New players help pull margins down as lending ranks swell

REAL ESTATE LENDING

Banks hike property lending targets as new providers intensify competition, reports Jane Roberts

“Never before have I seen this level of ambition,” says Savills’ Newsom on banks’ claims to be able to write big senior loans

The ground beneath the feet of banks lending to property still has an alarming tendency to shift: Co-op is in disgrace and Postbank possibly up for sale. And last week chancellor George Osborne said Royal Bank of Scotland’s real estate exposure would be a factor in a swift Treasury review into whether to split RBS into a good and bad bank.

Yet despite these shocks, the real estate lending market looks far healthier now than it did 12 months ago. Nassar Hussain, managing partner of real estate debt adviser Brookland Partners, says the lending market is “at a turning point”, with an increase in senior debt and new CMBS issuance.

In his 25th annual ‘Financing Property’ presentation this month, Savills’ head of valuation William Newsom identified more than 50 new lenders coming into the market in the past year, some of them among a total of 47 that claimed they could lend and hold £100m or more of senior debt. “Never before have I seen this level of ambition,” he said.

New lending actually fell last year from £27.5bn in 2011 to £25.4bn, the latest De Montfort University lending report shows. Last year’s total, including £11.1bn of extensions on new terms to maturing loans, was £36.5bn (see graph below).

Banks raise lending targets

However, sentiment started to improve in the second half of last year, with anecdotal stories of banks having far bigger lending targets for 2013, new non-bank players teeing up their first deals and early signs of downward pressure on lending margins.

p12-annualMany factors converged, including greater competition from new players entering the gap left by traditional lenders’ retreat. The banks left standing became more confident and are benefitting from government stimuli and low interest rates, adding up to an all-time low cost of funding, as Newsom noted.p12-new-real

Lloyds and RBS have set lending targets of £6bn for 2013, far more than last year. They are among the UK banks that can use government Funding for Lending money for real estate, “although most said their lending ambitions would have been the same without it,” Newsom reported. Funding costs have also fallen for German banks that use their domestic pfandbrief covered bond market to fund their lending (see more).

“Banks have been cutting back for so long and now need to expand their balance sheets and put money out,” Matt Webster, HSBC’s global head of real estate finance, said at last month’s Loan Market Association real estate conference. “I haven’t been this optimistic about the market for six years, because of the amount of liquidity coming in.”

UK bankers at the conference said regulators are putting pressure on them to deal with their legacy books faster (see graph above) so they can lend. As has been said many times, this is a difficult balancing act.

However, RBS has told customers it needs to issue between £4bn and £6bn of new property loans just to replace repaying performing loans, while Lloyds’ work-out team, its Business Support Unit, is said to be a year ahead of schedule – a key reason for the jump in Lloyds’ 2013 lending targets.

Global relative pricing for real estate lending is another factor behind interna­tional banks’ enthusiasm for the UK. This category includes German banks such as Aareal and DekaBank, which would like to lend more, as well as US banks returning to Europe. The investment banks have written loan-on-loan finance for (largely US) vulture funds to buy non-performing loan books, or backed private equity borrowers such as Blackstone buying transitional assets.

Growing stack of defaulted loans casts shadow over shrinking debt pile

The value of outstanding debt on UK lenders’ balance sheets fell a little more last year, by 7.7%, to £197.9bn, according to the De Montfort lending report. While the value of outstanding debt rose 25% or more last year for most insurers, other non-bank lenders and North American banks, it fell for most other banks and UK building societies.

Stripping out new loans, the report identified £30.6bn of reductions in the value of outstanding debt made by lenders holding 76% of the total amount reported to the research. If extrapolated to all 100%, this value increases to £40bn.

 p13-growingSome 39% was due to scheduled amortisation and repayments, but the other 61% “appears to have been achieved by lending organisations taking positive action to remove loans from their loan books”, including customers paying down (26%) and bank-influenced asset sales (20%).

That’s the good news. The bad news is lenders reported £45bn of outstanding debt (23%) with a 100%-plus loan to value ratio, “a sharp reminder of the extent of the non-performing legacy positions that many organisations have yet to resolve”, survey authors Bill Maxted and Trudi Porter say.

The number and value of loans in default also rose, to an estimated £45.3bn, or 23% of loan books. Almost 70% of UK banks’, insurers’ and building societies’ loan books are secured on property outside London. Non-performing loan portfolio buyers had 88% of their loans spread across the regions, “demonstrating their willingness to take on and asset manage regional propositions”.

Wells Fargo enters the mainstream

Wells Fargo’s agreement to buy Eurohypo’s UK lending business, in a deal expected to be completed next month, shows its commit­ment to mainstream senior lending. Wells is flexible, normally lending at loan-to-value ratios up to 65%, but says it could go higher and will lend in front of mezzanine finance.

The return of the banks looks like good news at this stage for start-up senior debt funds or other investors without origination teams: it gives them opportunities to participate in deals alongside experienced lenders (see more). It is also good for mezza­nine lenders, which a year ago were complaining that a shortage of senior debt was blocking their deal flow

p13-insuranceDe Montfort’s latest lending report found that insurers or other non-traditional lenders accounted for £3.8bn, or 15% of 2o12 new lending (see pie chart above). Opinion is divided about how much further and faster they will p13-interestpenetrate the market. At the LMA conference, Cameron Spry, acquisitions director at pan-European investment manager Tristan Capital Partners, said all 20 or so deals Tristan has completed in the past couple of years had been with banks. “The banking community still has primary position for senior financing,” he said.

However, nearly a quarter of the 47 organisations with £100m-plus lending ambitions in Newsom’s table are insurance groups (see table above). John Edwards, a director at JC Rathbone Associates, believes insurers will be around for a long time.

“They have a genuine economic require­ment for this market,” he says. “Bond pricing has been tightening for years and they see real estate lending as very attractive. The likes of Pricoa and other US insurers, and, on the continent Allianz and AXA – are serious players. In the UK we now have M&G and Legal & General as well as established lenders Aviva and Canada Life.”

New players drive down borrowing costs

New lenders have certainly played a part in cutting borrowing costs on prime property and for experienced sponsors such as REITs. Newsom estimates margins have fallen up to 100bps in the past six months or so for the best assets (see interest rate margins graph above) because of competition to finance them.

p14-grossCoupled with low interest rates, it is, he points out “a brilliant time to be borrowing. From a borrower’s point of view, since last year, loan maturity has moved from a threat to an opportunity. Provided you have a good asset, it is an opportunity to refinance at a historically low cost of money,” (see graph).

So far, no one seems very nervous about possible interest rate increases. But, cautions Edwards: “Short-term rates may be at current levels for some time but medium-term rates, which drive most financing deals, have risen and could continue to rise,” (see graph).p14-swap

The next issue everyone is focused on is whether more lenders will follow UK clearing banks in supporting clients that are buying in the regions again, also helping to fulfil their own lending ambitions.

“We’ve seen an uptick in regional activity, supported by relative stability in economic indicators,” says Stuart Heslop, RBS’ regional director for Scotland and the north. But big regional deals by non-UK clearing banks are rare; Aareal’s loan to F&C Reit to buy three malls and Legal & General’s financing of part of north-west based private property firm Bruntwood’s office portfolio stand out.

At the LMA conference, Peter Denton, head of European debt at Starwood, which raised £228m for a listed debt fund in December, summed it up when he said: “I don’t think the lending market is being tested yet.”

Pears Group’s protégé funds niche assets with a Capital A

austinAmong the 52 newcomers on Savills’ new lenders’ list is Capital A Finance.

Backed by the deep pockets of experienced UK property investor the Pears Group, the firm has lent £150m to UK property in 16 loans since its launch last September, illustrating how new lenders with a range of propositions are finding niches in the evolving lending market. Co-founder Daniel Austin (pictured) says these were mainly stretched senior loans and “office-to-residential plays”.

One of its latest deals was providing £12.5m of mezzanine finance for Ronson Capital Partners’ Riverwalk residential development on Millbank in Westminster. LaSalle Investment Management mirrored its contribution and their loans are expected to generate a 12-13% internal rate of return.

Crosstree Real Estate Partners supplied £30m of mezzanine/preferred equity for the project; £145m of two-year senior debt came from Barclays and Lloyds.

Austin set up Capital A with former Investec colleague Jonathan Arnst. At Investec, Austin first worked with Gerald Ronson, as part of a club financing the purchase and development of the Heron residences in the Barbican. Austin says Capital A continues to support Ronson’s companies and that the Riverwalk deal represents its strategy of backing best-in-class operators in their chosen sectors.

“We’ve done some planning risk deals,” he adds. “We’ve just done an office building at Buckingham Gate where the client is going for planning.” It has also committed to a big residential development in Highgate.

Among the six-strong lender’s other deals are senior financing for the purchase of three Marylebone office and retail properties, called the New Cavendish Street portfolio; co-financing the purchase of the Park Crescent East portfolio of eight mixed-use buildings in Regents Park, with Investec; and a development loan, again with Investec, for Generation Estates’ and The Carlyle Group’s student housing scheme in Southwark.

It is also involved in refinancing Victoria office and retail block Grosvenor Gardens House; and providing senior financing with a development tranche to turn a St James’s office building into a single home.

“We aim to get our book to £250m by this time next year,” says Austin. Capital A’s niche is providing from very small loans of £1m, but it is also working on a £65m whole loan to be held on its balance sheet.

It has a £75m ceiling for its largest loans, but would do bigger deals in a club. Its internal rates of return range from 8% “for pretty solid senior, up to 14% for mezzanine”. It also provides bridging loans and all its facilities have a maximum five-year duration.

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