The latest issue of consultants Ernst & Young’s annual distressed loan survey attracted our attention for its focus on what it sees as a major shift from the US to the European NPL market – although some cynics might say we’ve been hearing this annually for the last four years, and little of substance has happened yet.
The latest report, entitled Flocking to Europe, sees Europe emerging as a sizeable NPL market in its own right, headed up by Germany as the most interesting market, followed by the UK. Ernst & Young put the volume of NPLs at about €932bn in Europe, or 7.6% of total outstanding loans.
This year’s survey polled investors on both sides of the Atlantic for the first time, with European investors making up a third of respondents asked for their views in January.
More than 30% of distressed debt investors are looking to tap the European market after the US market failed to live up to their expectations, the report says. Most of the investors polled (65.6%) continued to see opportunities in the $164bn (€125.6bn) US distressed debt market, notably in the commercial real estate assets that make up, on average, 26% of assets held by banks with less than $10bn.
But a faster-than-expected decline in banks' non-performing loan portfolios, the decision of some banks to stay out of the market and, in some cases, the inability to agree on price have depleted potential opportunities, the report said. In contrast, 31% of the investors polled will target European banks with NPLs in total worth €€932bn, especially those collateralised by commercial assets in Germany (46%), the UK (39%), Spain (33%) and Ireland (30%).
The report points to new moves afoot by German banks to really begin shrinking the size of their balance sheets, to boost their capital requirements in view of the pending Basel III restrictions. Daniel Mair, a partner at Ernst & Young GmbH Transaction Advisory, said: “German and UK banks have already experienced a fair amount of distress, but clearly investors anticipate more product is waiting in the wings, and these remain highly popular investment markets.”
“In the course of deleveraging, banks have so far held on to their NPLs until investor pricing is more in line with bank carrying values,” he said. “Most banks have set up internal restructuring units to work out or sell NPLs, as well as dispose of non-core parts of their businesses. The gap between NPL bid and ask prices could narrow if the strength of German banks and property markets gives investors confidence to pay higher prices for NPL portfolios.”
A separate forecast by E&Y’s rival PricewaterhouseCoopers in New York says that European banks are expected to sell off an estimated $19.5 billion this year in non-performing commercial real estate loans, which represents a 20% increase compared to the $16.2 billion worth of loan portfolio sales in 2012.
Peter Nicoletti, a managing director in the capital markets group of Jones Lang LaSalle in New York said, in a recent note relating to the two studies, that investors were shifting their attention to new buying opportunities in Europe. “Where we see Europe today is where the US was in 2009. It is in the very early stages of its loan resolution business,” he said.
Behind the larger, highly-experienced US-based private equity groups such as Cerberus, Blackstone, Lone Star and Kennedy Wilson, new mid-sized buyers are now also lining up to target pieces of the market. Nicoletti said, “We see the mid-tier private equity players starting to create partnerships and trying to determine where they want to be in Europe.”
The last few years in Germany and Europe have seen the non-arrival of a long-heralded wave of non-performing loan sales, or at least not to anywhere near the extent envisaged by the NPL clairvoyants. Part of the problem may again be that the wave of demand is met by a lack of supply, with German banks marking only 3% of their loans as ‘non-performing’ – a figure slated to fall to 2.8% this year. For the rest of the eurozone, Ernst &Young predict the figure to rise to a new record high of 7.2%.