A place in the sun: Spanish opportunities

Portfolio sales in Spain last year demonstrated that bank deleveraging has begun in earnest and market participants predict it will accelerate this year. Banks and fund managers have done their groundwork in preparation for the long-awaited debt purge. 

But while the opportunity is certainly there, the idiosyncrasies of the Spanish market must be respected. 

Carlos Pla, a partner at Hayfin Capital Management, which purchased a number of portfolios in late 2014, explains to Private Debt Investor the rationale behind the returning capital. 

Until last year, the macro environment was so uncertain that it was very difficult to take a view on how a portfolio might pan out, he explains, adding that the necessary ground work has been done by corporates, financial institutions and public administrators “creating a very interesting environment to put capital to work”, the Spaniard says.

Credit investments offer the best opportunity, Ahmed Hamdani, managing director at HIG Bayside Capital, tells PDI

“Banks weren’t quite as willing to sell about a year and a half ago. Now their willingness and ability has gone up,” he continues. “Years ago it was easier to pick up property assets [in Spain]. But now the supply of debt loan sales is increasing, the opportunity is swinging more towards debt and people who can buy debt.”

The Spanish economy is also beginning to grow again. The pace is modest compared to the boom years but higher than some other periphery countries, and that is helping capital flow, says Pla.

REAL ESTATE

By the end of 2014, around €30 billion in real estate transactions were closed in Spain and a third of this figure was invested in debt, explains Ignacio Iturriaga, partner at Irea, which has acted as financial advisor to the state-controlled asset manager Sareb. “We can foresee a recovery in the Spanish economy especially in the real estate area,” Iturriaga says.

Banks still have debt portfolios to shed, particularly shopping centre, industrial, office and hospitality-linked assets, he says.

Real estate debt totals around €321 billion, estimates Iturriga, adding that there are a lot of written down loans that have not yet been sold on by lenders. 

In May last year, Commerzbank sold a €4.5 billion Iberian loan book, Project Octopus, to Lone Star, financed by JP Morgan. Sareb too closed a flurry of transactions at the end of 2014 including the transfer of three mixed loan and real estate portfolios with a face value of €41.2 billion to three local vehicles controlled by US-based fund managers Cerberus Capital, Apollo Global Management and TPG. 

In December, Sareb finalised another five deals totalling €847 million, including two real estate-linked corporate loan books – the €259 million Agatha and €140 million Olivia portfolios. A consortium-led by Hayfin bought Agatha while Hayfin purchased Olivia by itself.

Over the next two years, Iturriaga says an additional €40 billion to €50 billion par value non-performing loan assets are expected to be sold. Sareb will sell between 10 to 20 percent of that total but most will come from Spanish commercial banks, he adds.

Pla foresees the increase in activity spreading to other sectors including corporates and potentially renewable energy. 

CONSOLIDATION

Investors with plans to snap up discounted non-performing loans have had a long wait; the establishment of Sareb was announced at the end of 2012. Since then, the savings banks – badly hit by the crash – have consolidated, Iturriaga explains, shrinking from 60 institutions to not more than 15. Problem loans amounting to about €60 billion were transferred to Sareb.

Some of the commercial banks are holding off on divestments, behaviour driven by lessons learned during the last property crisis, he says.
“Some banks are selling a lot but then others think ‘let’s sell when there is a much higher value in the future’. Their interpretation is if they divest right now they will be selling to opportunity funds who will make the surplus returns,” Iturriaga explains.

Spain saw a lot of foreclosures between 1999 and 2003 with some banks selling quickly to clear their balance sheets. But the banks that didn’t sell, came through ok, he explains. 

They provided 100 percent debt provisions for their loans and when they did sell, they made capital gains on the back of a fast recovery in property, continues Iturriaga.

So some banks are holding out for a more substantial recovery. “That policy may be correct but meanwhile you need a lot of capital to wait and internal costs and that’s not easily accountable,” adds Iturriaga.

STRATEGY

Funds in Spain can be broadly pitched into two camps– those with a short-term view and those with more long-term ambitions.

Iturriaga says: “We can see [a] few funds acquire loan books and try to divest as quick as they can – they want to divest in two to three years and are not interested in being a big player in Spain”, he says joking that they will hit Italy next. 

But fund managers may not find it all that easy to divest, according to Hamdani: “That’s something that a lot of people are struggling with. The bank sales have been active but the on-sale market has not been as active. Funds which have a propensity for flipping out of their assets might have difficulties. The depth of the secondary market is yet to be determined.”

Hamdani points out that the UK has quickly established a secondary market for bad assets, while the process is taking longer in Ireland and Spain.
Meanwhile, firms like Hayfin and Bayside are looking to Spain long-term. 

Pla, who oversees Hayfin’s Special Situation fund, says the firm’s approach to Spain is similar to any other European market. It is looking for new lending opportunities, legacy assets are just a means to an end. “Whether we buy a new or existing loan we are indifferent. Buying portfolios gives us access to a number of borrowers which leads to new long term relationships,” says Pla. 

Spanish banks have not disappeared, continues Pla, explaining that for high performing businesses borrowing rates can be even tighter than the UK. “Having said that, for companies with a bit more leverage, some lenders have disappeared, and there we see opportunities,” Pla explains.

Bayside’s approach is similar but more real estate focused “We help borrowers refinance their debt and arrange capital to finance the assets. A lot of what we are doing is smaller assets, smaller loans,” Hamdani says. 

Hamdani also believes that alternative lenders will end up making an impact in Spain, as they have in the UK and elsewhere: “The growth of the non-bank lending market is a move that will continue for years. I just feel it’s going to be quite competitively priced.”

PRICING

Investing in smaller more granular loans might be more capital intensive but this is where the best returns are, Hamdani believes: “The bigger portfolios are more aggressively bid up. On the smaller portfolios you can make better returns.”

Iturriaga highlights that mixed performing and non-performing loans books are now being put up for sale and notes that there are very few pure performing books. He says performing loans are sold at over 90 percent whereas pure non-performing assets are priced at around 50 percent giving an overall average sale price of around 60 to 80 percent.

Unsecured portfolios with very granular non-performing loans have recovery rates of around 5 to 10 cent on the euro, Iturriaga adds.

PRICING RISK

One of the main risks for larger managers is over-paying for assets. Hamdani points out that the large portfolios have attracted the biggest funds, which are hungry to deploy capital. 

While Iturriaga adds that the managers’ assumptions can often be very wrong. “We have seen many buyers which are not good at predicting borrower behaviour. In their loan-to-own studies, they can normally make many mistakes in terms of cost and timing,” he says.

Hamdani and Iturriaga both point to the importance of local knowledge and expertise. The very different legal system and insolvency process is important to bear in mind too, says Iturriaga.

Pla too emphasises how local knowledge has helped Hayfin in Spain: “We have partnerships with local advisors. They have been instrumental in helping us to grow in the market.”

The rise of popular right wing politics in an election year has also added another element of uncertainty to investment in the country. While Spain’s persistently high unemployment figures have also been flagged as a continuing source of concern by rating agency Fitch. 

Despite the risks though, investors are positive on Spain. “We expect the next three years to be positive but fragile,” says Pla.

PLAYING THEIR PART

Following early reports of borrowers experiencing difficulties the purchasers of stressed debt, Iturriaga believes the situation has improved.
“[The] opportunity funds are much better for borrowers than the previous owners [as they are] much better at reaching new agreements,” says Iturriaga.

For Hamdani, the main issue for borrowers is their need for new money when banks are not willing to redevelop assets. “To extract value you need someone who has flexible capital,” he says.

So after more than five years of struggle, capital is flowing back into Spain. 

Fund managers, with both short-term and long-term strategies, will play an important role in Spain’s recovery, just as they did in the UK and Ireland.
The deleveraging cycle is just building up momentum in Spain and will continue to gather steam, buoyed by a renewed sense of confidence.
There are some potential disruptions that could impact how the drama unfolds, however. 

Firstly, a Spanish banking sector in ruder health, due to debt provisions and fresh capital, is dictating the price of assets more than seen previously in the UK and Ireland. Banks are out to eat more of the capital gains sought by opportunity funds. While the alternative lending scene may develop slowly given the lack of depth within the Spanish secondary market. And the third and final point; political stability is yet to be tested.

With an upcoming election, increased volatility in the market and an important ECB decision on quantitative easing, undetermined as PDI was going to press, Spain presents opportunity tempered with risk.