Loan-on-loan lenders wait in the wings

Investment banks are keeping watch on loan-on-loan opportunities, particularly in southern Europe, writes Lauren Parr.

With fewer large commercial real estate loan sales transactions closing so far this year compared with 2015 and 2016, opportunities for lenders to provide loan-on-loan finance have been relatively scarce. However, investment banks remain keen to fund portfolio purchases, meaning there is potential liquidity.

Loan-on-loan margins vary, but market players say they have stabilised since the first half of 2016, at around 350 basis points, in significantly from the first wave of deals earlier this decade in the 500-600 bps range. Leverage is typically around 60-65 percent loan-to-cost, or lower.

“It’s attractive business compared to corporate spreads, sovereigns and direct real estate financing,” says Matthias Baltes, head of EMEA CRE finance at Bank of America Merrill Lynch.

“All of the major investment banks are willing and able to engage in loan-on-loan financing,” adds Clarence Dixon, head of global loan servicing at CBRE Capital Advisors. “When someone like Lone Star or Cerberus comes up with a deal they are being chased by investment banks that want to do it.”

Last December, Morgan Stanley is understood to have financed Colony Capital’s €455 million purchase of the €1.5 billion Project Tolka loan book sold by Ireland’s National Asset Management Agency. The LTC is believed to have been reasonably high, at 65 percent or higher. “Both equity and debt bidding got pretty aggressive,” one lender who bid on the deal said.

Lenders are comfortable with the UK and Irish markets where “legal enforcement is straightforward, data attached to loan sales is relatively high quality, and assets are pretty decent”, says Dixon. However, there is little further opportunity to come out of these familiar markets. The NPL opportunity is shifting to new territories and with it, lenders on portfolio acquisitions are tracking their clients.

The sponsor is key in NPL lending deals. “People follow financial sponsors they trust. You need to be comfortable that people know what they’re doing and have the right set-up on the ground,” says Baltes. “Rather than saying, ‘We want to do NPLs in Italy,’ the reality is, ‘We like Lone Star and if Lone Star is doing deals in Italy then we follow them there.’”

There has been a select amount of investor activity in the Netherlands, where Lone Star and JPMorgan bought Dutch bad bank Propertize for €895.3 million last June with JPMorgan acquiring the performing loans and funding Lone Star’s purchase of the non-performing debt. The real battleground is now Italy owing to the magnitude of NPLs on banks’ balance sheets, and to some extent, Spain (see panel).

The Italian market is beginning to unlock as local banks finally begin to work through their loan books, yet loan-on-loan lenders are not preparing to jump in feet first. “The Italian market brings with it challenges that are not as prominent in other jurisdictions, most notably a slow and tedious enforcement process,” says Wesley Barnes, Citi’s European real estate finance head. “Workout times are very long compared to other parts of Europe. Servicing is more critical than ever.”

The servicing aspect of NPLs in Italy is more important than it is in the UK, where “you can slap in a receiver that works for you to sell the property very quickly”, according to one loan-on-loan provider.

There has yet to be a major example of loan-on-loan financing in Italy, with PIMCO taking the securitisation route through its purchase of UniCredit’s €1.2 billion Project Sandokan last year. Lenders are currently conducting due diligence of the market, which offers potentially higher returns but greater unknowns.

Efforts to standardise the Italian real estate enforcement process are bringing some comfort to lenders. “It’s good to see a genuine desire by the local legislative powers in Italy to simplify the existing framework to facilitate the work-out process, although it has not yet been tested,” says Baltes. BAML will therefore take a cautious approach. “While we see potential upside in Italy we will start with an underwriting basis assumption we made under the old framework.”

There are several considerations for loan-on-loan providers to reconcile in a complex market like Italy.

“Sponsor matters, but that doesn’t mean you’re automatically comfortable with a transaction,” says Baltes. “Enforcement regime plays a role because you have to assume the duration of debt is longer. You have to be comfortable there is a defined process through which principal will be realised. It’s more important to understand what status the debt is at: are you dealing with something that has been worked for many years but nothing is coming out; is it shortly before resolution; or is it still early days thereby offering a lot of opportunity?”

The experience of an equity investor is something else lenders will be very focused on. “Some have been there for years and have gone through it; guys that haven’t done that will suffer before they figure out how to do it properly,” says the unnamed debt provider.

Most alarming from a lenders’ point of view is a lack of information or data that is riddled with errors. “Many of the pools that are coming to the market are very granular. With a portfolio containing 50 assets, you can spend the required time to understand each asset. With a portfolio of 5,000 assets you have to rely on data and there isn’t much available,” says Barnes.

One particular deal in the market by Banco BPM, a €770 million loan book called Project Rainbow, contains numerous hotel assets yet the initial marketing material is said to be devoid of any information at all on the properties. “The one thing you need to underwrite hotels is cashflow,” says the debt provider. “Some things are not financeable; you can combine bad data but good legal enforcement and vice versa but both result in not having the security you thought you did.”

A means of embracing imperfect information is by moving towards a statistical approach, bucketing assets in order to come to a view on what the average will be, rather than pursuing a single property or loan underwriting approach.

“The best way to protect yourself is to make sure you’re comfortable with the day one advance rate, which could be 10-15 percentage points lower for Italy than a transaction in the UK or Ireland,” Baltes says.

In theory, Italy offers a favourable environment for loan-on-loan providers given the difficulty in underwriting and enforcing assets. “Lenders can name their terms,” the source says. The Italian loan sale market opportunity will require a large volume of loan-on-loan finance. It will also require lenders being prepared to follow clients into the market.

Secured financing opportunities emerge in Spain

There have been few commercial real estate loan trades to lend against in Spain over the last few years, being that most portfolio deals are residential focused. Credit Suisse financed one of the largest of these – Blackstone’s acquisition of around €6.5 billion of Spanish mortgages from Catalunya Banc – in 2014.

More secured real estate debt is coming out, however, linked to greater foreclosure upon development loans. “Recently we have seen a number of pools containing newly developed but unsold assets such as second-home condominiums, both in debt format and as owned real estate,” says Citi’s Barnes.

The business plan on such assets is to sell the individual units typically over a period of two to four years. “With little recurring cashflow in the meantime, advance rates and other loan terms need to account for that,” he says.