Fears (or hopes) that European banks would sell large amounts of risky loans to raise cash have proven wrong — so far.

Stephen Gillespie, a debt finance partner in the London office of law firm Kirkland & Ellis, advised on one of the few such transaction to be publicly disclosed: the purchase of 26 loans owned by members of the Lloyds Banking Group by Sankaty Advisors LLC, the credit affiliate of Bain Capital. The transaction, which involved loans with an outstanding value of more than £500 million ($794 million), was signed March 15.

It has been the exception, despite interest by U.S. banks and other buyers. Why?

Disposals have been limited because of differences in the way banks account for their riskiest loans, Gillespie says in an interview. Those banks that cannot attract prices for impaired assets that are above their holding values cannot sell without a loss. Still, he expects European lenders to bring more distressed loans to market before the July deadline for 65 European banks to reach a 9% ratio of core Tier 1 capital to risk-weighted assets.

A bank recapitalization plan announced in October 2011 left the largest institutions far short of the capital they would need, to the tune of €84.7 billion ($111 billion), as of Sept. 30. Banks have two ways to close the gap: raise capital or shed assets.

Some observers feared that such disposals could depress prices, creating the potential for big profits by investors. But so far, sales have been relatively limited, in part because the European Central Bank stepped in to provide liquidity, allowing banks to raise capital more easily, and in part because many prospective buyers and sellers could not agree on price.

Here are excerpts from the interview:

Why haven't we seen more loan sales, or at least sales of large portfolios of loans?

STEPHEN GILLESPIE: The reasons there have not been as many large disposals [of loans] has primarily to do with impairment policies. Different banks pursue different policies in the way they account for impaired assets on their on balance sheets. If a bank is carrying an asset at a value that is higher than a purchaser is willing to pay, clearly it's not going to want to sell (the asset) and crystallize the loss. The reason some banks are reluctant to show fully impaired value on their balance sheet is that the capital adequacy rules they are operating under [require them] to allocate capital on a point-for-point basis, relative to impairment. It's a double-edged sword.

Industry estimates for asset disposals over the coming years range from $655 billion to $3.9 trillion. Do you see any more deals in the pipeline?

There will be [more]. I am talking to bankers, our clients. … The market expects a number of larger portfolio sales before the end of July.

Is there a limited pool of buyers?

The buyer must be someone who understands the European market, how restructurings get done in cross-border context and has the appetite to put management time in to generate a return on assets. You don't buy at 80 [cents on the dollar] and get repaid at par in two years. …Fewer people meet this criteria. There are very deep pockets of finance available to buy these types of assets, the people who play in the space have raised significant amounts of money, but there are fewer of them.

How are sales conducted?

Typically these are sold through an auction process. The seller would invite individual bids from a broad group of first- round bidders, based on limited disclosure; it would invite a number into a second round, making much fuller disclosure, asking for fully financed, committed offers. Typically it would then go with a preferred bidder or put two bidders into a bake-off. Portfolios are sold much the way M&A is done in the secondary market. Normally you have an investment bank run process, but here the vendor normally is a bank, (so) banks can run the process themselves. They don't want another bank picking over the loan book."

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