Banks’ Positive Outlook Sets Stage for More Loan Sales

(Mark Your Calendars: RealShare Distressed Assets convenes in Dallas on May 3 & 4.)

DALLAS-Chris Seyfarth, a partner in Ernst & Young LLP’s transaction real estate practice based in San Francisco, will be the keynote speaker at RealShare Distressed Assets taking place here this Friday. He spoke with GlobeSt.com about investor expectations for nonperforming loan acquisitions and related market trends.

GlobeSt.com: Last month, E&Y released a survey saying that investors believe banks will be selling more nonperforming loans this year. Are banks generally in a better position to start making these decisions?

Seyfarth: All indications are that, yes, we will be seeing more loan sale activity in 2012.  In general, banks have had four years to set aside reserves and shore up their capital position and we are now seeing that investor pricing is a closer match with bank expectations. 

And it’s not only NPLs that banks are selling. We’re seeing a lot more activity in what are sub-performing loans, which are actually performing loans at the moment that could go nonperforming once they hit their maturity date. Because the loan-to-value is so high, it’s unlikely borrowers can refinance the loan, and thus the bank has to make a strategic decision on the best course of action. In today’s market, that now includes selling sub-performing loans, which, it turns out, are being strongly priced by investors

GlobeSt.com: We’ve heard that smaller banks have greater exposure to commercial real estate debt. Are they likely to be especially determined to get the sub-performing debt off their books before it creates problems for them?

Seyfarth: I don’t think they have any choice. And it isn’t necessarily just the smaller banks, although they do have a greater percentage of commercial real estate loans to total assets. If you look just at the top 100, which are banks with assets of roughly $10 billion or greater, as of the fourth quarter of 2011 they had about 8% of their assets in commercial real estate loans. For the remaining 7,300 banks, about 26% of their balance sheet was commercial real estate loans. That’s a big number compared to the large banks, but it gets worse when you get down to the smaller community and regional banks, where it’s far higher, sometimes over 50%. So it’s these institutions that are going to take the brunt of the maturing loan exposure. Investors believe these banks will have to move aggressively to deal with their problems.

GlobeSt.com: Obviously, not all banks will be successful with that, and so a certain number will go out that year. With that, do you anticipate that we’ll be seeing more of the structured transactions that the FDIC has been doing with investors?

Seyfarth: The FDIC loan sales are becoming a smaller percentage compared to the bank loan sales, partly because the FDIC is closing fewer banks. Through last week, the FDIC  closed 22 banks, compared to 39 by this time last year. The FDIC will continue to sell loans to investors; that’s their job. We’ve probably passed the high point in FDIC loan sales, though, unless something goes dramatically wrong with our economy

GlobeSt.com: Some of the European banks will have to start stepping up their sales of problem assets. Do you anticipate that US investors will be looking overseas?

Seyfarth: There are two opportunities here. There are the European banks that have US exposure, with some moving to resolve and/or liquidate that exposure, due, in some cases, to EU banking regulatory mandates. We’ve seen active selling by Irish banks and now the German bank, Eurohypo, recently sold a $750 million portfolio of performing and sub-performing loans. That’s the most current opportunity for US investors. For those that have the resources and capacity to go overseas and look at commercial real estate loan portfolios outside the US, it’s expected that Europe will provide that opportunity in the coming years. There’s an expectation that Europe is the next horizon. The only question is when.  

GlobeSt.com: The E&Y survey said investors have been more successful with closing transactions lately. That’s due partly to improved availability of financing. What else might be contributing to that?

Seyfarth: One, the availability of financing has allowed investors to leverage up their returns and better meet price expectations of the seller. Two, it’s been very competitive, and by nature a competitive environment will tend to drive up pricing. Three, the banks are in a better position to sell; their loan net book values are better aligned with the  pricing expectations of the market and the positive banking industry earnings trend helps put many banks in a better capital position to exit some of their problem loans.

GlobeSt.com: You’ll be delivering the keynote address at RealShare Distressed Assets this week. What will be one of the takeaways from that?

Seyfarth: I’ll be taking a look at the commercial real estate loan market and discuss factors that will be impacting the market’s longevity.  Recognizing that bank earnings are on the mend with reserves and bad loans declining, how much longer will buying opportunities exist?  That’s a tough question to answer, yet with a trillion dollars in looming loan maturities over the next five to seven years, the stage is set for greater sales activity, for the simple reason that banks can better afford that option due to stronger capital positions. If you believe in the adage that once an NPL, always an NPL, then the passage of time will not solve the problem. So the takeaway is that this market has some staying power and opportunities for investors will continue for the next few years.   

(Visit the Distressed Assets page on GlobeSt.com.)