Emerging Europe - the new hunting ground for bad loan investors    
Industry News

By: Marcin Goclowski and Gergely Szakacs

Source: au.news.yahoo.com

WARSAW/BUDAPEST (Reuters) - Central and eastern European countries are turning up the pressure on banks to clean up their balance sheets, creating new opportunities for bad loan investors that are seeing returns dwindle in recovering euro zone economies.

Keen to bolster fragile economic growth, countries such as Hungary, Poland and Romania are following the lead of their western neighbours and urging banks to sell off bad debts so they can lend more to businesses.

n some cases, it's the first time big portfolios of loans have been put up for sale, raising a host of legal challenges for would-be buyers, such as local banking secrecy rules, consumer protection laws, and other regulatory hurdles.

But with one-time high-yielding favourites such as Ireland and Portugal offering lower investment returns as they emerge from sovereign bailouts, and interest rates remaining low across the European Union, buyers are willing to put in the extra leg-work for deals that can yield 25 percent per annum.

"It is not just American distressed funds, but quite a number of potential buyers," said one mergers and acquisitions (M&A) adviser in Hungary, who asked not to be named.

Many EU banks are deep into a drive to clean up their balance sheets ahead of an assessment of their financial health by the European Central Bank, which wants to rebuild confidence in the industry and promote lending to support economic growth.

Data from research firm PwC shows that loan portfolio sales from Ireland, Spain and the UK alone totalled 23 billion euros (19 billion pounds) in the first eight months of 2013, based on the original value of the loans.

By comparison, an "other" group of countries that included those from central and eastern Europe accounted for just 2 billion euros of loan sales.

However, that is starting to change, with Mayank Gupta, a London-based partner at legal firm Mayer Brown who has worked on some of the transactions, saying sales in the region increased in 2013 and were set to rise further this year.

Last week, Volksbank Romania told Reuters it would sell 490 million euros of bad loans, while Robert Hejja, a Hungary-based private equity adviser, told Reuters an unidentified U.S. hedge fund was looking at a $100 million (60 million pounds) deal there.


Central and eastern European economies mostly saw a pick up in growth towards the end of 2013. But a recovery from the financial crisis is far from established and authorities see the high level of non-performing loans on banks' balance sheets as a particular brake on private sector expansion.

Non-performing loans (NPL) in Romania officially make up about 22 percent of total loans, a percentage not too far away from the 30 percent once seen in Greece. Mayer Brown's Gupta said the actual figure could be as high as 40 percent.

In Hungary, bad loans are running at 18 percent of all household debt, while in Latvia they are at almost 10 percent.

"The high NPL ratio continues to pose a risk, and therefore we consider it extremely important that cleaning activity in the banking sector be strengthened," the Hungarian central bank said in its latest financial stability report, in language typical of that being used by authorities across the region.

In Latvia, sales have already begun in earnest, though largely because of the exit of foreign banks such as UniCredit and GE Money and the bankruptcy of Lastvijas Krajbanka. Buyers have included Swedbank, Latvia's Rietumu bank, Norwegian-owned B2Kapital and Dutch-owned Stichting Galaxy Finance.

"We did not wait for five years as some others did, hoping that the situation was not that bad and everything would recover fast enough," Kristaps Zakulis, chairman of the Latvian financial and capital markets commission, told Reuters.

The process can be painful. "The forced situation of the sellers was more dominating in the price," he said. "Some decided to keep (the bad loan portfolios) when they saw that the discount rate was disadvantageous."

Mayer Brown's Gupta said buyers were typically hedge funds or private equity firms seeking an annual rate of return of 15 to 25 percent. That implies getting the loans at a substantial discount, since loans normally return less than 10 percent.

"The perennial problem is that views of the buyer and the seller about the price are always very different," said the Hungarian M&A adviser, pointing to the lack of activity so far.


The rates of return buyers are seeking may sound high, but these deals are not for the faint hearted.

Market sources say would-be buyers are largely funds that have snapped up loans in Spain and other euro zone countries hit hard by the financial crisis. U.S. fund Apollo was mentioned by several, though its New York-based spokesman said it had not done any deals in the region and declined to comment further.

Loans are also being bought by locally-owned debt collecting firms, such as Poland's Best.

"Over the last 3-4 years we were buying loan portfolios from banks worth 1.1-1.2 billion zlotys (218.93-238 million pounds) ) nominally a year," Best CEO Krzysztof Borusowski said. "But this will change, we've submitted an issue prospectus to the KNF (Polish regulator) to be able to sell bonds on the public market."

With the proceeds of the bond issue, and cash it already has, Best wants to buy 20-25 percent of the loan portfolios that Polish banks sell each year. In 2013, portfolios with a nominal value of 9.0-9.5 billion zlotys changed hands.

As well as the usual risks of bad loans never being repaid, would-be buyers must contend with a whole raft of challenges.

"The possibility to vet these portfolios is rather limited due to banking secrecy," said Hungarian private equity adviser Hejja. "Banks would like to sell some of these portfolios but they cannot divulge the data of their clients."

Regulations are sometimes being written almost as the deals are being done, such as consumer protection rules for deals involving portfolios of mortgages. Sometimes, the vehicle set up to buy the loans has to get a banking licence.

Miklos Fekete, a Budapest-based PwC partner, said that while the sale of small packages of mortgages and consumer loans was common in Hungary, several larger deals had fallen though.

"Even a foreign fund needs someone to handle these assets in Hungary and there are relatively few companies who can manage this on such magnitude," he said, adding that regulatory uncertainty was also hampering deals.

Similar challenges exist in some western European markets, but the path has been so well beaten that buyers can have much greater certainty about the outcome.

"It's never going to be as transparent as western Europe," said Mayer Brown's Gupta of central and eastern Europe. But "there's a fair amount of upside if you get it right," he added.

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