Bond holders’ reluctance to reveal their hands makes restructurings tricky, reports Lauren Parr
Nowhere is it clearer that restructuring debt in complex real estate transactions can be a fiendishly difficult job than in the CMBS market. As the bonds are publicly quoted, it has been the necessarily public rescue attempts of high-profile CMBS deals, rather than private balance-sheet loan work-outs, that have laid bare the problems and proposed solutions.
In distressed private deals, where banks replace original borrowers and bring in new equity, the terms “will never be disclosed”, says Ralf Nöcker, a former banker who is now managing director at private equity investor Corestate Capital. Corestate has invested €1.8bn in German property and one of its specialisms is buying into distressed residential portfolios.
Restructuring a CMBS deal has the added complication of involving the bond holders as well as lenders and potentially borrowers. One problem has been identifying who the note holders are at the outset, while getting investors in different classes of bonds to cooperate once they’ve been found is another matter.
CMBS bond holders aren’t bound to the same disclosure rules as investors that own stocks, who appear on a shareholder register and must inform the stock exchange if their individual holding exceeds 3% of the total.
A lack of transparency
Ryan Prince, chief executive of debt asset manager RealStar International, says: “Someone could own 80% of your bonds or there could be hundreds of people that own 3% or less, but you really wouldn’t know. The issue is lack of transparency.
“If you want to have a conversation with somebody who owns or is involved in your balance sheet, in today’s world you have to go through an investigative process where you sit around on the phone trying to get to the banks to find out who they originally sold to. Then you look at the registrar forms, plus a whole bunch of other sources.
“Mostly people put a notice on Bloomberg saying: ‘Who owns these bonds? We want to do something. If you want to talk to us please call this number.’ As people call up, from there they try and track down others.”
John Edwards, a director at financial risk adviser JC Rathbone, believes this is a ridiculous state of affairs and asks: “Why aren’t CMBS note holders registered with trustees as debentures are?”
As Prince points out, at the early stage of a CMBS restructuring, the person seeking the bond holders is sending a signal to the market – and the market will read into it what it will. It is impossible to have a dialogue with selected investors before trying to share with the market the fact that a restructuring is about to take place.
A challenging process
“That’s one of the challenges,” Prince says. “It creates a lot of fiduciary and legal responsibility, and potential risk that you might not otherwise want to generate. If two groups own 70% of your bonds, you might like to pick up the phone and say ‘do you want to have a cup of coffee?’”
For most people this is a very new world, he says, as “very few people have gone through these processes before”. One short cut available to those seeking to restructure CMBS deals is to use special research companies such as Bondmark, which track down bond holders. But these companies’ services don’t come cheap and servicers are technically responsible for their appointment.
“By and large, the experts will tell you they generally get the job done,” says Prince. “It depends on the distribution of owner-ship, though. Their fees aren’t crazy – not like a percentage of the value – it’s more like a professional service.”
However, Conor Downey, finance partner at law firm Paul Hastings, considers specialist companies to be relatively expensive. “The difficulty within a CMBS deal is who is going to pay, because typically when bond holders form a group to try and get something done, they usually do it themselves,” Downey says.
“Servicers are the party with the funds to pay, but it can be difficult for them to form a view that they should do it.”
He says it is not that difficult to find out who the bond holders are. “Usually, we find that the originating bank probably knows who they sold the bonds to originally, with a couple of exceptions such as Lehman Brothers. Most CMBS is a buy-and-hold product, so most investors haven’t traded. If you can find out who was involved in the original deal, you’ve probably got a handle on the vast majority of the bonds.”
However, the originating bank might not be willing to reveal who the bond holders were or now are. Moreover, some bond holders don’t want people to know what they’ve got. The only way the bank will cooperate is if it is still involved in the deal somehow – for example, if it is still the servicer or if it has some kind of stake in the deal and wants a restructuring to happen.
“I could write a list of 20 or 30 people who I could call and probably find the majority of bond holders on any deal,” Downey says. “The same names come up again and again – the big banks and specialist investors, such as Prudential M&G, ECM, Threadneedle and Metlife.”
The catch is that when CMBS deals get even a little distressed, this often leads to a lot of trading of the bonds. Banks’ trading desks tend to buy fairly large stakes and because they’re looking to trade, they can be secretive and don’t want to come forward; so some bonds ‘disappear’ as a result.
An even more difficult task can be getting the bond holders to cooperate once they have been located. “Bond holders tend not to be very proactive people,” Downey says. “Often they have inherited the positions from predecessors in the companies they are working for.
“To get momentum going in a restructuring you need a credible number of bond holders, though not the majority. If you can get 30-40% of bond holders to agree on a strategy, it gives them a lot of credibility and makes it difficult for the servicer, trustee or issuer to ignore what they’re doing.
Bond holders keep quiet
“Generally, if you set up a conference call or face-to-face meeting with bond holders, everyone keeps quiet and nothing happens. They don’t like expressing their ideas or talking publicly in front of their peers.
“You need to lead the conversation by putting ideas to them to get a sense of what they want. We’ll then say ‘there seems to be consensus of X, does anyone disagree?’
“Then there will be silence and we’ll say ‘we’ll take that as consent’ and will proceed with that course of action unless there are objections. This tends to be how it’s done. It’s informal, about building consensus in these private conversations.”
A more fundamental issue is that the junior note holders are typically out of the money and would rather extend a loan to buy more time, whereas senior note holders would prefer to get paid out more quickly.
Philip Byun, a vice-president at servicer/special servicer Hatfield Philips, says: “In some cases where CMBS notes have gone on a fully sequential pay down for any principal coming in, there is no incentive for senior note holders to agree to an extension.
“They might as well not agree to that, because then the sequential pay down and any amortisation coming in can stay as it is, whereas if you potentially extend the loan in a multi-borrower transaction, that may switch the notes waterfall from being fully sequential to pro rata.”
Byun adds: “In multi-borrower deals, it comes down to where the value breaks; the quantum of the senior notes in comparison to the loan principal amount; how the pay down is occurring; how the waterfall is structured in the deal; and the performing status of other loans in the CMBS.
“It’s the classic game of senior versus junior note holders – and in some cases other junior note holders outside the CMBS. It’s trying to get all of them to agree, which is always the challenge for us.”
This dilemma is emphasised by nuances within intercreditor documentation, which can further delay the restructuring process. “Intercreditors are all different; they usually vary by either vintage of deal or by law firm and banks involved,” says RealStar’s Prince.
Devil is in the document drafting
“Different groups have different views on different topics, so you tend to find that the devil is in the detail. Moreover, most of these complex documents were drafted very quickly or, when you pick up the document two people can read the same paragraph and disagree on its meaning. Resolving this is one of the biggest challenges.”
One example of a restructuring that did run smoothly is the refinancing of LRG, an entity named after Lehman Brothers, RealStar and GIC Real Estate that owns 61 UK hotels leased mainly by Holiday Inn.
“Although these were the only assets in the Tahiti CMBS, which made life easier, the refinancing had a very complicated structure,” Prince says. “We had a CMBS piece, a tranche of bank-syndicated debt and then all the equity partners, so there were a lot of people to identify and then get around the table.
“It is one of the few genuinely successful restructurings or formattings of a debt package in the market involving a totally solvent business where all the people who went into the deal on day one were still there at the end.
“That’s a testament to the assets we bought and the fact that we priced our assets in 2004, so it was early enough in the cycle that the values we had still hold up today. Also on our side was the fact that the partners all had capital to inject into the deal, plus we’ve been a good borrower.”
However, this deal may be seen as an exception rather than a rule. The proposal put forward on behalf of borrowers in the Plantation Place CMBS was rejected in December by Delancey, which owns some of the Class B notes, meaning a work-out of the deal has again been postponed.
Another vote on the restructuring has been scheduled for 31 January. Mark Rogers, a partner at Hoare Capital, which is advising some Plantation Place bond holders, says: “We are awaiting the results of the Class B note holders’ meeting and will decide then if we want to take matters further.”
Peter Hansell, head of property at debt adviser Cairn Capital, says: “We’ve learned that there’s no formula – every deal is different. Every proposed restructuring will be judged on its merits by note holders. The issues are different in every deal in terms of where the value is today, depending on the quantum of market decline experienced.
“The individual structures vary from securitisation to securitisation, so again, the issues are different. A flexible approach is required to be able to deal with the different challenges present in each deal.”
For servicers to combat this challenge, they need to take a generous view of their remit with bond holders from the outset.
Battle for control pushes special servicers into action
Special servicers are increasingly up against strong sponsors and borrowers trying to run around them and deal directly with the bond holders, as was demonstrated in the Fleet Street Finance 2 CMBS restructuring, where Goldman Sachs’ Whitehall Funds, advised by Cairn Capital, cut out the special servicer and went straight to the note holders.
“Probably one of the big issues right now is trying to keep control of the deals, given how complex they are and how many of them are going into default,” says Conor Downey, finance partner at law firm Paul Hastings. “It’s a big challenge for special servicers at the moment.
“We’ve had a bit of a phony war with special servicers over the past two years. We’ve seen transactions fall into default or special servicing, but not much happening. People were hoping that things would get better, but it’s clear that people are trying to see what they can do with their transactions now.”
Borrowers that are underwater are essentially trying to keep control of their properties, which they can really only do at the expense of their lenders one way or another, according to Downey.
“The world has become more aggressive and special servicers are having to adapt to that and react to the new status quo, where people are realising their property values aren’t going to recover and are not going to get easily refinanced.”
In the past, some bank-owned servicers have been distant from bond holders and “when that happens, transactions are exposed”, Downey adds.
Servicers sometimes take a narrow view of their role because some servicing agreements do not make it clear whether servicers have a direct responsibility to help bond holders; they may simply have an obligation to maximise recoveries for bond issuers.
Downey says: “A lot of servicers are now taking the view that it’s up to them to organise the bond holders, to organise an investors’ committee and to have a real dialogue on a day-to-day basis. For example, Capita have done that on Fleet Street Finance 2 and they have turned it around.
“Likewise, bond holders are starting to realise they’ll get a better deal if they let servicers do their job.”
Corestate feels at home in distressed German resi sector
Germany is certain to be a focus of increased restructuring activity in the next few years and the residential sector is already in the spotlight. With €70bn of rented residential portfolios traded between 2004 and 2007, according to Cushman & Wakefield, a large portion of refinancing will become due in 2011-2013.
Private equity real estate group Corestate, founded by ex-Cerberus partner Ralph Winter in 2006, has snapped up three distressed housing portfolios there in the past 12 months or so.
The latest deal, due to be completed imminently, is believed to be for a 2,500-unit portfolio in North Rhine Westphalia. It is thought that the original lenders have taken a loss and are selling after the local German owner’s equity was wiped out.
Corestate is said to be buying the flats at a 20%-plus discount to the original €95m acquisition price and putting in new gearing at a 75% loan-to-value level.
Last year the group bought 2,100 flats from BGP, also in the North Rhine Westphalia area, and a 2,000-strong portfolio in Berlin that had been bought by JER Partners’ European fund, financed and securitised through Lehman Brothers.
Corestate is believed to have paid €1 to invest alongside the note holders at a heavily written-down value after servicer Hatfield Philips extended the loan.
Those two acquisitions were made by Corestate’s residential fund, in partnership with international investors. The €1.5bn (gross) vehicle was launched in 2007 and its investors include Aviva Investors, Aberdeen, CBRE Investors, DTZ Investment Management, ING and Schroders.
In its latest deal, Corestate is investing in partnership with a European institution and many of its deals have been structured for individual investors. Andrew Hill joined last year from Credit Suisse to help expand the investor base.
Corestate managing director Ralf Nöcker says the residential fund “has firepower of €300m-€500m to spend”, part equity held back and part to re-invest from sales.
The company has substantial asset management strength and seeks to turn round portfolios and increase returns by injecting capital expenditure and letting empty properties. The latest portfolio is thought to be 15% vacant and Corestate will seek to increase the rents by 15-20% by re-letting and upgrading the properties.
Winter’s team is led by Nöcker and Philip Burns, Corestate’s new chief executive, who was previously at Terra Firma, which bought the massive Deutsche Annington German housing portfolio. With their experience, the firm is bound to be in the thick of the continuing activity in Germany’s residential market.