Distressed debt: AQR unearths a further €136 billion NPLs in Europe
Stress tests fail to address corporate lending; online platforms might have emerged too late.
One of the most eagerly awaited findings of the European Central Bank’s asset quality review (AQR) was its quantification of the volume of non-performing loans that sit on eurozone bank balance sheets. The potential disposal of these assets by banks across the region has been the trade of the last five years, although it has been a very long time coming.
| In Germany there is
a lot more on the books and off the books than people expect
PwC research showed in March this year that €64 billion of non-core loans were sold in Europe in 2013, with €80 billion of sales forecast for 2014. However, by November sales had reached just €62 billion, and were almost entirely focused on commercial real estate in the UK, Ireland, Spain and Germany.
“There is an incentive for banks that are in capital raising mode to speed up their rate of NPL sales but the pace overall is disappointing outside the UK, Ireland and to some extent Spain,” Andrew Wilkinson, partner at Weil, Gotshal & Manges in London tells Euromoney. “There is nothing like the volume that was predicted.” Wilkinson joined the firm in April from Goldman Sachs, where he headed the European restructuring business.
The AQR found that eurozone NPLs had been under-reported by €135.9 billion, calculating that the 130 banks under review together hold €879.1 billion of such assets. At a recent seminar hosted by Clifford Chance, Stephen Smith, partner at KPMG, claimed that 10% of eurozone banking capital is now tied up in NPLs, putting a huge drag on ROE for lenders. “This represents €100 billion of capital that could support €2 trillion of new lending,” he pointed out.
The slow pace of sales has long been a source of frustration for distressed debt investors but there had been a hope that high profile deals such a Project Octopus (the sale of €4.4 billion performing and non-performing Spanish loans by Commerzbank to JPMorgan and Lone Star earlier this year) could spur the smaller end of the market into action.
“The larger sales prime the market and give you price transparency for the smaller sales,” says Kingsley Greenland, CEO of Boston-based debt trading firm DebtX. “There is a premium paid for scale.”
This year several notable large portfolio sales have taken place. In Ireland the liquidation of Irish Bank Resolution Corporation saw €20 billion of assets sold within a short space of time. One way to speed up the sale of smaller loan portfolios could be via the expansion of online loan trading platforms in Europe. This is the thinking behind German online receivables exchange Debitos’s move into the sale of real estate loan portfolios. The firm was established in 2010 to trade non-performing SME receivables but has now sold a number of real estate NPL portfolios, the largest being €630 million in size.
“We assist the seller with a fully standardized data template. This enables buyers to do fast due diligence, which results in transaction processes for unsecured portfolios that last a maximum of four weeks,” says Debitos managing director Hajo Engelke. “A seller can co-ordinate up to 270 potential buyers much more easily through our platform than if he had to manage the process offline.”
|It is tough for buyers to offer attractive pricing … as the restructuring regimes can be so tortuous
Such platforms have a chequered history in Germany. In 2005 Kredit Börse Deutschland and Warenterminbörse Hannover established RMX Risk Management Exchange in Hannover to trade commodities and loans on one platform. It filed for bankruptcy in 2009. US real estate online auction firm Auction.com subsequently established operations in Germany in late 2012 but pulled out at the beginning of this year.
Engelke is optimistic that the volume of loans now targeted for sale mean that Debitos volumes will grow. “In Germany there is a lot more on the books and off the books than people expect,” he points out. “The huge efficiency gain [with the Debitos platform] is in organizing the investor Q&A and especially the bidding online. All buyers are informed in real time about all bids. It would be almost impossible to argue that this is not the market price.”
While such platforms might benefit from the price transparency that jumbo sales afford they will remain the preserve of the smaller end of the market. “Deals will probably never reach nine figures but we rather do mid-market deals. The highly complex Octopus deal, for example, would be impossible to trade online,” says Engelke.
DebtX has been active in Europe for more than a decade, and Greenland agrees that online platforms will only really aid sales of smaller portfolios. “Trading platforms don’t take away the P&L impact of a loan sale. So it is better to have a platform that allows you to sell in small chunks.”
However, he warns that new trading platforms might find it tough to gain traction. “It is too late to build the technology to catch the distressed debt trading cycle. You have to be there when the cycle starts,” he insists.
NPL sales in Europe have so far been focused on commercial and residential real estate not only because this asset class accounts for such a large percentage of distressed lending but also because corporate loan sales have proved such a challenge.
Wilkinson at Weil, Gotshal warns that the AQR has done little to tackle this problem at the banks. “Corporate lending is the biggest negative contributor to tier one capital ratios,” he says. “The stress tests are not making banks drill into the long-term ability of borrowers to service their debt. Companies can issue a high-yield bond but with current earnings levels, they will have deteriorating covenant quality and leverage levels aren’t coming down.”
The consequent uptick in distress will be much harder for the banks to deal with. “The disposal of distressed corporate loans has been pretty minimal as they need to be restructured,” says Wilkinson. “They don’t fall into the NPL bucket because lenders have lots of flexibility on waivers and extensions and are in forbearance. It is tough for buyers to offer attractive pricing for this category as the restructuring regimes can be so tortuous.”