Australia and the joys of distressed debt

Australian corporate banking has historically been dominated by a handful of local banks, with few foreign banks having made significant inroads by the time the GFC (Global Financial Crisis, a beloved Aussie term, best said with a twang) rolled around.  

The local banks had strong restructuring and workout groups underpinned by a good legal system for creditor rights. The banks would tend to work collaboratively on stressed obligors and were typically resistant to secondary purchases of debt by investors. 

So what changed? I think there were two foundation stones for the eventual shift. First of all the Australian private equity space was an early bloomer. You had an active and large (relative to the country) PE sector with significant international firms competing with very capable local players. Secondly there was an influx of foreign lenders into the country, typically North American and European players. This set up the scenario for change. 

Then suddenly all those highly geared syndicated LBO deals started blowing up and the foreign banks’ expansion strategies got thrown out of the window. So now you had very large (again relative) LBO exposures held by the local banks and foreign banks being forced to exit and looking to offload their Australian loan exposures. The clubbable old days were gone. 

Since 2009-2010 there has been rapid growth in secondary trading of Australian stressed and distressed debt. At the same time foreign investors have rushed to acquire property and mortgage loan portfolios, as well as structured credits with those underlying assets. This was partly driven by the legal system giving private debt investors comfort with regard to the enforceability of claims. 

On the loan portfolio side there was the usual hiatus where the supply of investment capital, for a period, outweighed the available investments. However this period of imbalance was short, especially in comparison to Europe. 

At the same time Aussie banks and primarily the exiting European banks started to look for buyers of their impaired syndicated leveraged loans. 

Since 2010-2011 Australia has seen significant and complex corporate restructurings where distressed debt investors have carried out debt-to-equity swaps such as Centro Properties, Redcape and Alinta. We have also seen private equity investors get squeezed out in restructurings such as diagnostics firm I-Med and Nine Entertainment with again debt investors taking over. 

In addition, significant numbers of sizeable debt portfolios have traded (for example BOSI alone sold over $3.7bn face value of portfolios) and now special situations financing seems to be filling some of the capital void created by the exit of foreign banks. There is also still significant secondary trading in certain names, primarily in the retail and infrastructure sectors, such as BrisConnections, a toll-road operator and actively traded name, with over $3 billion of debt and RiverCity with $1.3 billion. 

What is noticeable from all of this is that the Australian banks seem to have accepted the concept of secondary debt trading and offloading problem assets to specialists and interestingly the tiresome kneejerk accusation of  “vulture investing” has not been leveled by the usual suspects – politicians, unions and journalists. This is a refreshing change and I suspect that this is because the Australian insolvency process is so brutal that people realise the benefits of a debt-investor driven restructuring under a scheme of arrangement, with the firm trading as a going concern and jobs being saved.   

To further illustrate the development of the Australian market for private debt investors, we have recently seen the final chapter in the ownership tussle over Billabong International. Here you had basically two groups of investors duking it out to provide effective special situations financing to Billabong.  

To give some background, the company, established in 1973, expanded rapidly during the early 2000s through a series of acquisitions in the sportswear segment and building its own-brand retail outlet business across Asia, Europe and the US. This whole process of expansion led to high debt levels as earnings fell as the GFC took hold in 2008. In addition the Australian Dollar appreciation further negatively impacted earnings with approximately 70 percent of revenue ex-Australia.  

Following two failed attempts in 2012 by private equity group TPG Capital to take the company private at A$3.30 per share (down from a historic high of A$ 18.00), by mid-2013 the shares had fallen to less than A$0.40 per share. 

At this point a deal was announced with the US buyout firm Altamont Capital Partners with backing from another PE firm (Sycamore Partners) and GSO Capital Partners, the credit-orientated arm of alternatives behemoth Blackstone. This proposed deal was effectively a special situations debt financing with PE investment from the consortium. This consisted of a bridge loan of $275 million at 15 percent interest rate, a further $35million at 10 percent, the sale of a subsidiary brand to Altamont for $75 million, issuance of a convertible note and the consortium taking a 15 percent equity stake which would rise to 40 percent over time. 

However at this time Oaktree and Centerbridge had bought $290 million face value of Billabong loans from a group of banks in a secondary trade, apparently with a 10 percent discount to face value. This got them a seat at the table and access to the information for creditors. 

Following a back-and-forth and interjection by Australia’s Takeovers Panel, the Oaktree / Centerbridge group won out with a package which they argued lowered the total interest payable by the Company over five years, reduced the total outstanding debt of the company and constituted a significant premium for an approximately equivalent equity stake whilst allowing existent shareholders to participate at a discount through a rights issue. 

So here we have an example of highly sophisticated private debt investors competing over a sizeable special situations investment and resulting in the favourable outcome for the company and its stakeholders. I think it is safe to forecast that we will see more corporate situations like this in Australia where private debt investors will be vying with each other and also private equity investors and strategic corporate buyers. Thus it is fair to argue that Australia has got used to the joys of distressed debt investing.