KKR Doubles Rescue Lending as European Banks Take Hard Line
KKR’s special situations group, which focuses on European distressed debt, increased its investments -- mostly in the form of privately negotiated lending arrangements -- to $512.5 million in the first half, from $260 million in the first six months of 2011 and a 23 percent increase over last year’s second half, according to Nat Zilkha, co-head of the unit within KKR Asset Management.
KKR, along with Blackstone Group LP and Carlyle Group LP, have broadened their business beyond buyouts, which have fallen 32 percent globally to $116.2 billion this year, according to data compiled by Bloomberg. The New York-based firm, which started investing in debt in 2004, is stepping up its direct- lending as stringent regulatory requirements makes it more expensive for banks to extend credit.
“There is massive change in the behaviors of banks in the last six months as they are really taking a hard line with borrowers, demanding debt payment at maturity instead of amending and extending,” London-based Zilkha said in an interview. “We had often spent months and months on deals and in the last minute banks just agreed to extend, but that’s not happening anymore.”
Banks provided $104.1 billion of high-yield loans to borrowers in Europe, the Middle East and Africa this year, down from $139.4 billion a year earlier, Bloomberg data show. Lenders in the region have pledged to cut more than $1 trillion of assets to meet tougher capital requirements spurred by the sovereign debt crisis.
“Given the challenges of lending across Europe, private equity, mezzanine credit and venture capital investment managers are likely to be the best equipped to adapt to the relationship- oriented needs of borrowers in existing bank-loan portfolios, as well as direct lending,” Moody’s Investors Service’s London- based analyst Michael Eberhardt wrote in a report on Aug. 8.
The average interest margin banks charge non-investment- grade borrowers has widened 11 percent to 401 basis points more than benchmark rates this year, according to Bloomberg data. A basis point is 0.01 percentage point.
KKR’s special situations unit took advantage of the market’s shift in the first quarter of the year, profiting from most of the $370 million debt it bought in the secondary market during the third quarter when the yield for junk bonds denominated in euros surged to as high as 11.8 percent last year.
“The market is currently too bullish on the prospects of a smooth landing,” Zilkha said in an interview from his office. “Recent optimism feels overblown and most of the traded names still feel too high to us.”
KKR Asset Management’s biggest business is its bank-loan and high-yield debt funds, which have combined assets of about $12.2 billion.
“Direct lending has a return potential of an additional 200 to 400 basis points of yield, compared with returns on similar credits in the traded public-bond markets,” Moody’s said in the Aug. 8 report.
KKR, along with Morgan Stanley and energy investment firm AtlasInvest agreed to provide short-term funding to the insolvent Petroplus Holdings AG that allowed the company’s Coryton refinery near London to continue to operate, PricewaterhouseCoopers LLP, Petroplus’ U.K. administrators, said on Feb. 15.
The special situations unit also provided debt in 2010 to facilitate the restructuring of U.K. nursing-home operator Four Seasons Health Care Ltd., which was sold to Guy Hands’ Terra Firma Capital Partners Ltd. this year.
KKR has raised about $2 billion for special situations funds, with $486 million left at the end of June, according to its earnings report on July 27. The stock gained 10.8 percent this year after finishing 2011 down 9.7 percent.
At least 25 percent of unrated European companies, owned by private-equity firms, with debt due by 2015 may default as the economy worsens and owners refuse to inject capital, according to Moody’s. The default rate could more than double if companies are shut out of the high-yield bond market, according to Moody’s.
As Spanish 10-year government bond yields reached a euro- era record in July amid a deepening sovereign debt crisis, KKR has started to look for more investment opportunities in distressed companies in Ireland and would consider lending to Greek firms making staple consumer products or generating significant revenue from other countries, according to Zilkha.
“When everybody is running for the exit that’s usually a pretty good time to go in, even Greece,” he said. “We are quite bullish on the long-term prospect of Ireland because they have a highly educated work force and has a very good exports- led economy that will emerge from the rubble of the property boom that devastated the country.”
Funds investing in distressed securities generated an average 4.7 percent return in the first seven months of the year, according to an index compiled by Lyxor Asset Management, a unit of Societe Generale SA.
Blackstone bought Dublin-based Harbourmaster Capital Management Ltd. in October, tripling its European loans under management to 11.5 billion euros. Carlyle agreed last year to buy AlpInvest Partners NV, a Dutch money manager that oversees about 32 billion euros in private-equity and mezzanine funds, to expand its asset-management business.
KKR is also among buyout firms increasing mezzanine financing as junk bond sales fall. Companies in Europe raised $59.7 billion from high-yield bonds this year, down from $103.6 billion for the same period of 2011, Bloomberg data show.
KKR has invested almost 40 percent of its first mezzanine debt fund that closed at more than $1 billion in August 2011, with about half of it allocated to the region. It is one of the lead lenders in the 391.5 million-euro ($484 million) mezzanine financing for EQT Partners AB’s acquisition of German bandage- supplier BSN Medical, Bloomberg data show.
“We prefer northern Europe including Germany to other parts of the region because the macro environment is more stable and creditor rights are more clear cut,” Marc Ciancimino, head of KKR’s European mezzanine financing unit, said in a telephone interview. “Holland and the U.K. are the two countries where we spend the most time but Scandinavia and Germany also continue to generate interesting ideas.”
About 4 billion euros of funds are being raised this year to invest in mezzanine financing, according to CEPRES, a private capital markets information provider. European mezzanine deals pay an average 11 percent more than benchmark lending rates, including 6 percent from pay-in-kind debt, according to Munich- based CEPRES.
KKR’s mezzanine fund seeks to deliver an annual return in the mid-teens, according to Ciancimino. The firm recently relocated Alex Ramsay from San Francisco to London for its private-debt business, and hired Amos Ouattara from Goldman Sachs Group Inc.
“Mezzanine financing provides certainty and deliverability, it’s like a precise rifle shot for situations where you don’t want to take any chances on the public markets,” Ciancimino said. “We are busier right now in Europe than in the U.S because of this crisis.”
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