At a recent round table event hosted by Lloyds Banking Group and Real Estate Capital, representatives of leading borrowers and lenders addressed the changing shape of the property lending landscape. Banks’ struggle to restructure balance sheets, new regulatory pressures and the rise of new debt providers were among the topics discussed.
PARKER RUSSELL Head of corporate and commercial real estate securitisation, Lloyds.
JOHN FEENEY Head of real estate debt, Henderson.
SIMON CARTER Head of treasury and capital markets, British Land.
LYNDA SHILLAW Managing director of corporate real estate, Lloyds.
ASHLEY GOLDBLATT Head of real estate lending, Legal & General IM.
JEREMY BARD Finance director, Resolution Property.
Lynda Shillaw: The key players in the UK real estate investment lending space are still the big four banks. Both Lloyds and RBS have large amounts of real estate lending on our balance sheets and we are still reshaping and right-sizing. We are also facing significant headwinds both in terms of regulation and the economy. Without a general economic recovery picking up the pace it is going to be very, very challenging.
Regulation is making investment lending less viable for banks; we have to find other funders to take up the capacity that banks can no longer provide.
John Feeney: We want to do replacement bank funding. The market will require all sorts of alliances that didn’t exist in the past. Banks will still be a major part of the market, but will regularly be partnering with insurers and new funds, which have very defined strategies in different parts of the capital structure, or for different risk types.
A new model will emerge, which is more diverse, with lots of different players. A typical club might involve a bank, insurer and a fund. We’re in the process of building alternative funding vehicles and I think a much healthier funding model will emerge.
But we new providers have to build teams and new infrastructure. It takes time to raise capital and sell a strategy. We’re at a disjunc-ture between an old model and a new model, and it’s going to be a bumpy few years.
Simon Carter: A mix of lenders are entering the market, with differing lending objec-tives. The refinancing MetLife, Lloyds and RBS provided for our Hercules Unit Trust could be a template for the future. Nine months ago, I might have felt it would be difficult having banks lending alongside an insurer, because of potentially different lending criteria.
This deal suggests this might not be a problem. It is important to distinguish the way insurers want to lend. Some prefer longer-term lending, with bond-style early repayment penalties. With others, like MetLife in the deal we’ve just closed, it’s more like bank financing.
LS: Revolving facilities and development financing are increasingly attractive to us. We’ve always been an originate-and-hold bank and need to hold less of the invest-ment loans we put in place and distribute more. We will absolutely look for partners.
Ashley Goldblatt: I don’t see the world shifting as much as everyone else. Institutions are clearly not going to be real estate’s knights in shining armour. If you add up all the balance sheet capacity in that sector, they can’t possibly replace banks – even if you add all the capital talked about coming in from new fund providers and institutions.
JF: Much of the new capital will be focused on the same, easier stuff, so it isn’t going to change the picture for the more troubled part of the market. The only capital available for secondary or messy assets will be the opportunist capital looking for very high internal rates of return, of 20%, so the discounts will have to be very big from banks if they want alternative capital for that.
LS. My concern is with the tertiary class that emerged during the market boom. A lot of people who really didn’t understand property ploughed in and rode the market for return. That’s where the pain will come: banks will say: “We will not refinance it at this level so you have to put equity in’. A lot of these guys don’t want to, even if they have it.
Jeremy Bard: The problem is that the banks with these items on their balance sheet aren’t able to take those losses. So the debt will get pushed out until banks are making enough profits to write it off. If you put it into an agency like Ireland’s National Asset Management Agency you have time to deliver optimal value; it takes the pressure off. It must be incredibly difficult for a bank to deleverage and keep its relationships.
LS: We have two camps: stressed loans within head of CRE Richard Dakin’s business support unit and the mainstream loans in my world, or our mid-markets world. There’s separate strategies for the stressed stuff and the mainstream stuff. I focus on the mainstream, corporate real estate lending and clients, and businesses of the future.
There is still a degree of deleveraging even within those loanbooks, because as a result of bringing Bank of Scotland and Lloyds together, we have client concentration; some of our clients banked with both.
SC: Banks want to deleverage, but might be prepared to wait longer than they would have in the past. Banks like Lloyds and RBS have hired good-quality property people. Before, if a lease event came up, it was a trigger to do something with the asset, as there can be big changes in value on lease events, but you need to get someone to manage that asset.
I think banks want to transfer assets to the natural owners of property and having hired good asset managers, that process may run a bit more smoothly than in the past.
AG: It will only happen with the right clearing price. The blockage is in the amount of writedowns banks are prepared to take on assets. Until there’s some realism, that price transfer mechanism will not apply.
LS: Our stance has always been to manage for value. The market’s stance initially was: “We’ll take on this distressed stuff at a huge discount.” That would have just crashed the market. Banks have been very responsible in the way they’ve worked out strategies across their portfolios in a very methodical way.
JB: There is still a lot of pain to be suffered. We always talk about financeable and non- financeable assets, but an asset is a depreciating class. It needs money spent on it, good asset management and some TLC, otherwise it falls into a state of disrepair or reduces in value. Less prime assets will get worse; there will be less demand for them.
People are struggling in this climate; we see more and more tenants requiring incentives to go into schemes. The only way this can be refinanced is to have a debt-equity swap with banks. They will have to take a more proactive view on the debt they have.
LS: I can’t see any of the major UK banks going down that route willingly. But there is an opportunity for organisations with teams that have the right sort of property and debt skills to come in and say: “We’ll provide you with some debt, but we’ll have an equity stake in that asset and are going to work incredibly hard to drive returns.”
JB: That’s where people like us come in; the bricks-and-mortar specialists and the added-value merchants with asset management skills. I see three buckets of assets: those that are easy to refinance; then a second tier, with which property companies and people who add value can do well, perhaps in a joint venture with a bank or the sponsors. But expertise and additional capital are required, because a depreciating asset gets worse if you leave it. Then, thirdly, you have the tail of assets at the end, and I don’t know what’s going to happen with those.
Parker Russell: One option is a co-ordinated effort to create a stand-alone bad bank. NAMA is an example. A bad bank could be a catalyst to transform the lending market, a back-door way to recapitalise banks by purchasing bad assets. This is a public policy issue, though, not necessarily just a commercial one, and one that I don’t think is likely to be attractive in the UK.
JB: Setting up a bad bank to deal with this crisis is definitely something that needs to be considered. There are regulatory impacts on banks’ capital; we have slotting and all these things coming up. They are going to make life even worse, rather than better.
AG: This moves the attraction of property owning back to long-term institutions who are natural property owners, and to external investors looking for lower returns than was typically the case in the heady mid-2000s. Properties that produce robust, reliable income streams, which are not too demand-ing, but look attractive compared to what you can get from local sovereign bonds, will be an attractive investment.
That suggests commercial property will go through a fairly unexciting phase. Unless you find an undervalued asset you can make more valuable, the capital return you’ll make on a property will be very low; the income return will be much more important and you will need to be confident you will get it.
SC: You’re absolutely right. We did an analysis that showed that 70% of our capital returns last year came from asset manage-ment or our development programme. You have to work hard to generate these returns. So we are natural owners of those assets.
Some super-prime assets give a passive return that is quite attractive to some investors in this low-interest-rate environ-ment. Significant sums are being raised to put equity rather than debt in those assets, particularly by sovereign wealth funds. It’s an interesting landscape.
NEW PRODUCTS: Alternative debt sources will move into gap left by banks
JF: With banks no longer the sole drivers of the bus, there will be more products to suit investors’ needs and more space for fixed-rate products. We’ve had inquiries about inflation-linked debt, linked into leases with RPI uplifts; that might make sense for investors and borrowers. Natural link-ups between borrowers and sources of capital are developing now.
SC: More borrowers that might have solely relied on banks are looking at other products British Land has used in the past. The private placement market has been very active; people are looking at debentures again, there are corporate unsecured bonds; one day there might even be CMBS again.
JB: Big property companies have the ability to refinance. Smaller corporates will move to debentures; they are likely to come back.
AG: There’s a real possibility of limited issuance in debentures. But unless you get a £250m issue size, it will have illiquidity or a displeasure premium associated with it. Only a few deals are large enough.
PR: I agree we will go to more of a fixed-rate market, like the US. The question is how we manage that risk. To underwrite a 10-year, fixed-rate loan and sit on it for six months before we flip it is a challenge. We can hedge it, but the volatility in terms of the spread is frightening. So you won’t see that for a while.
AG: Recasting bankers’ role is important. Banks will increasingly move away from the originator/syndicator/distributor model to act as introducers, offering not so much a product as a service. There’s a real shortage of qualified advisers for borrowers needing to access this different finance stream no one is used to. Organisations like ours would benefit from introductions to people we are unfamiliar with, below the quoted market threshold…
SC: …Such as companies that were traditionally focused on the banking market, who don’t have a dedicated treasury team.
LS: This is our mid-market space of good- quality credits; property firms investing in good assets, who know what they’re doing.
AG: You are probably talking about smaller deals that are bankable, but don’t know how to get banked now. Our first deal was a large one, but we’re quite comfortable with going down to £25m for a relatively uncomplicated loan. Otherwise we finish up with a lumpy, non-diversified portfolio.
JF: Our sweet spot is £30m-£50m; some-times larger. We see banks as a vital conduit to source that risk, to restack it if needed and pass it onto us in a form we can digest.
AG: Perhaps similar but legally disparate people could be put together in a pool, maybe on a joint and several basis, and be imaginatively advised on how to access capital as efficiently as possible. I think this sort of product would go down very well.
PR: We tried to develop a vehicle with £20m- £30m whole loans; effectively a portfolio we could lay off to insurers. But without having the loans you end up having a dialogue about a £30m deal that could happen in six months’ time – investors are busy, they’re looking at other opportunities.