It is almost impossible to gauge the size of the commercial property loan-on-loan market in Europe, but real estate finance specialists say it is growing.

During a debate on the topic, held in London on 27 March by industry body CREFC Europe, one panellist estimated there was up to €2 billion of outstanding European loan-on-loan debt. This is finance provided by one lender, usually a bank, and secured by pools of loans written by another lender, usually not a bank.

This sort of activity has been taking place in the US since the early 1990s, when some banks retrenched from real estate lending. This created opportunities for debt fund managers to grow their market share, financed in some cases by the banks. During last week’s debate, one panellist conservatively estimated that the US real estate loan-on-loan market stood at around $40 billion, but said the figure could in fact be far larger.

Scale aside, the very fact that bank lenders in Europe are capitalising alternative providers of property debt shows that attitudes to how real estate can most effectively be financed are evolving. It goes some way to support the oft-made argument that Europe’s commercial real estate debt market is gradually becoming more like that of the US, where liquidity comes from an array of lender types that often work in tandem.

A functioning loan-on-loan market would benefit European real estate. Banks could effectively expand their origination capabilities by backing teams of non-bank lending professionals. Banks would also gain exposure to parts of the real estate market they do not lend into themselves – be that property types or ticket sizes that do not fit with their direct lending appetites. By lending at a certain loan-to-value ratio against a loan portfolio that already reflects a sensible LTV, banks could also take comfort from the fact that their leverage point would fall well below the value of the underlying properties.

Such deals also help to foster relationships. As one banker on the panel noted, loan-on-loan transactions can generate vanilla margins, but they create credit partnerships between banks and private real estate investors.

For alternative lenders – the borrowers of the loan-on-loan world – such facilities can help them to upscale their lending businesses. As one alternative lender at the event put it, they provide a home for every loan originated, thus reducing the need to find syndication partners for each deal.

As alternative lenders’ market share in Europe grows, loan-on-loan activity there is likely to increase too. However, there is some way to go. The number of banks providing these loans in the US is far greater than in Europe, meaning non-bank lenders in the continent do not yet benefit from a truly competitive market. There are other considerations: in the US, the collateralised loan obligation market is an exit option for lenders of loan-on-loan facilities, but a European commercial real estate CLO market does not yet exist.

There is also a debate around the level of recourse a loan-on-loan lender ought to have over the borrower. Some point out that the higher level of discipline on loan covenants in Europe, when compared with those in the US, should provide comfort for those banks embarking on loan-on-loan lending programmes.

Although much of the loan-on-loan activity in Europe this decade has involved investment banks funding buyers of non-performing loan portfolios, the new crop of deals is about long-term funding for performing loans. Loan-on-loan lenders will need to conduct the same amount of due diligence as if they were lending directly against the underlying properties. Yet this market has the potential to support the further growth of Europe’s alternative lending industry, while keeping banks’ exposure to real estate lending limited.

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