Distressed debt market to free up credit and liquidity

A MARKET that aims to free up blocks of frozen bank assets could be the lifeline of the Australian financial services sector.

According to the legal firm Blake Dawson and corporate advisors PricewaterhouseCooper, a distressed debt market is what the sector needs to steady it through troubled waters of non-performing loans and assets.

Distressed investment is a $US100 billion industry. As the consequences of the global financial crisis work their way through the global economy, it is one of the few areas that is set to grow significantly in the years to come as an increasing number of companies’ liquidity has been compromised.

Based on interviews with major financial players domestically and offshore, PWC says conditions are ‘ripe’ for establishing a robust distressed debt and asset market in Australia. PWC partner Michael McCreadie, says the secondary market, investing in debt and assets, is just one key factor needed to stabilise the financial markets, permit the transfer of risk and provide banks with the opportunity to unlock capital.

“A 15-year boom time has meant Australian banks have never needed to participate in the global distressed debt market which has an estimated $US50 and $US100 billion of capital to invest,” says McCreadie.

“That was then, this is now. Banks now have the opportunity to unlock capital tied up in non-performing loans and to start lending by making good loans to people and businesses. They need to be able to instil confidence in the banking system by crystallising the value of assets on the balance sheet and accessing the sources of alternative funding.”

The big four Australian banks have around $10 billion of provisions for bad and doubtful debts and there is a belief by industry experts that this will increase substantially over the next 24 months.

Between 2007 and 2008, the number of companies entering voluntary administration jumped by 10.3 per cent to 8300 and the number of insolvency appointments rose by over six per cent to 12,770. By the end of the 2008 fiscal year, the major banks had seen a rise of 174 per cent in bad debt charges.

Blake Dawson partner James Marshall says there is a lot of leverage in the system and there are a large number of distressed corporates with compromised balance sheets.

“We have already seen a public sector reaction to the crisis with the Government stepping in to provide liquidity solutions for particular sectors,” he says.

“The good news is that we are beginning to also see a private sector response where investors with risk tolerance enter the market to invest in distressed companies, or buy up distressed debt and assets from parties wishing to sell their positions.

“Distressed investors have a place in the capital structure to provide capital to both banks and distressed borrowers in order to facilitate successful restructurings. In some cases they can be the saviours of Australian businesses in times of compromised liquidity.

“Australia is now firmly on the radar of offshore funds, institutional investors and private equity markets which are looking at distressed investing.”

Bank of Queensland CFO Ram Kangatharan says he welcomed the distressed market, despite it being angled at the top end of town (Big 4).

“The good thing about this is that it’s a private market, free of government intervention,” he says.

“The fact that it’s a private market is a positive. This will stop banks behaving badly in the retail deposits sector. Definitely anything that provides any kind of liquidity helps to build confidence in the system.”