Masked by a general focus on the European sovereign debt crisis and the major central banks’ relentless inflation of their balance sheet, a European fire sale of European nonperforming loans (NPLs) is taking place right in front of our eyes. According to some estimates, more than EUR 1 trillion of NPLs have already changed hands, with European lenders ready to get rid of another EUR 2½ trillion in the years to come. Since banks and broker/dealers alike are on the same side of the trade (i.e. sellers), there has been virtually only one single type of buyer: private equity firms. Those guys can’t raise money quickly enough to sweep up the NPLs nobody else wants to touch, paying merely 30-50 cents on the dollar. Among those players are Blackstone Group, Apollo, KKR, Oak Hill, Castlelake and Avenue Capital. The manager of the latter, Marc Lasry, characterizes the current times we are in as a ‘European Bankruptcy Bonanza’. He is also quoted saying that ‘bank after bank’ has been offering his firm assets for sale.
As private equity firms are struggling to provide enough liquidity for the tsunami of NPLs coming their way, hedge funds are lining up to grab a piece of the action as well. Attracted by the imbalances in the NPL market and benefiting from their competitive advantages in evaluating complex instruments, they assemble credit trading team and commit more and more capital to NPL investments.
There is a good chance that a few years from now, one will look back and view this as one of the largest migration of financial assets the world has seen yet. And as so often when there is a huge imbalance between supply and demand, transactions are taking place at ridiculous price levels. While dislocations such as the monetization of US debt by the Fed (more than $3tr since the financial crisis) are somewhat limited due to relative value trading and arbitrage arguments, there is virtually no limit as far as the value of NPLs can fall. Already, about one-sixth of the NPL market is believed to trade at 20% of its face value or below. What this means, most likely, is that asset prices are now deflated to the point that they look attractive for the remaining balance sheets out there not handicapped by regulation or by industry pressure to participate in this fire sale.
There are a number of reasons, why all this gets less (if any) headlines from the mainstream media. First, and maybe most importantly, both sellers and buyers are very much interested in keeping quiet. Sellers out of embarrassment about the ugly write-offs they had to make, buyers because they don’t want to see the NPLs to improve in value until they have finalized their buying program. Second, when assets migrate onto central banks’ balance sheets or are bailed out by official institutions (EFSF etc.), the tax payer is essentially holding the bag, triggering a heated debate about tax payers potentially bailing out someone else. When the buying is done with private money from the world of shadow banking, there is little concern about potential investment losses. And third, the whole process of deleveraging banks’ balance sheet (at any cost) at the command of global regulators is widely perceived to be a healthy exercise coupled with the (maybe irrational) hope that at its end bank will become more active in the lending business again. Thus, nothing seems to be wrong with the tidal wave of NPL selling, as far as the average observer is concerned.
Ironically, it is the tax payer who foots the bill in the end. With most banks by now either owned, partially owned, explicitly guaranteed or implicitly supported by governments and pan-European government institutions, every Euro lost by banks is basically also one Euro lost by the tax payers. When assets trade, on average, around half of their face value in a fire-sale, the dislocation from their “fair value” price is probably not a basis point or two; more likely, it is 5%. 5% of, say, EUR 3 trillion is EUR 150 billion. This is roughly the size of Ireland’s GDP.