Restructuring deals and loan sales on the rise as banks drop “extend and pretend”, says Lauren Parr
The last quarter of 2011 saw a spate of debt restructurings finalised, as economic prospects got bleaker. “Nationalised banks were motivated to document or gain credit approval for deals that had been discussed throughout the year, because they needed to achieve targets at year-end with regard to restructuring and deleveraging their balance sheets,” says Caroline Snowden, head of structured finance at JC Rathbone Associates.
As more lenders withdrew from the market, borrowers realised they must deal with whoever is “at the table” – no longer is it realistic to try to refinance with another lender if a borrower doesn’t like a bank’s terms.
With the deleveraging process beginning to accelerate, institutions are showing a more aggressive approach to security enforcement and property disposals and loan sales, and an increasing reluctance to restructure by way of extension. “The days of extend and pretend are over,” says Lucy Wolley Dod, a finance partner at Norton Rose, which advised Bank of Ireland on the sale of $1.8bn of loans to Kennedy Wilson late last year.
Simon Dunne, a director at Savills Capital Advisors, foresees “more frank dialogue between banks and borrowers, where the borrower knows that the bank’s ability to keep a problem loan on its balance sheet has diminished, and that security enforcement followed by property sale or a sale of the loan is on the cards. In such cases, the bank and borrower may explore solutions where the borrower would work out the loan in a consensual manner.’”
The one area that’s still very difficult to negotiate is what Snowden calls “the middle ground”; that is, where debt facilities are in default but the sponsor still retains some equity and therefore doesn’t want to realise a write-off. “This middle ground is where people who still have some equity value remaining can be reluctant to recognise the extent to which their original equity investment has fallen in value,” she explains. In these situations it can be tricky to get a perfectly realistic solution across the line because “it might not be what the sponsor wants to hear”.
Lack of equity provides motivation
By contrast, where the sponsor has no equity, there is far more motivation for the borrower to agree to some form of restructuring that allows them to take an ongoing role in managing the property for the bank and potentially participate in the upside should their management skills result in increased values.
“The borrower may also wish to protect its reputation and be seen to cooperate with its lenders,” Dunne adds. “Professional property investors will be aware that the property and lending market cycles will eventually turn and they will not wish to impair their access to future finance by behaving improperly now. “Also, there may be the possibility of borrowers being able to earn property management or disposal fees where the bank is controlling the project but the borrower is behaving like an outsourced workout agent or an asset manager.”
While a year ago, if a loan couldn’t be refinanced its maturity would have likely been extended, banks are now “coming to the realisation that if they continue to push maturities out they are going to have to start reserving more of their capital against the loan, which is going to have a drag on their earnings,” says Chris Foley, senior vice-president of financial restructuring at Houlihan Lokey. “They’re already starting to conduct analysis about whether it makes sense to trade the loan just to get out of the situation or take the cost-of-capital hit.”
Banks are therefore thinking more rationally about whether or not they should offload assets, with the logical consequence being increased loan sales rather than holding on until maturity. In certain situations banks are starting to pull potential loan extensions that had been contemplated recently in favour of just trading out of the loan, to eliminate any ongoing cost-of capital hits.
Lenders reducing real estate loan books
More portfolio disposals are expected from the larger, particularly government-owned, lenders because they need to continue to reduce their real estate exposure, either Project Royal deal with Lone Star and Bank of s with Kennedy Wilson, or through structures where banks can get an equity sponsor to come in alongside them, such as s Project Isobel deal with Blackstone.
Kennedy Wilson and Lone Star are understood to have a three-year horizon to wind down the loan portfolios. Although the loans’ new owners face the same restructuring dilemma as the original lender, the difference is that they are buying at a distressed price, so their downside risk is far lower. However, Foley doesn’t believe any of these loans will trade back to par unless there is a significant improvement in cap rates. “As yet we haven’t seen a lot of lowergrade secondary to tertiary portfolios outside London, which I think is going to have to begin to be dealt with this year,” says Snowden.
A large portion of the property securing the CMBS universe is non-prime, which will make refinancing without losses difficult. Ope Agbaje, executive director of European fixed income, structured products at Neuberger Berman Europe, says: “With the decline in new lending by banks and the largely secondary quality of properties backing loans in CMBS, those of us left holding the CMBS are going to end up with more credit-intensive positions.”
The number of CMBS loans that are being paid off on schedule at maturity is extremely low (see graphs above) – Fitch estimates only around 27%. A further 5-10% of CMBS are thought to be repaying, but late. Most European securitisations were structured as bullet repayments, that is, with little or no amortisation of the debt over the life of the loan.
“For the rest the servicer is left to either extend the loan, assuming cash flows are still positive, or is being forced to look at workout, including a potential forced sale of the property. To the extent that the sponsor actually has any cash left the servicer will try to entice them, although it’s quite tough to get new capital injected,” Agbaje says.
“There’s so much maturing over the next few years and there’s no way to deal with it all,” warns Houlihan Lokey’s Foley. Just as alarming is the wall of lease expiries coming up that sit behind the assets; they need dealing with, and generally require more capital. One large debt restructuring in London that depends on a cash injection is Morgan Stanley’s Ulysses ELoC 27 CMBS.
After a £5m reserve facility ran out, Beacon Capital Partners is negotiating to stump up equity of between £10m and £20m in the loan securing its Citypoint Tower in order to avoid interest payment shortfalls caused by the cut in space occupied by one of the building’s main tenants, Macquarie Bank.
Even though the securitised loan doesn’t expire until 2014 Beacon would like some breathing room to re-let the space and get the rental income back up to where it needs to be. The same loan servicer, Morgan Stanley Loan Servicing, agreed a similar restructuring in February 2010 when Beacon re-geared the lease to Linklaters at its Milton & Shire House – reducing the rent but extending the lease and the building’s value. That worked out well and Malaysian sovereign wealth fund Permodalan Nasional Bhd has just bought the City HQ. The Radamantis ELoC 24 CMBS repaid this month.
In the current market, investors are focused on longevity of lease income. While 2011 began with a degree of optimism among noteholders about the way deals might play out, with the likes of Fleet Street Finance Three returning investors’ capital two years early, this rose-tinted picture faded as the year went on. A huge contraction of liquidity in the senior lending market in the final quarter has triggered a new focus on restructuring that will be done out of necessity, partly driven by a fear among senior noteholders that they could see losses up to the class A tranche if these portfolios of assets are forced to the market.
Agbaje explains: “Notes will continue to be extended, although instances in which senior noteholders take losses will remain few and far between. Clearly junior investors are taking a considerable hit and right now for a lot of them the write-down assumptions are quite high; they can only hope for a slightly positive revision, depending on what the servicer can achieve through a workout or a sale.
“More contentious decisions”
“As we’re approaching legal final maturity on more deals we will find servicers being unable to rely on loan extensions and being forced to consider more potentially contentious decisions.” The good news, says Wolley Dod and others, is that servicers appear to have “figured it out” over the past couple of years,
having initially been accused of not being proactive. “They can do a consensual deal or an extension if it doesn’t make sense to sell, because it’s a large portfolio, for example. Or if it’s a single asset you could sell it and see where the value crystallises,” says Foley.
Noteholders will continue to keep a close eye on synthetic deals reminiscent of EPIC Industrious, however, in which RBS was able to “[leave them] out in the cold” owing to the nature of the structure, whereby the servicer and various parties may not have necessarily owed noteholders a duty of care. Losses on that transaction were finally crystallised in October at around £503m. “We want to anticipate or avoid another EPIC situation if we can,” says one CMBS investor.
CMBS vs balance sheet restructuring: trends in the year ahead
Bilateral debt accounts for the majority of European deals, as Corestate Capital’s managing director Ralf Nöcker points out, with securitisation representing only about 10-12%. But most balance sheet restructuring is done privately by the banks, so the public focus is on CMBS workouts. Restructuring for a balance sheet bank tends to mean either an extension and amendment of the loan, or a sale.
CMBS restructuring is typically more complicated than bilateral, balance sheet restructuring owing to the multiple participants involved as well as complex – and sometimes flawed – documentation: the GRAND securitisation is just one, albeit very large, example (see pp 22-23). Getting consensus among different noteholders remains a sticking point, often involving a power struggle – the now infamous tranche warfare – within the structure. According to Peter Hansell, Cairn Capital’s head of property, a question commonly raised now is: “Can the class As get their money out without having to do an extension?”
Neuberger Berman’s Agbaje hopes to see a coherent voice emerge this year among senior noteholders, noting the general apathy among them and that it can be difficult to get other investors to rally round and focus on how to put forward a united front to borrowers, junior lenders and servicers. “In some cases they may look at a position relative to other problematic deals in a portfolio, and based on the time involved some may decide it’s not worth their while,” she says.
What has been scarce is new capital coming in in the middle of the senior loan between the bondholder classes. “If that’s possible then that could be a good template for future restructurings, but there are major challenges in achieving this. Another challenge is to restructure individual loans in conduit deals, beyond simple extend-and-amend models – something we haven’t really seen much of to date,” says Paul Lewis, a director in the CBRE special servicing team.
One of the benefits that multi-loan CMBS does offer is the availability of third-party liquidity facilities for interest or swap shortfalls, which can help in the workout and restructuring of deals that are cash flow-constrained.
In balance sheet restructuring, a new trend may be that relationships become less influential on the negotiation side, given that several banks are no longer pursuing new lending. Hatfield Philips’ vice-president Philip Byun points to a bilateral UK loan he worked on where the existing relationship between the lender and the borrower had minimal influence: “We worked in co-operation with the lenders to agree a restructuring plan with the borrower; however, the lender had made clear its willingness to take enforcement action.”
The unwinding of swaps attached to balance sheet loans continues to further complicate the process. This involves direct discussion with banks’ internal swap desks or risk management teams – an additional party that the likes of Hatfield would not normally have to engage with. However, a bank that holds many different exposures to the same loan, can sometimes be easier to negotiate with because it is more likely to take a pragmatic view.
Some of the issues face both types of debt workout. “The negotiation process is fairly similar,” says Byun. “For one of the balance sheet loans I’m working on the lender has syndicated part of its position to another institution; there was a junior noteholder as well. Effectively, the sponsor is no longer there but the asset manager has been replaced and we have kept the borrowing fund structure in place.”
Lewis points out: “As you get to a point where you’ve got more secondary assets or leases are running off, and the assets increasingly need new capital invested, that is where it becomes quite difficult from a bank’s perspective. Do they put in more capital in the hope of a higher long-term return, or do they cut their losses?”