The underdeveloped European debt brokerage model remains compelling, reports Lauren Parr
The relatively young market for debt advisory in Europe is facing its first potential test, with UK investment volumes down by 45 percent in Q2 and the political and economic climate up in the air.
It’s early days since the vote to leave the EU and whilst the odd deal has fallen apart, brokers largely refute a radical change in demand for their services.
“It hasn’t affected our strategy,” says Marco Rampin, who joined CBRE to expand its services in Europe, “but a slowdown is inevitable.”
Speaking in July not long after the vote he said the firm was “waiting for the dust to settle to see if there will be further indication of stagnation and how long this might last before activity restarts”.
There’s no denying the market in which debt brokers operate has changed and for some, business has shaped up differently than they had expected.
Situs, for example, saw the opportunity to help larger investors execute capital markets deals shortly after the launch of its European Capital Solutions business in April 2015, but found that the market moved away quickly. The number of potential deals that have required its debt advisory services this year has failed its expectations, reflects Bruce Nelson, Situs’s chief operating officer.
For others, the change in course of business has taken a natural flow. The parting of ways between hedging expert JC Rathbone Associates and broker Laxfield Capital on a debt sourcing joint venture boiled down to a culture clash, with neither party in favour of moving towards closer integration.
Laxfield is keen to emphasise it’s an end to end process business and, thanks to its up to date insight on the UK commercial real estate debt market as part of its research work, has been inundated with calls from investors trying to gauge how the financing land lies in the weeks since the referendum.
Essentially, lenders are acting with greater prudence and taking longer to transact. Pricing had already moved out since last summer but news of Brexit has enhanced this, with UK loan margins up by 20-50 basis points depending on the risk.
The impact on leverage is most pronounced. “Lenders were looking at what might have been 65 percent LTV all day long, but because they’re not sure yet when and by how much values are going to drop they’re erring on the side of caution at 60 percent,” notes James Spencer-Jones, head of EMEA structured finance at Cushman & Wakefield.
The very fact there is volatility in the market could generate greater demand for what brokers do.
One mezzanine provider points out that it’s difficult for company finance directors to keep track of the various lenders’ lending appetites and parameters at the best of times, particularly with the scores of new entrants since the last crisis, but in today’s world with “thoroughly different lender views about whether they want to be more aggressive or pull back, it’s even tougher for the finance guy in a fund to keep track of all that.”
Help with price discovery
Lenders are reassessing risk and borrowers want transparency on pricing, so good brokers who see a lot of deals are valuable. As Andrew Wilson, managing partner of two-year-old Bayhead Advisers, notes: “This should be an opportunity for brokers to add value. Accessing a wide pool of lenders and getting in some competitive tension can only work in borrowers’ favour.”
Sponsors are now turning to brokers to satisfy board opinions that the financing they’re looking at is in line with the market. Some are looking towards debt advisory because in-house staff cost money and they want to free up income.
By contrast, this time last year established debt advisers were a different kind of busy, fuelled by higher deal flow and relied upon by borrowers for capacity reasons.
Brokers were expanding into new European markets (see panel p.14) and new players were stepping in. With a far greater proportion of debt placement arranged by brokers in the US, there was everything to play for.
The brokerage market in Europe “greatly increased as a result of the global financial crisis, and compared to the early 2000s when direct broker activity was virtually nil, we now receive a lot more introductions,” says Chris Bates, head of real estate finance at insurance company lender Cornerstone Real Estate Advisers.
What has been dubbed ‘the Eastdil effect’ has opened the door for debt intermediaries to become a larger part of the market, with greater acceptance of their role. US-owned real estate investment bank Eastdil entered the European debt placement market in 2007 and has since gained a reputation for driving down pricing.
“Small brokers were active historically but the rise of broader platforms in Europe only started from around 2011 onwards,” says Nassar Hussain, managing partner of specialist firm Brookland Partners.
He believes “it’s probably an oversupplied market in the UK today”.
“The market has been tougher this year which will hit those firms whose focus is primarily on the UK. Those brokers that have developed a strong franchise and client relationships will come through fine; those that rely on commoditised product on an opportunistic basis will struggle,” he says.
Each broker has its own stamp, some working for borrowers only, others for both lenders and borrowers. CBRE is strong in development financing in the UK; Brookland and Cairn Capital specialise in complex deals; First Growth is active in France and Italy, for example. Bayhead has gravitated towards deals “banks would not easily do” says Wilson, who sees the opportunity to work more closely with alternative lenders in the short to medium term.
An additional area in which Bayhead has built up a good contact base involves sourcing equity capital for clients from high net worth family offices. Being well connected with the market and the ability to tailor solutions “without going far and wide” has allowed it to win this type of business. Wilson says “it’s not a process you can write. There are circumstances we come across that require equity and end up in a sale or JV.”
Boutique firm Seaford Finance has used its agility to engineer deals in previous downturns and it’s no different today. In addition to mortgage brokering, the outfit serves as a conduit for off-market deals thanks to its “access to clients looking to offload assets” says founder Morris Rothbart. “Our art is to cash in on the spur of the moment. We’re better positioned than bigger organisations to slot outside pure debt consultancy and into agency, overnight,” he says.
An ability to manoeuvre ‘in-house’ facilitated Broadoak’s position in the brokerage market. The finance start-up, recently launched by Tracey Folkes, formerly of Capita Asset Services, counts UK propcos and Middle Eastern investment banks among its exclusive mandates. “By working with clients over the entire life cycle of a transaction you become part of their deal execution team and if you’ve built up a position of trust, you will remain part of the team,” says Folkes.
The debt brokerage model is a modest business in terms of capital expenditure while “it only takes a handful of deals each year to be successful” one points out, therefore brokers may afford to ride out a slowdown.
Bayhead feels its range of services makes the business more than ‘just’ a debt brokerage. “We have skills round the table relating to work out and advisory on debt and equity transactions. We’ve set our stall out to advise around the wider capital stack and assets.”
Diversity of deals has driven one of Brookland’s best-ever starts to a financial year. It issued a £5 million mezzanine loan financing a government-let office in Liverpool for LRC. Business is still fed by restructurings like Ashbourne, a legacy Southern Cross Healthcare portfolio on which it is advising creditors. It also won a contract to assist with portfolio management for German bad bank Erste, recently.
Historically, the UK CRE debt market has been equally split between acquisitions and refinancings. Yet with investment volumes lower, five of the six deals Laxfield was working on over the summer were refinancings. “There’s always a need for refinancing on existing stock so to a certain extent debt advisory is a business that can be countercyclical,” director Alex Lanni says.
JLL’s David Lebus, director of UK debt, notes that the sustained low interest rate environment “brings into play clients looking at refinancing in order to take money off the table and de-risk”.
With a dip in values now likely, investors are more open to the prospect as a substitute for selling assets at a lower price than they would hope to achieve.
“In spite of the referendum, borrowers’ all-in-rate still looks attractive given the tightening of Libor swap rates,” adds Riaz Azadi, managing director and head of debt placement at Eastdil.
The slower market and changes in pricing have encouraged borrowers to choose separate senior and mezzanine debt financings over whole loans where they want more leverage. “We were doing a lot more whole loans because it could be done quicker, and arranging separate debt may have only saved up to 25 bps on the all-in rate of interest. Now, the pricing differential can be 50-75 bps so it’s worth doing if you have a bit more time on your side,” says Dan Uzan, Brotherton co-founder.
“Post-Brexit, whole loan providers are much less willing to take risk on syndication pricing so whole loans will get more expensive.”
The way forward for advisers
The debt brokerage model remains a compelling business opportunity, according to James Wright, head of Capita Real Estate Finance.
“The European market is still underdeveloped compared to the US and there has been an improvement in the nature of clients and transactions using brokers,” he stresses. “We’re in a slightly different market in terms of transaction volumes but that’s a timing point. There remains potential for strong deal flow.”
Opportunity could come from more activity on the distressed side, with fund managers quietly seeking to exit a number of portfolios that are “non prime, still have work out to be done, or because they overpaid marginally” according to Rothbart.
Eastdil is active all over the Continent where “business is carrying on,” says Azadi. The firm extended its platform in France last October, creating a “strategic alliance” with Paris-based Finae Advisors.
New entrants like CR, an experienced European asset and investment manager which has recently formalised a debt advisory offering (see panel below), hiring former Citi banker Stuart Hoare, want a piece of the pie while existing players are beefing up.
With Spencer-Jones’s hire, Cushman & Wakefield is building its EMEA Structured Finance business (following Cushman’s merger with DTZ). Coming from a lending background at GE Capital, he says “it’s an interesting time to move across to the advisory side. In the past some firms found it difficult to get traction but the market has continued to open up.”
Spencer-Jones intends to tap existing internal clients whilst pursuing new and larger past banking relationships. Working alongside Ed Daubeney, who ran the business at DTZ, he says “some of these investors are used to using brokers so if you can add value by introducing deals with an achievable financing package attached, there’s a lot of opportunity”.
For Situs, scoring defined agreements with lenders to help originate, underwrite and service new transactions will be an important line of business.
“Part of our future strategy is to develop those relationships to do this as a programme, as opposed to simply representing borrowers who need a loan,” Nelson says.
The company has reduced its expectations but still sees the European debt brokerage market as an opportunity. He says: “The advisory business should be a pan-European opportunity but it’s going to take a lot longer than initially expected.”
Advisers continue push into continental Europe
The likes of CBRE and JLL have made targeting mainland Europe a priority over the past year, where there is “a huge opportunity for debt advisory business” according to JLL’s David Lebus.
“Europe is less intermediated than the UK but there are a wide range of debt providers and a number of typically London-based lenders that want to gain exposure to Europe,” he says.
There has been less blowback on the Continent as a consequence of the UK referendum and financing activity remains robust.
For debt brokers, poorer banked markets like the Netherlands represent a particular opportunity.
Says James Spencer-Jones of Cushman & Wakefield: “There are certain continental markets that are attracting a lot of new buyers that do not have strong banking relationships locally but we do.”
Holland presents a source of refinancing opportunities coming out of non-performing loan books – business which CR believes is going to peak over the next 12-24 months. “UK and Irish NPLs are slowing down but the assets have now been transferred to private equity firms and plenty of those are going to need refinancing. Trickier stuff is coming through in the Netherlands which will need different financing, potentially from alternative lenders,” says Stuart Hoare, managing director of capital advisory at CR.
First Growth had expected to be involved more heavily in underwriting and work out strategies for NPL portfolio trades in Italy, but the market has yet to unravel. An area of expansion has been managing real estate loan portfolios for German lenders including in Italy “especially now we’ve been through court proceedings and loan enforcement there across various regions,” says Francesca Galente, co-founder. After winding down German bad bank FMS’s French real estate loan book, the company is mandated to provide special servicing on Commerzbank’s portfolio in Italy and more recently on some Greek loans.
Down the line, UK-based brokers might be affected by rules relating to operating under local licenses as a result of Brexit. JLL’s Lebus dismisses it as a serious issue “as long as the government gets a decent passporting arrangement”.
Click here to see a selection of European CRE debt placement advisors.