Small and medium-sized funds with capital to invest in non and sub performing real estate loan portfolios admit to frustration at a lack of opportunity to buy distressed European property-backed debt, according to a survey published this week by DebtX.
DebtX, the full-service loan sale advisor for debt buyers, said in a proprietary poll of more than 50 firms with €150bn in funds under management found that many investors would be active buyers of distressed European bank debt if the loan sales were structured in smaller pools, or piecemeal loan sales were permitted by deleveraging banks.
Deleveraging through loan portfolio sell-offs remains a source of contention across the industry, with banks arguing that the proportion relative to total reduction in exposure is relatively modest while the attention to this minority strategy is disproportionate.
The vast bulk of deleveraging by Lloyds Banking Group and Royal Bank of Scotland has been through the natural run-off of property loans at maturity and enforcement.
Germany’s ‘bad banks’ – West LB’s Erste Abwicklungsanstalt, Hypo Real Estate’s FMS Wertmanagement and now Eurohypo, soon-to-be-renamed Hypothekenbank – also all prefer the long, unwinding game rather than an abrupt run-off.
Capital erosive swap breakage costs as well as steep discounts required through loan portfolio sales deplete the very tier one capital reserves which banks are desperately trying to build.
These factors combine to ensure bulk sales through loan portfolios will be a minority, rather than dominant, strategy. Regulatory changes, the Eurozone debt crisis or a specific Lehman Brothers-esq shock, however, could prompt some banks to need deleverage quicker.
But the faster approach is the least efficient, and one which perpetuates a “death spiral” in exponentially eroding banks’ capital reserves.
Potentially, selling to smaller and medium-sized funds – such as those surveyed by DebtX – would offer an opportunity to deleverage to investors with a lower cost of capital, than the global private equity giants which have so far dominated the winners’ list of loan portfolio sales.
Because private equity funds target higher internal rates of returns – at 15% and upwards – they need to leverage to make those levels. More modest balance sheet investors often need to hit IRRs of 7% to 8%, removing the need for loan-on-loan financing, and theoretically at least, offers banks the opportunity to sell at a narrower discount.
That’s the theory.
DebtX said: “If Europe’s largest institutions can reduce the size of transactions, more liquidity would exist for European bank debt. European banks could then accelerate their strategic goal of significantly reducing non-performing loans and rebuilding their balance sheets.”
Around 60% of survey respondents indicated that they were seeking to invest in opportunities requiring less than €100m in equity, while 12% of the survey group had the resources to bid on opportunities requiring greater than €250m.
DebtX added: “Smaller funds have become increasingly frustrated. Having raised funds to invest, investors are being barred from participating in the few transactions that occurred in Europe in 2011 and to date in 2012 due to the prohibitive size of the deals.
“For example, the structure of Project Isobel precluded all but the very largest funds from participating. The European distressed market is perceived by some as an ‘invitation-only’ market favoring the very largest private equity funds.”
Survey respondents reflected their disappointment that too little product was coming to market, with the little supply disproportionately favouring the multi-billion-sized funds.