German lenders move back up risk curve

German lenders are throwing off their shackles. After several years of ultra conservative lending, many are finally willing to take on more risk – and finance decidedly less prime assets – as competition in Germany’s lending space intensifies.

'This year, German banks have become much more flexible than we would ever have believed possible two years ago,’ said Dirk Richolt, head of real estate finance at CBRE in Frankfurt. ‘They're going higher up the risk curve in search of better yields. It's tough to imagine what they can do next, though. We've seen a lot of aggressiveness on loan pricing this year and I think that will intensify next year,’ he added.

TIGHTENING LOAN MARGINS
On one recent multi-million euro deal, the loan spread was believed to be around 80 bps, according to Richolt, which is incredibly low. ‘I think going forward that loan pricing of less than 150 bps will become the norm for core deals,’ he added.

Tightening margins reflect a growing ‘buoyancy’ in the market, according to Jörg Schürmann, head of corporate finance at JLL in Frankfurt. ‘Now, it’s less problematic for would-be borrowers to get loans,’ he said. ‘If you have a good asset in a strong location, it’s fairly easy to get a loan. It’s also getting easier for development, providing the developer has a good track record,’ he added.

Moreover, increased competition in the marketplace has spawned ‘a clear trend of many lenders starting to lend more on assets in B and even C locations – if the underlying asset and tenant are strong,’ Schürmann said. ‘Many banks also want to increase their real estate loan books by lending more on assets such as offices and retail. Alternative assets, namely hotels and senior housing, are also becoming popular.’

Christian Schmid, managing director of business and syndication management at Aareal Bank, agrees: ‘Investor willingness to accept risk outside the so-called core segment has kept on rising,’ he said. ‘As there is scarce supply in the core segment and prices have gone up there, investors are looking more for higher-yielding properties outside top locations and are thereby taking on more risk.’

For some lenders, secondary assets are nothing new. According to Assem El Alami, head of real estate finance at Berlin Hyp, his bank has always been willing to lend on sub-core assets. ’We’re not only interested in bright and shiny assets,’ he said. ‘Going forward, we are not going to be tempted to change our risk policy. In Germany, we’re willing to underwrite loans with 10 year terms, typically against commercial and multi-family residential.’

Demand for commercial property in Germany remained high in the first half of 2014 with €16.9 bn of deals, up 29% year-on-year, according to Schmid. The increased deal volume also reflects that lenders are following their clients into regional markets, according to Michael Kröger, head of international real estate finance at Helaba. ‘It’s a more diversified market today but if you understand the market, you can still do business,’ he said.

According to an analysis of 15 major banks carried out by JLL in July, new lending in Germany also rose by 17% in 2013 (including renewals). The 15 banks analyzed – including Helaba, Aareal, pbb and BayernLB – combined did €34.9 bn in new business in Germany last year. DG Hyp took the top spot, with €5.3 bn in new business, followed by Helaba with €4.85 bn, pbb with €3.7 bn, HypoVereinsbank with €3.4 bn and BayernLB with €3.3 bn. Pbb witnessed the most dramatic increase, with lending up 127% on the previous year.

NEW HURDLES FOR NON-TRADIONAL LENDERS
Is the party already over for alternative lenders? Although non-traditional lenders such as insurers and debt funds have increased their market share over the past two years to between 10% and 15% of the lending market, many of them are now struggling to keep pace with traditional lenders, according to Richolt at CBRE: 'One change we've seen this year is that due to very low swap rates and interest rates, alternative lenders can no longer keep up. In the past, the advantage for alternative lenders was that banks had higher funding costs than they did. This is no longer the case. Also, the returns are too low for many alternative lenders - a floating-rate loan (over Euribor) generates less than 2%. That makes no sense for alterative lenders,’ he warned.

Schürmann agreed: ‘Non-traditional lenders expect a certain yield to make lending worthwhile, typically in the region of 3% to 3.5% That’s hard – even a 2% yield is a stretch today,’ he added. Kröger also acknowledged that increased competition has put pressure on margins: ‘Going forward, loan margins will continue to be under pressure,’ he said.

Subsequently, it will hard for alternative lenders to increase their market share, said Schürmann. ‘I don’t think they will ever account for as much as 30% of the overall lending volume in Germany.’

Initially, in addition to cheaper financing, the advantage of alternative lenders was that they would write bigger loans than traditional lenders and offer much longer loan terms of up to 25 years. However, banks are now becoming more flexible, too, and are offering longer loan terms, thereby eroding the former competitive advantage of non-traditional lenders.

Nonetheless, has also been a marginal shift in the available lending capacity from non-banks in Europe – up 4% to €145bn for the 2014-2015 period, according to DTZ.

Moreover, co-operation between traditional lenders and their alternative counterparts shouldn’t be written off yet, according to Bernhard Scholz, member of the board at pbb: ‘Most of the new lenders tend to finance ‘big ticket’ prime deals, primarily in core locations. They are competitors to a limited extend. Nevertheless we also view them as potential partners and have already financed some deals together with both insurers and debt funds,’ he said.

LOOMING SALES
The sale of WestImmo before the year-end is finally looking like a distinct possibility, with both Aareal and Berlin Hyp believed to have submitted bids ahead of last month’s deadline. Some bidders are thought to have offered to pay more than €300 mln, slightly more than half of WestImmo’s common equity of €575 mln, according to those who track the market. If Aareal succeeds in acquiring WestImmo it will mark the lender’s second acquisition of a rival in the past 12 months, following its acquisition last year of rival Corealcredit from US private equity group Lone Star for €342 mln. A spokesman for Aareal declined to comment.

One analyst, who asked not to be identified, told PropertyEU that private equity groups and French and Dutch banks were also likely to consider WestImmo, given strong interest in Germany’s real estate sector. The European Commission had originally asked for Westimmo to be sold by the end of 2011 as part of its conditions for WestLB's bailout. The latest attempt to sell Westimmo comes more than two years after talks with private equity investor Apollo failed.

Less certain, however, is the future of pbb Deutsche Pfandbriefbank, which also needs to be sold or wound-down in exchange for state handouts during the financial crisis. One analyst, who also asked not to be identified, told PropertyEU, that he thought it was now more likely that the lender would be wound down. Pbb announc√ed on 12 September that Thomas Köntgen and Andreas Arndt would take the company forward as co-CEOs of the five-man management board. Köntgen joins from Hypothekenbank Frankfurt and Arndt has been CFO of pbb since April this year. The announcement spells good news for the group, which had been without a CEO since Manuela Better stepped down in June.

EUROPE'S REFINANCING GAP NARROWS
Improved capital values and more aggressive refinancing have also helped to lower Europe’s refinancing gap for 2014-2015, which is down 33% year-on-year to €51 bn, according to DTZ. However, if the negative regulatory impact is also taken into account, it adds an additional €73 bn burden, thereby taking Europe’s gross debt funding gap to €124 bn, or 2% higher, year-on-year, according to DTZ. And while some countries like Spain, still suffer from net funding gaps, in Germany, the UK and France combined there is now a €45 bn lending surplus, according to DTZ.

CHALLENGES AHEAD
The key challenge for banks going forward is how to differentiate themselves from their competitors, according to Schürmann. ‘Just differentiating on price is not great for the market. However, covenants and the ability to structure complicated loans can be a differentiator. For example, Anglo-Saxon investment banks are typically better at underwriting large loans more quickly and there are borrowers who don’t mind paying more for a loan if it can be executed quickly,’ he added.

In addition, it is important to come up with a business model that can withstand ‘any market turbulence,’ according to Schmid at Aareal Bank.

For Scholz at pbb, the biggest challenge is finding ‘find the right, stable real estate asset in a market where yields are under pressure’.

Another challenge is the shifting framework conditions in commercial property financing. 'Like all other banks we have to adjust to this "new normal" which is characterised by higher capital requirements, stricter liquidity rules and the resulting lower expectations of profitability,’ said Schmid.

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Helaba
Newly acquired business as of 30 June 2014: €4.4 bn (1H 2013: €4 bn)
Renewals: 1H 2014: €0.5 bn (1H 2013: €0.4 bn)
Total volume of the property finance portfolio as of 30 June 2014: €33.6 bn

Berlin Hyp
Newly acquired business globally as of 30 June 2014: €1.8bn (1H 2013: €0.9 bn)
Total volume of the property finance portfolio as of 30 June 2014: €21.3 bn

Aareal
New business globally as of 30 June 2014: €4.2 bn (H1 2013: €4.4 bn)
Newly acquired business: €2.7 bn (H1 2013: €2.5 bn)
Renewals: €1.5 bn (H1 2013: €1.9 bn)
Total volume of the property finance portfolio as of 30 June 2014: €28.5 bn (H1 2013: € 23.7 bn). The main reason for this increase is the acquisition of Corealcredit Bank.

Pbb Deutsche Pfandbriefbank
New business globally as of 30 June 2014: €3.7 bn (H1 2013: €2.8 bn)
Consolidated total assets as at 30 June 2014: €77.8 bn.