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Europe’s $2 Trillion of Distressed Debt Set to Outstrip U.S.

The distressed debt market in Europe is set to outstrip the U.S. for the first time as the region’s sovereign crisis forces banks to sell $2 trillion of underperforming assets, Strategic Value Partners LLC said.

“The opportunity set in Europe is very attractive and rich,” Victor Khosla, founder of the Greenwich, Connecticut-based distressed-debt hedge fund manager, said in a phone interview. “It far exceeds the U.S. for the first time.”

Strategic Value Partners, which oversees $4 billion, is among hedge funds eyeing Europe as the fallout from the credit crisis and governments’ austerity measures trigger fire sales. Mark Unferth, head of distressed debt at London-based CQS U.K. LLP, is boosting investment in Europe and expects rivals to do the same, he said in an April 6 interview. New York-based KKR & Co. said March 1 it hired Mubashir Mukadam to head its push into the European market.

By comparison, U.S. banks have announced they need to sell $800 billion of assets since the credit crisis, Strategic Value Partners calculations show.

Distressed debt typically yields at least 10 percentage points more than government bonds. Hedge funds dedicated to buying the debt earned an average 4.1 percent return this year after reaping 23 percent last year, according to Singapore-based data provider Eurekahedge Pte.

‘American Invasion’

Distressed-debt funds seek to profit by buying assets at below their face value, providing high-yield financing which could give rights to a company’s shares and opportunities to restructure it or install new management before selling it at a higher value.

The second wave of restructuring in Europe will require “hardcore, true restructuring skill” handling debt-for-equity swaps and overhauling corporate operations, Khosla said. Lenders wrote off 6.5 billion euros ($9.4 billion) of senior loans as defaults peaked in 2009, according to Fitch Ratings.

Strategic Value Partners has 50 investment professionals in London and Frankfurt and has invested about $6 billion in European distressed debt since it was set up in 2002.

“Europe is not a market for everyone. Over the years we’ve seen American invasion followed by American retreat from those failing to grasp the how to do business in this region” including knowledge of different legal regimes from country to country, Khosla said. “Given the amount of the legacy non- performing assets that needs to be cleaned up, this restructuring cycle is going be at least three to five years and even longer for the peripheral countries because we don’t expect to see a sharp recovery in the economy there.”

Bank of Ireland said April 4 hired Deutsche Bank AG to sell most of its project finance business of U.K. infrastructure loans. Ireland’s central bank instructed four lenders on March 31 to raise 24 billion euros after publishing the outcome of the banks’ stress tests.

“The spate of equity fund-raising by European banks recently is positive for corporate debt restructuring because it will allow banks to be able to start taking writedowns on these assets,” Khosla said.

To contact the reporter on this story: Patricia Kuo in London at pkuo2@bloomberg.net

To contact the editor responsible for this story: Faris Khan at fkhan33@bloomberg.net

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