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Why Aren't Distressed Assets Selling

'First movers' will be positioned to extract the most value from the acquisition of generation infrastructure.
Fortnightly Magazine - May 15 2003

maturity, mini-perm facilities that relied on volatile and highly uncertain pricing and regulatory environments to bridge the gap until an eventual long-term refinancing in the capital markets.

Lenders now find themselves presiding over the sale of assets to maximize loan recoveries in a tough market with a glut of assets for sale, a supply/demand imbalance, and little incremental appetite or ability on the part of the usual market participants to allocate more credit or capital to the industry. Without the looming requirement to refinance more than $45 billion of medium-term debt within the next 36 months, it is arguable that IPP balance sheets would be under tremendous duress in the near to medium term. Lenders are therefore faced with realizing a short-term valuation on a long-lived asset due to the original short-term financial structure.

Some lenders have recognized the incongruity of this situation and have stepped back from making precipitous decisions regarding acceptable levels of recovery in the heat of the moment. Moreover, lender workout groups are practiced in maximizing available cash flows to meet debt service and taking other measures to avoid a distress sales situation. While this process has been going on there has been little interest in closing on the sale of assets, except where the level of the recovery of outstanding debt is close to 100 percent.

As a result of this pause, some creditors have started to consider other options. These lenders have taken the time to carefully assess when and under what structure-including a workout mode versus bankruptcy-is the appropriate time and framework to liquidate their positions. This perspective is important because there is incentive to avoid a sale today and maximize value tomorrow. However, waiting until tomorrow causes its own set of issues and challenges.

Project finance lenders may also have a little-noticed regulatory motivation to proceed cautiously with the sale of distressed assets. In 2001, the Basel Committee on Banking Regulation issued proposals for a New Basel Capital Accord ("Basel II") that, once finalized, will replace the current 1998 Capital Accord. The Basel II proposals say that asset-backed project finance lending is inherently riskier than unsecured corporate lending and therefore requires a higher risk-weighting and a larger allocation of regulatory capital.

Leading project finance lenders protested that the rules as drafted threatened the long-term viability of project finance lending and would result in increased pricing to borrowers and reduced credit capacity. The project finance banks argued in submissions to the Basel Committee that based on an analysis of their own portfolios, project finance loans have exhibited higher rates of recovery in default due to the credit enhancements that normally are a feature of asset-based lending, and that less and not more capital should be required to reserve against expected losses.

In the face of a more significant downturn in the project finance lending business, these same lenders will be increasingly focused on minimizing any losses taken on their project finance lending and will be strongly motivated to maximize recoveries to protect not only their previous positions with the Basel Committee but the long-term health