Reuters – UK Universities’ Pension Fund Eyes Distressed Debt Spree

Universities Superannuation Scheme, Britain’s second-largest pension fund, may double its allocation to distressed debt at the expense of cash-strapped banks that can no longer afford to hold on to troubled assets. The 32 billion pound ($50 billion) USS fund has around a quarter of its private equity assets, or 700 million pounds, in distressed debt. This could rise to up to half of the fund’s 3.5 billion pound private equity portfolio, Michael Powell, USS head of alternatives told Reuters.

(Reuters) – Universities Superannuation Scheme, Britain’s second-largest pension fund, may double its allocation to distressed debt at the expense of cash-strapped banks who can no longer afford to hold on to troubled assets.

The 32 billion pound ($50 billion) USS fund has around a quarter of its private equity assets, or 700 million pounds, in distressed debt.

This could rise to up to half of the fund’s 3.5 billion pound private equity portfolio, Michael Powell, USS head of alternatives told Reuters.

After resisting fire sales at the crest of the financial crisis, banks weary of regulatory demands and shrinking profits are tiptoeing nearer to sales of capital-intensive loans, bringing cheer to British pension funds hungry for bargains.

“The long-term repo programme in Europe has enabled banks to repo these assets and raise finance on the back of them, instead of selling,” Powell said.

“Given the macroenvironment in Europe and the fact that banks remain overleveraged, there will be distressed assets coming off those banks,” he forecast.

Most of Britain’s biggest banks have been able to resist substantial asset sales in the wake of the 2008 banking sector slump, in which banks like Lloyds and Royal Bank Scotland were forced to take state bailouts to survive.

But under pressure to repay taxpayers and rebuild capital reserves large enough to keep lending in a recession, banks are being encouraged to act now while there is ample demand to acquire such assets.

“The need for banks to realistically value some of their books has never been greater…there is a real appetite to purchase,” said Philip Williamson, chairman of mortgage servicer Acenden and former chief executive of building society Nationwide.

Around 8 percent of the mortgage market is subprime, representing around 30 billion pounds of possible opportunities for investors, Williamson estimates.

“Rating agency downgrades, software glitches and resulting customer difficulties and executive pay have dominated the headlines but they pale into insignificance relative to the challenges banks face in dealing with deteriorating mortgage books,” Williamson argues.

“Arrears and defaults continue to engineer increasing provisions…if around 15 billion pounds was offloaded this would go some way to easing their capital requirements.”

AMBITION

The loans eyed by USS include a mixture of assets ranging from mortgage backed securities and corporate loans to leveraged buyouts.

“We are building the groundwork to increase the allocation as and when the opportunity arises. We have been looking at some of the non-performing loan portfolios coming out of European banks,” he added.

Since the credit crisis, large numbers of corporate and particularly private equity owned companies have seen their debt trade well below face value, reflecting fear of hefty defaults.

Pension funds eager to increase the overall yield of their assets have turned to this segment of the market to buy this cheaply-priced debt, in hopes that companies will recover and repay their debts in full, earning them rich rewards.

Other pension funds weighing up allocations to the sector include the London Pension Fund Authority (LPFA), which runs around 4.2 billion pounds in assets.

Mike Taylor, chief executive of the LPFA, said the pension fund could invest up to 50 million pounds “opportunistically” in distressed debt, by allocating to a specialist fund manager.

USS’s Powell said the current cycle was reminiscent of the last global distressed debt shakeout three years ago when the fund held almost half its private equity allocation in distressed debt.

The fund currently has 10 percent of its assets allocated to private equity. Total allocation to alternatives which includes private equity, infrastructure and hedge funds stands at around 17 percent of total assets.

“We could get up to that kind of (2009) allocation but it will probably be a different type of allocation. We do not see senior debt trading down to 50 cents as we did in 2008-2009, but we will probably see more idiosyncratic opportunities in the distressed sector,” Powell said. (By Raji Menon and Sinead Cruise)