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Western EuropeApril 3 2005

Lone Star sees the silver lining

A US fund is leading the way in dealing with Germany’s bad loan overload. Brian Caplen reports.The great potential of German distressed debt may not be obvious to all but it is proving attractive to Lone Star, the US private equity fund that has purchased two-thirds of all the non-performing loans (NPLs) sold by German banks.Yet with an estimated €300bn of bad loans in the German banking system and so far only €10bn sold, there is no danger of supplies evaporating.
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Lone Star faces some muted opposition to its efforts. “German banks have been dealing with NPLs for decades, why should a US fund be able to deal with them better?” asks one German banker. But, in general, the fund is not regarded as an aggressive US outsider squeezing profits out of German weakness. Increasingly, it is viewed as a provider of superior technology in distressed debt that Germany badly needs to import.

In the firm’s tranquil offices in Frankfurt’s Hamburger Allee, there are no stars and stripes, no portraits of George W Bush and no Texans in sight. Karsten von Köller, the chairman of Lone Star Germany, is a former head at property lender Eurohypo AG.

In appearance and demeanour, Dr von Köller is the epitome of the conservative German banker. He speaks quietly and calmly and, despite three years working in New York with BHF Bank in the late 1970s, appears German to the core. After his retirement from Eurohypo, he started working as an adviser to Lone Star before taking on the role of chairman.

He notes the change in attitude among German bankers. “Until recently, German banks would not have considered selling NPLs. When I was at Eurohypo we said: ‘Why should we sell NPLs to someone who doesn’t know the market? The price must be very unattractive.’ It took time for the German banks to become convinced that it made sense.”

Lone Star has done two major NPL transactions with Hypo Real Estate, a subsidiary spun out of HVB. With HVB recently announcing that it plans to sell €15bn of property loans, more deals can be expected to follow.

Another key deal is being done with Dresdner Bank, which set up its institutional restructuring unit (IRU) at the beginning of 2003 and transferred more than €35bn of risk exposure to the unit in March of that year. Dresdner is currently negotiating with both Lone Star and Merrill Lynch to sell a €2bn portfolio of corporate and real estate loans. The deal should be wrapped up by mid-year.

“Dresdner originally planned to complete this restructuring in five or six years but now we will finish by the end of 2005,” says Björn Westberg, a senior adviser to the IRU. Dresdner’s restructuring has included sales of holdings in Chile, France and Turkey as well as loan portfolios.

Lone Star itself wants to buy a bank as an easier way of parking assets and has been linked to Mitteleuropäische Handlesbank, owned by Hannover-based NordLB.

Heavy workload

Dr von Köller says that it is important for Lone Star, and its workout affiliate Hudson Advisors, to do a good job on its NPLs in order to be trusted with other portfolios. “In Germany we have a mountain of NPLs; it’s an excessive amount. For the banks the workload is very heavy and they have to get over the history of the loan that makes agreement difficult. We establish a business plan for a portfolio with specific targets so that our loan officers know what they can agree to. When we approach a borrower, he quite often feels relieved that someone has finally called him.”

Germany’s NPL market is set to grow. Other US funds, such as Cerberus and Fortress, are interested and there are several new initiatives, such as the joint ventures formed between Citigroup and Eurohypo, and between WestLB and NordLB, to deal with NPLs.

Ancient legislation

The challenge of restructuring German bank balance sheets is made more difficult because of the antiquated state of German legislation. Borrowers, for example, must be consulted if their loans are to be assigned (unless they are in default), which makes securitisation difficult. The True Sale Initiative (TSI), a company founded by 13 banks and KfW, and which did its first deal for Volkswagen’s financial arm last November, is a first step towards redressing the problem (The Banker, February 2005, ‘Vibrant innovations’).

“We still have huge legal problems as far as true sale is concerned,” says Martin Ziese, head of asset-backed structuring at DZ Bank. “The big success of the TSI has been to clarify the situation but the securitisation market in Germany is largely synthetic.”

Where regulators and legislators fall behind, bankers must find innovative ways of achieving their ends – as illustrated by the rise of the NPL market and the TSI. German enterprise is being born out of German restrictions.

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