Mindsets have been re-set.
The secondary market is now firmly placed as a viable enforcement option in distressed situations to be weighed up against the long-term capital cost and uncertainty associated with informal workouts and the stigma of formal enforcements.
Despite this, where is the flow at? We all know the benefit for par lenders in trading out: the release of constrained capital, the opportunity to redeploy capital and to crystallise tax losses. As noted last year, however, while there is an ever-increasing demand for flow, supply-side pressure and soft economic conditions continue to hold back market growth and there has been limited activity in the public space.
This has been countered with an increase in activity in the single credit bilateral space and one-off portfolio sales which continue to buoy the market; portfolios with a face value in excess of A$12 billion have changed hands in the year ending 30 June 2016 (including the A$8.2 billion sale of ANZ's Esanda receivables business and GE's commercial book sale with around A$4 billion face value).
In the private space we continue to see more nontraditional participants enter the market and look to acquire stakes and leverage through debt participation trades. Reasons for this growth in the private secondary market include:
- increased lending hurdles and heightened risk exposure for traditional lenders;
- an oversupply and pricing pressure in particular sectors of the property market (inner city apartments in Melbourne, Sydney and Brisbane in particular);
- continued slowdown in the mining and mining services sectors; and
- traditional lenders' continued preference for avoiding the costs, risks and negative publicity associated with formal enforcement action.
These factors continue to present opportunities for investors to take out par lenders keen to exit particular borrowers or sectors. Investors are becoming more proactive, often structuring take-out and rescue packages directly with borrowers and looking to drive through debt trades with par lenders that may be reluctant to advance further funds necessary to bridge an outcome or complete a project. The ability to trade out in these circumstances is often seen as an efficient way (both in terms of time and cost) for a lender to exit and the investor to step into a senior secured position (at par or a discount). The rescue package will often see the original financing terms immediately amended and restated to reflect the borrower's current risk profile (and the investor's enhanced return hurdles) and may provide for additional secured funding that the par lender was not prepared to advance.
Given the gap in the funding market as noted above, we are seeing non-traditional distressed investors and lenders / boutique funds / financiers enter the space looking to take advantage of the funding gap. Time will tell whether those new entrants have timed their race.
As expected, agricultural-based lends continue to be a sensitive topic for lenders with enforcement action (including trades) being limited to exceptional circumstances because of ongoing reputational concerns.
The general reluctance of the main trading banks to provide funding solutions to mining, mining services and downstream contract service companies (such as construction, equipment, transport and logistics and accommodation service providers) at the moment is likely to continue to present the most opportunities for FY17. Investors that remain prepared to take a market position and provide facilities to bridge through the slowdown, often with equity linked upside, may soon find themselves competing with the mining and mining service companies themselves, if Atlas Irontype contractor sharing structures become more commonplace. Recent examples of investment opportunities presented through these circumstances include:
- AusGroup (manufacturing and construction) after breaching its financial covenants and having to renegotiate with noteholders to extend its debt maturity date;
- Arrium (iron ore miner), where the administrators were forced to seek government funding to purchase critical mining equipment to continue mining operations;
- NRW (civil contractor) renegotiating its debt maturity timetable with financiers due to the mining downturn and a significant contract dispute on the Roy Hill project;
- McAleese (transport provider) which has explored recapitalisation options much to the disapproval of its shareholders;
- Emeco (earth moving equipment provider) which is exploring refinancing options via a scheme of arrangement. (The creditors' scheme is to set to effect an unprecedented recapitalisation and three-way merger transaction with Orionstone Holdings and Andy's Earthmovers.); and
- Paladin (uranium miner) which is exploring recapitalisation options, including with a Chinese counterparty.
The consistent message we are getting from investors reflects the opportunities to fill the funding gap opportunities noted above. We will have to wait to see whether that gap represents an opportune time for new entrants or is a smart play by traditional lenders.
Investors are becoming more proactive, often structuring take-out and rescue packages directly with borrowers and looking to drive through debt trades with par lenders.
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.