The benefits of German banking consolidation

Deutsche Hypo’s purchase by one of its rival real estate lenders could prove a canny move.

The potential sale of Deutsche Hypo by NordLB presents its German rivals with a rare opportunity to grow through consolidation.

Fellow real estate lenders Aareal, LBBW and pbb Deutsche Pfandbriefbank are all reported to have approached NordLB, although a sale is not yet a certainty.

Banking consolidation is a hot topic in German finance circles. The number of credit institutions fell by 30 to 1,960 in 2015, the Bundesbank said last year, but Germany remains overbanked. There have been calls for further M&A activity for banks to boost margins and profitability to counter the squeeze of low interest rates.

In November, Deutsche Bank chief executive John Cryan added his voice to the debate, calling for more consolidation across European banking, especially Germany, so that European banks can compete on the global stage.

In the German real estate banking world, a sale of Deutsche Hypo would create a good opportunity for suitors to bolster themselves in a challenging domestic market.

With €25.8 billion of commercial property investment transactions in H1 2017, according to JLL, the market remains robust. However, with more equity at work, banks are competing for fewer mandates.

Figures from the latest German Debt Project report by the University of Regensburg speak for themselves. Albeit at 10 percent, growth in new business in commercial real estate finance last year was half as high as it had been in 2015, and it looks set to be halved to 5 percent in 2017.

Tough competition has kept loan margins shockingly low. In some cases, particularly when it comes to low leveraged core properties, debt financing can be arranged at below 60 basis points. Against this backdrop, consolidation in German real estate banking makes sense.

If Deutsche Hypo is put up for sale, its eventual owner would enhance its ability to provide large-ticket financings, as well as boost its presence in markets outside Germany with growth prospects.

Although Deutsche Hypo’s core business remained in its domestic market, new business volumes during H1 2017 – totalling €2.11 billion, up 17.4 percent year-on-year – were boosted by real estate lending in the Benelux region. In this market, the bank wrote €358 million, up by 321.2 percent over the same period a year earlier.

Benelux countries, as well as France, the UK and Poland, have been Deutsche Hypo’s longstanding target markets and the bank is now opening a new office in Spain after having pulled out in 2013.

As well as bolstering lending books, consolidation can help cut rising administrative costs. According to LBBW, stricter regulation is leading to an increase in operating costs of 2-10 percent until 2020, depending on the size of the bank.

There have been instances of German banks growing through consolidation in recent years. Aareal, one of Deutsche Hypo’s suitors, beat private equity firms to buy WestImmo in 2015 for €350 million, gaining a €4.3 billion performing CRE loanbook in the process. In 2013, it bought Corealcredit Bank for €342 million.

Another German bank currently on the block is HSH Nordbank. Owned by two German states, it needs to be sold by February 2018 under a deal between Germany and the EU to determine the future of a bank hit hard during the crisis by bad shipping loans. However, the HSH Nordbank sale has a very different profile of suitors, with US private equity groups understood to be circling.

The interest in Deutsche Hypo from German banks highlights that growth through M&A appeals to the market leaders. Although Deutsche Hypo’s sale is driven by its parent group’s need to repair its balance sheet, a deal could highlight the benefits of consolidation in Europe’s most competitive real estate financing market.