Distressed opportunity ripe in US, growing in Europe

Amend, extend (and pretend) may be going out of style.

At least among US financial institutions, according to delegates at the Wharton School of Business 2012 Restructuring and Turnaround Conference in Philadelphia Friday.

Banks are more willing to unload impaired assets, and book losses, now than they were a few years ago, delegates said. The willingness of banks to transact and shoulder losses translates into more opportunity for distressed investment-focused firms.

“In 2009, we made one investment, in 2010 we made zero investments, in 2011 we made eight investments,” said Gregory Segall, chief executive officer of Versa Capital Management.

For Versa, 2010 was the firm’s “single busiest year”, but it ended up not transacting due to “irrational” behavior of banks at the time, Segall said.

“We bid for a piece of debt from a bank and we said ‘We’ll give you 30 cents [on the dollar], and they said, ‘That’s better than we thought you would offer but [we] can’t take it because we’re holding it at par’. There’s no cost of carrying this thing and holding on to it, so sorry, we can’t do that,” Segall explained.

That mindset has changed now that banks – at least in the US – have found some sense of stability and are less reluctant to book losses as the economy continues to improve. Impending regulations are also pushing banks to offload risk-weighted assets.

“Banks are forcing out a lot of credit, particularly in 2011 and this year … lenders are very unsatisfied with the credits, they’ve lost confidence in management and they want deals to happen,” said Scott Victor, managing director with SSG Capital Advisors.

The market is flush with buyers as well, Victor said, including private equity and hedge funds but also strategic acquirers like corporations who are “flush with cash”, Victor said.

However, the story changes when it comes to Europe, where financial institutions, governments and companies are at the beginning of a process of de-leveraging that could take up to a decade, according to Jed Hart, senior managing director at Centerbridge Partners.

“From a timing perspective, this is a multi-year opportunity. De-levering [in Europe] in our view will take maybe as long as 10 years,” Hart said. “There are structural issues and real, true fundamental changes that need to occur with the psychology of banks in terms of marking down and accounting practices more true to reality. The selling we’re seeing is not a tidal wave, but a slow, steady stream,” he said.

European institutions, especially those in the southern regions, can’t take losses because they would collapse,

according to Marc Lasry, head of Avenue Capital Group, who gave a keynote speech at the conference.

“Everyone in Europe is working for more time, for banks, governments and companies to work this stuff out,” Lasry said.

One area that could become a particularly attractive opportunity in Europe is leveraged buyout loans made during the credit bubble years in 2006 and 2007. In the US, LBO debt was restructured so maturities were pushed back and portfolio companies were able to avoid default. Much of the debt used to finance buyouts in those years came with borrower-friendly covenants that gave borrowers flexibility to amend contracts.

The situation differs slightly in Europe, however, where LBO debt lacks the same kind of flexibility, Hart said.

“Unlike the US, those sponsors and deals have had very little in terms of exchange offers and push-offs of maturities,” he said.