Whether signs of a downturn can yet be detected is a matter of debate, but what is clear is that distressed debt has become a highly popular strategy with investors – the $61 billion raised last year meaning that it edged ahead of senior debt as the asset class’s biggest capital magnet by raising $61 billion.
In committing this capital, investors presumably are under the impression that – at some point at least – sufficient attractive dealflow will be available for the money to be deployed. In which case, here’s a word of warning: PDI has been made aware of distressed investors being deliberately barred from potential deals by borrowers benefiting from market conditions that allow them to do pretty much what they want.
These days, there are numerous manifestations of what is commonly described as a “borrower-friendly market”. One of the most important, according to sources, is the growth of restrictions – imposed by the borrower – on the transfer of ownership of loans.
Loan assignments typically rely on the consent of the borrower. Although this consent may not be unreasonably withheld, many lenders do not rely on this – chiefly because the burden of proving unreasonable behaviour rests with the lender – and draw up a list of firms the loans can be assigned to without requiring borrower consent.
However, in today’s market, borrowers have an increasing say over who does and does not make it onto this list. Distressed and special situations funds – especially those known for aggressive debt restructurings and loan-to-own strategies – are increasingly unlikely to make it. Indeed, in a growing number of cases, such firms are explicitly excluded rather than being subject to consent.
Some say things have gone so far that distressed investors are prohibited from almost all loan assignments in large-cap sponsored deals these days.
Certainly, data from Debt Explained clearly indicate the direction the wind is blowing. In 2016, 23 percent of deals on its database of European leveraged loans (almost all sponsored deals) gave the borrower complete discretion to withhold consent to a transfer to a distressed debt fund. Today, that figure is 47 percent – with three-quarters of these deals even allowing the borrower complete discretion to refuse consent after a default.
These increasingly strict limitations could limit liquidity by making it more difficult for sellers to identify buyers, potentially hurting fund performance. They could also damage the sponsor-backed companies themselves, by the avoidance of what may be necessary restructurings.
And then there is a third negative factor, which brings us back to the point made at the outset: the last thing newly flush distressed debt funds need is to have obstacles placed in the way of their ability to put capital to work. As Anthony Robertson of fund manager Cheyne Capital told us: “It makes it more difficult for the special situations and distressed funds to participate in the broadest array of loan opportunities.”
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