German banks are drowning in bad debts, particularly in the real estate branch. Yet one man’s trash is another man’s treasure. American equity funds have been snapping up the portfolios being discarded in Germany.
Frankfurt's skyline is home to Germany's banks -- and bad loans
Karsten von Köller does not give most people the impression of being a cowboy. Smartly dressed in a pin-striped suit, with an aristocratic air about him but still mild mannered, you would recognize him as a businessman, but you would not necessarily know that he is managing billions of dollars for Lone Star Capital, a private equity company from Dallas, Texas.
Perhaps unlike one of the Lone Star State’s more high-profile cowboys of the moment, George W. Bush, Lone Star Capital likes to spend time in Germany. A lot. Or better said: Lone Star likes Germany’s bad loans, in the industry referred to as NPLs -- nonperforming loans, and there are a lot of those. German banks are dumping the NPLs onto the market in record numbers. Not individually, but in packages or portfolios whose files are so valuable that they are transported with a police escort from one German city to the next after a deal.
Germany's HypoVereinsbank and its real estate subsidiary, Hypo Real Estate, are purging themselves of their nonperforming loans
The financial institutions are happy to purge them. “They can quickly clean up their balance sheets and get a shot of extra liquidity,” said Michael Hüther, director of the Institute for the German Economy in Cologne. The sums involved are by no means miniscule.
Billions of euros waiting to be harvested
Last September, the Hypo Real Estate Bank jettisoned a nonperforming loan portfolio with a value of 3.6 billion euros ($4.68 billion) to Lone Star. No details were given as to how much the Texas equity company paid, but analysts estimate anywhere from between 40 to 70 percent of the portfolio value, which would be up to 2.5 billion euros. In Germany, the current NPL market is worth an estimated 300 billion euros and more portfolios are expected to hit the market in the near future.
The sales serve a few purposes. Rating agencies and investors have been pressuring banks to increase the quality of loan portfolios and want to shine more light on the rotting pile of bad credit. In 2006, the new accounting agreement Basel II also comes into force. It requires banks to increase their reserves against problem loans, so German banks are washing their hands of the dirt of bad mortgage and real estate deals, many of which were reached in the heady days after the fall of communism and reunification.
The effect of such transactions for banks is twofold according to Hans-Günther Nordhues, a Frankfurt lawyer who is active in processing NPL deals.
“Getting rid of bad debts would open up the possibility for them to enter into more profitable businesses in the future,” said Nordhues. “Secondly, the German banks are then reduced in size since a number of services and functions would be taken over by the capital market.”
Considering that the big German financial institutes such as Deutsche Bank and HVB Group have declared downsizing to be primary goals in the upcoming years, this is one viable means to do so.
The recollection of loans is not a strong point of German banks, according to Hüther. Those institutes suffering the most under the burden of bad loans do not “necessarily have the best know-how at their disposal when it comes to dealing with loans.”
An inside job is easier
That is where Lone Star and Karsten von Köller enter. Just over a year ago, he still belonged to the clique of mortgage and real estate bankers.
Lone Star Germany's Karsten von Köller is now all smiles as he turns to his peers to ease their banks of bad loans, and Lone Star is the beneficiary
Throughout the 1980’s and 1990’s, von Köller was on the board of the German mortgage and real estate bank Rheinhyp. When that bank merged with two competitors in August 2002 to create Eurohypo, he was named chairman of the board. Shortly thereafter, the 65-year old switched sides.
In 2004 he assumed the position of director of Lone Star Germany and now is going to financial institutions throughout the country, visiting his peers, and offering to buy back poor-performing loans -- naturally at a discount. If he convinces them to sell, Lone Star’s subsidiary, Hudson Advisors, goes to work getting the borrowers to repay.
“We try to offer [the borrowers] a solution for their NPL problem and to reach an agreement,” said von Köller, “but we also prepare the necessary legal proceedings that we may have to take if the borrowers do not cooperate.”
Lone Star Germany
Besides Lone Star, companies with names like Cerberus and Fortress are taking billions of US dollars from institutional investors such as state, corporate and university pension funds to purchase nonperforming real estate loan portfolios in Germany. Von Köller would not give any specific figures for Lone Star but did refer to analysts’ expectations that profit margins of 20 percent and beyond were possible. German banks could only dream of such returns. On the other hand, they are getting an injection of badly needed equity to maintain their dwindling status on the world financial stage and as Hüther admitted, Germany and German financial institutions are potential beneficiaries of knowledge transfer from the American equity funds on how to achieve good returns even on bad loans.