ADVERTISEMENT

A Bad Bank's Surprise Success Sparks Scramble for Juicy Trade

A Bad Bank's Surprise Success Sparks Scramble for Juicy Trade

(Bloomberg) --

Investors who were bold or lucky enough to buy a little-known, opaque and illiquid vestige of one of Europe’s most dramatic bank failures may make a killing.

Their good fortune is another odd twist in the wild history of Hypo Alpe-Adria-Bank International AG, the Austrian lender that nearly collapsed under bad loans piled up in a state-sponsored buying spree in the former Yugoslavia. While the bank’s rescue, breakup and liquidation cost German and Austrian taxpayers billions of euros, ended political careers and put bankers in jail, its newfound success in offloading assets is reaping rich returns for investors.

Distressed debt specialists, looking at robust gains in the last year in an instrument -- a kind of warrant -- linked to the ability of Hypo Alpe and its bad-bank successor Heta Asset Resolution AG to dispose of assets, are hankering for more of it. Returns are poised to extend gains, according to six people involved in such trades who asked not to be identified because the deals are private.

“I bought them in March and then some in June at very low levels,” Najib Nakad, a portfolio manager at wealth manager Hof Hoorneman Bankiers NV in the picturesque Dutch town of Gouda, said of his purchases in 2018. “My only regret is that I didn’t find enough.”

The Esoteric CAPP

The story of this instrument goes back to Hypo Alpe’s 2016 debt restructuring. Under the deal, Austria and the Carinthia province, Hypo Alpe’s original owner, bought 11 billion euros ($12.4 billion) of debt from senior creditors at 90 percent of face value.

The bondholders were also awarded rights to a warrant, a so-called Contingent Additional Purchase Price, or CAPP, which would come into play once the bad bank’s asset sales raised enough to reimburse the Austrian government and covered the bank’s wind-down expenses.

With CAPP, any money left over would go to the former senior creditors, which have included Pacific Investment Management Co., Commerzbank AG, Bybrook Capital LLP, Dexia Kommunalbank Deutschland GmbH, Cyrus Capital Partners and Knighthead Capital Management.

A Bad Bank's Surprise Success Sparks Scramble for Juicy Trade

Few expected the CAPP to be worth anything at the time of the deal. The track record of Hypo Alpe and its bad-bank successor Heta Asset Resolution AG in selling assets -- everything from seized 5-series BMWs to the run-down Sarajevo Holiday Inn -- made it seem unlikely it could ever generate the required 79 cents for every euro of debt for the CAPP to kick in. After all, Austrian regulator FMA had predicted as little as 46 cents in 2016.

Yet over the course of 2017, hedge funds and bankers who had followed the story for years noticed that the economic recovery in Croatia eased the sale of Heta’s bad debt and seized assets. They started to put feelers out to senior bondholders.

Seeking Sellers

“Once things started to improve, and started to become more clear, I reached out to a broker to see if there was anyone willing to sell,” said Nakad.

A broker at a major investment bank who started to propose transactions in late 2017 said one of the first movers paid about 260,000 euros for CAPPs linked to around 100 million euros of face value of debt. As the deals remained few and far between, prices advanced to 1 percent -- or 1 million euros for 100 million euros of nominal value -- around April 2018, when Heta itself first indicated that the CAPPs could be in the money.

The first-moving buyer passed the CAPPs on for a little less than 2 million euros a few months later -- nearly eight times his initial investment, according to the broker. But that stunning return -- although a small absolute amount, to be sure -- is far from the end of the story. Some brokers say the payout may eventually hit 10 percent, or around 1.2 billion euros, the level at which it’s capped.

So far, the CAPPs are on track to pay at least 6.5 percent of the nominal, based on a calculation by the FMA, the Austrian regulator overseeing Heta’s wind-down. Heta itself said in December that it will reach at least 6.9 percent.

The people following the market say they saw CAPPs change hands at more than 7 percent earlier this year and they are currently being bid for at 7.1 percent to 7.25 percent.

Timing Question

The biggest uncertainty at this point is the timing of the actual payout, because that won’t happen before Heta and all its units are fully liquidated. The process of liquidation may start 2023 and still take several years after that.

Cutting short the uncertainty is one of the reasons why any creditor is selling the CAPPs at all.

Meanwhile, the hedge funds’ profits could reignite a postmortem political debate of the Heta wind-down in Austria. The CAPP effectively distributes to bondholders the contribution to the debt deal by Carinthia -- a de facto penalty for the excessive use of guarantees by which the region’s late nationalist leader Joerg Haider allowed Hypo Alpe’s breakneck expansion. Haider’s former Freedom Party has attacked that distribution as an unnecessary giveaway.

For now, though, investors are looking to ride the wave.

The risk-reward “is extremely attractive in bad-bank residuals as we have seen in the past decade,” said Nakad.

--With assistance from Zoe Schneeweiss.

To contact the reporters on this story: Boris Groendahl in Vienna at bgroendahl@bloomberg.net;Thomas Beardsworth in London at tbeardsworth@bloomberg.net;Antonio Vanuzzo in London at avanuzzo@bloomberg.net

To contact the editor responsible for this story: Vidya Root at vroot@bloomberg.net

©2019 Bloomberg L.P.