Recycled business

Debt is usually only talked about when it becomes a problem. With the current shopping spree for properties, the topic rarely features on the first pages of the trade press. But we have decided to take a look at it for this very reason. The property acquisitions made by Spanish and Irish investors during the investment boom of 2005–2007 may have now passed into the realm of myth, but the majority of these projects have since been sold to new owners, while many are just burning a hole in creditors’ balances – and more often than not, these creditors tend to be the banks. However, these banks are usually unwilling to exchange such properties for debt. “When it comes to the enforcement of receivables, banks are generally rather passive. They generally try to restructure distressed projects, somehow with the involvement of their client and try to persuade the client to sell the property themselves,” says Mira Kantor-Pikus, the strategic consultancy director at Cushman & Wakefield in Poland. “There are very few banks in Poland that aim to acquire properties through taking on full ownership of the property. Banks do not want to become owners because this would mean that they take on all the public and legal fees, such as taxes and the owner’s civil responsibilities,” she adds.

The product is out there

This view is confirmed by the market itself. Last winter we saw the acquisition of a portfolio of nine shopping centres with a combined area of 55,000 sqm by Castlelake and Invel Real from Caelum. This was financed by BZ WBK, which had earlier acted as the lender with regard to the portfolio. The transaction did not involve highly exposed properties, but it was somewhat typical because it included two large entities that specialise in the distressed debt market. Castlelake has so far traded more than USD 7.4 bln of such assets, while the equivalent for Invel exceeds EUR 20 bln. Through the acquisition of a distressed portfolio both institutions of course expect to make a profit. “We are convinced that the successful cooperation of Invel and Castlelake will allow us to discover and release the potential of the purchased properties, which will benefit our investors,” says Jonathan Fragodt, a partner and portfolio manager in Castlelake, who goes on to add: “We are waiting with some impatience for the opportunity to maximise the value of the acquired assets and at the same time are looking for new investment opportunities in the region. There will certainly be no shortage of opportunities to buy these.” At the end of June, Plaza Centers, which has been implementing a restructuring programme since 2014, announced the signing of an agreement with the bank that had been financing the Zgorzelec Plaza shopping centre. “An entity is to acquire the shares of the company responsible for the project, with the bank remaining involved in the process. The parties agreed to complete this process by mid-September. This will make it possible to reduce the debt considerably,” explained Dori Keren, the CEO of the company, in June.

Interested parties – abroad

The entities interested in such offers are mostly foreign. Polish financial institutions in this market are still in their infancy. Small securitisation funds are only just starting to emerge and they are now looking for projects. “Our market is very shallow. There is a lack of precise data, but portfolio sales can be counted on the fingers of one hand. Of course, I am not talking about the sale of retail receivables, which are quite popular. Polish banks often refrain from selling large receivables because they have not yet reached the stage when it is better to sell offering a substantial discount than to keep properties bearing bad debt in their portfolio. Only two or three banks have seriously embarked upon such an approach. The others are saying: we do not have such bad portfolios, so we are coping,” argues Mira Kantor-Pikus. It seems, therefore, that such problems are being swept under the carpet and treated like an embarrassing disease. However, Western Europe has managed to deal with this issue.

Billions traded... but not here

The annual value of transactions in the continent’s West and the South (particularly in the latter) is calculated in many billions of euro. “In spite of the relatively calm beginning to the year, we expect a considerable growth in activity over the next six months. Sales transactions worth app. EUR 28.6 bln are currently in progress. We expect that their value for the whole year will amount to EUR 70–80 bln,” claims Federico Montero, the receivables sales director in the corporate funding department at Cushman & Wakefield EMEA. “The successes of receivables sales in Spain and Ireland are the result of establishing an asset management agency and setting realistic reserves for unpaid receivables. Even though Italy has started to take some steps towards the liquidation of distressed debt, further legal reforms are needed in terms of enforcement proceedings and setting appropriate reserve levels in order to ensure the similarity of investors’ and sellers’ prices,” he adds.

Problems still lurking

While the debt trading machine is in full swing in the West and the South, it is still far from being up and running in Poland. “The banks here still have some problems from the past, and when it comes to acquiring properties in exchange for debt, this tends to relate to projects financed earlier on, particularly in 2007–2008, when financing at an LTV of 90 pct was very popular. This mainly involved 5 to 6-year loans that should have been refinanced in 2012–2013. However, the banks then were no longer willing to finance properties at levels of 80–90 pct LTV and this was actually when serious problems with bad debt started,” believes Cushman & Wakefield’s expert. And the problems mount up for the banks as well as the debtors. The bank does not want to take on the ownership, the debtor does nothing to the deteriorating property – and so both parties are held in a kind of suspended animation. The investors who have put their own funds into the property (regardless of the loan) consider it as their own enterprise and pay little attention to the bank. Financiers can admittedly increase their margin, but this results in incurring greater costs if not accompanied by active renovations. If the banks are faced with a failure to repay the debt, such projects are transferred to their restructuring departments, which are often poorly prepared for property management and the implementation of an efficient restructuring strategy. So the banks tend to focus their activities on making sure that their loans are repaid somehow, by increasing penalty interest and applying other pressure for the repayment of the capital. This keeps the debtor off-balance and less able to remedy the situation. However, there is a way out of this vicious circle. If an attempt to cooperate with the debtor does not work, decisive action needs to be taken. If the creditor sees that they have problems with a certain client, they should not wait until they have to implement the restructuring themselves but should sell the receivables straight away. This is when a professional real estate entity enters the game and starts treating the issue like an ordinary investor.

“The independent acquisition and sale of properties is not ideal for the banks for tax reasons. The revenue from the sales of properties is subject to a 19 pct tax. However, there is another way – the selling of receivables. If they are sold to a securitisation fund, the revenue from such sales is not subject to tax. Usually we deal with the sale of a package of properties; however, individual receivables are also sold, particularly the high-value ones,” claims Mira Kantor-Pikus. As she goes on to add: “Our market is not as developed as in the West. When the banks see the first symptoms of problems with a given client over there, they create packages of such receivables and then try to sell them. In Poland some banks have also started to think in such terms, mostly because we have two elements that are a burden for banks. They have to pay the costs of the bad debt and support the Bank Guarantee Fund (0.23 to 0.25 pct of the asset value per year). The bank tax, which amounts to 0.44 pct on the asset value per year, is another burden. This needs to be paid regardless of whether the debtor repays the loan or not. Because of this banks are starting to look for ways of off-loading the burden of bad debt. A large number of unpaid loans also increases risk costs and has a negative impact on the equity adequacy ratio,” emphasises Mira Kantor-Pikus.

The sale of receivables has one more, extremely important benefit with regard to the health of the market. Their buyers usually have highly effective legal departments. It is usually the case that a bank loan is not the only receivable that is a burden on the property. The bank is usually the main creditor, but this is accompanied by demands of the tax office, utility suppliers and debtors’ partners. The aim of the securitisation fund is to dispose of the other receivables upon taking on the creditor’s rights and to effectively obtain an unburdened property.

Financiers are more cautious

The banks are aware that the Polish market is already rather heated and they are preparing for the possible risks. There are also some serious concerns on the financial market with regard to interest rate levels and the złoty to euro ratio. This can be seen in the fact that the amounts secured by banks against an increase of interest rates are getting higher. Only recently 50–60 pct was enough – now it can be 80 or even 100 pct. This increases the costs related to financing and will indirectly impact yields. “Banks have drawn conclusions from what happened in 2008 and there has been a sea-change in their approach to financing commercial properties. When yield compression was observed in transactions for commercial properties, the banks started to lower the LTV level for financing projects. Just a year ago they were financing app. 70 pct of the project, but then the level dropped to 65 pct and to 60 pct by the end of 2015, which has been the level ever since. The banks have also adopted a more aggressive repayment scheme. In the past they were willing to accept 40-year amortization, but now 20-year amortisation is the standard – an average of 5 pct per year. The banks are also more selective with regard to project financing. They have become very reluctant to do this with older properties – due to the possible costs of the renovations and the relatively high risk resulting from new supply, which currently there is a lot of. Such an approach could result in lower volumes of bad debt generated by new financing,” forecasts Mira Kantor-Pikus.

We are focusing on the banks because, contrary to appearances, there are not so many options to choose from in Poland. There is financial leasing, where the leaseholder is the property owner; these have are higher LTV levels, but this market is very small. Mezzanine financing is also rare and is usually given for development projects built without pre-leases. There are also junior loans. The problem is that very few banks accept other ways of project financing, even given a well prepared contract. And then there are also joint ventures. However, this tends to work well only for small projects. Large investors usually do not want to have a partner. So our market is relatively poorly developed in terms of property financing. The banking sector is the main driving force on the market and will be the prime mover in terms of changes. “The market is small and many banks are not yet ready. However, if they realise the full consequences of holding onto distressed debt, they should become more serious about creating packages of receivables and selling them on. If more securitisation funds appear on the market, this should encourage things to move in the direction we have seen in the West. Perhaps it will take two or three years before the market starts to adopt the Western approach. There is, however, huge potential in doing so,” argues the expert from C&W.

Will there be a shortage of purchasing opportunities in terms of distressed receivables in spite of more cautious policies? The situation on more developed markets suggests we should not be too concerned about this. The question we should be asking is a different one. Is the market for distressed assets secured with commercial properties finally about to spread its wings in Poland? For this to happen we have to learn how to talk more volubly and openly about this issue.