2. ii Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
3. iiiFlocking to Europe Ernst & Young 2013 real estate non-performing loan report
Welcome to our fifth NPL investor survey
Only a year or so ago, global investors in distressed loans were primarily focused on the
US. Today, as our latest survey attests, investors increasingly are seeking investments in
Europe’s emerging market for distressed debt. They also continue to look for investment
opportunities in the US. Although the US distressed loan market has slowed, the market
still offers ample investment opportunities, according to investors who participated in our
current survey. In fact, almost 70% expect the US market to remain active over the next 12
to 36 months.
Yet, conflicting signals abound in today’s US non-performing loan (NPL) market.
On the plus side, bank earnings have soared, while loan loss provisions, loan charge-offs,
failed bank closures and the number of problem banks have all declined. The Federal
Deposit Insurance Corporation’s (FDIC) fourth quarter banking data paints a picture of
a stable and steadily improving banking industry. In commercial real estate, the heady
growth enjoyed by certain property types and locations has allowed certain borrowers
to keep their loans current, continue to invest in their properties and take advantage of
refinance opportunities.
However, issues remain. Property values have increased mainly in key US markets for
high quality assets. Elsewhere in the US, values remain depressed and borrowers continue
to struggle. Real Capital Analytics reports that US$164 billion in commercial real estate
mortgages remain distressed. Furthermore, tens of billions in looming maturities are a
constant threat to both borrowers and lenders because depressed property values limit
borrowers’ ability to refinance, increasing the risk of default at maturity.
As for banks, commercial real estate (CRE) loans constitute only 7% of the total assets
of big banks. However, for banks with US$10 billion or less of assets, CRE loans account
for a disproportionate 26% of total assets. These banks will likely focus on reducing the
percentage of CRE loans on their balance sheets through sales and other measures, which
could provide opportunities for investors to acquire loan portfolios or individual loans.
Yet, big global investors with huge pools of capital are starting to look outside the US. It’s
no secret that the US nonperforming loan market has not lived up to the expectation of
these investors. In the meantime, European banks have increasingly begun to reduce their
exposure to NPLs via portfolio sales. Consequently, global NPL investors are turning their
attention to Europe, and for good reason. An estimated €1 trillion of NPLs are sitting on
the balance sheets of the region’s banks, far surpassing the magnitude of distress in the US.
For this year’s report, we have included European-based investors in our survey. Their
consensus is that the markets with the most opportunity are the UK, Ireland, Germany
and Spain. And investors are taking the long view. As one notes, “we believe Europe is in
the early stages of resolving what appears to us as a very large problem with respect to
distressed loans.” For the first time since the global financial crisis and property market
downturn, investors now have opportunities on both sides of the Atlantic.
As always, we would like to thank
the investors who participated
in our survey. We very much
appreciate your perspectives on
the changing market.
Christopher Seyfarth
Partner, Ernst & Young LLP
Howard Roth
Global Real Estate Leader
4. Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Although the US NPL1
market remained active in 2012, there
may have been less investment activity simply because there
were fewer investment opportunities. The FDIC was not as active
in selling loans. The amount of net NPLs in banks’ portfolios has
been declining (see “Distressed loans,” page 6), which suggests
that banks have fewer NPLs to sell, although a substantial
amount remains on their books. Some NPL transactions were
not completed because investors and banks could not agree on
price, and some banks simply stayed out of the market.
Nevertheless, our survey respondents said they expect the
US NPL market to remain active, although for a shorter time
frame than they anticipated a year ago. The US economy
continues its slow but steady growth, commercial property
markets are improving and property values are rising. These
developments should help bridge the pricing gap between sellers
and investors and make conditions more favorable for NPL sales.
Furthermore, banks and servicers of commercial mortgage-
backed securities (CMBS) face a huge increase in loans maturing
over the next few years — and the risk that this might result in
an increase in their NPLs. That risk might motivate banks and
special servicers2
to accelerate sales of their existing NPLs as
well as subperforming loans.
Meanwhile, Europe is emerging as an NPL market in its own
right, with an estimated €1 trillion of NPLs on the balance sheets
of the region’s banks. In addition to local investors, the market
is drawing more investment from international investors, with
NPLs collateralized by commercial properties in Germany, the
UK, Ireland and Spain currently attracting the most interest.
Sales of NPLs could increase in 2013 as sellers take advantage
of the demand and investors grow more confident in the stability
of Europe’s economy and the euro and are therefore more able
to meet sellers’ price expectations. Sales activity is in its very
early stages, however, and banks could be selling NPLs for
some time to come.
In this year’s report, we look at the NPL investment markets
in the United States and Europe and how our survey respondents
view investment opportunities in the two markets. For the first
time, our survey includes European investors, who constituted
nearly a third of respondents. The rest were US investors.
(A summary of the survey results begins on page 19.)
5. 2Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Banks
By many measures, FDIC data shows that banks have returned
to profitability and their balance sheets are strengthening:
2012 earnings increase 19.3% to US$141.3 billion,
the second-highest amount ever
The banks’ 2012 earnings were about US$4 billion less than
the record US$145.2 billion in 2006. The largest contribution
to the increase in 2012 earnings came from reduced provisions
for loan losses, which fell by US$4.9 billion (or nearly 25%)
from 2011.
Fourth quarter 2012
• Profits increase more than a third over Q4 2011
Insured banks and savings institutions earned US$34.7
billion in Q4 2012, a 36.9% increase from Q4 2011 and
the highest fourth-quarter total since 2006. Well over half
of all institutions (60%) reported higher earnings than a
year earlier, and only 14% reported losses, down from 20%
a year earlier. Reduced expenses for loan losses and rising
noninterest income accounted for most of the year-over-year
improvement in earnings.3
United States
• Loan loss reserves decline 25%
Banks’ loan loss reserves were US$15.1 billion in Q4 2012, or
nearly 25% less than the US$20.1 billion in Q4 2011, marking
the 13th consecutive quarter that the industry’s reserves
have declined.
• Net loan charge-offs decline
Banks’ net loan charge-offs (NCOs) also declined in Q4 2012,
to US$18.6 billion, or 27%, from US$25.6 billion a year
earlier, making it the 10th consecutive quarter NCOs have
declined. All major loan categories improved from the prior
year. In real estate construction and development, NCOs
declined by US$1.3 billion, or nearly 63%.
• Bank failures fall
The number of bank failures fell to 51 in 2012 from 92 in
2011.4
The number of failures in 2012 was about a third of
the 157 failures in 2010, which was a nearly 20-year high.
• Number of problem banks declines sharply
The number of banks on the FDIC’s “problem list” declined
in Q4 2012 to 651 from 813 in Q4 2011. This marked the
seventh consecutive quarter that the number of “problem”
banks has fallen, and the first time in three years that fewer
than 700 banks were on the list. Total assets of “problem”
institutions declined to US$233 billion from US$319 billion
a year earlier.
Page 1
Bank earnings 1Q07- 4Q12
Quarterly profits continue to improve
-$40
-$30
-$20
-$10
$0
$10
$20
$30
$40
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12
US$billion
Source: FDIC
Ninth consecutive quarter that industry earnings have ir
Source: FDIC; as of 12/31/2012
4Q2012 net income was the highest fourth quarter total since 2006
Bank earnings 1Q07–4Q12
Quarterly profits continue to improve
6. 3 Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Page 2
Loan loss provisions 1Q07- 4Q12
Expenses for bad loans fall again
$0
$10
$20
$30
$40
$50
$60
$70
$80
US$billion
4Q2012 loan loss provisions declined year-over-year for the
13th consecutive quarter
Source: FDIC; as of 12/31/2012
Page 3
Net loan charge-offs 1Q07- 4Q12
Loan losses improve across most loan categories
$0
$10
$20
$30
$40
$50
$60
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12
US$billion
Quarterly net loan charge-offs drop to lowest amount since 1Q08
Source: FDIC; as of 12/31/2012
Loan loss provisions 1Q07–4Q12
Expenses for bad loans fall again
Net loan charge-offs 1Q07–4Q12
Loan losses improve across most loan categories
7. 4Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Page 4
$0
$50
$100
$150
$200
$250
$300
$350
$400
0
50
100
150
200
250
300
350
400
450
500
550
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Assetsoffailedbanks–US$billion
Failedbankcount
Failed banks
Total assets and failed bank count
Source: FDIC; as of 12/31/2012
The pace of bank failures has declined over the past two years but remains
at recent historically elevated levels
Assets of failed banks
Page 5
“Problem” banks 1Q07- 4Q12
Numbers of “problem” banks and bank failures decline
$0
$50
$100
$150
$200
$250
$300
$350
$400
$450
$500
0
100
200
300
400
500
600
700
800
900
1000
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12
Assetsofproblembanks–US$billion
#ofproblembanks
Source: FDIC; as of 12/31/2012
Number of institutions on the FDIC’s problem list declined
for seventh consecutive quarter
Assets of problem banks
Failed banks
Total assets and failed bank count
“Problem” banks 1Q07–4Q12
Numbers of “problem” banks and bank failures decline
8. 5 Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Risks
US banks turned in a very strong performance in the fourth
quarter of 2012 and for the entire year, continuing a trend
of positive earnings that began nearly three years ago.
However, their problems with non-performing loans are not
behind them — yet.
• Non-current loan balances remain high
Despite a reduction in non-current loans to US$276.8 billion
from US$292.8 billion at the end of the fourth quarter, such
loans are still about 2.5 times higher than when the recession
started in December 2007.
• Nearly half of all banks added to loan loss reserves
While banks’ total loan loss reserves declined by nearly 25%
or US$4.9 billion in Q4 2012, to US$15.1 billion, much of the
reduction was concentrated in the larger banks. Nearly half of
all institutions added to their reserves in the quarter.
• Maturing loans remain an issue
Maturities continue to be problematic for banks and special
servicers. (See “Maturing CMBS loans,” page 8.) The problem
is that many of the banks’ outstanding CRE loans do not
meet their current underwriting standards. For banks, the
challenge is how to best deal with this risk exposure as these
loans mature.
• Number of problem banks declines but is still relatively high
Although 651 problem banks were on the FDIC’s watch list
at the end of 2012, down sharply from 813 a year earlier,
that number was still much higher than in 2006, before the
financial crisis, when there were only 50 problem banks.
• Loan-to-deposit ratios decline
The banking industry’s loan-to-deposits ratio declined in
2012 to 72% from 95% in 2007. Deposits reached a record
US$10.6 trillion at year-end 2012. Since 2008, however,
loans outstanding at US banks and thrifts have declined 5.3%
to US$7.58 trillion (as of early 2013).5
CRE loan exposure
If you compare the amount of CRE loans held by the top 100
US banks with the remaining US banks, you get a relatively
balanced picture. As of September 2012, US banks held US$1.5
trillion of CRE loans, with the top 100 banks holding US$766
billion, or 51%, and the remaining banks 49%, or US$734
billion. Based on both dollar amount and percentages, the two
categories of banks were fairly even.
Compare the CRE loans of these two categories of banks against
their total assets, however, and you get a very different picture.
Of the US$11.3 trillion of total assets of the top 100 banks,
CRE loans accounted for just 7% of the total. By contrast, CRE
loans made up 25% of the nearly US$3 trillion of assets of the
remaining banks.
Table #1: US banks: CRE loan exposure
Banks Total assets CRE loans
% of
balance
sheet
7,190 total banks US$14.5 trillion US$1.5 trillion 10.4%
Top 100 banks US$11.5 trillion US$755 billion 6.6%
Remaining banks US$3.0 trillion US$760 billion 25.3%
Source: FDIC as of 12/31/12
Composition of CRE loans:
top 100 vs. remaining banks
Outside the top 100 banks, the remaining 7,000 or so US
banks are mainly regional and community banks. They hold
construction loans, acquisition and development loans, and
commercial property loans on thousands of small office
buildings, retail centers, apartments and condominiums, and
other commercial real estate nationwide. Individually, these are
small loans, but, in aggregate, they constitute a significant part
of the CRE loan market in the US.
By contrast, the largest banks tend to hold loans on large, high-
profile office towers, regional shopping centers and high-rise
apartments in leading markets in the US and globally. While
many banks, from global institutions to small community banks,
experienced an increase in distressed CRE loans, regional and
smaller banks have been especially affected because of their
greater CRE exposure in relation to their asset size.
9. 6Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Distressed loans
In December 2007, at the onset of the US recession and
financial crisis, distressed loans on the balance sheets of US
banks totaled just US$9.7 billion. Cumulative commercial real
estate NPLs6
held by banks, CMBS investors, and others have
increased ever since, reaching US$354 billion in December
2011 and US$394 billion in December 2012 (the latest month
for which information is available).
Because of banks’ steady progress in resolving NPLs, their net
distressed loans peaked in February 2011 at US$188 billion.
Net NPLs have declined since then; however, as of December
2012, lenders still held US$164 billion of distressed loans.7
2013 bank outlook
After rapid growth in 2012, US bank deposits fell sharply
at the 25 largest US lenders in early January. Some market
analysts said a key reason might have been the end of the
FDIC’s Transaction Account Guarantee (TAG) Program, which
guaranteed non-interest-bearing accounts above the FDIC’s
general US$250,000 limit.8
Whether this is the start of a long-
term decline in deposits remains to be seen.
In December 2012, the banks’ loan activity unexpectedly
jumped as corporate borrowers hurried to close loan
transactions before tax law changes took effect in 2013 as a
result of the fiscal cliff.9
In early 2013, bank lending to businesses surged as large banks
as well as small institutions sought to put their deposit money
to work. Some banks reportedly are easing credit standards
in an effort to beat competitors in originating loans, but the
new business has come at a cost: a decline in loan yields and a
narrowing of loan margins.10
Consolidation
Consolidation in the banking industry could be another driver
of NPL sales. Invictus Consulting Group LLC said in a study that
more than half of the 7,000-plus US banks should undertake
merger and acquisition activity to preserve shareholder value.
Banks across the country are facing increased regulatory capital
requirements, declining net interest margins and increased
competition, leaving many banks with no prospect of organic
growth.11
If consolidation accelerates, more NPL portfolios will
likely come on the market as banks clean up their balance sheets
in preparation for or subsequent to mergers.
Flocking to Europe | 2013 distressed real estate investor surveyPage 25
Additions to distress
$(10)
$(5)
$-
$5
$10
$15
$20
$0
$50
$100
$150
$200
$250
$300
$350
$400
'07 '08 '09 '10 '11 '12
Netchangeindistress(US$b)
Cumulativedistress(US$b)
Net Change in Distress Total Cumulative Distress Net Cumulative DistressNet change in distress Total cumulative distress Net cumulative distress
Total distress
Source: Real Captial Analytics
10. 7 Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
CMBS market rebounds
The delinquency rate of loans that underlie commercial
mortgage-backed securities declined to an 11-month low
in January 2013, according to researcher Trepp LLC.15
The delinquency rate fell to 9.57% in January from 9.7% in
Q4 2012. January’s rate was the lowest since February 2012,
when it was 9.38%.
In 2012, CMBS issuance reached nearly US$48.2 billion.
That was far below the peak of the market in 2007, when US
issuance exceeded US$228 billion. But after almost coming to a
halt in 2008, the market has made a strong comeback. Investor
demand for CMBS bonds has been increasing on the strength
of the recovery in the institutional quality commercial property
markets.16
Indeed, based on CMBS issuances through February
2013, underwriters are on pace to issue US$100 billion in
new bonds for 2013. Based on only two months’ volume, that
number may not be achieved; however, it’s a comforting signal
for borrowers that the CMBS market is on its way back.
Some property owners who once were shut out of credit
markets recently have found that they can obtain commercial
mortgage financing at relatively low interest rates and
increasingly lenient terms via the CMBS market.17
How long
conditions will remain this favorable for borrowers is uncertain.
But, if interest rates should rise, financing costs will increase,
likely limiting the ability of property owners to borrow.
2013 commercial property outlook
Market analysts say the US commercial property market should
continue to recover in 2013, based on the slow but sustained
growth of the US economy and improvement in property
fundamentals. However, to date, that improvement has been
concentrated in US gateway cities, such as New York, Los
Angeles, Chicago and San Francisco. Outside these centers
of commerce, commercial property values have risen only
modestly at best, and some tertiary property markets continue
to languish.
US economy: 2.4% growth consensus forecast
for 2013
The consensus forecast of economists surveyed by The Wall
Street Journal in early February was that the US economy
will grow at a steady but unspectacular 2.4% rate this year. In
2012, the economy grew at a 1.5% rate, the US Commerce
Department reported.12
Unemployment is forecast to drop to
7.4% from 7.8% in 2012.
Vacancy rate expected to decline
In its November 2012 quarterly commercial real estate forecast,
the National Association of Realtors said commercial property
vacancy rates are expected to decline in 2013.13
The office
sector should continue to have the highest vacancy rate and
multifamily the lowest.
Table #2: Commercial real estate vacancy forecast
Sector Q4 2012 Q4 2013
Office 16.7% 15.7%
Industrial 10.1% 9.5%
Retail 10.8% 10.6%
Multifamily 4.0% 3.9%
Source: National Association of Realtors
In another positive sign, Green Street Advisors reported that
institutional quality commercial property values moved steadily
higher in 2012. As of early January, some property sectors in
key national markets were close to their 2007 highs.14
11. 8Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Maturing CMBS loans
While CMBS new loan originations are improving, two issues
continue to loom over the market. One is the persistence of
delinquencies on CMBS legacy loans. The other is a sharp
increase in maturing CMBS loans that will begin in 2015. Until
then, the CMBS loan market will remain relatively stable. More
than US$50 billion in CMBS loans will mature this year and
about the same amount in 2014. In 2015, however, maturing
loans will jump to US$97 billion and, in 2016 and 2017, to more
than US$130 billion. In 2018, they will drop to US$7 billion.18
The spike in maturing loans over the next few years is significant
because some borrowers will not be able to pay off or refinance
their loans and will be at risk of default. Some of these loans
were written in 2007 at the height of a commercial property
boom, and borrowers were able to finance 80% or more of
property values. Today, lenders are financing or refinancing
mortgages at lower percentages of property values, thus
requiring property owners and developers to invest more equity
in their properties. By one estimate, the equity shortfall will
equal about US$100 billion annually for the next three to four
years.19
That is equity some borrowers may not have, and unless
they are able to negotiate loan extensions or refinancings with
lenders, they could be at risk of defaulting — and lenders could
be at risk of adding more NPLs to their portfolios.
2013 NPL sales outlook
Banks began stepping up their NPL sales in 2009, and sales
activity has continued to increase. Information about sales
figures is hard to come by, but it’s estimated that banks’ sales
of non-performing CRE loans totaled at least US$15 billion in
2012, down from approximately US$26 billion in 2011.
While many banks and CMBS special servicers have been active
sellers of NPLs, some have foregone sales. Part of the reason
may be that they have been waiting for the US economy to
recover more fully and property markets to rebound. Also,
they may not have been willing to sell loans at the discounts
necessary to attract investors. Even if they were to sell, banks
do not want to incur losses that would reduce their profits and
erode their capital, and special servicers do not want to reduce
distributions to CMBS investors.
More reason to sell in 2013?
Those banks and CMBS special servicers that so far have
refrained from selling NPLs may have more reason to do so in
2013. If the US economy continues its slow-but-steady growth
and the US unemployment rate continues to decline, there
might be a modest increase in demand for space in commercial
properties this year. Commercial property values are recovering,
and vacancy rates are declining, although vacancies remain at
high levels except for multifamily properties. “U.S. banks holding
large levels of non-performing assets (NPAs) on their balance
sheets are likely to pursue more bulk sales of distressed loans
this year and next,” according to Fitch Ratings.20
It said that if
market liquidity and asset pricing continue to improve in 2013,
many smaller institutions with large residual NPA balances will be
better positioned to use bulk sales to strengthen balance sheets.
12. Donald Sheets is a senior principal in the New York office
of Square Mile Capital Management (SMCM), a real estate
private equity fund with US$1.9 billion in assets under
management (AUM).
At SMCM, Sheets structures and negotiates nontraditional
commercial real estate investment opportunities, including
distressed debt, discounted performing commercial mortgages,
preferred equity, mezzanine financing and real estate enterprise
liquidations. He has more than 13 years of property acquisition,
turnaround, asset management and restructuring experience
across a variety of capital structures, asset types
and geographies.
Sheets is an adjunct assistant professor of real estate
development in Columbia University’s Graduate School of
Architecture, Planning and Preservation.
Could you provide an overview of SMCM? We’re an
opportunity fund focused on special situations investing. As
a result, we’re active in acquiring and resolving performing,
subperforming and non-performing commercial mortgage loans,
with a focus on the US market. We’re also pioneering on the
financing front. We’ve created unique structures, for example,
with respect to the securitization of pools of performing and
non-performing debt. In 2012, we brought to market one of
the first liquidating trusts that had been done in years, and we
completed another one at year-end.
On the acquisition side, is SMCM primarily focused on
commercial mortgage loans — performing, subperforming,
non-performing? Yes, but we have a mandate for other
business as well. We’re active in providing capital for consensual
recapitalizations alongside capable but over-levered borrowers
to effectuate DPOs (discounted payoffs) with existing lenders. In
these situations, we effectively are recapitalizing the equity side
rather than the debt side. We also are actively originating new
mezzanine financing via a separate account that we manage on
behalf of a large insurance company’s real estate subsidiary.
What returns are you looking for? About three-fourths of
the loans we buy are performing and subperforming, and the
remainder are NPLs. Our return criteria are different than those
of a buyer that invests mostly in NPLs or those investors with a
predicated “loan to own” strategy. We generally look for returns
in the low to mid teens on unlevered transactions, and levered
returns in the mid to upper teens.
Do you have a sense of what the volume of US NPL sales was
in 2012? I would say around US$40 billion, which would include
performing and subperforming loans as well. In 2011, there
may have been around US$50 billion in sales. But it’s a difficult
number to pinpoint.
What’s the outlook for US NPL sales in 2013? From our view
of the debt pipeline, 2012 had less volume than 2011. But
2011 sales were magnified by the Anglo Irish, Bank of Ireland
and Allied Irish Bank sales of their commercial real estate loan
portfolios. If you strip Irish portfolio sales away, then 2012 was
about as busy as 2011. As for 2013, I look for it to be about as
active as 2012.
Who will be selling this year? The caliber of sellers is
transitioning a bit. The FDIC clearly is not as active as it was. It
may do a structured sale or two specifically aimed at smaller
investors or it will securitize small balance claims. The agency
completed a couple of securitizations in 2011 and 2012. I
wouldn’t be surprised if it uses that mechanism going forward
versus the structured sale format. I don’t see them as that active
of a contributor in 2013, primarily because the number of failing
banks is decelerating.
What about special servicers? Special servicers for NPLs
certainly will remain active, and that activity should increase
in 2013. Unfortunately, those sales of claims probably will be
through the online auction process, which most institutional
investors do not participate in.
So special servicers will put assets up for auction on a one-
off basis? Yes, small balances — anything between US$1 million
and US$10 million — tend to be placed into an online auction site.
It’s distorting in terms of knowing what’s actually trading and at
what price levels.
Interview with Donald Sheets, Square Mile Capital Management
9 Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
13. And there will also be negotiated sales by banks in 2013?
Yes, there will be negotiated transactions through traditional
channels. Market participants also are talking about loss-share
agreements maturing.21
Beginning probably in the second half
of 2013, and continuing through 2016, buyers of failed banks
acquired from the FDIC under loss-share agreements will resolve
or liquidate in bulk non-performing assets. Any assets that the
banks aren’t able to resolve before the end of their five-year
window for loss recovery will probably go back on the market.
That five-year period generally started between 2008 and 2011.
This suggests that there could be an increase this year and over
the next few years in sales driven by these loss-share agreements.
Who else will be selling NPLs in 2013? Other sellers will
include well-capitalized money center banks that have extended
or modified loans on at least one or more occasions. They
will look for liquidity by selling loans, which generally will be
subperforming loans rather than non-performing. These loans
may be a bit over-levered and likely have been previously
restructured. These banks have sufficiently marked down most
of their loan books and now have the earnings to absorb losses
from selling them. In addition, some European banks that still
hold portfolios of US commercial mortgages might continue to
bring these portfolios to market in 2013.
How are buyers financing deals? Leverage terms have
continued to evolve. I would say that there are five or six
credible financing sources in the market. In addition, as of 2012,
there is also the public market, in the form of liquidating trusts.
In leveraged transactions, the advance rate has increased and
the coupon has decreased. That makes the cost of capital more
efficient to bridge the bid/ask spread in the marketplace.
There have been just a few big transactions by US banks
and foreign banks, but we really haven’t seen many sizable
transactions. Is that what you’re seeing? We expect
continued portfolio sales in 2013. But I also believe that we’ll
see one-off sales of large single loans backed by multiple
assets. Examples will include a credit facility secured by seven
or eight assets, or a single loan to a company that is secured by
the company’s assets, which might include real estate. Some
portfolios of participations also could come to market this year.
Sellers will include banks that are in various credits but do
not have full control rights and are looking for liquidity or are
winding down legacy loan books.
How do you identify opportunities and set up your pipeline?
It’s a mix. In this market, some sellers have to use a transparent
process, so we see product coming through the advisory
channel. But that doesn’t necessarily mean a lot of qualified
bidders show up. Only two or three credible bids may be made
that can close. So there are auctions — either broad auctions or
limited auctions. Then there are the bespoke transactions that
usually are one-off. Over the years, I’ve built relationships with
several banks, and if they have something to trade quietly and
swiftly, usually in the form of a one-off credit or two, we can
usually do a direct negotiation with the seller.
Any preferences on loan type and deal size? We’re agnostic on
geography, asset class and loan performance status. We typically
invest at least US$15 million in a single transaction, and we have
acquired portfolios in excess of US$600 million in outstanding
principal balance.
Do you see opportunities in Europe? We presently are
exploring opportunities in Europe, which is in the early stages of
NPL portfolio sales. To use a baseball analogy, the fans are just
taking their seats. Once there’s a mandate from the European
Central Bank for banks to start winding down their NPL
portfolios, there will be more product coming out of banks, but
I don’t know what they will look like since we are just beginning
to investigate the marketplace. Which loans will come out of
banks first? Better quality? Worse quality? Small balance? It
remains fluid.
How does that baseball analogy apply to the US
NPL market? I would say the US NPL market is in the fourth
or fifth inning in terms of sales activity. Some people are
moving away from buying mortgages and instead are migrating
toward acquiring properties directly. Therefore, the market for
secondary commercial mortgage debt is a little less crowded
today, which makes us happy.
Flocking to Europe Ernst & Young 2013 real estate non-performing loan report 10
14. 11 Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Europe’s market for non-performing loans is growing. Estimates
vary, but the market could be as big as €1 trillion to €1.5 trillion.
“By far, Europe represents the biggest opportunity worldwide,”
said Lee Millstein, Head of European and Asian Distressed and
Real Estate Investments at Cerberus Capital Management. (An
interview with Millstein appears on page 15.)
The opportunities in Europe have commanded the attention
of global investors. “Europe will attract more investment from
investors worldwide, and the pipeline will grow over the next few
years,” said David Abrams. He is Senior Portfolio Manager of
Non-performing Loans at Apollo Management International and
Managing Partner and Co-Founder of Apollo European Principal
Finance Fund. (An interview with Abrams appears on page 23.)
Investor interest isn’t limited to non-performing real estate
loans. European real estate generally is attracting more
investment, particularly from US investors.22
In December
2012, the German Government agreed to sell TLG Immobilien,
a company that owns stores, offices, warehouses and hotels in
the country’s eastern states, to Lone Star Funds for €1.1 billion,
including debt.23
Compared with a year ago, investors today see the Eurozone’s
future as more secure. Central Bank policies have reduced the
immediate risk of a Eurozone breakup, while progress has been
made toward a banking union that would put the euro on a
stronger long-term footing.24
Sale and refinancing targets
Morgan Stanley estimates that Europe’s banks need to sell
or refinance €700 billion of NPLs to meet regulatory capital
requirements, deleverage their balance sheets and achieve
other goals. As of January 2013, banks had sold or refinanced
NPLs equal to 20% to 25% of that target.25
Since the financial crisis, about half of the reductions to banks’
loan books has come from borrowers repaying debts, according
to Morgan Stanley. Roughly 20% has come from debt sales, and
another 25% has come from writing down debt. The balance has
come from asset repossessions, primarily in Spain.
Until now, the leading international buyers of Europe’s distressed
loans have been US-based private equity firms. Such is the
demand for NPLs, however, that other investors have entered
the market, including smaller private equity firms, sovereign
wealth funds, wealthy individuals, family offices and US real
estate investment trusts (REITs). In some cases, these investors
have offered higher prices than the big firms. Some banks are
starting to sell individual assets or small portfolios to these
investors while continuing to do large portfolio transactions with
the biggest investors.26
Europe
More investor interest
At an Ernst & Young real estate workshop held in January 2013
in London, we surveyed workshop participants on the outlook
for real estate NPL investment in Europe this year.27
About
three-fourths of those responding to the workshop survey said
they expect deal flow to increase in 2013. As for their own
plans, about 85% said they are in a “buying mode.” Among
European countries, the UK will be the most active market for
investment, according to two-thirds of respondents: about 22%
said Spain and 11% Ireland.
Another sign of interest in Europe’s NPL market comes from
the survey of real estate NPL investors for this report. (Nearly
a third of the survey respondents are based in Europe and the
rest in the US.) Of all of the respondents, a third said Europe
will be their primary focus for NPLs over the next 12 months.
The respondents focused on Europe are primarily interested
in investment opportunities in Germany, the United Kingdom,
Ireland and Spain. (See responses to Question 5 of the survey
on page 25 of this report.) More than half of the respondents
said the European market will remain active for the next 36
to 48 months.
European banks: more exposure to
commercial property lending
NPLs secured by commercial real estate are a primary target of
investors, because European banks are prominent commercial
property lenders, among other reasons. In Europe, about
three-fourths of outstanding commercial mortgage debt is
held by banks versus CMBS or insurance companies or other
institutions. By comparison, in the US, banks account for about
55% of commercial mortgage debt.28
Furthermore, Europe’s
CMBS market is relatively small compared with the US market
because European banks generally keep loans on their balance
sheets rather than securitizing them, so European banks have
more exposure to the risks of commercial real estate lending —
including the risk of some performing property loans becoming
non-performing. Moody’s said in a January 2013 report that
many European banks, particularly those in Spain, Italy, Ireland
and the UK, require material amounts of additional provisions
to fully clean up their balance sheets.29
It did not say how much
money would be needed.
15. 12Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Table #3: European banking snapshot30
2012 2013* 2014*
Total assets (€bn) 33,631 33,200 33,928
Total loans (€bn) 12,264 12,132 12,487
Business and corporate
loans (€bn)
4,619 4,628 4,821
Consumer credit (€bn) 604 597 606
Residential mortgage loans (€bn) 3,791 3,767 3,827
NPLs as % of total gross loans 6.8 7.6 5.6
Deposits (% year) 0.9 3.2 4.1
Loans/deposits
(% increase from prior year)
111 106 105
Total operating income (€bn) 632 651 706
*Source: Ernst & Young Eurozone Forecast
NPLs expected to peak in 2013
In the Eurozone, total NPLs (including real estate) as a
percentage of banks’ total loans increased from 5.6% in
2011 to 6.8% in 2012. This year, the Eurozone’s economy is
expected to contract slightly, and, based on Oxford Economics
research, NPLs will reach a euro-era high of €932 billion,
amounting to 7.6% of total loans of €12.2 trillion, according to
an Ernst & Young report.31
As economic conditions improve in
2014, NPLs are expected to drop to 5.6% of €12.5 trillion of
outstanding loans, or the same percentage as in 2011. However,
the Eurozone’s growth is expected to be modest, averaging
about 1.3% annually for the rest of this decade.32
To sell or not to sell
The expected increase in NPLs in 2013, as well as regulatory
requirements and banks’ increased focus on profitability, could
motivate banks to unload more of their bad loans. In addition,
banks will continue to focus on strengthening their balance
sheets and cutting costs in 2013,33
and they will try to sell
NPLs as part of the process of deleveraging and improving
their financial position. Finally, as we noted in a 2011 report on
Europe’s NPL market, some banks are changing to a stronger,
more sustainable and more competitive business model, one
that balances the need for profit against an appropriate level of
risk.34
This gives them another reason to sell NPLs.
Alternatives to selling
As an alternative to selling NPLs, banks could restructure
some of their loans — and some banks have done so. But
the restructuring process is often complicated, ties up bank
resources and is time consuming. Selling can offer a more
efficient, faster solution. As another alternative to selling, banks
have shored up balance sheets and increased capital reserves,
for example, by issuing shares or converting lower-quality
capital to common equity.35
But that still leaves them with the
problem of what to do with their NPLs.
The bad bank option
One solution currently in favor by some countries is to establish
a government-sponsored bad bank, where the troubled financial
institutions contribute their NPLs and other troubled loans to
the bad bank, thus cleansing their balance sheet of these loans
and freeing the bank from the distraction, costs and use of
resources inherent in managing a portfolio of troubled loans. Of
course, this strategy does little to reduce the overall exposure
to NPLs at the country level, since they still exist in the system,
albeit not at the banking level. Nevertheless, the strategy
has merit. Rather than individual banks implementing many
different strategies to resolve their NPL problems, the bad bank
can plan and execute an orderly disposition of the NPLs received
from multiple banks, whether at auction or through direct
negotiations or other strategy.
Holding NPLs
Against the reasons to sell, banks also have reasons to keep
NPLs on their balance sheets. In selling, banks would likely have
to recognize losses that would reduce their capital and cut their
profits. Undercapitalized banks with thin profit margins might
not be able to absorb such losses.
The European Central Bank’s (ECB) program to provide cheap
financing to some of the region’s largest banks has reduced the
pressure on these banks to sell bad loans. While the ECB’s moves
were designed to prevent a credit crisis and further weakening
of the European economy, market analysts are concerned that
banks will leave capital tied up in non-performing loans and
assets in a process known as “pretend and extend.” This could
leave some banks unable to provide enough credit to meet the
ordinary needs of companies, businesses and other borrowers.36
In January 2013, the Basel Committee on banking supervision
confirmed that it had given lenders four more years to put in
place the new liquidity coverage ratio (LCR). In 2015, banks
must have only 60% of the LCR in place instead of the original
100%. They will have four more years, or until 2019, to meet
the 100% requirement.37
The purpose of the rule change is to
16. 13 Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
ensure that banks have enough liquid assets to meet a short-
term market crisis. It could also give banks more time to work
out, restructure or sell their NPLs rather than taking more
immediate action.
Pricing issues
Pricing issues are keeping some banks from selling NPLs. Banks,
of course, try to secure the highest possible prices in order to
maximize their recovery and minimize their losses from NPL
sales. But some investors say banks have overpriced assets
given the current weakness in Europe’s economy, the general
level of commercial property values, and the risks and costs
to investors in performing due diligence and repositioning the
underlying collateral for restructuring and future sale. Another
challenge for investors lies in dealing with different legal
systems in countries where they invest. Nevertheless, deals are
getting done, but with a wide range in pricing. In the UK and
Ireland, NPLs sold last year for 20% to as much as 90% below
outstanding claim amount.
NPL sales activity picking up
So far, some of the largest sales of distressed loans have been
by banks in the UK and Ireland. Among other reasons, investors
have focused on these countries because of the relative ease in
getting to the underlying collateral, unlike some other countries
where, for example, foreclosures take a longer time period
to complete.38
This year, NPL sales activity is picking up as European banks
focus on deleveraging their balance sheets. In addition to selling
portfolios of NPLs only, some banks are retrenching and selling
so-called non-core portfolios consisting of a mix of performing,
subperforming and non-performing loans collateralized by
properties that typically are in regions outside the bank’s core
operating geography. Banks also are selling loans on single
properties, which could help to attract investors that might not
bid on large portfolios.
NPL markets
Germany
Germany developed into a mature NPL market during the 2003
to 2007 period, before the global recession and financial crisis
hit. Today, it has the necessary legal framework and advisor and
servicer network to attract international investors and support a
high volume of NPL transactions. However, while a small number
of larger NPL transactions were completed during the past two
years, overall market activity has so far remained unexpectedly
low considering the amount of NPLs on the books of Germany’s
banks. At the end of 2012, German banks held an estimated
€200 billion of NPLs. This year, because of increased NPL sales
activity and an improving Eurozone economy, the banks’ NPLs
are expected to decline to €183 billion in 2013, according to
the 2012–13 winter edition of the Ernst & Young Eurozone
Forecast.39
But that would still leave a significant amount of
NPLs weighing down the German banking system.
Banks have been reluctant to sell NPLs partly because of the
uncertainty created by the global financial crisis and Eurozone
crisis of recent years. Furthermore, almost all German private
banks and Landesbanken have been forced to deleverage and
shrink their balance sheets to reach or maintain Basel III core
capital ratios. In the course of deleveraging, banks have so far
held on to their NPLs until investor pricing is more in line with
bank carrying values.
While banks have refrained from selling NPLs, they have
been working on improving their core capital ratios, gradually
adjusting their loan book values to reflect investor pricing,
and restoring or maintaining profitability. Most banks have
set up internal restructuring units to work out or sell NPLs
as well as dispose of non-core parts of their businesses. In
addition, two German bad banks have been incorporated (FMS
Wertmanagement and EAA). They hold assets transferred from
Hypo Real Estate (FMS) and WestLB (EAA) to resolve large
pools of non-core and non-performing assets over a 15- to
20-year period. Their strategy so far has been more focused on
resolution solutions other than sales, although the bad banks
are expected to become more active in selling non-core and non-
performing assets in the years to come.
In 2013, conditions could be more favorable for the sale
of NPLs. The support of the European Central Bank for the
Eurozone has calmed financial markets. Most banks are in
the process of completing strategic realignments, while using
the cheap liquidity provided by the central bank to improve
profitability and core capital ratios. The value of the real estate
collateralizing NPLs is increasing on the overall strength of
German property markets. Germany is attracting more property
investment from international and domestic investors seeking
higher yields and a safe haven. The gap between NPL bid and
ask prices could narrow if the strength of German banks and
property markets gives investors confidence to pay higher prices
for NPL portfolios.
In February 2013, Lloyds Bank of the UK sold the first sizable
portfolio of non-performing loans secured by German retail real
estate collateral. This transaction, with a face value of €850
million, drew a number of global investors who competed to
secure the deal. While too soon to tell, this deal may come to be
the icebreaker transaction that will motivate a large number of
German banks to test the market for NPL sales.
17. 14Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
UK and Ireland
In 2011, an NPL market began to take shape in the UK and
Ireland. While there has not been the wave of transactions that
some market analysts anticipated, nine transactions totaling
more than €8 billion were completed between July 2011 and
September 2012,40
and more have been completed since then.
In January 2013, Fitch Ratings said in a report that major
UK banks are generally soundly capitalized, but they need
to continue deleveraging and restructuring to meet Basel
III targets. It took note of banks’ risk exposure to soured
commercial real estate loans, saying many may need to be
renegotiated or sold in the near future.41
Ireland’s property markets are showing signs of recovering.
Property prices are expected to bottom out in 2013. Ireland’s
state-owned banks reportedly are speeding up the sale of tens
of billions of euros’ worth of property-backed loans.42
In a move
to help prop up the banking industry and to facilitate the orderly
disposition of troubled loans, Ireland created a bad bank known
as the National Asset Management Agency (NAMA) in 2009.
The agency has acquired €74 billion of loans from participating
financial institutions. As of year-end 2012 it had disposed of
€6.9 billion in assets.43
In early February 2013, the European Central Bank cleared a
plan for Ireland to liquidate the former Anglo Irish Bank now
known as IBRC. Under the plan, the debt taken on by the Irish
Government to finance Anglo Irish’s rescue will be swapped for
long-term government bonds.44
The government initiated the
liquidation to reduce the burden of €31b in promissory notes,
a form of an “IOU” given to IBRC to allow it to borrow from the
Central Bank of Ireland.45
Domestic as well as international banks are selling real estate
loan portfolios, including portfolios of distressed property loans.
In November 2012, Apollo Global Management reportedly
paid £149 million to buy a portfolio of distressed commercial
property loans in Ireland from Lloyds Banking Group. Lloyds
has taken an aggressive approach to unwinding a reported
£24 billion of non-performing property loans; in the first nine
months of 2012 it reduced its real estate exposure by a reported
£4.1 billion.46
Spain
While currently not attracting as much interest from NPL
investors as other countries, Spain could become one of the
most active NPL markets. With Spain’s economy expected to
remain in recession throughout 2013, it is likely that NPLs
will continue to climb.47
Today, Spain has one of the largest
exposures to NPLs, with about €190 billion in troubled loans.
Yet transactions have been limited. However, recent regulatory
reforms have had the effect of enabling NPL transactions at
lower prices, and bid and ask spreads are narrowing, helping
to enable sales. Also helping sales are deal structures in which
banks share the risks with buyers in resolving the loans, such as
through workouts and restructures.
Spain’s Government has created SAREB, a bad bank designed
to acquire NPLs from the country’s banks. With SAREB in the
start-up stage, it’s too early to know its impact on the country’s
NPL problem. But expectations are high, and opportunities for
investors will likely follow. SAREB has begun the process
of buying up to €90 billion of NPLs and other assets from
banks. SAREB plans to sell the assets to investors over a long-
term period.
18. Lee Millstein is Head of European and Asian Distressed and Real
Estate Investments and Senior Managing Director of Cerberus
Capital Management.
In an interview, Millstein discussed opportunities to invest in
NPLs in Europe, the investment outlook in Europe and how the
European NPL market compares with the US market.
How do opportunities to invest in NPLs in Europe compare
with the rest of the world? Right now, Europe represents the
biggest NPL opportunity worldwide. In my view, European
NPLs are one of the best investment opportunities of any
asset class globally.
Why? That assessment is based on the significant size of
Europe’s banking system compared with the European
economy, the shortage of capital in the banking system,
the size of the NPL market, the state of the European
economy and other criteria.
What’s the size of the European NPL market? Between €3
trillion and €3.5 trillion of total non-core assets, including over
€1 trillion of NPLs. If you assume these numbers, and compare
it with NPL sales to date, sales activity has been moderate. But
there are numerous signs that it is picking up rapidly.
How did you arrive at the more than €1 trillion figure? It’s
derived from a country-by-country analysis of the NPL market.
It’s based on information that’s publicly available, talking with
people in the market, our long experience in this market and
other sources. If anything, that estimate might be understated.
What’s this year’s outlook for NPL sales in Europe? Sales in
2012 were probably 40% higher than in 2011. Looking ahead,
2013 is shaping up to be bigger yet.
What’s the basis for your outlook? It’s based on NPLs in the
pipeline, deals under discussion, deals that have already been
awarded in the first few weeks of 2013, in-depth discussions
directly with selling banks, as well as advisors and others. Like
any great opportunity, the European NPL pipeline isn’t growing
as big as investors likely prefer today, but it is moving in the
right direction. Banks and regulators realize that NPL deals are
the only solutions that work for everyone.
Are you focused on investment opportunities in particular
countries in Europe? There are five countries where we are
examining opportunities very closely: Germany, UK, Ireland,
Spain and Italy. Our primary focus has been on the UK and
Germany, and will likely remain so for the next 12 months,
based on the deals we’ve done, our deal pipeline and where we
see the best opportunities. But activity in Spain and Ireland is
growing rapidly.
In Europe’s commercial real estate sector, what types of
loans are you interested in? We look at everything. We invest
in a wide range of loans, including residential, consumer,
corporate, commercial and industrial, secured, unsecured and
others. We will consider investing in smaller loan portfolios as
well as in the largest.
How about deal size? We look at the entire range. We’ve looked
at deals as small as US$25 million to US$50 million. We’ve also
done a number of deals between US$300 million to US$500
million, and some above US$500 million.
What pressure is there on European banks from governments
and the market to move NPLs off their books? The pressure
in Europe is coming from several fronts. First, banks will have to
gradually meet the new Basel III minimum international capital
requirements, which make it very capital intensive to hold NPLs.
Second, it’s costly for banks to keep NPLs on their balance
sheets. NPLs generate zero income, and the banks typically
don’t have experienced workout platforms. So it’s better for
the banks, better for us since we know how to do workouts,
and it’s better for the underlying market. It’s a win-win. Third,
regulators in Europe and elsewhere realize that banks aren’t the
best holders and servicers of NPLs. A good example of that is
what happened in Asia in the 1990s. The European banks have
learned that lesson and understand moving first and fast is to
their benefit.
Why Asia? In Asia, Japanese banks held their NPLs for a
very long time, and when they finally did sell, it was at deeply
discounted prices. Korean banks moved NPLs off their books
more quickly, and at far better prices.
Interview with Lee Millstein, Cerberus Capital Management
15 Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
19. Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Irish banks and some other European banks have been selling
foreign assets, including NPLs and other non-core assets.
Do you expect this trend to continue? A lot of banks are
retrenching to their home markets. They want to concentrate
on addressing NPL problems in non-core markets. It’s a
continuing trend.
What returns do you anticipate from your investments in
Europe? It’s too early to say what they will be. We’ve had the
same teams working on NPLs globally for more than 10 years,
and returns to date in Europe have been more than satisfactory.
How long do you expect to continue to have investment
opportunities in Europe? Compared with the Asian NPL market
of the past, Europe’s NPL problem today is probably twice
the size of Asia’s. In Asia, there was a steady flow of NPLs for
six straight years. In Europe, I would expect the deal flow to
continue for another three to five years.
Are there any opportunities for small US investors to get
into the European NPL market? This is not an investment
for small US investors. There are two ways to do deals: at
auctions or in negotiated deals. On the auction front, most
investors are maintaining discipline. If more than three or four
investors are invited, most investors have the good judgment
not to participate.
How about on the negotiated deal side? As for negotiated
deals, banks want investors that they know, with a track record
of creative solutions to NPL problems, that have the capital, and
can help manage the assets and maintain confidentiality. What
all this means for small US investors is that it is very difficult to
break into the European market in competition with firms like
ours that have been in the NPL market for a long time and have
large dedicated teams to underwrite, acquire and service the
NPLs. It’s hard for any new entrant to build relationships with
banks considering that we’ve had those relationships for years,
have large amounts of capital to invest and have a proven multi-
year track record in this asset class.
16
20. 17 Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Overview
Investment activity
Survey respondents expect the US NPL market to remain
active, but for a shorter time period than they did a year ago.
More respondents to this year’s report said they expect the
market to remain active for 12 to 18 months; a year ago,
many respondents thought it would stay active for 24 to 36
months. As in past surveys, investors said their first choice for
accessing the market is through off-market transactions or
direct negotiations.
About a third of investors said they have shifted their primary
focus to Europe, which is emerging as the world’s largest market
for distressed loans. Investors targeting Europe are primarily
interested in NPL investment opportunities in Germany, the UK,
Ireland and Spain. More than half of them expect the European
market to remain active for 36 to 48 months.
Capital allocation
More investors said they have allocated less than US$100
million for investment in NPLs this year. This may be because
they expect to invest less in NPLs in 2013, and they are
directing their investments more toward buying smaller
portfolios from regional or local banks. Investor allocations of
more than US$100 million to more than US$1 billion are about
the same as a year ago.
Deal size
Fewer investors are seeking deals of less than US$50 million,
while more investors are looking for deals in the US$50 million–
US$100 million range. Investors who plan to allocate less than
US$100 million of capital in NPLs this year may prefer deals
in this range to transactions of less than US$50 million. Fewer
investors are seeking deals in the US$100 million–US$500
million range, perhaps because not as many investors have the
capital to buy NPLs in this range, or there simply were fewer
deal opportunities. About 8% of respondents, presumably
including the biggest NPL investors, are looking for deals of
US$1 billion or more.
Leverage
Investors appear to be putting more equity into transactions. All-
cash buyers increased in our latest survey, and the percentage
of investors using less than 50% leverage increased while those
using more than 50% declined.
Investment returns
Investors appear to have lowered their return expectations
somewhat, possibly because values of the properties underlying
NPLs have been improving along with a general recovery in
commercial property prices, and NPL yields are declining. More
investors are seeking 10%–15% returns, and fewer are looking
for returns of 20% or more. Those targeting 15%–20% returns
remained about the same as a year ago.
Survey findings
21. 18Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Survey findings: the details
1. Investment activity
The survey asked respondents how “active” they were, meaning the time, effort and resources they are
putting into seeking opportunities to acquire distressed loans. In 2010, only 5% of survey respondents said
they were less active than a year ago. That figure has increased every year since then. In 2013, it reached
30% for the first time. Correspondingly, there has been a decrease in respondents who were more active, from
49% in 2010 to about 32% in 2012. Respondents who said their investment activity was about the same as a
year ago declined to about 38% in 2012. In previous surveys, it was 46%.
Question 1: What is your NPL portfolio-activity level compared with 12 months ago?
2013 compared
to 12 months ago
2012 compared
to 12 months ago
2011 compared
to 12 months ago
2010 compared
to 12 months ago
Same 38% 46% 46% 46%
More 32% 26% 35% 49%
Less 30% 28% 19% 5%
Source: Ernst & Young LLP
troubleshooting, abs, Due Diligence, workplace, credit, Property-Management, Immobilie, NPL,
Rating, Real-Estate, Conact, conactor, Bad-Bank, Servicing, interim, turnaround, Cashflowsync,
CCFS, Distressed Asset, CMBS, portal solution, ICD, Kowollik, recupero di credito,
datawarehouse, cloud-solution, Workout, Incentive Care, Institutsverwaltung, distressed,
Orgaplan Italien, Special Servicing, DocRating, DueDiligence, Draftcheck, Lucidi, welltbuero,
Immobilienkongress, Audis, compliance, Ardea, NPL-Forum2012, risorse per ROMA SPA, RpR ,
protocollo di qualitá, capitale Roma, Aareal, Immoconsulting, Teramo, workplace management,
closing, interim, orgaplan, restructuring, fallimento, fallimentare, upgrading, turnarond,
22. 19 Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
2. Capital allocation
About a third of survey respondents have allocated less than US$100 million for the purchase of NPL
portfolios in 2013, up from 23% in last year’s survey. In other categories, planned allocations are
about the same as a year ago. More investors are specific about their plans this year: only 23% said
they haven’t allocated a specific amount for investment in 2013. Last year, nearly a third hadn’t decided
on an allocation amount.
Question 2: How much capital has your company allocated for the purchase of NPL
portfolios in 2013?
2013 2012 2011 2010
None — no plans to invest in NPL portfolios 9% 12% 14% 25%
Less than $100 million 33% 23% 19% 43%
$100 million to less than $500 million 22% 21% 27% 27%
$500 million to less than $1 billion 8% 7% 3% 3%
$1 billion or more 5% 5% — 2%
Do plan to invest in NPL portfolios, but no specific amount allocated. 23% 32% 37% —
Source: Ernst & Young LLP
3. Method of buying loan portfolios
As in 2012, respondents most often are accessing the NPLs market through off-market transactions and
direct negotiations, followed by broadly marketed offerings by sales agents (sealed bid auctions). Respondents
were least likely to use online auctions, which was also true in previous surveys. Some respondents said they
used other means to access the market, such as loan servicers, investment bankers or direct negotiations
with owners.
Question 3: How are you accessing the market for NPLs?
(Please rank from 1 to 4, with 1 being the most frequent.)
2013 2012
Using online resources such as internet auction sites 2.84 3.18
Off market transaction sources and direct negotiations 1.41 1.56
Participating in broadly marketed offerings by sales agents (multiple bid) 2.33 2.22
Other 3.42 3.08
Source: Ernst & Young LLP
Asset, CMBS, portal solution, ICD, Kowollik, recupero di credito, datawarehouse,
cloud-solution, Workout, Incentive Care, Institutsverwaltung, distressed, Orgaplan Italien,
Special Servicing, DocRating, DueDiligence, Draftcheck, Lucidi, welltbuero
Treuhand Intesa Unicredit Immobilien Ubibanca ByYou Jerome Chapuis First Atlantic
Ricucci EH-Estate Fortress condominio amministrazione immobiliare condominiale
integrazione sincronizzazione ruoli immobiliare millesimo conto economico Fondo
immobiliare IAS/IFRS commercialista KMPG Deloitte revisione MPS Unicredit SGR Banca
d`Italia Legge 106 cartoliarizzazione Reo Immobilie imueble Casa Recupero Credito Bad
Bank SIP Sistema integrada protection Caja workout Credito fallido credits en détresseTroubelshooting incentive care ICD Pfandbriefbank Eurohypo Portfolio ; Exit - Strategia
Immobilienfond Software Orgaplan CONact Unicredit CashflowSync RE-lifecycle Kowollik
deuda morosa UEN Union Estates Network lucidi vendittelli UCCMB italfondiario Due
Diligence Portal-Software Web-Solutions Property
23. 20Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
4. Europe draws interest; US remains primary market
With the growing investor interest in Europe’s NPL market, we added questions about Europe in our current
report. About 30% of respondents said Europe will be their primary focus in 2013, and some said the UK
specifically. About two-thirds of respondents said they will focus on the US. A few said Asia.
Question 4: For your company, what market is the primary focus for NPLs over the
next 12 months?
US Europe Asia Americas non US
65.6% 31.1% 3.3% 0.0%
Source: Ernst & Young LLP
5. European investors target Germany, UK, Ireland and Spain
Of the investors primarily focused on Europe this year, nearly half said Germany was their target market, more
than a third said the UK, about 33% said Spain and 30% Ireland.
Question 5: In which countries in Europe is your company focused on purchasing NPLs
over the coming 12 months? (Choose all that apply.)
Country
over the coming
12 months
Czech Republic 4%
Germany 46%
Greece 4%
Hungary 2%
Ireland 30%
Italy 9%
Poland 6%
Romania 2%
Russia 4%
Spain 33%
Turkey 2%
United Kingdom 39%
Not interested in European NPLs 41%
Other (please specify) —
Source: Ernst & Young LLP
24. 21 Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
6. Deal size
Since we began our survey, the biggest change in deal size has been in the percentage of investors seeking
deals of US$50 million or less. At 60% in our 2010 survey, that percentage declined to 35% in our latest
survey. Investors seeking deals of US$50 million–US$100 million increased in our latest survey to 23% from
20% a year earlier. Investors interested in deals of US$100 million–US$500 million declined to 16% from
20% a year ago. Those seeking deals of more than US$500 million increased to 8% from 4%. A slightly lower
percentage of respondents are unsure about the deal size they want.
Question 6: What deal size are you interested in?
2013 2012 2011 2010
$500 million or more 8% 4% 3% —
$100 million to less than $500 million 16% 20% 22% 18%
$50 million to less than $100 million 23% 20% 16% 22%
Less than $50 million 35% 36% 43% 60%
Not sure or depends 18% 20% — —
No plans to invest in NPL portfolios — — 16% —
Source: Ernst & Young LLP
7. Investment return requirements (unleveraged internal rate of return)
About half of the survey respondents said they are looking for returns of 16%–20%, the same as a year ago.
Those seeking returns of more than 20% declined to 22% from 25% a year earlier. The biggest change came
in the percentage of respondents seeking returns of 10%–15%. That percentage increased to 29% in our latest
survey from 20% a year ago.
Question 7: What are your investment return requirements
(unleveraged internal rate of return)?
Investment return requirements 2013 2012 2011 2010
below 10% — 3% — 2%
10% — 15% 29% 20% 30% 40%
16% — 20% 49% 52% 62% 42%
above 20% 22% 25% 8% 16%
Source: Ernst & Young LLP
25. 22Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
8. Leverage requirements
About 63% of respondents said they use some leverage, compared with about 67% year ago. But investors
appear to be using less leverage. Some 25% of investors said their leverage requirement is 51%–60%, down
from 33% a year earlier. By contrast, 20% of investors require 26%–50% leverage, up from 15% a year ago.
Those who indicated they were all-cash buyers increased to 37% from 33% the previous year.
Question 8: What is your leverage expectation or requirement?
Leverage 2013 2012
0% — all cash buyer 37% 33%
1% — 25% 3% 5%
26% — 50% 20% 15%
51% — 60% 25% 33%
61% — 70% 13% 9%
above 70% 2% 5%
Source: Ernst & Young LLP
9. US NPL market outlook
Respondents to this year’s survey shortened their
time frame for how long they think the US NPL
market will remain active. About 20% expect it to
remain active for up to 18 months vs. 4% a year
earlier. Only about 13% expect it to remain active
for up to 36 months vs. 29% a year earlier. Only 5%
see it staying active for 48 months.
Question 9: How long do you think
the US NPL market will be active?
2013 2012
No longer active 3% —
Next 12 months 14% 4%
Next 18 months 20% 14%
Next 24 months 22% 36%
Next 36 months 13% 29%
Next 48 months 5% 17%
No opinion 23% —
Source: Ernst & Young LLP
10. European NPL market outlook
Based on responses to this year’s survey, investors
think the European NPL market will stay active
longer than the US NPL market. More than half the
respondents said the European market will stay
active for 36 to 48 months. Only about 8% said it
will remain active for up to 24 months. The rest had
no opinion.
Question 10: How long do you
think the European NPL market
will remain active?
2013
Next 12 months 0%
Next 18 months 4%
Next 24 months 8%
Next 36 months 22%
Next 48 months 33%
No opinion 33%
Source: Ernst & Young LLP
26. In a recent interview, David Abrams and Steve McElwain of Apollo
Management International, LLP, discussed the outlook for distressed
debt markets in Europe. Based in London, Abrams is Senior Portfolio
Manager of Non-performing Loans at Apollo Management International
and Managing Partner and Co-Founder of Apollo European Principal
Finance Fund. McElwain is a Principal with Apollo European Principal
Finance Fund.
What’s your assessment of the size of Europe’s distressed debt
market? We estimate it’s about €1.5 trillion – about €750 billion of
NPLs and €750 billion of performing and non-performing, core and
non-core assets.
Where is Europe in terms of resolving its distressed loan problem?
We believe Europe is in the early stages of resolving what appears to
us as a very large problem with respect to distressed loans. Very few of
these problem loans have been sold, and we believe banks will be selling
loans for some time to come.
What’s the outlook for Europe’s distressed debt pipeline in 2013?
We believe Europe will attract more investment from investors
worldwide, and the pipeline is expected to continue to grow over the
next few years. The forced liquidation of assets by bailed-out banks
should continue. Banks are trying to manage new capital requirements
and address liquidity issues, and they are seeking creative solutions to
their problematic distressed loans. We believe this dynamic should result
in fewer auctions and more direct negotiations for the sale of
loan portfolios.
Will banks be selling assets other than distressed loans? From our
perspective, yes —we believe sales will not be limited to only distressed
loans. We are seeing banks and other financial institutions, not just in
Europe but elsewhere around the world, looking for ways to exit from
asset classes that no longer fit within their core areas of focus.
How much capital has Apollo raised for investment in European
NPLs? We raised approximately €1.3 billion for our first fund, which
is almost fully invested. We recently held the final fundraising for our
second fund, Apollo European Principal Finance Fund II, or EPF II, which
raised about €2.5 billion. We are actively evaluating opportunities
throughout Europe to identify opportunities to deploy the capital raised
in EPF II.
Where are you investing in Europe? Although we target investments
across Europe, we have focused on four markets: Germany, the UK,
Spain and Ireland. We seek to deploy our funds’ capital with the aim
of optimizing the outcome of the investments that are made — and
we take an active role once our funds invest in an asset. The funds
we manage typically own the servicers in each market in which we’re
active, and we believe that banks appreciate the fact that we conduct
our own servicing. In many cases, we have found that the banks and
other financial institutions we are engaged in dialogue with are looking
to redeploy their internal resources and would prefer to avoid having to
deal directly with managing bad loans.
In addition to NPLs, are you buying performing assets? Over the
past two years, we believe Apollo has been one of the largest investors
in performing consumer debt in Europe.
We continue to evaluate other performing asset classes, but in most
cases the pricing hasn’t met our return requirements. One of the most
significant variables is leverage. In the current environment, many
investors are taking advantage of low rates to obtain financing and
invest in deals. And some investors, rather than investing equity, are
entering the market and providing financing for deals.
Are you buying through the auction process as well as direct
negotiations? Some deals are widely marketed through auctions, but in
these types of situations valuations can be driven up, and we more often
than not get priced out of a deal. We generally prefer direct negotiations
with banks and other financial institutions, where we believe we can
provide a quick and holistic solution to the seller.
Have you done any joint ventures? Yes — we have participated in some
joint venture transactions, and, generally speaking, they have been
successful. We have found that in certain situations, while banks may
prefer to fully dispose of a portfolio of loans, for one reason or another,
they are unable to sell the entire portfolio up front and instead they
are comfortable to share in the risks of servicing the loan portfolio and
seeking to recover the value of the loans.
Are you interested in buying assets other than real estate? Yes.
Although loans secured by real estate remains our primary focus, we
continue to look for opportunities to expand our footprint in performing
consumer receivables. In addition, today there are opportunities in
alternatives such as rolling stock and shipping in specific markets.
Regardless of the asset, our decision to invest the funds we manage
depends on whether we believe we can price the asset competitively,
service it efficiently and meet our funds’ return requirements.
Interview with David Abrams and Steve McElwain,
Apollo Management International
23 Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
28. 25 Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
Survey questions and responses
Same
38.1%
Less
30.2%
More
31.7%
What is your NPL portfolio-activity level compared
with 12 months ago?
Less than
$100 million
32.8%
$500 million
to less than
$1 billion
7.8%
$100 to less
than $500 million
21.9%
How much capital has your company allocated for
the purchase of NPL portfolios in 2013?
None - no plans
to invest in NPL
portfolios.
9.4%
$1 billion or more
4.7%
Do plan to
invest in NPL
portfolios, but no
specific amount
allocated
23.4%
How are you accessing the market for NPLs?
(Please rank from 1 to 4, with 1 being the most
frequent.)
Using online
resources such
as internet
auction sites
2.84
Off-market
transaction
sources
and direct
negotiations
1.41
Participating
in broadly
marketed
offerings by
sales agents
(multiple bid)
2.33
Other
3.42
$500 million
or more
8.1%
Less than
$50 million
35.5%
Not sure
or depends
17.7% $100 million
to less than
$500 million
16.1%
$50 million
to less than
$100 million
22.6%
What deal size are you particularly interested
in? (Select one.)
For your company, what market is the primary focus
for NPLs over the next 12 months?
Americas
non-US
0.0%
Europe
31.1%
Asia
3.3%
US
65.6%
For your company, what market is the primary focus
for NPLs over the next 12 months? (Choose all that appy.)
Not interested
in European NPLs
40.7%
Italy
9.3%
United Kingdom
38.9%
Germany
46.3%
Spain
33.3%
Ireland
29.6%
Poland
5.6%
Russia 3.7%
Greece 3.7%
Czech Republic
3.7%
Turkey 1.9%
Romania
1.9%
Hungary
1.9%
Other 0.0%
Source: Ernst & Young LLP Source: Ernst & Young LLP
Source: Ernst & Young LLP Source: Ernst & Young LLP
Source: Ernst & Young LLP Source: Ernst & Young LLP
29. 26Flocking to Europe Ernst & Young 2013 real estate non-performing loan report
no longer active —
it has run its course
3.1%
for the next
18 months
20.3%
For the next
12 months
14.1%No opinion
23.4%
How long do you think the US NPL market will be active?
For the next
24 months
21.9%
For the next
48 months
4.7%
For the next
36 months
12.5%
For the next
36 months
21.9%
For the next
48 months
32.8%
No opinion
32.8%
For the next
18 months
4.7%
For the next
12 months
0.0%
For the next
24 months
7.8%
How long do you think the European NPL market will
remain active?
0% leveraged —
all cash buyer
37.3%
1%–25%
leveraged
3.3%
26%–50%
leveraged
19.7%
51%–60%
leveraged
24.6%
61%–70%
leveraged
13.5%
More than
70% leveraged
1.6%
What is your leverage expectation/requirement?What are your investment return requirements
(unleveraged internal rate of return)?
IRR below 10%
0.0%
IRR 10%–15%
28.6%
IRR above 20%
22.2%
IRR 16%–20%
49.2%
Source: Ernst & Young LLP Source: Ernst & Young LLP
Source: Ernst & Young LLP Source: Ernst & Young LLP
31. Global real estate services contacts
Country real estate services contacts
Howard Roth
Global Real Estate Leader
Phone: +1 212 773 4910
howard.roth@ey.com
Rick Sinkuler
Global Real Estate
Markets Leader
Phone: +1 312 879 6516
richard.sinkuler@ey.com
Christopher Seyfarth
US
Phone: +1 415 894 8738
chris.seyfarth@ey.com
Daniel Mair
Germany
Phone: +49 6196 996 24703
daniel.mair@de.ey.com
Mathieu Roland-Billecart
UK
Phone: +44 20 7951 5206
mrolandbillecart@uk.ey.com
Ian Cosgrove
UK
Phone: +44 20 7951 1054
icosgrove@uk.ey.com
David Frias
Spain
Phone: +34 0915 725 086
david.friasblanco@es.ey.com
Luke Charleton
Ireland
+353 1 221 2103
luke.charleton@ie.ey.com
28