Two cheers as Chiswick Park issue heralds CMBS 2.0 era

Investors back £302m DECO 2011-CSPK after last-minute structure changes, writes Jane Roberts

The first publicly-marketed European commercial mortgage-backed securities transaction for almost four years has been scrutinised from all sides. What would demand be like? How would it price? How different is the structure from ‘old’ CMBS deals? And would Deutsche Bank, the £302.3m deal’s arranger, make a profit? The German bank’s DECO 2011-CSPK CMBS is due to close on 28 June. The bank seems to have achieved its aim of selling the deal, proving that there is investor demand for new issues, despite the well-publicised problems with CMBS deals originated before the market shut down in August 2007 at the onset of the credit crunch.

Around 20 investors are said to have bought the three tranches of bonds. The AAA notes, which pay 175 basis points over three-month Libor, were just covered, while the AA notes, priced at 275bps, and the A notes, at 375bps, were oversubscribed. However, entirely expectedly, it seems that the process did not go completely smoothly. Market opinion is that the deal, which securitises a loan to Blackstone for the purchase of office buildings at Chiswick Park in west London, is not necessarily a template in every respect for future deals.

A note of controversy

With the deal not closed, the bank is not commenting, but market sources say one of the most controversial parts of the transaction was the inclusion of a class X note. In the heyday of CMBS issuance, these notes became the norm as the way for arranging banks to book profits from securitising deals, replacing deferred consideration in earlier deals.

The arranging banks issued and usually retained an X note to capture ‘excess spread’, with the X note ranking ‘super senior’ ahead of the other notes. As many deals ran into problems, it has been brought home to investors that X noteholders continue to receive interest ahead of other bondholders, even when loans fall into default and cashflow is reduced.

Class X bonds were introduced because rating agencies wouldn’t give any value to a deferred consideration, whereas packaged as a bond, it is viewed as assumed cashflow. The inclusion of class X bonds in DECO 2011-CSPK has been more tricky than Deutsche Bank and its law firm Paul Hastings had probably expected.

Concession on class X bonds

In the preliminary ‘red’ offering circular, they included a modification to the previous market standard-style X note, whereby the class X would become subordinated to the interest and principal payments to the A, B and C class and to transaction expenses, after the expected 2016 maturity date. This meant that if the loan was extended for any reason, the class X would not carry on.

But at the last minute, after the red offering circular had been issued, pressure from investor M&G Investments persuaded Deutsche Bank to alter the terms further in favour of investors. “Now, if there’s any loan default, the class X disappears – even if it’s cured later, so that’s tough luck for the bank,” says one source familiar with the changes. “So Deutsche Bank and its accountants can no longer look at this as guaranteed cashflow.

“I think it was deliberately done as an ambush. If investors had insisted on it at the outset, the deal could have been structured differently. But class X has become so controversial that some people are saying investors won’t take it to credit approval.”

Deutsche Bank also had to jump hurdles to get the deal rated. Under new regulations, issuers now have to pay to get transactions rated by not one but two rating agencies. In the event, the deal was rated by Standard & Poor’s and by Canadian rating agency DBRS, which has re-entered the UK market and is headed in London by Scott Goedken.

Moody’s and Fitch Ratings, however, are said to have been very conservative in what one insider felt “were petty ways”. On 3 June, in a note headed ‘Unsolicited Assessment of DECO 2011-CSPK’, Fitch EMEA CMBS managing director Euan Gatfield said: “The debt raised in Europe’s first benchmark CMBS deal since the crisis would not achieve the agency’s AAAsf rating.

“While DECO 2011-CSPK features structural elements that address shortcom-ings in existing European CMBS deals, credit enhancement in place is not sufficient to support Fitch’s highest rating level. While initially asked to provide feedback, Fitch was ultimately not asked to rate the deal due to its more conservative credit view.”

More explicitly, Gatfield said the senior bond leverage was too high; that Chiswick Park was outside an established office area;  the borrower structure was complex; and the assets are owned by entities in a different jurisdiction (Jersey), with enforceability not satisfactorily addressed in the loan level legal opinions.

Fitch did add that Deutsche Bank assured it that the legal opinions would be amended to address this concern. Another extra cost for the bank is meeting the new Capital Requirements Directive rule that CMBS issuers must retain 5% of deals. That is 5% extra cash tied up in the deal, plus the capital that has to be held against the bonds.

Deutsche Bank opted to retain a small ‘vertical slice’ of each of the three tranches, which is thought to have proved cheaper to hold than a first-loss piece. But for a bank of Deutsche Bank’s size, holding 5% of one £300m deal will not be a big problem. Nor will be cutting the fees from pre-crash levels, which it has done, says Paul Lloyd, head of CB Richard Ellis Loan Servicing, a former Deutsche Bank employee.

“The servicing fees have halved,” he says. “Deutsche used to charge 10bps of the deal for servicing; now it’s 5bps. For special servicing it used to charge 25bps; now it’s 12.5bps. That is right, because this should be a straightforward loan to monitor and maintain.”

Depressing prospects

But some former bankers, such as Natalie Howard, now at AgFe, believe the cost of 5% retention will have a depressing effect on future tranched issuance. Speaking at a conference on 9 June, she said: “Banks did CMBS because they made money out of it;  with the rule that 5% must be retained, it is not clear how they can do that now.”

The spread pricing is also higher than originally tipped and there is speculation that Deutsche Bank will not make a profit from the deal, while Blackstone could have sourced cheaper finance. But both want the CMBS capital markets to re-open. Sources close to this deal say that Deutsche Bank has two more lined up. The bank has hired Don Belanger from UBS to work on future deals, replacing Chris Dunn who is returning to the US. Meanwhile UBS, Morgan Stanley and Eurohypo are said to have potential deals  in the pipeline and will be studying this pioneering deal closely.

New DECO features reflect evolution of CMBS market

The DECO 2011-CSPK securitisation includes a number of features that were not market standard in 2007:

  • Greater servicer discretion, eg. the ability to sell the loan on default, and to draw additional funding, after fees are paid and before the coupons, for certain expenditure not covered by the liquidity facility.
  • A requirement for the servicer to produce an asset status report and make it public if the loan defaults.
  • Provision for an adviser to be paid just below the A class in a work-out situation.
  • A strengthening of the control valuation process to partly mitigate the risk of
    ‘capture’ by an out-of-the-money controlling class. Class C will be the controlling class, unless they are 25% impaired, when control switches to the class A.
  • More streamlined decision-making, for example written resolutions can be passed by 75% instead of 100% of investors and if 25% don’t actively object, they will be deemed to have accepted.

DECO 2011-CSPK: transaction summary

  • Securitisation of a single, £303m, five-year term loan to Blackstone Group for the purchase of nine buildings let to 40 tenants at the 1.1m sq ft business park Chiswick Park in west London.
  • Half of the underlying loan was advanced on a fixed-rate basis at a cost of 5.14%, equating to a 235bps margin over the swap; half was made on a floating-rate basis, floating at 235bps over Libor, but which is hedged against interest-rate risks via a prepaid borrower cap that kicks in if Libor goes over 3%.
  • A £61m junior loan, held by GIC, takes the all-in loan-to-value ratio to 79.5%, based on a £457m valuation.
  • The loan-to-value ratio was 66.1% at issuance, with scheduled amortisation reducing the LTV ratio to 63% at maturity.
  • Loan prepayments are required on property disposals, but only two disposals are allowed during the life of the loan.
  • The deal was rated by Standard & Poor’s and Canadian rating agency DBRS.
  • Deutsche Bank took almost all the main roles in the deal, including servicer, special servicer, swap and liquidity facility arranger, security and note trustee.