Hedge funds 'encourage bankruptcies' for profit
Elena Moya guardian.co.uk, Wednesday 14 January 2009 21.22 GMT Article historyHedge funds, private equity firms and other "vulture investors" that have pumped money into distressed companies present a huge obstacle to the government's plans to stem the flow of bankruptcies, a business adviser warned today.
Banks, even with a government-guaranteed loan, will find it difficult to stop a company going under when opposed by firms that can profit from the falling fortunes of companies.
"Parts of the current complexity arises from the existence of distressed debt investors who sometimes see commercial advantage from using an insolvency process to organise the sale of the viable part of a business to a solvent buyer leaving behind the least profitable parts," Tony Lomas, chairman of PwC Business Restructuring, said.
Vulture funds buy debt in struggling firms at a significant discount – sometimes at 20p in the pound – expecting that when the company breaches its loan covenants and falls into administration, a sale of assets may repay debt at a higher price.
It was London-based hedge funds who imposed the most stringent conditions to a debt restructuring of Martinsa Fadesa, Spain's largest construction company. The business could not meet them and eventually became one of Europe's biggest insolvencies last year with almost £5bn debt. The funds arranged a package that allows them to be repaid as assets are sold – ahead of Spanish banks.
Creditors can also profit from an insolvency or a restructuring as debt can be swapped for equity stakes – such as BlueBay Asset Management's stake in Drax, owner of Britain's largest power station, over recent years.
Pushing companies into insolvency can see their pension deficit automatically passed on to the country's pension protection fund, making a future sale more profitable. This was one of the reasons behind the administration of Crompton, a tea bag maker, three years ago, according to people familiar with the situation.