Scandinavian banks are set to become huge owners of Baltic real estate. A large proportion of home loans in the region come from Nordic lenders and repossessions are rising. Some banks are already making preparations to take over and service large numbers of homes. How will they manage this risk? Nordic banks are drawing on the lessons of Sweden’s property crisis in the early 1990s as an increasing proportion of their Baltic mortgage loans slide into trouble. With the local property markets comatose, selling repossessed homes would leave banks recovering a tiny fraction of their loans – one Riga-based banker indignantly says he was recently offered 5% of the original value to sell one portfolio to a local group of distressed investors. He turned the proposal down flat, but the alternative isn’t much more appetising. Rather than offloading assets at fire-sale prices, banks are opting for a change of role – becoming landlords instead of lenders, and creating local special-purpose vehicles (SPVs) to manage an expected flood of assets that will be sold off when values recover. It’s a business many of them expect to be in for five years or more and hope – eventually – to get most of their money back. “We are not looking to make money out of repossessing homes, but of course we’d like to get all our loans back,” says Carl-Johan Granvik, the Stockholm-based chief risk officer at Nordea. “So, if the choice is between dumping the collateral today at, say, less than 50% of the original value, or holding on and recovering between 80–100% of the value, then I think that’s a good deal.” Swedbank, for instance, has set up a subsidiary called Ektornet to manage a host of SPVs being created in Estonia, Latvia and Lithuania. Some will end up holding hundreds of individual apartments and other residential properties; others will manage chunky commercial property assets such as shopping centres or office buildings. As of mid-December, Ektornet owned assets worth around Skr200 million ($28 million), says Oskar Lundeberg, the company’s chief executive. But he expects to acquire up to Skr5 billion of assets in 2010, and a similar amount the following year. “We’re going to manage the property and wait for a couple of years to recover the value. When markets drop so quickly, a lot of people want to buy these assets but can’t afford them for the moment because they are suffering too. So, the way to do it is to wait for the economy to grow, as we did with Swedish property in the early 1990s, which was a successful strategy,” says Lundeberg. Skandinaviska Enskilda Banken (SEB) sees it more or less the same way, but will use the SPVs primarily for commercial assets. “The strategy is twofold. For residential flats and houses, the idea is to leave the owners there, paying what they can, and wait for their earnings capacity to recover,” says one Stockholm-based banker. “For commercial property, vacant lots, construction sites and walk-away houses, the idea is to take possession, sell them at auction and buy them via a 100%-owned subsidiary. Any property where there is a reasonable cashflow is more likely to stay in the hands of the owner, even if they are not covering all the interest. However, there are sufficient properties with little or no cashflow to make this a major exercise.” The bank registered one SPV in each Baltic country roughly six months ago – Estectus in Estonia, Litectus in Lithuania and Latectus in Latvia. All three started to acquire assets in November, and currently hold approximately 100 properties between them, says a risk manager at SEB. Nordea also has one SPV in each country but is using them solely for residential property, says Granvik. As of early December, the SPVs were holding between 30 and 50 individual properties – the idea is to repossess the homes and rent them back to their current owners or to other tenants at a price they can afford so the assets are generating some cashflow. Danske Bank is doing the same, a source says. One bank bucking the trend is Allied Irish Banks, which acquired a portfolio of Baltic mortgage loans for a reported €40 million from a US development fund in early 2008. A source at the bank says it has stopped making new loans but will keep the existing portfolio on its book and manage it as best it can. The banks’ problems are a result of the battering taken by the Baltic economies over the past two years. “There was a fairly large bubble, created over an extended period of time, with rapid loan growth and property price increases compounding the macro imbalances. The crisis exposed those vulnerabilities. As a result, the region has had to correct in a significant way,” says Mark Young, a managing director in the financial institutions group at Fitch Ratings in London. That means double-digit decreases in GDP and similar increases in unemployment and non-performing loans (NPLs). Homeowners are struggling to keep up repayments on mortgages that may now be worth twice the value of their property, office buildings stand half-empty and new shopping centres are searching for shops and shoppers – for example, the Ozas mall in Vilnius, which was under construction for two years and opened at the end of August. “It has 60,000 square metres of retail space, which is large for this market, and it opened right at the bottom of the trough,” says Algis Vaitiekunas, a Vilnius-based fund manager at the region’s biggest institutional property investor, Baltic Property Trust. “There are a lot of concerns about it. The tenants who had gone in there on pre-agreed terms are now trying to get a better deal and there are lots of vacancies – something like 30–40% – but the owner is a German institution and probably believes it can ride out the storm.” Lenders only have themselves to blame, especially when it comes to residential mortgages, says Vaitiekunas – too much money was pumped too rapidly into economies that don’t have an established credit culture. One banker who arrived in the region within the past two years agrees: “The concept of property ownership is relatively new here. More than one person has said to me they borrowed as much as they could and spent it in the good times because they didn’t think those times would last. Just 10 years ago, a 25- or 35-year mortgage was not conceivable, and then Swedish banks arrived here offering people 30,000, 40,000 or 50,000 litai: they saw it as money to play with, basically.” Banks are now suffering the consequences. More than half the roughly Skr50 billion in credit losses suffered by Swedish banks in 2009 have come from their Baltic businesses, according to a report published on November 10 by Finansinspektionen, the Swedish regulator. Danske Bank had Dkr29.4 billion ($5.65 billion) in total Baltic credit exposure as of the end of September 2009, and had made provisions of Dkr2.4 billion. For the same period, Nordea had €3.8 billion in impaired loans, with €522 million in the Baltic region. The pain isn’t going away. The SEB risk manager estimates banks will see NPLs for their Baltic portfolios peaking at around 20–25% next year – a figure Fitch’s Young agrees is realistic. Despite the huge volume of distressed assets, it will take time for the SPVs to build their stock. For a start, many banks are restructuring loan terms to try to keep the current owners in the property – a Fitch Ratings report published on December 2 suggests up to 20% of outstanding loans fall into this category at some banks. “We are trying to manage the residential properties,” says the SEB risk manager. “The rule is we don’t put families out of their primary residence: we try to work something out. If that rule is broken – and it hasn’t been broken yet – we’ll probably have to move the property into one of the SPVs.” Once the bank has decided to foreclose, the asset has to be repossessed and auctioned off with a number of other properties – the auction process being used to establish some kind of objective market value for the property. Getting to that value can take some time. The starting price in the first auction might be the same as the loan value. In the second auction, it might be cut by 20%; in the third, it will be even lower – the SEB risk manager says many apartments end up going at auction for around 50% of the loan value. Finally, ownership needs to be legally transferred, which can take between six months and two years, says Ektornet’s Lundeberg. As a result, although loan books are in a terrible state, the SPVs haven’t seen huge inflows of assets. That needs to change, says Jan Kvarnström, one of the founding partners at London-based bad debt consulting firm European Resolution Capital Partners (ERC), who served as the chief executive of Sweden’s banking rescue vehicle, Securum, as well as Dresdner Bank’s institutional restructuring unit. ERC has been working as an adviser to Swedbank on its bad Baltic loans. “My message is you need a huge sense of urgency to get control of the underlying assets and position them for an exit: stop the bleeding, get control and make sure it’s well managed. In Securum, with residential assets, we started quite early on to paint the staircase and cut the grass so we could negotiate with the tenants about rent increases,” he says. A sense of urgency alone isn’t going to transform lending officers and credit controllers into painters and decorators – the Nordic banks are effectively going to own property management businesses for the next five years or more, which means they need new skills. Swedbank has decided to do most of the work itself, hiring Lundeberg – another veteran of the Swedish crisis – to run Ektornet as a full-service property subsidiary that could have as many as 100 full-time staff by the end of 2010. In contrast, Nordea, which has a smaller portfolio, has outsourced the property management role to a local real estate brokerage, says Granvik. These differences will have an impact on the banks’ respective exit strategies. Nordea will emerge from the Baltic crisis as the owner of a big portfolio of property but with no ownership of the infrastructure and skills needed to service and maintain the assets. Swedbank, on the other hand, will own a fully fledged property company that could conceivably be listed or sold in its own right, as SEB did with its own property subsidiary, Diligentia, following the Swedish crisis. If the SPVs haven’t yet hoovered up much of the region’s distressed assets, neither have bargain-hunting investors. Baltic Property Trust’s Vaitiekunas says the firm plans to launch a €150 million opportunity fund next March, which will pick up distressed commercial property. He also admits it might not be easy to prise assets away from the banks in the short term: “We all talk about the discounts on offer, but anyone who has property that might be distressed – are they interested in selling it, are they offering it? Some of these banks aren’t actually holding this property yet. They have the owners under pressure, but they’re not in a position to sell.” Another distressed fund has already closed due to a lack of interest on the part of investors. “We were marketing from April 2008, but didn’t get enough to launch. We thought there was a good entry point, but the Baltic region is small, recovery prospects weren’t clear and people were cautious,” says the would-be fund manager. Bigger players have been sniffing around. The SEB risk manager says the bank has been contacted by more than one of the international distressed debt investors that moved aggressively into Germany when bank property portfolios ran into trouble in 2002 and 2003 – firms such as Cerberus, Oakwood and Lone Star. But he adds the interest has been “casual” so far. It’s likely to stay that way for now, says Nordea’s Granvik: “I think they might come later. At the moment, portfolios are just being put together, and they have no interest in doing that kind of work. International investors don’t come in and buy portfolios worth millions of euros – they want hundreds or at least tens of millions to make it worthwhile.” One or two smaller investors have been showing up at the state-run property auctions – sometimes individuals hoping to pick up a nice apartment cheaply – but the banker at SEB says lenders are often the only bidders. For now, then, the banks are on their own – and they’re happy enough that way. The Stockholm-based banker at SEB says despite the credit losses, banks can afford to be patient: “The unique feature of this Baltic property crisis is that it is highly capitalised foreign banks – Swedbank, Nordea, Danske and us – who are calling the shots. We have big provision reserves, have all taken new equity and can therefore control the market. We do not need to sell to the vulture funds and probably won’t do so unless those guys really start driving up the values.” Ektornet’s Lundeberg is similarly sanguine – Swedbank has a financial recovery and restructuring group, which has the mandate to arrange sales of distressed assets if they can find a good deal for the bank, but properties acquired by Ektornet are there to stay, he says: “We’ve heard from some distressed investors who want to ‘help’ the bank, but we can afford to wait. When property comes into Ektornet, we have it there for recovery and we don’t sell it cheap – we’ll keep it for better times.” When might better times arrive? The answer varies from one country to the next, with Estonia generally being seen as the best bet for a rapid recovery and Latvia as the worst, but in all three there is a sense the worst is now over. One banker in Riga says the Soviet-era apartments that make up around 85% of the city’s housing stock dropped from a peak value of €1,700 per square metre to a trough of about €460 – a drop of 70% or so. In recent months, though, prices have recovered slightly, to around €500. “Estate agents are starting to say €700 a metre is a level that might be achievable in the near term if some liquidity comes back in – and I think €1,000 is a figure any bank would be very comfortable selling at. But I suspect there’s a long way to go before that happens. A lot of the banks here are taking a five- to seven-year view on this market. It’s going to take that long to get any value out of the properties being repossessed,” the banker says....
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