The rise of credit funds and other private capital investors is shifting the dynamic of restructuring processes compared to those in which commercial banks are the predominant lenders. The increasing influence of credit funds on restructuring outcomes has been seen for many years in the U.S. and U.K. and is now spreading to Continental Europe and elsewhere.
Private credit/CLO funds fall outside the scope of prudential regulation and are therefore not subject to the capital charges and other forms of supervision applied to traditional banks and financial institutions. As a result, credit funds are less likely to immediately seek to exit their positions via secondary trades when a borrower is in distress, nor are they required to value and mark to market their loan positions.
Funds generally more open to exploring creative work-out solutions
In Australia, in contrast to what has traditionally been an adversarial, bank-led environment we are seeing some larger private credit funds tend to participate in more collaborative restructuring processes, often with a view to broader global relationships with sponsor and borrower clients. These funds might offer borrowers in distress more latitude than banks, as they have greater leeway to defer enforcement and delay the disclosure of defaults to their investors.
The perception that this is effectively leading to the shielding of “bad borrowers” has been identified by Australia’s parliament and regulators as a risk, particularly where credit funds have retail or wholesale investors. Looking ahead, we therefore expect new regulation to be introduced in an attempt to address this issue.
Looser loan covenants drive uptick in out-of-court settlements
That same relationship focus has seen more loans issued with looser covenants in recent years, which in countries including the U.S., Australia and the U.K. is driving an uptick in out-of-court restructurings (also known as liability management transactions).
In the U.K. we expect more restructuring deals to use these flexible provisions (or “baskets”) to inject liquidity into under-pressure businesses in the year ahead, possibly combined with restructuring plans to put pressure on, or to cram down, creditors. Increasingly these processes are being used to drive non pro rata outcomes between creditors. We anticipate that this development will fuel further restructuring-related litigation, a topic we explore in our European roundup.
After a wave of “amend and pretend” restructurings which sought to defer a hard restructuring, the fund finance providers that increasingly support the liquidity requirements of credit funds are beginning to impose greater discipline on their clients. Fund financiers typically insist on valuation and other covenants in their loan documentation, which is eroding the degree of latitude that funds can extend to borrowers in distress seeking maturity extensions or other waivers.
Private capital providers focus on distressed M&A opportunities
Elsewhere, restructuring situations are increasingly seen by private capital providers as distressed M&A opportunities. In the U.K., private equity and other types of investment funds are buying debt (typically in respect of small- and mid-cap companies) with a view to acquiring the underlying business via a distressed disposal executed via an intercreditor agreement.
We are also seeing private capital funds moving into traditional bank asset classes such as data centers and infrastructure by taking mezzanine, PIK (payment in kind) and preferred equity positions, or by making equity investments that have debt drivers.
Credit funds that participate later in the restructuring process via secondary transactions at a discount to par typically show greater appetite to inject new money into businesses in distress than commercial banks.
Credit funds active in the Australian market are using this investment strategy to take control of companies, sometimes informally, as was the case with Camp Australia, and sometimes via formal restructuring processes, as happened in the restructuring of Genesis Care.
Credit funds pursuing loan-to-own strategies in Europe
Private capital funds are also increasingly pursuing loan-to-own opportunities via restructuring plans in Spain, which permit debt-for-equity swaps in situations where equity investors are out of the money. Here, investors that hold majority stakes find it relatively easy to put forward solutions that allow them to capitalize claims.
Credit funds are similarly showing an appetite to explore restructuring situations in the UAE and across the wider Middle East, including in Saudi Arabia. Here we are seeing special situations funds buy into distressed debt of fundamentally sound businesses and actively drive restructurings. This is a dynamic we expect to continue, with regional banks willing to divest their exposures before or during insolvency processes as they look to offload non-performing loans and reduce their capital provisioning requirements.
Specialist debt investors are using their experience from other jurisdictions to manage complex situations, albeit with the need to adapt to the local legal framework.
In some cases, where banks have reached their lending limits, credit funds have been willing to take on more risk and provide funding to help companies navigate financial difficulties, such as last-mile financings for real estate developments. Again, in situations where equity is far out of the money, funds are also pursuing debt-for-equity swaps as a route to majority ownership.
Just as in other parts of the world, investment funds have recognized the need to operate collaboratively and build trust with stakeholders across the Middle East. While there are times when dissenting creditors need to be crammed down, driving consensus among decision-makers early on in a restructuring process is crucial for success.
