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ULI Europe Annual Conference Paris 2012: The Only Problems Left Are the Big Ones
from attendees from a broad cross-section of disciplines, including property developers and owners, fund managers, financiers and senior public officials, who convene at the event to debate and explore how the real estate industry faces up to the current economic, political, and business trends.
The restructuring of the European banking sector has progressed significantly since the financial crisis began, but it still has a way to go. With hopes of an early recovery dashed, institutions have become more proactive in dealing with their problem debt and face increasing pressure as loan maturities approach in the next two years. Although loan sales are expected to rise in the coming months, new lending is likely to remain on a strictly conservative basis for some time as most banks have adopted a cautious approach to real estate. This means that liquidity for the European property market will continue to be limited.
The collapse of U.S. bank Bear Stearns in March 2008 heralded the beginning of what was initially dubbed a worldwide credit crunch, but it soon became clear it was far more serious than a liquidity shortage. With the September 2008 fall of Lehman Brothers—an institution so big no one thought it possibly could fail—the consequences of excessive lending were soon being felt across the global banking sector, including Europe.
| In April, Deutsche Bank issued the first publicly marketed CMBS since 2007-a securitization of a £408 million ($639 million) purschase of Chiswick Park in west London in January.|
William Newsom, head of U.K. valuation at property consultancy Savills, insists that the first signs of a downturn in the property market were visible much earlier on, by March 2007, although the Lehman Brothers debacle accelerated the process. “There’s always a preliminary period of denial when people think it’s just a blip,” he says. “The period of denial for banks took them through to the end of 2007. By the start of 2008, it was clear that softening values were for real. Even then, many players sat on their hands for a period hoping things would recover.”
The repercussions of the market crash were severe. Hypo Real Estate, a property lender based in Germany, had to be rescued by its national government, as did the Irish banks. The National Asset Management Agency (NAMA) was established to buy at a discount all the Irish banks’ major property loans.
Next to implode was Iceland’s financial sector, with its two principal banks, Kaupthing and Landsbanki, left to falter. The U.K.’s biggest property lender, the Royal Bank of Scotland (RBS), was partially nationalized, while HBOS was taken over by Lloyds.
As a result of state intervention, many German banks retreated to their home territory, pulling out of European markets they deemed noncore. Likewise, RBS decided to exit certain markets, such as Spain. It sold €400 million ($547 million) of Spanish property loans to U.S.-based private equity firm Perella Weinberg at a significant discount in March.
“From the beginning of 2009, banks have had two and a half years within which to focus on the issues and start addressing them. All the banks I know have spent that period usefully in staffing up,” Newsom says.
Because there had not been a downturn for more than 15 years, “the skills sets for loan workouts were absent. Banks had to staff up and train employees from other parts of the business, so it was slow moving at first,” he continues.
“All the banks have measured the size of the hole they’re in by calling for valuations and for business plans that by and large have come through. Whether a bank has acted on that advice varies from bank to bank,” Newsom says.
Despite different levels of loan default—from technical loan-to-value covenant breaches to nonpayment of interest or amortization —properties remain owned by borrowers, he adds.
Without borrower cooperation and against a background of a potentially costly and time-consuming foreclosure process, and with loan maturities still relatively distant, “extend and pretend” strategies were at one stage widespread. “In many cases, borrowers had lost their equity, but more importantly, when banks first approached them they felt they were in the [driver’s] seat,” Newsom recalls. “Today, we are further on, and borrowers have realized it serves no purpose being hostile. They have realized it’s a partnership between banks and borrowers.”
Banks’ workout teams are now well advanced in wading through legacy loan books, working with borrowers to review their business plans, and evaluating what can be done. “They are pursuing different strategies depending on the quality of the loan, the client, and the property,” explains Natale Giostra, head of U.K. and Europe, Middle East, and Africa debt advisory at CBRE Real Estate Finance. “The three main options are working with the borrower to produce a new business plan, selling the loan, or trying to repossess the asset and then selling the asset and recovering the money.”
The European divisions of the U.S. banks were the first to exit their positions, taking writedowns early on. The European banks, which could not afford to suffer large hits in one go, lagged behind, but are now starting to catch up.
Europe is seeing the beginning of a return of the commercial mortgage-backed securities market, as in the loan for Chiswick Park in West London.
“The real issue for the banks is not how far they have come because the last 20 percent is going to be 80 percent of their headache,” says Marc Mogull, founder of Benson Elliot Capital Management and chair of ULI U.K. “Unsurprisingly, they have dealt first with the situations that are easiest to resolve. You will continue to see them moving toward selling off assets this year, and we continue to stay engaged with the banks, but I don’t think we are going to see a dam break and all of a sudden distressed selling start.”
Although loan sales in Europe are still in the early stages, they are expected to pick up over the next two or three years. The largest transaction to take place so far this year was the sale of £1.4 billion ($2.2 billion) of U.K. property loans by RBS to U.S.-based Blackstone in July.
The deal was not without its glitches, however. The bank had initially tried to sell more than double the amount of loans, at £3 billion ($4.7 billion), but could not attract enough interest at that scale. “Investors struggled because the sorts of buyers that want to buy these assets are private equity houses that need high returns. The only way they can get these high returns is by using leverage, but there’s none available in the market at the moment,” says Conor Downey, finance partner at U.S.-based law firm Paul Hastings.
“Historically, if a bank was selling its own assets, it might have been willing to provide leverage. But at the moment banks are not even willing to do that, so there is a bit of a block in the market.”
The sale of large loan books is common in the United States, where there is a greater trading culture. “It takes much longer here to work out with the bank and for them to get approval for going to the market to sell some loans,” Giostra says.
In addition, in some jurisdictions in Europe, loans are difficult to trade because of liquidity problems. For example, the foreclosure procedure in France, Italy, and Spain is much slower than that in the U.K., so the price that investors are willing to pay tends to be lower given the difficulty in recovering the debt. This means that banks will think twice before selling those loans and will first try to pursue a workout strategy with the borrower. By comparison, “it’s much easier and faster in the U.S. to recover your position because of the legal framework,” according to Giostra.
In Ireland, NAMA is selling assets, but slowly and on a piecemeal basis. There has been a notable lack of large portfolios coming out of NAMA, however. “It is very early days,” says Mogull. “One reason we are seeing little out of Ireland is the upward-only rent reviews issue. Until there is clarity about the potential change in legislation, there aren’t a lot of buyers who will price on a predetermination basis because it could move the whole market down by 20 to 40 percent. This means deals that are going to get cut today have to be done on the assumption that it is going to go the wrong way.” And with more sellers than buyers in the market today, Mogull does not see the Irish banks ready to take that hit yet.
Banks have also restructured the way they do new business. With banks being more cautious about property lending in general, speculative development financing is effectively nonexistent. “Pricing is higher, loan-to-value ratios are lower, and banks have stricter credit approval processes. Overall, there is quite the reverse of the gung-ho attitude that was seen before the downturn,” notes Newsom.
That being said, Europe is seeing the beginning of a return of the commercial mortgage–backed securities (CMBS) market. In April, Deutsche Bank issued the first publicly marketed CMBS since 2007—a securitization of a £302 million ($473 million) commercial real estate loan the bank made to Blackstone for the £408 million ($639 million) purchase of Chiswick Park in west London in January. However, with fewer tranches of debt and backed by just a single asset, the structuring of the deal was a far cry from the complex CMBS of the past.
European banks have come a long way in the past few years, both in terms of working through their legacy positions and their approach to new business. They are becoming more proactive in dealing with problem situations, with loan sales starting to pick up and likely to increase, although there will not be a flood of distressed debt coming to the market. Yet, with a bubble of loan maturities looming in 2012 and 2013, banks still have more challenges to tackle.