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Berkowitz on Opportunity in Bankruptcies

The Fairholme manager comments on the fund's significant investment in the convertible bonds and bank debt of bankrupt mall operator General Growth Properties.

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Michael Breen: You touched on your flexibility and how a dollar doesn't care where it comes from and how it is made. Your fund has a pretty flexible mandate, and you can invest in different spots on the capital structure. Can you touch on that, and what you are seeing right now in addition to equity convertible debt floating rate notes, other types of vehicles that you're looking at?

Bruce Berkowitz: Absolutely. As we study the equity of companies, you just have to study the companies. And we take a look at the entire capital structure of a company, from bank debt to senior secured, senior unsecured, subordinated debt, preferred stock, common stock, and look to understand the returns on each part of the capital structure.

In the past that's led us to the bank debt of bankrupt securities and presently it has led us to the various levels of debt of GGP, General Growth Properties. We own bank debt; we own convertible bonds.

Breen: And that firm is a big mall operator, correct, that's in bankruptcy?

Berkowitz: One of the biggest in bankruptcy, and there seems to be two or three groups interested in it. And the good news is, in our opinion, that the bond is basically money good. And if you understand the bankruptcy process, you're purified in bankruptcy, and the money good is asset-backed, bought at high yields. And today's senior debt in a bankruptcy may be tomorrow's new equity.

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Breen: For our viewers' sake, can you perhaps expand on the concept of the bankruptcy purifying the company, and how that differs with whether you own the equity or the debt, as you do in this case, or the senior debt?

Berkowitz: Through Chapter 11 in the United States it's all about resuscitation. It's all about giving the company another chance. Chapter 11 allows the debtor, it allows the bankrupt company to decide which contract it can keep, which contract it doesn't have to keep, what it can throw out, what it wants--tremendous flexibility.

And then the process involves having the company get to a stable capital structure in order to get out of bankruptcy and progress in a new life. It's a reincarnation to some extent. It's a giant mulligan.

What happens is there are cram-downs, where bankruptcy, normally the common stock goes to zero and then the preferred, or some junior subordinated debt, may go to zero. And then the more senior debt becomes either new debt or equity or a combination of the two.

That may not be the case in GGP, given the asset values there. That is, there may be some asset value in the equity, I really don't know. But we do believe that the bonds and bank debt are money good, and we built a significant position, which I believe will eventually allow the shareholders of the fund to be at the negotiating table.

Michael Breen does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.