Feb 13 (LPC) - The confluence of widespread deleveraging among European banks and a significant wall of debt maturities that must be refinanced is creating a rising tide of distressed credit opportunities for U.S. alternative investors. However, the pace of activity is developing more slowly than anticipated, according to credit investors.
European banks are under pressure to recapitalize, but have so far been reluctant to purge assets at the steep discounts on offer. As such, the anticipated wave of asset sales has not yet materialized, credit market participants say, noting that there has been a lot of positioning among investors, but less activity.
Banks can't just sell. They can't absorb the capital losses, says Jamie Weinstein, co-head of KKR Asset Management's global special situations business. There is still a large opportunity in distressed credit, but it will be a slower unwinding of assets, not a massive selloff.
Still, investors are gearing up for what is expected to be a significant period of deleveraging across the European financial system, which suggests much needed access to alternative sources of credit as issuers demand capital and banks lend less.
European banks must meet by June 30 the increased capital ratio requirements set by the European Banking Authority following last year's stress tests. The EBA has determined banks need to raise the equivalent of 115 billion euro in new capital.
Meanwhile, leveraged borrowers are staring at a sizeable refinancing wall that must be scaled. The volume of European sponsored-driven loans set to mature between now and the end of 2014 stands at 264.39 billion euro, according to Thomson Reuters LPC.
Given dislocation in the overall capital markets, a lot of companies will need help refinancing - both healthy companies that can't access capital and stressed companies requiring rescue financing - which presents interesting opportunities, says Weinstein.
Europe is a bank-centric market. The universe of liquid syndicated loans is limited and the high yield bond market is relatively small. Banking institutions are the primary holders of loans, while the institutional investor base is thin and less developed. Access to traditional sources of funding is therefore limited when capital is constrained.
The market could see a bifurcation between issuers who can refinance in the traditional capital markets and the storied credits with high leverage that will have to seek non-traditional sources of financing at considerably higher cost of funds, says Tom McDonnell, managing director and head of distressed debt at global investment manager Babson Capital Management.
In the last 12 to 18 months a steady march of U.S.-based alternative investors, from global asset managers to private equity investors and hedge funds, have ramped up existing platforms, rebuilt distressed desks that closed up shop in 2008 and launched a variety of new credit opportunity funds and distressed debt strategies keen to take advantage of market dislocation.
Depending on the depth of operations on the ground in Europe, some managers are equipped to benefit primarily from depressed asset prices in the secondary market. Others with more established European-based teams and long-standing relationships with banks are looking at providing solutions for assets where the underlying credit is stressed or distressed.
As a result of deleveraging and derisking, situations will surface where asset values and prices are divorced, which creates buying opportunities, says one distressed debt investor looking at longer term, private equity-backed investments involving the acquisition of credit assets to restructure and grow the business.
And, to the extent that banks seek to sell distressed loans, alternative investors are ready to step in as buyers. Alternative investors have a unique opportunity to acquire assets at attractive prices that could generate outsized returns, an appealing prospect given the compressed yields in the U.S., says Edward Marrinan, head of U.S. macro credit strategy, RBS Global Banking & Markets. Private equity and select hedge fund investors will be the natural home for a good portion of these loans, he notes.
Potential returns vary depending on where in the capital structure investors are playing and under what scenario. Cash on cash returns will be more modest for both loans and high yield bonds, while an event driven refinancing or default scenario would create a lift in value, perhaps into the high-teens to over 20 percent for stressed high yield bonds.
(Leela Parker is a reporter with Thomson Reuters Loan Pricing Corp in New York)