SECURITIZATION OF THEIR property portfolios has been a no-brainer for corporates in recent years. From supermarkets to pubs, company treasurers swiftly realized that the leverage they could achieve by monetizing their real estate was far higher than anything on offer elsewhere. The corporate securitization market therefore morphed into a hybrid CMBS market, with tenant quality and operating cashflows taking a back seat to ballooning property values. But UK commercial property has had a catastrophic start to the year, and this logic has been turned on its head. "In this environment it may well be the case that you can get higher leverage through a whole-business securitization than through an opco/propco deal," says a CMBS banker, with an air of weary resignation.
This is a complete reversal of the dynamics that have driven the corporate securitization market for the past five years. "Previously, corporates with real estate assets could use them to repeatedly refinance the business," says Andrew Currie, managing director at Fitch Ratings. "Sentiment has now completely switched. On the basis that it is a hard asset, real estate should be as good a form of collateral for corporate finance as anything else. Using commercial property as collateral for corporate loans should not, therefore, be closed – but in practice it probably is currently."
So where does this leave securitization as a corporate financing tool? The technique now has a serious image problem (see Securitization: The S Word, EuromoneyNovember 2007) so the assumption is that any corporate securitization would be a very hard sell at the moment. Traditional whole-business securitization almost disappeared over the past few years and presumably opco/propco securitization will now do the same.
Back from the dead?
But if this part of the market is anything to go by, the securitization market’s reputation for reinvention looks as if it might be well deserved. Far from being despondent, bankers involved in corporate ABS seem enthusiastically upbeat. It seems a very long time since Euromoney has spoken to a securitization banker with a bulging pipeline of deals and a positive story to tell. However, for those in this niche sector of the market, what has happened over the past six months could be all good.
"We have a strong pipeline going into 2008 but the key for 2008 will be distribution," says James Miller, head of corporate securitization at RBS in London. "We have seen a lot more interest in corporate securitization generally as a funding option and people want to know what can be done again. The last few years have actually been tougher for capital markets, given the liquidity available in the banking markets. But this has to change, and refinancing risk is much higher on the agenda for a number of asset owners we have met recently."
Easy credit made it difficult for corporates to be persuaded to undertake the cost and expense of a whole-business securitization. Instead they embraced opco/propco structuring with gusto – lured by the much higher leverage that was on offer. By splitting the operating company from its real estate, this technology boosted potential ebitda multiples from around six times under a traditional whole-business structure to more than nine times in some cases. Not surprisingly, the advent of opco/propco saw many firms unwind their existing financing arrangements and take advantage of the boost in funding available.
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"The last few years have been tougher for capital markets, given the liquidity available in the banking markets. But this has to change, and refinancing risk is much higher on the agenda for asset owners"
James Miller, RBS |
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One of the most high profile instances of this was ABN Amro’s acquisition of the Priory healthcare group in 2005. Previous owner Doughty Hanson undertook a £207 million ($403 million) whole-business securitization in 2003 but redeemed it just two years later in 2005 with the same assets reappearing in a hybrid CMBS deal. The £375 million trade, via ABN Amro’s CMBS conduit, Talisman, involved notes being issued down to triple-B in an A/B note structure. The £200 million B loan pushed leverage in the structure way above anything that could have been achieved in the whole-business market. A more recent example is that of the General Healthcare Group, which was acquired by South African healthcare group Netcare in April 2006 – a process in which its outstanding whole-business securitization was redeemed and replaced with a hybrid CMBS transaction in early 2007. Pub operators Mitchells & Butler and Greene King were also both looking at opco/propco financing structures before last summer. This decision proved particularly painful for Mitchells & Butler, which had put an interest rate hedge in place before its £4.5 billion opco/propco plan was scrapped. This decision has now left M&B nursing a £391 million loss and facing the inevitability of being sold.
But just because an opco/propco structure would be very difficult to push through in the present market, are structurers being over-optimistic that corporates will automatically re-examine the value of whole-business securitization? "Whole-business securitization is now a much more efficient alternative than it was before," admits a banker at a European house with a large CMBS conduit programme. "The last few years have witnessed a blurring of operating risk and property risk in these structures and, given sentiment towards commercial property, the two now need to be separated again. As a result, you might see whole-business securitization coming back as a financing technique."
Ganesh Rajendra, managing director at Deutsche Bank, says: "Legacy whole-business securitization will probably make a comeback. It was squeezed out by the banks’ capacity and appetite to lend in the longer term. That has now changed dramatically and the capital markets will come back as a key source of long-dated finance." For any corporate, the two things that matter when considering any form of securitization are cost of funds and leverage. The cost of the structure was not competitive in an environment of very cheap bank lending but in the present environment of zero bank lending it begins to look very attractive indeed. This is because the fixed-rate, long-term deals are priced to gilts, which have come in sharply as they have benefited from the flight to safety over the past six months. The yield on three-month UK gilts was 5.45% on January 21 2008, compared with 5.35% on January 29 2007. But the six-month yield was down to 4.38% in 2008 from 5.55% in 2007 and the one-year yield was 4.3% in 2008 compared with 5.5% in 2007. Most whole-business securitizations incorporate both fixed-rate and floating-rate tranches. "On the back of the credit crunch we have also seen underlying yields rally, the 20-year gilt yield has tightened 70bp since June for example, which has largely offset the widening credit spreads we have also seen," explains Miller at RBS. "So for a whole-business securitization the cost of funds may not be vastly different on an all-in basis, yet this is not often the perception," he says.