Distressed debt investment in Spain: opportunity to acquire small and medium size companies´non performing loans

Distressed debt investment is no new business. In fact, it´s a highly competitive field where international investors such as Fortress, Cerberus, Apollo or Oaktree manage multibillion dollar funds pursuing acquisition of big non performing loans portfolios at a discount. These funds have been actively analysing NPLs opportunities in the Spanish market for the past 3 years. Nevertheless, few transactions have taken place in Spain. What were are seeing is very big spreads between bidding and asking prices, some times as high as 30%, specially in those assets in the Savings Loans´balance sheets, making transactions impossible.

In our opinion, there is little chance for distressed debt investors to close significant deals if the continue to target (only) financial institutions and big corporations. These potencial sellers are very reluctant to accept the big discounts investors are looking for, unless:

1) They go bankrupt and their assets are liquidated

2) They are enforced to show real market prices for their troubled assets (eg real state related debts) and not simple “guesstimated” accounting values.

The market knows (and bankers too) that the real value of these assets can be well bellow their book value in many cases. Selling their non performing loans at market values to distressed debt investors would surely result in significant losses in many cases and this would probably would require capital increases in a time where liquidy is scarce and the cost of capital high. Additionally, this would have a high reputational cost for top executives at these companies and financial institutions.

At MercaDeuda we think its time for institutional investors with an interest in distressed debt investment in Spain to start focusing on an untapped class asset: small and medium size non performing loans, both from public and private debtors. As opposed to big corporations and financial instituions, most SME´s financial decissions are mostly driven by cash requirements, rather than accounting implications. In a context where there are significant cash restrictions for smaller companies – due to highly leverage financial instituions and crowding out effects driven by public deficits – smaller companies are experiencing many difficulties financing their operations. In the past 3 years more than 200.000 SME´s have gone out of business, due to financial restrictions and delays from debts, in many cases Spanish Public Administrations (mainly municipalities and regional governments).

In our opinion there is an significant opportunity with all the non-financial debt of Spanish Public Administrations. There are no less than € 50 billion of these debts still to be payed by regional and local administrations. In many cases, creditors are SME´s that traditionally obtained liquidity from banks, which is not the case anymore. Many of these SME´s are going backrupt (or undergoing serious financial difficulties) because of delayed payments by Public Administrations. Since in many cases they have little or none financial alternative (they are too small for capital markets) we find that in many cases SME´s are willing to sell their credits at higher discounts compared to corporations and financial instituions.

MercaDeuda currently has over US 350 million of credits (face value) publish in it site, mostly from private companies and public administrations. Discounts range between 5% and 95% of the face value. Speaking about public administrations, we find sellers willing to transact at 50% discounts (+ accrued interest), enabling 25%-30% target yields for investors in a 3 -5 year time frame. MercaDeuda is focused in identifying and aggregating these type of debts to build up porfolios that can be acquired distressed debt investors.
We acknowledge Spain is undergoing a severe economic recession that will end last for at least all 2012. Nevertheless, we are very confident with the new government and its policies. There is a clear compromise to reduce public deficits, which should be under 3% by 2014. We expect that highly disciplined fiscal policies will help to gradually bring back confidence to the Spanish economy, normalising the flow of liquidity to our economy. In this context, we think 2012-2013 will offer the best investment opportunities in these type of assets.
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