Study on distressed debt from a banking perspective
The distressed debt business in the corporate sector is set to grow in the near future. A Roland Berger study on distressed debt in Germany, Austria and Switzerland shows that banks expect transaction volumes to increase from EUR 13 billion in 2005 to EUR 15 billion in 2006, and EUR 14 billion in 2007.
Since banks' experience in the distressed debt segment is limited, they tend to prefer classical restructuring and full loan repayment to ensure that their claims are met. To date, banks' involvement in the distressed debt segment has been opportunistic, and they are prepared to accept considerable discounts.
In spring 2005, Roland Berger Strategy Consultants surveyed 26 banks for its study in Germany, Austria and Switzerland. Half of these have an annual new credit volume of over EUR 10 billion.
Reasons for distressed debt
Based on the banks' experience, liquidity crises (73.9 percent), price decreases (69.6 percent) and endangered equity (65.2 percent) are the most common reasons for distressed debts in the corporate sector.
In order to recognize non-performing loans at an early stage, 73.9 percent of banks rely on their own internal early warning systems. Credit risk criteria pursuant to Basel II are applied by 52.2 percent of banks to classify their commitments. In contrast, banks seldom use general defaults in payment (26.1 percent) or inconsistent payment behavior (8.7 percent) as an indicator of distressed debt.
Growing transaction volumes
Banks estimate that in Germany, Austria and Switzerland, the distressed debt transaction levels for companies will grow from EUR 13 billion in 2005 to EUR 15 billion in 2006, and EUR 14 billion in 2007. They expect the transaction volume for mortgage/real estate loans to decrease from EUR 16 billion to EUR 10 billion in the same timeframe. Portfolio transactions are forecast to decrease by roughly 10 percentage points, from 48.5 to 39.1 percent. Single name and basket transactions are expected to see a light increase (to 32.3 to 35.6 percent and 19.2 to 25.2 percent, respectively). Overall, the share of distressed debt in the total portfolio is high: nine out of ten banks have a distressed debt share of up to 7.5 percent.
The study showed that the banks carry out a varying number of transactions that are highly dependent on chance. In 47.1 percent of debt sell-off cases, discounts of over 40 percent of the nominal value are quite common.
Seventy-five percent of the banks surveyed consider that investors without bank licensing will face long-term difficulties in the distressed debt segment, as a license is required to buy up loans that have not been terminated by the banks. In cases of capital reorganization, no fresh capital can be made available to companies, as lenders in Germany must have an official license and are subject to government supervision.
Banking secrecy and data privacy protection are barriers
Other barriers to becoming active in the distressed debt segment are, according to the banks, banking secrecy and data privacy protection: 89.5 percent of respondents see sub-participation as the best solution. Fifty-five percent think that convincing the debtor of the benefits of a sell-off is a good solution. Seventy percent of banks only offer non-performing loans if the debtor approves. Almost half of all respondents believe that transactions could be cancelled because of banking secrecy and data privacy protection.
Despite these difficulties, investors (77 percent) and legal consultancies (36 percent) are seen as having considerable experience in the distressed debt segment. Thirty-two percent of banks consider their own experience to be limited.
In cases of loan default, 80 percent of banks see corporate restructuring and subsequent full debt repayment as the best solution to ensure that claims are met. Seventy-one percent of banks consider that partially waiving a debt and repayment of the remainder is another good option. In contrast, corporate liquidation and liquidating collateral is not an appropriate exit strategy, according to 38 percent of respondents.
