Although volumes are lower, Europe’s leading real estate banks are still cautiously underwriting new business while loan loss provisions are ‘manageable’.
German real estate banks are approaching the end of 2020 with their lending model intact, and relatively low levels of distress considering the damage being wrought by the global coronavirus pandemic.
Banks like Aareal, Helaba and Pbb Deutsche Pfandbriefbank are key to providing liquidity to European property; in good times this trio alone lend €25bn-€30 bn a year between them. In 2020 they have all lent less and made higher provisions. But unlike the dark days of the global financial crisis, this year’s provisions have been relatively small compared to the size of their books. While they are more cautious about their lending, they have not been knocked off course and continue to contribute to liquidity in the market.
It is not only the banks themselves that claim to be managing through the crisis thus far. Jacob Lyons, managing director at Rivercrown, a real estate debt and equity asset management firm which was very active in working out sour loans during the GFC, says the same.
‘We are not seeing the volume of non-performing loans coming out of banks like we did last time - the dynamics now are fundamentally different. In the global financial crisis, we were involved with NPLs and distressed CMBS transactions and worked with special servicers, the likes of Hatfield Phillips, Capita or Situs, and on loans in CMBS conduits,’ he told PropertyEU.
This time, he predicts sources of assets for sale via the debt ‘are more likely to be due to “house-keeping” rather than distressed sales. For example, a lender with a retail loan coming due might want to sell it. We are talking to one insurance lender which has a UK hotel exposure which they would like to sell and they are prepared to take a small discount’.
In 2020 lenders have approached clients at an early stage following the outbreak of the crisis and remained in continuous, close communication with them since: many banks were bitterly criticised by borrowers for doing exactly the opposite when the GFC struck.
Sectors under pressure
Clearly for all lenders including the German banks, the sectors hit worst by the pandemic - retail, leisure, food & beverage and hospitality - are extremely management-intensive. As Thomas Koentgen, deputy CEO at Pbb, confirms: ‘Managing our hotel financing portfolio is more time consuming these days, to say the least.’
Pbb’s hotel portfolio accounts for 5% of its book, or €1.5 bn of its assets at an average LTV of 53%, and is entirely concentrated on business hotels in core locations. Koentgen says: ‘At these low LTV levels, sponsors usually have a high interest to protect their investments. We may discuss adjustments with our clients, for example covenant holidays, but interest is being paid.’
The bank has a number of hotel loans where there is subordinated debt in the transaction, but mezz lenders also have a vital interest in keeping the senior lender in the loan and constructively discussing borrower requests.
Pbb’s public statements about provisions this year point to UK retail as having been the most difficult sector. The bank explicitly stated that Q3’s additional provision of €14 mln reflected dropping valuations on UK shopping centres. ‘UK shopping centres accounted for the majority of recent single loan loss provisions. The pandemic acts like a catalyst for the structural issues the sector is facing,’ Koentgen points out.
The German bank with the largest exposure to hotels is Aareal with almost €9 bn of loans in hospitality on its book.
Aareal supports clients via deferrals of repayments and liquidity lines which also cover interest payments. Christof Winkelmann, member of the management board at Aareal Bank, says that at the end of Q3 2020, of the top 15 loans in the hotel portfolio (all of which exceed €150 mln, including 12 portfolio financings), six have required liquidity injections since March.
‘Liquidity support has been provided for 35% of our hotel exposure - approximately €3 bn - since the beginning of this year’, he says. He adds: ‘The aggregate of support measures for our hotel financings equates to around 1.4% of our total portfolio volume.’
Overall across Aareal’s real estate portfolio since the crisis began, he says, financial support required has been manageable: €80 mln in deferred repayments, plus €107 mln in liquidity facilities or deferred interest. ‘This translates into a share of less than one percent of our aggregate commercial property finance portfolio.’
Refinancing test case
One obvious area where liquidity is going to be tested for real estate markets in the coming months is refinancing, according to Lyons’ colleague, Rivercrown MD Stephen Benson.
‘We call it situational distress, that is difficulties repaying loans on some non-core assets. If you have a retail park, a hotel or a co-working office that was worth £100 mln with 65% loan-to-value debt on it and it falls in value by £20 mln the debt is still fine. Most lenders were at those kinds of sensible LTVs. But the problem is what to do about refinancing that loan when it comes due. There are going to be some issues next year where values have fallen and lenders are also going to be sensitive to LTVs.’
Likewise as time goes on, the pain seems likely to increase for more office tenants. Until now banks - and their borrower clients - have only had to manage the situation regarding offices, but the question is what the rent collection rates will be in six months’ time.
‘The jury is still out regarding developments in the office property markets,’ Koentgen agrees. Regarding its own office loan portfolio, he argues: ‘At Pbb we think the advantage of our conservative risk profile particularly regarding locations was a good decision in better times in the cycle. Because, if you look at the rent collection rates on an office tower in a core, prime location in London, Frankfurt, New York, Stockholm, Paris or similar, they are better. The tenants who pay £100 psf usually are more robust than the tenants paying, say £22.’
New business
While new lending this year is down across the board, Germany’s banks are still active. ‘We continue to underwrite good levels of new business, despite the Covid-19 pandemic, with margins beating expectations and low LTV ratios,’ says Winkelmann.
‘This shows that the business model in commercial property finance is working and is viable for the future. At €4.2 bn for the first nine months, the level of new business has been at a very solid level in view of the pandemic.’
Aareal is relatively optimistic about the outturn at the end of 2020, reflected in metrics such as its forecast of only a modest increase in the average LTV ratio of its entire property finance portfolio at year-end compared to the beginning of the year.
‘In our base case scenario, we assume that whilst local lockdown measures might be taken, global economic activity will continue to gradually normalise. We expect a recovery in 2021 and 2022 that will successively gain momentum and breadth,’ Winkelmann explains.
He also points out that even in difficult times there are opportunities: ‘We want to actively exploit those, provided the risk profile is good.’
While the bank has set about diversifying sector exposure recently, making a push into student accommodation which is a new area of expertise, and focusing on lending as much as it can to logistics, Winkelmann says new financings will continue to include hotels.
‘Even though hotel properties are particularly affected by the pandemic right now, we continue to consider hotels as an attractive property type in our long-term strategic direction and remain ready to extend finance to this sector...We anticipate being able to continue to achieve an attractive risk/return profile going forward, leveraging our experience and USPs. Hotels are likely to be amongst those sectors staging the fastest recovery once the pandemic has been overcome.’
Both Aareal and Pbb are very cautious on lending against retail. ‘We have significantly reduced our retail portfolio starting already in 2016. We will continue our very selective approach,’ Koentgen admits. ‘Our focus is on day-to-day and food retail as well as unrivalled high street locations with strong tenants and low LTVs.’
‘The pandemic will likely further accelerate the long-running trend of high growth rates in online commerce – a trend to which we have already responded some time ago, by entering into new business for retail properties on a selective basis only. The current situation is without doubt extremely challenging for numerous retailers, requiring tailor-made measures within our client portfolio,’ Winkelmann chimes.
Non-bank lenders
There is an expectation that non-bank lenders will step in to fill gaps where banks are especially ‘selective’. 2020 has been notable as a year of successful capital raising for new debt funds with Rivercrown’s own Special Situations Credit Vehicle launched in June just one of them.
It is an interesting question as to whether, say, lending 70% LTV on a business hotel somewhere is a good deal for an alternative lender if it is not something a bank would - or is able to - do.
Benson says Rivercrown’s Special Situations Credit Vehicle is currently progressing four new loans to close within the next month. It will look at sectors that are currently out of favour if the sponsor and transaction quality is high.
‘The kind of deals we’re trying to close are ones with a level of commitment and risk-return that makes sense. Much of what we see are the kind where we know there will be more favourable deals next year. For example, in Spain there are a lot of half-built hotels or residential schemes with planning and we’re not prepared to take the risk.’
Pbb’s Koentgen observes that the fact that debt markets have significantly diversified since the global financial crisis is a very good development as it allows borrowers and lenders to finetune their activities to their individual risk appetite.
But he isn’t sure whether alternative lenders will be more aggressive in the market. ‘They may benefit from a lower level of regulation but they will have an informed view on the risks they take,’ he believes.
‘What currently helps the real estate market is that there is a lot of liquidity, in the debt as well as in the equity market. The majority of senior lenders are significantly less leveraged than they were 10 years ago.
‘In addition we have a lot of what I would call “experienced money” in the market, both on the debt and equity side. In this situation an asset market benefits from the more experienced participants compared to 12 years ago when dealing with an external shock.’
Banks’ risk provisions are burdened by Covid-19
Aareal Bank’s total loss allowance for the first nine months amounted to €167 mln, of which €111 mln was attributable to Covid-19-related burdens. The latter figure includes €57 mln in ‘management overlays’ – loss allowance recognised to cover model-based risks related to the pandemic.
The overall Covid-19-related burdens on the items of loss allowance, net gain or loss from financial assets, and net other operating income/expenses for the first nine months of the year, included impairment charges of €138 mln from the pandemic, roughly half of which was in management overlays.
Aareal’s total property portfolio volume at Q3 was €26.7 bn
Pbb added €84 mln of new risk provisions in the same period: a significant increase but still small in relation to the €32.7 bn outstanding book. The bank explicitly stated that Q3’s additional provision of €14 mln reflected falling valuations on UK shopping centres.
About half of Pbb’s total risk provisioning so far in 2020 (€43 mln) was categorised as stage 3 impairments which relates to financings already with indicators of impaired credit quality - as opposed to stages 1 and 2 where the credit risk has increased.
It is understood that the majority, €31 mln, was attributable to loans for shopping centres in the UK and due to falls in market value but that the loans are performing with interest being paid.
For European banks generally, the European Banking Authority and other relevant regulatory authorities have recommended adopting a realistic assessment of expected loss without overstating short-term effects during the pandemic. Accordingly, not all measures automatically trigger rating downgrades, or lead to a significant credit deterioration or default, given that risk provisioning is based on lifetime expected loss.
Alternative lenders look forward to rich pickings
‘There is a lot of capital sitting on the sidelines; alternative lenders are well-capitalised,’ remarks Clark Coffee, a debt expert who is launching a pan-European debt investing platform for AllianceBernstein with €1.5 bn of capital to lend.
Coffee, who moved from a bank into establishing an early post-GFC debt fund alongside fellow ex-banker Heath Forusz, at Tyndaris, set up his own firm, Lacarne Capital, last year. He wanted to establish his new business at scale and teamed up with AllianceBernstein, a US investment management operation with $631 bn in client AUM.
The European Commercial Real Estate Debt business (ECRED) which has AB’s backer Equitable insurance company as an investor, will make most of its loans by volume as senior, charging rates commensurate with mid to high single-digit returns for the institutional investors. There will also be a high-yield lending pool of capital where returns sought will be low double digits upwards.
Clark says there is still liquidity from banks - ‘they are just restricting what they want to do...This is great news for an alternative lender as we feed off the periphery of banks’ appetite.
‘When banks rein in, then our opportunity increases disproportionately, because banks are still such a large component of the European debt market. If you said banks are 80% of the market and alternative lenders are 20% and bank appetite reduces by 20%, that’s 16 points. That almost doubles the market share for alternative lenders.
‘What’s exciting is that during the next couple of years, during the recovery from Covid, we’re going to have an opportunity to put better risk on our books than we anticipated when we conceived the business. But bank appetite will recover and when it does, we’ll go from a relatively easy time finding good risk, back to more normalised conditions.’
