More lenders are writing high LTV loans to sell on chunks later, reports Alex Catalano
In Europe, whole loans have been gaining traction. “Whether it’s banks or debt funds like ours, there is a lot of activity in this space,” says Rob Harper, head of Europe at Blackstone Real Estate Debt Strategies.
“Whole loans” is a term loosely applied to financings at higher-than-senior loan-to-value levels, organised by one lender, usually with the intention of selling part of it. They can take different forms (see panel), and the term can be a confusing one.
Barclays, for example, provided £335m for Oaktree’s and Patrizia’s purchase of three UK business parks from MEPC, dubbed Project Aviemore. The bank kept the senior and the mezzanine was provided by Highbridge Capital Management.
Jason Constable, head of specialist real estate at Barclays, says: “Our aim is to be the principle originator of the entire loan and distribute the risk as appropriate, as we did on Project Aviemore, but we will work with trusted counterparties to club the facility from day one, or to participate in a senior syndication run by a junior lender.”
Investment banks have previously been the main whole loan providers; they were commonly used for CMBS before the crisis. More recently they have used them for big financings, syndicating or selling most of both tranches.
For example, earlier this year, Bank of America Merrill Lynch financed Lone Star’s purchase of the iconic Coeur Défense tower in Paris with a €930m loan, split into an €805m senior tranche, at a 62% LTV ratio, and a €125m junior one, at a 72% LTV ratio. Chunks of the senior debt were sold to AXA Real Estate and BAWAG, and via a private CMBS placement; AXA, BAWAG and LaSalle Investment Management also bought into the junior debt.
Debt funds move in
Debt funds set up to lend mezzanine also increasingly provide whole loans, selling the senior part. Last year, DRC Capital and Cheyne Capital provided £170m to finance Queensgate Investments’ acquisition of Executive Offices group, and subsequently sold the £130m senior chunk to Barclays.
“We do whole loans, typically with the higher leverage senior lenders won’t touch,” says DRC managing partner Dale Lattanzio. “Borrowers don’t want to worry about finding and marrying the senior and junior.”
Axel Brinkmann, LaSalle Investment Management’s director of debt investments and special situations, also notes an increase in whole loans, especially with mid-70s LTV ratios. “Sponsors are pushing for whole loan solutions,” he says. “They say, ‘I don’t want to go through the brain damage of organising two parties. You sort out the missing piece in the capital structure and offer me the best blended price on the whole loan’.”
As liquidity has returned to Europe’s debt markets and with deal volumes rising, speed is of the essence for lenders. “The urgency and certainty needed means borrowers want to deal with one counterparty they know and trust to show up with the money on the closing date,” says Harper.
“If you say: ‘I’m tied to this guy and we have to get there at the same time’, for a borrower, you’re not the most competitive lender, because it’s logistically challenging.”
The whole loan model also works well for complicated deals. In May, BREDS refinanced Internos’s Invista portfolio with a three-year, €220m whole loan carrying a 770bps initial margin over Euribor. It sold €100m of the senior debt to Bank of America Merrill Lynch, keeping the rest.
“It was a complex deal across multiple countries and products,” says Harper. “A lot of lenders would have been unable to tackle that complexity. It also moved fairly rapidly. We had to do the whole loan to access the mezzanine opportunity.
“We do the math and identify which portion we call senior and where we’d like to sell it. But we underwrite it to own the mezz. It’s not a syndication, where you might originate and sell everything to earn fees.”
Borrowers know they will probably pay a bit extra for a one-stop solution. Senior whole-loan lenders pad the junior loan with extra margin so they are not out of pocket if the junior becomes a bit more expensive; similarly, junior whole-loan providers will have some wiggle room in the senior pricing.
A deal-specific market
It is a fluid, deal-specific market, with no rule of thumb on leverage, mezzanine’s attachment point or pricing. “Increasingly, senior and junior lenders are picking up the phone to each other,” says Brinkmann.
Both types of lenders say they have a good view of where pricing lies, but call each other to gauge specific assets and confirm what they think about pricing. “It’s easier to go to credit when you have strong signs of the senior terms,” says Brinkmann.
Harper adds: “Sometimes the time frame is so rapid that there’s no chance for a material dialogue with anyone before closing. But if the pace is slower, you can have detailed talks with senior lenders and maybe identify someone who can close simultaneously with you.”
For their part, senior players are picky about who they deal with on the junior side.
Brinkmann concludes: “Whole loans are likely to increase, as senior and junior lenders get more comfortable taking on syndication risk on the senior or junior tranche.”
Whole loans: key points on definition and structure
“Whole loan” sounds simple: one loan, one borrower. In some cases, it is that simple: “whole loan” is a euphemism for a lender providing higher loan-to-value ratios. These uni-tranche loans that stretch beyond conservative senior debt are kept entirely on the lender’s balance sheet — with “stretched senior” or even mezzanine levels of leverage.
But “whole loan” is mostly now a term attached to a higher LTV financing originated by one lender, then divided into senior and junior tranches, one of which is sold to another lender (or lenders).
This either takes the form of a single loan tranched into senior (A) and junior (B) parts, or two loans with structural subordination of the junior loan. Either way, the “whole loan” originator may underwrite the entire debt without lining up buyer(s) for the part to be sold. In this case, the borrower pays a blended margin and interest goes into one pot.
Structural subordination requires a complicated stack of special-purpose vehicles that effectively divide the loan into separate senior and junior loans. In this case, the borrower pays a separate margin on each loan; there are separate payment waterfalls and interest payments go first to a senior and then into a junior pot.
“That way you enhance the senior liquidity by a mile, because a lot of senior banks prefer structural subordination,” says LaSalle Investment Management director Axel Brinkmann.
Jason Constable, Barclays’ head of specialist real estate, says: “It is more typical for us to see fully structurally subordinated senior/junior debt structures with two ‘Midco’s’ in between the senior and junior borrowers. This has a cleaner structure to syndicate and factors in junior lenders’ requirements to step into the equity in a deal in need, while preserving the senior financing structure.“
However, borrowers don’t always like such complicated arrangements and the extra costs involved. The alternative A/B structure has simpler documentation. Here, the priority of payments, interest rate split between tranche holders, their rights and other terms are set out in the intercreditor agreement (usually entered into between only the senior and mezzanine lenders, not the borrower).
The borrower will pay interest to one facility agent who distributes it to all lenders according to the intercreditor agreement.
But the A/B structure can cause lenders complications, for example, when there is a breach of covenants or other serious defaults. The way cash is applied in such situations (or to cure a default) can be problematic, as these structures often require interest paid to junior lenders to be used to speed the amortisation of the senior tranche in priority to the junior.
This can cause the weighted average interest rate set out in the intercreditor agreement on the senior and junior pieces to creep above the blended rate the borrower pays. Over time, this “rate creep” can cause a shortfall in what is due to the junior lender — but if the borrower still makes payments at the blended rate, because it is a single loan, the junior tranche cannot capitalise unpaid interest or charge default interest. This does not happen with structural subordination, as senior and junior are two separate loans.
The Commercial Real Estate Finance Council Europe has taken the lead in developing guidelines on intercreditor issues.
“Now that whole loans are finding greater favour with certain lenders and borrowers, it is a welcome move that the CREFC intends to supplement its existing working group with an additional initiative dealing with structural issues arising from the tranching of whole loans,” says Paul Gray, partner at DLA Piper.