Obsession

December 18, 2012

Everyone wants a piece of Europes distressed debt pie. But investing is hardly easy.

While all the US banks cut their ties to Europe, a new crew of players is just getting in, making big investments as the typical supporters of European growththe banksget out. This US fund spending spree has been constrained to northern Europe alone. This reality deepens the prospect of continued recession in the South; whereas there might be a floor on how far Germany can fall, a moment when Italian, Spanish, or even French assets will be deemed cheap enough remains far off. Although European leaders have moved closer to making the euro area an integrated unionmost recently with an agreement to establish a centralized banking supervisorthe next challenge to averting a protracted economic meltdown are ineffective legal systems.

Case in point: the legal challenges around enforcing mortgages are already stopping funds from purchasing assets they may otherwise view as cheap, allowing companies and properties to further decline in value. Just take the biggest distressed real estate debt player right now Lone Star Funds. The firm, which had already purchased 1.6 billion ($1.3 billion) in distressed commercial loan portfolios earlier this year21% of all such sales that had happened up to Septemberadded to that bet last week with the 1.1 billion acquisition of TLG Immobilien. which owns 800 buildings across Germany. But Lone Star is just the most prominent of the private equity and hedge funds gorging itself on distressed debt in Northern Europe.

Certainly part of the reason for this is regulatory, according to a lawyer for Vinson & Elkins, a firm which has worked closely with Lone Star and other asset management firms in the past. France and Italy restrict the ownership of many distressed debt assets to firms that are recognized and regulated as banks (pdf). Right off the bat, this rules out asset management firms which might otherwise like a share, too.

Then there are the legal issues involved in enforcing any kind of distressed debt agreement. The lawyer offers an example: In France its certainly more difficult enforcing on a mortgage than it is in the UK, for instance, the lawyer says. Unlike France, in the UKthe time period for enforcement and selling the propertyit can be done almost immediately.

Then again, the relative surge in northern versus southern European deals may have more to do with bad numbers. While all European banks are trying to get rid of their property assets, banks are constrained by earnings: These banksthey cant really come down as much as they want [on the price of distressed debt] because they cant take that many losses on their books, says Natale Giostra, the head of UK & EMEA Debt Advisory for London-based real estate research firm CBRE. There is some activity all across Europe of banks looking to divest their loan portfolios but its not like there are a flood of loans on the market.

The dearth of southern European distressed deals this year because of bank health gets at a much simpler and related problem; it seems that Germany has institutions and an environment friendly to growth, investment, and innovation. Even France, which has a more stable economy than its southern neighbors, does not maintain policies that are friendly to business. Just take the case of Arcelor-Mittal, which tried (and failed) to shut down two unprofitable factories in Florange, France, last month. Such cases suggest that the shake-out of prolonged crisis in euro land could establish new hierarchies even among the crisiss winners.