The European Bank Loan Trade Is Not Yet Done

by Dechert LLP

Here at Dechert, we have seen a slow but steady work stream over the past several years in assisting institutions in either buying or selling of pools of financial assets. Just recently, we advised Wells Fargo Bank in connection with its acquisition of a $4.5 billion performing pool of UK loans and the simultaneous financing of Lone Star's acquisition of $1.5 billion NPL and SPL pool, all acquired from what had been Euro Hypo's and now - Hypothekenbank Frankfurt. Needless to say, we would certainly love to see more.  

Several years ago, we projected that tightening credit, worsening economic condition across the EC and heightened regulatory burdens would result in the release of a serious amount of assets from European banks to healthy US lenders and other financial players. This seemed an easy thing to predict with almost all the macro trends aligned to squeeze the European banks to shrink. To say the least, however, this notion has underperformed. While we have seen a number of deals over the past couple of years, it has definitely been a trickle as opposed to the tsunami that we had expected. We clearly under-appreciated the capacity and commitment of the European governments to facilitate a broad banking exercise in duck and cover.

But never give up hope on a really good idea. It's time to double-down. I noted with enthusiasm a recent Financial Times report that the Royal Bank of Scotland has published an analysis of the European Community that concludes that European banks needed to shed €3.2 trillion of assets in reasonably short order to meet obligations under Basel III and its attendant rules. Now there are a lot of ways to shrink balance sheets, but as the old saw goes, "there's a pony in here somewhere." If the European Community disposes of something in the order of $5 trillion of assets, there will be major portfolios on the block.

And now the ECB's imminent appointment as the lead regulator of Europe's biggest banks is on the doorstep. This is the long promised single supervisory mechanism which has been talked up for the last year and a half as a big a part of the solution to the European bank dilemma. But the ECB has now concluded that, before it takes ownership of that tar baby, it will examine the balance sheets of all the major banks and make an independent judgment of whether the banks have adequate capital to support their positions. It has long been received wisdom that many European banks have been energetically optimistic in marking assets and it is hard to believe that unless the supervisory function is entirely toothless, this process won't result in even more pressure on banks to de-lever. It also should embolden and perhaps force march the banks to fess up to reality and sell assets even where the sale will occasion realized losses.

Oh boy! If this happens, and given the history of political and regulatory shenanigans in Europe, that still is a big if, this may be the straw that breaks the camel's bank and releases significant assets at fair value into the marketplace across Europe. Live in hope, die in despair as my Cajun father-in-law used to say! I'm betting deals are coming.

Now these are not easy transactions to accomplish for a host of both legal and business reasons, but the rewards of putting to work money in large lump transactions is a near to compelling reason to pursue these trades. Yes, these will often include a bidding process and the bidding is painful. Yes, it often involves navigating complicated issues of optics, political considerations, regulatory arbitrage, and employment concerns, as well as more technical legal issues surrounding hedging structures, transferability and asset quality. But with all that said, our judgment is that the pain of doing these deals will not put off either sellers who, at the end of the day, must meet regulatory guidelines or buyers who really need to put money to work.

So we won't be throwing away those pages of our business plan focused on major intra-bank transactions quite yet. We think we'll be back at work moving the metal soon.


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Dechert LLP

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