SAMPLE. The UK Commercial Property Lending Market Research Findings 2012 Year-End

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1 The UK Commercial Property Lending Market Research Findings 2012 Year-End

2 Commercial Property Lending Market: Year-End 2012 Bill Maxted Trudi Porter May 2013 Department of Corporate Development Faculty of Business and Law De Montfort University The Gateway Leicester LE1 9BH

3 This research was undertaken by Bill Maxted and Trudi Porter Tel: (0116) Department of Corporate Development, De Montfort University May 2013 All rights by law of copyright and by virtue of international copyright convention are reserved by Department of Corporate Development, De Montfort University. This report should not be relied upon as a basis for entering into transactions without seeking specific, qualified, professional advice. Whilst facts have been rigorously checked, De Montfort University can take no responsibility for any damage or loss suffered as a result of any inadvertent inaccuracy within this report. Information contained herein should not, in whole or part, be published, reproduced or referred to without prior approval. Any such reproduction should be credited. The opinions expressed in this report are entirely those of the authors and should not be attributed in any way to the financial supporters of the research. i

4 CONTENTS Acknowledgements x EXECUTIVE SUMMARY xi INTRODUCTION xviii MARKET ACTIVITY Loan book size recorded by the research for Value of outstanding loan books Estimation of market size year-end Value of loan originations completed in MAIN FINDINGS 7 2. UK commercial property lending 1999 to Aggregated value of outstanding debt Reductions in loan book during Repayment Allocation of outstanding debt by level of loan-to-value ratio Allocation of outstanding debt by income to income cover Composition of aggregated loan book secured by prime property Annual volume of loan originations Market share of loan originations New loans and refinancing Allocation by Project Type (for organisations comprising Banks, Building Societies and Insurance Companies) Typical Loan Lengths 2012 for organisations comprising Banks, Building Societies and Insurance Companies Commercial Mortgage Backed Securitisation (CMBS) Syndications and Club Deals 26 3 Loan terms Average interest rate margins Average loan-to-value ratios Average arrangement fees Average income to interest cover Loans above 100m Junior debt and mezzanine finance for investment loans Hedging strategy 33 4 Loans in breach of financial covenant and defaulted loans Structure of outstanding loan books Allocation of outstanding loan book by type of project Lending preferences by type of property Proportion on outstanding loan book, by value, by borrower type Regional allocation of outstanding loan book 45 6 International lending 47 7 Lending intentions 48 8 Other Non-bank Lenders Commentary Value of outstanding loan books Structure of outstanding loan books Loan originations by project type Loan structure and future intentions Loan Terms 54 9 Commentary on purchasers of non-performing loans portfolios 58 ii

5 10 Conclusion 61 List of Figures Figure 1: Allocation of drawn and undrawn funding, reported to this research by category of lender 2 Figure 2: Allocation of drawn funding secured by commercial property 2 Figure 3: Allocation of loan originations undertaken in Figure 4: Aggregated value of outstanding debt 7 Figure 5: Allocation of outstanding debt secured by commercial property by category of lender 8 Figure 6: Changes in book size by aggregated book size ( m) 10 Figure 7: Proportion of outstanding debt secured by commercial property held by the largest six and the next largest six organisations from 1999 to Figure 8: Composition of largest twelve lenders by book size Figure 9: Reasons for reduction in book size before taking loan originations into account 12 Figure 10: Proportion of debt due for repayment: All Lenders 13 Figure 11: Maturity profile of balance sheet debt and CMBS loan maturities 14 Figure 12: Current Loan-to-Value ratios by proportion of outstanding debt 15 Figure 13: Value ( m) of gross annual lending 1999 to 2012 All Lenders 18 Figure 14: Market share of new loan originations 1999 to Figure 15: Proportion of annual loan originations completed by the 12 most active lenders 21 Figure 16: Proportion of annual loan originations completed by the 12 most active lenders 21 Figure 17: Allocation of new lending by project type 23 Figure 18: Average interest rate margins for different sectors: 1999 to Figure 19: Average interest rate margins for different projects: 1999 to Figure 20: Average maximum loan-to-value ratios for different sectors: 1999 to Figure 21: Average arrangement fees: 1999 to Figure 22: Average income to interest cover: 1999 to Figure 23: Primary reason cited as the cause of breach at year-ends 2011 and Figure 24: Proportion of outstanding loan book by type of project Figure 25: Figure 26: Allocation of aggregated loan books, by proportion, secured by different types of projects Banks, Building Societies and Insurance Companies 39 Allocation of development finance: Banks, Building Societies and Insurance Companies 40 Figure 27: Allocation of outstanding debt to investment and owner occupied property 41 Figure 28: Allocation of outstanding debt to development property 42 Figure 29: Allocation of loan books, by proportion, to the different property sectors 43 Figure 30: Proportion, by value, of outstanding loan book by borrower type 44 Figure 31: Regional distribution of outstanding loan book at year-end Figure 32: Regional distribution of lending 2001 to Figure 33: Proportion, by value, of outstanding loan book by type of project : Other Non-bank Lenders and Banks, Building Societies and Insurance Companies comparison (based on Figure 24) 51 iii

6 Figure 34: Proportion, by value, of outstanding loan book by project and property type at yearend 2012 for Other Non-bank Lenders 51 Figure 35: Proportion, by value, of outstanding loan book due for repayment: Other Non-bank Lenders and Banks, Building Societies and Insurance Companies comparison (based on Figure 10) 52 Figure 36: Proportion, by value, of outstanding loan book by borrower type: Other Non-bank Lenders and Banks, Building Societies and Insurance Companies comparison (based on Figure 30) 52 Figure 37: Proportion on outstanding loan book, by value, by region: Other Non-bank Lenders and Banks, Building Societies and Insurance Companies comparison 53 Figure 38: Proportion, by value, of loan originations by project type: Other Non-bank Lenders and Banks, Building Societies and Insurance Companies comparison (based on Figure 17) 53 Figure 39: Proportion, by value, of UPB by type of project 59 Figure 40: Proportion, by value, of UPB by type of property 59 Figure 41: Proportion, by value, of UPB by regional distribution 60 iv

7 List of Tables Table 1: Category of lender and type of finance 1 Table 2: Value and allocation of loan originations in Table 3: Year-on-year changes in the value of outstanding debt recorded in loan books 8 Table 4: Changes in book size during Table 5: Maturity profile of CMBS issuance 14 Table 6: Current Income-to-Interest cover by proportion of outstanding debt 16 Table 7: Allocation, by value, to prime property 17 Table 8: Year on year changes in the value of loan originations 19 Table 9: Market share of loan originations 19 Table 10: New loans and refinancing 2001, 2004 to Table 11: Annual amount ( m) of completed CMBS issuances 2000 to Table 12: Annual amount ( m) of completed syndications and club deals: 2008 to Table 13: Table 14: Comparison of Senior Debt, Junior Debt and Mezzanine terms on loans secured by prime office investment property (Banks, Building Societies and Insurance Companies) 32 Comparison of Senior Debt, Junior Debt and Mezzanine terms on loans secured by secondary office investment property (Banks, Building Societies and Insurance Companies) 33 Table 15: Proportion of lenders with interest hedging strategy in place. 33 Table 16: Number and value of loans in breach of financial covenant 35 Table 17 All Lenders: Defaulted loans 2008 year-end to 2011 year-end 37 Table 18: Number of UK based property teams lending outside UK and value of outstanding loans secured on commercial property 47 Table 19: Allocation of lending as proportion by country 47 Table 20: Future lending intentions: loan book size and originations 48 Table 21: Future lending intentions 48 Table 22: Responses to specific questions relating to the financial crisis 49 Table 23: Table 24: Table 25: Table 26: Table 27: Table 28: Table 29: Category of Lender and type of finance: Other Non-bank Lenders and Banks, Building Societies and Insurance Companies comparison (based on Table 1) 50 Loan terms of Other Non-bank Lenders for senior debt secured by investment projects 54 Loan terms of Other Non-bank Lenders for junior debt loans secured by investment projects 55 Loan terms of Other Non-bank Lenders for mezzanine finance secured by investment projects 56 Loan terms of Other Non-bank Lenders for senior debt secured by development projects 57 Loan terms of Other Non-bank Lenders for junior debt loans secured by development projects 57 Loan terms of Other Non-bank Lenders for mezzanine finance secured by development projects 58 v

8 Appendix A Structure of loan books Change in loan book size 1 Range of outstanding loan book sizes 3 Loan maturity 5 Prepayments of loans held on balance sheet 5 Lending reported to the Bank of England 6 Mezzanine and junior debt finance (Banks, Building Societies and Insurance Companies) 7 Lending against single assets and portfolios 8 List of Figures Figure 42: Annual change in aggregated value of outstanding loan book value by category of lender 1 Figure 43: Total loan book split by lender 4 Figure 44: Composition of the 12 largest organisations (by book size) at year-ends 2007 to Figure 45: Lending reported to the Bank of England 6 Figure 46: Number of Banks, Building Societies and Insurance Companies, by category of lender, with mezzanine in loan books 1999 to 2010, and mezzanine finance and/or junior debt in loan books at year-ends 2011 and List of Tables Table 30: Range of outstanding loan books by m 3 Table 31: Proportion of debt held by 12 largest organisations 1999 to Table 32: Proportion of debt (%) due for repayment by category of lender 5 Table 33: Total value ( m) of mezzanine recorded in loan books (including residential investment and development) 2005 to 2010 and mezzanine and junior debt 2011 and 2012 (Banks, Building Societies and Insurance Companies) 7 Table 34: Allocation of loan books, by value, between single assets and portfolio lending by category of lender: 2009 to Table 35: Allocation of loan books, by value, between single assets and portfolio lending for All Lenders 1997, 2000 and 2003 to Appendix B Annual Lending Allocation of annual loan originations by organisation 1 Value of biggest individual loans completed 3 Typical loan size achieved 3 Length of loan 6 Lending limits 8 List of Figures Figure 47: Lending in calendar years 2011 and 2012 allocated by organisation 1 Figure 48: Value of annual loan originations undertaken by the six and twelve most active lending organisations 2 Figure 49: Composition of the most active 12 lenders 1999 to List of Tables Table 36: Value of the biggest individual loans completed 3 Table 37: Typical loan size achieved 4 Table 38: Typical loan size achieved 1999 to Table 39: Length of loan and proportion by value of lending for investment projects 6 Table 40:` Typical loan length data for investment projects: 2011 and Table 41: Expectation of length of loan for investment projects before being repaid or refinanced 7 Table 42: Length of loan and proportion by value of lending for development projects 7 Table 43: Lending Limits 8 vi

9 Appendix C Securitisation and syndication CMBS 1 Intentions to securitise 1 Intentions to syndicate or participate in club deals 2 Bilateral loans and syndicated/club loans 3 List of Figures Figure 50: Annual amount ( bn) of completed CMBS issuances 2000 to Figure 51: Allocation of outstanding loans books between bilateral loans and syndicated/club loans 3 List of Tables Table 44: Proportions of lenders intending to securitise 1 Table 45: Proportions of lenders intending to syndicate loans 2 Table 46: Proportions of lenders intending to participate in club deals 2 Table 47 Allocation of loan books between bilateral lending, leading syndications and participations by category of lender 4 Appendix D Loan terms offered by Banks, Building Societies and Insurance Companies commercial property sectors investment and development Typical senior debt interest rate margins on prime office property 1 Typical interest rate margins on secondary office property 4 Typical senior debt interest rate margins on prime retail property 7 Typical senior debt interest rate margins on prime industrial property 8 Typical senior debt interest rate margins on secondary retail property 9 Typical senior debt interest rate margins on secondary industrial property 10 Maximum loan-to-value ratios on prime office property 11 Maximum loan-to-value ratios on secondary office property 13 Maximum loan-to-value ratios on prime retail property 15 Maximum loan-to-value ratios on prime industrial property 16 Maximum loan-to-value ratios on secondary retail property 17 Maximum loan-to-value ratios on secondary industrial property 18 Loan-to-value ratios in a default situation 19 Summary of average lending terms 20 Debt service cover ratios 21 Development finance 22 Average interest rate margins by type of office project 27 Junior Debt and Mezzanine Finance terms for investment loans for commercial property 28 Retail Property 28 Industrial Property 29 Junior Debt and Mezzanine Finance for development loans for commercial property 30 Terms for residential investment and development projects 31 Residential investment project terms 31 Mezzanine finance for residential investment projects 34 Residential development for sale project terms 35 Mezzanine finance for residential development projects 36 List of Figures Figure 52: Pricing of loans secured by prime office property by category of lender: Average typical margins 1999 to Figure 53: Pricing of loans secured by prime office property: Typical margins 2012 and Figure 54: Pricing of loans secured by secondary office property by category of lender: Average typical margins 1999 to Figure 55: Pricing of loans secured by secondary office property: Typical margins 2012 and Figure 56: Pricing of loans secured by prime retail property: Typical margins 2012 and Figure 57: Pricing of loans secured by prime industrial property: Typical margins 2012 and Figure 58: Pricing of loans secured by secondary retail property: Typical margins 2012 and Figure 59: Pricing of loans secured by secondary industrial property: Typical margins 2011 and Figure 60: Maximum loan-to-value ratios on prime office investment: 2012 and Figure 61: Average maximum loan-to-value ratios secured against prime office property: 1999 to vii

10 Figure 62: Maximum loan-to-value ratios on secondary office investment property: 2012 and Figure 63: Average maximum loan-to-value ratios secured against secondary office property: 1999 to Figure 64: Maximum loan-to-value ratios on prime retail property: 2011 and Figure 65: Maximum loan-to-value ratios on prime industrial property: 2012 and Figure 66: Maximum loan-to-value ratios on secondary retail property: 2012 and Figure 67: Maximum loan-to-value ratios on secondary industrial property: 2012 and Figure 68: Levels of LTV where organisations expect to have no risk of loss: Prime office in Central London 19 Figure 69: Average interest rate margins of loans secured against different categories of office project 27 Figure 70: Pricing of loans secured by residential investment projects: Typical margins 2012 and Figure 71: Maximum loan-to-value ratios on residential investment projects 2012 and List of Tables Table 48: Terms applied to investment property 20 Table 49: Debt service cover ratios: Prime Office 21 Table 50: Intentions and achieved development finance 22 Table 51: Interest rate margins (bps) on loans secured by commercial development projects 23 Table 52: Loan-to-value and loan-to-cost ratios on commercial development projects 24 Table 53: Terms for 50% pre-let:50% speculative commercial development projects 26 Table 54: Comparison of Senior Debt, Junior Debt and Mezzanine terms on loans secured by prime retail investment property (Banks, Building Societies and Insurance Companies) 28 Table 55: Comparison of Senior Debt, Junior Debt and Mezzanine terms on loans secured by secondary retail investment property (Banks, Building Societies and Insurance Companies) 28 Table 56: Comparison of Senior Debt, Junior Debt and Mezzanine terms on loans secured by prime industrial investment property (Banks, Building Societies and Insurance Companies) 29 Table 57: Comparison of Senior Debt, Junior Debt and Mezzanine terms on loans secured by secondary industrial investment property (Banks, Building Societies and Insurance Companies) 29 Table 58: Loan terms for loans secured by fully pre-let commercial development projects (Banks, Building Societies and Insurance Companies) 30 Table 59: Proportion of organisations prepared to fund residential investment projects year ends 2006 to Table 60: Summary of other terms applied to loans secured by residential investment project 34 Table 61: Loan terms for loans secured by residential investment portfolio (Banks, Building Societies and Insurance Companies) 34 Table 62: Lending terms for residential development projects 35 Table 63: Level of Loan-to-Value and Loan-to-Cost at which mezzanine for residential development projects is provided (Banks, Building Societies and Insurance Companies) 36 Table 64: Interest rate margin charges for provision of mezzanine for residential development projects (Banks, Building Societies and Insurance Companies) 36 Appendix E Allocation by project type List of Figures Figure 72: Proportion of lending by type of project and category of lender viii

11 Appendix F Allocation by property sector List of Figures Figure 73: Allocation of loan books, by value, to different property sectors 1999 to List of Tables Table 65: Allocation of loan books m by property sector 2002 to Table 66: Lending preference by type of property and type of project by category of lender 2011 and Appendix G Regional distribution of lending List of Figures Figure 74: Regional distribution of lending by category of lender 1 List of Tables Table 67: Regional distribution of lending 2 Appendix H Future lending intentions List of Tables Table 68: Future lending intentions 1 Table 69: Future lending intentions: loan book size 2 Table 70: Intentions v Achievements to increase loan book size 2 Table 71: Intentions v Achievements to increase loan originations 3 Appendix I Overseas Lending List of Tables Table 72: Allocation of lending as proportion by country 1 Appendix J Respondents' comments Lending policy/attitude to Lending 1 Lending Market and New Players to the Market 5 Commercial Property Market 13 Interest Rates & Margins 15 General Loan Terms 18 Hedging 19 Problem Loans, Breaches and Defaults 20 UK Economy and Economic Conditions 24 Regulation 31 ix

12 ACKNOWLEDGEMENTS The authors gratefully acknowledge the generous financial support provided by Allen & Overy, Association of Property Lenders, the Bank of England, British Property Federation, Canada Life Ltd, Capita Asset Services, FitchRatings, GIC Real Estate, Helaba, Jones Lang LaSalle Corporate Finance Limited, Kingfisher Property Finance Limited, Nationwide, Building Society Savills and The Royal Bank of Scotland This report could not have been produced without the considerable assistance of the lending organisations listed below. Aareal Bank AG Hypothekenbank Frankfurt AG - UK Division AIG Asset Manangement ING Real Estate Aldermore Investec Bank (UK) Ltd Allied Irish Irish Bank Resolution Corp. Ltd. (formerly Anglo Irish Bank (GB) Bank Corp. Ltd.) Aviva UK Commercial Finance (UKCF) Israel Discount Bank Axa Real Estate J P Morgan Securities Bank of America Merrill Lynch Kennedy Wilson Bank of Ireland Group Landesbank Baden-Wüerttemberg Bank of London and the Middle East LaSalle Investment Management Barclays Corporate and Barclays Capital Leeds Building Society BAWAG P.S.K. Legal & General Bayerische Hypo-und Vereinsbank AG (HVB) Lehman Brothers International Holdings Inc Berlin-Hannoversche Hypothekenbank AG / Lloyds Banking Group Landesbank Berlin AG BNP Paribas Lone Star Management Europe Ltd Bristol & West Property Finance Longbow Real Estate Capital Canada Life Ltd M & G Investment Management Ltd Cheyne Capital Manangement (UK) LLP Metropolitan Life Insurance Company Citi Group Munchener Hypo Bank EG Close Brothers Property Finance N M Rothschild and sons Clydesdale Bank Nationwide Building Society Contour Capital Newcastle Building Society Co-operative Financial Services Northern Rock (Asset Management) plc Cornerstone Real Estate Advisers Europe LLP Oaktree Capital Coutts & co Och-Ziff Management Europe Limited Credit Agricole Oversea-Chinese Banking Corporation Limited DB Realisations Building Society Partners Group DEKA Bank pbb Deutsche Pfandbriefbank Deutsche Bank AG Pluto Finance in a joint venture with Mountgrange Deutsche Hypothekenbank Pramerica Real Estate Investors (Europe) (Actien-Gesellschaft Pricoa Mortgage Capital Deutsche Postbank AG Principality Building Society HSBC Bank plc DG Hyp Qatar Islamic Bank DRC Capital LLP Renshaw Bay Dunbar Bank plc The Royal Bank of Scotland Erste Group Bank AG Santander Corporate Bank Europa Capital Mezzanine Urban Exposure Limited Europe Arab Bank plc Wells Fargo Bank International GE Real Estate West Bromwich Commercial Ltd Helaba Landesbank Hessen-Thüringen Westdeutsche Immobilien Bank x

13 EXECUTIVE SUMMARY Responses to Research At year-end 2012, data was received from a total of eighty-seven lending teams operating out of seventy-eight lending organisations. The lending organisations comprised of fifty-five Banks and Building Societies, seven Insurance Companies and sixteen Other Non-bank Lenders. (see page xx) Other Non-bank Lenders are identified as a category of lender for the first time in this research for year-end This is because of their recent entry into the market during Data trends prior to year-end 2012 will, therefore, not include this new category. This category includes debt funds, asset managers and other organisations that are prepared to provide junior debt, mezzanine finance and more recently senior debt. Due to the increasing number of insurance companies that entered the market during 2011 and 2012, in this report, Insurance Companies will only be identified as a separate category of lender in restricted instances in relation to aggregated loan book size at year-end 2012 and annual volume of lending at year-end Their inclusion as a separate category is restricted to guard against identification of individual companies within the aggregated data. In the remaining analysis, therefore, insurance companies will be included by nationality as in previous reports. Loan Book and Market Size A total value of 217.1bn of outstanding debt, including loans of approximately 19.1bn secured by social housing was recorded by the survey as at 31 st December (see page 1) The aggregated value of outstanding debt recorded in loan books and secured only by UK commercial property, declined from 214.4bn at year-end 2011 to 197.9bn at year-end This represents a fall of 7.7%. (see pages 7 and 8) The value of 197.9bn at year-end 2012 was allocated; 195.4bn held by banks, building societies and insurance companies and 2.5bn held by Other Non-bank Lenders. (see pages 1, 7 and 8) The research recorded the reasons for a reduction in loan book size before new loan originations are included. A total of 30.6bn of reductions were reported and allocated at yearend 2012; 39% scheduled amortisation and repayments, 26% customers paying down, 20% bank/lending organisation influenced sales, 6% value of loans written off, 8% value of loans sold, and 1% Other which included transfers of assets to other institutions. (see pages 11 and 12) It is extremely difficult to ascertain the total size of the commercial property lending market in the UK. As part of the process of widening the scope of this research to make it as comprehensive as possible, in addition to 197.9bn collected by the research the following amounts of outstanding debt have been identified: i. Approximately 20.6bn of debt has been identified from the published financial statements of non-contributing organisations. (see page 3) ii. An estimated 2.5bn of UK debt had been sold during 2012 by those lending organisations that have contributed data to this research. (see pages 3 and 11) iii. Fitch Ratings provided data on the balance of outstanding CMBS issuances that they had rated and include loans secured by UK commercial property. At year-end 2012 this amounted to 27.4bn. Fitch Ratings estimates that the total outstanding balance of UK CMBS at year-end 2012 was approximately 38bn. (see page 3) iv. By March 2012, it is estimated that NAMA held assets of an approximate value of 8.5bn (at par value) located in the UK and which will not have been reported to this research. (see page 4) Thus, at year-end 2012, an estimated approximate total value of 268bn of outstanding debt secured by commercial property has been identified by this research. (see page 4) xi

14 In addition, a further 15.1bn of loans were committed but not drawn at year-end (see pages 1 and 2) UK organisations (UK Banks and UK Building Societies) held 57% of outstanding debt retained on balance sheet and secured by commercial property, Other International Banks 19.6%, German Banks 13%, North American Lenders 1%, Insurance Companies 8.1% and Other Nonbank Lenders 1.3% (see pages 2, 8 and Appendix A) An additional feature of the UK lending market during 2011 and 2012 has been the emergence of organisations that have purchased mainly non-performing loan portfolios from traditional bank lenders. For the first time, the research at year-end 2012 included responses from such organisations. At year-end, those organisations that held non-performing loan portfolios purchased in 2011 and 2012 reported an aggregated total of 2.23bn as the outstanding Unpaid Principal Balance of loans secured by UK commercial property. (see page 4) Structure of Loan Books The allocation of the aggregated unpaid principal balance of 2.23bn held by the purchasers of non-performing loan portfolios was, at year-end 2012, 99.9% investment property and 0.1% owner-occupied property. (see page 59) The allocation of the aggregated loan books of 2.5bn of Other Non-bank Lenders was, at yearend 2012, 85% investment property and 15% development property. The development loans were allocated 90.5% to residential development and 9.5% to commercial development. (see page 51) The aggregated loan book of 195.4bn for banks, building societies and insurance companies was, at year-end 2012, allocated 81% secured by investment property (81.5% at year-end 2011), 3.5% to commercial development (4% for 2011), 6% to residential development for sale (7% for 2011), 2% owner-occupied (2% for 2011) and 7.5% other (5.5% for 2011). (see page 39 and Appendix F) During the next five years between 2013 and 2017 inclusive, approximately 72% of the outstanding debt of 197.9bn is due for repayment. This equates to 143bn. Approximately 45.5bn matures in 2013, 27.7bn in 2014, 23.8bn in 2015, 23.8bn in 2016 and 21.8bn in (see page 13) With regards to the regional distribution of outstanding debt at year-end 2012 of 195.4bn held by banks, building societies and insurance companies, 29.5% was allocated to Central London, compared to 25% at year-end (see page 45, 46 and Appendix G) In addition, loan book allocation to the remainder of the South East increased from 17% at yearend 2011 to 18% at year-end (see page 45, 46 and Appendix G) In contrast, the purchasers of non-performing debt portfolios had just 10% of their outstanding Unpaid Principal Balance of 2.23bn allocated to Central London and 12% to the remainder of the South East. (see page 60) Other Non-bank Lenders at year-end 2012 had 65% of their aggregated loan books of 2.5bn allocated to Central London and a further 11% to the remainder of the South East. (see page 53) Banks, Building Societies and Insurance Companies only At year-end 2012, 61% of loans in the aggregated loan book of 195.4bn for banks, building societies and insurance companies had interest rate hedging in place. Sixty-five percent of organisations reported as always requiring interest rate hedging to be in place when originating new loans. (see page 33) It has been reported to this research for 2012, that 42% of outstanding debt held by banks, building societies and insurance companies is secured by prime property. This compares with 41% reported at year-end (see page 17) xii

15 Legacy Debt At year-end 2012, 53% of outstanding debt of 195.4bn held by banks, building societies and insurance companies, had a loan-to-value ratio of 70% or less. This is an improvement compared with 50% at year-end At year-end 2012, 50% equated to approximately 104bn. Whilst at year-end 2012 senior debt lenders were generally unlikely to provide senior debt at a level of above 65% loan-to-value ratio, much of the 104bn was, on a loan-to-value basis, assumed to be potentially refinanceable and regarded as secure lending. (see page 15) At year-end 2012, 24% of outstanding debt had a loan-to-value ratio of between 71% and 100%. This represented approximately 47bn. This compares with 30% and 64bn similarly recorded at year-end Thus, it appears that loans within this range of loan-to-value that still have value because the LTV is below 100%, have been the subject of various work out and/or disposal strategies. (see page 15) At year end 2012, 23% of this outstanding debt had a loan-to-value ratio of 101% or above which represented approximately 45bn. This compares with 20% and 42.5bn similarly recorded at year-end During 2012 declines in capital value generally and of secondary and tertiary properties in particular, appear to have increased the value of property loans in severe distress on a loan-to-value basis. (see page 15) For the first time at year-end 2012, respondents were asked to consider the proportion of outstanding debt that has a current income-to-interest cover (ICR) falling in specific brackets. Teams holding 93bn of debt were able to provide data and so the results can only be regarded as indicative. On this basis, 55% of debt had an ICR of above 1.6x which is the level of cover required for new lending in the market at year-end Conversely, 45% (equating to 79bn if applied to the whole sample of outstanding investment loans of 176bn) had a level of cover below this threshold of which 17%, representing 30bn, had an ICR of less than 1x. (see page 16) Loan Originations and Loan Extensions During 2012, 25.4bn of new loan originations including refinancing on commercial terms was recorded as having been undertaken by banks, building societies, insurance companies and Other Non-bank Lenders. (see pages 18 and 19) In addition it is estimated that a further 11.1bn of loans, held by banks, building societies and insurance companies that should have matured during 2012, have had their maturities extended into later years. (see page 18) UK organisations (UK Banks and Building Societies) completed 48% of loan originations during 2012, German Banks 16% (26% in 2011), Other International Banks 15%, North American Banks 6%, Insurance Companies 10% and Other Non-bank Lenders 5%. (see pages 19 and 20) Approximately 57% of the 25.4bn of new lending completed during 2012 was undertaken by just six organisations. Approximately 72% of loan originations completed during the whole of 2012 was undertaken by twelve organisations. This compares with 58% and 74% respectively, recorded at year-end The decline in proportion originated by the top twelve organisations demonstrates the increasing influence of new lending organisations entering the market. (see pages 20, 21 and Appendix B) Three Insurance Companies are represented in the top twelve most active loan originators at year-end (see page 21) Of the 24.1bn of loan originations undertaken by banks, building societies and insurance companies, 82% was allocated to investment projects, 5% to commercial development, 12% to residential development and 1% to owner/occupied projects. (see page 23) Of the 1.3bn of loan originations undertaken by Other Non-bank Lenders, 91% was allocated to investment projects, 3% to commercial development and 6% to residential development. (see page 53) xiii

16 During 2012, 17 of the 72 (27%) of traditional organisations (banks, building societies and insurance companies) reported no new loan originations whatsoever (and not including extensions to maturing loans). (see page 21) Of the 17 Other Non-bank Lenders that responded to the research at year-end 2012, 13 (76%) completed loan originations. (see page 21) Securitisations, Syndications and Club Deals A single issue of 210m of debt was reported as being securitised during the first half of (see page 25) During 2012, approximately 2.0bn of debt was reported as being syndicated and approximately 4.5bn was reported as the value of participations in club deals by organisations that contribute to this research. This total of 6.5bn compares with 6.9bn similarly reported at year-end (see page 26) Future Lending Intentions At year-end 2012, 54% of banks, building societies and insurance companies intend to increase their value of loan originations compared with 44% at year-end Forty-six percent of organisations intended to increase the size of their loan book compared with 38% at year-end Thus, lending intentions are slightly stronger than those recorded at year-end (see page 48 and Appendix H) One-hundred percent of Other Non-bank Lenders intended to increase loan originations and loan book sizes. (see page 54)) By the end of 2012, the 54% of lending teams (banks building societies and insurance companies) intending to increase loan originations combined with 22.5%, intending to maintain their level of originations, completed 23.1bn (96%) of the 24.1bn new loan originations during (seeon page 48 and Appendix H) Problem Loans: Banks, Building Societies and Insurance Companies The value of loans in breach of financial covenant at year-end 2012 and reported to the research was approximately 19.9bn and represented 11% of the total aggregated loan book of organisations that contributed data. This compares with 22.8bn representing 12% at year-end (see page 35) With regard to loan defaults, at year-end 2012, 21.5bn of loans was reported to the research as having been declared in default during This compares with 19.6bn reported to the research at year-end (see page 37) The total combined value of loans in default and breach of financial covenant is estimated to be approximately 45.2bn and represents approximately 23% by value of the total aggregated debt of 195.4bn reported to the research by traditional lenders (banks, building societies and insurance companies). (see pages 35, 36 and 37) During 2012, lending organisations reported generally that the weak UK economy and increasing incidences of tenant failures, particularly in the retail and hospitality sectors, was having a detrimental impact on borrowers cash flows and the capital value of commercial property. There was a reduction in the year-on-year number of new impaired loans but the situation with many existing problem loans were deteriorating. Lending organisations had become more inclined to sell properties securing non-performing loans with these decisions often being driven by regulatory pressure. (see pages 36 and 37) During 2012, lending organisations reported the lack of economic recovery, weakening cash flows due to tenant defaults, tenants not renewing tenancies on expiry and lease renewals at lower rents, were causing further declines in capital values and loans to breach financial covenants or to be declared in default. This most frequently occurred with loans that had already been identified as problematical. The rate of new referrals, however, had generally slowed compared to previous years. (see pages 35, 36 and 37) xiv

17 Senior Debt: Loan Terms for Investment Property Offered by Banks, Building Societies and Insurance Companies Between mid-year and year-end 2012 interest rate margins declined for all sectors. This was the first decline in interest rate margins recorded by this research since year-end The average margin for loans secured by prime office, for example, declined from 335.1bps recorded at mid-year 2012 to 323.8bps recorded at year-end. For loans secured by secondary offices, average interest rate margins declined more modestly from 386.9bps recorded at midyear 2012 to 384.5bps at year-end. (see page 27 and Appendix D) Between year-end 2010 and year-end 2011, the average loan-to-value ratio for all sectors fell to the lowest levels recorded by this research. Between 2011 and 2012, average loan-to-value ratios broadly stabilised for loans secured by prime offices and prime retail property and increased for loans secured by prime industrial property. For example, the average loan-tovalue ratio for loans secured by prime offices was recorded at 64.3% at year-end 2011 and 64.2% at year-end For loans secured by secondary property, average loan-to-value ratios declined between year-ends 2011 and 2012 for loans secured by office and industrial property and remained stable for loans secured by retail property. For example, those for loans secured by secondary offices declined from 60.0% at year-end 2011, to 58.9% at year-end (see page 29 and Appendix D) During the first half of 2012, average arrangement fees increased for loans secured by all property sectors. However the rate of increase had reduced compared with that for During the second half of 2012 the trend varied considerably. Arrangement fees increased modestly for loans secured by prime office and retail property from 120bps (office) and 118.3bps (retail) at mid-year 2012 to 122.5bps (office) and 118.6bps (retail) at year end and declined for loans secured by prime industrial. For loans secured by secondary property, arrangement fees increased for loans secured industrial property, declined for loans secured by retail property and remained stable for those secured by office property. (see page 30 and Appendix D) For loans secured by prime property, income-to-interest cover ratios generally increased slightly during the first half of 2012 (for example for office property, 1.60x at year-end 2011 to 1.63x at mid-year 2012) and then declined during the second half of 2012 (1.59x for offices at year-end 2012). The exception to this general trend is for loans secured by prime industrial property which increased from 1.71x at year-end 2011 to 1.73x at year-end For loans secured by secondary property, the income-to-interest cover ratios showed only minor variations between year-ends 2011 and (see page 31 and Appendix D) Junior Debt and Mezzanine Finance: Loan terms Offered by Banks, Building Societies and Insurance Companies At year-end 2012, four organisations were prepared to provide finance above a senior debt level for prime investment office property, the same number as at year-end The average loan-to-value ratio increased for senior debt between 2011 and 2012 from 64% to 65%, whilst the maximum loan-to-value ratio ranged from 70% to 80% for junior debt/mezzanine finance. Interest rate margins declined during 2012 and ranged between 275bps to 400bps for senior debt, 500bps to 700bps for junior debt and 500bps to 1050bps for mezzanine. (see page 32) At year-end 2012, only one organisation provided data relating to funding above a senior debt level for loans secured by secondary offices. At year-end 2011 two did so. Compared with 2011, at year-end 2012 the maximum loan-to-value ratio remained at 60% for senior debt whilst margins declined from 412bps to 375bps. For junior debt, the average maximum loan-to-value ratio declined from 78% to 65%. Mezzanine was offered to a maximum of 75% at year-end Interest rate margins for junior debt/mezzanine finance lay between 800bps and 1200bps. (see page 33) xv

18 Development Finance: Loan Terms Offered by Banks, Building Societies and Insurance Companies At year-end 2012, only fourteen lending teams from banks, building societies and insurance companies provided data for loans secured by fully pre-let commercial development. This compares with sixteen that did so at year-end 2011 and eighteen at year-end The average interest rate margin was 421bps which was an increase from 374bps reported at yearend The average loan-to-value ratio was 58% (59% year-end 2011) and the average loan-to-cost ratio was 61% (63% year-end 2011). (see Appendix D) Seven lending teams from banks, building societies and insurance companies provided data for loans for 50% pre-let: 50% speculative development schemes. This compares with eight that did so at year-end 2011 and ten at year-end The average interest rate margin was 471 bps which is an increase from 419bp reported at year-end The average loan-to-value ratio was 52% (50% year-end 2011) and the average loan-to-cost ratio was 59% (57% yearend 2011). (see Appendix D) At year-ends 2011 and 2012, no organisation was prepared to offer terms for speculative commercial development. (see Appendix D) Residential Loan Terms: Loan Terms Offered by Banks, Building Societies and Insurance Companies At year-end 2012, twenty lending teams from banks, building societies and insurance companies provided terms for loans secured by residential investment property. This compares with 18 that did so at year-end Interest rate margins were recorded in the range of 240bps to 500bps with an average for All Lenders of 352bps. This compares with 312bps recorded at year-end Loan-to-value ratios increased from 59.7% at year-end 2011 to 62.4% by year-end (see Appendix D) For residential development projects, seventeen lending teams from banks, building societies and insurance companies provided loan terms. This compares with thirteen that did so at yearend Average interest rate margins increased to 458bps at year-end 2012 from 404bps reported at year-end Average typical loan-to-value ratios increased to 57% at year-end 2012 from 56% at year-end 2011 whilst loan-to-cost ratios remained at 63%, at both year-ends. (see Appendix D) Senior Debt: Loan Terms Offered by Other Non-bank Lenders At year-end 2012 those organisations that were prepared to offer senior debt would have done so for loans secured by prime property within a range of 60% to 65% loan-to-value ratio, 225bps to 800bps interest rate margin, 1% to 2% arrangement fee and a profit share of up to 2%. (see page 54) For senior debt loans secured by secondary property, loan-to-value ratios were recorded within a range of 60% to 65%, interest rate margins 300bps to 800bps, arrangement fees 1% to 2% and 2% profit share. (see page 54) Junior Debt and Mezzanine Finance: Loan Terms Offered by Other Non-bank Lenders At year-end 2012, those organisations that were prepared to offer junior debt for loans secured by prime and secondary property would have done so within a range of 60% to 75% loan-tovalue ratio 10% to 12% interest rate margin/coupon, 2% to 3% arrangement fee, 3% exit fee/profit share and seek an internal rate of return of 8% to 15%. (see page 55) At year-end 2012, those organisations that were prepared to offer mezzanine finance for loans secured by prime property, would have done so within a range of 70% to 85% loan-to-value ratio, 9% to 15% interest rate margin/coupon, 1% to 2% arrangement fee, 1% to 3% exit fee/profit share and seek an internal rate of return of 10% to 17%. (see page 56) For loans secured by secondary property, organisations loan-to-value ratios were recorded within a range of 65% to 85%, interest rate margin/coupon 11% to 15%, arrangement fee 1% to xvi

19 2%, exit fee/profit share 1% to 3% and seek an internal rate of return of 10% to 17%. (see page 56) Development Finance: Loan Terms Offered by Other Non-bank Lenders. Those organisations that were prepared to fund fully pre-let commercial development projects would have offer a loan-to-value ratio to 50%, an interest rate margin/coupon at 10%, and an arrangement fee of 3%. (see page 57) Those organisations prepared to offer junior debt for a fully pre-let commercial development would offer a loan-to-value ratio within a range of 50% to 60%, an interest rate margin/coupon of 12% to 25%, an arrangement fee of 6% and seek an internal rate of return of 15% to 17%. (see page 57) Those organisations prepared of offer mezzanine finance for fully pre-let commercial development would do so within a range of 65% to 85% loan-to-value ratio, 70% to 100% loanto-cost ratio, seek an interest rate margin of 15%, arrangement fee of 2%, an exit fee of 2% and seek an internal rate of return of 12% to 17%. (see page 58) Mezzanine finance was also available for speculative commercial development to a maximum loan-to-value ratio of 55%, loan-to-cost ratio of 60%, interest rate margin/coupon of 17%, arrangement fee of 2% and an exit fee of 2%. (see page 58) Residential: Loan Terms Offered by Other Non-bank Lenders Those organisations prepared to provide senior debt to loans secured by residential investment property did so within a range of 60% to 65% loan-to-value ratio, 225bps to 350bps interest rate margin/coupon and a 1% arrangement fee. (see page 54) Junior debt would have been provided to a loan-to-value ratio of 75%, an interest rate margin/coupon of 12%, an arrangement fee of 2%, an exit fee/profit share of 3% and seek an internal rate of return of 8% to 10%. (see page 55) Mezzanine finance would have been provided within a range of 60% to 85% loan-to value ratio, 11% to 15% interest rate margin/coupon, 1% to 2% arrangement fee, 1% to 3% exit fee/profit share and seek an internal rate of return of 11% to 17%. (see page 56) With regard to finance for residential development for sale, senior debt would have been provided to 75% loan-to-value ratio, 90% loan-to-cost ratio, an interest rate margin/coupon of 12%, an arrangement fee of 2% and an exit fee of 2%. (see page 57) Mezzanine finance would have been provided within a range of 40% to 85% loan-to-value ratio, 40% to 100% loan-to-cost ratio, an interest rate margin/coupon of 16% to 20%, an arrangement fee of 2% an exit fee of 2.5% and an internal rate of return of 12% to 30%. (see page 58) Important Issues from Conclusion (see page 61) The aggregated loan book is being gradually reduced and the reduction in outstanding debt with a loan-to-value ratio of between 71% and 100% suggests that banks are resolving issues with legacy debt positions, especially where the transactions still have value. However, the amount of legacy debt with a loan-to-value ratio above 100% increased in absolute terms to 45bn at year-end 2012 from 42bn recorded at year-end Thus, there are substantial legacy issues that still remain unresolved. Recent market entrants are becoming active lenders but their lending appetite remains selective and shows a clear bias towards central London and investment projects. It appears, therefore, that these organisations are unlikely to offer major solutions to the lack of lending to commercial development projects and in the regions generally. Lenders commented that improvements in the commercial property and lending markets generally, continue to be constrained by a lack of confidence in recovery in the UK economy and the regulatory environment that makes lending secured by commercial property more difficult. xvii

20 INTRODUCTION This report analyses the lending patterns of the major commercial property balance sheet lenders and Other Non-bank Lenders operating within the UK for the year-ended 31 December This is the fourteenth such report to be published by De Montfort University and is the most recent addition to a series of consecutive annual and half yearly reports that commenced in As part of an initiative to enhance the range of data collected by this research there has been an increase in the number of organisations that have contributed data. At year-end 2012, data was received from a total of eighty-seven lending teams operating out of seventy-eight lending organisations. In addition data was received from three organisations that purchased nonperforming loan portfolios secured against UK commercial property. A number of organisations from across the categories adopted in this research have completely withdrawn from commercial property lending. However, these organisations continue to report their value of outstanding debt to this research and are included in these numbers. During the first two quarters of 2011, the National Asset Management Agency (NAMA) completed the acquisitions of loans from five banks whose head offices are located in Ireland. The three largest of these banks have regularly contributed data to this research, and have continued to do so in respect of their UK operations. In this report, the data received from these organisations will exclude the value and details of loans transferred to NAMA that are secured by UK commercial property. The rate and detail of response to individual questions varies between organisations due to reasons of confidentiality and availability of data. Thus, 100% response rate may refer to a different total from one question to another. For Banks and Building Societies generally the analysis is based on a total of sixty-three lending teams operating from fifty-five organisations. For Insurance Companies, generally the analysis is based on a total of eight lending teams operating from seven organisations. For Other Non-bank Lenders generally the analysis is based on a total of 16 organisations. Throughout the research complete anonymity is maintained. No lending organisations are named anywhere in this report other than in the list of Acknowledgements. Presentation and methodology This report is divided into 2 parts followed by 10 appendices. The first part gives a brief summary of market activity during This gives the aggregated value of debt outstanding at 31st December 2012, together with data on the value of new loans that were originated during the year. The Main Findings of the research for year-end 2012 are presented in the second part, together with data from previous years so that market trends can be identified. Data for both mid-year and yearend 2012 will be presented where this has an impact on trends previously identified. The following 10 appendices provide detailed information on the topics included in the Main Findings. Each appendix has its own index for ease of reference to any particular item of information. The final appendix, J, records the comments made by lending organisations in respect of current issues and concerns within the UK commercial property lending market. The findings of this research are presented mainly in graphical form supported by brief summaries that highlight the pattern and the features most relevant to the analysis. The summaries are largely descriptive making no attempt at this stage to explain the research findings in detail. xviii

21 To accompany this report, there is a Technical Supplement available in pdf format available to download from or by request to cplr@dmu.ac.uk. This sets out the detailed lending terms that would be offered for senior debt by the different categories of lenders used throughout this research. No lending organisations are named. Definitions and classification of lenders Definitions Throughout this research, commercial property lending is taken to mean all lending secured on UK commercial property and held on the balance sheet of lending organisations. This includes residential investment and development but excludes owner occupier residential mortgages. Where reference is made to the commercial property loan books of lending organisations, this is taken as the net exposure to UK commercial property excluding equity finance (i.e. net of any loan amounts sold down to other lenders and net of any securitised loans unless otherwise stated). Classification of lenders In order to show the variety of lending patterns and the differences between lending organisations a categorisation of lenders has been devised which is applied throughout the analysis. With effect from the year-end 2009 report, data from Building Societies and UK Lenders have been combined. This is to guard against identification of individual active Building Societies within the shrinking numbers within this category. In this report for year-end 2012, Insurance Companies have been included as a specific category for the sections of the report that analyse outstanding loan books and annual lending only. This is because of the recent increase in number and activity of these organisations in the UK commercial property lending market. However, their inclusion as a separate category is restricted for this report to guard against identification of individual companies within the aggregated data. Where insurance companies are not categorised separately, the individual organisations will be categorised by nationality as in previous editions of this research. All: refers to all lending organisations that have responded to a particular question. UK Banks and Building Societies: comprises those lending organisations where the head office is located in the UK and includes Building Societies in the UK. During 2009 two organisations that previously were included in UK Lenders have merged with and have become part of an Other International Lender. Since 2009, these lending organisations will be reported under Other International Lenders. German Banks: comprises all lending organisations, the head office of which is located in Germany. North American Banks: refers to all lending organisations, the head office of which is located in North America. These organisations are recorded as a separate category since Prior to this, they were included with Other International Lenders. Other International Banks: refers to all lending organisations, the head office of which is not located in the UK, Germany or North America. It includes lending organisations whose head office is located in Eire. Insurance Companies: refers to all insurance companies irrespective of the geographic location of the head office. Other Non-bank Lenders: refers to debt funds and asset management companies that specialise in providing mainly mezzanine finance/junior debt and, in some instances provide senior debt as well. xix

22 MARKET ACTIVITY Loan book size recorded by the research for 2012 This introductory section provides details of the value of outstanding loan books of both the major commercial property balance sheet lenders at 31 st December 2012 and Other Non-bank Lenders that are becoming an important part of the commercial property lending market in the UK. For the first time in this research and for the sections that analyse outstanding loan books and annual lending, insurance companies have been included as a specific category. This is because of the increase in number and activity of these organisations in the lending market. Previously, insurance companies that reported to the research were categorised by nationality. 1.1 Value of outstanding loan books A total value of 217.1bn of outstanding debt, including loans of approximately 19.1bn secured by social housing (but excluding equity participations) was recorded by the survey as at 31 st December In addition, a further 15.2bn of loans were committed but not drawn at this date. Table 1 presents the categories of lending organisations and their value of outstanding senior debt, junior/mezzanine finance and undrawn amounts. Table 1: Category of lender and type of finance Categories of Lender Reported UK outstanding senior debt loans including social housing Junior debt and mezzanine finance Total Reported amount of committed funds not yet drawn m m m m UK Bank and Building Societies 130,203 1, ,499 12,415 German Banks 25, , Other Int Banks 39, ,425 1,296 North American Banks 2, , Insurance Companies 15, , Other Non-bank Lenders 1,118 1,403 2,521 - All Lenders 213,732 3, ,078 15,121 The data from Table 1 is shown proportionately in Figure 1. 1

23 Figure 1: Allocation of drawn and undrawn funding, reported to this research by category of lender UK Bank and Building Societies German Banks Other Int Banks North American Banks Insurance Companies Other Non-bank Lenders Drawn Funding (217.1bn) Undrawn Funding (15.1bn) 18% 12% The value of undrawn funds recorded at year-end 2012 was 15.1bn. This has declined from 16.0bn recorded at year-end At year-end 2012, approximately 82% of the undrawn amounts were held by organisations within the category of UK Banks and Building Societies. The lending organisations that provide the committed facility have to provide the appropriate capital to satisfy Basel II regulations. The borrower will pay a commitment fee, typically 50% of the drawn margin, until the facility is drawn or the commitment withdrawn. The value of outstanding debt secured only by commercial property (this excludes undrawn amounts and loans to social housing) stood at approximately 197.9bn at 31 December The allocation of this debt between the different categories of lender is shown in Figure 2. Figure 2: 1% 7% 1% 61% 4% 9% 4% 1% Allocation of drawn funding secured by commercial property Drawn Funding excluding social housing (197.9bn) UK Banks and Building Societies Other International Banks Insurance Companies 20% 13% 1% 8% 1% German Banks North American Banks Other Non-bank Lenders 57% 82% The greatest variation between Figures 1 and 2 is the reduction in market share of UK Banks and Building Societies when the value of lending secured by social housing is excluded. There is a corresponding increase in the market shares of the other categories of lenders, except North American Banks and Other Non-bank Lenders, as a consequence. 2

24 1.2 Estimation of market size year-end 2012 In common with previous reports, it is extremely difficult to ascertain the total size of the commercial property lending market in the UK. There are a number of reasons for this. The definition of commercial property is not uniform across the lending industry in the UK. An example of this is included in this research. From 2005 this research included loans to large scale residential investment and development projects as commercial property. This was because of advice from commercial property lending teams responding to the research who explained that they had become involved in lending secured by residential projects because of the large value of the loans involved. During the investigations and preparation of this report some organisations that are not detailed contributors of data to this research but whose financial statements have been examined, simply classified all their lending to real estate as property lending, others classified non-residential lending as commercial. However, commercial could include loans secured by commercial property, loans secured by land, overdrafts for businesses and unsecured lending backed by other (and often) personal guarantees only. Thus, in estimating the total size of the specialist commercial property lending market, the following factors are considered: 1. This research has always targeted those organisations that have specialist commercial property lending teams. Consequently, lending to commercial property on a smaller scale undertaken at branch or regional level by UK Clearing Banks is not necessarily captured in its entirety by this research; 2. It is recognised that some lending into the UK commercial property market is by organisations neither located nor domiciled in the UK and thus is not captured by the research. More specifically and as part of the process of widening the scope of this research to make it as comprehensive as possible, at year-end 2012, the following additional amounts of outstanding debt have been identified: i. Approximately 20.6bn of debt, believed to be mainly secured by commercial property located in the UK but held by organisations that to date, have not participated in this research. This data has been obtained from the published financial statements of the organisations concerned. The organisations contained in this grouping include those that are running down their exposure to commercial property lending in the UK as well as those whose exposure is increasing in value. At year-end 2012, the 20.6bn identified has increased from 19.5bn similarly recorded at year-end ii. iii. An estimated 2.5bn of UK debt had, by year-end 2012, been sold by those organisations that had contributed data to this research (see page 12). Whilst recorded at year-end 2012, it is unlikely that this research will be able to monitor, in detail, the future management and status of this debt. Fitch Ratings have provided data on the value of outstanding CMBS issuances that they have rated and that included loans secured by UK commercial property. At year-end 2012 this amounted to 27.4bn. Additionally Fitch Ratings estimate that the total outstanding balance of UK CMBS was approximately 38bn at year-end iv. The value of loans held by the National Asset Management Agency (NAMA) that had acquired good (performing) and bad (non-performing) loans secured by all forms of real property from five financial institutions whose head offices are located in Ireland. NAMA is a state owned workout vehicle that manages the loans that it holds with the intention of obtaining the best possible return for the taxpayer of Ireland over an estimated time frame of seven to ten years. 3

25 By year-end 2011, NAMA had acquired loans with a face value of 74.2bn (approximately 62bn) 1. Approximately 21.6bn relates to loans secured by property located in the UK 2 and of this amount, 88% (c 19bn), could be broadly described as commercial property assets. By March 2012 it is believed that this value had been reduced by disposals of loans and property assets to approximately 8.5bn. The value of 8.5bn represents an additional amount of debt that will not have been reported to this research at year-end Therefore at year-end 2012, an estimated total value of 267.5bn of outstanding debt secured by commercial property has been identified by this research. This value does not include any assumption as to the size of the market not captured by this research as detailed in points 1 and 2 above nor the value of the 15.1bn representing committed but undrawn funding recorded at yearend Excluding the value of loans held by NAMA, the total value reduces to 259bn. The comparable value at year-end 2011 was 277.5bn. Thus a reduction in the total value of outstanding debt of approximately 7% has been recorded during (The value of loans held by NAMA has been excluded because the value recorded by this research at year-end 2011 requires a downwards adjustment but the exact amount of this cannot be identified.) An additional feature of the UK lending market during 2011 and 2012 has been the emergence of organisations that have purchased mainly non-performing loan portfolios from traditional bank lenders. For the first time, the research at year-end 2012 included responses from such organisations. At year-end, those organisations that held recently purchased non-performing loan portfolios reported an aggregated total of 2,234m as the outstanding Unpaid Principal Balance of loans secured by UK commercial property. There is evidence elsewhere of additional transactions by other organisations and so the 2,234m reported to the research at year-end 2012 will be the minimum amount transacted. 1 National Asset Management Agency, Section 53 Annual Statement 2012[WWW] National Asset Management Agency available from [accessed 02/05/12] 2 National Asset Management Agency (2011) NAMA Annual Report 2010 ) [WWW] National Asset Management Agency available from [accessed 02/05/12] 4

26 1.3 Value of loan originations completed in 2012 In view of the changing market conditions and the ongoing impact of the financial crisis, since yearend 2009 the research questionnaires have asked for details not only of new lending but also of extensions to loans that should have matured during the reporting period; in this case during Extensions to maturing loans can be recorded as new lending, refinancing or not lending in the strictest sense. Table 2 below gives amounts indicative of the total value of loans originated and where possible this figure has been stripped of any extensions granted for loans maturing in The values of extended loans are given as a separate value where these have been reported to the research. Table 2 gives the amount of new senior debt loan originations, junior debt/mezzanine finance and loan extensions completed during 2012 and secured by commercial property and social housing. Table 2: Value and allocation of loan originations in 2012 Value of senior debt lending Junior debt excluding and Categories of Lenders extensions mezzanine to maturing originated loans m UK Banks and Building Societies Value of extensions to loans that should have matured during 2011 Total 13, ,057 14,561 German Banks 3, ,423 Other Int Banks 3,767-5,193 8,960 N. American Banks 1, ,623 Insurance Companies 2, ,829 Other Non-bank Lenders ,328 All Lenders 25, ,040 33,724 The value of 25.7bn includes 1.3bn of lending secured by Social Housing. The value of loan originations (senior, junior and mezzanine combined) secured only by commercial property is 25.4bn. In addition 7.0bn of extensions to maturing loans was reported. Figure 3 gives the proportional allocation of loans originated in 2012 secured only by commercial property (i.e. without social housing). 5

27 Figure 3: Allocation of loan originations undertaken in 2012 Loan originations excluding social housing and extensions to loans ( 25.4bn) UK Banks and Building Societies Other Int Banks Insurance Companies 15% 6% 10% 16% 5% German Banks North American Banks Other Non-bank Lenders UK Banks and Building Societies recorded 48% of the total loans when identifiable extensions to loans and social housing are excluded. The analysis contained in the remainder of this report will exclude lending to social housing unless otherwise stated. 48% 6

28 MAIN FINDINGS 2. UK commercial property lending 1999 to 2012 This part summarises the main findings of the research for year-end This is presented together with data collected from previous years to identify trends in the market. It should be noted that the following analysis does not included loans held in the CMBS market or NAMA unless this is explicitly stated to the contrary in the text. The organisations reporting to the annual research in the most recent years will be different from those reporting in earlier years. This is due to new organisations entering the market, others dropping out, and takeover and merger activity Aggregated value of outstanding debt RECORDED IN LOAN BOOKS (excluding the value of loans securitised into the CMBS market, loans held by NAMA and lending secured by overseas property) Figure 4: Aggregated value of outstanding debt Aggregated loan book size reported to the research Social Housing Figure 4 presents the net aggregated value of outstanding debt recorded in loan books and secured by commercial property and social housing that has been reported by lending organisations to this research since By year-end 2012 this stood at a total of 217.1bn. At year-end 2011 the comparable value was 232.6bn and thus the total value of outstanding debt had declined by 7.7% during the year. In relation to the value of debt secured by commercial property only (i.e. excluding social housing) this has increased by 397% from 49.8bn in 1999 to 197.9bn by year-end However, between 2011 and 2012, for the fourth consecutive year, the value of outstanding debt secured by commercial property recorded by this research, has declined. The value declined by 14.6bn from the comparable value of 214.4bn at year-end 2011 to 197.9bn recorded at year-end This represents a fall of 7.7%. Table 3 presents the year-on-year changes in value of outstanding debt secured by commercial property and recorded by organisations that have consistently reported to this research and organisations that entered the market during

29 Table 3: Year-on-year changes in the value of outstanding debt recorded in loan books Year % change in value of aggregated outstanding loan books 1999 to % 2000 to % 2001 to % 2002 to % 2003 to % 2004 to % 2005 to % 2006 to % 2007 to % 2008 to % 2009 to % 2010 to % 2011 to % The decline in value of 9.9% recorded between year-ends 2009 and 2010 was strongly influenced by the large scale transfer of loans from lending organisations to government agencies and resulted in these loans no longer being recorded in the research data. Figure 9 below (see page 12) provides a detailed description of the activities of lending organisations that resulted in a further decline of 6.9% being recorded in outstanding value between year ends 2011 and Figure 5 shows the changing proportions of outstanding debt secured by commercial property and held by each category of organisation between 1999 and Figure 5: Allocation of outstanding debt secured by commercial property by category of lender UK Banks and Building Societies German Banks North American Banks Other International Banks Insurance Companies Other Non-bank Lenders 10% 10% 13% 11% 15% 14% 16% 18% 21% 22% 23% 20% 20% 2% 2% 22% 23% 18% 2% 22% 16% 13% 2% 10% 2% 1% 1% 1.5% 11% 9% 10% 11% 10% 12% 1.3% 8.1% 19.6% 1% 13% 69% 66% 65% 70% 70% 71% 72% 69% 68% 66% 66% 68% 66.5% 57%

30 To reflect the changing composition of the lenders in the market, in 2012 Insurance Companies and Other Non-bank Lenders are shown as distinct categories. Prior to this report for year-end 2012, insurance companies that undertook secured lending into the UK commercial property market were included in the relevant category by nationality. Since 2011, secured lending to commercial property has become more attractive to these organisations due to pending regulatory changes and business opportunities created by the withdrawal of banks from this sector. Consequently more insurance companies have entered the market in the UK hence the inclusion of these organisations as a separate category in this section of the report and 2012 have also seen the establishment of a variety of debt funds and asset management companies that are prepared to provide mezzanine finance/junior debt to the commercial property lending market and, in some instances, senior debt as well. These organisations are included and categorised in this section of the research as Other Non-bank Lenders. Between 2011 and 2012, the proportionate market share for UK Banks and Building Societies, Other International Banks and North American Banks all recorded declines in values. These reductions are due almost in their entirety to insurance companies being classified as a separate category. The market share for German Banks increased from 12% to 13%. At year-end 2012, collectively Insurance Companies held 8.1% of the total aggregated loan book and the market share for Other Non-bank Lenders was 1.3%. Table 4 shows the changes in loan book size by category of lender between year-end 2011 and year-end Data is included of all lenders that provided book size data at both year-ends. Thus, the analysis is based on a total of 67 organisations. There are a further 12 organisations that were new to the market in 2012 and, therefore, only provided book size data for year-end 2012 and so a comparison cannot be made. Table 4: Changes in book size during 2012 Categories of Lenders Increase of 26% or above Increase of between 11% and 25% Increase of 10% or less Maintain Decrease of 10% or less Decrease of between 11% and 25% Decrease of 26% or more Proportion of lenders % UK Banks and Building Societies 11% 6% 11% - 33% 39% - German Banks 13% 13% 27% - 20% 27% - Other Int. Banks 6% - 12% 6% 29% 29% 18% North American Banks 60% % - 20% Insurance Companies 60% 20% 20% Other Non-bank Lenders 72% - 14% % - All Lenders 24% 6% 15% 1.5% 22.5% 25% 6% Overall 45% of organisations increased the value of their outstanding loan books during One hundred percent of Insurance Companies recorded an increase in the value of their outstanding loan books with 50% recording an increase of 26% and above. The value of the aggregated loan book held by Insurance Companies increased by 13.6% from 14.1bn to 16.0bn at year-end Five organisations reported consistently between these two dates. Eighty-six percent of Other Non-bank Lenders recorded an increase. The value of the aggregated loan book held by these organisations increased from 1.4bn recorded at year-end 2011 to 2.5bn 9

31 at year-end This represents an increase of 75%. Eight organisations reported consistently between these two dates and seven of those recorded an increase, with six recording an increase of above 25%. An additional nine organisations within this category are new entrants to the market and held a loan book for the first time. German and North American Banks record the highest proportions of banks and buildings societies that have succeeded in increasing the value of their outstanding loan books during 2012 at 53% and 60% respectively. However, the proportion recorded by North American Banks is strongly influenced by the small number of organisations within this category. Figure 6 shows the changes in loan book size by aggregated book size. By combining the data from this Figure and the data from Table 4 above it shows, for example, that the 24% of All Lenders that recorded an increase of 26% or above held a total of 9.6bn of debt on their loan books. Conversely, the 23% of organisations that recorded a decline of 10% or less in the value of their outstanding loan books held 97.2bn of outstanding debt. The figure demonstrates that organisations holding 142.6bn of the 196.1bn of debt included in this part of the research recorded changes of between + or 10% in their value of outstanding debt during Figure 6: 9,646 Increase of 26% or above Changes in book size by aggregated book size ( m) 5,255 Increase of between 11% and 25% 45,368 Increase of 10% or less 28 Maintain 97,168 Decrease of 10% or less 37,569 Decrease of between 11% and 25% 1,097 Decrease of 26% or more Figure 7 presents the proportion of outstanding debt held by the largest 6 and then the next largest 6 lenders. Since 1999, the largest six organisations, by book size, have held over 50% of the total outstanding debt retained within loan books. Combined together with the six next largest organisations, the largest twelve lenders have, since 2006, held close to 80% of outstanding debt. However, since 2009 there has been a small and continuous decline in the proportion of debt held by the largest twelve organisations. At year-end 2012, the 12 largest organisations held 75% compared to 78% recorded at year-end

32 Figure 7: Proportion of outstanding debt secured by commercial property held by the largest six and the next largest six organisations from 1999 to 2012 Proportion held by the next largest 6 lenders 300 Proportion held by the 6 largest lenders Aggregated loan book size reported to the research 250 bn % 20% 20% % 19% 18% 58% 62% 61% 18% 61% 59% % 60% 57% 18% 15% 14% 15% 25% 25% 57% 58% 50 52% 54% 53% 50% 57% Figure 8 shows the composition of the largest twelve organisations by category of lender in Figure 8: Composition of largest twelve lenders by book size 2012 UKBanksand Building Societies Other International Banks 2.2. Reductions in loan book during 2012 German Banks Insurance Companies Contributors to the research were asked to consider the reduction in value of their commercial property loan books BEFORE loan originations were taken into account. At year-end 2012, 54 of the 71 lending teams from banks, building societies and insurance companies (not including Nonbank Lenders) identified a reduction and these held 76% of outstanding debt recorded at year-end Collectively they identified a reduction of 30.6bn. Figure 9 shows the reasons for the reduction in loan book by proportion

33 Figure 9: Reasons for reduction in book size before taking loan originations into account Scheduled repayments and amortisations 20% Customers paying down Bank/lending organisation influenced sales (including foreclosures, taking possession and selling property) Value of loans written off Value of loans sold Swapping debt for equity Other 6% 26% 8% 1% Year-end % 17% At year-end 2012, 39% of reductions occurred due to the scheduled repayment and amortisation of loans. This is similar to the 40% being recorded at year-end Customers paying down, 26% and Bank/lending organisation influenced sales, 20%, record increased proportions compared to 21% and 17% respectively recorded at year-end 2011 The most significant variation in data between mid-year 2012 and year-end 2012 is in the proportion of loans being sold. On a pro-rata basis, just 1% of the reduction at mid-year 2012, representing approximately 0.2bn, was recorded as being due to loan sales. By year-end 2012 this had increased to 8% representing approximately 2.5bn. Where it was reported to the research, discounts to the par value of loans sold ranged between 4% and 60% with 5%, 17%, 20% and 50% being cited. Where information was provided, purchases were completed by other lending organisations, investors, and specialist purchasers of non-performing loans. 5% 14% 21% Year-end % 2% 40% 12