The appointment of Morgan Stanley to refinance Green Property’s Blanchardstown town centre with a €750m (£538.5m) loan was the latest, and largest, in a series of deals that appear to herald a move towards using higher leverage.
Morgan Stanley will provide finance at an 83% loan-to-value. In addition, last week Bank of America Merrill Lynch securitised a loan that saw the leverage on a landmark German property creep over 73% – the €455m Taurus 2015-2 DEU CMBS, held against IVG’s The Squaire at Frankfurt Airport.
These sort of loan-to-value ratios have not been seen regularly in the market since the top of the last cycle in 2007 and 2008.
Does this indicate that the market has suffered collective amnesia, or is it too early to be ringing the alarm bells?
According to Sharon Quinlan, managing director of regional commercial real estate lending at Barclays Commercial, there is no cause for panic.
“I don’t think it is a replay of previous events. I actually think there is a far more structured, measured way of providing leverage into deals as there are different layers, which are attracting different returns to reflect the different risks in the capital stack,” she says.
She says that in the senior debt market things have remained stable over recent months. “I would say it is still holding its own in the mid-60s for senior debt across the board at the moment and that has not moved for some time,” says Quinlan.
She argues that senior debt creeping up in isolation is no cause for concern because markets are continuing to strengthen and historically cheap interest rates make repayments out of strong rental flows easily achievable for borrowers, even in a downturn.
However, according to data from CBRE, the maximum LTV levels on offer were already at 65% at the start of 2012 and remained constant until the last quarter of 2013 when they hit 70%. They have since edged up to 75%.
The balance for highly leveraged loans has been made up by mezzanine debt, which is priced and structured to absorb the risk of higher leverage rates. Also, some debt providers are offering whole-loan solutions in order to clinch deals and then looking to syndicate the mezzanine or senior piece, depending on their appetite for risk.
This is true for the Blanchardstown deal. Morgan Stanley is expected to syndicate the mezzanine debt on the deal, which will detach at a 65% LTV.
With many mezzanine debt players raising funds during a more subdued lending market, the target returns they have promised investors have become less attainable as the market has become more competitive. In order to deliver these returns, some mezzanine players have had to take on more risk and provide higher LTVs.
Martin Wheeler, partner at ICG-Longbow, says: “Over the past 12 months we have seen a greater use of mezzanine in the market, typically by opportunity fund borrowers financing larger assets or portfolios. This works well for the borrower as returns are increased, while the mezzanine provider will typically contribute strong property security and a highly skilled counterparty. With smaller or more complex property transactions, we still see the whole loan as a more relevant structure.”
Although lenders argue that memories of the last crash are still fresh, the LTV ratios that are becoming increasingly common bring about distinct risk.
Given that average values dropped to around 40% following the collapse of Lehman Brothers, senior lenders at current levels would already be taking considerable hits, while mezzanine lenders and equity investors would be wiped out completely. Pricing in this risk to financiers’ lending will be crucial to the stability of the industry in the long term.
