Vol 3 (2006) - Issue 5

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The Changing Nature of Stakeholders in Restructurings

The European loan market has undergone significant changes in recent years. All-time low default rates in the past couple of years have pushed non-bank financial institutions into new areas in order to extract value during a period of excess cash and low returns. This in turn has enabled arranging banks to structure ever bigger and more complicated debt packages comprising tranches of senior debt, second lien, mezzanine and sometimes junior mezzanine. The composition of creditors participating in these debt packages is rapidly changing as the traditional line between banks, hedge funds and other asset managers blurs, a trend which is set to continue. Hedge funds and CLO/CDO vehicles traditionally investing in second lien and mezzanine tranches are now investing in senior tranches of leveraged deals and are actively looking to participate in investment-grade loans, an arena which has in the past been dominated by the commercial banks. This is illustrated by the GBP 1.32 billion financing for Wendel
to fund its leveraged buy-out of a French chemicals company in May 2006. The lead arranger, BNP Paribas,
estimated that three-quarters of the money that Wendel needed to fund its acquisition would come from ‘institutional investors’ such as hedge funds.
Whilst non-bank financial institutions continue to make inroads into the primary markets, the European secondary markets have continued to grow significantly,year on year for the past five years. The majority of this growth has come from the ‘buy side’, US hedge funds attracted by the relatively higher returns in the Euromarkets. This increased liquidity in both the primary and secondary markets has been a contributing factor to the low default rates, as corporates that may have been ripe for a work-out are able to find new money to refinance existing indebtedness.
Most commentators believe, however, that a combination of higher interest rates, higher commodity prices, weakening consumer demand and wage inflation in emerging markets such as the PRC, may lead to a credit crunch in the next 12 to 18 months, with the automotive, transportation and utility industries most at risk. If this were to occur, a number of highly leveraged corporates may find themselves facing a work-out, or even worse, an insolvency process.
The increased number and differing composition of creditors participating in debt packages is set to change the face of future work-outs. Many wonder whether non-bank financial institutions will have the appetite for a work-out. Second lien creditors are an unknown quantity when it comes to restructurings. Will their interests be aligned with, or opposed to that of the senior creditors, who have traditionally been the dominant force in restructurings, or will their interests be very different? There is a consensus amongst restructuring and insolvency professionals that the multiplicity of stakeholder positions, and the diverse agendas pursued by the broad range of institutional and private investor classes, will unquestionably complicate turnarounds and restructurings in the coming months and years.
Given the possible complexity and time-consuming nature of future work-outs and the uncertainty of the return, certain stakeholders may choose to sell their positions to specialist distressed investors. The strength and depth of the secondary markets has given stakeholders a variety of exit options. Through the use of sub-participations and credit default swaps, stakeholders can effectively transfer the economic ownership/interest in any particular position whilst still remaining a lender of record. This will, in turn, present turnaround professionals
with new classes of stakeholders, whose interests may be very different to that of traditional senior lenders.