Cass CRE Lending Survey mid-year 2018 update with:

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1 Cass CRE Lending Survey mid-year 2018 update with: Chair: Hans Vrensen, Managing Director & Head of Research & Strategy, AEW Laurence Mutkin, Global Head of G10 Rates Strategy, BNP Paribas The end of quantitative easing: risks & opportunities Dr. Nicole Lux, Senior Research Fellow, Where are we in the lending cycle? Professor Markus Hesse, Director, International Real Estate Business School, Regensburg The German lending market

2 The Cass CRE Lending Survey is sponsored by: Allen & Overy Association of Property Lenders Bank of England GVA British Property Federation Canada Life Ltd Asset Services CREFC Europe Fitch Ratings GIC Real Estate Helaba JLL Corporate Finance Limited Chrestbridge Savills Royal Bank of Scotland The Cass Commercial Real Estate Lending Survey Mid-year 2018: the lending cycle - 10 years on from the GFC Nicole Lux, Senior Research Fellow, City University London 106 Bunhill Row, London EC1 8TZ nicole.lux@city.ac.uk

3 The Cass CRE Lending Survey mid-year 2018 The lending cycle a retrospective Loan books, originations and lenders Underwriting interest rates and margins, book LTV

4 The lending cycle loan books, a 20 year retrospective Indexed, Average = Leveraged Long Boom Black Leverage Deleveraged Recovery The New Normal? Mid bn CRE Outstanding Loans RCA Transactions Volume MSCI Capital Value Index (r/h scale) Measured by outstanding loans, CRE lending has had only three states up, down, and flat. Through the long boom, capital values rose by 50%, loan books by 120%. Through the deleveraged recovery, capital values rose by 27%, loan books fell by -35%. It seems linkages between lending, market value and market activity are highly variable.

5 The lending cycle originations, a 20 year retrospective Indexed, Average = Leveraged Long Boom Black Leverage Deleveraged Recovery The New Normal? CRE Originations RCA Transactions Volume MSCI Capital Value Index (r/h scale) Measured by origination volume, links between lending, value and trading are much clearer. Loan books were cut back by write offs and debt sales; origination has tracked the recovery. Over the full history, originations correlate at 0.82 with values, 0.60 with trading. You may note that in from 2005 to 2007, origination and values looked decoupled from trading

6 The lending cycle - originations vs transactions volume Fairly static loan books across a range of capital values does not mean lending is disconnected from market conditions The chart plots loan originations against trading, and show a fairly consistent linkage through most years. All years since 2010 fall close to the predicted origination volumes. Perhaps we can add a drift in origination above the levels indicated by trading to the list of amber to red signals for CRE lenders. CRE Origination bn Origination = x Transactions R² = 0.70 The fitted regression excludes as outliers, or best forgotten RCA Transactions Volume bn

7 The lending cycle % loan book in default by value 25% 20% UK Banks & Blg Soc US & Other International Other Non Bank Lenders German Banks Insurance Companies Average The end-product of misjudged borrowing and lending through the middle 2000s was a wave of defaults. Default here is defined as payment beyond 90 days overdue, covering 155 bn in defaulted loans since % 10% 5% 0% Across lenders, defaults varied widely in both severity and timing. Our more detailed analysis suggests the main factors explaining variation in default were the concentration of originations in the mid-2000s, plus loan book exposure to developments and provincial markets.

8 The lenders originations 1 st half 2018 bn & % of total % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% UK Banks & Bld Soc Insurance Companies Other International Banks German Banks Other Non-Bank Lenders North American Banks Loan origination was 22.5 bn in the first half of % up on the same period last year.23 So the total for 2018 is likely to exceed the billion in each of the previous four years. UK Banks share in origination ended a long decline in 2016, and has settled close to 50%.

9 The lenders originations as % of outstanding loans 140% 120% 100% 80% 60% 40% 20% 0% Mid 2018 UK Banks & Bld Soc Insurance Companies Other International Banks German Banks Other Non-Bank Lenders North American Banks Up to 2016, the most rapid book-building was by North American and Non-Bank lenders. Who have remained the most active lenders, but at a distinctly slower pace.

10 Collateral originations 1 st half 2018, bn & % by lender German Banks Other International Banks Other Non Bank Lenders Insurance Companies UK Banks & Blg Soc North American Banks 0 5 0% 50% 100% Central London Rest of SE West Midlands/Wales North Scotland Mixed 46% of loans originated were secured by Central London assets 75% for German lenders. This compares with around 30% of RCA transactions, and 20% of MSCI Annual Index value. The spreads show German lenders the least, North Americans the most, diversified.

11 Collateral origination 1 st half 2018, bn & % by lender size Big 1 bn to 5bn Large over 5bn Medium to 1bn Small - Less than 500m % 50% 100% Central London Rest of SE west Midlands/Wales North Scotland Mixed The spread of lending also varies across lenders with different sizes of loan book. The most diverse lending patterns appear at the extremes of the large and small lenders.

12 Underwriting average target lending margins bps 400 Prime Office Secondary year average. Retail Industrial 10 year average Mid Mid 2018 Lending margins on prime assets have moved little since 2016, at 10 year lows. On secondary assets spreads across sectors have almost disappeared, as retail margins continue to drift out.

13 Underwriting lending and borrowing rates vs yields % Borrower Cost 5 Year Swap 3 month LIBOR MSCI Highest Quartile Initial Yield MSCI Average Initial Yield MSCI Lowest Quartile Initial Yield Lender Interest Jan 2012 Jan 2013 Jan 2014 Jan 2015 Jan 2016 Jan 2017 Jan 2018 LIBOR rates, tracked by Swap rates with static spreads, have moved out since late Against a small fall in market yields, so the 130 bps margin between borrower s cost and average yield is still below the 150 bps average for the last six years.

14 Book quality - % of outstanding loans by current LTV North American Banks Insurance Companies UK Banks & Blg Soc German Banks Other International Banks Other Non Bank Lenders % by value of outstanding loans 0% 20% 40% 60% 80% 100% Large over 5bn Small - Less than 500m Big 1 bn to 5bn Medium to 1bn All Lenders Loans at Current LTV of: <50% 50% - <60% 60% - <70% 70% - < 85% 85% - <100% 100% - <120%

15 Respondent views on main risks... % of responses 100% 90% 80% Very Concerned 70% 60% Concerned 50% 40% 30% Mildly Concerned 20% 10% Not Concerned 0% Property Fundamentals Brexit Interest Rate Rise Regulatory Risk

16 Summary The Lending Survey tracks 20 years of market history. New originations 22.5 bn in the first half, take loan books to 163 bn. Originations 27% up on 2017 H1 likely total for 2018 in line with recent years. A new normal? - lender mix, target markets fit the pattern of last three years. Prime lending margins push below 10 year lows. Secondary margins remain higher, with no spread across sectors. Book LTV and ICR varies, small / medium / new lenders on weaker figures. Lender worries: Brexit of course, market cycle, interest rate drift.

17 With thanks to the Cass CRE Lending Survey sponsors:

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