It is unlikely that the German government intended things to be this way, but the announcement of a €50 billion bailout package for Hypo Real Estate was dramatically timed, coming as it did just as 42,000 real estate market participants were meeting at the Expo Real in Munich last month.
Hypo's large stand became a bit of a circus on the opening day once news of the bailout hit the wires. Journalists and even a camera crew swarmed the stand following the announcement, which detailed a huge commitment from the German government and a collection of German financial institutions to help the bank through the credit crisis.
The shock circulating Expo Real was palpable. If Hypo would not be underwriting any new business for a while, wondered delegates, then who would be? The same day, it emerged another significant real estate lender, Royal Bank of Scotland, would need funds as its share price crashed 40 percent. But Hypo was the greater shock, as it was still reckoned to be actively lending.
Hypo, a Munich-based international bank, has not collapsed, but the €50 billion it has received has wide implications for anyone involved in real estate investment in Europe. Among the most serious will be the general effect on confidence. Until the events of October, Hypo Real Estate had been a beacon of credit in an otherwise dark lending environment
It lent €65.6 billion in 2007, ranking it Germany's second biggest commercial property bank and one of Europe's largest biggest behind RBS, Eurohypo and Anglo Irish, but its steadfastness in adversity had marked it out.
One private equity real estate fund manager told PERE: “Hypo has been one of the few European banks still lending as long as you are a good business.”
Another noted potential long-term effects on his market: “Banks like Hypo are looking to de-lever and that is going to be the world we operate in for the next couple of years.”
These two statements point to a broader industry assumption that Hypo is no longer open for much, if any, new business in the short-term. This is a worrying reversal for an otherwise very active bank. Since June it has entered into a string of deals. For example, it agreed to take a €91 million senior tranche of a 2007 loan taken out by Curzon Global Partners and affiliate AEW Europe to acquire 18 German properties. It also provided a $130 million loan to Robert Siegel and the Hermes family to buy the global flagship store of Tommy Hilfiger in New York. Then there was a $46 million loan to finance the acquisition of the InterContinental Chicago by Citibank Strategic Hotels and Resorts and GIC, the investment arm of the government of Singapore.
Balance-sheet triage
Now, the assumption is that there will be far fewer of these facilities. GPs say that the Hypo real estate team is focused on reducing balance sheet leverage rather than taking on additional loans.
According to clients of Hypo that PERE spoke with recently, the first communication they received from Hypo regarding its bailout was a press release on 6 October. It explained that the German government, the Central Bank, financial regulator BaFin and senior representatives of the German banking and insurance sector had agreed an addition €15 billion lifeline in addition to €35 billion of rescue money already announced. “This solution ensures that Hypo Real Estate Group is stabilised, will have access to sufficient liquidity even in an ongoing financial crisis, and can continue to operate,” the statement said.
However on the same day, it also became clear that Hypo would need to sell off loans. To do this, PERE understands from industry sources that talks are now being held between Hypo and clients, including private equity real estate firms. These talks centre around the possibility of buying back loans, among other remedies.
One GP client, who will likely be buying loans from Hypo, told PERE: “We will be dealing with [the bank] in a very different way than in the past, which is to help them.”
Hypo's problems are typical of the current environment. In 2007 it bought Irish public finance and infrastructure bank Depfa for €7 billion on unsecured short term debt that it has found a terrible burden. Depfa's business model was built on lending long to governments around the world, but borrowing short. Following the collapse of Lehman Brothers, Hypo found Depfa's funding requirements dangerously difficult to meet. Instead of trying to ride it out, chief executive Georg Funke and the Hypo supervisory board decided to approach the German authorities and negotiate a package that would see the bank through 2009, and theoretically beyond that when assets on its book mature. According to Funke (who has since resigned), in 2010, Hypo will have more assets maturing than liabilities.
However it will still need to reduce its balance sheet, the bank says. The difficulty facing Hypo is that while it wants to reduce its balance sheet, it does not want to enter into fire sales. Hypo has a large loan book, which in theory represents locked-up profits for years to come, so it doesn't want to cast these off too cheaply. It has had to put up €44 billion of assets in order to secure €33 billion of liquidity according to what Funke told analysts on 6 October, so it has to choose with care which assets to sell. When asked if the real estate business would be writing any new business he said: “We have to look at the risks. This is not the time to be aggressive on new business.”
When it came to the question of fire sales he was more emphatic. “We are intent on reducing our balance sheet in certain areas, but no fire sale,” he said. “No, the price has to be right. We will pick markets and what assets.” He was also asked if the bank had changed its internal rates of return requirements for the real estate business. “Yes, just today we adjusted our IRR requirement to match the market,” he responded.
So, there are three implications for private equity real estate firms of the near collapse of Hypo. The first is that the bank will no longer be lending much. f it does, its loans will be more expensive. Thirdly, there may well be opportunities to buy loans from Hypo, but if the bank gets its way, firms may not be able to negotiate anywhere near fire sale prices for those assets.
Flowers powers
For two particular private equity firms, the decline of Hypo has been particularly painful. Earlier this year, JC Flowers and Grove International acquired a 25 percent stake in the bank. At the time, Hypo's board welcomed the firms as partners, but whether the spirit of partnership remains strong is something neither side of the deal has publicly commented on.
In April, the two US firms and a third party, Japan's Shinsei Bank, agreed to offer Hypo shareholders €22.50 a share in a cash-equivalent offer of €1.1 billion in return for 25 percent. At the time, Flowers and its partners tempted shareholders to accept its offer by arguing it was a 20.5 percent premium to the previous three month weighted share price average. At press time, they were trading on the Frankfurt Stock Exchange at €6.20 a share, less than a third what the consortium paid for them.
“We will be dealing with [the bank] in a very different way than in the past, which is to help them.”
The departure of Funke has allowed Hypo to be infused with fresh blood. Axel Wieandt, global head of corporate investments at Deutsche Bank, which presumably supplied part of the €50 billion funding, started as new chief executive of Hypo on 20 October. Klaus Pohle, the deputy chairman of Hypo's supervisory board and associate of JC Flowers head Christopher Flowers, and Grove's Richard Mully, who are also on the board, have stepped up to become interim chairman now that Kurt Viermetz has stepped down.
Pohle, Flowers and Mully will have a key role steering Hypo through the choppy waters of the financial crisis for months to come. Their presence ensures that private equity real estate is not just a bystander suffering the general fall-out as real estate borrowers. Instead, private equity is at the heart of Hypo's future.
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