Yet, as with subprime, these structured loans no longer look so smart. Many of the biggest users of these pre-IPO convertibles were in sectors that are now reeling, particularly Asian real estate. Essentially debt with equity upside, they were predicated on initial public offerings at bloated 2007-style multiples, upwards of 30 times projected earnings. Many deals were written at the top of the market when participation was more important than analysis. In the worst cases, term sheets barely covered an A4 sheet of paper and due diligence was often cursory. Now that the IPO exit is effectively shuttered, hedge funds and other investors find themselves loaded up with illiquid paper they have no way of marking to market. Sound familiar?
The better deals can be restructured by, say, extending the payback date. But many participants are looking at losses, either because they cannot afford to wait or security is minimal. Investors may have some call on a Cayman Island registered entity but the assets themselves are held further down the line, and on-shore to boot. As such any claims by, say, Chinese banks rank well ahead of foreign hedge funds. Lawyers, now handling swathes of these deals, report a potential failure rate of 50-70 per cent with their workload building as deadlines loom. Conversion periods were typically 18 months to three years, with some written just a few months ahead of the IPO. With no money in the till, that should mean a round of disappointments from next year.