The global hunt for yield is having some interesting knock-on effects in corporate debt issuance, especially internationally and especially in Europe. ‘CCC’-grade issuance is at record levels because ‘the companies have been able to get away with it’. Here’s the opportunity.
Paul Hatfield, the chief investment officer at the specialist credit manager Alcentra Group, has been in leveraged finance and distressed debt for more than 20 years.
He says that a lot of the new issuances have not been priced to reflect the risk. Plus, there is a wall of non-performing loans in Europe which are waiting to come onto the market as sales. The refinancing of those loans will take four-five years. The scenario is music to the ears of a distressed debt fund manager.
London-based Hatfield, a regular visitor to Australia, said in Sydney last week that Alcentra, which is an affiliate manager of BNY Mellon, believed that US interest rates would probably start their long-awaited uplift now about next March. This will mean a readjustment in corporate spreads and more capital flowing back to the US. Which means more distress in Europe.
The big opportunity in Europe, where Alcentra is the largest manager in the distressed debt space, is an estimated two trillion euro (A$3.06 trillion) of non-performing loans held by European banks coming onto the market over the next couple of years. According to a study by PwC, only about 150 billion euro of this has so far made its way into sales to other lenders and investors.
Hatfield said that the European market was different from the US, which had been “well picked over”, because it was “not one size fits all”. There were different jurisdictions, a different interest rate cycle – rates probably won’t go up in Europe any time soon – and opportunities were more stock specific, rather than sector driven.
In the US, for instance, distressed debt opportunities tend to reside in several industry sectors, such as energy, metals and mining, pharmaceuticals and some media and telecoms. In Europe, it is much more esoteric, meaning company specific.
Hatfield believes that when a company gets into trouble, nine times out of ten this is because of poor management. Alcentra has a full-time lawyer on its distressed debt team for when things get nasty as well as during acquisitions and sales. Alcentra is also experienced in taking ultimate control of a company when it is in danger of default. It is a lot like a private equity operation, with a similar time horizon, but without the start-up losses factor. However, the asset class usually outperforms all others when compared to the hedge fund universe, especially since the global financial crisis. Investors need to be patient, though, because it can take several years for a distressed opportunity to play out into a turnaround and sale.
With Alcentra’s latest fund, European Strategic Credit, which is being offered to Australian institutions via BNY Mellon, there is a six-year lock-up comprising generally of a three-year investment period and a three-year harvest period. The Fund is targeting to deliver 15% plus pa. net returns over this time period.
Phil Filippelis, the country head, Australia, for BNY Mellon Investment Management, said that a great deal of interest in the Strategic Credit Fund was coming from institutional super funds and the high-net-worth/family-office space which did not jump in early into the first wave of European distressed debt offerings around 2009-2012
This proved to be too early and managers had difficulty efficiently deploying capital raised against a backdrop of quantitative easing being adopted by the European Central bank.
“The timing is much more conducive, now, for dedicated exposure to this sector” he said, “because of imminent rising interest rates in the US and more pressure being exerted on companies.”
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