Covid-19 has undoubtedly caused significant disruption to businesses and national economies. While corporates with bases in Europe have been able to benefit from government interventions to prevent long-term unemployment, it is unsustainable for the public purse to continue to prop up businesses, particularly the private sector, to such a degree.
It is predicted that aggregate corporate-debt-to-GDP ratios will rise by up to 1,000 basis points in 2020, reaching 95 percent of GDP – well above the global financial crisis peak in 2009.
Although interest rates across the continent are extremely low, and are only expected to increase up to 30bps over the next five years, some corporations’ ability to service record levels of debt is on a knife edge, while others are taking advantage of the abundance of debt available.
A review of assets, particularly property, would be a natural place for corporations to start to find the liquidity they need. While the cost of borrowing from banks is relatively cheap now, accounting changes mean lease liabilities from sale-and-leaseback transactions are now visible on balance sheets, where they once were not. While these transactions are a popular solution for corporates looking to raise cash, creating a tailored credit-linked lease agreement is another solution and one which is gaining greater traction in the region.
Credit tenant leases can enable organisations to raise funds in the short-term at highly competitive rates, equivalent to the corporate borrowing rate, which are repaid over the long-term agreement. They ensure continued full control of the asset with retained ownership at the end of the lease term.
These structures are complex and are typically provided by specialist direct lenders such as insurance companies, pension groups or corporate banks.
We are currently working on a new build-to-suit project in the Netherlands for a fast-moving consumer goods client, with a total financing requirement of around €40 million. In addition, an investment-grade, US-listed FMCG client is looking to secure around $200 million for the financing of six new build-to suit facilities across Latin America and Europe. When we compare the economics of the fully amortising debt structure against traditional equity structures, the results are compelling in favour of CTL.
What is a credit tenant lease?
A CTL is a hybrid corporate real estate finance structure, designed to secure discounted borrowing rates. Loans are determined by the credit rating of the tenant and structured with an assignment of rental payments to the lender, unlike a typical real estate loan, which is underwritten based on the underlying asset value. The asset is pledged as collateral by way of a first lien, thereby enhancing the credit of the CTL. Parent company guarantees are also used to further improve the credit of the CTL.
The structure can be used to release capital locked in illiquid assets, while allowing the corporate borrower to maintain ultimate ownership and control of the asset or fund the development of specialised facilities. The capital itself is raised via a private placement of bonds – backed by the right to receive the rental income and collateralised by the assets. To ensure maximum leverage, CTLs are typically granted on a triple-net-lease basis whereby the tenant is responsible for all repairs, taxes and insurances.
CTL financing is treated as a bond of the tenant, rather than being priced on the real estate value, providing considerably cheaper long-term funding. Up to 100 percent loan-to-value can be borrowed for up 30 years, which is fully amortised over the lease term. They offer a very low debt service coverage ratio, of between 1-1.5x.
Such structures can be used for both owned and non-owned assets allowing the tenant to purchase the property at the end of the term for a nominal value, and are often utilised in sale-and-leaseback transactions to improve the commercial lease terms, resulting in cheaper funding and better economics over the term.
Now is the time to consider these niche financial structures, while there is some respite in the region and ahead of a potential second wave of the pandemic.
Robert Campkin is head of EMEA corporate capital solutions at real estate consultancy Colliers International