German lenders show greater flexibility as margins hit all-time low

German lenders are becoming more flexible against a backdrop of miniscule margins, which are making it increasingly challenging for them to position themselves strategically, according to Markus Hesse, head of the German Debt Project 2018 study published by the International Real Estate Business School (IREBS) at the University of Regensburg.

‘The German banking sector is under an extreme amount of competitive pressure,’ Hesse told REFIRE. ‘A big part of the story is the change in new business, which is now falling (by 7% last year), although that’s only part of the story. More importantly, we found during the interviews with banks that their answers regarding a range of questions, including risk returns, have become a lot more diverse. Their strategic positioning has become more difficult. In the past, there was more talk of lending in B and C cities but this year, some players are focusing a lot more on financing the largest share possible of a core deal, while others are looking more at high-margin development opportunities. The middle market wasn’t discussed as much. It hasn’t gone away, it’s simply been more aligned to core.’

For the IREBS’ German Debt Project, Hesse met with 24 banks in Germany and sent out a large questionnaire to other lenders with a combined credit volume of €185m.

According to the IREBS, new business is expected to fall in Germany this year. ‘I expect it to fall again because it was already down 20% q-on-q in the first quarter this year,’ Hesse said. ‘That’s more than we expected.’

A major hurdle for lenders is that it is becoming increasingly difficult to differentiate on loan margins because they are so low – at just 50 bps to 70 bps for core, Hesse said. ‘Some banks are differentiating themselves by pushing through loans more quickly - in just a week - and there are clients who are willing to pay a premium for that. At the same time, it’s important that the quality of decision making remain at a high level.’

Gross margins in general have tightened significantly since 2013’s average of 161 bps, falling to just 121 bps today, according to the IREBS.

Moreover, you can’t just look at average figures because they don’t tell the true story – you have to look at risk clusters, too, Hesse said. Given the ‘micro margin’ environment, ‘managing to core’ is becoming increasingly popular. ‘The question for lenders is: if they go up the risk curve, can these properties be turned around? Sometimes, assets are only priced like core. It can be very attractive for a bank to lend on if they get it right. We see that loans are becoming more complex, so going forward, lenders are going to have to get used to underwriting more and more complex loans.’

LTVs are also falling, averaging 59% last year, down from 63% in the previous year. Lenders are also upping their exposure to project development and value-add and opportunistic assets, according to the study.

The study was sponsored by JLL, the Commercial Real Estate Finance Council Europe (CREFC), INREV and ZIA. It has been carried out annually since 2013. (ssk)