Distressed Debt

Distressed-Asset Vultures Watch—and Wait—Over Europe


Banco Espírito Santo put €2.5 billion ($3.6 billion) of loans on sale in January, hoping for bids from hedge funds. Seven months later, the Portuguese lender has sold only half the loans, which funded the construction of roads, airports, and sports stadiums. Money managers who balked say the assets were offered for just 5 percent less than face value, making it difficult for them to earn a profit. “We passed on that trade,” says Galia Velimukhametova, manager of GLG Partners’ European Distressed Fund. “We are waiting for a situation where price expectations are much lower.”

Hedge funds and private equity firms that have raised money to buy assets from European sellers crushed by the sovereign debt crisis may have to wait awhile. Banks have little incentive to offload bad loans because selling them at a discount would trigger losses. Meanwhile, low interest rates imposed by the European Central Bank help indebted companies meet their payments, keeping the default rate in Europe at an historic low. “There’s a level of frustration among investors,” says Robert Boulding, a consultant at PricewaterhouseCoopers in London. “They expected a tsunami of deals from European banks, and the reality has been very different.”

Private equity firms raised $5 billion in 2010 for funds targeting European distressed assets and corporate turnarounds, compared with about $400 million during the 2002 recession, according to researcher Preqin. Apollo Global Management, Leon Black’s private equity firm, is seeking to raise $2.8 billion for a fund that will aim to buy European loans in, or near, default, according to two people with knowledge of the matter. Oaktree Capital Management, the Los Angeles-based private equity firm led by Howard Marks, is seeking as much as $3 billion for a fund that will buy assets in Europe, say people with knowledge of the plans. Officials at the two firms declined to comment.

Hedge funds are also zeroing in on Europe. New York-based Marathon Asset Management started a Europe Credit Opportunities fund in July. It plans to buy real estate and corporate loans with a face value of at least $1 billion from banks in Portugal, Ireland, Spain, the U.K., and Italy, according to a presentation to potential clients.

Vulture investors are circling the Continent because fewer opportunities for profit exist in the U.S. Hedge funds that targeted distressed assets in North America reaped gains of 46 percent on average in 2009 and 29 percent in 2010, according to data provider Eurekahedge. Returns have plunged this year to 4.7 percent through July, as the number of large asset sales dries up. In Europe, hedge funds buying distressed assets gained 7.1 percent on average through July, according to Eurekahedge.

For investors, the opportunities are potentially huge. European banks may sell as much as €1.3 trillion of assets as they shrink their balance sheets and seek to raise capital, according to an April report by PwC. More than $2 trillion of European, Middle Eastern, and African corporate and commercial real-estate loans will also mature in the next five years, according to KPMG.

Nonetheless, deals have been slow to materialize because European banks have had their capital levels bolstered with government injections of cash, allowing them to avoid selling loans at distressed prices. Lenders are required to take a loss when they sell loans for less than book value. By selling performing loans that haven’t been marked down, like Espírito Santo is doing, firms can raise capital without incurring significant losses. “Why would the banks sell those loans so that investors can make 50 percent returns,” says Christophe Evain, chief executive officer of Intermediate Capital Group. Evain’s London-based investment firm bought a package of leveraged loans with a face value of €1.4 billion from Royal Bank of Scotland Group in August 2010. He declined to disclose the price paid.

Hedge funds and private equity firms expect the pace of transactions to pick up once interest rates begin to rise. Low rates have allowed struggling companies to refinance loans and meet debt repayments. Defaults on speculative-grade loans in Europe fell to 1.4 percent in the second quarter from 5.6 percent a year earlier, according to Moody’s Investors Service. “When interest rates start to rise, as expected, over the next few years, these problems are going to emerge,” says Gareth Davies, the London-based managing director responsible for corporate restructurings at Greenhill, a boutique advisory firm headquartered in New York. “The challenge for investors will be to be patient, not to rush into things because currently things are very expensive.”

GLG’s Velimukhametova isn’t waiting for a European yard sale. Her $200 million fund was up 10 percent this year through June, mostly on bearish bets made against the stocks and bonds of companies she says are likely to be restructured. These include telecommunications firms in Portugal and steel, cement, and chemical companies throughout Europe. GLG is owned by London-based Man Group, the world’s biggest hedge fund, with assets of $71 billion. Default rates will “undoubtedly” increase within the next 18 months, and banks will have to start selling loan books because they have few other options for raising capital, says Velimukhametova. “It’s a good time to be ready and raising capital.”

The bottom line: Investors with an appetite for distressed debt have built up resources to deploy in Europe. But they’re holding out for fire-sale prices.

Westbrook is a reporter for Bloomberg News in London.
Chassany is a reporter for Bloomberg News in London.

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