Traditionally holders of debt on their balance sheets, the country’s lenders are now increasingly selling down positions. Lauren Parr looks at why, how and who is on the buy side.
German banks’ annual results for 2015 provided a window into how they are making their real estate business work amid a tougher regulatory environment.
The likes of Helaba, Aareal Bank and pbb Deutsche Pfandbriefbank revealed their intention to syndicate a greater proportion of loans than they may have previously.
In Helaba’s case, this equated to 20 to 25 percent of the €8 billion to €10 billion of new origination (half of it in Germany) that it’s aiming for in 2016.
The new approach marks a major shift. Just a few years ago, the bank’s lending was purely bilateral, held on balance sheet.
The process of selling down positions to debt buyers has become a bigger part of what traditional German real estate balance sheet lenders now do.
Driven by regulation and lower margins
Helaba’s head of debt capital markets including syndication, Norbert Kellner, believes banks are being “forced to think about how they can smartly amend their strategy” as a consequence of regulatory uncertainty combined with “the low interest yield situation we’ve been facing for years now, and don’t know how much longer will go on for”.
Historically, German banks involved in long-term asset-based lending held a notion of real estate financing that loans were to be booked and retained on balance sheet. A very established way of business for mortgage banks has been to refinance through the pfandbrief market.
Post-crisis, a fact banks must face is that the cost of doing such business has, and continues, to get higher as regulation takes hold.
Furthermore, Basel committee proposals could shake up the way most German banks quantify required capital for credit risk. Currently, banks use their own ‘Advanced Internal Risk Based’ (A-IRB) model. However, this may be replaced by a standard version, akin to the slotting regime UK banks are governed by.
Discussion over the final incarnation of Basel III and new dialogue regarding Basel IV, which banks expect to have an even bigger impact on what they are allowed to do, has set the tone for continued uncertainty.
Kellner’s view that “the cost of holding debt on balance sheet is likely to be higher in two to four years’ time than it is now” is widely echoed.
The natural bank response is to pass higher costs onto borrowers by way of increased loan margins, yet this hasn’t been practical in the German real estate market. For the last several years spreads have been reducing particularly for the core, safe business that German banks lean towards.
“The bottom line is: German banks have to alleviate higher costs but the returns generated by their usual business are getting lower. It’s coming to a point where people need to rethink strategies,” Kellner reiterates.
“For us to be in this market we have to create additional income. It’s getting more important, especially with additional regulations and uncertainty,” he says.
How it works
The potential to syndicate provides banks with the comfort to underwrite large deals, attached to which are higher margins. When they sell down debt, arranging banks typically retain more than half the fee they earn up front on a loan and take a ‘skim’ on the margin which improves the pricing on the piece they keep.
“The number one reason for a traditional balance sheet lender to syndicate is to manage its balance sheet,” says Anni Hönicke, global head of real estate lending at DekaBank.
It has always been used as an instrument to manage large loan limits and concentration risk by asset class, region and client group.
Risk diversification remains an important element but with the cost of holding capital against some loans affecting banks’ profits, each deal is looked at closely and the importance of active balance sheet management is amplified.
Aside from access to the widest possible range of loans, another reason a bank might engage in syndication is to “create a reputation as being an active player and maintain relationships with participants,” Hönicke says.
Helaba’s move towards greater syndication builds on “what we’ve done so far successfully but, by deleveraging, uses our book a bit better,” according to Kellner.
In order to facilitate this it has structured its business into distinct units reflecting two groups of clients seeking different product: fellow banks, big insurance companies and debt funds; and regional savings banks (known as Sparkassen) which make up the majority of its shareholder base.
At the low-risk end, Sparkassen will take smaller, lower return positions while life insurers – for example – prefer core, long-term loans and can bear a large final hold but are typically less flexible than banks when it comes to early prepayment charges.
Those institutions with established real estate lending teams like Allianz Real Estate and Standard Life can take part in more complicated deals.
Allianz provided €365 million as part of a €630 million senior facility Aareal underwrote for NorthStar’s acquisition of 11 office assets from SEB last year: a deal which involved financing a cross-border portfolio with tranches in various currencies.
Working in conjunction with an insurer can make the difference in a bank winning a deal, if a client wants a large quantum of debt or long-term financing.
Allianz’s ability to hold large tickets of €300 million and over makes it an attractive syndication partner from banks’ point of view.
Banks want to guarantee their clients consistency “even in cases when large loan limits would prevent us from doing new business,” says Anna Ginkel, head of syndication at Aareal.
The same applies to limits on loan duration – up to 10 years for banks. Insurers on the other hand can lend over 10 to 20 years.
“Long-term debt has become more important because in a low interest rate environment sponsors want to secure low-cost funding,” points out Andreas Wuermeling, responsible for syndication at pbb.
Many borrowers prefer dealing with a single lender in order to simplify and reduce the workload associated with a transaction. It also provides greater security over execution.
“When a client is looking for development or refurbishment bridge finance it involves a lot of underwriting which banks are prepared for but they often want to put in place long-term finance at low interest rates for the investment phase and this is where insurers can leverage their long-term investment horizon Wuermeling says.
On this basis, pbb invited German insurer ERGO to team up on the financing of the Neue Balan project in Munich. Pbb structured a 20-year investment and development loan totalling €160 million for the commercial campus on behalf of developer client Allgemeine Sudboden Grundbesitz. ERGO has agreed to take over part of the existing credit provided by pbb after the development phase is complete.
Debt funds looking to syndication for diversification purposes are the most flexible investor group to work with, although their high return expectations means the total volume of loans they are invested in in the German market remains relatively low.
The majority of bank financing doesn’t warrant syndication as average lot sizes range between €30 million and €50 million.
A particular area of the market where pfandbriefbanks are “keen to get us involved,” says Andrea Vanni, head of European real estate debt investments at Deutsche Asset Management (Deutsche AM), is on residential financings because portfolios tend to be substantial in size and assets must go through a time consuming process in order to make it into loan cover pools. “A bank might decide it takes too much effort to put into the cover pool,” he says.
Banks are making the most of more new entrants looking for debt as an asset class, and are generally becoming more sophisticated on the syndication side.
“There has always been an element of gaining income from loan sales but this is only one driver amongst others,’” Wuermeling notes.
Banks continue to use the process as a way of diversifying risk or providing complementary products to their clients and securing the deal. And with regulatory uncertainty banks need to have the tools in place to turn to syndication.
The impact of Basel IV on lenders’ equity is yet to be seen but likely increased capital requirements may be addressed by raising new equity or managing the equity on banks’ balance sheets.
“It’s about being prepared to deal with a situation if it occurs,” says Wuermeling.
Insurers: When a sufficient return is good enough
Banks’ moves towards increased syndication ties in with a concurrent market trend among German pension funds and insurance companies, which have begun investing in senior debt alongside the banks.
“The share of institutional investors amongst our syndication partners is increasing steadily,” notes Aareal’s Ginkel.
The rationale for insurers is based around higher relative returns the asset class can offer in the low interest rate environment.
“Most important is the quality of the assets, whereas the returns should be sufficient,” says Dr. Eckehard Schulz, divisional head of real estate finance at ERGO Group.
Solvency II rules also provide an incentive for insurers to invest in real estate loans.
“Mortgage investments are regarded as conservative so the level of underlying risk capital is moderate. This makes commercial real estate debt attractive from an asset allocation perspective,” Schulz explains.
By now, most of the large and mid-size insurers have established a strategy for real estate debt, he reckons. Sometimes their resources are brought together in a partnership with a bank — often on repeated business, although it’s not always an exclusive arrangement between the two.
Larger insurers can originate loans directly while pension funds and smaller insurers make investments through credit funds.
Says Schulz: “Banks have significant resources to originate and structure new loans and insurers have a broad capital base. Syndication is an efficient way to get to large tickets, higher diversification and access to a strong customer base.”
Banks meanwhile have come to accept insurers as an important part of the financing market.
Their appetite to lend may have returned but a roster of German banks including pbb, Helaba, Aareal and Berlin Hyp “realise insurance companies as partners make absolute sense for them,” believes Roland Fuchs, head of European real estate finance at Allianz.
The insurer’s first major transaction in the real estate finance market alongside Aareal and Helaba in 2012, involving the financing of a large German shopping centre, saw each of the parties brought together from day one in the underwriting process.
“Today banks’ underwriting capacity is back but it’s still a different story when it comes to final takes. They still need certainty of execution so it makes sense for them to talk to major ticket takers to be sure what they take on book can be placed out straight away,” he says.
It is important to Allianz when teaming up with a bank to be in contact at an early stage of a deal’s structuring.
“We’re not willing to buy a black box of documentation; we want to feel comfortable investing by way of doing it on a long-term basis,” Fuchs says.
This way of doing business fits particularly well with traditional German banks which work off models to make loans eligible for pfandbrief refinancing. “A lot of those criteria are equally relevant for loan investments of insurance companies,” he says.
“We need a first ranking mortgage, a standard security arrangement and free transferability of our loan investment, for example”.
Banks feed Sparkassens’ appetite for more private debt
An integral part of German mortgage banks’ distribution strategies revolves around their symbiotic relationship with regional savings banks, or Sparkassen.
These public banks fund the banks in their capacity as shareholders, and banks’ syndication of positions in loans they make can be viewed as giving something back in return.
“When they syndicate, pfandbriefbanks’ first stop tends to be with their shareholders; then they go to the wider market,” says Deutsche AM’s Vanni.
DekaBank, which has been serving its investors for some time, designates small, pari passu portions of certain originations to open-ended funds managed by the banks’ asset management arms, keeping a piece of equal ranking on its own balance sheet.
Helaba (which is 88 percent-owned by Sparkassen) has restructured its syndication team to establish a dedicated unit to work for its shareholders, headed by Wolfgang Hild. The model it pursues involves apportioning a vertical slice of senior loans the bank writes.
Helaba expects to sell approximately one-third of the €2 billion it plans to syndicate this year to Sparkassen.
These banks are seeking more private debt because returns are so low from other forms of debt investing, such as lending to corporates.
“A lot of these savings banks had been invested in higher-yielding products that are no longer available, prior to the financial crisis. At the same time, the current interest environment provides a good opportunity to invest in asset-based finance,” explains Kellner.
There are more than 400 German Sparkassen in total, often with very small balance sheets. Their capacity for loan positions can be in the range of €1 million to €2 million.
Regulation governing the savings banks requires them to lend in their local markets, therefore syndication provides them exposure to bigger deals outside of their jurisdiction.
“They are very cautious about who they like to team up with and prefer investments in debt originated by someone with a similar risk profile and skin in the game,” says Kellner.
These investors need some kind of profit but their interest requirement is low compared to typical Anglo Saxon debt investors. “They can live with just double-digit margins”, says a distribution expert.