London: More UK banks are seeking to offload old risky mortgage books as rising property prices provide an opportunity to finally sell out after years of sitting on heavy loan losses.
A number of lenders with legacy mortgages that were written down in value after the financial crisis are pursuing deals with private equity funds that now have access to cheaper financing. For banks, the chance to sell out of closed or “toxic” mortgage books is a way to boost capital buffers and clean up their balance-sheets.
At the same time, appetite for higher-yielding assets among hedge funds and private equity investors in the current low interest rate environment is growing. UK Asset Resolution, the government vehicle that acquired the loan books of defunct lenders Northern Rock and Bradford & Bingley, recently sold a portfolio of performing residential mortgages for £2.7 billion (Dh15.8 billion).
The deal resulted in a £33 million profit as the mortgage book was sold at a premium over book value to Commercial First, a consortium owned by private equity group Carval Investors.
Experts believe the sale represents a turning of the tide for banks stuck with legacy mortgage books, as investor demand has returned. “It’s a significant development that a portfolio of performing assets of that size could be sold,” says Justin Sulger, partner at AnaCap, a private equity house. “That funding was not available for those assets two to three years ago.”
Over the past 18 months, private equity firms have been able to take advantage of cheap debt to help leverage portfolios. Andrew Jenke, a partner at KPMG, says: “Will there be more residential performing loan deals taking place in the UK? Yes, because private equity firms have a desire to own these sorts of assets and are becoming more active. The UKAR sale underlines that.”
He adds that there are a number of performing mortgage deals at the moment with bids “in excess” of book value. Experts say that private equity firms can also be more willing to take on “riskier” mortgages such as higher loan-to-value loans, for example.
“Private equity firms don’t have those concerns in the same way banks do, and as long as the interest rate can sustain their financing costs and provide them with a small return, they’re a good owner,” one expert says.
Rising property prices in the UK have positioned the market as a “safe haven” relative to Europe, Sulger says. “There’s now more willingness to take risk... you’ll see more performing loan transactions.”
In the year to August, house prices rose by 11.7 per cent, according to the Office for National Statistics — although there has been some evidence of a softening in the market in recent weeks. Ray Boulger of John Charcol, a mortgage broker, says: “With property prices having risen across the country, the degree of problems for mortgage lenders — even where borrowers have defaulted — are clearly lessened. Investors are looking to higher yielding assets because of ongoing lower returns from risk-free assets.”
But lenders should not count on offloading loan books at a premium, like UKAR. Banks selling unprofitable legacy loans that were originated on low interest rates tend to require a discount to be sold. “We’ve invested in performing and non-performing loans, and required some level of discount,” Sulger says.
Banks have also had some success shedding non-performing loans — those mortgages where borrowers have fallen into arrears — as they seek to reduce risk, boost capital buffers and exit certain markets. Lloyds Banking Group, for example, recently agreed to sell about 4,000 non-performing Irish mortgage loans to Lone Star Funds, a private equity group. The bank sold the assets at a discount to their €1.1 billion (Dh5 billion) face value, and the sale was capital accretive.
Meanwhile Investec, the specialist lender, sold Start Mortgage, its subprime mortgage business, also to Lone Star. The loan book had fared badly through the crisis and made a pre-tax loss of £21 million in the year to March.
The move followed Investec’s sale of Kensington, a specialist lender it bought in 2008 just after Northern Rock went bust, to private equity owners Blackstone and TPG, for £180 million in cash.
“Had they sold a few years ago, they would have taken a hit,” Boulger says. “Now the market has picked up and there’s an opportunity for Kensington to increase lending.”
Selling at a “premium” should be viewed relative to how much the book value was written down by in the first instance, Boulger says. “It could be misleading... the degree to which the book was written down could be quite large. It might be a premium to marked-down book value, but in all probability a discount to par value.”
— Financial Times
