Private party in high-risk space as banks turn away

Blackstone and TPG move into gap as regulation forces banks back, reports Al Barbarino

Blackstone’s continuing expansion into debt investing and TPG’s launch of a lending business throw the trend for private equity firms to take market share in the US from banks into sharp relief.

Blackstone Real Estate Debt Strategies’ whopping acquisition of $9bn of loans from GE Capital Real Estate means the private equity giant has not only boosted its US book by $4.6bn, but now has the infrastructure to expand its lending business into new markets, including Canada, Mexico and Australia, as well as the US and Europe.

A third fund in the works, likely to be of a similar size to the $4bn, now almost fully invested BREDS 2, will give Blackstone a wider pool to fish in for both the higher-yielding loans it writes for private funds and Blackstone Mortgage REIT.

In the private equity debt world, recent high-profile people moves include Jonathan Pollack’s departure from Deutsche Bank to become BREDS’ chief investment officer. Meanwhile, Ladder Capital co-founder and CIO Greta Guggenheim has joined TPG Real Estate Finance Trust as CEO.

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Pollack: “The crisis led to…an opportunity for private capital to be deployed in scale”

“The crisis led to a slew of distressed real estate assets and debt – loans and securities – changing hands,” says Pollack. “That created an opportunity for private capital to be deployed in scale, making it a launching point for privately funded debt businesses.

“Blackstone is such a tremendous presence in the debt space – multi-faceted, multiple capital sources, well-financed, operating on a scale you wouldn’t have seen before. That was extremely attractive for someone with my background.”

Privately funded businesses are focusing on a gap in the market left by banks: financing for higher-yielding, transitional assets needing management to increase their value, thus representing a higher risk.

Fall in high-risk lending

US origination figures from the Mortgage Bankers Association highlight the banks’ retreat from this type of lending: in 2007, the top eight CRE lenders originated $133bn; this fell to $79bn in 2014, partly due to the decline of top banks.

Gone are the lending arms of former US powerhouses Lehman Brothers, Wachovia, Bear Stearns, Merrill Lynch and Countrywide, foreign players such as RBS and Germany’s Eurohypo and WestLB.

Bank of America’s self-reported originations halved from $40.2bn to $19.2bn between 2007 and 2014; Wells Fargo’s dipped from $32.2bn to $31.6bn; while Key Bank’s fell by more than $10bn, to $6.8bn.

Post-recession regulation has subdued banks’ risk appetites. “Basel III, Dodd-Frank and the Volcker Rule created this massive  regulatory framework and compliance burden that’s brutal for the banks,” says Jeff Friedman, co-founder at Mesa West Capital, the US’s fourth largest private lender.

One Basel III change was the creation
of a high-volatility commercial real estate (HVCRE) loan category, intended to curb the sort of excessive construction lending that helped create big losses in the recession (see September issue, p12).

But critics argue that the HVCRE category, which requires a 150% risk weighting for regulatory capital purposes on a bank’s balance sheet, compared with 100% for other CRE loans, is discouraging banks from financing construction.

“If you look at why Pollack and others are leaving banks and why firms like us are doing well, you have to look at the big capital suppliers out there,” Friedman says. “Bank of America and Wells Fargo are active, but to date haven’t been aggressive. They are willing to lend at 2-2.5%, but don’t want to take any risk.”

Data from Citi Research and the Federal Reserve show mortgage REITs, debt funds and other private debt capital sources upped their share of commercial mortgage debt outstanding from 11% in 2007 to 15% in Q4 2014, a jump from $336bn to $503bn.

But while the commercial banks have slashed acquisition, construction and land loans by more than 70% in favour of lower-
leverage, stable assets, the Citi/Fed data shows they still increased their share of CRE debt outstanding from $1.4trn to $1.68trn (compared to a total $3.1trn and $3.39trn).

Meanwhile, the largest private lenders, Blackstone and Starwood Property Trust, completed just about $5bn each last year, which still pales in comparison to top banks with largely reduced lending operations. Mesa West did about $2.1bn.

Banks still the big players

“The capital supply coming from the large commercial banks was typically $20bn-40bn,” Friedman says. “But last year we were the fourth largest originator [in our lender category], and we did $2.1bn. We’re still small relative to the banks, so you would need a lot of groups like us to make up for the volume.”

In January, one of those groups, TPG, bought 75% of a $2.5bn, high-yield real estate loans portfolio from Deutsche Bank’s Special Situations Group, along with 11 staff, raising $750m in capital to be deployed by a REIT Guggenheim will run (see panel).

Peter Sotoloff
Sotoloff: “Banks deployed depositors’ capital in imprudent ways when there should have been zero risk for investors”

In another high-profile move, BREDS co-founder Peter Sotoloff joined Mack Real Estate’s new debt arm, Mack Real Estate Credit Strategies, as CIO last year.

“We had the benefit of having worked through a number of real estate cycles,” Sotoloff says. “When we don’t like what we see, as in 2006, we hit the brakes on lending when others kept lending into the abyss.

“Banks deployed depositors’ capital in imprudent ways when there should have been zero to no risk for investors,” he says of the pre-crisis bubble. “Regulators are doing their job by creating a range of good, risk-adjusted opportunities for folks like us who regulate risk ourselves. We deal with sophisticated investors who understand they are delegating those risks to us.”

Crucially, Sotoloff believes regulators are unlikely to “see enough systemic risk” to warrant an extension of stricter regulations to private lenders.

Richard Mack, co-founder of Mack Real Estate Group, says his decision to move into CRE lending hinged on that. “Our existing infrastructure was ideally suited to make great credit decisions and be great asset managers in the debt space,” says Mack.

“When we looked at launching the business the regulatory environment was  in the front of our minds. We understood it would be very hard for banks to compete on transitional assets.”

Debt funds “not gunslingers”

Friedman adds: “We’re not gunslingers. We have a compliance and regulatory framework in place and are registered with the FCC – but it’s nothing close to the regulations on a bank.”

However, in July, Janet Yellen, chair of the  Federal Reserve System’s board of governors, hinted that there may be further regulatory changes aimed at addressing the so-called “shadow banking system”.

Ironically, one of the largest private lenders, GE Capital, called it quits this
year after regulators deemed the company to be a systemically important financial institution (SIFI).

At the end of 2014, GE Capital’s ending net investment was over $360bn and it controlled assets worth about $500bn. Last year it completed about $12bn in commercial real estate loans, but besides its desire to focus on its industrial business, concluded that the benefits weren’t worth bearing the regulatory burdens of a major bank.

The market will watch closely to see if regulators turn their attention to other non-bank entities that are increasingly making CRE loans.


 

Guggenheim steps from Ladder to run TPG property debt arm

TPG Real Estate’s appointment of Greta Guggenheim, Ladder Capital co-founder and former chief investment officer, as CEO of its Real Estate Finance Trust lending business highlights the need of new, non-bank lenders to hire top talent to run their lending arms.

The REIT was formed in January when TPG bought 75% of a $2.5bn portfolio of high-yield real estate loans from Deutsche Bank’s Special Situations Group.

The business has already begun to lend as it awaits the arrival of Guggenheim, who had not yet joined and was not available for comment at the time of going to press.

The REIT recently provided Gaia Real Estate with $112.8m in acquisition financing for a residential development at 416-422 West 52nd Street, New York. Another loan from TPG’s new debt arm was a $95m mortgage against Beekman Tower, a 178-unit corporate-housing property in Turtle Bay, Manhattan.

In July, TPG and Deutsche pulled off their most notable deal since the latter’s portfolio sale, refinancing the 150-room Mark Hotel on Manhattan’s Upper East Side. TPG provided $150m and Deutsche the other $50m to back  the nearly 90-year-old, landmark hotel.

“We’ll miss [Greta], but have a particularly deep bench of senior management in commercial real estate and look forward to continued success,” Thomas Harney, head of merchant banking and capital markets at Ladder, said.

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