There is an ever-increasing list of traditional banks no longer actively looking to write new real estate loans in the UK. Against this backdrop, it is relevant to assess what the future for the market could hold, and if there are any positive signs emerging as to what liquidity may exist going forward.
The context of the decisions being made by banks is a reminder – if we ever needed one – that the political-economic backdrop remains challenging and overall is trending negative rather than positive.
The evolution of the sovereign debt crisis continues to weigh heavily on the price at which all banks are able to raise liquidity, and thus the availability and price of new loans.
For those organisations whose home currency is the euro, and with the ultimate outcome for the currency union still unclear, this is especially relevant.
Across the Continent, banks are assessing which sectors and geographies they wish to support, and the answer is usually fewer, and those that tie up liquidity for as short a period as possible.
At the same time, banks face ever-increasing regulation and a requirement to hold more, and often better-quality, capital against real estate loans.
These are loans that tie up balance sheets for relatively long periods of time within organisations that often remain overexposed to the real estate sector. These dynamics have intensified in 2012.
Slotting was not a commonplace expression at the start of the year, but the requirement for UK banks to recalculate how they rate and allocate capital against real estate loans appears to be no longer a point of debate but rather one of timing.
Against this backdrop, it is hard not to conclude that more banks will announce withdrawals or reductions in their commitments to the sector.
Thus, unsurprisingly, there has been increasing commentary and expectation put on the role that non-banks can play in alleviating these pressures.
Debt funds
There has been significant news about new senior debt funds being launched in the first half of the year. However, I am not sure there has been too much of a practical impact so far. If the frequency of these announcements were directly correlated to increased liquidity in the market, then we would all feel more positive.
However, many of the funds relating to these announcements have yet to raise any equity, and many will focus on the 8-10% return space which, while useful, is not the layer of the capital stack where the most acute shortage of liquidity is being felt.
Insurance companies and pension funds continue to peruse the space, but often their lack of familiarity with the product, together with their own uncertain and evolving regulatory regime, have led to caution.
Many observe the attraction of the risk-return available but, with a few exceptions, most have tended to remain formulating their strategies or opted to continue to seek long-dated paper, which remains a small part of the market.
However, there is no doubt that these non-bank sources of debt will be the key to the future of the sector.
Certainly there will be part of the market that is appropriately blue chip, has sufficient long-standing relationships or can offer enticing levels of ancillary business to benefit from traditional bank leverage. However, this will not affect most of the market.
What really needs to happen is for alternative sources of non-recourse, term finance to be available in much more volume so that some of the wider market constipation in the sector can start to dissipate.
On this front, there are some encouraging signs. First, the stretch senior/mezzanine investors have started to deploy capital in increasing volumes. Successfully adding intermediate capital into transactions significantly broadens the potential investor and transaction base.
Loan portfolios
Second, activity relating to the sale of loan portfolios is increasing and growing. While still small in absolute terms, it is bringing in new capital and liquidity in the market.
Finally, the non-bank community, while not yet delivering serious liquidity, now very much has real estate on its radar, and often at return levels that makes affordable sense for 0-60% LTV, which has to be the key going forward.
Whether it is immediately apparent or not, the real estate finance sector is one that is in transition. This is a move away from bank-dominated liquidity to alternative sources of finance. The challenge for all of us in the sector – even for those traditional banks that want to remain active – is to find a way to guide this potential liquidity into the market as soon as possible.
Michael Acratopulo is managing director, Eurohypo London branch
