German banks face difficult foreign policy decisions

A reliance on external markets puts Germany’s real estate lenders in a vulnerable position, but also compels them to consider cautious moves into less familiar territories.

Germany is a nation of exporters – its cars, electronics and pharmaceuticals among the goods sold across Europe and the wider world. Once a source of envy, this exposure to foreign markets is now a concern given the threats posed to international trade – including by the UK’s exit from the EU.

A less obvious German export, but one also vulnerable to such uncertainties, is senior real estate debt. German banks have been cross-border property lenders for decades, but there is a need for them to re-examine their foreign strategies.

German real estate bankers are under pressure to lend, driven by the need to replenish the asset pools which back their Pfandbrief issuance. Their domestic market is a crucial source of business, but intensely competitive.

They are rightly focused on maintaining underwriting standards and higher-margin business in the core sectors of foreign markets is the natural pressure valve. However, German bankers can no longer rely on some of these markets due to political and economic worries. The latest edition of the University of Regensburg’s German Debt Project showed there was just 1 percent growth in foreign business across its lender sample in 2016 – down from 14 percent in 2015.

Several lenders have cooled their interest in the UK market following the Brexit vote. Deutsche Hypo’s H1 2017 UK volumes dropped to €253 million from €472 million in the same period in 2016. The long-term future of this key market will not be taken for granted by German banks and exposure could be reduced depending on how Brexit negotiations play out.

France, a key market for several German real estate banks, had a shaky start to 2017 in the run-up to the presidential elections, although some are pinning hopes on the ‘Macron effect’ for an upswing. Poland has supplied core financing opportunities in recent years, but the uncertainty created by the populist right-wing government has had an impact on property transaction volumes.

The Netherlands remains popular, although increased competition from domestic lenders has been noted. The solid Nordic markets have also been targeted, with Helaba and pbb Deutsche Pfandbriefbank among those active recently, but they are relatively small markets.

The US has been viewed as the answer by some; Helaba’s €35.8 billion property loan portfolio is now 22 percent weighted to North America – more than the UK and France combined. Aareal raised its gross margins by 260 basis points across its book during Q2, partly on the back of high-priced US deals. It is a land of opportunity, but is already a well-financed market.

Expect to see German banks explore European jurisdictions that have been off the table in recent years. The impressive recovery of the Spanish market is creating prime financing opportunities which will attract German banks. Aareal noted the country’s performance in its latest results, saying that while transaction volumes might decline in some markets – namely the UK – they will rise in others – such as Spain. Deutsche Hypo also said it is preparing to resume business in Spain, once a target market.

As they hunt for lending opportunities, German banks are likely to reconsider countries, or maybe just certain cities, to expand the list of European locations they are comfortable with. That will mean revisiting places that caused headaches during the last cycle. In 2014, for instance, Commerzbank offloaded the Iberian legacy loan book that formerly belonged to EuroHypo – including €1.4 billion in non-performing loans.

By selectively lending into European markets they have sidestepped during the past decade, German banks could bring greater liquidity to core sectors where domestic banks remain subdued. However, in doing so, they will need to keep in mind the pitfalls of overenthusiastic foreign excursions from the last cycle.