E? I imagine it makes distressed investing harder. If the cap structure at the bottom is so volatile and unpredictable, how do you coalesce around a restructuring plan? How many competing plans should there be? Should it always be an auction? It’s great fun to watch though.

PETITION: We recently snarked on Twitter about meme stock, Bed Bath & Beyond ($BBBY)(PETITION Note: after issuing a ROUGH update about declining foot traffic and supply chain issues and providing ugly go-forward guidance, the stock plummeted ~28% on September 30, 2021). You responded:

Do tell.

Dominique: I’m new to Twitter. I would snark if I knew what that means. My impression is that it’s better to be catchy than thoughtful. Well, that Tweet of mine was right in line. Let me think about where I was going with that soundbite…ah yes: video rental. Who remembers Movie Gallery – a competitor to Blockbuster that was highly levered, and went completely, utterly bust? I think even the first lien revolver got impaired and that says a lot. Well, most investors thought it was due to the cap structure and the sub optimal scale. That is, until Blockbuster, the category killer which didn’t have a particularly bad cap structure, went spectacularly bust a few years later. Both Linens and BBBY are in the same category of course and for a while Linens was a worthy competitor, expanding fast and furious into superstores. After an Apollo LBO, things went sour – comps became negative, with a leveraging effect on EBITDA given the fixed rental expenses, and a double whammy for being financially levered too. It tried to restructure for a while but ended up liquidating. Now Bed Bath & Beyond is stumbling. Makes you wonder.

PETITION: You were involved in some of the largest, most complex restructurings in history—Lehman Brothers, Puerto Rico, and PG&E, to name a few. Many of these were free fall bankruptcies. But in recent years, we’ve started to see more prepackaged bankruptcies and out-of-court restructurings. How would this affect your analysis when you’re approaching a potential investment in a distressed name?

Dominique: True, corporate restructurings are increasingly imposed by, and designed to maximize recovery for pre-petition senior creditors. Between 1995 and 2000, only 10% and 13% of DIP loans required management to implement a specific transaction and hit negotiated milestones. From 2015 to 2018, 50% of DIP loans funded a specific deal and 86% imposed covenants to lock in a preferred outcome and protect the claims of the capital providers. So, I would approach any distressed situation with these questions: can I and do I want to position myself in the senior secured layer pre-bankruptcy? If yes, do I have to capital to fund the DIP post filing? If not, am I going to be, as an unsecured creditor, a passenger on the bankruptcy ride or are there ways to drive the bus or at least control its route?

PETITION: We’ve been very critical of directors in bankruptcy. You happened to sit on the board of PG&E while in bankruptcy. Tell us about your experience there. What were some of the bigger challenges? Is there anything that could have been done differently? What is your take on the reports that fire victims aren’t getting the benefit of their bargain while, at the same time, trust administrators are making a pretty penny?

Dominique: You have? Not to their faces, I hope. I did comment on a recent study by Jared Ellias (“The Rise of Bankruptcy Directors”) which argues that distressed companies, particularly private equity-owned, prepare for bankruptcies by appointing bankruptcy experts as “independent directors”. These men belong to a small pool of repeat directors and consequently tend to work towards the interest of the private equity firms that nominate them rather than the estate optimization for the benefit of all, including creditors. Their conclusion, not mine. I was indeed the chair of audit of PG&E during its recent bankruptcy. The experience was one of the most fascinating cases I’ve ever worked on. One because I was on the inside – and realized how much you don’t know as an investor. The sausage making, for any company, is a messy, smelly process. Two because unlike other bankruptcies, some parties did not appear on the balance sheet: the Governor’s office, the CPUC, and the press. Some decisions can no longer be made on a purely economic basis in that context. Expediency and demagoguery are unfortunate by-products. And if one of the parties is tied by a deadline, its negotiating power is gravely impaired. That deadline was the participation into the California wildfire insurance fund by June 2020, imposed by the state onto PG&E.

As to the reports that victims are not getting the benefit of their bargain – let me be French: au contraire. The victims’ attorneys insisted on a share participation. Mostly because they wanted their clients to take part on any upside. Also because without stock, the company would have needed more debt to satisfy the exceptionally large settlement they negotiated, which debt would not have been permitted by the regulator. The lawyers were similarly adamant that PG&E not be involved in choosing the trustee, how much and when it got paid, and in any proceeds distribution. That is outside the control of PG&E, contrary to what the media portray.

PETITION: We wondered if maybe you would comment on this recent bit of reporting by Lily Jamali that made the rounds on Twitter. This Twitter account, largely believed to be associated with Jim Chanos, the short seller, followed up with a "told you so." Thoughts? 

Dominique: I would say two things. First, the victims, through the lawyers representing them, insisted on getting compensated in stock to capture potential upside. No one forced anyone to take stock compensation. This was, as noted in the report, a "settlement", i.e. a negotiation between two willing parties. Two, as your readers will know, a backstop has a fee. To say that the backstopping hedge funds "got the stock without paying a cent for it" is a clever choice of words. No paper bills or shiny pennies were exchanged, that is true, but there was an assumption of risk to buy the stock at a defined price, for which hedge funds got paid in stock. Did they get paid despite the backstop not being hit? Yes. Just like you pay your insurance premium even if you don't make a claim. That's how insurance works: you pay the fee and hope the triggering event does not happen.   

PETITION: Things have obviously been relatively quiet. What is your prognosis for Q421 and beyond into ‘22? What is the catalyst that creates a more robust restructuring market?

Dominique: Define “robust”. If you are thinking 2001 or 2008, I don’t see it happening. I’ve said before that the Fed is the Grinch who stole distressed – a catalyst does not a distressed windfall create. The largest bankruptcy last year was Hertz with $26 billion while at the same time Oaktree, Blackstone and Goldman alone raised $28 billion in distressed funds. We talk about Evergrande as a seminal event, but that’s $300 billion in liabilities versus Lehman at $600 billion. Supply is small, demand is large – you do the math. Both COVID-19 and the shale oil crash of 2016 failed to produce a lasting bonanza in distressed assets – it was a tempest in a glass of water. For small, nimble funds, it was probably robust enough. A trillion dollars of distressed bonds appeared around March 2020. The retail industry was reshuffled. That keeps you busy if you can act swiftly in minor cases. I imagine that an Evergrande demise, a crypto-crash or a tech stock meltdown would offer a good but short hunting season.

PETITION: What is the best piece of professional advice that you’ve ever gotten and why?

Dominique: I don’t remember. Which means I must have not paid attention to it.

PETITION: What are some books that have helped you in your career?

Dominique: French poetry - Apollinaire, Baudelaire. 19th century literature - Balzac, Zola, Wharton, Kipling. It’s helpful to find beauty if you can get your head out of your ass when you lose money.

PETITION: Finally, you’ve likely noticed that we like to snark “Long ABC” or “Short XYZ.” What are you “long” these days? What are you “short”? Feel free to be creative here (because we don’t mean that you’re literally “long” or “short”). We’d prefer to hear you say what trends you’re short/long and any specific companies and why. 

Dominique: Part of my money is invested like a retiree – which I am – muni bonds and the likes. The rest is split between emerging funds of people I trust in sectors I like, micro caps, arbitrage, vol trade, litigation finance, small business loans. I’d love to explore DeFi but I’m lazy. Generally, investing my own money bores me so I have no specific names to offer. I am long polo ponies, which I unsuccessfully try to pass as investments to my family.

PETITION: Thanks Dominique. We wish you all the best with both your pony investments and the book. Cheers.