According to a May survey by consultancy PwC, hedge funds and private equity investors have amassed almost €60 billion to buy loans from stricken European banks.
PwC, which is advising many banks on asset sales, estimates European banks have almost €2.5 trillion of non-core assets they could sell. It expects loan portfolios worth €50 billion to sell in 2012 and €500 billion over five years, peaking next year as banks begin to plan repayment of loans from the European Central Bank.
| Sizeable opportunity |
| Expected European portfolio sales |
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| Source: PwC |
Since the onset of the financial crisis in 2007, distressed investors have been expecting carnage in the corporate sector but default rates have been slow to rise. However, as more companies across industries struggle to operate and, in some cases, survive, so the waiting game that hedge funds and private equity investors have been playing may now be over and a new distressed debt cycle beginning. With such a big supply of impaired assets to come and investor demand rising to new levels, this distressed debt cycle is expected to be different in scale and scope to any seen before. The billions of dollars of investment these specialist investors have raised in anticipation of this have started to be deployed, and there is little sign that fundraising for distressed debt investment will slow down anytime soon.
In May, TPG Credit Management – a special situation investment firm allied to private equity investor TPG Capital – and AnaCap Financial Partners, a private equity investor specializing in the financial services sector, became the latest investment firms to successfully complete fundraisings targeting distressed debt and dislocated credit investment opportunities.
Distressed debt investors engage in a diverse range of investment strategies. In the main, many focus on profiting from buying the bonds and loans of stricken companies and holding out for a recovery in the value, while others might look to take control of a stricken company through a debt-for-equity swap in a restructuring.
Takeovers
Distressed debt investors have taken over several European companies, including Greek telecoms operator Wind Hellas and UK estate agent Countrywide. They are also taking over UK gym operator Fitness First and Ireland’s largest phone company, Eircom.
TPG CM says it had raised more than $340 million for its new fund, targeting a range of distressed credit assets, including European non-performing loans, while AnaCap says it had raised £350 million for its fund, part of which will focus on non-performing European debt.
Large, earlier fundraisings have been much higher. US hedge fund Strategic Value Partners, for example, said in January it had raised more than $900 million for its European-focused distressed debt fund.
New investment firms are being launched to focus specifically on the asset class, such is the perceived wealth of opportunity in distressed debt investment globally.
TFC Investment Management – founded by Martin Dent and Julian Nichols, who ran Deutsche Bank’s global distressed debt investment and trading business before leaving the bank in 2009 – is the latest and most notable.
Pierluigi Volini, managing director and head of distressed research at Credit Suisse in London, says it is evident on the demand side that "there is a very considerable amount of investment capital out there to pick up distressed assets" that has been building for some time.
Volini expects to see a new global distressed debt cycle emerge, and although signs have been visible for some time, he believes the pace will accelerate amid a challenging macro-economic environment and as bank deleveraging intensifies, particularly in the UK and Europe.
While the larger, FTSE 100-listed blue-chip companies have proved resilient to the turmoil, as bank lines remain in place and capital markets are open to high-grade corporate issuers, it is the smaller and overly indebted UK and European companies that are more susceptible to the treacherous combination of anaemic economic growth, government austerity and systemic banking stresses.
Where UK and European banks have tended to deal with their impaired loans by extending maturities in the hope an economic recovery would restore many companies to financial health, there are signs that the main lending banks are starting to take a more proactive approach to tackling their bad debts.
Bill Derrough, global co-head of restructuring at Moelis, told Euromoney in January: "We are at the beginning stage of this cycle now. Banks have dealt with the problem by not wanting to engage in dialogue. They would just as soon deal with the problem later but now they cannot avoid that conversation."
Regulatory pressure
One of the main drivers is regulation. Most European banks are under pressure to divest assets this year, not least to meet their European Banking Authority capital-ratio targets in June.
Recent examples include Lloyds Banking Group, which through its Project Royal deleveraging strategy sold £900 million of commercial property loans to Lone Star, the US private equity group. The UK bank now plans to offload a further £1.2 billion of loans via Project Lundy.
The Spanish banking sector is expected to be the next hunting ground for private equity investors and hedge funds to pick up impaired property loan portfolios. And they have plenty of cash to do so. Volini says the key differences are the length of time this cycle is expected to last, the breadth of industries and companies that will be affected, and the complexity of the larger distressed debt situations.