Investors hold the key to kickstarting the economy
Corporate finance expert Kevin Beary explains why the catalyst for banking liquidity might just be under our noses
Published 12/06/2011 | 05:00
though there are real grounds for optimism in terms of our ability to attract fresh capital, to understand why it has taken so long to match the supply and demand for new capital, we need firstly to consider some of the respective issues confronting the three major stakeholders.
The key challenge for Nama is that while it acquired assets in 2009 at heavily discounted values, the market has continued to fall -- resulting in banks being even further under water on their books today.
Banks need to downsize their portfolios (or in the cases of Nama, Anglo and Lloyds HBOS wind down their portfolios completely).
The projected future value (NPV) of the borrowers' cashflow, versus taking cash today to cut their losses must be weighed up. Additional funding is required from the bank to maintain the asset quality and value.
There must be a huge emphasis on the quality, integrity and trustworthiness of the current management team and their ability to execute the business plan.
It is important to examine the merits (and cost) of appointing a receiver to sell or manage assets where the relationship between the borrower and the bank has broken down
The bank's likely exit timeframe and mechanism is crucial, be it sale, refinancing or a capital markets structure such as Real Estate Investment Trusts (REIT), Commercial Mortgage Backed Securities (CMBS) and so on. Banks' overall return on capital and anti-embarrassment concerns in the event that the new investor receives early windfalls also needs to be considered.
There has been a noticeable improvement in sentiment and investor interest in Ireland, no doubt helped by the PCAR/PLAR stress test and bank restructuring announcements which were well received by the international investor community earlier this year.
Investors considering Irish banking assets believe that the Irish banks simply have little other option but to take their money.
But only a small number of these investors will succeed in acquiring assets from the Irish banks and at the same time make economic returns in the next four to five years.
Some of the new investors actively looking at Irish debt or assets include private equity groups, VC houses, hedge funds, sovereign wealth funds, infrastructure funds, overseas property development companies from the US & UK.
There is also strong interest in UK and US debt and assets from sovereign wealth funds from such countries as Abu Dhabi, Saudi Arabia, Qatar, Oman, Sweden, Malaysia, Monaco, Singapore -- even Libya.
However, banks and borrowers have grown weary of receiving presentations from scores of these investors week after week. To understand why this is the case we need to look closer at some of the different types of investors courting banks.
First, there is the low baller, who believes that because he has very deep pockets, this allows him to buy for a steal the assets from banks who are desperate for cash. However, there is a lack of appreciation among low-ballers that there simply isn't capacity on the balance sheets of our banks to suffer further losses.
Then there's the tyre kicker, who runs the slide rule over many projects in pursuit of the perfect deal. They will usually have impeccable credentials, are highly numeric, have an imperious command of issues such as global distressed markets and covered bond markets. But by the time they are finished their chin-stroking, the investment had been completely de-risked and the exiting bank had managed to re-lend into the deal. These investors have been looking at the merchandise for over 18 months and have yet to find the perfect deal. Guess what?
They are joined by the cherry picker, who tends to bid for a single prize blue-chip asset. But a serious flaw in a cherry-picker's thinking is that good practice dictates that banks will invariably sell the vast majority of blue-chip assets on the open market to the highest bidder.
The last sort of investor is the big spender. In some cases, market- related value may not always be the driving force behind their ambitions. A recent example were two recent London transactions involving Quinlan assets -- the Audley Square car park loan bought by Nama (believed to be sold at a profit of £140m to Qatar Holdings). More recently, there were several offers to Nama from middle eastern and other sovereign bidders for the loans associated with Maybourne Hotel Group. These bids valued three Maybourne hotels at over stg£1.1bn -- over 20 times EBITDA -- a great day out for the Irish taxpayer.
The borrower is in the weakest position today, and in most cases their equity values have been wiped out and they are left with huge personal exposure.
There has been a marked increase in the level of co-operation between banks and defaulting borrowers after enforcement actions taken by both the Nama and non-Nama banks.
To balance this, the majority of borrowers are managing their exposure in full co-operation with the bank and now realise that the only sensible course of action open to them is to work with the banks and stay in the game. This strategy is likely to provide borrowers with a second opportunity at some point in the medium term .
Some borrowers have unwisely chosen to play games with the banks, in the misplaced belief that they will be able to force the banks into further losses while remaining in control themselves.
Borrowers do have legitimate grounds for complaint with the lack of timely engagement from the banks where borrowers have invested significant time and capital either in preparing business plans, or in assisting the banks in reducing their exposure by capital raising or by selling assets as part of a process.
It's all about balance
In spite of all the many stakeholder conflicts and issues, real interest is being expressed by new investors who have taken the time to understand the depth of the Irish banking crisis, are realistic in terms of their value and return expectations, and are working in tandem with banks and borrowers, usually working through experienced local advisers. Some of the more creative themes and ideas emerging are as follows:
Investors are prepared to structure investments through instruments including preferred equity, convertible loan notes and mezzanine finance. This investment approach creates a very significant opportunity for the Irish banks to capture future upside while not being required to finance future cash calls to cover capital and operating expenditure.
There is no leverage available in the banking market at present. Investors prepared to do all-equity deals today and refinance at a later stage when normal leverage parameters return will get deals done and command better terms. Believe it or not, these investors do exist.
Compatible investors will either work closely with existing management teams of the borrowers or alternatively bring fresh management and operational solutions in sectors including real estate; hotels & leisure; retail & distribution.
It is important for banks and borrowers to understand clearly the mandates of different investors, i.e. are they control-orientated or empowered to enter into joint venture arrangements, will they focus purely on income bearing assets?
Expected returns from investors range between 1.5 to 2 times the value of their initial investment over 3-5 years. Investors are willing to incentivise management teams and are also prepared to share future upside with Nama/banks to mitigate anti-embarrassment concerns.
Given the need to inject liquidity into the stagnant bank portfolios and the arrival of a limited number of realistic and creative investors it seems that starting the process of re-capitalising the banks is closer and more achievable than we realise. You should expect some transactions completed within the current year.
If we are to believe our politicians, the bond markets may have to wait a little longer -- but the real market never waits for the perfect deal.
While some of the early investors will inevitably take some initial pain, those who move in early under well-protected and equitable structures and adopt a medium to long-term strategy on real estate values will see significant gains over the same period.
Kevin Beary is Managing Director of Beary Capital Partners, an independent advisory firm
Sunday Indo Business