Liability management through debt exchanges and buybacks has been one of the big themes of 2004. Last month saw UK commercial property firm Land Securities announce a novel refinancing that makes its debt both cheaper and less of an encumbrance on its day-to-day business.
Historically, Land Securities has followed an unsecured funding strategy and aimed for a single A credit rating. But as last year progressed, a number of Land Securities' unsecured bonds and debentures had high coupons. Although their face value was approximately £1.8 billion, their market value was close to £2.4 billion.
Debentures can be especially annoying for property companies, which need operational flexibility to buy and sell property assets quickly. If those assets are mortgaged to debentures, Land Securities has to ask the debenture trustee to release the properties from charge and accept substitute properties.
“As we got into last year, the advantages of unsecured debt that we had seen particularly post-Enron were less clear,” says Andrew Macfarlane, Land Securities' group finance director. Property companies often set up joint ventures, and it wasn't clear that debt raised by these JVs was non-recourse.
Before Christmas, Land Securities sat down with long-term relationship bank Citigroup to work out how to tackle the problem. At the end of September, it unveiled its solution. Noteholders will be invited to exchange their existing debt for up to £2.4 billion of new bonds.
A hybrid transaction
“We'll keep the maturities the same but will reset the coupons to the market, boosting the face value,” says Macfarlane.
What's different about the new bonds is that they are secured. From its total assets of circa £9 billion, Land Securities has moved £6.2 billion of investment properties into its secured group of operating companies.
“We'd say the assets are segregated rather than ring-fenced,” says Macfarlane. “This structure differs from a CMBS structure when you look at what happens within the secured group, because we have what we call a tiered covenants regime.”
Tiered covenants give the deal a hybrid feel. Land Securities, whose unsecured debt is rated A minus, wants the benefits of securitisation – chiefly the ability to issue AA rated debt. But covenants on CMBS deals usually restrict active asset management – exactly what Land Securities wants to avoid.
Tiered covenants set limits for Land Securities. If it stays within them, it enjoys unsecured-style financing with only loose constraints on the business. But if the loan-to-value ratio of the secured group of companies exceeds 65%, or if interest cover falls below 1.45 times, tougher restrictions in line with a secured deal come into force.
“At high LTV levels we could still operate the business,” says Macfarlane. “But it would be sufficiently uncomfortable to incentivise us to keep LTV below 65%, where it feels pretty much as it does today.”
And if it keeps LTV at 55% or below, Land Securities can have a debt to equity value of around 185% – beyond the reach of many borrowers.
Land Securities is also putting in place a new £1.5 billion, five-year committed bank facility, underwritten by Citigroup, Lloyds, and Barclays Capital to refinance all of its unsecured debt.
If it had closed the deal at the end of September, Land Securities' weighted average cost of debt would have dropped from 7.6% to 5.6%, saving £25 million a year. As it is, Land Securities has to wait for bondholder approval, with the deal scheduled to close at the beginning of November.
The bondholders get larger, more liquid bonds with a higher nominal amount in return for a lower coupon. There is also a cash incentive for bondholders who sign up quickly, funded by reducing the spreads slightly on their bonds. Even with reduced spreads, however, the better quality paper should trade at a higher value. A special committee of the Association of British Insurers (ABI), representing 37% by nominal value of the outstanding notes, has recommended the deal. While debt holders get their cash upfront, Land Securities' equity holders get the benefit of cheaper debt over time. According to Citigroup, the net present value of the deal to equity holders is £52 million.