Hypo Real Estate Holdings

HypoVereinsbank’s spun-off property banking business will lend internationally via a Dublin-based unit, while cutting back its troubled domestic HRE/Westhyp operation

After five years of mergers and restructuring, HypoVereinsbank (HVB) is to spin off its commercial property activities into a separate corporate entity, in line with efforts to reduce the group’s risk and increase its profitability. Hypo Real Estate Holdings (HREH) will go public on 6 October. HVB shareholders will receive an additional share of Hypo Real Estate Holding for every four they hold in HVB. The new property bank’s core capitalisation will be around €4bn.

Unlike other property banks, which provide a range of property-related or fund management services, HREH will focus on offering property finance. It will have three arms: the Dublin-based Hypo Real Estate Bank International (HRI), the German-based Württemberger Hypothekenbank (Württhyp), and Hypo Real Estate Bank/Westfälische Hypothekenbank (HRE/Westhyp).

HREH will be based in Munich but will have a strong focus on international financing – hence the establishment of HRI in Dublin. “We will concentrate on medium- and large-ticket transactions, which allow us to make full use of our lending and structuring skills,” says Georg Funke, chief executive designate for Hypo Real Estate. “Typically, the transactions we are looking for are undertaken by larger, professional real estate players.”

While the old HVB mainly pursued straight lending, HRI will look for investment bank-type deals that generate fee income. An example is the €1.6bn short-term bridging finance HVB arranged for Merwede group and Lehman Brothers last year when they took Dutch property company Uni-Invest private. “We have yet to decide whether to participate in the long- term part of the deal,” says Funke. “Our exposure in such deals is now more likely to be around €50m, rather than the €500m we would have committed in the past.”

Funke adds: “We will not contribute equity to deals we finance, as this creates competition with our customers’ business. But we are prepared to take equity-type risk by providing subordinated loans, a structure that enables us to monitor the progress of the investment closely. If the interest is not paid, we can act on that early warning signal and take appropriate steps.”

The bank has identified several key markets, among them the UK and the US. “We are over-invested in Germany and the property markets are going through a difficult patch. There are still deals for us in Germany, albeit not many that fit our strategic goals, but its importance will decline,” says Funke. To look after this business HRI will set up a Munich branch.

The US market also features strongly in HRI’s business plans. From its beginnings as a property department of Bayerische Vereinsbank in New York in 1989, the group’s US operation has built up a €7bn loan book. The US team will be transferred to HRI, but it has yet to be decided if parts of the US portfolio will also be taken on board by HRI.

HRI and its predecessors have been active in the UK for nearly 15 years. Starting out as a lending division of the former Hypobank, the bank later set up Hypo Property Services, which by the mid-1990s had acquired properties worth £500m. The UK investment unit sold the properties between 1994 and 1998, pocketing a £92m profit.

On the financing side, in 1997 the bank started to provide mezzanine debt, linked to profit sharing arrangements with borrowers, and two years ago it arranged its first conduit financing, raising £375m for Pillar Property Investment.

HVB has set up local branches in other European markets over the past three years. Last year the bank made France’s premier league of property financiers when it arranged financing for Europe’s largest sale of corporate property assets, which saw France Telecom sell a €2.9bn portfolio to a joint venture between Goldman Sachs, GE Real Estate and Caisse des Dépôts.

In Italy, HVB has lent €1.2bn to international investors since opening its Italian office two years ago. In Stockholm, the branch has completed seven deals totalling €650m, including the mandate to structure a €430m Whitehall deal for assets belonging to construction company NCC – so far the largest deal by an international investor in the Swedish market. The deal was fully underwritten by the bank and subsequently half of the deal’s financing was syndicated to other lenders. In the Netherlands, meanwhile, HVB is in negotiations to sell FGH Bank, which it bought in 1998.

HVB has built up a strong market position in central Europe, but HRI will not be able to benefit from it. The restructuring will see all central European assets transferred to another HVB subsidiary, Bank Austria. HRI will also look at business opportunities in Asia, a region which is believed to offer tremendous growth potential.

On the domestic front, the group’s second operating unit, Württhyp, is a traditional German mortgage bank. “Württhyp will typically lend against first mortgages, which is a virtually risk-free business earning small margins,” says Funke. “We would like to maintain this business at its current level as it makes a stable profit contribution.”

HREH’s third operating unit, Hypo Real Estate Bank (HRE/Westhyp), is the product of the merger of three domestic mortgage banks in a previous HVB restructuring. Plans to sell mortgage bank Westhyp have been scrapped, and it will remain part of the HREH group.

While HVB’s international activities have been highly profitable and incurred very little in terms of write-offs, the group has fared less well with its domestic lending. As German property markets have slumped in recent years the bank has piled up a portfolio of roughly €3bn in bad loans, with further loans of €1.1bn being placed on the watch list.

For the next two years HVB has agreed to shelter loan losses in HRE/Westhyp’s portfolio in the order of €590m. Funke stresses that HRE/Westhyp’s main problem now is much less the quality of its assets, since bad-debt provisions have reached a level that fully accounts for the market downturn, than its lack of profitability. Much of the business in recent years was written at very small margins. Now the bank plans to all but stop underwriting new domestic business.

In the first half of 2003, HRE/Westhyp’s new lending totalled €107m, down 87% over the same period last year. The bank is expected to reduce its total loan book from €40bn to €30bn or less over the next three years. Loans that come up for renewal are being priced to ensure that they contribute more to the bank’s bottom line. This has led just over 40% of customers with loans up for renewal to repay their loans. In Germany, mortgage loans usually have a 15 to 25 year repayment period, with interest rates being adjusted every five to 10 years to the prevailing market conditions.

Funke says the bank is considering other options for dealing with bad loans, but adds that it is too early to discuss them yet. The sale of non-performing loans has been a subject for debate in Germany in recent months, but no such deals have been disclosed yet. Funke does not think such sales will play an important role in the market, partly because buyers and sellers have such different price expectations. This is often because of difficulties in arranging the refinancing for such loans.

While the HREH is expected to be profitable from the start, Funke expects that it will take five years for its HRE/Westhyp subsidiary to reach profitability. To achieve this goal, operating costs are being cut, operating procedures streamlined and redundancies made. All branches, except for two back-up offices in Dortmund and Nuremberg, have been closed.

While optimistic about business potential on the lending side, HREH’s management admits that there is a question mark over the liquidity available in the market. However, one encouraging sign of the newly constituted group’s refinancing capabilities has been the A-rating assigned to it by rating agencies.

Hypo Real Estate group: financial highlights
HVB is spinning off HRE as a separate corporate entity
Figures in €m	2001	2002
Total assets	170	178
Loan book	127	123
Total operating income	938	824
Pre-tax profit	387	60
Source: Hypo Real Estate

Hypo Real Estate group: selected property lending transactions
The CGW SASdeal was Europe’s biggest ever corporate property sale
Client	Amount	Property	Deal type	HRE’s role
CGW SAS: Caisse de Dépôt, GE Capital UIS, Whitehall Fund jv	€2.3bn	France Telecom offices/ technical portfolio	Acquisition finance	Agent/co- arranger
CSC	£550m	Lakeside shopping centre, UK	Term loan	Lead manager
Pillar Property Investment	£375m	UK retail portfolio	Conduit finance	Arranger
Kungsleden	SKr4.2bn	Mixed-use Swedish portfolio	Revolving credit facility	Arranger
Orion European Real Estate	€346m	French portfolio	Term loan, senior & mezzanine finance	Arranger
Vomado Realty LP	$490m	Bloomberg office tower and condominium, New York	Construction loan	Lead arranger
Apollo Real estate Fund lV	€200m	Pascall Towers, Paris	Senior/mezzanine loan	Arranger
Source: Hypo Real Estate