Little domestic competition and lots of distress make Italy lenders’ next target, reports Lauren Parr
Italy is taking its turn as flavour of the month among real estate lenders, the dynamic having shifted so that it offers far better returns than can be secured at an apparently similar level of risk-taking in the UK. At the Commercial Real Estate Finance Council Europe’s two-day Spring conference, held last month at Paul Hastings’ Bishops Square office in London, the Italian market overshadowed Spain in a panel session that explored commercial property lending opportunities in the two countries.
Delegates heard that Italy’s political landscape has changed a lot in the past 12 months, with a new government putting in place reforms aimed at encouraging foreign investment. The launch of a state ‘bad bank’ is still considered unlikely in the near future, but a number of banks are contemplating setting up a private bad bank.
Speaking on the panel, Riccardo Delli Santi, of counsel at law firm Paul Hastings, said Italy’s struggle is continuing, but is “getting to an end”. Italy is beginning to emerge as a possible next stop for debt investors after Spain – as investors find the latter market has “moved on even before they’ve started looking”, noted Marco Rampin, BNP Paribas’s head of real estate capital markets.
A fundamental contrast between the two has been “a significant pull back by local banks in Italy, [creating] opportunities for those willing to deploy balance sheet”, said Deutsche Bank director Roman Kogan. Italy’s greater problems on the banking side than in Spain, where domestic lenders are ahead in terms of clearing their balance sheets, will keep Italian banks out of the game for longer.
“Twelve months ago it was a difficult proposition to lend [in both territories], with just a few non-performing loan buyers,” said panel moderator Ramon Camina-Mendizabal, Goldman Sachs’ head of real estate finance. “This has dramatically changed.”
The deal pipeline could be fed by scope to finance the conversion of real estate funds into SIIQs, said Delli Santi, while Rampin expects more mergers and acquisitions as international investors take over some of Italy’s many small operators. If the three banker panellists reflect consensus among the financing community, lenders are poring over cities such as Milan, Rome, Madrid and Barcelona, as demand grows in two of the most rapidly changing of Europe’s recovering investment markets.
Camina-Mendizabal pointed out that the €430m refinancing mandate in the market for the UniCredit Tower in Milan is “drawing more interest than anything seen in Europe recently”.
Loan distribution is a vital strategy
However, there was a sense that lenders are treading with caution and distribution, delegates gathered, is pivotal to banks’ business model. The market has been long beset by various operational complexities, not least the challenge in enforcing security – a factor that is reflected in creditors’ “stellar due diligence”, according to Rampin. Kogan added: “The best protection is the leverage and risk point you choose to underwrite a deal at, in addition to the sponsor and what the relationship is. When possible, we try to also get some form of security outside Italy.”
But the risks seem offset by the premium from entering a market like this: the margins on some deals can top 500 basis points. The window of opportunity could be open for just 12 to 18 months, the bankers agreed, as the Italian and Spanish markets are moving fast. They are also considered ripe for securitisation. One of the first multi-asset deals has already taken place: Goldman Sachs’ €360m Italian CMBS, Gallerie.
Camina-Mendizabal inferred that one of the two countries could see the first multi-borrower securitisation. Optimism for the CMBS market was echoed later in the conference by another banker, who felt a two-or three-loan conduit CMBS would return this year, with volume picking up next year.
Syndication is this year’s model for lenders seeking safe ‘middle ground’
Investment banks are banging the drum for distribution business once more, this time “embracing the ability and desire to build a balance sheet – not tens of billions but a part of each transaction”, said Tom Jackivicz, managing director at Citigroup, during a discussion on banks’ ‘originate to hold’ versus ‘distribute’ models.
He said this “middle ground” was a healthy trend, rather than the pre-crisis model of originating for distribution and fees. Moderator Riaz Azadi, managing director at Eastdil Secured, opened the second day with a neat summary of the transition from club deals for larger transactions to full underwriting and the start of a primary syndication market. “Building the market is getting easier”, he said, as more participants seek commercial real estate debt exposure.
Typically, a few large partners are involved early on and loan documents are being negotiated in greater detail. Standardisation has been slow to emerge as lenders have different priorities, often relating to their experiences of the financial crisis. But there is growing cohesion on the matter of how senior and mezzanine, for example, should be structured.
For some, the distribution model is a way to access new markets like Italy and Spain. s one panellist said: “You don’t see a lot of people underwriting there purely to hold.” A lender on an earlier panel called the complexity and costs of syndication in Italy “brutal”; yet this model will be used, not least “because the government uses it all the time”, said Paul Hastings’ Delli Sant Deutsche Bank director Roman Kogan said its drawbacks are another reason why “for very large financings in Italy, CMBS, for the foreseeable future, is required”.
Despite investor appetite for new CMBS bonds, some borrowers are wary of their loans being securitised, said Jamie Younger, GE Capital’s director of debt origination: “A number of borrowers say, ‘are you going to do CMBS? Because if you are, we’re not interested’.” RBS managing director Jennifer Wallaert agreed that “there is a certain negativity around CMBS from borrowers”.
‘Investment frenzy’ raises fears of market overheating
Lurking behind the positive threads coming out of the conference were questions about whether aspects of the market are starting to overheat, reflecting the feeling among those who attended last month’s MIPIM conference in Cannes. The welcome speech by CREFC Europe’s chief executive Peter Cosmetatos summed up “the market’s complete transformation over the past 12 months”, to the extent that again, “worries about asset bubbles and underwriting standards” were surfacing.
“No market in Europe is done yet,” assured one US non-performing loan buyer during a session on asset-backed sales desks and hedge fund investment. “The UK is becoming less attractive with what’s happening in the property market and Ireland is getting frothy,” he said, while “the Italian market is starting to evolve”.
With debt markets broadening to include funds, insurers, hedge funds and money managers, the opportunity to deploy senior debt – let alone mezzanine – has toughened. The premium for senior debt provision is starting to compress in terms of relative value and spreads have come in “to the point where at least one fund manager has lowered its target returns and given investors the option of reducing or withdrawing their subscriptions”, revealed Mercer principal Paul Richards.
“The clock is ticking” for smaller mezzanine lenders that raised funds with 10-15% target returns, said a US-bank lender during a debate on the first day. The speed at which the market is moving is contributing to what the CREFC termed an “investment frenzy” in the conference literature. Competition among lenders and “slicing and dicing” of the capital stack reminded the US banker of the 2004-2006 era. Moderating the asset-backed sales desk session, Peter Denton, head of European debt at Starwood Capital, noted a worrying “term mismatch” between hedge funds providing short-term bridge loans to help finance loan purchases from banks, as non-performing debt can take a long time to work out.
The very relevant question in moderator and Ernst & Young partner Dean Hodcroft’s mind during the conference’s closing session was whether the rapidly recovering market would go “berserk” and drop underwriting standards. Banks insisted that fundamentals were stable at their end: they said they are competing on margins, rather than loan-to- value ratios. “We’re not getting too crazy on leverage; it’s healthy for now,” said Citigroup managing director Tom Jackivicz.
The unspoken truth was that some slippage is inevitable to a certain extent, as evidenced by the recent first ‘covenant-lite’-term loan to take place in Europe since the onset of the global financial crisis, as seen by HSBC’s global head of real estate finance, Matt Webster. Speaking at the end of the conference, UBS’s head of global real estate, Anthony Shayle, accurately depicted the score. He said: “When you start getting price competition, then comes covenant competition, and that’s when you get to the thin end of the wedge and where regulators have to start biting.”
The Asset Quality Review, the European Central Bank’s health check of 128 banks, should help keep standards in check, however. Webster said that in drawing on many thousands of loan files, the review marked the first time he had seen ECB regulators address underwriting.