* High-yield buyers lap up operating asset deals
* Future of the market could be in pure real estate
* CMBS borrowers struggle to finance at high leverage
By Owen Sanderson
LONDON, March 1 (IFR) - High-yield investors are moving into securitisation territory, as booming conditions in the market make bonds the instrument of choice to finance highly levered operating assets - and in future potentially pure real estate.
If high-yield can provide a consistent source of highly leveraged asset finance, this could help the European operating asset and real estate market deal with huge volumes of pre-crisis debt coming due soon.
Good quality assets that simply had too much debt loaded upon them before the crisis ought to be able to refinance - cashflows remain strong, even if capital values have declined.
However, the traditional sources of funds have dried up.
Before the crisis, securitisation in CMBS format was usually used for senior loans, with subordinated financing placed in the B note market. Regular B note buyers included German regional banks, Icelandic banks, Anglo Irish Bank, and even sound institutions like Co-Operative Bank and Nationwide.
High-yield could potentially come in at this level and replace that kind of financing - investors in the asset class tolerate high leverage as a condition of doing business.
"The real estate market needs another source of debt - CMBS is on its way back, but we still don't know how deep the market is, particularly at high levels of leverage," said Conor Downey, real estate and securitisation partner at law firm Paul Hastings.
The high-yield market has thrived while other highly leveraged lending has dried up because it transfers risk to those that are still able to bear it - the capital markets, rather than banks.
European high-yield has also benefited from the rude health of the US capital markets over the past two years where issuers have offered 144A/Reg S formats, as did Annington Finance 5. This brings much needed liquidity to the market.
START THE OPERATION
The first steps towards financing real estate are through operating companies.
These are hybrids of the asset-lite cashflow companies which are the traditional mainstay of the high-yield market, and the landlord companies which are the main CMBS borrowers.
Care homes, holiday camps, telecom infrastructure, and motorway services can all be structured using the property security to lower borrowing costs, but the assets are specific to that business - and much more valuable if operated together.
Whole business securitisations were typically used for these assets, though some were packaged into CMBS structures pre-crisis.
Moving into this market means a challenge to long-held market traditions.
"A key philosophical difference between high-yield and real estate markets comes down to how far the company is tied up," said Downey.
"High-yield investors accept that companies need to be allowed to engage in normal business activities - they view operating risk as something to price in, but not something to eliminate. Real estate investors prefer to map out possible futures and try to squeeze operating risk out."
However, real estate investors are much more sanguine about being subordinated in a company's capital structure, and dealing with super senior swaps - both features of the recent Arqiva broadcast tower deal.
Flexibility, for high-yield bankers, is a selling point for financing in their format.
TAKE ME OUT
Three securitisation refinancings have already used high-yield features - Blackstone-owned Center Parcs took out its CPUK Mortgage Finance CMBS with a whole business securitisation in 2012, featuring a tranche sold to high-yield investors that was inside the securitisation ring fence.
Following Center Parcs, two Terra Firma-owned property assets were refinanced with high-yield. Terra Firma's purchase of Four Seasons healthcare, a care home group originally financed through a securitisation, was financed with vanilla high-yield raised by Barclays and Goldman.
This was followed by Terra Firma's buyout of Annington Homes in December 2012, which used an innovative hybrid structure.
It included a high-yield rating and syndication and was located outside the existing Annington securitisation, but it piggy-backed on securitisation covenants, and featured a CMBS-style waterfall, reporting, and control over cashflows on enforcement.
Five real estate investors were brought onside to give structural feedback early on.
Although not a pure real estate play, broadcast and telecom tower owner Arqiva incorporated high-yield into the take-out of its acquisition debt last week, placing the high-yield outside the securitisation - but incorporating non-standard features.
"The covenant package was not traditional high-yield incurrence-based covenants but rather maintenance covenants, offering stronger relative protection to high-yield investors," said Kevin Connell, high-yield syndicate at RBS, a bookrunner on Arqiva.
"Restricted payment lock-ups also prevent dividends from leaving the group if certain conditions are not met."
REAL ESTATE IMPACT
If high-yield investors can be persuaded to look at real estate risk in pure form, it could be a lifeline for the European market.
There is around EUR960bn of European commercial real estate debt outstanding, according to BlackRock. The shortfall in rolling over this debt in Europe is estimated to be EUR147bn during 2013.
Only 24 of 122 CMBS loans maturing in 2012 paid at maturity, according to Fitch, with the failure to pay driven in large part by lack of finance.
Quality assets owned by private equity companies might be early beneficiaries of high-yield refinancing. Germany multifamily properties, such as the GRAND portfolio, could use high-yield. A mandate for an eastern European CMBS takeout with residential risk is already out, with a deal expected in the next month. According to Fitch, EUR4.2bn of German multifamily CMBS loans mature this year.
Other operating assets could also join the pipeline, with RBS-structured care home deal EPIC (Barchester) a possible candidate, with a loan maturity in September. Tank & Rast, a German motorway services group owned by Terra Firma, also looks plausible.