European Banks Get ‘False Deleveraging’ in Seller-Financed Deals
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European banks, vowing to sell distressed assets as regulators tighten capital requirements, are lending money to buyers to get deals done.
Royal Bank of Scotland Group Plc (RBS) may provide as much as 600 million pounds ($939 million) in debt to help Blackstone Group LP acquire part of a 1.4 billion-pound portfolio of commercial mortgages from the bank after the private-equity firm struggled to get outside funding, three people with knowledge of the transaction said. The deal, scheduled to close within weeks, follows Credit Suisse Group AG (CSGN)’s agreement to finance the sale of $2.8 billion of property loans to Apollo Global Management LLC in December, two people with knowledge of the matter said.
“The use of vendor financing to de-lever defeats its own purpose,” said David Thesmar, a professor of finance at HEC Paris, a business school. “The assets may become safer because the buyer injects equity, but the actual gain in core Tier 1 capital ratio for the bank isn’t as great as if it was purely and simply sold. It shows banks’ deleveraging is going to be tougher than planned.”
The increase in vendor financing reflects the challenge European banks (BEBANKS) face selling their distressed loans and avoiding greater losses as the sovereign-debt crisis deepens. Lenders have pledged to cut assets by more than 775 billion euros ($1.05 trillion) within two years as regulators require them to meet a 9 percent core capital ratio earlier than planned and urge them to reduce funding needs.
‘Off Your Books’
Because most buyers of distressed assets fund purchases with debt, which has become increasingly expensive and difficult to obtain, banks are financing transactions themselves, even if it means retaining loans on their balance sheets. That will slow deleveraging and make more asset sales necessary, analysts say.
“A lot of those asset sales might be dependent on the banks themselves, the sellers, providing financing to the buyers,” Raoul Leonard, a London-based RBS analyst covering southern European banks, said on a conference call with clients Oct. 20, without referring to any specific deal. “It’ll be almost false deleveraging going on, but it’s off your book and you can argue that the risk-weighting changes.”
Sales of loan portfolios have been sluggish, in part because banks are reluctant to sell assets at the discounts sought by private-equity firms such as Apollo, Blackstone and Colony Capital LLC. Selling at a loss would reduce banks’ capital at a time when regulators are demanding they raise more.
The issue isn’t banks’ high-quality assets, which can be sold to other lenders, pension funds and insurance companies without debt financing, said Andrew Jenke, director in KPMG’s Portfolio Solutions Group in London, who advises buyers and sellers of loans. Nor is it their poorest-quality assets on which firms can afford to accept discounts because they have been written down already, he said.
“The issue is the large pool of medium-quality loans that are not yet provisioned because there hasn’t been a credit event triggering an incurred loss,” Jenke said. “There is a big price gap: too risky for other banks, and not enough cheap financing for the private-equity buyers. This will make vendor financing crucial.”
European banks will dispose of less than 100 billion euros of the more than 500 billion euros of distressed loans and other impaired assets because they can’t afford to take losses on the sales, Huw van Steenis, a Morgan Stanley analyst in London, wrote in a Nov. 13 note. Banks may have to unload some of their good assets to U.S. or Asian competitors, he said. Van Steenis estimated banks in Europe may shrink assets by between 1.5 trillion euros and 2.5 trillion euros in two years.
Boosting Bid Prices
Buyers of distressed assets seek vendor financing because it’s the cheapest debt option and helps them boost their bids, said Joseph Swanson, managing director at investment bank Houlihan Lokey in London.
“With very few exceptions, banks will get the best price for their assets if they provide the financing package themselves,” Swanson said. “The bank already has the risk on its books and knows its assets better than any third-party financier. As a result, it should be in the best position to provide financing which allows the buyer to put in less equity and boost the price.”
The issue is more acute for large portfolios of loans, said Dilip Awtani, managing director in charge of Colony Capital’s European distressed-debt investments in London.
“The pricing gap between buyers and sellers is still huge, and one of the ways to close it is vendor financing because the lending market is contracting and the pockets of capital for third-party financing are very limited,” Awtani said.
RBS, which got a 45.5 billion-pound taxpayer bailout in 2008, said in July that New York-based Blackstone (BX) would find outside financing to buy part of a 1.4 billion-pound U.K. commercial-property loan portfolio codenamed “Project Isobel.” Blackstone and RBS agreed to set up a vehicle to hold the assets, which were priced at a 29 percent discount to face value, said the people with knowledge of the talks who asked not to be identified because they weren’t authorized to speak.
The world’s largest buyout firm, which will manage the assets, agreed to buy a 25 percent stake, while RBS will retain the rest and sell it over time, the Edinburgh-based bank said in a July 13 statement.
Blackstone, seeking to finance the acquisition with 60 percent debt, has struggled to secure outside lending because credit contracted and became more expensive as Europe’s crisis worsened, the people said. China’s sovereign-wealth fund, China Investment Corp., may buy half of Blackstone’s stake, or 12.5 percent, they said.
RBS said in the July statement that the deal was structured to allow it “to participate in potential future profits of the fund and from Blackstone’s asset management and market recovery while at the same time reducing its exposure and risk.”
David Gaffney, a spokesman for the bank, declined to comment further.
“We think this innovative structure could serve as the model for future transactions as banks look to dispose of non- core real-estate assets,” Michael Nash, chief investment officer of Blackstone Real Estate Debt Strategies in New York, said in the statement. Helen Winning, a spokeswoman for Blackstone in London, declined to comment.
‘Not Enough Money’
RBS also provided a loan in September to help Patron Capital Ltd. purchase 24 U.K. hotels the bank seized after Jarvis Hotels Ltd. defaulted on loans. The lender provided financing to an RBS venture with Patron that bought the properties. Because the deal was relatively small, loan terms were comparable to what was available from other lenders, said Keith Breslauer, managing director of Patron, a London-based buyout firm that specializes in real estate and manages about 1.7 billion euros of assets.
For larger transactions, “you need vendor finance to get deals done,” Breslauer said. “Without it, the deal doesn’t get done.” Patron is in talks on three deals that will collapse unless the vendor provides finance, he said, adding “there’s not enough money out there.”
Richard Thompson, a partner at PricewaterhouseCoopers LLP, who advises on loan sales in London, said about half the deals his firm is handling involve vendor financing.
Credit Suisse, Lloyds
Credit Suisse, Switzerland’s second-largest bank, agreed to sell $2.8 billion in distressed property loans to New York-based Apollo at a 57 percent discount in December, a person with knowledge of the deal said at the time. The bank provided a loan to help fund Apollo’s deal, two people familiar with the transaction said. Adam Bradbery, a spokesman for Credit Suisse in London, declined to comment.
Lloyds Banking Group Plc (LLOY), which received a 20.3 billion- pound government bailout, is considering vendor financing in the sale of 1 billion pounds of U.K. mortgages, a person with direct knowledge of the talks said. Ian Kitts, a spokesman for London- based Lloyds, declined to comment.
The National Asset Management Agency, set up to purge Irish banks of risky property loans, said it will also provide as much as 70 percent of financing to help sell commercial assets.
“Vendor finance sounds like window dressing to me,” said Christophe Nijdam, an AlphaValue analyst in Paris. “The risk isn’t properly transferred.”
The use of such funding can reduce the riskiness of the assets and free up regulatory capital, David Abrams, in charge of European nonperforming loan investments at Apollo Global Management in London, said in an interview.
“The risk for the banks changes,” he said. “In a way, they are turning nonperforming loans into performing loans.”
The buyers need to inject sufficient equity for the banks providing vendor financing to benefit from a regulatory capital point of view, said Alexander Greene, managing partner at New York-based private-equity firm Brookfield Asset Management LLC.
“Ultimately, regulators scrutinize those deals,” Greene said. “The question is then, will the investors be able to earn their returns if they overcapitalize?”
Banks must be innovative to sell the “stickiest” of their assets, said Ian Gordon, an analyst at Evolution Securities Ltd. in London.
“Banks will be naive if they use vendor finance to notionally dispose of assets at whatever price the market will take,” he said. “They could fall in the trap in giving away the upside without meaningfully reducing the downside.”
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