But nascent distressed opportunities are already apparent in Europe. If some US funds struggled to deploy capital in Europe a few years ago, the opportunity set now looks substantial with the supply of investible credit assets set to surpass trillions. In public markets Alcentra may see advantages in being the biggest player but distressed is quite different. “We would not want to run $10 billion given the typical clip sizes in European distressed. We do not want to be the largest holder of an issue here” explains Forbes-Nixon. So Alcentra intends to cap assets in its new locked up distressed strategy at around one billion in order to remain highly selective.
Alcentra is sifting through opportunities emanating from three main event-driven sources in Europe which cause stressed and distressed leveraged loan supply to come to market: bank deleveraging; the High Yield maturity wall coupled with record levels of CCC rated issuance, and pending CLO maturities which will lead to more CLO deals being called.
Bank deleveraging “The bank deleveraging theme is enormous” foresees Forbes-Nixon, who thinks European banks are years behind those in the US. “After four years of QE in the US, their banks have been very disciplined about cleaning up and shrinking their balance sheets and improving capital ratios. But European banks have not addressed the issue properly”. Europe’s banks need to take on board the ECB’s Asset Quality Review (“AQR”), and comply with Basel III. The challenges are swelled by the scale of balance sheets. European banks’ assets of $42 trillion are about 2.5 times the size of US bank assets, yet the US and European economies are of similar size at $17-18 trillion” Forbes-Nixon illustrates. Little wonder that the European banks need years to work through their books.
The first wave of bank deleveraging focused on real, hard assets including real estate, shipping and aircraft related debt. The next wave is corporate loans and non-performing loans (“NPLs”), and is already underway with sales of €150 billion so far in 2015. Alcentra is of the opinion that hundreds of billions of Euros worth of loans still being marked at par should be provided for as recommended by the AQR. Provisioning, however, is a blunt instrument and if loans are currently marked above fair value, Forbes-Nixon’s experience makes him believe that some banks will over-provision and mark the loans down below their true value. This could provide rich pickings for Alcentra to step in and buy the loans at discounted prices below intrinsic value. “Our job is to identify good businesses with over-levered balance sheets that will trade through problems (or in some cases need a reduction of their debt levels) and will eventually get re-rated by the market. We have a deep team of high quality, experienced, professionals
to assess this opportunity set” Forbes-Nixon expects. PWC state NPLs held by banks could amount to €1.1 trillion (source: PWC Portfolio Advisory Group Market Update Q2 2015). Deloitte research indicates over €800bn of NPLs reside on the balance sheets of European banks. (source: Deloitte Deleveraging Europe Market Update H1 2015) But PWC and Deloitte agree that 2015 will be another record- breaking year for loan sales in Europe with both firms forecasting EUR 150bn of transactions. Alcentra sees circa EUR 2 trillion of NPLs and other non-core assets and projects the run rate of bank asset sales will accelerate to EUR 200bn a year, providing a huge source of opportunities. As part of this process, some banks have started taking provisions on balance sheets and other countries may copy the UK and Irish model of setting up ‘bad banks’ such as National Asset Management Agency (“NAMA”). The key catalyst for this catharsis is QE in Europe, finally allowing European banks to recapitalise, sell portfolios and shrink balance sheets.
Maturity Walls and Cliffs However, non-financial companies may not want to contract their own balance sheets. A maturity wall of EUR 345bn, of mainly bonds and some loans, will need refinancing over the next six years, according to the S&P European High Yield Weekly Review from May 2015. Alcentra expects some healthy companies will grow into their capital structures, and get refinanced or extended. But for some issuers the maturity wall will become a cliff. Following record CCC issuance in 2013 and 2014, some of the lower quality CCC issuers will default, forcing selling by many lenders and investors, playing into the hands of stressed and distressed investors. The US has already seen a significant increase in default rates from lows of 1.4%, with S&P forecasting a doubling of US
Fig.2 European CCC Issuance
€ 0B € 1B € 2B € 3B € 4B € 5B € 6B € 7B € 8B
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 20015 YTD
defaults by 2016. Europe should follow suit in 2016 or 2017 as “the historical pattern is that Europe lags the US by 12 to 18 months” Forbes-Nixon expects.
Stress and Volatility Performing paper can also offer potential returns high enough for the distressed credit strategy. On an ongoing basis, Alcentra has a ‘work in progress list’ of 122 European leveraged loans or High Yield bonds, with issue sizes of €100mm or more outstanding, that are trading at yields to maturity above 12% or bond prices below 80 cents. This is partly a consequence of market volatility, which has recently reached equity market levels in High Yield, with September 2015 seeing a huge surge in the number of bonds dropping by more than ten points in the month. Forbes-Nixon seems genuinely excited by escalating volatility in 2015. “The third quarter was the worst in 4.5 years for the public equity markets, with $10 trillion wiped off public company valuations, and emerging markets and commodities particularly hard hit” he observes.
The stressed watch-list is valued at around EUR 63.8 billion, and some of the names are still performing. “We are conducting a ton of work in the energy space and are being very patient, waiting for the right price point” Forbes-Nixon mentions. Stressed credits are widely misunderstood by the market. They tend to be at a crossroads, in that within a year “two thirds of them continue to perform and migrate into a sustainably tighter spread range while one third become distressed and need to be restructured” Alcentra has observed. The volatility of stressed names creates good opportunities but Forbes- Nixon warns “those who are not close to company management, have a tenuous relationship with the sponsor and have little history on the organisation have often subsequently been burnt”.
Source: JP Morgan European High Yield Weekly, 26 October 2015
11
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60 |
Page 61 |
Page 62 |
Page 63 |
Page 64 |
Page 65 |
Page 66 |
Page 67 |
Page 68 |
Page 69 |
Page 70 |
Page 71 |
Page 72 |
Page 73