European Convergence Development Co Plc : Shareholder Update

ECDC plc

Shareholder Update

October 2013

European Convergence Development Company PLC ("ECDC" or "The Company")

The Manager presents its latest Shareholder Update report covering the three month period 1st July 2013 to 30th September 2013. This report is intended to update investors on progress over the last three months and is not intended to deal with the financial statements of the Company.

Economic Overview

ROMANIA

GDP expanded in quarter 2 by 1.5% year on year, down from the 2.2% recorded in the first quarter of the year. The Government recently increased its full year GDP forecast to 1.9% with further acceleration in 2014 to 2.2%. The main driver for the improvement in the second half is a strong performance by the agricultural sector, excluding agriculture GDP flat lined in quarter 2. However, underlying GDP growth for 2013, excluding agriculture, is forecast at 1.4% year on year expansion. For the first time since 2008, Romania recorded an external funding surplus in foreign capital flows in the first half of the year (January-July). The surplus amounted to around 6.3% of GDP. The main factors fuelling the external funding surplus were very large portfolio inflows, a contraction in current account deficit and an increase in the use of EU funds. The external funding surplus enabled the country to cover loan repayments to the IMF due by the central bank and the Finance Ministry (2.5% of GDP) and also resulted in an increase in official reserves to 3.1% of GDP. Exports grew 12.1% in quarter 2 compared to 9.1% in the first quarter and imports contracted from -0.1% in quarter 1 to -1.7% in quarter 2.

In September annual inflation fell from 3.67% in August to 1.88% due to tax-driven falls in bread prices and within the 1.5% - 3.5% central bank target range. Bread prices were down approximately 12% on the month after the government cut value-added tax for bakery products to 9% from 24%. The central bank forecasts monthly inflation to fall to 3.1% year-on-year by the end of 2013. Data showed consumer prices were down 0.6% on the month in September. Food prices fell 1.8%, while non-food prices were flat. Services edged up 0.4%.

The NBR further eased the monetary policy rate at the end of September by another 25bps, to a current level of 4%. This was the fourth reduction and was followed up by an unequivocal public communication towards the commercial banks regarding lowering the interest rate on RON denominated loans.

On 12th September Romania borrowed EUR 1.5bn in a 7Y Eurobond. Investors' appetite for RON denominated government securities improved also in the second half of September. Fitch Ratings affirmed the country rating at BBB- and its current outlook.

BULGARIA

As reported in the half year financial statements, the government continues to work under the daily pressure of large protests which started on 14th June.

The Government has amended the budget for 2013 by increasing the deficit by BGN 500 million to 2.0% of GDP and permitting the Government to issue BGN 1 billion of additional government debt. This has been necessary because the full year forecast GDP is reduced to 1%, lower tax revenues (BGN 555 m) through weaker domestic demand.

GDP expanded 0.2% in quarter 2 compared to the same quarter in 2012 and decreased 0.1% compared to quarter 1, representing virtual stagnation. Unemployment declined by 0.9% to 12.9% in the second quarter because of seasonal activities in agriculture, tourism and trade. Industrial Production decreased 2.4% in August compared to the same month in 2012 and represented the sixth straight month of declining numbers.

Exports declined approximately BGN 70 m between July and August to BGN 3,909 million. In August imports declined BGN 760 million between July and August to BGN 3,664 million.

Inflation in September was -1.6%, declining further from the -0.7% recorded in August driven largely by base effects in energy and administered prices. This was the lowest rate in the EU.

General government debt, including government guaranteed debt, amounted to 17% of GDP. Both the deficit and the government debt compare favourably to other EU countries and the Government has announced that it will be placing an amended budget before the Senate in an attempt to drive growth.

Property Market Overview

Romania

No notable transactions were reported in the second quarter of 2013. NEPI was again one of the most active investor securing several sites and announcing further development plans following additional capital raising. Separately it is noted that the successful float of the Global Growth real estate fund launched by Ioanis Papalekas on AIM with a total raised amount of approximately EUR 53.6 m was on the base of a Romanian investment property portfolio.

Office

Only two medium sized office buildings totalling 7,800 sqm completed in quarter 2 which took the office supply completed in the first half of the year to approximately 80,000 sqm and the total modern office stock in Bucharest to an estimated 2.04 million sqm, with class A stock accounting for 51%. Several projects are expected to complete during the second half of the year with Floreasca Park (37,500 sqm) probably the most advanced.

The overall vacancy rate for Bucharest is estimated to be 15.66%. This represents a slight quarter-on-quarter decrease of 22 basis points. The highest vacancy rates were recorded in the northern locations such as Baneasa and Pipera North, both with vacancy rates exceeding 35%.

Prime headline rent remained unchanged over the last 12 months at €18.00 to €18.50 per sqm per month. Over the last quarter, a generous increase of the incentive packages, in both rent free periods and fit out contributions, was noticed. These are applicable to lease requirements exceeding 2,000-3,000 sqm for existing buildings where previously it would have been applicable to larger pre-leases.

In quarter 2 the total gross take-up reached 59,000 sqm in 45 contracts with new demand generating 49% of the quarter leasing activity and 35% represented by lease renewals. By geography, Pipera North attracted 32% of the gross takeup activity, followed by Center North and CBD locations with 27% each. By industry IT&C, FMCG and automotive related companies generated 37% of the total leasing activity. The total leasing activity in the first half of the year reached 123,000 sqm which is similar to the total area leased in the same period in 2012.

In the second half of the year project pipeline has been revised down to 40,000-50,000 sqm. The pipeline for the next two years, 2014-2015, is estimated by Jones Lang LaSalle at between 180,000 - 200,000 sqm with some projects expected to be completed in 2014 but, due to the large volume, delivery may easily slip into 2015. In addition, a couple of phased business parks may start construction works or their additional phases by the year end, based on pre-leasing activity. In this case, the current pipeline can be extended by circa 30,000 sqm. Take-up is forecast to remain at the level recorded in the last couple of years.

Retail

No modern shopping centre was delivered in Romania during quarter 2 and therefore the modern shopping centre stock remains unchanged at an estimated 850,000 sqm in Bucharest and at 1.5 million sqm for the rest of the country. In Bucharest, the most notable addition will be in October with the opening of the 35,000 sqm Calea Floreasca, which is currently more than 80% pre-let.

As mentioned in the half year financial statements for the Company, Kingfisher acquired the 15 unit Bricostore business. Kingfisher plans to increase the network to 50 stores in the medium term, most probably through another acquisition on the local DIY market.

Retailers remain cautious in expanding their networks and focus mainly on prime projects. Mass market retailers who are already present in most of the well performing shopping centres in the country are starting to assess the new retail projects, but the conditions they are prepared to offer make it difficult to justify new developments.

Rent for both prime shopping centres and prime high street units remains at €55-65/sqm/month. The highest rents are achieved in Baneasa Shopping City and AFI Palace Cotroceni which are considered the two most dominant retail schemes in Romania. Rental decreases were reported in the old city centre, as the location has lost some of its initial attraction and became more of a mass market destination.

Residential

Two major developments are moving this segment of the market. First the banks have become more aggressive in their liquidation process of both foreclosed residential units in old communist apartment buildings as well as the bulk sale of distressed new developments in various stages of completion. Secondly a significant shift was recorded this summer with the cancellation of the Prima Casa, the Government backed mortgage lending scheme. The Government in close cooperation with the Central Bank has stopped the backing of EUR denominated lending scheme and replaced it instead with a new format where it supports a RON denominated programme. This measure together with the decision of the largest commercial bank, BCR, (20% of the market by assets) to only finance RON denominated mortgages is putting significant pressure on the current market prices.

Despite this, transaction volumes have stabilized to fairly low levels suggesting a reluctance of sellers who are not pressured to dispose of their assets, to adjust to further price decreases.

Bulgaria

Retail

The Strand Bourgas (30,500 sqm) opened to the public in July. Its opening puts Bourgas on top of Bulgaria's city rankings for shopping space per capita with 468 sqm per 1,000 residents. Three other projects in Sofia are currently under construction and will provide an additional 120,000 sqm.

With the opening of all these malls the average lettable area per 1,000 inhabitants for Bulgaria will increase to approximately 120 sqm compared to 250 sqm for Europe as a whole (Colliers International, Retail Real Estate Marker Overview) and 200 sqm for CEE. Presently the gross leasable area of all the operational shopping malls is about 735,000 sqm and the GLA per 1,000 residents is 101 sqm.

As developers try to lure consumers to locations in Sofia's periphery, prospective tenants recognise their bargaining position and as a result prime rents for new leases were down 11% from quarter 2 to €24 per sqm per month. Underperformance and store closures are to be blamed for a similar decline of rents outside Sofia. In the country's second-tier markets prime shops in the 100-150 sqm range are expected to lease for between €16 and €18 per sqm. But lack of transactional evidence and elevated vacancies in most cities suggest even these rates may prove unsustainable.

The investment market remained stagnant, the only transaction in the retail sector was an investor acquisition Panorama Mall in Pleven with 17,000sqm lettable area through a distressed public sale. The deal was concluded at a value considerably lower than the total development cost and below the bank debt.

Development Projects Romania

Cascade

Currently the building is fully leased generating positive cash flow after meeting all its financial obligations from an operational and banking point of view. All financial obligations are up to date with no collection delays on the revenues side.

With the completion of the leasing process the JV partner has managed to position the building as one of the prime office products on the Bucharest real estate market. There is continued interest in the building by potential tenants, with inquiries being addressed and managed by the building's management team.

Oradea and Iasi Shopping Centres

Following the notice for repayment issued by the Company with respect to the investments in both Oradea and Iasi, the Manager is currently in advanced negotiations over a possible structuring of the repayment.

Further to the Cypriot crisis as reported in the last shareholder update, the loan situation with the banking loan syndicate for both Iasi and Oradea is still pending a resolution with regards to both the main development loan in Iasi and additional tenant fit out contributions pending release in Oradea. It is expected that the current situation will continue for the foreseeable future until a solution is found for the current loan book of the Bank of Cyprus Romania.

Argo Real Estate Opportunities Fund (AREOF)

Proton Bank has served a termination notice to AREOF for its EUR 28.5 million loan. As a consequence AREOF's shares have been suspended from trading pending further clarification of the current situation. The AREOF representatives are in continuous negotiation with the Bank to find a suitable resolution.

An additional threat had been presented to AREOF by the announcement made by NEPI of negotiations for the purchase of part of the Volksbank's debt in another shopping centre owned by the company in Romania, Sibiu Shopping City. However, this threat has since been diminished as it is unlikely NEPI will be able to acquire the whole debt. AREOF are in advanced restructure talks with its banks in Sibiu.

The Manager will continue to monitor the restructuring process.

Oradea Shopping Centre

ERA Oradea continues to increase traffic each month recording a 20% increase in traffic for July year on year. Carrefour reported a 2.5% increase in sales year on year for July.

LEMS, a large furniture tenant, signed a lease for 2,100 sqm of space and opened in September. A lease for 3,000 sqm was signed with Stockhouse, the sister company of Leonardo. The intention is to open a discount unit selling, clothes, food and electronics based upon a similar format of a German discount retailer Kik. In addition, they will open a 470 sqm furniture store Studio Blue and will change the current Leonardo outlet back to a full Leonardo store. This is a significant boost in the letting activity. Competition for tenants remains fierce between the three other shopping centres in the city, resulting in very low rents. With Auchan taking over Real's unit across the road, there is likely be a decline in traffic in quarter 4 but the issue has been somewhat mitigated with the new tenants.

Iasi Shopping Centre

Monthly traffic remains consistently lower year on year, down 16% for July, due mainly to the retail competition within the city. July traffic is slightly higher than June due to returning migrant workers. The major road improvement works throughout the city increased journey times and reduced the number of people willing to drive to ERA. These works are progressing slowly, but on completion should improve the situation. The summers marketing activities and promotions have been successful with a third of tenants reporting year on year sales improvements in July. Marketing activities and expenditure are very focused on offers, giveaways and promotions and clearly are well received by customers. This marketing activity will have to be maintained over the next 12 months to ensure increased traffic levels.

Sprider closed their store in May and were replaced by a discount fashion tenant, San Francisco. San Francisco opened in early August and initial sales have been very encouraging. Lettings to Tiffany (tailors 98 sqm), Dry Cleaners (98 sqm), Schneider (fashion 129 sqm), Divanissimi (furniture 284 sqm) are open and trading. Several negotiations are ongoing with local retailers for small units.

Development Projects Bulgaria

Plovdiv

In quarter 3, occupancy levels declined by 10% to 64% of the GLA and finding new tenants continues to be challenging, requiring the injection of new funds to pay fitting out contributions. At the beginning of quarter 3 the interim contract with the international leasing consultant was extended by a further two months but will not be renewed because of lack of support by one of the partners in the project. The shareholders provided very limited temporary funding to support the international consultant during July and August.

In line with the strategy, the initial negotiations with several international tenants continued but did not materially progress beyond what has previously been reported. Conclusion and execution of lease deals continue to be predicated on the availability of funding for fitting-out contributions.

The discussions with the bank to restructure the banking facility were resumed in quarter 3 and the management of the company and shareholder representatives held a couple of meetings with the Bank, at which it was agreed that a new restructuring proposal would be presented. The executive director of the development company led the negotiations with the bank and they are ongoing, a satisfactory conclusion has yet to be reached.

As reported at the end of the quarter 2 the centre manager left the project and the shareholders appointed the technical manager to temporarily carry out the day to day activities. The Mall still has operational deficit on a monthly basis and has been unable to meet all of its operational obligations from the collected rental and service charge income. This has led to increasing overdue payments to service providers and the fiscal authorities. Unless the restructuring is resolved quickly and fresh cash made available to cover operational needs, the company faces serious liquidity problems which threaten its operations.

Mega Mall Rousse

During quarter 3 occupancy dropped from 56% to 51% due to closing of two fashion operators, the kids centre, and an insurance office. As reported, the management team immediately started initial talks with prospect tenants in order to secure adequate replacements. As at the end of quarter 3 2013 a lease agreement with a bank was signed and the tenant opened in mid-August. The management team is completing the negotiations with a new kid's centre operator and a café. Despite the partial success in replacing tenants, leasing is still proving to be extremely difficult and as previously reported, is highly dependent upon the provision of fit-out contributions.

As previously reported the Bank has initiated a series of aggressive actions and defaulted the entire facility, payable with effect from the end of April 2013. Further, during quarter 3, the Bank transferred the loan to its branch in London. The Manager and partner have tried to hold a number of meetings with the Bank to discuss restructuring the loan facility but no satisfactory results have been achieved. The Project continues to face liquidity problems and whilst our partner has provided some short term liquidity, if a restructuring plan is not achieved soon it is highly likely that key service providers may stop the supply.

Trade Centre Sliven

As previously announced, there has been no change in the position regarding the development itself and the Manager is discussing with the partner how best to take the development of the site forward. All options are being considered including an exit from the development and splitting the assets between the shareholders.

Bourgas Retail Park

There has been no further progress made with this site as it is very much linked to the developments in Plovdiv.

Investor Relations

Tel: + 44 (0)20 7518 2100 Fax: + 44 (0)20 7518 2199

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