LBBW wrote a major London loan as the EU referendum loomed. Daniel Cunningham asks the German bank whether the Brexit vote has changed its view on the UK.
Back in April, during the countdown to the UK’s historic referendum on EU membership, Stuttgart-based Landesbank Baden-Württemberg (LBBW) was busy inking one of London’s largest real estate financings of 2016 so far.
Alongside ING Real Estate Finance, the German bank underwrote a £400 million refinancing of the Salesforce Tower, known to many by its former name the Heron Tower and to many to more as one of the City of London’s most recognisable skyscrapers.
The circa 60 percent loan-to-value facility was provided to a consortium including Gerald Ronson’s Heron International as well as Middle Eastern investors. It was a significant commitment at a time when many real estate investors and lenders were quietly sidestepping UK business.
Thorsten Schönenberger, a member of LBBW’s executive management board and its global head of real estate, disputes the suggestion that the UK market was severely hampered by uncertainty as the deal was closed.
“Honestly, most of us expected a different outcome to the referendum,” he says.
Regardless of whether the UK stayed in the EU, the Salesforce Tower opportunity suited LBBW’s lending criteria, Schönenberger explains. The bank provides senior finance to familiar sponsors secured by core properties with solid income streams. “We’re still confident with the risk. It’s still the same building in the same location,” he says.
“We were conscious of the timing of the deal, but we felt it was the right deal to do,” adds Simon Marshall, the bank’s London branch head of real estate lending. “It’s a good sponsor, the building is well-let to a diversified tenant base and it has a strong long-term outlook.”
The Salesforce Tower loan is currently being syndicated by LBBW and ING. Four banks are understood to have taken slices shortly before the referendum, although a minority of the facility is still to be syndicated. The banks insist that there are interested parties.
Real Estate Capital meets Schönenberger and Marshall in the bank’s London office, located a short walk from the Salesforce Tower. Since 2013, when its UK lending resumed in earnest, LBBW has become a significant force in the London CRE finance market. Notable deals have included a £325 million joint financing, again alongside ING, of the Sea Containers office and hotel scheme on the South Bank of the River Thames in January 2015, as well as a £160 million senior loan to Tribeca Holdings for a valuable strip of retail along Oxford Street in the city’s West End last December.
In 2015, the bank lent €7.5 billion of real estate debt across its three target locations; Germany, the US and the UK. Around half was done in Germany, with the other half divided between the other two countries. The UK real estate loan bank stands at around €4 billion.
The majority of UK business is focussed on central London, with an element of regional lending. The outlook on the country will not change as a result of the Brexit vote, Schönenberger insists, with one deal already approved since the referendum.
“There isn’t a big difference for me whether a cyclical event comes from a thing called Brexit or just through the regular real estate cycle. If times become more difficult we don’t like it, but we factor it into the steering of our portfolio and when we enter new risks,” he says.
“There’s uncertainty, but little has changed so far,” he adds. “What repercussions the exit will have for Europe, the German banks and LBBW depends largely on the outcome of the upcoming Brexit negotiations, which will presumably be very long and drawn-out. So today it is not yet possible to predict what the aftermath will be. Independently of this, the repercussions for LBBW will be very manageable because the bank’s activities in Great Britain account for only a limited share of its business.”
Marshall acknowledges that there will be an impact on property values in the short-term, with a 30-50 basis points yield shift likely. However, he argues that lower interest rates could encourage investment in real estate: “We also believe that there will be a flight to quality; the type of assets we like to finance,” Marshall adds. “We’re not so naïve to think that the market will carry on as normal and our underwriting process will scrutinise deals very closely and stress test them.”
LBBW is the largest by total assets of Germany’s ‘landesbanken’, its network of state-owned banks. A prudent approach to lending has been hardwired into the real estate team as a result of lessons learned during the global financial crisis, when the bank received a €5 billion bail-out from it’s state-owned and public authority shareholders.
“We are a conservative lender and our clients are aware of that,” explains Marshall. “We price our transactions accordingly to reflect that.”
Schönenberger agrees: “The real estate lending business does not provide much room for error. It’s a fixed income business and in competitive times there is no room for mistakes. We are a long-term player and we’re too young to make mistakes. If we don’t lend to budget, that is for a reason.”
Leverage across its new business was below 60 percent in 2015. Development finance accounts for only a small element of its lending. Only in cases where a relationship sponsor is putting sufficient equity into a core scheme will LBBW stray into financing property which doesn’t fit the usual ‘institutional’ profile. An example was the Chelsea Market retail and office scheme in Manhattan which it financed for an institutional fund client.
“Sure, it can be difficult in a competitive market to stick to the criteria that you promised to yourself and your shareholders,” says Schönenberger. “It is essential that there is a common understanding within the organisation that we are not driven by gross business, but by doing the deals that are right for us.”
Germany, LBBW’s ultra-competitive home market, is a case in point. From 2011 to 2014, lending was roughly 70/30 weighted towards Germany versus overseas lending. Last year, that ratio was in the order of 50/50. The simple reason, Schönenberger says, is that fewer German deals fit LBBW’s risk and return profile.
“We do not compete for the €15-30 million no-brainer transactions which every regional bank is queueing up to fund. It is definitely an overly competitive, over-banked market. If a deal doesn’t make sense for us, we don’t do it.”
Significant German loans have included a €1.35 billion facility to Hudson’s Bay Company to finance a portfolio of Galeria Kaufhof department stores late last year. The bank has also recently been awarded a sizeable residential financing mandate which it was able to commit to in a short time frame.
Other major German banks have cited low margins in the domestic market as the driver for their expansion in the US market as they seek higher-value deals. Schönenberger says that this is not the case for LBBW. The purpose of the US operation is to widen its net in order to source sufficient core deals which fit the risk profile. The cost of capital including the need to swap currency means that US deals are not necessarily more profitable than core European business.
Last year was a peak year for the bank’s real estate lending stateside.
“We lend in the US because it is as profitable as Germany and the UK, so it’s about diversification, because Germany has limited supply,” says Schönenberger, “but I don’t think we would go too far beyond $2 billion per year. We are very much a ‘gateway cities’ lender in the US.”
The discussion turns to the challenges facing real estate lenders. Like other German banks, regulation is a threat. As the Basel Committee on Banking Supervision mulls proposals to scrap internal ratings-based models of allocating risk, German lenders which typically use such models are concerned about the impact of future methods of risk weighting on their profitability.
“I hear my colleagues in the sector and on the one hand we are in the same boat because the regulatory burden on the banks is really heavy,” Schönenberger says. “But look at our balance sheet.”
At the end of 2015, LBBW’s total capital ratio under the CRR/CRD IV capital requirements directive was 21.4 percent fully loaded, based on the rules that will apply at the end of the transition period. The common equity Tier 1 capital ratio under the CRR/CRD IV capital requirements directive was 15.6 percent fully loaded.
“Of course the burden will increase, but we have decided to ramp up equity when we can ahead of time. There is a cost to having such an equity ratio, but it is a conscious decision. We’ve seriously reduced our balance sheet, voluntarily and without much noise.”
At the end of 2008, LBBW’s balance sheet was €448 billion. It was €234 billion in 2015. Commercial real estate exposure at the end of 2015 stood at €22.5 billion. New business in 2012 to 2015 averaged €5.8 billion per year and the bank plans a new business volume of around €6 billion in the long-run.
The bank’s preoccupation with profitable, low-risk deals means that it lends in lower volumes than some of its German peers, but Schönenberger insists that approach will support it in the longer term.
“Whatever capital requirements are put on the banking industry, we’re optimistic that we will fulfil them all.”
Click here to view a selection of LBBW deals.