German lenders warm up for 2015 deleveraging race

Commerzbank set to lead lenders’ push to cut domestic exposure, reports Lauren Parr

Commerzbank’s planned sale of an €800m former Eurohypo German non-performing loan portfolio, in potentially optimal commercial conditions, could fire the starting gun on greater property loan deleveraging by German banks at home.

REC 02.15 - 09
Ernst & Young’s Daniel Mair

Daniel Mair, a partner in Ernst & Young’s transaction advisory team in Germany, says the first sizeable German commercial real estate portfolio sale by a German bank is likely to achieve a good price “because there is a lot of investor interest and that will encourage other banks to do the same thing.

“It’s quite likely that larger players from the banking side will offer portfolio deals through a competitive auction process in the future and we’re getting quite close to somebody making a move,” he notes.

Commerzbank no doubt deems it a good time to sell just over a third of its €2.1bn of German non-performing loans (according to its Q3 2014 results), having achieved better-than-expected prices for Eurohypo’s £4bn UK portfolio and nominally valued €4.4bn Spanish portfolio (Project Octopus).These were sold respectively to Wells Fargo and Lone Star at a 3.5% blended discount in July 2013; and JP Morgan and Lone Star for €3.5bn in May 2014.

Asset sales stack up

Other banks may also consider commercial conditions to have reached a point at which German asset sales now stack up. “We are in discussions with banks that think it is a good transaction market now,” says Mair. “The market dynamic is good and funds have been raised that would like to buy non-core assets. So 2015 and 2016 could see more active deleveraging through loan sales.”

Sellers may include big banks such as Deutsche Bank, UniCredit’s HVB and others. At least one European bank is willing to sell a “three-digit-million” loan portfolio secured by German real estate this year, an adviser notes. Landesbanks are also expected to sell loans in their domestic market, but it is hard to estimate when, in what quantities and how much will be performing and how much non-performing (see panel).

REC 02.15 - p 24 pieBad banks FMS and EAA, linked to Hypo Real Estate and WestLB respectively, theoretically have plenty to sell in Germany. FMS’s €5.8bn of German commercial real estate exposure is largely intact, despite it having run down an inherited €27.2bn of CRE loans to €13.4bn in just over three years to the end of 2013 (see charts, left).

It sold a further batch of US property loans last June, nominally valued at $1.2bn, to Deutsche Bank, taking advantage of strong liquidity and heightened investor interest, FMS said at the time. In October it launched the sale of its remaining circa €750m Spanish and Portuguese commercial real estate book, dubbed Project Gaudi.

Meanwhile, EAA is under way with the sale of WestLB’s property finance arm, WestImmo, which holds €10.4bn of German commercial real estate loans (see below).

Bad banks in no rush to sell

Sources say bad banks’ value-preserving strategies and long lives mean they are in no rush to sell and are likely to market assets opportunistically in the coming years. But while most FMS loans have long maturities, its real estate book is shorter term.REC 02.15 - p 24 bar

Most German banks defined what constitutes core and non-core assets up to three years ago. Cushman & Wakefield recorded around €90bn of gross non-core real estate exposure at the end of Q1 2014 (before the Project Octopus sale) by eight German institutions – Hypothekenbank Frankfurt, Commerzbank, Deutsche Bank, LBBW, DZ Bank, Deutsche Hypo, FMS; and EAA – with €48bn of the total in Germany.

While German banks have been steadily deleveraging commercial real estate debt – PwC figures show €19.5bn of CRE loan portfolio sales since 2012 by banks with a German head office – their activity has so far been mainly in international markets.

Commerzbank’s sale of former Eurohypo assets abroad made it one of 2014’s most active sellers. Besides its UK and Spanish loan portfolio sales, it sold €700m of loans in Japan, to PAG, and has also sold around two thirds of its circa $2bn US exposure.

The group is also thought to be close to selling its Polish commercial real estate performing loan portfolio, which has a €900m unpaid principal balance, and is mulling sales of its Dutch and Italian books.

HSH Nordbank aims to sell in the Netherlands, where it lent to closed-end funds that have made big writedowns. It has made good progress in resolving its €3.2bn Nordic exposure in the past three years, through borrower-by-borrower restructuring and refinancing, managed by Situs.

But in their home market, German banks have been “sitting it out”, comfortable with the domestic environment, says Mair.

Volker Oehls, managing director of Situs’s Frankfurt office, says: “So long as collateral values improve, even without active asset management and with lending still the banks’ business focus, there is no immediate need to sell loans, especially sub- or non-performing ones. For performing loans, banks are not going to sell assets below par because previously agreed margins are higher than on newly originated loans.”

 A political dimension

Also, as CR Investment Management managing director Jacob Lyons notes, in Germany, banks “have always been more perceived as customer-focused businesses in the long term, versus say UK banks or investment banks. It is not seen as politically acceptable for a German bank to sell or assign a domestic loan to a third party, so banks haven’t offloaded much.”

Domestic deals by German institutions in 2014 were few and far between. Deutsche Bank sold the €828m Mars Fixed I Loan to Kildare Partners, secured against 28 German commercial properties, in March; while German fund and asset manager Publity sold a portfolio of non-performing loans with a face value of €213m to Link Financial, via loan auction platform DebtX, in May.

But there were sales of German debt portfolios by foreign banks “typically wanting to get their money back and concentrate on markets they will look at in future”, Oehls says. Lloyds sold the €590m nominally valued Project Aberdonia to Marathon in March, while in April, Nationwide sold Project Adelaide, a sub-performing German portfolio with a circa €850m outstanding balance, to Oaktree Capital Management.

Investment banks were the first to cut their non-core exposure following Lehman Brothers’ collapse and “have not got much left in Germany”, the adviser says. Morgan Stanley “had a large book, but has less than €900m left; everything else has been repaid”.

While only a small portion of German banks’ non-core exposure has been shifted, the market could evolve in the next couple of years as institutions take advantage of favourable conditions.

Profits squeeze and Basel lll may slim down a crowded market

What constitutes non-core business for German banks could change in the future, because of the Basel III capital requirements, which are being phased in by 2019.

All but one of 24 German banks passed the ECB’s Asset Quality Review (AQR) and stress test. Corporate banks such as Aareal Bank have completed equity raisings from shareholders, while the landesbanks are now “clean”, according to one adviser.

But one European originator says that if the exercise had been carried out on a Basel III basis, more banks would have failed. “A lot of banks deferred difficult decisions but they’re running out of time now,” the originator says. One result could be more sales of capital- intensive performing loans — as Deutsche Bank has done in the US in its sale to TPG.

PwC’s Richard Thompson, global leader for portfolio transactions, says commercial real estate lending is less profitable than it used to be. “The regulatory cost is fairly significant; the operational risk spotlight is on; then factor in the cost of capital and a benign, low-growth, low-interest-rate environment. These elements have an impact on bank margins’ cost base.”

Germany has a very competitive CRE lending market, with around 20 big lenders and margins as low as 40bps for strong assets in top cities. Corporate and savings banks are financing smaller assets, up to €25m.

With no lack of finance, margins on some deals heading too low to be profitable and higher-margin lending more capital intensive, banks are evaluating where they deploy capital and there could be room for consolidation in Germany’s overbanked sector.

The AQR is also expected to prompt further bank deleveraging and restructuring. “A raft of banks ‘above the line’ will need to restructure to improve returns to shareholders and there will be dialogue with major investors seeking to acquire assets from banks,” says Thompson.

One property banker says: “The topic of 2015 in German property is what happens to Deutsche Pfandbriefbank.” The government-owned bank is due to be privatised by the end of the year. The market is also waiting to see which of two bidders, Aareal Bank or Apollo Global Management, will win WestImmo.