FOR PROFESSIONAL CLIENTS ONLY, NOT TO BE DISTRIBUTED TO RETAIL CLIENTS THIS DOCUMENT SHOULD NOT BE REPRODUCED IN ANY FORM WITHOUT PRIOR WRITTEN APPROVAL BNY Mellon Investment Management Global Investment Conference Alex Veroude Commercial Real Estate Lending in Europe 17 October 2013
A once-in-a-cycle opportunity
In the news Europe has an insurmountable 1trn of property loans maturing by 2015. CoStar European landlords have 582.7 billion Euros ($779 billion) of commercial property debt maturing by the end of 2013 at the same time regulators are urging banks to shrink their balance sheets. FT.com February 2012 CBRE Ellis September 2012 Bloomberg.com September 2012 Europe s banks in 20bn property loan sell-off. European Banks Dispose of 7.5bn property Loan Portfolios year to date. February 2012 ds ale suspen r é n é G té Socié nding. k property le Costar.co.u Eurohypo suspends new business. Propertyeu.info November 2011 2011 November European banking rules to double real estate debt funding gap We now estimate a 450-700bn CRE financing gap IPE Morgan Stanley May 2012 November 2012
European commercial property loan market has a supply/demand imbalance The European commercial property loan market is valued at c.us$2.6trn with over US$950bn worth of loans expected to fall due between 2013 and 2015 European CRE loans c.$2,600bn. Source: DTZ Research Money into Property 2013, 2012 position Source: DTZ Research 2012.
Creating opportunities for new lenders to enter on favourable terms at a time when bank deleveraging is reducing traditional sources of finance Deloitte Bank Survey: divestments concentrated on commercial real estate loans New lenders are able to enter the European lending market as has been the trend in the US Sources of funding Commercial real estate Corporate: other Corporate: asset finance & leasing Retail: secured Retail: unsecured Small & medium enterprises Other Corporate: public sector 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% % of respondents Source: Deloitte 2012 Bank Survey. Numbers are percentages of respondents answering core/very core component of divestment plan. Source: DTZ Research, 2013.
Commercial property loans: an overview Mezzanine loan fund manager 2 Mezzanine loan fund manager 1 Senior loan secured holder 3 Senior loan secured holder 2 Insight client Loan Originator (e.g. banks) Coupon/ origination fee Owner/sponsor (e.g. property companies, family offices, institutions) Rent Property (e.g. retail, leisure, office, industrial) Tenants (e.g. multinationals, corporate entities, government entities)
Comparison commercial property loans versus investment grade corporate bonds Commercial property loans Investment grade corporate bonds Yield 3.5 5.5% 1.95% Interest rate Floating Fixed Covenant protection Strong None Information Detailed, mostly private Limited, public Security position Secured Unsecured Default risk A+ A- Recovery upon default 90% average 40% average Data as at June 2013.
New investors can enter the lending market on favourable terms Attractive spreads and low LTVs Spreads on senior loans versus high quality corporate bonds Average maximum LTV ratio 80 75 70 c1.75% premium 65 60 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Bloomberg, Insight Investment as at 31 March 2013. Source: De Montfort University, Bank s Financial Stability Directorate, 2013.
A low risk investment alternative Case study: what could go wrong? Dutch commercial property prices have fallen dramatically since 2007, but property loans remained resilient where loans had a loan-to-value of 70% or less Dutch commercial property prices (indexed to 100) Dutch commercial property loan experience Source: Dutch Central Bank 2012.
Debt compelling alternative to equity in current conditions Property debt versus equity IRR 15% 10% 5% 0% -5% Real estate prices -10% -15% -20% -25% -30% Investor returns -70% -60% -50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% Property price return Property Returns* Senior Debt Returns- bank loan Note: Insight model for illustrative purposes. * Property purchased without debt.
Risk and return Typical loan terms applied 100 550 % 80 60 40 20 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 450 350 250 150 50 bp Ave margin (RHS) Ave LTV (LHS) Source: Deutsche Bank, De Montfort and Insight. Data for Insight clients covers the period of January to August 2013.
Indicative yields demonstrate greatest expected return on regulatory capital Yields on direct property lending are between 3.5% and 5.5% for investment grade quality For the risk involved these are show up as the best loss adjusted risk/return Description Yield Rating Expected default Recovery Expected loss Loss adj. yield Capital charge** Yield per unit of capital** Real Estate Loan 3.50% AAA* 0.01% 90% 0.00% 3.50% 4.5% 0.78 Real Estate Loan 5.50% BBB* 0.36% 90% 0.04% 5.46% 12.5% 0.44 RMBS 1.00% AAA 0.01% 90% 0.00% 1.00% 35% 0.03 Covered Bond 0.50% AAA 0.01% 60% 0.00% 0.50% 3.5% 0.14 Corporate Bond 1.63% BBB+ 0.27% 40% 0.16% 1.47% 12.5% 0.12 Financial 1.96% A 0.12% 25% 0.09% 1.87% 7.0% 0.27 Corporate Bond 4.68% BB 1.35% 25% 1.01% 3.57% 22.5% 0.16 Corporate Bond 6.93% B 2.72% 25% 2.04% 4.89% 37.5% 0.13 Corporate Loan 5.10% B+ 1.77% 70% 0.53% 4.57% 37.5% 0.12 Source: Barclays and Credit Suisse March 2013. * Insight rated.**capital charge assumes all holdings are 5 year duration for comparability, standard formula stress module for publically rated issues and using internal rating for real estate loans. Reflects current Solvency II favourable treatment for covered bonds and latest capital charge for structured/ ABS which is subject to review.
North American direct lenders in the European market Fund Geographic focus Strategy Type of product Metlife UK Senior debt Direct lending GE Capital UK and Western Europe Senior debt Direct lending Cerberus (BAWAG) UK and Western Europe Senior debt Direct lending Mass Mutual (Cornerstone) UK Senior debt Direct lending AIG UK Senior debt Direct lending Canada Life UK Senior debt Direct lending Prudential US UK and Western Europe Senior debt Direct lending and syndication Source: Insight.
The range of strategies Loan types LTV Range (%) Target gross IRR return (%) Loan term Average loan size ( m) Senior debt strategy Senior loans 0-60 4-6 5-10 50-150 Whole loan strategy Senior stretch 0-75 6-8 5-7 40-100 Mixed debt strategy Loans & Securities 0-80 8-10 Subordinated debt strategy Junior and mezzanine Low risk 60-70 High risk 70-80 8-12 12-15 3-7 10-25 Distressed debt strategy Distressed loans 50-100 15-20
Requirements for CRE Management 1. Real estate Local presence in Europe Ability to value buildings Ability to work out problems 2. Credit underwriting Corporate credit analysis ability Structuring and risk pricing ability 3. Documentation Ability to structure loan agreements Ability to monitor and enforce positions 4. Governance No conflicts of interest or management of them Unconstrained pipeline of deals
Process Filtering/origination STEP 1 Location Macro/micro location strength Take up by tenants Tenant requirements Vacancy rate and supply Development pipeline Underwriting STEP 2 Asset quality STEP 3 Tenant roll STEP 4 Borrower Building condition Environmental Lease length Strong history of managing real estate assets Tenure Quality vs competing space Rent versus estimated rental value Improving value of an asset Alternative uses Legal terms Diversity Track record of repaying loans STEP 5 Loan structure Loan-to-value Maturity Mezzanine rights Hedging Covenants Reserves Substitution rights Prepayment risks Legal documentation Closing Risk control/ portfolio mgmt
Case study Regional retail (+410bp strategy) Location Photos Acquisition financing: deal closed in December 2012 with 65 million purchase price Dominant location: dominant centre in Cumbria, representing half the city retail offering with no major retail mall within an hour and a half drive of the subject property Strong cash flow: Highly diversified tenant roll with good leases and reversionary upside. All tenants internally credit rated Institutional backing: strong motivated sponsor that is fully incentivised through a material equity stake in the property Waiting List: Long waiting list including Primark and TK Maxx
A case study: the loan Loan information Loan amount at closing 42,300,000 Upfront fee 0.75% Asset type First mortgage loan Index FRN 3m L Coupon L +410 Hedging 5% interest rate swap Initial maturity date 4 years Extension options NA Prepayment Yr1-4%, Yr2-3%, Yr3-2% Amortisation type Contractual Appraised value 65,000,000 Loans per NSF 102 Facility documentation LMA Syndicated loan agreement Property information Property type Retail Location Carlisle, United Kingdom Number of properties 1 Year built 1981 Freehold/leasehold Leasehold NSF 415,100 Occupancy 100% Major tenants (by GRI) Diversified Capital structure Tranche Tranche size Cumulative loan amount % of total debt Cumulative per SF/unit LTV A note 42,300,000 42,300,00 100.0% 102 65%/58.5% Equity 22,700,000 Total 65,000,000
Conclusions Once-in-a-cycle opportunity to invest in high quality secured transactions at an excellent rate of return: attractive returns: 3.5% to 5.5% yields for AAA to BBB ¹ secured loans resilient deal structures: credit metrics remain robust even in stress scenarios Good fit for investors seeking to match duration liabilities and discretionary liabilities enables greater control over overall matching strategy and the timing of expected returns Who are the winners in this situation? Clearly anyone with money to lend against property, who can pick up unprecedented risk adjusted returns in the sector (wider spreads, lower LTVs). Deutsche Bank June 2012 improved likelihood of being able to meet long term liability payments attractive capital treatment relative to comparable instruments Important attributes to look for in an investment manager: ability to tailor to your risk, return and capital requirements: term, fixed, floating, inflation-linked strong track record with focus on rigorous credit risk management ¹ Insight rated.
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