Borrowers will struggle to refinance debt behind multi-family housing CMBS, writes Lauren Parr
German multi-family housing may be a resilient asset class, but it is carrying a massive load of debt that needs to be refinanced just two years from now. Some €12.5bn of this debt is securitised in CMBS and Barclays Capital estimates that a €1.5bn funding gap will need to be plugged with equity to refinance these loans at maturity. Around €9bn of this CMBS debt is due to mature in 2013 (see graph, right). This is dominated by four deals, including the €4.8bn GRAND CMBS – the biggest ever European securitisation. “The reason why these deals remain on rating watch negative is because they’re so incredibly big – billions and billions,” says Gioia Dominedo, a senior director in Fitch’s EMEA CMBS team.
Balloon risk is Fitch’s key concern for the largest deals, even though the outstanding loans in German multi-family housing securitisations dropped from €15bn to €12.5bn over the past year. The fall is largely due to the refinancing of deals such as the €890m GSW loan, which was securitised in Windermere IX and Fleet Street 3. On a smaller scale, the €179m Hallam deal was fully refinanced in April 2011 by a pfandbrief lender. There are fewer concerns over the quality of the underlying property. Only nine of the 57 multi-family housing CMBS loans identified by Barclays Capital are suffering payment defaults.
The WOBA loan, which was also securitised across two transactions – Windermere IX and DECO 14-Pan Europe 5 – is on rating watch negative because refinanc-ing talks are on hold until there is clarity regarding a legal action against the WOBA borrowers by the City of Dresden. German banks have returned to lending and refinancing conditions are favourable, with margins relatively low for borrowers. But lenders want prime assets and top asset management.
Debt available for high-quality assets
“The refinancing of the GSW loan in February sends a strong positive signal about the availability of debt for the highest-quality portfolios,” says Dominedo. “But the fact that it took six banks [to complete the refinancing] indicates that a full repayment of the largest facilities would be extremely difficult to arrange, based on current lending limits of individual banks.”
However, Dirk Richolt, head of CB Richard Ellis’s debt advisory business in Germany, believes German multi-family housing CMBS outperforms the wider CMBS market in Europe. The Fitch Ratings Maturity Repayment Index improved to 40.4% from 38.3% in June. Richolt expects to see more transactions refinanced ahead of schedule this year. “Underlying loan performance is relatively good so it’s comparatively easy to refinance,” he says. “There are a few outliers but, on balance, it’s a pretty resilient asset class.”
Corestate chief executive Philip Burns also takes a more relaxed view on the refinancing wave, deeming it somewhat of a “red herring”, as he believes a large amount of CMBS debt is likely to be extended. He refers to a structural provision often found in CMBS documentation that can allow, in certain cirumstances, extensions. “It would not be unusual to have a one- to three-year extension on a securitisation, so a trustee’s first response is ‘let’s not take a principal loss – let’s kick the can down road’. “Therefore the refinancing wall will be put back from 2012-14 to 2013-2016 or 2017 – and so much more can happen between now and then. Maybe some assets will be de-leveraged or there will be a slow work-out over time.”
He points out that some assets may not even be close to defaulting and “it’s simply a matter of quantum that causes the problem”. Deals will emerge over the next three to five years for investors that understand the complexities of debt, as well as those that can sweat the underlying assets, he adds. There could be opportunities to consolidate medium-sized portfolios of multi-family properties and in the non-performing loan market, although stabilised cash flows and potential to increase rents are essential.
The stability of income offered by multi-family housing, allied to the pace of Germany’s economic recovery, is attracting interest from investors and lending banks. “Everyone is watching with interest to see how banks deal with the product when it comes up for refinancing,” Burns adds. Inevitably, new equity will be required, as not enough bank finance will be available.
Big deals on the cards
More German housing is expected to come up for sale over the coming months. Large deals being anticipated include the sale of LBBW Immobilien’s multi-family housing operation – a collection of high-quality assets that would suit an investor looking for low volatility. Meanwhile, various distressed portfolios linked to Deutsche Speymill are also generating interest.
Wells Fargo is also known to be selling a €80.1m performing loan secured by the leasehold interest in a 10-property multi-family and assisted living portfolio in eastern Germany. It originally provided the debt to Forum Partners in 2006. Dominedo notes that the borrowers in some CMBS deals have been proactive in appointing advisers or approaching note- holders to discuss possible restructurings or refinancings. But there are “still a lot of question marks over the balance of debt that needs some kind of solution”, she adds.
This sentiment has been reflected in the secondary CMBS market. A further tightening in German multi-family housing debt took place during the second quarter of this year, triggered by talk that the borrower behind the GRAND deal – Terra Firma, through Deutsche Annington – was looking to refinance the debt ahead of schedule. But following a rally at the start of the year, secondary market pricing for senior and mezzanine tranches fell several basis points in June, as the market came to realise refinancing the debt wasn’t going to be easy.
For example, GRAND 1 B traded recently at around 86.50-86.75%, compared with 90% at the end of May. However, this is an improvement on bid levels of 83.5% when prices weakened in June, according to a secondary CMBS trader. Sponsors have several options to deal with maturing loans and are likely to use a combination of them for bigger deals, given that multi-family portfolio values are not expected to climb in the next three to five years, while lending conditions remain prudent. Properties securing German multi-family loans have fallen 16% in value since origination, on average, Barclays Capital points out. As such, many loans are likely to go into ‘extra time’.
Loan extensions may occur on highly geared assets that still generate enough cashflow to service the debt. In addition, loans in multi-loan deals are more likely to be extended than those in single-borrower issues, because the time gap between loan and bond maturity is typically longer in multi-borrower deals. borrower transactions.
Two refinancing options
For large loans, sponsors could try to get refinancing by arranging a club deal of several lenders, or by splitting portfolios into smaller parcels, either at or before loan maturity. A recent example of the latter approach is the partial prepayment of the €974m loan securitised in Immeo Finance 2, after the sponsor managed to secure €260m of debt in December from German banks for part of the property portfolio.
Another option is to sell part of property portfolios before loan maturity with the aim of reducing the maturity exposure, and de-leveraging the loan. But the sale of whole portfolios might not be possible owing to a lack of available credit for buyers. If all else fails, highly leveraged loans with poor cash flows could default on their maturity date.
Even though some believe German multi-family housing loans will be repaid ahead of maturity or their maturities will be pushed back, the scale of the debt that needs addressing points to the likelihood of some kind of restructuring in many deals. s economic recovery. A further improvement in lending terms is also expected off the back of this.
Terra Firma seeks solution to GRAND debt problem
Terra Firma, the borrower behind the GRAND CMBS, needs to refinance €4.8bn of debt that matures in July 2013, in view of a potential flotation of its property firm Deutsche Annington, through which it built up a portfolio of German housing. The debt used to buy the assets was refinanced in this single securitisation in 2006, which was organised by Barclays Capital and Citigroup. Terra Firma has appointed Blackstone as its financial adviser and has approached noteholders about extending the maturity of the debt. Brookland Partners and Paul Hastings are advising noteholders and the loan servicer.
With the bonds maturing three years after the loan, Barclays Capital believes a restructuring that includes extending the bonds by three to five years is probable, combined with increased amortisation and an undertaking by the sponsor to dispose of more properties until the extended loan maturity date. But there is a major flaw in the loan documentation, drawn up by Clifford Chance, concerning voting and extraordinary general meetings.
Although the quorum for calling an extraordinary general meeting of noteholders is specified, the threshold for passing a resolution was omitted, so any restructuring is effectively in limbo for the time being. One possible plan of action is to set up a UK Scheme of Arrangement – a court-approved agreement between a company and its shareholders or creditors – to govern any changes. This follows work with the borrower by Freshfields and Rothschild, who are legal and financial advisers to a steering committee of six investors, representing about 25% of all the notes.
Corestate aims to make assets sweat in multi-family housing work-outs
During the boom years, the likes of Terra Firma, Corestate, Cerberus and Fortress bought German multi-family property for its defensive qualities. “It hasn’t seen the housing bubble that you’ve had in other places,” says Philip Burns, Corestate’s chief executive. “It has incredibly low volatility in terms of rent increases and decreases, so it is thought of as a very stable asset class.
“Throughout the crisis that proved to be true. Having said that, many people maybe paid too much for the assets’ low volatility or layered inappropriate capital structures or debt financing on top of that. Sometimes people bought poorly and financed poorly, and they’re in pretty bad shape.” Furthermore, between 2004 and 2007 many international investors bought housing thinking that they would run it themselves, but management needs local expertise.
Burns believes there will be opportunities for Corestate to work with banks, special servicers and property owners as a wave of refinancing works its way through the system. “Although some assets have performed as they should have done, a lot need to be managed better,” he says. “You can drive rents higher and vacancy lower if you invest in assets and manage them well.”
With €1.5bn of assets under management, 70% of which are based in the German residential sector, the private equity real estate group looks for opportunistic or value-added returns, typically in the mid teens. It achieves this by targeting portfolios that have vacancies and that need some TLC, or overleveraged portfolios that need to be refinanced, for example.
In the past 12 months Corestate has completed three off-market deals with a total asset value of between €300m and €350m. Two were debt restructurings, one in connection with a German lender holding the debt; another in connection with the restructuring of a securitisation. The third deal involved securing new debt.
Having an asset management platform that is spread across Germany is a fundamental part of Corestate’s strategy. “We aim to achieve opportunistic returns by getting our hands dirty,” says Burns, who dismisses the notion that German multi- family housing provides 20% plus returns. “If you can find the right portfolio and you have a convincing business plan, you can still get financing from local German banks at reasonable rates. It’s just that you’re not going to be able to get sky-high loan-to-value ratios, which isn’t going to give you opportunistic returns. That’s why you need to layer on an asset management or operational approach.”