We also commented on the leading indicators we were seeing in the hotel investment market last quarter. Early indications for European second quarter hotel investment volumes are more than a 70 per cent increase quarter on quarter to over EUR3 billion. This is also over 70 per cent higher than the second quarter of 2020. There is still further to go to get back to the pre-pandemic level of EUR6 billion in the second quarter of 2019. Other positive indications are the number of large transactions in the market agreed in the second quarter which are likely to close in the third quarter, and, as with many other real estate markets, there is currently very strong demand and relatively low supply of product for sale.

We are also now seeing the beginning of investment market activity on the retail side. We expect to see a more positive sentiment on the retail investment market spread with increased data on post pandemic spending habits, followed by tenant activity then following through to the relevant investment markets. The British Retail Consortium reported retail sales were 13.1 per cent higher in June than in the same month two years ago, while the total for the second quarter of 2021 was 10.4 per cent up on the same three-month period of 2019. UK retail warehouses are leading the way in the sector with Savills reporting the pandemic-related pause in transactional activity to be short-lived, with the investment market off to a good start to 2021 with GBP476 million of transactions in the first quarter. This is the largest volume of first quarter transactions since 2017 and is up 47 per cent on the same period in 2019. Yields have been moving rapidly and are tighter by as much as 75 basis points for prime assets since last year. The many different types of retail in Europe will move at differing paces and it will be interesting to see how momentum builds in this space.

Inflation has become a concern for markets with uncertainty about whether high short term readings will translate into longer term inflation. The markets are currently signalling that this is a short term effect with continued low long term bond yields. Evercore note the last time US short term inflation was this high, the ten year US treasury bond yielded 7.7 per cent whereas it is only 1.3 per cent today. If expectations changed on long term inflation then we would expect to see interest rate policy responses and in this case the Group's portfolio would benefit as 78 per cent of the portfolio is floating rate debt which would benefit from higher short term interest rates. While the income from floating rate loans would benefit from increases in rates, these loans all feature interest rate floors which protect income against very low interest rates. This results in an asymmetrically better upside to an increasing interest rate environment versus the downside of a decreasing interest rate environment from here. Capital markets generally have continued a positive trajectory. The FTSE 100, FTSE 250 and the iShares UK Property ETF are up 4.8 per cent, 4.0 per cent and 6.5 per cent respectively during the second quarter of 2021.

The trend in non-bank lending to the real estate market continues to be highlighted by data coming through from the Cass business school survey which is the most comprehensive survey of UK commercial real estate lending. The statistics provide a clear picture of the scale of the migration from domestic balance sheet lenders to other sources of capital in commercial real estate lending. In 2008 GBP170 billion of UK commercial real estate debt was held by UK banks and building societies. By the end of 2020 this had reduced to GBP77 billion. That corresponds to a reduction of market share from 66 per cent to 40 per cent. This trend is clearly being seen in the Group's pipeline which includes a diverse set of opportunities and is at the strongest level since the Group was established.

All of the above factors combined give us confidence of positive momentum in our markets and activity amongst our counterparties; we therefore expect our portfolio to continue to perform robustly and we expect to see further opportunities for loan origination.

Expected Credit Losses & Fair Values

All loans within the portfolio are classified and measured at amortised cost less impairment. The Group closely monitors the loans in the portfolio for deterioration in credit risk. There are some loans for which credit risk has increased since initial recognition. However, we have considered a number of scenarios and do not currently expect to realise a loss in the event of a default. Therefore, no credit losses have been recognised.

This assessment has been made, despite the continued pressure on the hospitality and retail markets from Covid-19, on the basis of information in our possession at the date of reporting, our assessment of the risks of each loan and certain estimates and judgements around future performance of the assets. The position on any potential ECLs on the Spanish retail assets in particular continues to be closely monitored and analysed, and we have sought input, analysis and commentary from Spanish market advisers in this regard, to supplement our own information. As referred to above in the portfolio update, during the quarter, we have received independent, external valuations of the underlying assets secured against the Spanish loans. This information did not change our analysis on the Spanish loan and we note that valuation headroom remains on these loans. The updated valuations are reflected in the sector and portfolio LTV tables presented in this factsheet.

Fair Value

The amortised cost loan recognition is governed by IFRS9 and we do not have a choice of methodology to follow - we are not eligible to follow fair value accounting for the vast majority of our loans, and historically only one loan has ever been eligible to be recognised at fair value (the credit linked notes which repaid in 2020). Therefore, our NAV does not show significant fluctuations during periods of market volatility.

The table below represents the fair value of the loans based on a discounted cash flow basis using different discount rates. 


Discount Rate  Value Calculated       % of book value 
4.7%          GBP 439.3 m               104.4% 
5.2%          GBP 434.6 m               103.3% 
5.7%          GBP 429.9 m               102.2% 
6.2%          GBP 425.3 m               101.1% 
6.7%          GBP 420.8 m = book value  100.0% 
7.2%          GBP 416.4 m               98.9% 
7.7%          GBP 412.0 m               97.9% 
8.2%          GBP 407.8 m               96.9% 
8.7%          GBP 403.6 m               95.9%

The effective interest rate ("EIR") - i.e. the discount rate at which future cash flows equal the amortised cost, is 6.7 per cent. We have sensitised the cash flows at EIR intervals of 0.5 per cent up to +/- 2.0 per cent. The table reflects how a change in market interest rates or credit risk premiums may impact the fair value of the portfolio versus the amortised cost. Further, the Group considers the EIR of 6.7 per cent to be conservative as many of these loans were part of a business plan which involved transformation and many of these business plans are advanced in the execution and therefore significantly de-risked from the original underwriting and pricing (for example the Hotel, Spain). The volatility of the fair value to movements in discount rates is low due to the low remaining duration of most loans.

Investment Portfolio at 30 June 2021

As at 30 June 2021, the Group had 18 investments and commitments of GBP455.3 million as follows: 


                           Sterling equivalent        Sterling equivalent unfunded        Sterling Total (Drawn and 
                           balance (1)                commitment (1)                      Unfunded) 
Hospitals, UK              GBP25.0 m                                                        GBP25.0 m 
Hotel & Residential, UK    GBP49.9 m                                                        GBP49.9 m 
Office, Scotland           GBP4.9 m                     GBP0.1 m                              GBP5.0 m 
Office, London             GBP13.6 m                    GBP7.0 m                              GBP20.6 m 
Hotel, Oxford              GBP16.7 m                    GBP6.3 m                              GBP23.0 m 
Hotel, Scotland            GBP38.1 m                    GBP4.5 m                              GBP42.6 m 
Hotel, Berwick             GBP13.1 m                    GBP1.9 m                              GBP15.0 m 
Life Science, UK           GBP19.5 m                    GBP7.1 m                              GBP26.6 m 
Logistics Portfolio, UK    GBP0.6 m                                                         GBP0.6 m 
(2) 
Total Sterling Loans       GBP181.4 m                   GBP26.9 m                             GBP208.3 m 
Three Shopping Centres,    GBP31.2 m                                                        GBP31.2 m 
Spain 
Shopping Centre , Spain    GBP14.6 m                                                        GBP14.6 m 
Hotel, Dublin              GBP51.6 m                                                        GBP51.6 m 
Hotel, Spain               GBP46.6 m                                                        GBP46.6 m 
Office & Hotel, Madrid,    GBP15.9 m                    GBP0.9 m                              GBP16.8 m 
Spain 
Mixed Portfolio, Europe    GBP24.8 m                                                        GBP24.8 m 
Mixed Use, Dublin          GBP3.9 m                     GBP8.7 m                              GBP12.6 m 
Office Portfolio, Spain    GBP13.2 m                    GBP0.3 m                              GBP13.5 m 
Office Portfolio, Ireland  GBP30.2 m                                                        GBP30.2 m 
Logistics Portfolio,       GBP5.1 m                                                         GBP5.1 m 
Germany (2) 
Total Euro Loans           GBP237.1 m                   GBP9.9 m                              GBP247.0 m

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July 23, 2021 02:00 ET (06:00 GMT)