Nonperforming loan market picking up steam for investors

The results of Ernst & Young’s latest US nonperforming real estate loan survey revealed that investors could see more opportunities to acquire commercial real estate debt in the year—if not years—ahead.

Investors are beginning to enjoy an uptick in opportunities for acquiring nonperforming commercial real estate loans after a few years of rather slim pickings, according to a new survey conducted by Ernst & Young. In addition, investors believe the nonperforming real estate loan market could remain active for up to another four years. 

The results of Ernst & Young’s latest US nonperforming loan survey revealed that investors could see more opportunities to acquire commercial real estate debt in the year ahead. Despite improvements in bank earnings and declining loan loss reserves, the sheer volume of US commercial real estate loans maturing in the next five years, which is estimated to be nearly $1 trillion, could put pressure on US banks to step up their efforts to sell off some of the more than $100 billion in nonperforming loans currently on their books.

Ernst & Young found that, in 2011, more investors allocated capital for buying nonperforming loans from banks than in previous years. Not only that, but those investors also wound up experiencing a higher rate of success in closing transactions than in previous years.

“In 2011, investment activity was at its highest level since we began our survey four years ago, and the expectation is that sales volume will remain high in 2012,” said Chris Seyfarth, a partner in Ernst & Young’s transaction real estate practice. “In fact, the survey found that investors generally expect the nonperforming loan market to remain active for another two to four years.”

Seyfarth noted that respondents to the survey are mindful of the impact the Federal Deposit Insurance Corporation (FDIC) is having on the market, especially with the high level of FDIC-designated ‘problem banks’ and their potential for selling off both individual nonperforming loans and nonperforming loan portfolios. Smaller banking institutions also are garnering the attention of investors. 

According to the survey, regional and local banks that have made thousands of construction loans and acquisition and development loans in regional or local markets across the US constitute a significant part of the commercial property loan market in the US and, due to the downturn, a significant part of the distressed loan market.

“Nothing is certain in the distressed market, but the decisions banks make this year on whether or not to reduce their exposure in the commercial real estate debt arena will tell us a lot about how long the distressed market has to run, “ Seyfarth said.

The survey also found that, of those who sought to purchase loans last year, two-thirds met with success, which is an improvement over the previous year, when fewer than 50 percent successfully closed transactions. In addition, despite concerns about the general availability of financing, investors also continue to seek leverage as part of their investment strategies, with 67 percent of respondents expecting some level of financing to facilitate their purchases. This is down, however, from the rather high 84 percent in 2010. Of those who expected or required leverage, roughly one-third aimed for leverage between 51 percent and 60 percent, and only a few expected to need financing for more than 60 percent of the purchase price.

US nonperforming loan investors also are casting their nets wider in search of the right deals. Europe’s sovereign debt crisis has resulted in more European banks restructuring their balance sheets and considering the option of putting portfolios of distressed loans on the sales block. The survey revealed that this has not gone unnoticed by larger US investors, who see Europe as a nonperforming loan market offering more opportunities and potentially higher returns than are available in the current US market.