This article is sponsored by First Growth Real Estate & Finance
In a historic period, with base rates and liquidity costs rising and the way forward becoming increasingly uncertain, we see experienced, expert advisers are proving ever more valuable. Moreover, this extends far beyond sourcing capital in restructuring.
Finding the right financing solution is, always has been and always will be a core competency for any debt adviser worth their salt. However, we are now seeing increased importance being placed on a broader range of skills, including restructuring and special situations workouts.
The tide is turning
In the face of current macro-economic and geopolitical headwinds, deal volume started to decrease in Q2/Q3 2022. This trend is forecast to continue into 2023 as many investors adopt a more cautious stance or pause investments until volatility settles down.
Equally, lenders’ risk appetite is significantly smoothing, with some adopting a ‘wait and see’ approach towards certain asset classes or strategies, while focusing on reviewing their books to analyse the impact that inflation and an economic downturn might have on their loan portfolios over the next six months or couple of years.
In such a world with lower liquidity, especially for more risky business plans or out-of-favour asset classes, debt advisers who can find tailor-made financing solutions to all business plans and asset classes are increasingly hired and valued. Minimising cost of debt through competitive pressure and by casting a wide net – encompassing outliers and new players versus a limited network of historical lenders – also becomes key to achieving target returns when both base rates and margins are experiencing consequent increases.
Five-year euro swap rate (%) (click to enlarge)
As the chart shows, there has been considerable variation in the euro five-year swap between the beginning of the year and end of July (circa +150 basis points). Additionally, we see margins increasing from 15bps to 50bps depending on risk profile and lenders. Combined, this leads to an increase in financing costs in the range of 165-200bps.
On average, balance sheet lenders remain more open for business than lenders who have very low visibility on their exit (syndication/CMBS market). For transactions that are at pre-syndication stage, this may result in higher pricing being introduced and/or lower leverage. Post-closing, it may also result in higher margin or upfront fees through market flex.
Good advice is hard to find
Overall, since the beginning of the war in Ukraine, debt funds have been more active lenders, demonstrating their flexibility to respond to ever-changing market conditions. Certain debt funds created pockets of allocations with a lender IRR of 3-7 percent, allowing them to position themselves in the less competitive market segment between senior lenders and high-yield debt funds. This offering further completes the financing solution span for investors with more aggressive LTV level requirements and/or riskier deals, who are reluctant to enter into high double-digit margin loans.
Navigating the current debt maze is getting increasingly challenging and requires a blend of expertise and longstanding experience coupled with a deep network in the real estate industry. First Growth is well placed to assist in a difficult environment through real estate and financial expertise combined with an institutional approach and an extensive network, with lenders ranging from small regional players, which need to be pooled, to global giants.
Our institutional-quality deal financing presentation materials are essential to attract interest from lenders, as they have less information-gathering, underwriting and analysis work to perform and can use our documents for internal approval processes. That saves us all significant time in increasingly long approval processes.
Similarly, our deep network with regional lenders allows us to put together pools of numerous lenders to achieve best-in-class pricing by cutting syndication margins offered by arranging banks in a market where the originate-to-distribute model has become the rule. As an example, we recently structured a loan secured by a portfolio of French fast-food restaurants where we pooled together six French lenders. Aligning lenders on the terms of the deal and pre-placing the debt led an optimal leverage/pricing couple. We have proceeded in similar ways for hotel financings in Italy and Spain and serviced offices in France.
In-depth knowledge of relevant financing instruments allows bespoke advice during the capital sourcing process. Long-standing experience in real estate facilitates early-stage identification and mitigation of risks. Combined, these skills lead to creative solutions for complex debt fundraising mandates.
As a further example, we recently raised a hunting credit line for an aggregation strategy of single houses to be converted into co-living assets around Madrid. Despite the absence of a seed portfolio and the nascent asset class in the Spanish market, we successfully sourced a flexible credit line. Likewise, the highest level of execution becomes paramount as processes takelonger with credit risk departments’ level of diligence increasing.
Not just sourcing
Another impact of the recent market turmoil is the materialisation of a growing number of loan restructuring/workout situations (which we are already covering) early on, which is a key difference versus the former global financial crisis.
Since the start of the covid pandemic, we’ve seen banks/debt funds being generally constructive (compared with previous crises) by accepting waivers, with only limited cases of lenders taking a more aggressive stance. However, the current turbulent environment is exacerbating liquidity issues and we expect restructuring to increase exponentially as time passes and lenders become less accommodative of borrowers’ requests and state-funded relief loans expire.
We have recently seen several borrowers struggling to refinance maturing debt holdings and are working on several mandates involving a mix of loan amend-and-extends with incumbent lenders (often in pools) and new capital injections for partial paydowns of existing lenders or replacing some lenders not able to extend.
This is what happened, for example, when we helped a French private equity fund amend and extend a loan secured by a large pan-European hotel portfolio. As part of the transaction, some of the lenders in the pool did not renew their commitment and were replaced by a new bank that intends to syndicate part of its new commitment. We successfully managed a lengthy negotiation process to align the demands of the new lender and the existing ones on the terms of the extended loan.
Having a dual structuring and restructuring skill set is perfectly suited to this kind of situation and keeps us very busy in current times. We believe we are the only specialised quintessentially Continental European debt adviser with such positioning, which differentiates us from others who are solely focused on capital sourcing activity.
Also, as former investors, we understand very well our clients’ position and negotiate as if it was ours. Finally, the possibility of working both on new financings and restructurings deepens our client relationships.
This is useful in a market such as Italy or Spain, where the significant retreat of banks and generally cautious approach by international lenders create significant capital sourcing needs.
We are, for instance, focusing on the restructuring of a loan backed by a shopping centre that is maturing shortly and needs to be refinanced to allow more time for the centre to stabilise operations post-covid. In the absence of straight refinancing options, we are working out a solution combining the extension of the senior loan against a partial paydown combined with a new subordinated loan to fund the senior loan paydown.
Getting stuck in
The growing wave of loans in workout also means some lenders need assistance with troubled loans, especially when those are outside of their domestic market. Based on discussions with several banks’ internal functions, the number of loans being transferred into workout is following an upward trend.
We have a track record of special servicing loans for various banks to maximise recoveries in distressed situations, which we therefore anticipate capitalising on. For example, we helped many German bank lenders wind down their entire books in France and Italy when they retrenched during the last GFC. Since, we have done this sporadically for specific loan positions but are now being approached by bank lenders and funds for more than one loan.
Our experience shows us that having such complementary and countercyclical skill sets is invaluable. It allows us to create strong value for our clients – even in uncertain times such as these.
Cyril de Romance is co-founder and partner at First Growth Real Estate & Finance