In a market awash with opportunities for distressed debt investors, some are finding their path barred to buying loans of companies that have fallen onto hard times.

The reason is that many European loans sold during the era of ultra-low interest rates include a so-called white list, which only allows the debt to be sold to a select group of potential buyers. The restriction seemed like a good idea when demand for risky assets was high because they prevented speculative investors from trying to take over companies, but now it’s limiting the pool of buyers as asset prices fall, exacerbating a liquidity crunch. 

In a recent example, a €500 million ($533 million) loan of Australian health care provider GenesisCare started dropping into distressed territory last summer, after its earnings slumped and a restrictive white list cut off demand from distressed-debt funds. It’s possible for the lender to bypass the white list by getting approval from the company to sell to someone else, but by the time it does that, the price can fall even further. The loan is currently trading at around 30 cents on the euro, down from more than 80 cents in June.

“The result of white lists is that they introduce more complexity for loan traders at banks, making the security more illiquid,” said Jens Vanbrabant, head of European high yield for the plus fixed income team at Allspring Global Investments. “GenesisCare is a good example of this.”

Increasingly Restrictive

White lists emerged in the European loan market from the ashes of the 2008-2009 financial crisis when distressed funds took advantage of depressed prices to buy up debt and take control over companies previously owned by private equity firms. 

In other parts of the world, particularly the U.S., some loans include blacklists, which name specific funds that aren’t allowed to buy the debt. Those restrictions have come into focus recently as Wall Street banks grapple with how to offload tens of billions of dollars of debt for buyouts that they haven’t been able to sell to institutional investors.

Over the past decade white lists have become more prevalent in the euro debt market and increasingly restrictive. Many loan documents contain additional language that bars lenders from transferring to any “loan-to-own” funds.

Private equity firm KKR & Co., which owns a 31 percent stake in GenesisCare, is known to have particularly restrictive white lists, according to Vanbrabant. Last year the firm blocked some distressed debt funds from buying loans of Dutch food company Upfield Holdings BV. The other owners of GenesisCare are China Resources Pharmaceutical Group Ltd. and the company’s management and doctors. KKR declined to comment.

The “common market standard several years ago was that the consent should not be unreasonably withheld, and typically you can’t do it just based on the fact that you feel that somebody is going to take a different commercial approach,” said Neil Devaney, co-head of Weil, Gotshal & Manges LLP’s London restructuring practice. But in more recent deals this provision has either been removed or coupled with a blanket restriction on distressed funds, according to Devaney.

Waiting for Default

Lenders that want to exit a distressed situation have two options: they can wait for a default, in which case the restrictions fall, or they can wait for the company to ask for a covenant waiver in case it has breached or is set to breach one of the terms laid out in the loan documents. But high demand during the era of ultra-low interest rates also allowed private equity firms to remove covenants from loan documentation. 

Those trying to find an escape route from GenesisCare might not have long to wait. The company “may undertake a distressed exchange or other form of debt restructuring that we would consider a default over the next six months,” S&P wrote in a report, in which it downgraded the company to CCC-, three steps above default. 

The firm has depleting cash balances, shareholder loans due in November 2023, high capital expenditure and weakened earnings, S&P said. The company has been in talks with existing lenders to fund that liquidity requirement and has also held discussions with funds not involved in the capital structure. 

Going forward, it may start to make sense for private equity firms to allow opportunistic credit funds to own their debt when decisions need to be made quickly and bringing money to the table can help restructure a business, according to Katrina Buckley, co-head of Allen & Overy LLP’s restructuring practice in London. 

“There may come a point when they decide they’re not interested in the business any more and it makes sense for them to open the list to this type of investor,” she said.