US private equity firm will take pick from package of Lehman property debt, writes James Wallace
Lehman Brothers’ legacy in European real estate lives on almost three-and-a-half years after its dramatic collapse. Last month, CoStar News broke the story that the Bundesbank had selected global private equity firm Lone Star as preferred bidder on all the outstanding loans in Excalibur, a debt portfolio packaged up in 2008 to hold Lehman’s real estate debt that couldn’t be sold at the time.
Nothing better encapsulates the tangled web of Lehman’s own making on this side of the Atlantic than the €2.9bn Excalibur collateralised debt obligation (CDO), hastily assembled for offloading to the European Central Bank’s emergency re-purchasing ‘eurosystem’ in late May 2008. The aim was to provide critical bank liquidity as global financial markets descended into unprecedented turmoil.
As European property values had begun to fall in the second half of 2007, some banks had scented the panic, but Lehman’s real estate deal-making machine continued well into the first quarter of 2008.
Around the turn of the following quarter, Lehman realised it was unable to exit its warehoused real estate debt positions, either through its usual open-market securitisations, issued under its Windermere CMBS conduit programme, or by selling down debt in the syndication market.
Less than six months before the ultimate demise of what was once the world’s fourth-largest investment bank by assets, Lehman packaged up as much unsellable real state debt as the ECB would permit and securitised the positions in the two-tranche, €2.88bn Excalibur Funding No.1.
The resulting Excalibur was loaded with unsold bilateral senior and mezzanine loans, development loans, B-notes, CMBS bonds, corporate loans to real estate companies as well as syndicated positions non-and sub-performing loans bought from other banks. Excalibur was structured with a €2.16bn class A tranche and a €722.18m class B tranche, with a 46-year maturity, in 2054.
When first transferred to the ECB eurosys-tem, the projected initial aggregate financial liabilities on Excalibur, including the notes’ outstanding balance and due quarterly interest payments over a 46-year life cycle, were a staggering €9.91bn, according to a Companies House filing.
The ECB passed on the original CDO, laden with 62 debt positions, to Deutsche Bundesbank, Germany’s central bank, to try and sell on after Lehmans’ collapse.
But given the financial crisis engulfing global markets, the Bundesbank, under a mandate to recover as close to par as possible on the outlay to taxpayers, had no choice but to hold the giant CDO until markets calmed and investor appetite returned.
Announcing the deal with Lone Star last month, the bank said the highly complex Excalibur structure was one that “just a few large, financially strong and risk-taking investors worldwide would consider buying.
“Given these constraints, it is in the general interest – and ultimately in the [German] taxpayer’s interest – to dispose of collateral, such as Excalibur, as optimally as possible under the given circumstances. The realisation strategy must take due account of the complicated subject matter, the difficult market environment and a central bank’s duty to neutrality.”
Agfe, which took on a team of former Lehman Brothers bankers led by Natalie Howard, advises the Bundesbank. So far, Lone Star has only bought one of the remaining securities in Excalibur; last month, the private equity firm paid €279.28m for the €430.4m Carlyle loan, reflecting a 35.11% discount. The loan, also known as Cerep III, accounted for 20.3% of the outstanding Excalibur portfolio at the time of the trade.
The Carlyle loan is the remaining balance of €586.3m Lehman Brothers provided to The Carlyle Group in May 2008 to finance the acquisition of a portfolio of Lehman’s own Windermere XIV CMBS bonds for inclusion in Excalibur. The Carlyle loan matures on April 27, 2015. Lone Star has already sold the Carlyle Loan’s par-valued €322.9m class A Winder-mere XIV bonds to Credit Suisse.
The Bundesbank offset the discount accepted from Lone Star by calculating the loss alongside the quarterly interest and principal payments it had received over the past three and a half years. The bank is looking at its realisation of Excalibur collateral in the context of a total €8.5bn of Lehman loans that it ended up taking on its book. The Bundesbank says that across the whole Lehman legacy portfolio, a near par return will be achieved.
This, of course, depends on the extent of principal repayments and costs incurred in managing the portfolio, which include loan servicing, accountancy, trustee, legal, receivers as well as agency fees.
Last month Joachim Nagel, a member of the bank’s executive board, told the Financial Times that the eurosystem had made provisions of €5.7bn mainly to cover the Lehman losses. By the end of 2010 those provisions had fallen to €2.2bn and Nagel said figures for last year would show a further reduction when they are published.
Lone Star is now in the driving seat to choose the positions it wants to buy. While Excalibur is convoluted, with many loans priced out-of-sync with the evaporating market liquidity of 2008, the underlying properties should not be judged by the debt that obscures them.
There is a wide spectrum of quality, with some hidden gems. There is also a real range in the performance of the underlying loans; while at least a dozen are in special servicing, many more are not and are making interest payments.
Lone Star and its loan servicing subsidiary Hudson Advisors are poring over the remaining positions, as part of a complex work-out and unwinding of the CDO. The separate positions in Excalibur have been reduced from 62 to 33 – 20 of them in default, according to Excalibur’s January quarterly report – through prepayments, enforcements and now sales to Lone Star. Below is a cross section of these positions, which exemplifies Excalibur’s diversity and complexity.
Project Octopus: €209.29m senior and €8.0m mezzanine outstanding, as of Jan 2011
Former German asset management firm Barg Group bought 41 properties from Sireo, the asset management arm of Deutsche Telekom, for around €250m in March 2007.
The portfolio comprised mainly West German assets, with an original 55% weighting to offices. Deutsche Telekom accounted for 76.7% of the annual income.
Project Octopus was financed with 10% equity from Barg, at €25m; and a €219.2m, four-year senior loan from Lehman Brothers, which also provided a €8.04m mezzanine loan, taking the overall loan-to-value ratio to around 94%. Project Octopus has an undrawn €2.9m capital expenditure loan.
Both the senior and mezzanine loans were transferred to Excalibur and matured last April. Lehman initially intended to sell the portfolio within 12 months of the March 2007 deal closing, through the sale of sub portfolios, after which the investment bank contemplated debt syndication. Both strategies failed and Project Octopus was spun into Excalibur.
Over the subsequent five years, three properties have been sold; the 38 left were last valued at €175.37m, with a 16.68% vacancy rate. At the October interest payment date, the annual total net income was €16.2m, while the portfolio has a weighted average lease length of 8.3 years. Liquidation of the portfolio has begun.
Goodwater – €206.89m senior loan outstanding, as of Jan 2011
Lehman Brothers Real Estate Partners (LBREP), the bank’s equity investing subsidiary, and Hamburg-based asset manager Atos, bought two office portfolios aged €1.7bn portfolio, at virtually the top of the market.
One of its banks, UniCredit, sold an industrial portfolio to Hansteen (see March 2010 issue) and the fund management platform went to Jos Short and Andrew Thornton’s Internos Real Investors for the nominal sum of €2 and €7m working capital in December 2009.
Landmark Loan – €27.70m senior and €11.20m mezzanine outstanding, as of Jan 2011
Kenmore Property Group, the former Edinburgh-based European property investor with a €1bn portfolio, bought a 14-strong office portfolio in the Netherlands for €135m, from White Estate Investments’ MK Capital fund in April 2007.
The 57,745m2 Landmark portfolio, which comprised properties mainly in Amsterdam, Utrecht, Breda and Amersfoort, was financed with a five-year, €114.5m whole loan from Lehman Brothers, set to mature in July 2012.
Lehman syndicated the majority of the senior loan but €27.70m of it was trans-ferred into Excalibur, along with an €8m mezzanine loan.
The senior loan was priced at 5.47%, and the mezzanine loan at all-in rate of 12%. The outstanding mezzanine loan has risen to €11.20m, because of successive shortfalls in interest payments.
Only one asset from the portfolio has been sold. In October, the portfolio had a 23.9% vacancy rate and provided annual rent totalling €7.36m.
Windermere XIV legacy lives on in three B notes
Excalibur still contains three B-notes, which formed the junior loans to senior debt securitised in the €1.1bn Windermere XIV CMBS.
These B-notes – the €18.29m Kapiteeli Sisu, the €4.37m Project Baywatch Loan and the €1.63m Queen Mary Loan – are secured, in part, by the same collateral pool that is in the Carlyle Loan. This loan was in turn provided by Lehman to buy a portfolio of Windermere XIV CMBS bonds.
UK, German and French portfolios back Excalibur’s CMBS bond securities
Diversity Funding – outstanding €107.67m CMBS bond balance, as of Jan 2011
Lehman Brothers bought Northern Rock’s entire commercial real estate loan portfolio, dubbed Project Gospel, in late May 2007 for £1.6bn, reflecting a 1.3% premium to par value.
The portfolio comprised 1,159 fixed and floating-rate loans, backed by 2,000 UK properties, with a weighted average loan-to-value ratio of 68%. The granular portfolio was 43% in offices, 21% in retail and 16% industrial, with a diverse geographic spread. The 10 largest loans accounted for 20% of the overall pool.
Lehman’s exit was through securitisation in November 2007, in the form of the £1.14bn Diversity Funding CMBS.
Excalibur received €114.40m worth of bonds across four classes of the seven-tranche Diversity Funding CMBS – classes D through G.
Diversity Funding has a final legal maturity of November 2046. The outstanding balance fell to €107.67m by the January interest payment date.
Project Green – €55.30m CMBS bond balance, as of Jan 2011
Lehman Brothers bought two German real estate loan portfolios, named projects Yellow and Blue, and combined them to create the €585.41m Green German CMBS portfolio in November 2007.
The two loan portfolios are believed to have been sold by insurer AMV, which was seeking an exit to its commercial real estate exposure.
Project Yellow comprised performing, sub-performing and non-performing loans, which Lehman paid €569m for in January 2006, reflecting a 6% discount to par value.
The Project Yellow portfolio was part of a heavily concentrated and predominantly West German portfolio, with the five largest loans accounting for 69% of the overall loan pool.
Lehman won the Project Blue portfolio bid in December 2006, paying €365m, reflecting a 4% discount. The portfolio was secured by 230 properties consisting of 38% multi-family housing, 23% retail, 14% office, with the balance mixed-use.
Lehman’s exit strategy was to refinance and work-out the loans, as required, and combine the two loan portfolios into Portfolio Green and securitise the loans in Q4 2007.
The investment bank issued its €585.41m Portfolio Green German CMBS that November. The five lowest ranking tranches of the eight-tranche CMBS – classes D through to H – were later transferred to Excalibur, amounting to €79.91m. The outstanding balance in Excalibur at the October interest payment date was €58.80m.
The margins on four classes of notes, all over three-month EURIBOR, are priced at 1.75% for class D, 3.50% for class E, 5.00% for class F and 6.00% for class G.
The loans that underpin Project Green mature in April 2050 and comprise 416 commercial mortgage loans, secured on 205 properties across Germany. The underlying borrowers include German closed-ended funds, listed real estate companies and private individuals.
Windermere XII – €53.90m CMBS bond balance, as of Jan 2011
Lehman Brothers Real Estate Partners (LBREP) and Atemi, the French asset management company, agreed to buy the 1.9m sq ft Coeur Défense Paris office complex in March 2007 for €2.10bn from Unibail and Goldman Sachs Whitehall Funds. Lehman’s equity position in the deal was held in LBREP III.
The price reflected a 4.1% net initial yield. The transaction was financed by a Lehman-led debt package, which was provided in July 2007 then later securitised in the €1.2bn Windermere XII CMBS.
Lehman underwrote the senior loan, provided to a joint-venture partnership in which its subsidiary, LBREP, was the majority owner. Furthermore, the minority equity partner, Atemi, was itself 40% owned by LBREP.
In addition, Lehman provided bridge equity to close the transaction and co-arranged the subsequent securitisation, with Goldman Sachs, in what was then Europe’s largest-ever single-asset transaction and CMBS.
Lehman provided a €1.63bn senior loan, 50% of which was syndicated to Goldman Sachs (the parent of one of the two vendors) when the loan was issued in mid-July, at a 75% LTV ratio.
The bank also provided €475m in bridge equity financing, of which €75m was syndicated to GE Pension Fund in mid-August 2007.
Two tranches were later transferred to Excalibur: €38.15m of the €81.3m class F notes and €15.75m of the €20m unrated, subordinated debt.
The class F and class I3 notes have margins of 80bps and 200bps over three-month EURIBOR. Windermere XIV has a final maturity of July 2017.