PORTFOLIO COMPANY NEWS
In Italy, a renaissance beckons for distressed deals
after years of stagnation
August 28, 2015 - "You must read, you must persevere, you must sit up nights, you must inquire, and exert the utmost power of your mind. If one way does not lead to the desired meaning, take another; if obstacles arise, then still another; until, if your strength holds out, you will find that clear which at first looked dark."
Tengram Capital Partners may have taken inspiration from Renaissance poet Giovanni Boccaccio's exhausting-sounding advice to students as it doggedly tried to unlock the secrets of Italian restructuring protocol in order to buy luxury menswear maker Zanella Confezioni SpA.
During the nearly three-year chase, the midmarket, consumer private equity firm cut its offer after Zanella's situation deteriorated. Then, even after securing court approval for a pre-bankruptcy purchase, it faced a hold-up while it worked round the clock to obtain consent from about 35 creditor-banks. In June, it finally closed the deal, paying roughly €9 million ($10 million) plus working capital. The acquisition ended eight years of financial uncertainty for the Vicenza company, and marked a successful conclusion to its third attempt at an in-court restructuring.
"Clearly the courts, the banks and the trustees are now trying to figure out ways to streamline and make the process easier for foreigners to come in and rescue these companies," said Tengram co-founder and general partner William Sweedler. "We are effectively white knights - we're bringing capital to a capital-starved environment."
Tengram's acquisition of Zanella reflects growing overseas interest in the "Made in Italy" marque, whether in clothing, ceramics, food, car parts or aerospace components. It also aligns with an increased appetite among international investors for distressed Italian assets, be they nonperforming loan portfolios, such as the €2.4 billion book Fortress Investment Group LLC (FIG) agreed to buy from UniCredit SpA in February, real estate assets foreclosed by banks, or manufacturers, like electric insulation and glass blocks maker Seves SpA, which became a portfolio company of Germany's Triton Advisers through an October debt restructuring.
And, as Tengram's Sweedler suggested, forces are converging to make things easier for distressed buyers -- and sellers.
SUCH DEALS IN ITALY have traditionally been extremely difficult. Italian courts are famously relaxed about swift outcomes. Tales of 20- or 30-year bankruptcy processes at the Palermo court may sound apocryphal but have happened, and 10-year bankruptcies in the Sicilian capital are standard, noted PricewaterhouseCoopers LLP partner Fedele Pascuzzi, who heads the firm's Italian business recovery services.
Then there is banks' stranglehold on the provision of finance and their long-standing reluctance to deal with bad loans. PricewaterhouseCoopers estimated in March those amounted to about €185 billion, or 15% of the European total.
The structure of Italy's banking sector sheds light on the problem. The country's 80-plus banking foundations, a product of bank privatizations of the 1990s, have often been both unable to participate in rights issues to shore up lenders' balance sheets, and unwilling to see their own shareholdings diluted. So a culture of "pretend and extend" has prevailed among lenders, allowing debtor companies to limp along -- down, but not quite out.
Meanwhile the preponderance of regional mutually owned, or popolari, banks, has held back mergers and led to some strange governance and lending decisions.
However, changes emanating from Frankfurt and Rome are transforming the landscape.
First, the advent of the European Central Bank last year as single banking supervisor for the euro zone's largest lenders has shone a spotlight on those banks with weak finances -- and spooked others into getting their houses in order.
Italian banks, led by Monte dei Paschi di Siena SpA and Banca Carige SpA, fared the worse in the ECB's so-called asset quality review last October. But behind those headline failures, other big lenders, led by UniCredit, had begun to do their homework well before the ECB took on the role of banking watchdog, selling troubled assets and loans to investors including Cerberus Capital Management LP and Fortress.
The cultural shift accompanying the ECB's new remit also helped.
"The regulator is no longer the same guy who has been regulating them for the last 30 years in Rome but maybe a Lithuanian guy in Frankfurt who doesn't speak a word of Italian," said Paul Hastings LLP's Bruno Cova, co-chairman of the firm's Milan office.
Meanwhile, a liberalization of banking services in Italy to allow competition from other types of lenders is gradually opening up the market, while a March pledge from banking foundations to diversify their holdings, and a controversial restructuring of the mutual banking sector of popolari lenders are also getting things moving.
"In Italy we have historically had a monopoly of banking activities in the hands of banks. If a bank wanted to sell debt to someone else, the only entity that could safely buy the debt was another bank," Cova said. "What is changing is that we have a government under [Prime Minister Matteo] Renzi which finally after 20 years of political stagnation is tackling some of these issues in a comprehensive fashion."
"Italian companies now if they need cash still have the good old option of going to an Italian bank, but now they can come to London, see hedge funds, do high yields, issue mini bonds. This is a big change after 60 or more years of a banking monopoly," Cova added.
TENGRAM'S DEAL for Zanella came a week before some significant additional developments in the Italian market that should encourage bad loan write-downs, facilitate restructurings and boost the fledgling market for distressed debt.
A June decree, which passed through parliament on Aug. 6 largely intact, built on a major legal shakeup in 2012 which aligned proceedings more closely to Chapter 11 restructurings in the U.S.
Among the new rules are important revisions to two key pre-bankruptcy restructuring facilities. One is the concordato preventivo, an in-court process through which Tengram bought Zanella. The other is a semi-in-court restructuring procedure known as 182-bis, after the section of Italian bankruptcy law in which it features.
The reforms open the concordato up to the possibility of auctions if the court-appointed judicial commissioner supervising the restructuring decides the debtor's own proposal falls short. The concordato is still managed by the debtor, though the commissioner has oversight.
ITALIAN PRIME MINISTER MATTEO RENZI
The changes also allow for a creditor or creditors holding at least 10% of the debt in a concordato to submit alternative proposals unilaterally if the debtor's proposal doesn't cover 40% of the unsecured creditors' debt.
The changes "go in in the direction of dissuading the debtor from making a very low proposal knowing at the end of the day the creditors don't have any alternative," said White & Case LLP partner Iacopo Canino, who advised Tengram on its purchase of Zanella alongside lawyers at Pedersoli & Associati.
And reforms to the restructuring agreement under 182-bis allow for English scheme of arrangement-style cramdowns if a restructuring is backed by financial investors holding 75% of the debt.
"Allowing the cramdown should minimize the holdup by minority investors," said White & Case's Canino.
The reforms also make it easier for a restructuring debtor to secure urgent interim financing.
In addition, to encourage banks to get to grips with bad loans, they will now be able to deduct new loan write-offs for tax purposes in the year they are taken, rather than spread the tax benefits over five years. That will further accelerate a market which was already coming to life. PricewaterhouseCoopers had predicted in March that nonperforming loan portfolio transactions in Italy would likely rise to more than €15 billion in 2015, from €8 billion in 2014.
And Mediobanca SpA analyst Antonio Guglielmi noted in June that the more favorable tax treatment -- and accompanying accelerated recovery procedures -- will narrow the 25% price gap, or bid-ask spread, between sellers and potential buyers and "favor the development of a more structured market" for nonperforming loans. He noted that "deteriorated" loans, which include nonperforming debt, amount to 20% of GDP, and account for 16% of all loans, up from 5% in 2007.
In the same week as the June legal changes, well over two years of discussions came to fruition when KKR Credit, a debt investment unit of Kohlberg Kravis Roberts & Co. LP (KKR), unveiled a vehicle to house an initial €1 billion ($1.1 billion) of distressed assets held on the balance sheets of lenders Intesa Sanpaolo SpA and UniCredit as the basis of a broader investment venture in struggling Italian companies.
The vehicle, effectively a private sector "bad bank," will be ultimately owned by KKR Credit, but the Italian lenders will retain an interest in the assets they are transferring over, which comprise both debt and equity in restructuring companies. Ultimately, it is hoped, the lenders will benefit from KKR Credit's restructuring expertise and its greater willingness to say no to harried mayors or local union officials, and by pooling their resources the banks will gain more influence over restructuring outcomes.
UniCredit CEO Federico Ghizzoni noted at the time that the model "can be duplicated in different contexts in Europe" and said the venture's industrial goal was to help struggling Italian manufacturers.
Further favorable developments include a weakening of the euro -- it's fallen about 17% against the dollar in the past year, partly because of the Greek debt crisis and concern about the euro-zone economy. But at the same time, Italy is pulling out of a three-year recession and fears that the country will leave the single currency have dissipated.
"Sellers' expectations are more realistic, and the weakening of the euro has made it easier for buyers from the U.S.," said Paul Hastings' Cova, who advised KKR Credit on the distressed assets platform. "There is a good alignment of things that regardless of the reforms have made Italy a more attractive place than it has been for the last few years."
Having largely exhausted opportunities in Spain, foreign distressed debt investors are increasingly eyeing its eastern neighbor, market protagonists report.
UNICREDIT CEO FEDERICO GHIZZONI
"Our check on the market is the number of meetings with new-coming investors. In the period between 2007 and 2014 we had less than a meeting a month - now we have more than three meetings a week," said PricewaterhouseCoopers' Pascuzzi.
ONE MAJOR REFORM pending -- seven years after the onset of the credit crisis -- is the creation of an Italian bad bank. The issue is the subject of intense discussion between the Bank of Italy, the government, Italian lenders, would-be private sector backers and Brussels officials.
But expectations are muted since the private investors officials hope will back the plan, under the auspices of the state-backed Cassa dei depositi e prestiti, won't be willing to pay 100% of the value of the risky assets being transferred that some banks apparently still expect.
Then there are the state aid watchdogs in Brussels to navigate.
"A lot of the media has considered a bad bank as a panacea for ensuring deeper access to credit. Personally, I don't think it is the case, and I don't think even the authorities think it would be a panacea in all situations," said Adriano Bianchi, head of Alvarez & Marsal Holdings LLC's practice in Italy, which was designated a preferred service provider to the KKR Credit/UniCredit/ Intesa Sanpaolo distressed assets vehicle.
Some observers argue that the bankruptcy law needs further updating to, for example, give creditors the power to initiate pre-insolvency restructurings, rather than having to wait on the debtor's filing.
But PwC's Pascuzzi believes that it's the implementation of the law, rather than the rules themselves, that has fallen short. The result of the June changes "is one of the most advanced bankruptcy laws in Europe," he said. "The problem is the way bankruptcy law is applied in practical terms."
He noted that restructurings are too vulnerable to the whims of individual judges and the often lone practitioners overseeing them who very often lack commercial nous. In August, the Italian parliament watered down a tighter regime for court-appointed receivers after lobbying by the profession.
Other obstacles include a basic lack of resources, particularly at smaller banks, to consider initial claims for debt concession before it's too late, advisers said.
"Often Italian banks are really difficult. They tend not to take decisions and restructurings can last forever because banks are not prepared to take the actions that are clearly required," said White & Case's Canino. The current regime "makes the debtors very shy. Banks get worried. You don't get decisions because lenders may be exposed to liabilities."
Furthermore, observers noted that the advent of the ECB as single supervisor for the euro-zone's largest lenders has created a two-tier situation where Italy's leading banks are coming to grips with their bad loans but where smaller lenders continue to put their heads in the sand.
The EC in June stated that Italy had made "some progress" chipping away at its bad-loans mountain, but efforts have been concentrated among its leading banks.
PricewaterhouseCooper's Pascuzzi said a medium-sized Italian company might typically have 10 lenders, which can make for "a strange dynamic" during restructuring discussions. "You have at the table some banks that have already written down the credit by 30% or 40%. They are ready to accept it. But the small banks haven't written it down.
"Maybe the company is in the same territory as that bank; maybe it's the bank's first client. The crisis of the company is almost the crisis of the bank. The bank can not afford write-downs."
Then there's the prevalence of family ownership among small and midsized companies. In times of distress, a crippling mix of pride, fear and the understandable desire to preserve what may have taken generations to build up can lead to stasis.
"Cultural change is very important for all the parties. They need to look at financial distress as something that might happen," said White & Case's Canino.
Of the Zanella deal he said: "Zanella already tried unsuccessfully to achieve a pre-bankruptcy agreement twice in the recent past and the situation of distress lasted very long and created a lot of tension amongst the shareholders."
Since its June acquisition, Tengram has installed Todd Barrato, CEO of portfolio company Luciano Barbera, a healthy "ultra-luxury" apparel maker it bought in October, as the head of Zanella too.
The Westport, Conn.-based private equity firm is aiming to build on Zanella's in-roads with upscale retailers, including Nordstrom Inc., Neiman Marcus and Mitchells Family of Stores to restore the annual value of Zanella's retail sales to pre-credit crisis levels of around $100 million from about $45 million to $50 million now. It's also planning mono-brand outlets of its own.
"The typical philosophy of brands remaining only within the Italian community has definitely changed," said Tengram's Sweedler. "Those foreign investors that are willing to deal with a more onerous process are reaping the benefits of a more open Italy."