Where to dump €600bn of unwanted German loans?

A comprehensive report published by Reuters crossed our desk last week, dealing with the extent to which the major German banks are still grappling with their need to shed a massive €637 billion of unwanted assets – including shipping loans and sovereign debt, but including an awful lot of real estate restructurings as well. Reuters describes it soberly as “equivalent to the annual economic output of the Netherlands”.

Among the institutions with the most "non-core" assets are the biggest German casualties of the global financial crisis, led by bailed-out banks Hypo Real Estate, WestLB and Commerzbank. 

The pile of unwanted holdings has ballooned ever since global regulators forced banks to set aside more capital for risky assets, a rule that has forced many to drastically shrink their balance sheets. Assets which could not be sold immediately have been parked in so-called ‘non-core’ banking units, which many observers believe could be around for decades.

This ‘non-core’ banking sector emerged after banks were forced to overhaul their business models in the wake of the crisis. Since then, the battle for slim returns and tighter bank safety rules has forced even healthy players like Deutsche Bank to shed assets which absorb too much balance sheet in relation to the returns sought by investors.

Banks created separate divisions for their toxic and other unwanted assets as a way to draw investor attention to a newly defined 'core' of profitable operations in the hope of rekindling investor interest in a sector plagued by low returns. But these assets are often still part of the same balance sheet, and risk watering down the returns promised by the ‘healthy’ parts of a bank. 

Deutsche Bank alone has parked €97 billion worth of assets in its 'non-core operations unit', while across town in Frankfurt, rival Commerzbank has identified €151 billion worth of assets. 

Most banks initially wanted to shed risky assets via an accelerated portfolio rundown or shrinking the portfolio as quickly as possible either by not renewing loans or by actively selling them off. But this strategy has proved hard to implement, since if banks accelerate their disposals too much they end up selling at firesale prices and having to write their asset valuations down so aggressively that it eats up their capital.

This partly explains why disposals have so far been so limited, despite annual forecasts of a wave of distressed debt portfolios imminently coming down the turnpike. Private equity firm Lone Star and Wells Fargo are in talks to buy a 4 billion pound UK property loans portfolio put up for sale by Commerzbank, for example – a legacy of the massive lending undertaken by now-defunct subsidiary Eurohypo. However, that is just a fraction of its total commercial real estate exposure, as we’ve reported in several recent issues of REFIRE.