Partha Pal
Ropes & Gray

Investors are paying close attention to real estate-related non-performing loans, says Ropes & Gray’s Partha Pal

How has the European market for non-performing loans developed in the past couple of years?

There has been a lot of development. The number and size of non-performing loan (NPL) portfolios coming onto the market from Spain has definitely been a noteworthy feature, and this year in particular the amount of transactional activity in Italy is also
very significant.

These are the markets that continue to be the most important in Europe, and velocity in both of them has increased over the last couple of years.

In markets such as Ireland and the UK however, velocity has tailed off a little bit in terms of the number of transactions, primarily because the NPL issues in both markets has been dealt with over the course of the last several years.

The National Asset Management Agency (NAMA) in Ireland has been particularly successful in resolving bad loans, taking a lot from the Irish banks and making good progress in resolving them.

Tunstall Real Estate Asset Management recently launched a debt fund to target the €11 billion dutch NPL market, in which other European markets is activity growing?

The Spanish and Italian markets go into the hundreds of millions in terms of NPL supply so, although interesting, the Dutch market is small in comparison. There are very positive economic signs in the Netherlands, so I can see why investors would be interested in trying to get NPL exposure as the economy seems to be moving in the right direction.

Other than Spain and Italy, Greece has been a market I have heard a lot about recently. Piraeus Bank has recently done its first NPL deal. Cyprus also has a significant supply of NPLs and I believe the Bank of Cyprus was trying to do a deal too, but it has been put on hold.

From what I am seeing and hearing it is still very much a Southern Europe-focused market, and investors are looking to Portugal as well. It is a small market relatively speaking, and the large NPL investors like volume because of the large amounts of capital they have to deploy. However, due to availability of NPLs and the fact that not everybody is looking at Portugal, it has piqued various people’s interest.

How is risk mitigated by funds taking on bad debt?

The first thing a buyer of NPLs does is look at the value of the collateral. For example, if you had a pool of NPLs, the buyer will look at the principal amount that is owed for each and compare it to the value of the underlying collateral. If you have a loan with a face amount of £100 million secured on a property that’s worth £80 million, you’re obviously not going to pay more than £80 million.

Chances are you will pay a lot less, something like £30 or £40 million, because logically there has to be a difference between what you pay and the underlying collateral value, which represents the profit you can make. How much less depends on a variety of factors including the environment for enforcing legal rights.

Secondly, NPL deals are, to a great extent, all about servicing. You can buy the loans at a good price, but you have to have the platforms to work them out. Some investors, such as Lone Star Funds, have their own servicing platforms, which has worked well as it means they can intensively service the portfolios they buy.

Those who don’t have in-house servicing platforms have developed relationships with particular servicers. An example is Aktua in Spain, which has been appointed by some very significant investors. You are also finding London-based servicers that have established local operations, for example Mount Street Loan Solutions recently set up an operation in Greece in order to prepare for a more active market.

Thirdly, you have to make sure your financing is properly structured. It’s no good having a well-serviced portfolio if you have a financing structure that means you are required to pay back before you have actually resolved enough of the loans to be able to pay back.
What sectors offer the most opportunity for non-performing loans to be acquired?

Although these cover a mixed set of assets, it is usually real estate-backed NPLs that start to trickle through first. The reason for this is it’s relatively easy for investors to work out what the underlying collateral is worth. Unsecured NPLs are also quite prevalent, but they are harder to manage. It is a combination of working out where the supply is and what the nuances of particular sectors are.

You could find an opportunity to buy a lot of corporate debt, but determining its real value in markets such as Italy or Greece is maybe harder than working out the value of real estate loans, because real estate involves collateral that is easier to value and to extract
value from.

This is true both in relation to commercial real estate and residential real estate.

You will see some brave souls looking at consumer loans, and some looking at corporate type loans, but from what I have seen investors are often particularly focused on real estate-related NPLs.

How does the UK differ from other European markets in relation to non-performing loans?

The UK institutions have been good about cleaning up their balance sheets. The environment in the UK, in terms of forcing creditors rights, is so much more sophisticated and user friendly than anywhere else in Europe, with the possible exception of Ireland, which pre-disposes relatively easy resolution of NPLs.

As you move into less familiar and less creditor-friendly legal environments, it becomes harder to do this business, or at least to do so with the same degree of safety.

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