EDITOR'S CHOICE: Europe’s 'stress test' underscores North-South divide

The results of the European Central Bank’s Asset Quality Review (AQR) and ‘stress test’ released earlier this week point to a growing North-South divide in Europe.

Of the 130 banks participating in the assessment, 25 failed the stress test and a large part were Southern European lenders including Italy's Monte dei Paschi di Siena, the oldest bank in the world. In fact, Italy suffered the worst count, with nine of the country's 21 banks examined failing the test. Greece's NBG, Hellenic Bank and Eurobank as well as Portugal's Banco Commercial Portugues and Ireland's Permanent TSB were also found undercapitalised.

Interestingly, Spain – one of the most crisis-hit countries – has fared well after completing one of the most far-reaching financial restructurings ever. Germany, Europe's largest market, has seen only one of the 25 major banks fail the test.

The impact of the AQR and stress test will likely be twofold. On the one hand, the results should inject new confidence into northern European lenders about their solvability while boosting their willingness to lend. On the other hand, the countries where several banks failed the test such as Italy will be placed under even greater scrutiny, with the lenders forced to restructure their balance sheets or raise additional capital in order to rectify the situation.

According to Berenberg Bank’s analyst Kai Klose, the completion of the comprehensive assessment 'ends a period of uncertainty for most banks'. 'The good news is that the banks which passed - the great majority after all - can now take a deep breath and hopefully concentrate on their core business of funding the real economy,’ Klose wrote in a note to clients.

GERMAN FINANCING SURPLUS
As German banks resume lending to their southern European counterparts, Germany’s €500 bn financing surplus should partly compensate for Spain’s or Italy’s €200 bn deficits, Klose added. ‘But we expect these processes to be gradual,’ he noted.

Banks that failed the test need to roll up their sleeves and find ways to raise new capital in the next six to nine months. An acceleration of property loan sales is widely expected, now that ‘the true extent of banks’ non-performing loans is out in the open’, agent CBRE said in its response to the publication of the AQR. In total, the recent assessment exposed €136 bn of further non-performing loans, of which about €53 bn securitised against real estate assets, largely commercial property.

'Before the AQR, selling off loan books would have meant admitting that they were not properly valued in the banks' accounts. On the back of this, and ongoing improvements to real estate values, we can expect to see an increase in loan sales over the next year,’ commented Neil Blake, head of EMEA Research at CBRE.

Some of the banks which have failed the stress test have already started to restructure their balance sheets. A case in point is Irish bank Permanent TSB, which has an identified €850 mln capital shortfall according to the ECB. The bailed-out Irish lender has hired Morgan Stanley to sell its commercial real estate and subprime residential mortgage loan books on the back of rebounding Irish commercial property values. The books have a combined face value of about €2.6 bn.

Monte dei Paschi di Siena, which was identified as the single weakest bank and needs to raise €2.11 bn, is believed to have hired Citigroup and UBS to advise on its options. The world’s oldest bank is also in negotiations with the Italian state to postpone the reimbursement of €750 mln of bailout funds. Genoa-based Banca Carige, which has a capital shortfall of €810 mln, said it would seek to raise at least €500 mln by selling new shares.

ITALIAN PROPERTY VALUES LEVEL OFF
Although the recovery in property values seen in Ireland has not been repeated in Italy, values have at least shown signs of levelling off, and Italian lenders might take advantage of this renewed stability. 'Italian banks still look likely to try and sell off some of their non-performing loan books rather than to issue new capital to plug the gap,’ commented Blake. ‘Hitherto, they have tended to only sell off low value unsecured non-performing loan books. Now that the AQR has cleared the air, this looks set to change.'

The signs look promising. Hot on the heels of the AQR’s results, Italy has seen the launch of a first fund investing in non-performing loans owned by local financial institutions. Asset manager Algebris Investments said this week it has raised €370 mln for the fund, which will largely target commercial real estate-backed credit. The targeted return is between 15% and 18% a year.

‘We believe that Italy will become one of Europe’s most dynamic investment markets in terms of NPLs, particularly in light of the results of the AQR and the stress test,’ commented Davide Serra, founder and CEO of Algebris Investments.

A number of assets are already up for grabs. A consortium of US asset manager Fortress and Italian listed property services group Prelios are believed to be in pole position to acquire UniCredit's non-performing loan platform, according to well-informed market sources. The sale involves both UniCredit Management Bank's business operations, as well as a bad loan portfolio worth around €3.4 bn. Sources say the unit is valued at around €700-800 mln.

The two partners had also made a bid for Banco Popolare's bad bank, Release, which was later withdrawn from the market after its owners failed to receive an appropriate offer.

EXCLUSIVE TALKS
Meanwhile, Intesa Sanpaolo is in exclusive talks with US private equity firm Colony Capital and asset manager IdeaFimit to sell a portfolio of 113 assets. According to well-informed market souces, Colony Capital and IdeaFimit have been selected as the winning bidders and are paying €175 mln for the 115,000 m2 package, which includes vacant bank branches and historic office buildings in a number of city centres.

Also in Italy, Deutsche Bank is divesting a portfolio of Italian bank branches to a joint venture of Qatar Investment Authority and asset manager Hines Italia. The Middle Eastern sovereign wealth fund is believed to have emerged ahead of a joint venture of Kennedy Wilson and Prelios as local asset manager as well as a partnership of Colony Capital and asset manager IdeaFimit in the bid to acquire the assets which have a market value of around €134 mln.

The properties, which will be leased back by the German lender under a 12-year rental agreement, are being transferred to a new fund called Italian Banking Fund (IBF), which has already raised €300 mln of equity from the Qataris to invest in banking assets.

In total, Algebris’ Serra said he expects over €40 bn worth of commercial real estate non-performing loans to change hands in Italy over the coming years. ‘We anticipate that a number of Italian lenders will try to accelerate the clean up of their balance sheets,’ he noted.

ITALIAN LOAN SALES
Other market experts remain more cautious. Paolo Bellacosa, CBRE Italy’s MD for capital markets, noted that the success of NPL sales will depend on whether the AQR has forced Italian lenders to take sufficient provisions enabling them to sell the loans without booking new losses. 'In this case we can expect a new "sale season". But at this particular moment at which banks can borrow equity at a conveniently low rate, the main financial institutions will only resort to loan sales if they will not incur further losses,' h√e noted.

To increase the attractiveness of the NPL market, Italy should also address the tricky issue of debt collection, Bellacosa added. ‘A reform to speed up repossession is highly advisable. It should not take years for an investor to take possession of a defaulted asset. These processes need to be fast-tracked and should take just a few months, both to make the sector more attractive for investors and to get better pricing for the banks on the offered loans.'

Virna Asara
Editor Southern Europe