Although vast quantities of pre-crisis real estate loans have traded this decade, Europe’s banks and state-mandated asset management agencies still hold a large volume of unwanted property exposure on their balance sheets.
Ascertaining progress in the deleveraging of Europe’s non-core real estate debt is difficult, although by investment banking firm Evercore’s calculations, there has been a €386 billion reduction since the end of 2013, bringing the remaining total of gross non-core exposure – including non-performing loans, debt identified for deleveraging and properties of which lenders have taken ownership – to around €528 billion.
Given that Cushman & Wakefield figures put loan sales volumes in 2012 and 2013 – when the market built a head of steam – at €21.7 billion and €30.3 billion, respectively, it is reasonable to argue that deleveraging is approaching the halfway mark.
“In general terms, the UK, Ireland, Germany and the Netherlands have deleveraged pretty much everything while the pace in Southern Europe has not been as fast as expected, although improved in recent years,” says Federico Montero, Evercore’s managing director of real estate portfolio solutions. “Spain is moving ahead, Italy is making good progress, while Greece is just starting,” he adds.
Real estate loans contribute to the mountain of bad debt across all asset classes clogging up the European banking system, which the European Central Bank estimated at €1 trillion at the end of 2016.
However, banks achieved a significant reduction in non-core property debt last year, with a rebound in loan sales activity following political uncertainty in Europe during 2016. Last year, loans and lender-owned property with a face value of €104 billion changed hands, up from €51 billion in 2016, Evercore reported, the largest annual total since deleveraging began. Although sales were modest in Q1 2018, with €4.6 billion sold, €61.3 billion of planned sales were being monitored by the end of March.
Last year’s volumes were largely comprised of a small number of huge deals. The top five transactions accounted for 73 percent of volumes, as certain vendors tackled their toxic debt problems head on. Mega-deals included Santander’s sale of €30 billion of loans and properties it inherited through its acquisition of the failed Banco Popular into a joint venture vehicle it formed with Blackstone.
The composition of live transactions being tracked by Evercore – 21 deals totalling €34.6 billion – suggests smaller portfolios are hitting the market.
By geography, Spain dominated last year’s activity with €51 billion of transactions, including BBVA’s majority sale of its €13 billion real estate business to Cerberus Capital Management (p. 20). Business also picked up in Italy, with 26 transactions totalling €29 billion, according to Evercore, up from €10 billion the previous year.
With the largest real estate NPL exposure of any European country, all eyes are on Italy. A range of banks including Intesa Sanpaolo, Banca Monte dei Paschi di Siena, Banco BPM and UniCredit are making progress and all have portfolios in the market.
“Italy is well under way now,” remarks Richard Thompson, global leader of portfolio advisory at PwC, “it offers good price discovery owing to a greater volume of deals, which means sellers can be more comfortable with the prices they can achieve.”
The emergence of Greece was another 2017 story, with the launch of the market’s first secured loan portfolio (p. 18). At the time of publication, Piraeus Bank was due to receive binding bids for its circa €1.6 billion Project Amoeba, which contains corporate non-performing loans backed by real estate. However, Greek banks’ low share prices are an indicator of their limited deleveraging activity. “Greece is getting to the targets set by the ECB but the market is saying ‘it’s not happening fast enough’,” Montero says.
“There is still a massive amount of NPLs on banks’ balance sheets, especially in Italy, Greece and Spain, not only in terms of volume but in terms of percentages,” points out Montero. NPLs held by Italy’s banks still represent 15-20 percent of their total balance sheets, while Greek banks’ exposure amounts to 40-50 percent.
However, Thompson adds that many of Europe’s banks are benefitting from tackling their toxic debt piles. “If you look at the whole bank restructuring agenda around Europe, banks have made great strides; raising capital, restructuring themselves and selling assets. They are in a much healthier position in terms of capital ratios.”
Political pressure at the European level has provoked banks to solve their debt problems. The European Banking Authority continues to squeeze owners of NPLs to encourage a clean-up of balance sheets. In March, it published a consultation paper on draft guidelines for dealing with non-performing exposures, setting an NPL threshold of 5 percent from which credit institutions should establish a strategy to deal with distressed loans.
The introduction of IFRS 9 accounting standards in January, which are designed to encourage a forward-looking view of credit quality, is likely to force banks to recognise higher levels of NPLs, potentially encouraging more proactive balance sheet management on an ongoing basis.
However, in Montero’s opinion, the greatest driver behind banks’ deleveraging efforts is the market itself. “The ECB is there to police the banks but ultimately they are incentivised by the market,” he says.
“Progress is generally a result of increased regulatory focus and a narrowing of the bid/ask spread between buyers and sellers as underlying real estate values have improved in certain jurisdictions,” agrees David Lane, a partner in Deloitte’s portfolio lead advisory services team.
Buyers are also seeing the potential in buying performing loans from organisations strategically aiming to deleverage. Deloitte’s 2017-18 Global Deleveraging Report showed that, across all asset classes, 20 percent of last year’s deal value was for performing books, up from 9.5 percent in 2016.
Blackstone and Prudential’s £11.8 billion (€13.4 billion) purchase of former Bradford & Bingley mortgages from UK Asset Resolution last March was the clearest example of performing debt trading hands. More performing books are expected to be sold in 2018, especially in the UK and, potentially, in Ireland, Deloitte said.
MORE TO COME
Of the €60 billion-plus of planned real estate loan and bank-owned property sales currently being tracked across Europe, almost half relate to Spain. Additionally, after a pause in 2017, Irish banks are now back on track with their loan sales programme, with some aiming to clear out the remainder of their legacy exposure. Lloyds, Permanent TSB and Royal Bank of Scotland are expected to market largely residential portfolios worth €12.7 billion this year.
Portugal’s deal pipeline is also building, helped by an improving economic environment and increased bank provisioning. The country’s largest bank, Caixa Geral de Depósitos, is expected to sell €1.8 billion of NPLs by the end of 2018.
Where banks are bringing large, secured portfolios to the market, they are aiming to strike deals that allow them to retain a stake in the upside once loans are worked out. “Deals that involve profit sharing are usually structured that way because a vendor is not able to recognise all the losses in one go,” Montero explains.
The European real estate loan sales market has changed in many ways since the start of this decade; activity has shifted to Southern Europe, banks that had their heads in the sand are now putting large portfolios on the market and, perhaps crucially, political pressure is yielding results. There is a long way to go, but the loan sales market is gathering pace.