With the cost of UK senior debt between 50 to 75 basis points lower today than around this time last year, it’s not surprising that the owners of one of London’s most iconic hotels have arranged a refinancing at a cheaper rate, less than 18 months after the last refinancing.
Last month Deutsche Bank was chosen to refinance the iconic Savoy hotel in London’s West End with around £300m of new debt by its owners Lloyds Banking Group and Saudi Prince Alwaleed’s Kingdom Hotel Investments.
Their adviser, Eastdil Secured, shortlisted six lenders, having kicked off the process in July and received offers from Citibank, which ran Deutsche Bank close for the Deutsche Bank providing a whole loan, Savoy’s previous 380-400bps debt margin. mandate, Goldman Sachs and incumbents how and if the mezzanine tranche is syndicated was yet to be determined as Real Estate Capital went to press.
It is thought that the debt has been priced below 300bps – up to 100bps less than The Savoy’s previous 380-400bps debt margin.
With lending opportunities scarce and competition among lenders getting “more and more fierce”, according to one core fund borrower, borrowing costs have fallen. Six months ago margins on prime, core office or retail assets stood at 150-160bps. “Now it’s probably 120bps,” says the borrower. “Margins are pulling in all the
time; it’s more borrower-friendly.”
In The Savoy’s last refinancing, in April 2013, Crédit Agricole CIB and DekaBank each provided £100m, replacing senior debt from Bank of Scotland. A £70m piece was sold to Allied Irish Bank and Santander, with DekaBank only modestly reducing its £100m as part of the syndication.
The sponsors injected capital in the form “Just as many debt funds and institutions, of various mezzanine positions, as well as if not more, are looking for this kind of equity, while there is also a loan from the product,” says the originator. “Cash-pay deals, hotel operator. Last October, The Savoy’s where income services interest, in the 70holding company said loan covenants might 85% range, now attract 7-8% all-in returns.” be breached if trading did not improve. One example is the £344m financing
The Savoy’s refinancing is not only about Oaktree Capital Management has agreed reducing the margin, says a source involved with Barclays for its purchase alongside in the deal. “Other various factors would Patrizia of three regional UK business parks make a refinancing interesting for the from MEPC. The whole loan reflects an sponsors,” he says. One factor is that the 80% LTV ratio, with a 15% mezzanine current debt carries a prepayment penalty.
Lenders under pressure
Other lenders, from banks to debt funds,report similar pressure from new and existing borrowers. With increased liquidity in the market, it is not uncommon for borrowers to play off lenders against each other. For example, sponsors are going out with term sheets, then returning to offering lenders and asking them to do it cheaper.
Borrowers also want greater flexibility in their financing, and it is the returning investment banks, partly on the back of the reviving syndication market, that are said to be pushing previous boundaries.
“Investment banks feel they can give the client what it wants on a whole loan basis, while being confident that they can syndicate portions throughout the capital structure,” says a German landesbank originator.
Senior debt levels are rising for the best quality assets, with LTV levels of around 65% – the absolute maximum a year ago – now considered ‘normal’, rather than a ceiling. More senior lenders are also having to partner with mezzanine lenders to provide higher-leverage debt.
“Just as many debt funds and institutions, if not more, are looking for this kind of product,” says the originator. “Cash-pay deals, where income services interest, in the 7085% range, now attract 7-8% all-in returns.”
One example is the £344m financing Oaktree Capital Management has agreed with Barclays for its purchase alongside Patrizia of three regional UK business parks from MEPC. The whole loan reflects an 80% LTV ratio, with a 15% mezzanine tranche likely to be syndicated as well as around half of the senior debt.
Some borrowers say they are prepared to leverage up more on certain deals to make returns work, to compensate for yield compression. This, coupled with rising interest costs, means interest cover ratio covenants are also lower. Default levels are nearing just 1x cover, leaving little margin for error. However, such low levels are usually justified by expected rental growth, which will in turn improve interest cover.
A process of negotiation
Ultimately, agreeing loans is a negotiation, and lenders and sponsors prioritise various aspects differently. Investors’ objectives vary according to strategies. “We’re investing core funds so we’re most concerned about pricing,” says the core fund borrower. “We’re not pushing for an LTV ‘holiday’; we’d rather take benefit on the margin.”
But for private equity players, pricing is not always the driving factor (see panel). One debt fund manager says his fund’s policy is to uphold at least two out of three key covenants in all its funds’ loans, one of those being loan-to-value covenant.
Nevertheless, borrowers hold more sway today and look likely to tighten the screws in the next few months, taking advantage of intense competition among lenders. ■
Borrowers seek a flexible break with loan-to-value holidays
Borrowers are showing a greater propensity to ask for loan-to-value holidays, of one to two years for medium-term loans. North American and private equity firms are also trying to greatly loosen or remove LTV covenants and “will sit there until they find somebody to lend on those terms”, says one debt fund manager.
The loosening is being done by providing greater headroom, of up to 20-25%, for falls in valuations. Alternatively, the LTV covenant is set at a level at which the lender can sweep cash from surplus rental income, instead of having a hard default. It is thought Citi’s May financing of The Walbrook Building in the City of London with a five-year senior loan of around £300m included such features.
Wells Fargo’s and Metlife’s £185m financing at just under 150bps for Blackstone’s Alban Gate City acquisition, also in May, is said to have a very flexible LTV covenant. “For Blackstone it wasn’t all about price; it wanted a flexible structure to show core-plus fund investors that it could negotiate loose terms,” said an underbidder on the financing. The deal was Blackstone’s first as part of its strategy of buying low-risk prime European assets, aside from its opportunistic investing.
The deal also featured flexible hedging, subject to a trigger rate. “More clients are asking to ‘gamble’ with interest rate exposure by requesting less debt is hedged or all the debt to float, subject to a trigger rate where a proportion of debt will then be fixed,” he adds.
Putting the squeeze on prepayment fees
Normally prepayment fees protect lenders from early payback, safeguarding their funding costs. Therefore bankers would only expect deals lacking high prepayment fees to come up for early refinancing.
The fees penalise borrowers for paying back in the early years after a loan is issued. There is no market standard, but in the first year they range from 1.5% to 2% of the total amount prepaid, ratcheting down by 25 basis points towards the end of a loan’s life.
“Most deals negotiated in 2008-09 had prepayment fees in up to the first three years and would naturally be more in play for refinancing, especially with the amount of liquidity we are seeing,” says one German landesbank originator.
“There is greater negotiation over terms including prepayment fees, with periods shortening over the past 18 months. Since 2008 lenders have been able to get prepayment fees in most years of the loan. Now, with increased competition, this is down to the first couple of years for five-year terms.”
Some borrowers now insist on having no prepayment fees on deals. “We’ve lost deals because the borrower didn’t want any prepayment penalties on the loan,” says one debt fund manager. The fund in question is required to have these for the debt mandate it manages, and also prefers it for its fund.
Other banks, such as clearing banks that manage their liquidity costs more efficiently, are said to be prepared to waive prepayment fees to avert long-standing customers from seeking cheaper refinancing elsewhere.