European bad banks’ €260bn gross liabilities set to spiral after ECB completes asset quality reviews

Europe’s ten largest bad banks still have €263bn in nominal loans remaining to de-lever of the coming five to 10 years, which is about to be imminently bolstered following the European Central Bank’s asset quality review (AQR) programme.

Cushman & Wakefield Corporate Finance, in the third quarter report of its fascinating Loan Sales Market series, has calculated that European  asset management agencies (AMAs) have completed €96.7bn in de-leveraging, or 27% of inherited exposure since their respective formation.

C&W’s €263bn calculation of European bad banks’ remaining nominal commercial real estate (CRE) loans, residential mortgages and real estate owned (REO) entities is an aggregate of the last publicly disclosed figures.  

Screen shot 2014-10-05 at 21.22.06By implication, the current nominal balances will inevitably be lower.  

However, the outcome of the AQRs next month is expected see the creation of new bad banks in markets which have yet to properly deal with their legacy problems, such as in Italy and Central Eastern European (CEE) markets.

Furthermore, the 131 institutions under review across Europe in the AQRs could even throw up some surprises within banks in Europe’s core markets, such as Germany and France.

In Italy, C&W estimates that there is €38bn in gross real estate exposure currently recognised as non-core and as yet not transferred to a national bad bank.  

C&W argues that Italian banks will be under pressure from the ECB to recognise its problem assets “which in turn may lead to some government intervention in the form of a newly created AMA”.

This €38bn figure, therefore, could rise substantially.  In Italy so far, UniCredit and Intesa Sanpaolo announced in April that they were teaming up with KKR and turnaround specialist Alvarez & Marsal to help manage their non-performing loans (NPLs).  

CEE markets have the furthest still to move to address their legacy real estate, with jurisdictions such as Romania and Bulgaria plagued by inconsistent legal frameworks and uncertain creditor rights.

In Romania, over last 18 months, positive macro news flow – driven by the positive performance of the Romanian stock market and the levels at which sovereign debt is trading – has starting to feed into a re-rating of the risk premium for the country.

As a result, the country is emerging as the forerunner for non-core de-leveraging within the CEE region.  Already, 

Volksbank has traded a €495m non-performing loan portfolio, at the the of July to a consortium comprised of Deutsche Bank, AnaCap Financial Partners, H.I.G. Capital International Advisers and APS Holding.

The Austrian bank still has the more difficult €460m Project Donau NPL  up for sale, but some say the process has stalled.  Nevertheless, Volksbank’s deal have acted as a catalyst for legacy Romanian debt. 

Bank of Cyprus is selling the €545m Project Ariadne, a three-tranche corporate NPL portfolio and Banca Comercială Română (BCR), owned by Erste Group, is selling the €433m Project Saturn NPL.

For ‘core markets’, such as in Germany and France, the AQRs issues are expected relating to the “risk weighting” of assets, that is, banks’ capital buffers which are determined internally according to lending riskiness.  

The variations between the way some of Europe’s largest banks risk-weight their assets has ben found to be considerable, when measured on theoretical portfolios.  

If this risk weighting is streamlined, and banks are required to abandon their own internal risk-weighting modeling, some seemingly well-capitalised banks could look threadbare.  

This, in turn, could trigger both fresh equity raisings, and of course, further de-leveraging of affected banks’ balance sheets.

All the while, private equity investors will be keeping a vigilant eye over developments, eager to take advantage of emerging opportunities.

Federico Montero, head of loan sales, EMEA Corporate Finance at Cushman & Wakefield, said: “Many European banks will be forced to

finally face up to the facts.  If they hold troubled assets, they will be required to reclassify them in the upcoming stress tests which in turn may cause a few capital requirement challenges. 

“With the clear success of the Irish and Spanish AMAs, other European governments may follow suit in setting up AMA to workout the non-core exposures.”

So, what makes up this €263bn in European bad bank debt?

Almost two-thirds of European AMA real estate exposure is held by just two institutions, SAREB and UKAR, with €101bn and €70bn, respectively, the vast majority of which is residential mortgages.

NAMA is the third largest bad bank, with €57.2bn in gross liabilities which dates back to the 2013 year end.  Together the top three account for 86.7% of C&W’s €263bn figure.  

EAA, the West Immo bad bank, comes in fourth with €10.4bn, which is subject to an ongoing sale effort, followed by FMS, the bad bank spun out of the former Hypo Real Estate, and the Netherlands’ Popertize, with €7.4bn.  

Screen shot 2014-10-05 at 21.23.04By geography, across all European bad banks, gross exposures to Spain tops €100bn, followed by the UK, at just under €80bn, with Ireland in third at above €50bn and Germany at around €10bn. 

Despite disposal activity surging in 2014, Spain still holds nearly 40% of the total gross non-core real estate exposure of AMA in Europe, writes C&W.

The report continues: “With SAREB accounting for almost the entirety of this exposure, it will continue to be a key target for opportunistic investors looking to grow their presence in Spain.

“Similarly, although the UK and Ireland have been a hive of activity over the past three years, AMA still have a gross exposure of c. €130bn to these markets.  Once again, this demonstrates the extent of the initial situation the UK and Irish AMA were faced with.

“It is also worth noting that although the AMA have a far greater gross non-core exposure to Spain than to the UK, the net figures show a bigger exposure in the UK.  

“This emphasises that Spain is in an earlier phase of the de-leveraging process than the UK and that the non-core assets are more challenging (including development land) than those in the UK, hence the larger loan provisions applied to the gross amounts.”

Underlying collateral by sector is 51% is secured by residential assets, 31% secured by CRE assets and the remaining 18% by developments and land. 

Bad bank CRE loan portfolio and REO sales to date

Lone Star has been the most prolific winner of bad bank loan portfolio and REO sales, buying €11.8bn, or 33% of all the €35.8bn in net sales since 2012, according to C&W’s report.

C&W’s report stated: “This is of no surprise, since the US private equity firm has been successful several times over the past year in its bids for loan portfolios from the most active seller of “mega-deals”, IBRC.  

“In fact, Lone Star has purchased almost 60% of all CRE loan and REO portfolios from NAMA since it was created.” 

Screen shot 2014-10-05 at 21.24.24The €35.8bn of net sales reflects a blended 62.9% discount on the €96.7bn gross liabilities since 2012.

Cerberus Capital Management comes in second place for net loan and REO acquisitions from AMAs since 2012, with €6.1bn, or 17%, followed by Carval Investors in third, with €3.6bn, or 10%. 

Deutsche Bank is in fourth with €2.5bn, or 7%, with JP Morgan making up the top five with €2.15bn, or 6%.

In the third quarter, €14.5bn worth of transactions closed taking the figure for the year to date to €54.9bn, reflecting a more than 200% increase on the same period last year.

In fact, the total volume of deals completed over the first nine months of 2014 is more than the combined total recorded for 2012 and 2013, according to C&W.

For the full 2014 calendar year, therefore, breaking the €60bn barrier – C&W’s forecast six months ago – now looks inevitable with as much as€30.8bn in live CRE loan and REO transactions.

Among the live sales is Ulster Bank’s sale of its third Irish non-performing real estate loan portfolio, the €1.7bn Project Aran, while the €1.2bn Project Achill is still to complete.

Further ahead, C&W has visibility of an additional pipeline of €24.0bn in planned disposals, 35% of which relate to the UK including a €6.9bn UK residential loan portfolio from Permanent TSB.

“AMA will remain active over the next 10 years, with c. 73% of the total original gross exposure transferred to the AMA still to be addressed, the CRE loan and REO sales market is certain to remain highly active over the next five to 10 years. 

“With over €40bn of de-leveraging expected from the AMA alone in 2015, it is foreseeable that disposal volumes will reach the same levels as 2014.”

Further ahead, C&W Corporate Finance expects that AMA will still have a combined non-core real estate exposure of over €100bn to be worked-out in 2019 onwards.

Frank Nickel, chairman of EMEA Corporate Finance at C&W, said:“Whilst the UK, Spain and Ireland continue to dominate the investment landscape, new geographies are beginning to attract global capital for the first time – a trend that is only set to continue with the ongoing AQRs helping to facilitate the de-leveraging process. 

“However, investors will remain cautious in regards to new markets, with the country’s legal system being a crucial investment factor.”

About CoStar News

Finance Editor, CoStar News
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