Deals by US equity funds lead pick-up in non-performing property debt sales, reports Jane Roberts
“Loan sales have gone from nothing three years ago to being a significant part of how the European property market will resolve its problems,” says one principal at a US private equity firm that buys non-performing loans.
Since early last year, banks have sold European loan portfolios with a face value of £11.46bn, according to figures compiled by Real Estate Capital. That total rises to £20.6bn if sales of their other overseas legacy loan books are included and does not include portfolios on, or expected to come to, the market. The figures are also bound to be an underestimate as data is not freely available.
The pick-up in activity started after a frustrating 2010 for investors in secondary balance-sheet debt. Following some large portfolio sales in 2009 by investment banks such as Merrill Lynch, Goldman Sachs and Credit Suisse, the expectation that UK and European banks with huge legacy loan books would start selling was not realised straight away.
Complexity prevents a quick fix
The reasons for the lack of loan sales were various and have been well-rehearsed. They included the sheer volume and complexity of the task facing banks such as Lloyds Banking Group and Royal Bank of Scotland, and ‘bad banks’ such as Ireland’s National Asset Management Agency, and for many banks the impossibility of writing down everything at once.
By late 2010 there were signs of deals coming. After months of rumours that RBS had a £3bn UK portfolio to sell, the bank lifted its skirts and launched Project Monaco, later reduced in size and re-named Isobel.
Last June, The Blackstone Group’s Chad Pike, one of the suitors for Isobel, predicted that the flow of deals was bound to pick up as the wall of 2006/07 vintage loans matured, resulting in a steady stream of transactions.
“Banks now recognise that, in many cases, loan sales are the most effective way of diminishing their balance sheet leverage and exposure to real estate,” said CBRE’s head of European debt advisory Natale Giostra earlier this year.
“In 2011, this was reflected in an increasing number of loans being brought to the market by a wide variety of institutions. We expect loan sales in Europe, the Middle East and Africa this year to reach at least the same levels as in 2011.”
Most of the bidders and buyers have been US funds with previous form in this sector. The process of investing in non-performing loans (NPLs) is not for the faint-hearted. Considerable financial and property skills are needed to carry out the due diligence process to price portfolios, service the loans and asset manage the underlying properties afterwards to work them out so that they produce good returns.
For this reason, NPL investors are looking to access investments through experienced buyers such as Blackstone, Lone Star, Colony Capital, Cerberus and Kennedy Wilson.
An opaque market in Europe
Other reasons are the opaque nature of the market and low hit rate in Europe so far. Banks are secretive about what they are working on and selective about whom they talk to; bank financing for buyers needing debt is thin and the debt is expensive; and economic and property markets are volatile.
Volatility is worsening after Greece failed to form a government following elections earlier this month. Several debt portfolio sales talked about for months have been held up – or haven’t materialised at all. A year ago, Bradford & Bingley cancelled its £500m UK loan book sale due to low offers. Indicative first-round bids were made at the start of this year for both Irish Life & Permanent’s €2bn commercial property book and its €6.5bn Capital Home Loans buy-to-let book, but both disposals have been put on hold.
Société Générale identified €2.5bn of performing and non-performing loans for sale more than six months ago, but has so far only sold a sub-portfolio with a €200m face value, to Lone Star.
This year started quietly in terms of fresh loan portfolios coming to the market. The recent long-term financing operation (LTRO) by the European Central Bank was partly to blame, said Matt Webster, global head of real estate financing at HSBC, at the Commercial Real Estate Finance Council London conference in March.
The €1tn of three-year money offered at 1% via LTRO and taken up by European banks eased their funding pressures and postponed their need to deleverage.
Don Belanger, managing director in Deutsche Bank’s European CRE team, spoke for many at the conference when he said: “There were four non-performing loan portfolio sales in the market in October – more than at any time in the previous three years. Now they have gone through the process there haven’t been any new, large portfolios for sale.
“The frustration for a lot of us who are buying or financing these portfolios is that they are not coming out quickly.”
But at the same conference, Lone Star managing director Jordi Goetstouwers Odena stressed: “Negotiating is a long process and it is going on behind the scenes,” suggesting that a lot of to-ing and froing continues to go on between buyers and sellers, with banks putting out feelers and buyers putting out indicative prices that the banks may not initially like.
The result is that what is eventually sold isn’t always exactly what was put up for sale. Lone Star does not comment on individual deals but its negotiations with the Bundes-bank over the German central bank’s sale of Excalibur, the €2.5bn former Lehman Brothers collateralised debt obligation, are thought to have taken two years. Lone Star bid against others including US hedge fund Baupost and eventually bought all the whole loans, with a face value of €1.4bn.
Banks hold out for the right price
Certain banks, particularly RBS, continue to insist that they may sell loans, but not at any price and only if buyers could reduce their cost of capital. The brief for Lazard, which advised on Project Isobel, was a difficult one: to sell £3bn of sub- or non-performing loans with the minimum writedown to the bank.
In the end, it wasn’t much of an exit: the portfolio was cut down to £1.4bn, RBS retained 75% ownership and provided all the £550m debt finance for the joint venture with Blackstone that now manages the portfolio. China Investment Corporation is a co-investor with Blackstone in a 25% stake.
At the CREFC conference, RBS managing director Rajesh Sivaraman, who worked on Isobel, and Steve Clegg, a senior director in the bank’s 60-strong global restructuring group, both stressed that selling loans was just one option for the bank – and often the least preferred solution.
Sivaraman argued that the high costs of capital of some debt buyers, plus the more liquid market for direct assets, means RBS often prefers to sell the property rather than the loans. He added that it may also be easier to get financing for assets than to get loan-on-loan finance for debt.
Clegg pointed out that RBS has both the asset protection scheme, which gives it time to tackle its bad property loans, and West Register, a property company that can and does purchase assets – it already has £5bn of property and 40 staff. This gives a floor for prices when the bank sells loans or assets.
For loan portfolio sales that require a discount, he admitted: “The advantage is you clear the balance sheet in one hit,” but added: “We have been most successful at restructuring deals so existing owners can sell, and then standing behind them.”
There isn’t a liquid market for all direct property, however. Lone Star’s Goetstouwers Odena pointed out that if a bank wants a full price it “has to deliver a clean asset. Someone has to be paid to do that, but it is time-consuming and there is risk.”
Investors expect the pace of loan sales to pick up again in the second half of this year. After Isobel and Lloyds’ Royal portfolio sales last year, two more UK loan portfolios are expected to surface shortly.
Allied Irish Bank is carrying out due diligence on a large portfolio of small loans with an £800m face value. Advised by JP Morgan Cazenove, which steered the Royal sale, Lloyds is considering bringing a second, similar portfolio to the market (see table below).
Otherwise, the focus has shifted to Ireland (see below) and also to Spain, where investors such as Lone Star and Kennedy Wilson are spending more time.
Lone Star’s Spanish head with a focus on acquisitions is Juan Pepa. Kennedy Wilson’s European head, Mary Ricks, says her company is talking to Spanish banks about the company’s loan auction service, which has been selling loans in the US since the 1980s. Spain’s finance minister told banks this month to raise provisioning on property loans after Madrid took a €4.5bn stake in troubled lender Bankia.
German market lies dormant
The least active market has been Germany, which went through a round of NPL sales in 2002-2005 when some of today’s US buy-ers, such as Lone Star, were active there.
RBS has more than £4bn of German non- core real estate exposure, much of it highly structured, and talks with Lazard about a second Isobel-style loan sale, called Project Nina, are believed to have been abandoned earlier this year in favour of asset sales.
The alternative to loan sales – enforcing to take control of the property – is a difficult course to take in Germany, though the bank does have control of Pegasus, a portfolio worth €2.1bn at the top of the market, which Morgan Stanley Real Estate Funds VI handed back after its equity was wiped out.
The bank also controls a €751m former ABN Amro loan made to Moor Park Capital Partners, secured on German Praktiker DIY stores. Philip Cropper, managing director of CBRE Real Estate Finance, says: “There is institutional demand in Germany, so why would you sell to opportunity funds with their high cost of capital?”
Other banks with performing real estate loans in non-core markets, or which simply need to shrink their books, are selling loans, often at par or very small discounts. JLL expects more of these as time goes on.
HSH Nordbank has been a steady seller in the UK as it retreats back to its domestic market. In the past year it has sold more than £200m of its loan to a UNITE Group joint venture to three other banks and it was prepaid by Big Yellow’s refinancing this month.
Eurohypo sold two UK loan portfolios last year at par to AXA Real Estate’s debt arm, totalling almost £350m. The German bank has just sold two US portfolios at a rumoured discount of just 5-10% to face value (see table overleaf) and was almost trampled in the rush with 100 parties registering interest.
Since parent Commerzbank’s 30 March announcement that Eurohypo will resume lending in the core UK, German, French and Polish markets later this year, it is expected to sell some loans in the markets it will quit. As well as the US, they include Italy, Spain, Portugal, Turkey and Russia.