Aggressive borrowers

Your recent paper on distressed debt highlighted the frequency with which European borrowers are halting investment funds’ acquisition of their debt. Is this a recent development?

It is not a recent development but the issue of borrower consent is coming up more often as the number of investment funds looking to get involved in the secondary market [for] bank debt of large and medium sized European corporates continues to grow.

European companies have traditionally considered their senior secured lenders to be part of a private club. You’re seeing more and more companies have to deal with the prospect of having secondary investors and hedge funds involved in their capital structure in a potential restructuring and distressed scenario.

While distressed investors have been active in Europe for many years, the breadth with which it is happening now is new. As a consequence, borrowers are looking at their transfer requirements and consent rights under their credit agreements more carefully and are trying to maintain control over who will have a seat at the table when they’re talking to senior lenders about a restructuring.

What factors lead borrowers to oppose investment funds’ acquisition of their debt? Is there a due diligence process? Or is it a kneejerk reaction against what they perceive to be ‘aggressive’ investment funds?

It can be both. There are certain borrowers that are simply anti-investment fund and do not understand the value that investment funds can bring to a turnaround while other borrowers take a more a reasoned approach, looking at who the fund is, what their track record is and what their intentions are. This reputational issue is critical for funds to understand if they want to be active in Europe for the long term.

Are borrowers looking at North America for guidance on how to deal with this?

Many European corporate cultures take a very different view than the current norm in North American, however, if you look back 20 years in the US, when a corporate would restructure, you would go into a lender meeting, and you may have some investment funds – but for the most part you would have traditional senior lenders. Over the last 20 years, the North American landscape has shifted into an environment where a stressed borrower expects to walk into their bank meeting and find the room full of funds.

Investment funds are ingrained in the turnaround landscape in North America. Europe is in a transition period.

Do you think that evolution is inevitable? Or can it be staved off by borrowers sticking to their guns on the composition of the lender pool?

The European landscape is changing but where it ends up is difficult to forecast. You have relatively new laws in France, Germany, Spain and other countries that are intended to create a more restructuring-friendly, as opposed to liquidation-centric, regime. Whether or not they’ll be successful on a large scale is still not clear.

While many funds have raised capital for Europe after success in large and relatively liquid trading situations, in today’s market sourcing is much tighter and the funds that are doing deals have spent time developing local connections and have the ability to invest into less liquid and longer term turnaround situations that certain funds are simply not built for.

What about regulations like Basel III which limit those relationships?

Basel III requirements will continue to limit certain bank’s ability to lend for some time. However, the overall European lending market continues to improve for banks that are willing to deliver on a covenant-light basis. Even with the current banking crisis limiting the ability of certain European commercial banks to lend, investment banks, direct lending funds and other shadow banks tare filling the void. In the long term, those local commercial banking relationships will continue to be an important part of the equation.

Will we see a wholesale change in Europe where as soon as a situation becomes stressed, your bank meeting is going to be completely filled with investment funds? I don’t know if we’re ever going to get there. The one thing that is clear is that change for distressed investor is underway.

David Karp is a partner in SRZ’s London and New York offices. He specialises in restructuring, special situations and distressed investments, distressed M&A, and bankruptcy.