It must have been with some relief that UK bank Lloyds finally offloaded a £1.2 billion ($1.9 billion) portfolio of UK corporate loans at the end of the summer.
The pool consisted of between 40 and 50 legacy loans the bank acquired as part of its ill-starred merger with HBOS. The process, dubbed Project Lundy, saw several potential buyers walk away, and the final price at which the assets were sold to Goldman Sachs and private equity firm TPG reportedly ended up at around 50p in the pound.
The UK bank sold another portfolio of UK leveraged loans with a face value of £500 million to another private equity buyer, Bain Capitals credit investment arm Sankaty Advisors, earlier this year. That deal was also priced to sell.
The two quasi-nationalized UK banks, RBS and Lloyds, both of which have declared targets for balance-sheet reduction, have dominated corporate loan portfolio sales in Europe so far this year (see Distressed Debt: European sales 'leave money on the table', Euromoney August 2012).
Lloyds sold £23 billion of non-core assets in the first half of 2012 and RBS had reduced non-core assets to £83 billion by the end of the first quarter, down from £258 billion at the end of 2008.
The Irish banks have also been active in selling off legacy debt: in July, AIB sold a portfolio of leveraged and corporate loans to Bank of America Merrill Lynch.
As recapitalized organizations, the UK and Irish lenders are ahead of the pack, as their capital positions are sufficiently shored up for them to consider taking the hit. Other lenders in the region are still sitting on their hands, happy to value the loan at 100%, so long as interest payments are met.
Many European banks, blindsided by the freeze in US money market liquidity last year, have, however, been shedding US assets with rather more urgency. In June, Wells Fargo announced the purchase of a $6 billion portfolio of loans and funding commitments to US-based private equity and real estate from WestLB. Another German lender, Eurohypo, sold $760 million of US real-estate loans to US Bancorp, Wells Fargo and Blackstone.
Wells Fargo has been aggressively hoovering up US assets from European banks, buying $9.5 billion of oil-and-gas loans from BNP Paribas, and further assets from AIB and Bank of Ireland. Citi paid $1.3 billion for a portfolio of Société Générale-owned shipping loans in June.
Leveraged loans in Europe face a much-anticipated refinancing cliff in 2014, the point at which the glut of collateralized loan obligations that were written between 2005 and 2007 reach the end of their reinvestment periods and become static.
|End of the reinvestment road|
|Loan market refinancing peaks as CLOs turn static|
|Source: BAML; S&P|
The impact of this cliff is unlikely to be as severe as first thought, given that a good chunk of loan-to-bond refinancing has been done, and many managers will extend maturities and amend covenants, hoping for better days.
However, a rump will have to be fundamentally restructured, and this CLO run-off is another source of refinancing pressure. Some expect to see more secondary sales of CLO portfolios and bank-originated leveraged loans.
"A lot of money was raised for distressed secondary sales," says Zak Summerscale, chief investment officer of Babson Capital Europe, which has $140 billion in assets under management globally. "For various reasons that has not happened to the degree that was expected, but there will be sales, and institutions will play an important role."
ICG completed one of the biggest secondary transactions when it bought 1.4 billion of leveraged loans from RBS in August 2010.
"Banks seem to think valuations between 95 and par are right, even though they often have not marked these assets," says Jeff Boswell, head of portfolio management at ICG. "The problem is that a valuation of 85 is an enormous hit."
That hit is taken first in the profit-and-loss account, but will also be reflected in the balance sheet at a time when banks are looking to boost capital. The prices available to the banks might be more toxic than the assets they hold.
|Zak Summerscale, chief investment officer of Babson Capital Europe|
ICG investment director Max Mitchell cites the case of Erste Abwicklungsanstalt, the bad bank established after the sale of WestLB to Helaba.
"Weve talked to them, but it does not seem to be a priority to work the balance sheet aggressively and return money to the taxpayers," says Mitchell.
Babsons Summerscale has had similar experiences. "Weve raised third-party money and said to banks we are ready to look at portfolios," he says. "They are not yet willing to engage in a discussion on performing assets. There are some horrible distressed portfolios out there, but thats not where we see value."
Even if banks do reach the final stage of grief acceptance only a handful of managers look likely to have the depth of credit skill required to evaluate large secondary portfolios. Boswell says that to complete the RBS deal, 2 billion of loans and 125 separate assets were assessed.