Faced with uncertain financing conditions, more real estate borrowers are aiming to push out the maturity of their existing loans by up to two years, according to Jackie Bowie, head of Europe for risk management firm Chatham Financial.
Rising interest rates and tightening credit conditions have prompted borrowers to address their upcoming loan maturities. Bowie, who leads a team that acts for clients in areas including loan hedging, sees sponsors negotiating with their current lenders.
“We are seeing borrowers try to extend their existing facilities. People are actively negotiating a one/two years extension to debt terms, so although they would pay an arrangement fee for this, it is not a full refinancing,” she said.
Bowie has seen a mix of outcomes in how borrowers and lenders negotiate extensions, with margins increasing in some facilities by 25 basis points to 100bps. However, the terms on which extensions are granted depend heavily on the starting point for margins and loan covenants, she added. Chatham has seen in cases complete waivers of servicing covenants for a period, and situations in which there is no change in covenants aside from a reset of forward-looking measures.
As a result of the increase in loan extensions, Chatham is advising on a lot of hedging extensions. “[Clients] might have had three-or-four-year hedging, be two years in, and are adding a year at the other side, so constantly looking out three years. We call it top-up hedging or short dated extensions.”
Bowie said Chatham is also talking to lenders about permitting borrowers to hedge beyond the end of their loan terms. “The borrower can protect refinancing risk because when the loan matures in two years, all it is negotiating at that point is the margin as the underlying rate is already fixed.”
After the global financial crisis, banks reined in borrowers’ ability to hedge beyond their loan terms, Bowie explained. “Huge amounts of debt that had matured had long tails of hedging, and because interest rates had fallen, that hedging was out of the money and was a huge liability to cancel.”
However, banks are now open to discussing longer-dated hedges, which Bowie says can help reduce risk for sponsors. “There’s certain language needed in the documentation to say if this loan is not refinanced at maturity, then the hedging needs to be broken. But it gives me comfort borrowers are looking to protect the refinancing risk a little.”
Active decision
Speaking to affiliate publication Real Estate Capital Europe in September 2022, Bowie said the sharp rise in rates, and therefore hedging costs, had taken many real estate clients by surprise. She says hedging options remain a key consideration for borrowers. “Cap rate premia have come down in line with swap rates, but the absolute premium costs are still high. Much more attention is being paid by borrowers as to whether to buy a cap or fix and not put cash out on day one. It’s a much more active decision then it was before.”
Bowie sees signs of real estate debt pricing settling, partly due to debt funds competing for transactions. “We’ve come off the highs of the third quarter last year but there is an expectation still rates will go up. Both the euro and sterling swap curves are inverted, so the three-year swap rate in euros today are 3.05 percent and five-year is 2.83 percent, so if you hedge for longer, the rate is lower.”
She warns against sponsors putting off hedging on the expectation of falling rates. “We warn them the market is already pricing this in. If you’re going to hang off fixing your rate, it must be because you expect rates will fall even more than the market is already pricing in.
“If you can hedge sterling interest rates for sub-5 percent today, and you can get a margin at 2-2.5 percent, depending on your asset, an all-in cost of funds of 7.5 percent is kind of normal, if you look back over the longer term.”
Non-bank growth
Chatham sees an increase in activity from alternative lenders as they target market share at a time when banks are pulling back, Bowie added. “We see it because we have a substantial FX [foreign exchange] hedging advisory business, and those funds tend to hedge their FX exposure at the fund level. They might be euro denominated but they extend loans in sterling, Swedish krona, etc. Their return targets have increased because they are able to earn much more from lending than they would have done two years ago.”
While financing market conditions remain uncertain, Bowie says the impact of US regional bank failures, beginning with Silicon Valley Bank in March, is not having a clear impact on real estate debt pricing in Europe.
“It’s hard to separate the impact [of US bank failures] on credit pricing from the general malaise in the market. What did happen was that, when SVB failed, there was a big increase in credit being drawn, across markets including corporate lending. As soon as the banking issues started, borrowers drew down any debt which was available to them.”
She added: “Pricing in the real estate debt market is much more driven by conditions in asset classes themselves. For instance, sentiment towards offices is very negative, more so in the US than Europe.”
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