Negentropy Capital Partners Bringing Order To Italian Non-Performing Loans
Distressed debt is very much an ‘in vogue’ investment strategy at present, with opportunities across industries and geographies – and in the public and private markets - brought to market by the effects of lockdowns designed to combat the spread of Covid-19. New funds launched in 2020 are seeking to jump on this seemingly once-in-a-generation chance to grab a bargain or three as the anticipated effects of the pandemic, even as most major economies begin to re-open, are expected to persist for a year or two at least.
The current climate echoes that of the ashes of the global financial crisis in 2009 in the sense that there has been a significant event causing dislocation in certain industries. London-based private debt manager Negentropy Capital Partners was born shortly after the GFC, eyeing opportunities in Italian non-performing loans. Alexis de Dietrich, a Partner at Negentropy Capital, says that the country which gave Negentropy their start continues to provide a consistent pipeline of deals.
“As a result of post-GFC regulation, Italian banks have been steadily reducing their stock of NPE (Non-Performing Exposure) through the sale of portfolios of loans or individual exposures for a decade now and there is still plenty more to come. It has the richest tapestry of private debt investment opportunities in Europe in our view,” he said.
NPE disposals often take the form of large portfolios of loans; consequently, determining the value of such a large number of individual line items requires a quantitative approach because statistical methods are the market standard, and really the only way to analyse large portfolios of loans. The benefit of this approach is that these methods give a good, broad picture of the expected return; the negative is that the line items are so numerous, that it’s difficult to intervene or take control of the details of the recovery process. In the early years of NPL disposals, these portfolios were sold at a sufficiently discounted price that the expected return - and the range of expected error around that return - represented a good investment. As the international community became more interested in NPL portfolios, the effect of more investor interest on NPE pricing made Negentropy Capital tweak their approach.
“The auctions began to attract the interest of all of the international players in Italian Private Debt which had the effect of driving prices to levels that we considered no longer attractive. So we started to focus on more granular portfolios where we can perform more fundamental analysis of the line items to accurately ascertain their value. In these portfolios, our local knowledge is our differentiator,” said de Dietrich.
Italy represents the largest European pool of banks’ NPEs; it’s projected to reach €389bn in 2021 and €441bn in 2022, according to a report published in January by Banca Ifis, and that’s before any Covid-19-related NPE gets packaged up by the banks ready for sale.
“We expect the current difficulties to further constrain bank lending, adding to the challenges faced by SMEs,” said de Dietrich. “As governmental support measures are phased out, many companies may face capital constraints or financing difficulties. We’re able to support companies or acquire assets which are in stressed or distressed financial positions where banks can’t. This will present investors with some very attractive opportunities that they will not want to miss.”
Navigating the investment landscape in Italy for many investors carries preconceptions grounded in a perceived opacity, a red flag to many investors who value transparency and clarity as much as they do returns. de Dietrich disagrees, of course, and says that the perception is rooted in a misunderstanding of how business is done in the country.
“I don’t agree that the investment environment in Italy is opaque, but I do agree that it’s fragmented,” he said. “Italians identify with their regions and each region has its own characteristics. The banking system is also local with a network of cooperative banks providing services to local citizens or even specialised groups based on their professional affiliation and the corporate sector is also more fragmented in the sense that SME’s have a larger share of employment and generate more value than the European average. Investing in Italy does require both a strong network and experience in doing different types of deals with different parties.”
Negentropy reviews around 500 to 1,000 deals annually, investing in only a handful of these. The firm’s bottom-up approach focuses on the fundamentals of the underlying loans that are packaged up for sale; some of these loans may be to companies that are enduring short-term dislocation caused by certain events, some may not, but de Dietrich says that the basics of private debt investing remain foundational regardless of the current climate.
“Success in private debt investing means that you have to have a deep and granular understanding of the underlying assets and the potential risks to these loans re-performing. We focus on fundamental values and cash flows that will deliver uncorrelated returns,” he said. “Market movements may seem to provide opportunities, but we do not focus on timing the market, we are fundamental investors. By focusing on the deconstructed cashflow streams / cashflow structure, we are able to deliver returns throughout market cycles.”
Negentropy Capital Partners is expanding its product roster to include a senior debt fund, an absolute return fund and a dedicated vehicle targeting opportunities in the Italian personal luxury goods sector, one that has been hit hard by the pandemic, and consequently one where Negentropy Capital sees an opportunity to step in. The firm wants to capitalise on its ability to deliver private debt returns and offer investment and risk profiles to suit a broader, more varied audience of investors, which de Dietrich says will continue to provide strong risk-adjusted returns beyond the anticipated economic recovery from the Covid-19 pandemic.
“Private debt differentiates itself as an asset class by its adaptability and ability to perform exceptionally despite shocks and cyclical downturns. That’s why over €680bn has been allocated to this asset class globally and it’ll continue to grow because not only are the returns attractive, the steady cashflow streams available in private debt investing are not subject to the price fluctuations of traded markets and their volatility,” he said. “The opportunities in the asset class are abundant and will continue to grow regardless of the prevailing economic environment.”
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