SYNDICATION: Pricing wobble unlikely to shake wider debt demand

Market jitters make some exits harder, but demand remains robust, writes Jane Roberts

The primary syndication market for European commercial real estate loans really fired up this year, but, as the months have rolled by, it’s looking more and more like a year of two halves.

Everything was going swimmingly until the summer, when worries about a possible Greek exit from the European Union returned, followed by falls in Chinese stocks and the ensuing global market wobbles.

All credit markets were affected, and while pricing for balance-sheet European commercial real estate loans “did not take as obvious a clip as CMBS since the summer”, says one investment banker, the anecdotal evidence is that pricing has changed.

After at least two years of rapid downward pressure on margins, spreads for CRE private lending seem to have stabilised, or in some cases gone up. Many lenders welcome what seems to be an inflexion point in pricing. “There has been a healthy reality check,” says one director in real estate distribution at an investment bank.

“Many investors in real estate debt are part of the wider credit world and they can’t completely ignore some of the volatility experienced this year. Even pure balance-sheet lenders such as German banks have hit their lowest possible returns (on real estate lending) for certain deals and geographic areas; for instance, they won’t lend inside 110-120 basis points in the UK.”

Mark Titcomb, head of UK real estate lending at DekaBank, says: “Lenders are nervous because they were working off rock- bottom returns. A variety of things are coming into play: one is cost of funds and the other is loan rating systems. Ratings appear to be starting to reflect the fact that we’re later in the cycle and in some cases people are saying the return is not adequate.”

Pricing problems

However, while an uptick in pricing is good for lenders writing new loans, investment and commercial banks with a lending strategy wholly or partly dependent on syndicating loans may have inventory on their books that they can’t sell at the price they had anticipated a few months ago.

“I’m pleased we didn’t underwrite any large deals just after the summer because pricing has changed,” says one German banker. “Most banks’ liquidity costs increased over China and risk went up.”

It is difficult to gauge how much pricing is moving, as there is little transparency in the CRE private debt market (see panel opposite), but it has been obvious in public CMBS markets, where the past three deals have been sold wholly or partly at below par (see Forum report, pp14-16). “A few people have had difficult exits,” the investment banker says. “The credit story is still good, but banks are more cautious around pricing.”

The good news, market sources say, is that financial market jitters have not put off the deepening pool of banks, institutions and debt funds, which still want to buy CRE loans because they like the risk/returns (see pp30-31).

Unlike CMBS, which often competes with other asset-backed securities and structured products, interest in syndication feels stickier because loan buyers are not necessarily so driven by market pricing. “They are likely to be buying to hold and are driven by total risk/return requirements,” says one investment banker.

This means investment banks such as Goldman Sachs, which mainly operate an originate-to-distribute model, are more likely to syndicate than securitise debt in the near future, while the likes of Deutsche Bank, BofAML, Morgan Stanley and Citi, which often hold some debt on their balance sheets, will do the same.

DB operates a mixed model, originating some loans for its book while also using the syndication and CMBS markets to recycle capital. BofAML, Citi and Morgan Stanley typically look to hold 20% on their balance sheets to ensure alignment with their distribution clients.

BofAML head of distribution Greg Clerc says: “We always keep some to help with the distribution and because we have a book to hold participations, of around £50m-£100m of the large loans that we target.”

For syndicating banks with the opposite ‘distribute to originate’ model based on underwriting loans to access debt to hold, indigestion in the market at worst means more concentration in large, individual deals than they ideally would have wanted.

Dutch commercial bank ING has been one of Europe’s busiest lenders this year, writing around €7bn of loans by the end of summer and syndicating around €900m of that total in the first half of 2015. “We want to feed our platform with assets we like and always hold a significant portion of the debt,” says ING Real Estate Finance head of syndication Jean-Maurice Elkouby.

“This has been a huge year for us. We will have distributed three times last year’s volume in about 20 deals. We garnered a lot of mandates in Q2 and ended up with €1.2bn to place in June. We’ve worked out our positions and are now at €250m or so. By the end of the year we should have placed north of €2bn.”

Distribution “makes sense”

Lloyds has also been an intensive user of syndication in the past 12-18 months. Ab Shome, a director in Lloyds corporate real estate banking, says: “John [Feeney, global head of commercial real estate] has said senior debt pricing has got tight and it is more difficult for banks to compete on  prime, trophy deals. So it makes sense to deliver these types of deals to clients and try to enhance our returns via distribution.

“We generally only underwrite where we would be comfortable holding some of the loan, which is different to lenders that sell out of a loan completely in a syndication.”

As well as enhancing returns, syndicating  large loans helps Lloyds spread its balance sheet further – a factor behind the £7bn- plus the bank put out last year, almost entirely in the UK.

Shome says. “Syndicating helps to avoid concentration risk with individual clients and ensures that you are not using all your balance sheet capacity on one large deal, for example, so you can do more for them.”

For lenders and investors lacking bigger banks’ underwriting capacity, buying a participation is easier than doing all the work. They get more exposure to markets or sectors they like, in the sizes they like. Lloyds is “probably in regular dialogue with about 30 or so partners”, Shome says, plus others it may deal with less regularly.

Some banks have specific mandates or accounts. ING REF, for example, has a joint €400m mandate with ING Investment Management to build a CRE loan portfolio for ING associate Nationale-Nederlander Life, while DekaBank keeps at least 60% of the loans it writes, sometimes selling the super-senior ranking portion to a real estate debt fund backed by its German savings banks owners.

The pricing risk for syndication is exacerbated by the time it takes to complete deals – much longer than a capital markets exit and typically anything from two to six months on a big, complex loan.

The European market is not as sophisticated as the US market. Says one investment banking source: “You can’t give potential buyers two weeks and ask for their bids. It’s more relationship driven.”

Lloyds’ Shome says: “Underwriting banks that syndicate, like us, are doing more deals and repeat business, building up good relationships with certain lenders – Lloyds is very relationship-focused, both with our borrowers and our loan partners.

“We tend to be conservative, so our risk appetite tends to be aligned [with that of our lending partners].We work with people early and our approach tends to be a collegiate one.”

The decision whether to sell at par and make money purely through fees, or to take more profit via a ‘skim’, selling at the original underwriting minus a margin, varies from bank to bank and according to the deal structure.

Skimming is more common on big deals, but is difficult on low-margin, prime assets. The banks’ argument for skimming with a full underwrite is that they take a profit because they took the risk and have the franchise and the relationships.

Reasonable fees

It is considered reasonable for a bank to retain more than half the fee it earned for arranging a loan, but not everyone is happy with a skim on the margin, arguing that participants are exposed to the same risk.

Not all banks are as intent on skimming, however. “If we originate low to get on book, we’re less concerned by how much we can skim,” Elkouby says.

Despite the market risk around distribution, banks committed to real estate lending look likely to cement it firmly into their strategies, because of changes to the way they operate since the financial crisis.

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Norbert Kellner: “Syndication can help us to manage the portfolio ‘smarter'”

“It is a more balanced way to fund our business,” says Norbert Kellner, head of debt capital markets at specialist German real estate bank Helaba.

“All banks expect higher equity costs and more regulatory authority constraints. We need to look at how balanced our balance sheet is and how we spread risk. Syndication can help us to manage the portfolio ‘smarter’, as well as to go for bigger deals.”

He says this year Helaba has syndicated about €800m of an €8bn-€9bn total CRE loan book. But the bank’s board, headed by new CEO Herbert Hans Gruentker, has agreed plans to ramp this up in the next few years until Helaba regularly syndicates about €2bn a year, or around a quarter of what it originates. It plans to syndicate to other banks, institutional investors and its own German savings banks owners.

“It’s a game-changer,” Kellner says. “We want selling-down to be an essential part of what we do.”

Syndication table promoters believe knowledge is power

A year ago a group of mandated lead arranging banks, including Crédit Agricole CIB, Helaba, ING and Wells Fargo, got together with the aim of producing “some league tables worth publishing” on European CRE private loan syndication, says ING head of syndication Jean-Maurice Elkouby.

The results, last March, were the first bi-annual figures for EMEA syndicated real estate finance in Europe, produced for the banks and their counterparties by Dealogic from information they submitted.

The aim is to support increasing debt liquidity in European property markets by improving transparency.

The second set of figures, in July, recorded €13.4bn of EMEA mortgage-secured, syndicated CRE lending in the first half of 2015, rising to €27.6bn including corporate facilities, a handful of which were very large.

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Elkouby: Syndication tables are “baby steps” towards transparency

Elkouby called the data “baby steps towards more loan market transparency” at a presentation with Dealogic’s global head of loans research Roody Muneean at last month’s Real Estate Capital Europe Forum.

He also reported excellent feedback, for example from sponsors in Asia who said they would use the tables and data to consider whom to invite to pitch for financings. Muneean said: “All stakeholders benefit: arrangers, participants and regulators.”

Some 20 lenders took part and the aim is to encourage more to do so, including non- bank lenders. Several banks, including ING, now include a publicity clause in their term sheets authorising basic disclosure.

Stuart Perry is head of leveraged and asset finance syndicate at BNP Paribas loan syndications, which syndicated a €740m refinancing facility for Powerhouse France in January and topped the H1 2015 bookrunner secured-financing league table.

“The arranging market hasn’t really changed, but what we see changing is potential market participants,” Perry says. “Whether that is insurance companies or funds coming in on one side, or banks from as far away as Asia, the list seems to be extending all the time.”

Churchill’s UK strength inspires rare loan-on-loan syndication

The select number of lenders, mainly investment banks, that can underwrite debt financings of large, non-performing loan portfolios tend to keep relatively more of those deals on their balance sheet.

This is partly because the returns are higher — the margins are fatter and the deals tend to repay faster — and, says one investment banker, “it is a good discipline, because people who buy those deals like us to have a large participation”.

Citi and underwriting partner Morgan Stanley are part-way through the syndication of a £1.5bn, three-year loan with two one-year extensions they closed on a 50:50 basis for Lone Star’s Project Churchill purchase last month. The £2.3bn acquisition from Aviva comprises a portfolio of loans backed by office, retail and industrial assets, car showrooms and care homes across the UK. The margin on the loan is believed to be about 350 basis points over Libor.

“This syndication ticks a lot of boxes regarding what’s a good non-performing loan portfolio,” says a source. “It’s UK assets, which is good, because UK NPLs are becoming rarer; it has an excellent sponsor, which is key; and it’s a good mix of assets with a strong concentration in London and the South East. It has been very well received.”

Citi and Morgan Stanley are looking to syndicate about £1bn, with £200m of that already taken up by JP Morgan, which acquired a £200m portfolio of performing Churchill loans from Lone Star.

The transaction could appeal to large institutional buyers and debt funds that like shorter-term duration loans, such as Insight and PruCap. It is expected to be taken up in large tranches of about £200m by three or four more buyers.

In February, Citi financed Cerberus’s £680m purchase of UK ‘Carlisle’ NPLs from Nationwide, providing £500m at around 300bps and subsequently selling down.

Syndication table