U.S. Distressed Asset Hedge Funds Positioned to Capitalize on European Opportunities

June 11, 2012

As storm clouds grow darker still over continental Europe and trading markets the world over remain captive to the unfolding events, a number of U.S. distressed debt hedge funds have raised significant capital as of recent to best capitalize on the opportunity.

The focus on the European crisis and the opportunities presented for distressed asset funds has translated into additional hiring within the group as firms have increased staffing and added to or established offices in London and other major European financial centers. This trend is evidenced in recent reports that credit and distressed shops have increasing been hiring investor talent.

Amongst the group are some of the biggest distressed debt investors in the world, including the likes of U.S.-based funds such as Oaktree Capital Management, Oak Hill Advisors, Columbus Hill Capital Management, Strategic Value Partners, Marathon Asset Management and myriad others.

Industry insiders have long speculated that the European situation would offer a tremendous opportunity, but timing and hard-learned lessons have kept activity largely in check till now. According to Neuberger Berman managing director Jeff Majit, U.S. investor groups have fresh memories of costly mistakes made on their home soil not so long ago. “They’ve been more cautious and done their homework this time around,” says Majit.

An additional consideration has been the European Central Bank’s Long Term Refinancing Operation; a three-year program that has provided cheap funding and much needed liquidity to some 800-plus eurozone banks dating to late 2011.

The LTRO program has allowed banks there to stave off wide-scale de-leveraging via distressed-asset sales; something leaders and bankers alike in Europe have sought to delay, fearing the fallout likely to emerge when such losses become fully recognized on balance sheets and disclosed to the public.

But with Greece edging closer to an EU exit and sovereign debt yields climbing to seemingly unsustainable levels yet again in Spain and Italy, real solutions have yet to emerge, leaving European banks at serious risk still and in the untenable position of being forced to strengthen their balance sheets by unloading assets.

A primary issue driving the timeline at this point is the European Banking Authority’s mandate requiring banks to increase their Tier 1 capital ratio to nine percent by the fast-approaching June-end period.

If wholesale deleveraging does unfold in the form of distressed-asset sales, industry expectations are for trillions of dollars of assets to be sold off at deeply discounted prices over the next three to five years. Lending credence to that notion is the International Monetary Fund’s recent forecast for the region. The IMF expects that European banks will be forced to sell nearly two-trillion euros of assets over the coming 18 months.

Estimates vary, but Wall Street and hedge fund industry experts alike seem to agree that distressed asset investors will likely enjoy face-value discounts averaging 40 percent or more, with the potential of garnishing double-digit returns approaching 25 percent on such investment.

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