News analysis: There will soon be more secondary – but few bulk buys
Recent figures support the notion that banks have embarked on an incremental disposal strategy in recent years. But Shayla Walmsley wonders whether this is actually set to change.
DTZ this week predicted an influx of secondary assets onto the market: lenders in the process of deleveraging would run out of sellable prime and begin to work through their non-prime real estate.
Banks were estimated to be holding close to €1.8trn in commercial real estate debt at the end of 2011, but this figure was significantly different to that of a few years before. These numbers support the notion that banks have embarked on an incremental disposal strategy over the past few years. But is this actually set to change?
"In the UK, you've seen a fair number of consensual sales, with banks putting pressure on borrowers rather than forcing a sale," said Nigel Almond, associate director of forecasting and strategy at DTZ. From now on, he added, they would step up deleveraging and begin to look at mass disposals.
"It's easier to package loans in bulk and get them off the balance sheet," he said. "It's more efficient to get rid of a €500m or €1bn portfolio than to dispose of €10m here and there. More loan packages will be sold, but it depends on the structure of the loans."
Almond contrasted the sale of the Lloyds portfolio - which took from last summer to the end of the year - with RBS, which has taken longer simply because of its more complex structure.
One reason why assets have not been offloaded en masse - and why this might begin to happen now - has been reluctance on the part of lenders to incur swap-breakage costs midway through a loan period. Now that those loans are approaching maturity, breakage fees, which could add significantly to the overall cost, are less of an issue.
That said, there are still a couple of reasons why banks might not give up their remaining assets so easily. First, they have insufficient capital for large-scale transactions. Roger Barris, partner at Peakside Capital, claims already to have seen the rate of disposal accelerate towards the end of 2011, as he forecast it would in IP Real Estate back in September - but in sales of individual assets and small portfolios.
"What you haven't seen is banks taking a $10bn [€7.6bn] portfolio and putting it out to bid," he said. "They're not well enough capitalised to take the hit." With a lack of availability of finance to acquire secondary assets, moreover, there could well be a hit on secondary pricing.
A second reason why banks might not give up assets so easily is that the funding cost for holding them is relatively low. That is a major difference from the early 1990s, when high interest rates made the cost of holding onto assets prohibitive.
Third, banks' previous experience of disposing of assets wholesale has not been a positive one in terms of price. Philip Burns, chief executive at Corestate Capital, says banks are still constrained by the bid-ask spread, which would mean they would have to take write-downs to dispose of assets. Even if secondary portfolios come to market, they are unlikely to appeal to cautious institutional investors still committed to prime assets in core markets.
Justin Metz, head of fund management at Related Companies, which this week announced that it had raised $825m for a fund targeting distressed development and renovation debt, pointed out that his fund effectively makes core from distressed.
"Distressed assets are no less risky, and the strategy is pretty far from core initially," he said. "We're taking unstabilised assets, making them stabilised, then selling them into the core market where the liquidity is - with a discount."
In any case, given the barriers to disposal, according to Barris, banks will be unlikely to act unless regulators force them to. "Banks can carry on indefinitely like this if they have the collusion of central banks and regulators," he said. "No-one wants to tell the truth unless there is pressure to do so from the regulators or the stock market. Right now, everyone's playing the same game."
Holding on to these assets has its cost, of course. Even some non-zombie banks are trading at a discount. But, according to Barris, that will not be enough to compel banks to sell. "Banks will come under pressure to clean up their balance sheets, but it will take 10 years - and in the meantime, who cares," said Barris.
In the meantime, banks are getting tired of listening to demands that they effectively sell at a loss. Better to work with them, said Burns.
Corestate recently acquired a residential portfolio that involved restructuring debt with three existing lenders. "The best debt you can get is the debt you already have," said Burns. "The bank doesn't have to take write-down on day one, and, if a restructured deal with a new owner fails, they get the asset - and probably in a better condition."
He added: "You have to work collaboratively with banks. If they were prepared to write down assets, they would have done it in 2008. They aren't going to leave them to the vulture funds."