Loan servicing specialists prepare for commercial property shocks

Investors looking to cash in on distressed situations and attractively-priced non-performing loan (NPL) portfolios have so far been largely keeping their powder dry as the pandemic continues to dampen economic activity. Uncertainty and a lack of price visibility have been holding specialists back, along with the enormous level of various government support schemes which have so far held vendors back from having to sell at hefty discounts.

This has led to a plunging level of European NPL sales, well down on the record levels seen in 2018, which saw €162bn of real estate-backed loan sales.

A new report from property adviser CBRE on the European market shows that last year only €40.4bn of secured loan sales were transacted in Europe. The leading markets were Italy and Greece, which sold €15.9bn and €11bn respectively, making up 66% of the market. (Greece has continued strongly into 2021, with €15.7bn sold in Q1 alone.)

The CBRE report highlights how the majority of portfolios sold in 2020 were secured by mixed assets, including single-family homes and land. This growing trend for mixed-use portfolios is in contrast to previous years where commercial real estate was typically the sole collateral.

The CBRE researchers speculate that the volume of NPLs traded could surge as the various government support and stimulus schemes across Europe are wound down, again with Greece and Italy leading the way. Retail, Hospitality and Leisure loan sales will be to the fore as covenants come under pressure while capital values continue to fall, they say.

CBRE's highly experienced global head of loan sales, Clarence Dixon, said: "After a very subdued market in 2020, we began to see the first signs of activity in Q4 and this momentum has carried on into the first quarter of 2021. There is no shortage of dry powder looking to deploy capital into NPL portfolios but the pandemic has created unexpected uncertainty in the market and the vast amount of fiscal stimulus provided by Governments and Central Banks throughout the pandemic has meant the true impacts are yet to be realised. Consequently, we expect to see the sharpest increase in NPLs occurring during 2022 and 2023 as likely covenant defaults begin to trigger distressed loan or asset disposals."

The latest figures from the European Central Bank's Financial Stability Report show a continued deterioration on European property markets, which see prices falling further. At the same time the latest readings from the BF.Quartalsbarometer, which measures sentiment in the German real estate financing industry, saw a noticeable uptick in its recent Q2 survey, albeit still remaining in negative territory. It was nonetheless the second quarterly uptick in a row, a good sign normally.

BF.direkt CEO Francesco Fedele acknowledged the contrast, putting it down to property financiers already looking beyond COVID and to recovery ahead. Another factor may have been the juicier margins they're able to get, the highest for six years - and in the case of developments, even for seven years. Average margins have risen over the past 24 months from 119 bps to 157 bps for existing property and from 203 to 239 on project developments.

Manuel Köppel, CFO at BF.direkt, said that respondents were divided as to how they saw NPLs developing. About half said they didn't see an increase in volume coming, the other half were strongly of the opinion that particularly for hotels, non-food retail, gastronomy and leisure, there was real trouble ahead. "However, the extent of the difficulties is still hard to measure, given that so many state support mechanisms are still clouding the picture. I expect we'll have more clarity in about six months."

A recent survey published by the Bundesvereinigung Kreditankauf und Servicing (BKS), the Federal Association of Loan Purchase and Servicing, said that the NPL portfolios held by commercial property financing institutions in 2020 fell at more lenders (24%) than rose (14%). But ominously, not one bank is expecting falling NPL volumes over the coming year, while 38% expect new trouble. 22% of the BKS respondents said they expected to sell NPL portfolios or hive them off to servicers over the next twelve months, up from 4% last year. 

Additionally, 29% - three times more than last year - expect falling prices for their NPL sales. The risk managers of the surveyed banks said they saw the NPL ratio for commercial property loans rising from 1.7% last year to 2.5% this year, and 3.1% next year.

Again, these are mixed figures, not offering a very clear picture. REFIRE knows from experience that German banks traditionally declare that they are well-prepared for any eventuality, until they're not. Even during and after the financial crisis, many were caught unprepared, with staff or expertise, to deal with the bad loans sitting on their books. For years afterwards, many were loath to outsource the workouts to third parties, re-assigning staff internally to handle work that normally requires very specialised knowledge. However, after a decade-long property boom in Germany, such specialists are now thin on the ground.

In anticipation of this, NPL specialists like Berlin-headquartered CR Investment Management, which is normally among the first to pick up on weakening or distressed situations in firms or sectors, have been beefing up their teams to be in pole position when - as they expect - a sudden wave of insolvencies suddenly get dumped on the market as their temporary support structures get pulled away. 

Torsten Hollstein, CR Investment Management's CEO, said recently he expected to see 'strong shocks' in commercial property, after years in which risk was unrealistically priced into deals. Almost anything was saleable, he said, irrespective of tenant structure, lease duration or other risk factors. Insufficient attention was paid to inherent risk. Now, tenant risk is becoming more crucial than ever, as is active management of the asset, in the absence of automatic price appreciation.

While many of the banks are in much stronger positions than they were ten years ago, with higher levels of equity and stronger covenants, Hollstein pointed to the rash of new debt funds which have entered the market with mezzanine and subordinated lending, and who are more likely to come under immediate pressure. As part of the overdue clean-up process, as Hollstein sees it, their lack of experience and over-optimism will see many of these lenders being forced to sell properties that they have financed at a loss, with a number ultimately disappearing from the market.