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NPL trading takes off in Germany    
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The market in German non-performing loans is booming as the country’s banks start an aggressive sell-off of their portfolios.Alan McNee reports.

Sales of non-performing loans to foreign investors are becoming more common in Europe. Morgan Stanley, for example, bought a €430m portfolio of problem loans from Italy’s Banca Nazionale del Lavoro (BNL) last year.

However, the main focus in Europe at present is on Germany, where banks such as Dresdner and Hypo Real Estate (HRE) have been restructuring their portfolios and selling them off to foreign investors. The next stage could witness the involvement of the Sparkassen (savings banks) and co-operative banks which make up the bulk of the country’s banking system.


Guy Miller: banks must attempt to maximise their cash returns without destroying the potential to create future cash flow

The legacy of Germany’s post-reunification real estate boom, along with the idiosyncratic structure of the country’s banking system, have left German banks with a huge volume of non-performing assets. Estimates put the notional amount of NPLs in the system as high as €300bn.

Asset-hungry investors

NPL sales by German banks are being driven by a number of factors – among them the emergence of a new, asset-hungry investor community, pressure from shareholders and ratings agencies, and the approach of Basel II implementation, which will make holding higher risk or non-performing assets more expensive.

In the same way that Japanese banks have laboured under similar constraints, the relationship-driven nature of German banking often makes it hard for domestic banks to initiate aggressive workout procedures with borrowers. Guy Miller, head of advisory at Royal Bank of Scotland’s Financial Institutions Group (FIG), says that when a bank has problems with a borrower, it has to attempt to maximise its cash returns without destroying the potential to create future cash flow. “This is a tricky balance to achieve,” he says, “and once the scale of a bad debt gets beyond a certain level, you may not want to do this on your own balance sheet.”

Types of buyers
This leaves the bank with various options, says Mr Miller. It can hold on to the debt; or sell it on to a financial investor, which will buy the loan at a discount to gross book value, but may pay either a discount or premium to net book value, depending on market conditions. Typical buyers would be opportunity funds (such as Cerberus or Lone Star), hedge funds, private equity firms and the proprietary arms of investment banks. Other options might be to sell a part interest in the loan, create a joint venture in it, or perhaps spin the loan portfolio out into a new special purpose vehicle.

Increasingly, German banks are taking the view that selling off their NPLs allows them to focus on new and hopefully more profitable business. HRE, formerly owned by HypoVereinsbank (HVB), last year sold its €3.6bn real estate loan portfolio to Lone Star – a sale which reduced HRE’s NPL portfolio by 75% in a single transaction. HRE’s chairman, Georg Funke, says: “The disposal enabled the bank to concentrate on new business again, whereas an ongoing in-house workout would have tied up resources and management attention for a longer period.”

Dresdner Bank has taken a different approach to its bad loans. Allianz, Dresdner’s parent group, was keen to exit non-strategic business lines, so the bank created an institutional restructuring unit (IRU) into which not only NPLs but also sub-performing loans and other non-core assets (including many non-distressed assets, such as performing loans and private equity investments) could be bundled and sold off.

Dresdner transferred €35bn of exposures to the IRU, and is due to finish selling it off by the end of this year. A deal to sell €2bn of real estate and corporate loans to Merrill Lynch and Lone Star is understood to be near completion.

Horst Clemens, head of the Dresdner IRU’s corporate finance unit, says this sort of NPL divestment was unusual in Germany as recently as two years ago, but has become increasingly accepted. “Regulators support it, since they want the problem out of the banking system. If you sell a loan to a fund, it’s effectively out of the banking system,” he points out.


Horst Clemens: ‘If you sell a loan to a fund, it’s effectively out of the banking system’

A seller’s market
Mr Clemens also notes that, despite the large volume of NPLs on the books of German banks, the country remains a seller’s market when it comes to distressed assets. “The experience of Japan, where some foreign firms were able to pick up distressed assets extremely cheaply, won’t be mirrored in Germany,” he predicts. “This is definitely a seller’s market, with a lot of capital chasing assets.”

Others participants agree that the current terms of trade favour NPL sellers in Germany. “Germany is a seller’s market right now, with a lot of money chasing relatively few opportunities,” says Joachim Koolman, managing director, global distressed products at Deutsche Bank.

Restructuring

The evolution of Mr Koolman’s group reflects the changing way in which investors are approaching German NPLs. Deutsche’s distressed products business used to focus purely on trading distressed assets, buying from German banks and placing them with investors. But over the past 18 months, says Mr Koolman, his group has done more restructuring business. “This typically involves acquiring up to 100% of the bank pool, then working with the company on a financial restructuring.”

Mr Koolman says a grey area is now developing between hedge funds and the private equity world, with investors prepared to spend more time on restructuring businesses rather than focusing on the traditional ‘time is money’ motivation of NPL buyers.

“Traditional PE funds want 100% ownership, whereas hedge funds traditionally don’t mind taking a minority stake and dealing with debt instruments such as loans or convertible bonds. But there is now more overlap between them, so a hedge fund might stay involved for longer – anywhere between six and 24 months – and take part in the restructuring,” he says.

Real estate assets

Most market observers seem to agree that there is scope for further NPL sales. HRE’s former parent, HVB (now merging with Italy’s UniCredit), is understood to be setting up a restructuring unit to deal with real estate loans, and is widely expected to come to the market this year with some of the €14.5bn portfolio of real estate business that it has now written down.

The next market development could be a move from selling loans secured against real estate assets towards selling off non-performing corporate loans. Oliver Kehren, vice-president, European NPL portfolio team at Morgan Stanley, says there has been an emphasis on real estate loans because it is generally easier for banks to part with them and easier for both parties to evaluate their price.

“It’s simpler for both parties to agree on a fair price,” he says. “However, as the gap between book value and market value narrows, we will probably see more activity on corporate loans as well. Basel II and fair value accounting rules will create impetus for this. Basel II doesn’t really differentiate between loans to corporates and loans secured against real estate, and banks will be forced to set aside capital against any risky loan, so there’s going to be a greater incentive for German banks to sell corporate loans.”

Non-collateralised loans

The other important development could be the involvement of co-operative banks and savings banks, or Sparkassen, which have so far been reluctant to sell off their NPLs.

Sankar Krishnan is managing director of restructuring specialists Alvarez & Marsal. He is also acting CEO of German drug store chain Ihr Platz, which was put into restructuring after Deutsche Bank purchased its debt. He says that while most sales so far have been of loans secured against real estate, sales of non-collateralised loans are also starting to pick up. “I’d expect the next move to be towards selling off loans made to specific industry sectors,” he predicts. “The automotive parts industry, for example, is under pressure. This could be one area where we see more activity in the future.”

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