After years of much talk and little action, there appears to be some real movement in real estate refinancing and bank deleveraging. Ari Danielsson says the early evidence suggests there is no one-size-fits-all approach
Is there a white knight for European real estate loans refinancing and bank restructuring? Experience of the past three years would tell us that the answer to that question is a loud and clear ‘no'. In fact, banks, regulators and politicians in most European countries have been percieved by most observers as acting rather slowly, cautiously and, unfortunately, inconsistently over this period of time, when much more direct and co-ordinated actions would have been needed, clearly with eyes first and foremost fixed on domestic agendas.
To a certain extent this can be understood. When faced with problems of unprecedented magnitude and complexity, complacency and delayed reactions are often the natural reflexes. Another justifiable reason would be the fact that solving a problem that is itself constantly shifting and changing requires a continuous revaluation of the proper course of action.
Lastly, the sector has undergone a massive power shift in the wake of public sector bailouts; mandates, control and decision-making have been moved from the private sector to the public sector, away from banking executives to politicians, regulators and their newly established asset management units, such as the NAMA in Ireland, FMSA in Germany, Finansiel Stabilitet in Denmark and the Asset Protection Agency (APA) in the UK. Naturally, these entities need time to organise themselves, employ staff, and build infrastructure and processes before they can react efficiently. Some would say three years is enough for that, and the time for some serious action is now.
So just how big is the problem? Or rather, first, what is the problem? Several industry experts have made reasonable attempts to define and quantify the need for refinancing within the European real estate sector. This can be done by looking in detail at aggregate maturity profiles or, more crudely, by looking at the monstrous lending vintages of 2005-07 and assuming an average of five to seven-year terms. Either way, this indicates that more than €100bn of refinancing would be needed annually over the next five years.
With the commercial mortgage-backed securities (CMBS) market in a near flat-lining state and with most banks, particularly state-aided banks, under significant pressure of down-scaling and deleveraging (at least on the property end), it is not easy to see how the banking sector will satisfy this refinancing need. It is easiest to conclude that it would not. The new champions of European real estate finance will be insurance companies and institutional investors channelling their funds to market directly - or via some of the massive debt, mezzanine and equity funds being raised. Every week there is a new story of a fund closing - for example, Pramerica's €500m mezzanine fund closing in June and Blackstone recently reporting $6bn (€4.17bn) raised for its latest multi-billion dollar venture - and that is in just four months.
Other analysts have looked at the non-performing loans of European banks and the provisions they have made in their accounts as an indicator of the size of the problem. This approach is naturally limited to the strictest interpretation of accounting standards that normally look at payment defaults of 30, 60 and 90 days. But this would only reveal possible liquidity problems of borrowers and not solvency or valuation issues. In fact, most lenders have simply chosen to ignore loan-to-value (LTV) covenants, and other so-called ‘soft covenants' for the past three years, and have chosen not to default based on those. This was perfectly understandable at the outset, as this would only have escalated the problems of most borrowers. But at the same time this masks a significant component of the problem when looking at banks' balance sheets.
The truth seems to be that most European banks still have a long stretch to go when it comes to making adequate provisions to reflect the true state of their real estate-related assets and are certainly way behind their US counterparties on this front (according to the likes of Blackstone).
This again has had a chain reaction when it comes to discussions with external investors regarding possibly offloading or refinancing those assets, since in the current situation the banks simply cannot take the additional required losses in their profit and loss account - the short-term pain is simply too great. This - in conjunction with the fact that investors have, until now, set an unrealistically high price on their capital - causes a lack of price convergence, leading to break up in deal flow.
To clarify, the market has moved beyond the vulture mood of late 2008 and early 2009. We are no longer talking about investors wanting to pick up distressed assets from even more distressed owners at the price range of 15-25 cents on the euro. Any sensible investor in today's market realises that those deals are not going to happen. The approach favoured today seems to be in the form of joint ventures between original asset owner (the bank) and a capable asset manager with access to both the skillset needed to maximise asset recovery and the required and correctly priced capital.
How the deal parameters are adjusted depends on the individual situation, but is normally engineered to bridge the different perceptions of price and risk between the buyer and the seller. In most cases, this is greatly influenced by the aforementioned lack of provisioning by the seller, as well as the yield requirement of the investor. The same goes for the actual transaction structures and legal set-up. This is dependent on the jurisdiction of the deal, the priorities of the seller, such as in terms of required asset de-recognition, staff reorganisation and regulatory aspects and, finally, the requirements and mandate of the buyer and its actual funders. In recent months there has been a slight pickup in such deals in the market, as the cases of Apollo and Credit Suisse and Blackstone and RBS demonstrate. It is tempting to conclude this is just the beginning and there is much more to come.
And while the market is generally favouring any type of transaction that leads to bank restructuring, there has been some healthy criticism of this joint-venture approach as well. Market commentators have pointed out that a clean sale is a much more effective way to push banks beyond their current backward-looking state and that the JV approach is simply extending the suffering.
Whether it is elaborate JV structures, clean sales or anything in between, one thing is clear: as European regulators, banks and investors manage their way through the much needed restructuring, one size does not fit all.
Ari Danielsson is managing director at Reviva Capital