What is Distressed Debt Investing

Distressed Debt Investing

Table of Contents

List of tables

List of figures

List of abbreviations

1 Introduction
1.1 Problem description and objective
1.2 Procedure

2 Fundamentals and framework conditions of distressed debt investing
2.1 Definition of terms
2.1.1 Distressed Debt Investing Debt Distressed Debt Sub- and Non-Performing Loans Distressed Debt "Investing"
2.1.2 Debt-Equity Swap
2.2 General economic conditions for distressed debt investing
2.2.1 Historical development
2.2.2 Current market volumes
2.3 Legal framework in Germany
2.3.1 Banking secrecy and data protection
2.3.2 Assignment of Claims
2.3.3 Banking license
2.4 Players in the distressed debt market
2.4.1 Motives of market participants Starting position and sales incentives of the seller Motives of the buyers
2.4.2 Investment strategies and forms Passive investment Active investment Types of Transaction
2.4.3 Investment process
2.4.4 Exit options

3 Debt-equity swap following a corporate distressed debt investment
3.1 Typical starting situation for renovation cases
3.2 Investor's Preliminary Considerations
3.3 Process of a debt-equity swap transaction in German corporations
3.3.1 Simplified capital reduction
3.3.2 Increase in capital and collection of the receivable
3.3.3 Regulations on Equity Replacement Law
3.4 Consequences of changing the investor position

4 Critical market analysis of debt equity swaps in Germany in 2003-
4.1 Overview of the latest developments on the German distressed debt market
4.2 Analysis of selected transactions
4.3 Evaluation of the strategies of selected transactions
4.4 Status of the investments

5 conclusion
5.1 Achievement of goals
5.2 Perspectives and recommendations for action



List of legal sources

List of tables

Table 1 - Overview of the sample

Table 2 - Financial data of the target companies in the sample

Table 3 - Distribution of the sample investors by type of investor

List of figures

Figure 1 - Distressed debt delineation

Figure 2 - Dimensions of distressed debt investing

Figure 3 - Worldwide boom phases in distressed debt markets in 1970 -

Figure 4 - Sample BdB "Asset Trade Clause"

Figure 5 - Assignment of claims

Figure 6 - Distressed Debt Market Participants

Figure 7 - Main Motives of Sellers of NPL Transactions

Figure 8 - Main Buyers / Investors Motives for NPL Transactions

Figure 9 - Active and Passive Investment Strategies

Figure 10 - Distressed debt investment process

Figure 11 - Debt Equity Swap process

Figure 12 - Average equity returns in Europe Banks 2000-2004

Figure 13 - Chronological distribution of the sample over the years 2003-2011

Figure 14 - Sector distribution of the target companies from the sample

Figure 15 - Seller of Distressed Debt Title Sample

List of abbreviations

Figure not included in this excerpt

1 Introduction

1.1 Problem description and objectives

Starting with the stricter requirements for equity backing for bank loans according to the banking supervisory regulations of "Basel II" from 2006 and intensifying by the financial crisis since late summer 2007, the lending business has changed to a great extent, especially in Germany. Triggered by these events, the banking industry is undergoing a structural change that is developing into a capital market-oriented financing policy. The credit institutions are legally obliged to back riskier commitments with more equity. Credit institutions generally have a strong interest in reducing or selling their risky receivables in order to provide capital for new business. As a result of the current financial and banking crisis, the number of corporate insolvencies in Germany is increasing, and thus the proportion of loans in bank balance sheets that are classified as problematic or non-performing and are referred to as "distressed" in financial practice. On the buyer side, this loan offer meets investors who have specialized in taking on these risk exposures and generating high positive returns from them. This form of investment, which is also increasingly developing in Germany, is called "distressed debt investing".

In the past, a pool of creditors was usually formed from banks, which agreed and coordinated the restructuring together with the company management and the owners. With the appearance of distressed debt investors, banks now have a new exit option (exits) close to the capital market to end their credit exposure. These use the purchased debt to exert as much influence as possible on the target company and to reorganize it by converting it into equity and to become new owner. The receivables are usually acquired well below their nominal value, which means that high, attractive returns can be achieved with a sustained increase in value followed by the sale of the company. The main players are international financial investors and specialized hedge funds. The conversion of debt capital into company shares (debt-equity swap) as a restructuring and takeover instrument is becoming increasingly important due to the attractiveness of German companies.

1.2 Procedure

The discussion of the topic takes place under the aspect of the legal and economic framework of the Federal Republic of Germany. At the same time, the historical roots of the topic lie in the Anglo-American area and are taken into account accordingly in the elaboration. Tax aspects are not dealt with by the author and therefore not dealt with in the explanations.

In Chapter 2, the most important terms are explained in order to lay the foundations for understanding the methodology of distressed debt investing and to prepare for further explanations. Starting with the development of a term definition and demarcation, the most important economic and legal framework conditions are examined and presented in detail. The history of the international distressed debt market is described and current developments and market volumes are shown. The special features of the German legal framework are worked out in detail and the most important market players and their respective motivation are described. Finally, the investment process is described and the most important investment strategies and forms are presented and characterized. Finally, the most important exit options are explained.

In Chapter 3, the initial situation of companies in the event of a restructuring is first presented in detail, in order then to explain the associated considerations of investors about an investment. Furthermore, the process of a debt-equity swap transaction is described in detail, taking into account the special features of German company law. At the end of the chapter, the implications of changing the investor's position are shown.

Chapter 4 provides an overview of the most recent developments in the German distressed debt market and contains a description of selected transactions from 2003 to 2010. The strategies used by investors are explained using typical example transactions and the current status of the investments is shown.

Chapter 5 summarizes the main findings of the elaborations on the topic and the resulting recommendations for action are developed, as well as an outlook on the future development of the problem description in Germany.

2 Basics and framework conditions of distressed debt investing

2.1 Definition of terms

2.1.1 Distressed Debt Investing Debt

The term "debt"[1] can be translated as guilt, obligation or liability. In addition, debt is understood as a credit or loan and is linked to the civil-legal term loan[2]. The word credit is derived from the Latin terms "credere"-" believe "as well as"creditum"-" that which is entrusted in good faith "[3] from. In the narrower sense, this means the transfer of use of justifiable items as a trade credit or capital or purchasing power in the form of banknotes, coins or deposit as a loan. In a broader sense, credit is also seen as the confidence in the ability and willingness of the debtor to meet his obligations to repay or provide cover to accounts[4].

The term credit is differentiated from the loan by its more extensive definition. This includes both money and credit lending, in which the credit institution makes its creditworthiness or creditworthiness available to the debtor for a fee. This transfer takes place, for example, in the form of guarantee or acceptance credits. Credits or loans are granted to a third party for a period of time specified in advance for payment in the form of interest. Further conditions are the amount of the loan, any fees and expenses incurred by the bank, the times of payment and the amount of the interest payments, repayment modalities and the securities to be provided by the debtor[5].

Mainly credits or loans from credit institutions such as savings banks, commercial banks, universal banks, central banks or cooperative banks are granted to private individuals, companies or states. The most important examples are current account loans, real estate loans, working capital loans, investment loans or public loans, e.g. in the form of exchange-traded federal bonds and federal bonds of the Federal Republic of Germany or municipal loans[6].

Bond issues on the capital market are also a form of credit as government or corporate debt. Private individuals can also grant loans to other private individuals, companies or states. The federal treasury note can be used as a very popular and important example of this.
In this thesis only corporate debts to banks and savings banks from loans and corporate liabilities from issues of interest-bearing securities on the capital market are taken into account. Distressed Debt

The term "distress" is translated from English as "misery", "need", "danger" or "suffering"[7]. However, within the financial markets there is neither a globally recognized, generally applicable classification based on a uniform standard, nor is there a binding legal definition for non-performing loans in the scientific literature[8]. The term found its origin in the USA. There, liabilities are characterized as "distressed" whose debtors had come under the Bankruptcy Act, also known as Chapter 11[9].

"The classification of loans as" non-performing "varies due to different tax, accounting and regulatory guidelines"[10]. Due to the lack of a uniform global definition, the international provisions from the credit and bond markets and the provisions from "Basel II" have become established in valuation practice[11]. Distressed debt is used to describe liabilities that are characterized by an increased probability of default in terms of debt servicing or repayment, or for which a performance disruption or default in payment has already occurred[12]. A clear indicator of the distress status is the fact of the "default", i.e. the actual default in payment of interest and repayments by the debtor as well as the breach of covenants[13]. German synonyms for distressed debt are problem loan or non-performing loan[14].

Covenants are additional or subsidiary agreements in loan agreements or loan terms. With these agreements, the debtor undertakes to carry out certain actions or to refrain from others (positive or negative side agreements).[15] For banks, covenants represent an early warning system for assessing the risk of the debtor. The aim of this system is to record the status quo of the economic and legal conditions that existed at the beginning of the loan commitment throughout the entire credit period[16].

In practice, it has emerged that the term distressed debt is rather used in connection with non-performing individual commercial loans that are sold in the course of corporate restructuring[17]. In contrast, the term corporate distressed debt encompasses the entire area of ​​non-performing or impaired corporate loans[18].

The term distressed debt also encompasses all receivables such as corporate loans, leasing finance, trade finance, customer receivables, supplier receivables or equity investments[19]. In contrast, a non-performing loan is understood to be a non-performing loan that is secured by mortgage liens such as a mortgage or land charge[20].

Edward Altman defined another classification of claims for exchange-traded securities. He described them as distressed if they are traded with a risk premium of more than 1,000 basis points (bps) compared to the corresponding government bonds[21]. However, historical comparisons have shown that these risk premiums can be very volatile and thus the boundary to distressed debt is becoming increasingly imprecise[22].

It can thus be summarized that a liability referred to as distressed debt describes on the one hand the risk that a debtor cannot or does not fulfill his contractual obligations, but on the other hand also describes the actual payment default or default of interest and redemption payments[23]. Distressed debt thus functions as an umbrella term for the categories of sub- and non-performing. Sub- and Non-Performing Loans

As already described above, liabilities in the "distressed" status can be subdivided into the categories of sub-performing or non-performing[24]. Sub-performing loans are characterized by the features already described, such as a deterioration in the creditworthiness or financial situation of the debtor and an increased probability of default[25]. The debtor only partially meets his contractually stipulated interest and repayment payments[26]. This means that there is a payment or service disruption, but not yet a bad debt loss (default)[27]. For this reason, the contract has not yet been terminated and there are still no requirements for termination[28]. However, the probability that the contractual conditions (covenants) will be violated is estimated to be very high, which is why this type of liability is usually on an internal "watchlist" with an increased need for checking and monitoring[29]. A default probability of at least ten percent is expected and the bank assigns an internal rating of at least B- or worse[30].

Loans that have not yet been noticed due to performance disruptions, but which, according to the assessment of the credit institute, are assigned to intensive support, are often classified in the category of sub-performing loans[31].

In the case of non-performing loans, on the other hand, the requirements for terminating the contract either already exist or it has already been terminated[32]. Furthermore, the debtor is already more than 90 days in arrears with his interest and repayment installments, which defines a default of the debtor according to the framework agreement for capital measurement and capital requirements of the Basel Committee for Banking Supervision ("Basel II")[33].

According to a recommendation by the Bank for International Settlements, credit arrangements are to be classified as non-performing if the debtor has already been three to six months behind in fulfilling his obligations[34]. A full repayment of the liability is no longer expected and the loan is in the default status[35]. Insolvency claims are also classified in the non-performing loans category[36].

Due to the lack of generally applicable German terminology translations of the words distressed debt, sub- and non-performing in the literature, the English technical terms will be used in connection with problem loans.

The following illustration is intended to clarify the author's understanding of the English technical terms:

Figure not included in this excerpt

Figure 1 - Distressed debt delineation[37] Distressed Debt "Investing"

After the most important basic terms of distressed debt have been explained, the essence of investing - "Investing" - is discussed and explained in more detail. Investing is basically characterized by the active action of the investor, which has the goal of creating or building up assets by using financial resources through excess payments over payments[38]. Furthermore, the term distressed debt investing must be distinguished from vulture investing. The term Vulture, in English "vulture", is used because these investors have a preference for "dying" or "sick" companies[39]. In the 1990s, Vulture investors in the USA were mainly interested in debt capital from companies that had to contend with an enormous interest burden and an exceptionally high rate of debt due to leverage buy-outs[40]. Due to this situation, an investment in the company's equity was preferable to a reduction in borrowed capital. As a result, vulture investing was associated with the sub-category of debt investing, debt investment[41].

The distressed debt market in particular was described by Edward Altman as "securities market of problem firms that affords opportunities if their problems are resolved and if current prices are over discounted"[42].

In this thesis, distressed debt investing is understood to mean the acquisition of sub- and non-performing corporate debts for a limited period of time, i.e. non-performing corporate liabilities such as loans and bonds, for the purpose of making a profit[43].

With special expert knowledge and with a high investment of capital from current mispricing, a return that is well above the average with at the same time low correlation with other asset classes is to be achieved[44].

The following figure illustrates the focus of this study on distressed debt investing.

Figure not included in this excerpt

Figure 2 - Dimensions of distressed debt investing[45]

The active and passive investment strategies belonging to the investment dimensions shown in the figure above are explained in detail in Sections and

2.1.2 Debt-Equity Swap

The term debt-equity swap is made up of the three terms debt, equity and swap. These three are translated as debt, equity, and swap. This technical term describes the conversion of debt into equity[46]. That is, the lender (s) convert their bad loan receivables into stakes, such as stocks or shares, in the debtor company[47]. Thus, through this capital structure measure, creditors become shareholders who "pay" their share with the loan claims brought in[48].

As part of a capital increase, the creditors bring their claims in whole or in part into the equity of the company to be restructured in order to reduce or eliminate an impending or existing balance sheet overindebtedness[49]. It is important to provide evidence of the intrinsic value of the claim to be brought in, because the economic value is decisive when it is brought in and not the nominal value of the claim[50]. If the worthlessness is determined in retrospect, in the event of insolvency, the former creditors are obliged to make a cash contribution of the excessively high value of the converted loan (differential liability).

This exchange is used in distressed, but capable of restructuring companies within the framework of restructuring plans, flanked by further restructuring measures. The conversion will relieve the company's balance sheet and cash flow without necessarily having to add new liquidity[51]. As a rule, specialized investors buy the non-performing loan capital shares from the creditor banks, as they have greater know-how and thus better asset utilization compared to credit institutions[52]. Among other things, investors use the debt-equity swap to take control of their "target" and thus influence corporate policy and necessary restructuring[53]. Further explanations and explanations of the individual phases of a debt-equity swap are described in detail in Chapter 3.

2.2 General economic conditions for distressed debt investing

2.2.1 Historical development

The history of distressed debt investing has its origins in the aftermath of the stock market crash in 1847, when investors bought sharply fallen shares in railway companies in the United Kingdom of Great Britain, actively involved in the restructuring of these and were thus able to achieve high profits when the shares were later sold[54]. However, it was not until after the Great Depression of the 1870s that an extensive trade in distressed debt developed in the United States. An increasing number of corporate bankruptcies (e.g. Penn Central Railroad[55] ) attracted further investors who increasingly pursued active restructuring strategies[56]. Other investment targets were, in chronological order, the liabilities of real estate trusts (mid-1970s and 1980s), energy and steel companies (1980s and 1990s) and, since 2000, telecommunications companies[57].

The savings and loan crisis in the USA in the mid-1980s marked the beginning of the standardized trade in credit receivables and led to the establishment of a distressed debt market through the bundling and sale of large quantities of NPLs[58]. This has arisen as a result of the increasing deregulation of banks and the relaxation of legal provisions governing the business activities of credit institutions[59]. Then, as the US economy and real estate market began to cool, credit default rates rose and bank earnings fell to threatening levels. In the course of this crisis, not only did more than 1,000 credit institutions disappear from the market, but the security funds of these banks also became insolvent[60].

The rise in savings bank insolvencies in 1989 led to the bankruptcy of the Federal Savings and Loan Insurance Corporation (FSLIC). Only with the intervention of the US state and the establishment of the Resolution Trust Corporation (RTC) in 1989 did the banking market gradually stabilize. This state institution was entrusted with the task of taking over, restructuring and liquidating the 1,043 savings banks affected, with assets totaling US $ 519 billion[61].

In 1988, the Texan investor Robert Bass acquired and restructured the American Saving and Loan Association for US $ 500 million through his company Bass's Colony Advisors. In 1991 he bought 210 loans from Resolution Trust Corporation with GE Capital and Cargill. Bass later founded Brazos Partners to get large amounts of credit out quickly and effectively, and liquidated approximately 1,500 loans[62]. According to the Federal Deposit Insurance Corporate (FDIC), the liquidation rate after two years was 94 percent and the rate of return was 77 percent. Thus, the first fund focused on distressed debt, Brazos Fund, already had a very successful history. In 1993, the Resolution Trust Corporation was dissolved after five years of successful work in the recovery of problem loans through techniques such as securitization and auctions[63]. Many of the US distressed debt funds still active today attribute their origins to this crisis. Max Heine, who originally came from Berlin, founded the company Heine Securities in New York in 1949, which set up the Mutual Shares Fund[64]. Among other things, this fund invested in distressed opportunities, i.e. securities with high valuation discounts.

A high point of the distressed debt market was in the 1990s, when the economic situation in the USA increasingly came to a head and the proportion of "bad" companies rose sharply[65]. Previously, only the balance sheet restructuring was in the foreground, but now an operational restructuring was also necessary, which was not only more time-consuming, but also risky for the investors[66]. Triggered by the loose and open credit policy at the end of the 1990s, the distressed debt market reached another peak in 2002. New high-yield bond issues between 1997 and 1999 totaled over 100 billion US dollars. These were issued by non-investment grade borrowers and could no longer be serviced due to the slowdown in economic growth from 2001 (bursting of the new economy bubble)[67].

In retrospect, the consistent and rapid state intervention in the market to counter the crises can be viewed as successful. The trading volume in non-performing loans rose from US $ 4.4 billion in 1991 to more than US $ 57 billion in 2003[68].

The following figure shows the global boom phases in the distressed debt markets from 1970 to the present day.

Figure not included in this excerpt

Figure 3 - Worldwide boom phases in distressed debt markets 1970 - 2009[69]

Both the burst real estate bubble in Japan in 1990 and the Asian crisis in 1997 and 1998 are the origin of the non-performing loan markets that arose there[70]. The causes of these two profound crises were, among other things, the deregulation of the financial systems of the countries of the East Asian region in the 1990s, the abolition of capital controls on the recommendation of the IMF and the insufficient preparation of the national financial systems for opening and liberalization[71]. Due to the impressive economic growth of the Asian tiger and panther states, a poor understanding of risk among creditors and debtors intensified the course of the crisis[72].

The liberalization of the financial sectors resulted in a credit boom with an average growth in credit volume of 8-10 percent above the growth rates of the gross domestic product. Driven by low interest rates, particularly in Japan, the bulk of the credit was invested in stocks and real estate, creating an investment bubble and, due to the higher valuation, a cycle of rising lending and investment. At the height of the real estate bubble, the land value of the Imperial Palace in Tokyo alone was valued as high as the land value of the US state of California[73].

When the first investors withdrew capital from the region, confidence in the countries fell and the capital markets were accordingly skeptical about future prospects. After years of prosperity, the countries were faced with a deep recession and, as a result, high loan default rates. In Japan, for example, this led to a non-performing loan volume of over one billion US dollars[74]. With the help of the international community led by the IMF, it was possible to stabilize the financial markets and bring the countries back on a growth path. To solve the problem of a large number of NPLs, most Asian countries took their lead from the USA model and founded so-called asset management companies (AMCs), such as RTC, to which the relevant claims were transferred for subsequent exploitation[75].

In Europe, too, the first transactions in the distressed debt market occurred due to national banking crises in the 1990s[76]. Italy was one of the first European countries to face the problem of non-performing loans[77]. Here, too, the cause was a sharp increase in lending, caused by the deregulation of the banking system in the early 1990s, and mainly benefiting the real estate and stock markets[78]. Threatened by the economic imbalance when the markets began to fall, the Italian state had to intervene massively in the market. In 1999 the government enacted a law that simplified the amortization of losses on the sale of bad loans below their book value[79]. Benefiting from the ability to write off losses from securitisations over five years, Italy created the first large European market for NPL securitisations[80].

The liberalization of the financial sector also led to enormous growth in the volume of credit in Sweden and the associated sharp rise in the equity and real estate markets. The Swedish state had to intervene in 1992 when the markets crashed the year before by setting up two rescue companies to restore confidence in the banking market as quickly as possible and prevent the bankruptcy of two of Sweden's largest banking groups.[81] The rapid and consistent problem-solving on the part of the Swedish government can be seen, among other things, for the advantages of state bad banks in financial systems.

There was also brisk transaction activity in Austria, Poland, Portugal, Russia and Spain[82]. From 2000 onwards, there was a sharp increase in NPL stocks on the balance sheets of Polish banks, which led to the first NPL transactions from 2004 onwards. On the buyer's side, through a change in the law that was created at the same time, there were securitization funds. Losses incurred could only be deducted for tax purposes when they were sold to these funds.[83] Another publicly known sale took place in Austria when, in 2005, liabilities of the insolvent securities dealer Refco were taken from BAWAG P.S.K. were sold to an investment bank[84].

In Germany, investors have been trying to acquire portfolios of non-performing loans since the 1990s. However, the German banks were not ready to sell. This was due to the long-term economic weakness at that time and the bear market in equities that began in 2000, which is why the banks had little scope on their balance sheets to sell non-performing loan portfolios below their nominal values. The credit institutions could neither nor would they afford to sell at the market prices prevailing at that time. The situation only eased through value adjustments around the turn of the millennium and created the necessary space for such transactions[85].

While in other countries the emergence and establishment of distressed debt markets were promoted by the respective governments, e.g. in Italy through improved write-off options, in Germany there were no significant state incentives for banks to part with their problem loans[86]. In 2006, the market potential for non-performing loans in the loan portfolios of German banks was estimated at up to EUR 300 billion, which was the largest in Europe at the time[87].

Up until 2003, no transaction relating to the sale of non-performing loans was publicly known in Germany, despite the fact that an active market for synthetic receivables had already been established in Germany at the beginning of the 1990s[88]. In 2003, the first distressed debt sales with a total volume of around EUR 1.6 billion were announced to the public. Lone Star bought a loan portfolio of EUR 225 million from the insolvent Gontard & Metallbank, which fell into crisis due to the collapse of the Neuer Markt and was finally closed by BaFin.[89] The bank was very generous in granting loans to Nemax companies and to private customers to buy shares. These loans were secured by the shares of the respective companies or by the securities deposited by the customers. When the shares lost value in a month-long downturn on the stock exchanges in the course of the crisis, the value of the collateral also fell and, in connection with the debtors' failure to make additional contributions, triggered the bank's over-indebtedness. In addition, with the lack of issuing business in the Nemax, an important pillar of income for the bank collapsed.[90] This sale was a portfolio transaction[91].

Another milestone in the development of the German distressed debt market was the purchase of risky real estate loans in 2003 by the US investment company Lone Star together with JP Morgen Chase from Hypo Real Estate with a nominal volume of EUR 490 million in the form of a basket transaction[92]. In 2004, Hypo Real Estate sold a further 4,200 non-performing real estate loans with a total volume of around EUR 3.6 billion to Lone Star in a portfolio transaction[93]. Dresdner Bank in particular took a pioneering role in the German distressed debt market, as it founded its own subsidiary in 2003 to process and sell problem loans and non-strategic commitments[94]. In this special company, called "Institutional Restructuring Unit" (IRU), Dresdner Bank bundled a loan portfolio with a volume of approx. EUR 30 billion for badly performing receivables with the aim of winding them up and thus reducing the risk capital requirement by up to EUR 3 billion. Lower EUR[95]. The IRU was dissolved again on September 30, 2005, as the set goal could be achieved earlier than planned[96].

In 2004, the financial investor Lone Star, which is very active in Germany, took over the Düsseldorfer Hypothekenbank, which had already been saved by the deposit insurance of the branch association of private banks and sold on to Lone Star[97]. The medium-sized company IKB and Allgemeine Hypothekenbank Rheinboden were also taken over by the investor in the course of its expansion in Germany[98].

Starting with the first transactions in 2003, the German distressed debt market developed very dynamically into an established market[99]. The large portfolio transactions, which were primarily carried out at the beginning and with which the banks pursued the goal of reducing their very high NPL portfolios, attracted a great deal of attention[100]. At the beginning of its market development, the German distressed debt market was seen as a seller's market with high levels of competition among buyers and the resulting high sales prices for the banks[101]. Due to the high number of transactions that have now been carried out, a certain saturation effect has set in on the market, so that investors primarily only showed interest in attractive portfolios with a professional transaction process[102].

More and more standardized structures developed in terms of data preparation, the process flow and the contractual documentation of NPL transactions in Germany. This led to falling transaction costs and volumes with a simultaneous increase in the number of transactions[103]. With this increasing standardization, the German distressed debt market developed into the largest and most important market for the trading of non-performing loans in Europe, despite existing legal and regulatory risks[104]. By standardizing the transactions in conjunction with reduced transaction costs, it was possible to carry out smaller portfolios (approx. EUR 20 - 50 million) and even single-name transactions (EUR 2 - 5 million)[105].

The development of distressed debt markets worldwide is to a large extent dependent on the development of the overall economy and lending behavior[106], because negative economic phases and the correlated high bad debt losses lead to an increase in the supply of distressed debt in the respective region[107]. As a result of this increase, investors are pushing into the market, hoping for corresponding opportunities to generate returns and actively looking for transaction targets[108].

2.2.2 Current market volumes

The current volume of the distressed debt market in the USA has risen sharply due to the subprime and financial crisis alone. This is also proven by a continuous analysis by the financial and economic data service provider Thomson Reuters, which publishes figures for loan sales in the secondary market. The trading volume for the third quarter of 2009 amounts to a total of 288.84 billion US dollars. Distressed loans have a share of around 84.84 billion US dollars, which is a relative share of around 29.4 percent. Compared to 2008, this corresponds to an absolute figure of 45.97 billion US dollars and a relative 14.4 percent, almost a doubling of the distressed volume. The total volume of secondary loans traded for 2008 was 318.38 billion US dollars. Since the beginning of the analysis, the volume of trade has risen from 8 billion US dollars in 1991 to its peak in 2007 with around 342 billion US dollars.[109] The trend in the volume is rapidly increasing and is expected to exceed the mark of 400 billion US dollars in 2010.

Current figures for Asia from Price Waterhouse Coopers (PWC) for 2009 assume an estimated NPL volume for the three most important countries Japan, China and India totaling 289 billion US dollars. Japan has a share of around 17 trillion Jap. Yen, this corresponds to approximately 198 billion US dollars. For the People's Republic of China, a volume of non-performing loans of approx. 518 billion Chinese renminbi or approx. 77 billion US dollars is assumed and for India approx. 14 billion US dollars.[110]

The data published by PWC in 2010 for the most important countries in Europe show an estimated NPL volume for Germany of approx. 213 billion euros in 2009, which means an increase of around 50 percent compared to the previous year with approx. 142 billion euros[111]. The second highest volume is estimated in Great Britain at around 155 billion euros. Other countries are Spain with approx. 97 billion euros, Italy with 59 billion euros and Russia as well as Greece with 22 and 20 billion euros in NPL volumes.[112]

2.3 Legal framework in Germany

2.3.1 Banking secrecy and data protection

The legal framework of distressed debt investing in this thesis relates to the transaction structures of the assignment and transfer of credit claims as well as their legally relevant provisions.

In the context of distressed debt transactions, the investor needs precise information about the debtor for his own assessment or assessment of the credit, in particular the creditworthiness of the debtor as part of a conscientious due diligence[113]. In the run-up to the acquisition, the buyer is interested in having a comprehensive inspection of the complete credit files of the selling bank as well as all information available to the bank on the intrinsic value of the collateral provided or the quality of the business relationship, among other things. for the purpose of determining the purchase price[114]. Banking secrecy and data protection represent a particular challenge for the initiation and implementation of such a transaction[115].

Unlike in Switzerland, for example, banking secrecy does not constitute a legal regulation or even a law in Germany[116]. Rather, banking secrecy is based on pre-constitutional customary law and is assumed to exist in business dealings[117]. It establishes a contractual obligation of confidentiality due to the legal business relationship between the customer, both private and business customers, and the bank. The only written stipulation can be found in the general terms and conditions of the banks in No. 2 Paragraph 1[118]which, however, is only of declaratory importance[119]. The content and scope of banking secrecy obliges the bank to maintain secrecy about all customer-related facts and assessments of the economic and personal circumstances of a customer, of which the bank gains knowledge through notification of the customer itself, through third parties or through its own perception in the context of business activities as well as the corresponding right to refuse information to third parties[120].

In addition, the bank may only pass on information if the customer has consented to this, statutory provisions require this or the bank is authorized by the customer to provide bank information[121]. However, this confidentiality extends not only to information about customers, but also to non-customers, according to the doctrine of the protective effect in favor of third parties, if the bank has learned information about these persons in the course of its business activities[122]. Thus, the data of different security providers, such as guarantors and tenants of real estate deposited as security, are covered by the protection of banking secrecy. This double direction of protection is intended to strengthen the special relationship of trust between the bank and the customer[123].

If the customer refuses to consent to the disclosure of the data, there is broad agreement in the specialist literature that the information may be passed on by the bank if this is justified by the bank's legitimate self-interest (Section 193 StGB)[124]. This was clarified by the Cologne Higher Regional Court in its judgment of July 8, 1992, file number 11 U 43/92. So there is largely clarity with regard to the problem of the assignment of claims in connection with banking secrecy, that in the case of canceled or callable loans due to default in payment, the interest of the bank justifies the breach of banking secrecy[125]. The Frankfurt am Main regional court ruled on April 17, 2004 in the judgment file number 2/21 O 96/02[126]that the bank's obligation to maintain secrecy does not include an implied prohibition of assignment for terminated or callable loans[127].

If there should be a conflict of interests between the interests of those involved, which are worthy of protection, this conflict must be resolved by weighing up interests and interests. The bank's interest in disclosure of banking secrecy data must be weighed against the customer's interest in keeping his or her data confidential[128].

The interest of the customer is to be assessed as a priority if he fulfills his contractual obligations. If the bank disregards the facts, it can lead to a claim for damages and even an extraordinary termination in accordance with No. 18, Paragraph 2 of the General Terms and Conditions of the banks by the debtor if the continuation of the business relationship is unreasonable for the debtor[129].

If the interests of the bank or third parties are to be rated higher, the customer can be denied an appeal to banking secrecy[130]. This is regularly the case with sub- and non-performing loans, as the debtor's behavior in breach of contract and in breach of trust prevents the bank from properly and economically realizing the claim and, moreover, the bank in its economic freedom of movement[131]. The credit institution must be entitled to all of the liquidation options available on the market in order to achieve the best possible liquidation result, also in the interest of the debtor. One possibility for this is to involve specialized third parties, such as opportunity funds or investment banks with work-out departments, because these too must guarantee data protection and the usual confidentiality[132].

In order to control, distribute and outsource assumed risks, other instruments such as outsourcing or the sale of accounts receivable can be considered. The implementation of these measures is supported by the regulatory capital rules "Basel II". Banking secrecy must therefore subordinate itself to the interests of the credit institution regarding risk diversification, equity relief and refinancing and thus the obligation from § 25a KWG, since it is on par with the other areas of responsibility of a bank and not above them. Due to the importance of the banking sector, the economy has a legitimate interest in the functionality and stability of the financial system.[133]

In summary, it can be stated that a sale of receivables and the associated transfer of debtor data is generally only legally permissible if the customer agrees in advance, if there are important reasons for termination on the part of the bank due to the debtor's behavior in breach of contract or if the bank is interested in the transfer of the data is to be valued higher than the protection of the customer through banking secrecy.

In practice, the legitimate interests of the customer to maintain banking secrecy are taken into account by providing information on distressed debt transactions only to a limited extent by restricting the group of people and signing confidentiality agreements by those involved in the transaction[134]. The Federal Association of German Banks therefore recommends including a so-called "Asset Trade Clause" as part of the contract with the debtor when the loan agreement is concluded[135].

The following illustration shows a sample of such an "Asset Trade Clause" of the BdB. Illustration not included in this excerpt

Figure 4 - Sample BdB "Asset Trade Clause"[136]

Just like banking secrecy, the Federal Data Protection Act (BDSG) is intended to protect against unauthorized disclosure of individual data to third parties. In contrast to banking secrecy, however, the Federal Data Protection Act only protects the personal data of natural persons with the aim of protecting them from impairment of their personal rights (Section 1 (1) BDSG)[137]. The concept of personal data is legally defined in Section 3 (1) BDSG. The scope of the BDSG includes the collection, processing and use of personal data by, among others. non-public bodies if this data is processed or used for professional or business purposes (Section 1 Paragraph 2 No. 3 BDSG)[138]. This also applies to banks, provided they collect personal data, which is the rule in lending business with private customers. According to § 4 BDSG, however, this is only permitted on the basis of legal provisions or with the consent of the person concerned[139].

However, it does not apply to data from legal entities or partnerships[140]. One-person GmbH is an exception when it acts as a borrower[141]. The right to informational self-determination is protected from Article 2, Paragraph 1 of the Basic Law in conjunction with Article 1, Paragraph 1 of the Basic Law. Therefore, as with banking secrecy, citizens are first of all in control of their data. However, according to § 28 BDSG, the transmission for the fulfillment of own business purposes to safeguard legitimate interests is permissible, if there is no predominantly protectable interest of the person concerned[142].

The obligation to maintain statutory confidentiality obligations in accordance with Section 1, Paragraph 3, Clause 2 of the BDSG, which are based on statutory provisions, remain unaffected by the BDSG. This means that already existing legal confidentiality obligations cannot be overridden by the BDSG. The majority of the specialist literature therefore assumes that banking secrecy takes precedence and that the Federal Data Protection Act has a catch-all function.[143]

A violation of the BDSG can also result in claims for damages or even fines according to § 7 or § 43 BDSG[144].

2.3.2 Assignment of Claims

Legal risks in the transfer of claims represent challenges that should not be underestimated for both NPL investors and the selling banks[145]. These are to be analyzed in this chapter as part of the assignment under the points of banking secrecy and the Federal Data Protection Act considered in the previous chapter 2.3.1.

In paragraphs 398ff BGB, the assignment of claims is regulated in the German Civil Code (BGB).[146] The norm of § 402 BGB states that the previous obligee is obliged to give the new obligee all information necessary to assert the claim and to hand over all documents serving as evidence of the claim, insofar as these are in the possession of the assigning obligee[147].


[1] See http://dict.leo.org/ende?lp=ende&lang=de&searchLoc=0&cmpType=relaxed§&spellToler=&search=debt, status: 10/30/210.

[2] See Lützenrath, C. et al. (2006a), p. 83.

[3] See o.V. (1990): Langenscheidt hand dictionary Latin-German, p. 205 .

[4] See Bösch, M .; Heinig R. (2007), p. 4.

[5] See Keller, M. (2009), p. 4.

[6] For more details see: http://www.deutsche-finanzagentur.de/de/startseite/, status: 01.11.2010 .

[7] See http://dict.leo.org/ende?lp=ende&lang=de&searchLoc=0&cmpType=relaxed§&spellToler=&search=distress, status: 02.11.2010.

[8] See Schuppener, J. (2006), p. 11.

[9] See Kestler, M .; Striegel, A .; Jesch, T.A. (2006), p. 9.

[10] o.V. (2005), p. 4.

[11] See Dick, M. (2010), p. 9.

[12] See Daimer, A. (2009), p. 3.

[13] See Richter, N. (2006), p. 10.

[14] See Prüver, T. (2007), p. 9.

[15] See Schober, M. (2006), p. 216.

[16] See Beeken, G. (2009), p. 1.

[17] See Windhöfel, T. (2006), pp. 101-102.

[18] See Hansen, H. (2006), p. 287.

[19] See Schalast C .; Daynes, C. (2005), p. 8.

[20] See Windhöfel, T. (2006), p. 102.

[21] See Altman, E. I. (1999), p. 18.

[22] See Schalast C .; Daynes, C. (2005), p. 9.

[23] See Aldenhoff, H .; Kalisch I. (2006), p. 878.

[24] See Damnitz, M .; Rink, A. (2006), p. 48.

[25] See Aldenhoff, H .; Kalisch I. (2006), 878.

[26] See Dick, M. (2010), p. 10.

[27] See Bösch, M .; Heinig R. (2007), p. 6.

[28] See Richter, N. (2006), p. 12.

[29] See Lützenrath, C. et al. (2006a), p 149.

[30] See Schuppener, J. (2006), p. 11.

[31] See Windhöfel, T. (2006), p. 101.

[32] See Prüver, T. (2007), p. 11.

[33] See o.V. (2004), p. 106.

[34] See Kestler, M .; Striegel, A .; Jesch, T.A. (2006), p. 9.

[35] See Brenner, P.J., (2010), pp. 55-56.

[36] See Schuppener, J. (2006), p. 11.

[37] Own illustration based on Dick, M. (2010), p. 11.

[38] See Koss, C. (2006), p. 8.

[39] See Rosenberg, H. (2000), p. 25.

[40] See Richter, N. (2006), p. 15.

[41] See Richter, N. (2006), p. 15.

[42] See Altman, E. I. (1999), p. 5.

[43] See Schalast C .; Daynes, C. (2005), p. 10.

[44] See Richter, N. (2006), p. 14.

[45] Own illustration based on Richter, N. S 16.

[46] See Windhöfel, T. (2006), p. 100.

[47] See Daimer, A. (2009), p. 38.

[48] See Hass, D .; Schreiber, S .; Tschauner, H. (2006), p. 843.

[49] See http://www.channelpartner.de/knowledgecenter/finanzen/259076/index.html, as of October 23, 2010.

[50] See Brenner, P.J., (2010), p. 123.

[51] See http://www.handelsblatt.com/umwandlung-mit-tuecken;2345833, as of October 29, 2010.

[52] See Richter, N. (2006), p. 161.

[53] See Schulz, D. (2006), p. 120.

[54] See Dick, M. (2010), p. 16.

[55] See Altman, E. I. (1999), p. 3.

[56] See Rosenberg, H. (2000), p. 7.

[57] See Richter, N. (2006), p. 73.

[58] See Schuppener, J. (2006), p. 12.

[59] See Young, R. Jr. (2006), p. 24.

[60] See Prüver, T. (2007), p. 14.

[61] See Richter, N. (2006), p. 74.

[62] See Kestler, M .; Striegel, A .; Jesch, T.A. (2006), p. 21.

[63] See Young, R. Jr. (2006), p. 24.

[64] See Kestler, M .; Striegel, A .; Jesch, T.A. (2006), p. 21.

[65] See Daimer, A. (2009), p. 46.

[66] See Richter, N. (2006), p. 75.

[67] See Dick, M. (2010), p. 17.

[68] See Prüver, T. (2007), p. 15.

[69] Own illustration based on Schalast C .; Daynes, C. (2005).

[70] See Prüver, T. (2007), p. 15.

[71] See http://www.bpb.de/publikationen/J333HG,1,0,Ostasien_nach_der_Krise%3A_Interne_Reformen_neue_Finanzarchitektur_und_monet%E4rer_Regionalismus.html#art1, as of November 3rd, 2010.

[72] See Young, R. Jr. (2006), p. 26.

[73] See Jäger, C. (2009), p. 8.

[74] See Young, R. Jr. (2006), p. 26.

[75] See Prüver, T. (2007), pp. 15-16.

[76] See Dick, M. (2010), p. 20.

[77] See o.V. (2006), p. 64.

[78] See Prüver, T. (2007), p. 16.

[79] See Dick, M. (2010), p. 23.

[80] See o.V. (2008a), p. 17.

[81] See Prüver, T. (2007), p. 16.

[82] See Dick, M. (2010), p. 20.

[83] See o.V. (2006), p. 62.

[84] See Dick, M. (2010), p. 24.

[85] See Prüver, T. (2007), p. 62.

[86] See Young, R. Jr. (2006), p. 22.

[87] See Lützenrath, C .; Schuppener, J .; Peppmeier, K. (2006a), p. 149.

[88] See Prüver, T. (2007), pp. 16-17.

[89] See Richter, N. (2006), p. 84.

[90] See http://www.manager-magazin.de/finanzen/artikel/0,2828,196713,00.html, as of October 29, 2010.

[91] See Richter, N. (2006), p. 84.

[92] See Richter, N. (2006), p. 84.

[93] See http://www.manager-magazin.de/finanzen/artikel/0,2828,318256,00.html, as of October 29, 2010.

[94] See Richter, N. (2006), p. 87.

[95] See https://www.allianz.com/de/presse/news/geschaeftsfelder_news/bankgeschaeft/news67.html, as of October 29, 2010.

[96] See http://www.manager-magazin.de/unternehmen/artikel/0,2828,377318,00.html, as of October 29, 2010.

[97] See http://www.wiwo.de/finanzen/us-finanzinvestor-lone-star-kauf-duesseldorfer-hyp-434412/print/, as of November 20, 2010

[98] http://www.wiwo.de/unternehmen-maerkte/die-mission-impossible-des-bankensammlers-438366/print/, as of November 20, 2010.

[99] See Schäfer, S. (2007), p. 12.

[100] See Schalast, C .; Dickler, R.A. (2006), p. 5.

[101] See Dick, M. (2010), p. 22.

[102] See Wentzler, J. (2006), p. 15.

[103] See Schuppener, J. (2006), p. 12.

[104] See Prüver, T. (2007), p. 17.

[105] See Schuppener, J. (2006), p 23.

[106] See Cherubim, M .; Waschkuhn, W. (2005), p. 6.

[107] See Altman, E. I .; Swanson, J. (2007), p. 3.

[108] See Dick, M. (2010), p. 19.

[109] See http://www.loanpricing.com/analysis/volume.php, as of December 4, 2010 .

[110] See o.V. (2009b), p. 2, for India no information is given in local currency.

[111] See Drost, F.M .; Koehler, P. (2010).

[112] See o.V. (2010), p. 1.

[113] See Richter, N. (2006), p. 133.

[114] See Schalast C .; Daynes, C. (2005), p. 46.

[115] See Schäfer, S. (2007), p. 4.

[116] See Windhöfel, T. (2006), p. 103.

[117] See Brenner, P.J., (2010), p. 98.

[118] See Bösch, M .; Heinig R. (2007), p. 18.

[119] See Kestler, M .; Striegel, A .; Jesch, T.A. (2006), p. 60.

[120] See Nobbe, G. (2005), pp. 1537-1538.

[121] See Glos, A. (2006), p. 164.

[122] See Brenner, P.J., (2010), pp. 97-98.

[123] See Richter, N. (2006), p. 134.

[124] See Kestler, M .; Striegel, A .; Jesch, T.A. (2006), p. 61.

[125] See Schalast C .; Daynes, C. (2005), p. 46.

[126] See http://www.lg-frankfurt.justiz.hessen.de/irj/LG_Frankfurt_Internet? Cid = 5c0d6580ff37a7990ffcb2ed19c8e2dc, status 04.11.2010.

[127] See Windhöfel, T. (2006), pp. 104-105.

[128] See Brenner, P.J., (2010), p. 98.

[129] See Keller, M. (2009), p. 19.

[130] See Brenner, P.J., (2010), p. 98.

[131] See Dick, M. (2010), p. 114.

[132] See Prüver, T. (2007), p. 24.

[133] See Brenner, P.J., (2010), p. 100.

[134] See Richter, N. (2006), p. 135.

[135] See Schalast C .; Daynes, C. (2005), p. 47.

[136] Own illustration based on Schalast C .; Daynes, C. (2005), p. 48.

[137] See Richter, N. (2006), p. 137.

[138] See Windhöfel, T. (2006), p. 109.

[139] See Prüver, T. (2007), p. 23.

[140] See Brenner, P.J., (2010), p. 103.

[141] See Kestler, M .; Striegel, A .; Jesch, T.A. (2006), p. 59.

[142] See Windhöfel, T. (2006), p. 109.

[143] See Brenner, P.J., (2010), p. 103.

[144] See Glos, A. (2006), p. 170.

[145] See Dick, M. (2010), p. 108.

[146] See Richter, N. (2006), p. 130.

[147] See Bales, K. (2009), p. 225.

End of excerpt from 98 pages