Capital Markets Replace Banks European Real Estate Companies Banking on Financing Alternatives Special Report

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1 29 June, 2015 Capital Markets Replace Banks European Real Estate Companies Banking on Financing Alternatives For the largest European real estate companies, alternative sources of financing are becoming more important. The reasons are many banks are consciously reducing financing for commercial real estate, and insurance providers, pension funds and other institutional investors are searching for returns amid low interest rates. Scope believes borrowers will profit from the greater choice in financing. The ten largest listed European real estate companies by market capitalisation ( Top 10 ) are relying less on banks for external financing. While the proportion of bank loans was 54% in 2009, this fell to just 37% in 2014 a significant change in the liability structure of the monitored companies. The volume of outstanding bank loans also fell in absolute terms: in 2009 the balance sheets of the Top 10 had EUR26.4bn of bank loans in total, compared to just EUR19.4bn in 2014, a reduction of EUR7bn or 27%. On the other hand, alternative financing sources are gaining importance. In 2009 these sources comprised 46% of all liabilities. This rose to almost twothirds in 2014 at EUR32.8bn, a growth of EUR22.8bn in absolute terms. Figure 1: Liability structure: Top 10 Analyst Philipp Wass Associate Director +49 (0) p.wass@scoperatings.com Presse André Fischer +49 (0) a.fischer@scoperatings.com 46% 50% 50% 60% 58% 63% 54% 50% 50% 40% 42% 37% % Liabilities (bank) % Liabilities (alternative financing sources) Source: Annual reports of monitored companies, Scope Ratings Sixfold increase in capital-market transactions from 2009 Capital markets are the most important source of alternative external financing besides alternative credit providers, such as insurance companies or debt funds. In particular, the top 10 are using bonds such as medium-term notes, convertible bonds and commercial paper to generate external funding through the capital markets. The volume of issued bonds among the Top 10 increased more than sixfold in six years from EUR1.3bn to EUR8.5bn (Figure 2). Around 80% of these debt securities issued in the capital market were denominated in euro. Durations on new issuances averaged around 8.5 years. Scope Ratings AG Lennéstraße 5 D Berlin Phone +49 (0) Fax +49(0) Service +49(0) info@scoperatings.com June / 5

2 Figure 2: Issuance volumes of capital market debt (EUR bn) among Top Source: Annual reports of monitored companies, Scope Ratings, Bloomberg ( ) Winding down on real-estate credit exposures due to financial crisis Basel III: reduction of risk-weighted assets Low interest rates provide push towards capital market financing What s behind the trend for capital-market financing? Scope believes the declining portion of banks financing property companies is due to the withdrawal of individual European banks from the market in response to the financial crisis, resulting in a massive fall in credit exposures in the commercial real estate segment (CRE loans). For example, as of 2010 banks with official plans to reduce assets held EUR771bn of real-estate credit exposures on their books. By the end of 2014 over a-third of these credit exposures had been divested. No other credit institutions have matched this reduction. One reason for the significant fall in real-estate credit exposures are the Basel III regulations, which mandates a gradual increase in capital requirements for risk-weighted assets from 3.5% (2013) to 7.0% in 2019 (4.5% minimum common equity plus 2.5% capital conservation buffer). Banks with weak capital structures are especially eager to reduce CRE loans that are classified as risky assets under regulations. Alongside Basel III enforcing reductions in banks risk-weighted assets, in Scope s view, low interest rates in Europe strengthens the trend for capital market financing and alternative credit, providers (see Figure 3). Figure 3: Money market rates: euro and British pound (%) Figure 4: Coupons: capital market debt vs interest rate swaps (same duration) J 09 A 09 J 09 O 09 J 10 A 10 J 10 O 10 J 11 A 11 J 11 O 11 J 12 A 12 J 12 O 12 J 13 A 13 J 13 O 13 J 14 A 14 J 14 O 14 J 15 A 15 3M EURIBOR 3M GBP LIBOR J M M J S N J M M J S N J M M J S N J M M J S N J M M J S N J M M J S N J M M BPSW8V3 Curncy EUBE8V3 Curncy Coupon Trend (Coupon) Source: Annual reports of Top 10, Bloomberg ( ) Source: Bloomberg ( ) June / 5

3 The search for yield Financing on capital market cheaper than banks Institutions drawn to the financing of real estate companies On the investor side, real estate companies search for alternatives to bank loans affects insurance providers, pension funds and other institutional investors hunting for sources of return. With the relatively low-yield requirements at present and the longer investment horizons, investors now prefer fixed income products. For these investors looking to increase allocation of fixed income products, the EUR2.5 trillion real-estate financing market (according to AEW Europe) is increasingly coming into their sights. The swing to real estate financing for these investor groups is also benefitting from Solvency II. The relationship between expected yields and capital costs is more advantageous for insurance companies and pension funds (particularly for investment-grade real-estate loans) than in other investment classes, for instance, directly investing in real estate or securitisation. The strong market entry of this new investor group in 2012 and the resulting increase in demand for fixed income products in the real estate segment, has led to an observable drop in yields according to Scope (Figure 4). Since 2012 it was particularly sound for European real-estate companies to refinance in euros over the capital market because bank financing assuming refinancing is at the same duration was more expensive in comparison (see Figure 4). Increasing diversity in financing is credit positive Effect on credit rating The increase in alternative sources of financing is generally positive in Scope s view, as there is less dependence on individual lenders. Real estate companies particularly with an investment-grade rating are currently using their chance to get financing over capital markets or through institutional investors/alternative lenders. However in the European high-yield bond segment, real estate companies only have a marginal market share of 1% (Source: Bloomberg ). Yet Scope expects a gradual increase in institutional investors that focus on the upper end of the high-yield area (up to BB-). As a rule, financing costs in particular which are also falling have a positive effect on the financial risk profile of real estate companies. Slowdown in growth for alternative financing sources More diversity in financing in the future Outlook Scope expects a slowdown in the growth of alternative financing, accompanied by an upturn in activity among traditional banks. A reason is that sinking financing costs and falling target yields is also providing a boost for the rising competitiveness in banks. Lastly the European market in commercial real-estate financing will have a larger and more diverse pool of credit providers, in which banks will continue to take the leading role. Scope believes borrowers will profit from the larger range of potential financing sources. June / 5

4 Top 10 listed real estate companies in Europe Market Financing % Company capitalisation 3) EUR m Bank Alternative 1 Unibail-Rodamco SE 22,186 16% 84% 2 Land Securities Group plc 13,608 16% 84% 3 Deutsche Annington Immobilien SE + Gagfah S.A. 13,063 41% 59% 4 Klépierre S.A. + Corio N.V. 1) 12,285 23% 77% 5 The British Land Company plc 11,564 34% 66% 6 Deutsche Wohnen AG 7,315 86% 14% 7 Gecina SA 7,273 29% 71% 8 Hammerson plc 6,885 10% 90% 9 Intu Properties plc 5,875 29% 71% 10 Fonciere des Region S.A. 5,101 73% 27% 1) Bloomberg June / 5

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