A cocktail of counteracting macro and regulatory influences are influencing banking liquidity for real estate finance throughout Europe at the early point of this year which in turn is impacting on global capital flows into the sector, asset prices and lending appetites.
Ever-changing new regulatory requirements, central bank intervention and macro dynamics – such as the collapse in oil prices and Greece’s imminent attempts to renegotiate the terms of its €240bn bailout – are partly obscuring the outlook for banking liquidity for real estate finance.
First, the regulatory headwinds arising from three sets of requirements will have an impact on banks’ plans to exit legacy non-performing loans and appetite for new lending. These comprise:
- last October’s Asset Quality Review (AQR) process;
- the increasing focus on Basel III compliance; and
- the adoption of the ‘liquidity ratio’ metric, which will be mandatory for bank by 2018.
Starwood Capital, as investment manager for the listed European debt fund Starwood European Real Estate Finance Limited (SWEF), wrote in its quarterly investment update that the “AQR process may well have been somewhat massaged, but ECB oversight has encouraged further impaired loan pools to be marketed for sale with the Dutch, German, Portuguese and CEE markets”.
This, of course, adds to the current flow of loan portfolios in the UK, Ireland, Spain and, more recently, Italy, following the €9.7bn gap in capital identified in the AQR assessment.
The AQRs, a comprehensive assessment of 130 European credit institutions to identify problem exposures with a view to strengthening banks’ balance sheets, identified a further €52.8bn in real estate non-performing loans (NPL), taking the total real estate NPLs as of the end of 2013 to €371.1bn.
Cushman & Wakefield Corporate Finance said there are hints at increased sales activity in the Italian CRE and REO market in 2015. “However, this recovery will be prolonged as Italy’s economy remains behind the curve when compared to that of other European nations,” wrote Cushman in its European Real Estate Loan Sales Market report on 2014.
“At the same time there is increasing focus on the need to be Basel III compliant – the phasing in of the higher capital requirements starts this year, and recently greater focus has been given to the ‘liquidity ratio’ which will be mandatory by 2018,” writes Starwood Capital in the quarterly investment update for SWEF.
The liquidity ratio is a simple tool to track how leveraged a bank is. Normally a bank focusses perhaps more on ‘risk weighted assets’ (RWAs) rather than the face amounts of its assets. For perceived low risk assets RWAs are lower than face and vice versa.
The impact of banks holding AAA-rated sub-prime mortgage bonds in the crash was that expected low risk, low RWA assets were shown to be actually very high risk. To learn from this lesson, a new regulatory ratio was devised which is tier 1 capital divided by face value of assets – a very simplistic measure of bank leverage.
Starwood Capital continued: “Basel III imposes a 3 per cent minimum, the Fed has indicated this will be 6% globally systematic important banks (GSIBs) and the ECB and Bank of England are likely to follow suit.
“Such a target will be yet another headache for the banking community, especially in France and with a number of German institutions. The net impact remains likely to be at best continued anaemic lending growth if not outright decline.”
The second major influence currently driving banking liquidity for real estate finance is central bank intervention.
The impacts of the ECB’s €1.1bn quantitative easing (QE) programme, at a monthly pace of €60bn for 18 months from March, will have more ‘second order’ effects on European bank liquidity for real estate finance and in turn, asset prices and leverage appetites.
The ECB’s QE programme – designed to counter current Eurozone deflation, the threat of prolonged low inflation and stimulate investment and growth – expands the existing covered bond and ABS purchase programmes (CBPP3 and ABSPP, respectively).
“The ECB QE announcement is not aimed at the EABS market directly, but the spill-over effects and the search for yield will likely cause the spread tightening bias from the past few years to continue for now,” writes Nomura’s European ABS Research team.
The third major driver of banking liquidity for real estate finance is macro risks, from the implications of the collapse in the price of oil to the imminent attempts by Greece’s newly-installed far-left government to renegotiate the terms of its €240bn bailout, as well as impending elections in other European markets, notably Spain.
Starwood Capital wrote: “Most of the Eurozone countries are now running current account surpluses, with a major exception being France. The biggest change is the peripheral countries. One might think this is a good thing, but arguably it reflects those countries also not spending, a key growth driver.
“Without exchange rate tools, the Eurozone’s peripheral countries have to deflate more than the core to improve competitiveness and inevitably this increases the real cost of debt.
“Negative scenarios do not simply impact the lending market but also the asset value side. One could foresee further value strengthening in London, being a perceived ‘safe haven’, and value decline on the Continent.”
A final area of risk focus is oil. Oil prices are down by over 50% over the last six months, with Brent oil now at $48 a barrel. There should be follow on impacts to the European real estate market.
Starwood Capital wrote: “Lower oil prices will boost GDP growth and create more consumption, which should boost retail spending and hence strength of and opportunity in the retail real estate sector. Deflation is the obvious fear and comparisons are made to Japan’s ‘lost decades’. Note that Japan’s GDP still grew in this period whereas such growth eludes the Eurozone today.
“One other impact is that oil rich Sovereign Wealth Funds are often large-scale buyers of real estate using surplus funds generated from oil revenues. Without such large surpluses (Saudi is running a deficit at the moment) their capacity for further acquisition may be tempered over the short to medium term. On a geographical note, Aberdeen and maybe the rest of Scotland will be hit.”