Banks are steadily offloading real estate loans. But could market developments reduce the volume of deals in the short term? Lynn Strongin Dodds reports
Over the past year, UK and European banks have been slowly whittling down their commercial property debt burden. But the current volatile market environment could temporarily halt this activity if the news about the unravelling of the joint venture between private equity company Blackstone and Royal Bank of Scotland (RBS) is anything to go by.
There were reports that the deal struck between Blackstone and RBS might fail because the private equity firm was unable to arrange debt funding from banks, including Goldman Sachs, Citi and HSBC Holdings. It is believed that deteriorating markets conditions have made banks either unwilling or unable to provide loans on anything other than punitive terms. It has since emerged that Blackstone has been in talks with China Investment Corporation sovereign wealth fund about co-investing in the deal.
RBS has reportedly agreed to sell a 25% equity stake in its £1.4bn (€1.61bn) UK commercial real estate loan portfolio to Blackstone, which would inject £100-150m. It would also manage the portfolio while RBS retains a 75% stake in a new vehicle set up to house the portfolio. In the 30 months since announcing its recovery strategy, RBS has reduced its non-core assets to £125bn, less than half of its original size, equivalent to 13% of the group's funded assets.
The joint venture, dubbed Project Isobel, required about 60% of debt funding from third parties. It covered non-core businesses, including other large packages of real estate debt in the US and Germany, as well as €300-400m-worth of less-risky real estate loans in Spain. The main advantages of this type of transaction is that it allows the bank to tap into both the liquidity in the market and the skills of the private equity firm. In addition, any upside in the portfolio can be reaped, while the risk is reduced over time.
The deal's collapse would be a major blow to other property lenders which are looking at similar types of structures on which to offload riskier loans.
"The Blackstone and RBS joint venture was seen as a template other banks were expected to follow, rather than drip-feed smaller portfolios or individual assets onto the market, in light of the scale of de-leveraging required," says Mike Keogh, senior investment and economic analyst of Henderson Global Investors. "This could have a knock-on effect for other deals and for pricing."
However, there has been a flurry of activity in recent months. Lloyds' appointment of JP Morgan to sell property loans with a face value of around £1bn is a sign that the bank is accelerating the unwinding of its £24bn bad-loan book. The sale, which includes loans made at the top of the market on offices, high-street shops and factories, is understood to have attracted interest from pension funds, private equity firms and overseas investors.
Meanwhile, the Bundesbank is looking to dispose of €4bn-worth of Lehman Brothers property loans, while Ireland's National Asset Management Agency (NAMA) appointed advisers to quicken the disposal of its assets and loans. The state-run organisation has spent approximately €30.5bn acquiring loans with a nominal value of €72bn and had only sold €3.3bn-worth of properties by June. In addition, Spanish bank Santander has reportedly put €8bn-worth of property on the block.
However, this is the proverbial drop in the ocean compared with total outstanding loans. In the UK, as of June there was over £350bn of outstanding debt in the commercial property market, and £250bn of that was secured against non-prime property, according Savills, the international real estate adviser.
In Europe, the figure is about €960bn of outstanding commercial real estate. Recent research by consultancy EC Harris showed that over 40% of respondents still hold a high proportion of property assets linked to loans in default. The survey, which canvassed 31 property lenders from 22 banks across Europe, found that post-2012 there will be an increased risk that mature loans in need of refinancing will not be able to access leverage through traditional commercial mortgage-backed securities, leading to a further increase in debt levels.
Matthew Cutts, head of lenders and investors at EC Harris, has identified two emerging groups: "Those that are taking Basel III seriously and have work-out groups that are selling off assets, and those that are not wanting to realise their losses," he says.
"We found that the German banks, for example, were in the first category and have sold properties regardless of market conditions. Other parts of Europe believe in the old saying that if they wait long enough, the value will improve. This is dangerous territory to be in and they should be developing an effective disposal strategy now."
Bill Hughes, managing director at Legal & General Property, does not expect "an avalanche" of transactions, more a steady flow. "Many [transactions] have been completed and will continue to be below the radar screen," he says.
"I think there could be a short-term postponement of banks trying to sell down their positions, because it is currently not a good time to sell, unless they are high-quality assets. They are unlikely to get a price that makes sense, but once things settle down, we will see straight sales as well as joint ventures return to the market."
Michael Brodtman, executive director, valuation, at CBRE, also believes that "banks are making steady progress towards de-leveraging, and are in year three of a 10-year process".
He says: "It is taking time but I think this is appropriate, given the complexities of transactions. Banks do not want to rush into anything and they are looking at different solutions, such as consensual sales or joint ventures, depending on their particular circumstances and requirements."
According to Ronald Dickerman, founder and president of Madison International Realty, a private equity firm specialising in equity partner replacements and balance-sheet restructurings, "today, banks are much more innovative and willing to consider a variety of solutions to offload assets or facilitate restructurings with preferred borrowers".
He adds: "There has been a great deal of market volatility over the past six weeks, which has called into question the reality of a rosy future for rental growth and asset appreciation. This might make [banks] face reality and motivate them to consider non-traditional routes such as friendly equity capital injections."