Whither all those rubbish European bank assets?
There are plenty of soured loans lingering in the system, on top of a €500bn-outstanding leveraged loan market still being shaken out.
Barclays Capital believes both these things could be the foundation for new European distressed debt market. And it starts around now.
Check out the below BarCap charts:
The first shows the proportion of defaults, restructurings and loan amendments undertaken amongst European credits in recent years.
You can see that amendments have recently overtaken defaults and restructurings in terms of prevalence. That means that the volume of amendments — though decreasing overall — is now higher in Europe than the US, which you can see in the second chart.
But, notes BarCap’s high-yield strategist Eugene Regis:
… Forbearance measures were granted because projected recoveries on credits would have been very low during the recession. If companies do not turn around after receiving covenant amendments, we would not expect banking syndicates to keep amending, especially for names close to maturity/amortisation payments. Also, given that banks are under pressure to hold onto more regulatory capital under Basel 3, they may be more incentivised to push names into restructuring and extract a higher recovery rather than seeing them default …
Under new Basel III rules, BarCap reckons, banks will need to raise capital but also probably have to shed some assets. After all, there are leverage ratios, plus more of a focus on matching maturity to bank liabilities, to think about here.
Says BarCap:
… Not all banks will want to sell given the capital hit they may have to take. Most loan debt is held on the banking book and generally marked at par. If, for example, a senior loan is seen as intrinsically worth €70 and is still paying its coupon, a bank will not force a €30 loss by pushing for a restructuring – they would give a credit time to get a higher recovery or par. Despite this, there are certain circumstances that could force a bank to sell:
- * A bank itself becoming distressed (eg, Anglo Irish)
* The bank thinks the ultimate recovery could be lower than the current value.The reorganisation of the European banking sector is already resulting in asset sales for some banks across the EU. Conditional upon receiving EC approval of state aid, some banks are shrinking via asset sales over specified time frames. For example, we expect German landesbanks to be broadly net sellers of assets because they used their guaranteed balance sheets to build up assets in the past decade – some of which ended up as distressed.
Banks are trying varied solutions to dispose of distressed assets outside of traditional distressed debt investors. For example, a recent CLO from ICG saw €1.4bn of loans of varying credit quality exit the books of RBS with the equity tranche taking up 41% of the total deal…
And the conclusion:
A true market in European distressed securities will develop over time. We expect some poorly performing companies to be unable to refinance maturities and lending groups to be less willing to use forbearance measures. The larger proportion of distressed debt will be par bank loans, in our opinion, due to banks needing to delever and shed some assets ahead of Basel 3 implementation and bad banks potentially unwinding holdings of distressed loans. The size of the distressed market depends on the willingness of current asset holders to continue to crystalise losses now or later.
In other words, if European banks do decide they want (or need) to sell, then hold on to your high-yield hats.
Related links:
Big returns lure investors to distressed debt – FT
Lloyds to sell Crest Nicholson stake – FT