Banks provide NPL feast for hungry private equity players

DISTRESSED DEBT INVESTING

US investors are circling as banks prepare next round of distressed loan sales, writes Lauren Parr

Banks’ deleveraging of European real estate-backed balance-sheet debt is well under way now, with more than a dozen loan portfolio sales last year with face values of more than €500m to prove it.

Lloyds is fully immersed in the loan sales market, having offloaded £3bn of property loans this year alone and more than £9bn since 2011, including some Australian as well as European debt (see below). “There is more to come from Lloyds; it is taking advantage of huge demand and is making a good profit – it’s getting more than fair value,” says one adviser.

The number-one non-performing loan vendors are European banks outside their home markets. German banks’ main focus is getting out of the UK, Spain and Ireland, while France’s Société Générale is selling assets in Germany, and British building society Nationwide is reviewing options for a €1.2bn portfolio there. “There is a rush of banks trying to get out,” the adviser says.

Loan sales have been concentrated in the UK, Ireland, Germany and Spain, accounting for almost 90% of closed sales by volume this year. The interest in the UK and Ireland is hardly surprising, given that US buyers see them as first-stop markets in Europe with no language barriers, but more sources of loan-on-loan financing. Now more activity is picking up in Spain and Germany.

Attention turns to Germany

“Banks tried selling in the UK and Ireland as the first market and found a lot of appetite,” the adviser adds. “Now they’ve done some deals, they have portfolios around Europe, Germany is quite a big market and they can see demand for German product.”

Bad banks such as Ireland’s NAMA – which is reviewing a €1.6bn German portfolio – and Spain’s Sareb are also feeding deals into the market, the latter for the first time with its €219m, mainly residential Project Bull portfolio (see tables, pp18-19).

Spain has reached a tipping point and deal flow has started to gather pace. “The perception of
Spain has changed because of Sareb,” the adviser says. “Spain got the bail-out everyone expected but politicians kept refusing. Last year, there were worries about Spain getting out of the eurozone. These concerns have now gone.”

Some people even say Spain reached the bottom during 2012. One key question is how far lenders have progressed through the overall deleveraging process. At a recent discussion organised by Brookland Partners, Stephen Eighteen, Royal Bank of Scotland’s former head of non-core real estate, said banks have been successful and there was a steady flow of deals.

“Today’s demand has allowed Eurohypo to exit its whole UK business in a two-part transaction,” he pointed out. Wells Fargo is buying the performing part of the German bank’s £4bn UK loan book, with a £2.7bn face value, and Lone Star is buying its £1.3bn of non-performing loans.

On the other side of the see-saw, there are a wealth of private equity firms and hedge funds primed  to absorb these loan- buying opportunities.

Private equity players circling

“If you think right back to the beginning [in 2011], when Kennedy Wilson bought a $1.8bn UK loan book from Bank of Ireland in one of the first large loan portfolio sales, there weren’t many private equity players in the market,” recalls Savills Corporate Finance director Simon Dunne. “Today, a lot of big private equity houses are circling: Lone Star, Cerberus, TPG, Northwood, Och-Ziff etc.”

In 2013, Cushman & Wakefield predicts a total of €14.59bn of closed, live and planned loan sales, both non-performing and performing, in the UK and Ireland. By comparison, Germany’s figure is €6.47bn and Spain’s €5.59bn.

“It’s a European story,” says Federico Montero, partner, leading loan sales in Cushman & Wakefield’s EMEA corporate finance department. “You can’t separate out the UK (although it has more new investors, as it is a good place to dip a toe in) – the same investors invest across Europe.”

He reckons buyers are mainly US private equity firms: “They sell it [to their investors] as a European story. The UK is the first stop because it’s easier and less painful. Some jump France, where the legislation makes it more complicated, and then target Southern Europe with a focus on Spain. They go to the south when they have more risk permission,” he adds.

Investors are also starting to explore opportunities in the Netherlands – where Dutch bank SNS was nationalised in February – and wider Benelux countries, where there is an oversupply of offices and values have fallen.

Fortress is bidding on a €693m loan book called Project Vermeer that Morgan Stanley is selling in the Netherlands, while another global bank is selling a smaller, €35m loan portfolio backed by five distressed assets.

There have been a handful of select deals in Eastern Europe. In Russia, IBRC recently sold a €400m mixed commercial real estate loan book to Russian investor A1. In Poland, Santander is selling €1.56bn of residential mortgage loans.

Investors suffer from ‘bidding fatigue’ The pricing standoff between buyers and sellers has dissipated, generally, although it is still a sellers’ market and there can be “fatigue around the bidding process”, as Eighteen puts it. Investors say they are put off by widely marketed loan sales, which can be very labour-intensive.

“To actually mount a credible bid for these big non-performing loan portfolios that have a managed sales process, and to underwrite all those loans, taking legal advice etc, costs can rack up,” says Dunne, who advised on NAMA’s sale of the £216m Saturn loan portfolio in 2011.

“NAMA marketed Project Aspen very widely so some investors felt that, given the high level of competition, pricing wouldn’t end up being that attractive,” he adds.

Some big private equity houses, such as Blackstone, “don’t appear to be targeting non-performing loan portfolios”, Dunne notes. Since winning RBS’s Isobel loan joint venture, Blackstone has focused on classic property transactions, buying Chiswick Park, Devonshire Square and the Adelphi buildings in London, for example.

“People have learned that there is a large amount of investor interest, but still a finite amount of loan sale product,” Dunne adds. “This may explain why NAMA has paused before launching its next large loan sale after Aspen, as more loan sale portfolios are coming down the track later this year, including the big IBRC disposals,” (see panel below).

Banks are looking at Germany as a place to offload assets “because they have to be careful not to be the last one in the queue to put products on the market [bearing in mind] that it can take six to nine months to put something like this together”, adds Montero.

The bidding process could be smoothed if one package of due diligence materials were made available to all bidders, the cost of which would be paid for by the winner, suggests Berwin Leighton Paisner partner Paul Severs, who advised on the Project Isobel loan sale.

Accurate information is critical

“When selling, it is absolutely critical to make sure all the information relating to the loan and the security is complete and accurate before starting the auction process,” he says. “The minute bidders find a defect it causes them to question the integrity of the entire information and therefore the pricing reference points.”

However, the feedback from investors is that banks generally are getting better at putting together comprehensive data packs. Buyers also appear to be taking action to better their chances of clinching deals, by acquiring established loan servicing businesses in some cases.

Other first-time European players are prepared to pay a premium to build a relationship with key vendors. Oaktree, for example, “overpaid by 10-15% for Harrogate”, claims the earlier-mentioned adviser, referring to its purchase of Lloyds’ Project Harrogate defaulted loan portfolio. “It had been in the UK market for 24 months and had to close a deal to get the wheels turning.”

Likewise, Marathon’s €400m purchase of Lloyds’ Project Chamonix non-performing loan portfolio in Germany reflected a substantial premium to other bids. Yet some investors are less convinced by the progress lenders have made in deleveraging in Europe. David Abrams, managing partner of Apollo Global Management’s European non-performing loans franchise, believes that “the problem is large and far reaching, [so we’re] closer to the beginning than the end”.

Private equity firms’ grasp on the level of returns that can be expected from non- performing loan purchases has come a long way, believes Eighteen. “Prior to the formal launch of Project Isobel, RBS spent one year educating the private equity industry about what risk they would be taking – they wanted high returns,” he says. “This allowed private equity firms time to raise specific funds from their investors for the transaction, generally at lower target returns than their existing main funds then required.”

The market has unquestionably opened up, going by last year’s €21.9bn of recorded non-performing and performing loan sales, compared with €14bn in 2011, according to figures from Cushman & Wakefield. Deal volumes this year are expected to finish up in excess of €30bn.

Most market participants say lenders have now worked through their books and settled on an exit plan. However, the success of such plans may depend on market conditions and some institutions have made more progress than others, primarily due to their greater underlying capital reserves.

Furthermore, non-performing loan sales are not a cut-and-dried process: they are often complicated by the very nature of the non-performing assets involved. For one thing, it can be hard to value large and often granular loan portfolios, where there are sometimes high levels of distress.

“To value the underlying collateral you have to look at the loan amount,” Severs says. “If the loan amount is greater than the value of the assets, then the maximum amount you’ll recover is the value of the assets. Then you have to look at how long it might take to realise that amount, what the realisation costs will be and the return on your money for the hold period.

“If the time period to liquidate an asset worth, say, £107m is one year and your annual hurdle return is 15%, your bid price is £85m, based on liquidation costs of £5m plus a contingency of £2m.”

Project Pivot a notable failure

One non-performing loan sale that fell through last year was Allied Irish Bank’s Project Pivot, after several revisions to the final loan pool. The £383m original portfolio was chopped down to £100m and some of the best loans were taken out.

“Pivot’s [ failure] was the result of setting a minimum price and having poor quality data,” says Severs. “No bidder was prepared to bid at that minimum price.”

More recently, with NAMA’s Project Club sale, there are thought to be concerns that potential investors are teaming up with the borrowers – and unlike IBRC, NAMA is not allowed to sell loans back to borrowers.

This situation also applied in the case of Project Aspen: Starwood is said to have been working with the borrower, David Courtney, and Irish boutique Key Capital before Aspen came onto the market.

The Project Club sale had been on hold while NAMA took stock and focused on closing Project Aspen. The NAMA Winelake website reported that NAMA may in future package up loans from different borrowers.

Nine loan sales are planned in the UK this year, excluding IBRC, and between four and six in Ireland, Germany and Spain, where Sareb is seeking a sales adviser for a €500m-600m loan portfolio that it plans to bring to the market.

Project Rock gets ready to roll as liquidators line up €6bn IBRC sell-off

For weeks now, the most shrewd loan buyers have been keeping a close eye on what is happening at IBRC, the ‘bad bank’ set up to hold Anglo Irish Bank’s distressed property assets, which is being wound down.

It has emerged that liquidator KPMG and PricewaterhouseCoopers, in charge of loan valuations, will market a €6bn, mainly UK commercial real estate loan portfolio in September, named Project Rock according to CoStar.

The bulk of the loans being sold are non- performing, backed by assets including Royal Exchange and Finsbury Dials in the City. One sixth of the loan pool is made up of European loans, mainly in Germany.

Two other Irish loan books have also been parcelled up for sale: Project Rock and Project Sand,
with a combined €11bn face value. These mainly constitute commercial loans, but also residential investment loans and development facilities.

However, there are doubts over the chances of success for the process, as only a small discount is to be applied to the loans, because the Irish government cannot afford to take a greater loss.

A 4.5% discount rate will be applied to determine the value of future cashflows and a 2.3% discount will be made to reflect security or title issues.

NAMA will acquire any of IBRC’s loans that are unsold after KPMG has completed the loan valuation and sales process. The final deadline is 31 December. NAMA has established a special-purpose vehicle, National Asset Resolution, to acquire and manage unsold IBRC loans.

The idea of closing down IBRC is that the government can “get rid of short-term debt”, one source says. NAMA, on the other hand, holds long-term debt. This will equate to savings of €3bn per year.

But, the source adds, “there’s no way €24bn of assets can be sold in two months at this value – if they were, it would reflect fire-sale values”.

Lloyds’ £9bn sell-off has led deleveraging trend

Lloyds’ information about its real estate deleveraging is tantalisingly opaque – the bank releases impairment provisions held against the loans in its work-out division, the business support unit, but doesn’t provide any detail on the make-up of its impaired book.

By its 2012 year-end it had reported £13.2bn of impairment charges on distressed property loans since 2009, theyear after it acquired HBOS’s property book.

It began packaging up loan portfolios for sale in earnest in 2011 and since then at least a dozen £100m-plus sales have made their way into the press, with a £9bn face value (see table below). These portfolios have sold for discounts ranging from the mid 30s% up to 90%, with the three Irish portfolios, Projects Prince, Pittsburgh and Lane, going for the deepest discounts.

The bank sometimes confirms sales – it commented on Project Lane last year, saying the €1.8bn of loans had generated losses of £202m in 2011 alone. But the sale at such a deep discount still made sense because the impairments held against the loans were large.

The market believes the bank has benefitted from frequently being the first to test investors’ appetite for loans in different geographic areas and loan book sizes, and it has sold to a string of different buyers.

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