Six years on and the “bad bank” industry is less than halfway through expunging legacy commercial real estate loans. Since the trickle of early loan portfolio sales in 2010, the loan sales market in Europe has undergone rapid expansion.
This has been driven by a perfect storm of regulators and governments pressuring banks to deleverage while global private equity funds — the cornerstone buyers — have operated under a different kind of pressure: to put their opportunistic investment capital to work.
It is fair to say that Europe’s real estate loan market has now matured. In the past three years to the end of 2015, the aggregate European real estate loan sale market is estimated at circa €200 billion, according to figures compiled by Cushman & Wakefield’s Corporate Finance team in London.
Annual transaction volume in 2015 was expected to reach €70 billion, a 13 percent year-on-year decline compared to 2014’s €80.6 billion — the high watermark of loan sale activity in the market’s six-year history.
Cushman & Wakefield’s team estimates that the potential remaining pipeline of real estate loan sales throughout Europe is still more than half a trillion euros — €531 billion in gross non-core real estate assets. After allowing for loan loss provisions, the total net exposure amounts to €333 billion.
But this data includes residential loan sales, real estate–owned (REO) portfolio sales and LPA (Law of Property Act) sales. Stripping out those elements, and purely counting sub- and nonperforming commercial real estate loan portfolio sales, the picture revealed is of a marked slowdown in year-on-year activity.
In 2015, total Europe, Middle East and Africa commercial real estate loan sales — including live deals expected to have closed by the year-end — were €44.1 billion, down 47 percent on 2014’s €83.5 billion, according to figures compiled by JLL.
Over the full five years from 2011 to 2015, aggregate EMEA commercial real estate sub- and nonperforming sales were €166.4 billion, which included €110.2 billion in the United Kingdom and Ireland alone.
Richard Stanley, head of real estate workout banking advisory at JLL, explains: “The Bad Bank issue is that successful deleveraging is reliant on market conditions that they need to balance against stakeholders’ pressure. While market conditions for a number of asset classes remain very poor, this clearly creates an imbalance that needs to be addressed.
“For the first time since the establishment of the NPL sales in this economic cycle, continental European deals on the market exceed the total volumes being offered in the United Kingdom and Ireland. International investors will be looking carefully at the lessons learned from the United States, the United Kingdom and Ireland and there will be a first-mover advantage for those investors who can act quickly in this growing market,” Stanley adds.
Loan stock is sourced from existing bad banks and asset management agencies (AMAs) as well as from anticipated new bad banks that have still to get underway, particularly in central and eastern Europe.
Stepping up to the plate
New bad banks are set to include HSH Nordbank, which finally confirmed such plans last October, while others such as Austria’s HETA Asset Resolution and Slovenia’s BAMC still have much of their original inherited NPL stock to sell.
In addition, Italy looks to be the next major jurisdiction to watch in 2016, with the nation accounting for 32 percent of the €92.7 billion in live loan portfolio deals that Cushman & Wakefield was tracking back at the end of 2015.
With European banks’ exposure to noncore real estate located in Italy increasing by approximately €30 billion over the past 12 months, according to Cushman & Wakefield, these assets remain a burden within the Italian banking system and must be dealt with while investor appetite for distressed assets remains high.
The constituents of bad banks and AMAs providing this product come in two principal types — individual institutions and sector-wide agencies — each adapting to a bespoke economic and political context as well as differing real estate fundamentals.
Firstly, there are the single bank iterations — that are often, but not always, run as internal noncore divisions of still functioning banks — that have been common throughout the United Kingdom, Germany and the Netherlands, such as Lloyds, RBS, Commerzbank, FMS Wertmanagement, WestLB and Propertize.
Secondly, there are the system-wide aggregators of defaulted loans — such as Ireland’s NAMA (National Asset Management Agency) and Spain’s SAREB (Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria/Management Company for Assets Arising from the Banking Sector Reorganisation) that were created at the behest of the European Central Bank. This model, it seems, is catching the eyes of regulators in jurisdictions such as Italy and Greece where solutions are yet to emerge.
Learning from the experience of others
So how have the system-wide bad banks fared over the six years since the loan sale market has developed, and what can new and soon-to-form bad banks learn from their successes and failures?
Blair Lewis, CEO at Hatfield Philips, explains: “Each ‘solution’ must be analysed bank-by-bank, comparing the local constraints specific to each situation and market.
“The UK banks acted quickly and reduced their noncore exposure greatly after the crisis to release capital and shore up core banking activities. In Germany, there has been good progress, but some of the mortgage lenders did not have a ‘core’ function to pass capital to. Some of these institutions were more politically controlled and made hold/sell decisions with a very different capital cost, thus holding assets longer.
“There continues to be a stalemate in some jurisdictions,” says Lewis, “where the property markets have not recovered as dramatically as say the United Kingdom and where capital constraints do not figure as prominently in decision making.”
The two sector-wide bad banks, NAMA and SAREB, make interesting case study comparisons.
“Broadly speaking, NAMA is perceived as a successful venture,” says Will Newton, a partner in the restructuring services team at Deloitte.
“NAMA was created at the right time, with the right framework and in more recent times has had the benefit of property fundamentals and financing availability moving in its favour. That is not to say it’s been an easy ride,” comments Newton. “Far from it.”
Criticism has often come in a local, media-charged context, with the major problems that NAMA has faced being more deal-specific — such as the inquiry into the sale of Project Eagle, the Northern Irish loan book — than procedural.
There appears to be a natural correlation between the size of the bad bank relative to the host country’s economy, or GDP, and the scrutiny that its actions are put under. If NAMA’s scrutiny sometimes seems severe, it is arguably not as severe as in Slovenia, where the decisions and processes of BAMC, the country’s bad bank, frequently make the front pages of the domestic national newspapers — and not for the right reasons.
The right notes, in the wrong order?
SAREB, by comparison, was arguably slow to kick-start its operation, learning considerably from the transparency of NAMA’s operation in establishing itself in November 2012.
The Spanish bad bank’s major strategic move came early on with the adoption of an outsourced loan servicing model in which major private equity firms keen to acquire SAREB loans — such as Apollo, Blackstone, Cerberus, TPG and others — competing to win loan-servicing mandates to work out portions of SAREB’s loan book.
Newton reflects: “It was a bold and risky thing to do at the time — but certainly a smart thing to do in ensuring that the best expertise is helping you with the scale of the work and the complexity of the restructuring undertaken prior to sales.”
A common criticism made of SAREB so far in its three-year history is in the bad bank’s preference for selling the better-quality assets and loans that are more income-producing.
“In the early trades, SAREB sold real estate–owned books, rather than real estate loan books, principally because it was easier to sell assets than loans as everyone understands asset sales so they are easier to begin with,” explains Deloitte’s Newton.
Hatfield Philips’ Lewis observes: “SAREB has had the benefit of massively increased liquidity into the country despite property fundamentals not truly underpinning rising values.
“It is not obvious to the casual observer that SAREB has sold the right assets at the right time, however. Have they sold the jewels in the portfolio to create liquidity to pay the returns promised on the share capital raised in the original shareholding?”
SAREB’s hybrid ownership structure is that 45 percent is owned by the Fund for Orderly Bank Restructuring (FROB), the bank bailout vehicle set up by the Spanish government in 2009, and 55 percent by currently 21 predominantly Spanish banks.
SAREB has a 15 percent annual return on equity target and its majority shareholders are the banks that it will compete with as a seller in the residential property market. The largest five are Santander, Caixabank, Banco Sabadell, Popular and Kutxbank.
To make its promised ambitious return, SAREB must deliver cashflow or sell assets and use the proceeds to make the return target. The decision of what, when and how much to sell comes down to the fundamental strategy of SAREB, and the extent to which these return targets influence these decisions is self-evidently crucial.
It is suggested that — eventually — the SAREB board, which is significantly changed from three years ago, may have to restructure its equity return target with shareholders.
Early movers earn the plaudits
Cushman & Wakefield’s head of EMEA Loan Sales, Federico Montero, says: “We have seen more and more bad banks set up since the financial crisis and that all key markets that have a bad bank shows that the European model has had some success.
“Despite having varying approaches, the early adopters such as Ireland and Germany have learned quickly and run efficient processes that maximise pricing and take advantage of the high level of investor sentiment.
“Only time will tell if the more newly-established bad banks in central and eastern Europe have the same success,” says Montero. “However, as investors start to look further up the risk curve and hence further afield in Europe, we are likely to see more sales coming from these entities.”
Alan Patterson, a managing director at Lazards, adds: “Any assessment of success has to reflect the circumstances at the time — did the bank or sovereign have market access, were there credible alternatives? — as well as whether the banks concerned were put on a path to rehabilitation and whether the cost to the shareholder or taxpayer of the chosen mechanism was reasonably assessed upfront and subsequently risk-managed effectively.
“The system-wide structures measure up pretty well on those metrics, whereas the individual bank support mechanisms are perceived to have produced more mixed results.”