Commentaries

CMBS rides again

Well, sort of.

UK supermarket retailer Tesco is planning a 559 million pound securitisation of retail stores and distribution centres.

It’s good to see some kind of CMBS market getting going in Europe given the vast amount of real estate loans that need refinancing in coming years. But, like some of the earlier deals this year, this transaction is just a very tentative toe in the water, rather than a market revival.

Fitch Ratings notes that the deal is entirely expected to be repaid by cashflows derived from Tesco’s rental payments, and the rating agency grades the bonds the same as Tesco (A-). In other words, bond investors aren’t taking much real estate risk —  they’re just taking Tesco credit risk and presumably will get paid a small pick-up over the company’s corporate bonds to compensate for the more complex structure.

British Land’s best assets – its liabilities

British Land is in a good position to take advantage of opportunities. We know because the chairman told us. Why then, is he supposed to be contemplating selling a stake in London office complex Broadgate to Blackstone?

Given how far prices have fallen, the timing looks odd, especially for a company that claims to be in a solid financial position. However, it may make more sense than it appears to. Bank lending and property markets are soft, but the peculiarities of Broadgate’s debt structure may make it worth while for both sides.

Broadgate, now over 20 years old, is showing its age and, at 2.2 billion pounds, is an uncomfortably big lump in British Land’s portfolio. Selling a stake would allow the company to reduce risk and diversify its business.

For a buyer, the attraction lies as much in the quality of Broadgate’s liabilities as those of its assets. The estate may need some work, but it has a state-of-the-art pre-credit crisis debt structure, which any buyer would inherit.

The complex carries 2 billion pounds of debt paying interest of 5 percent, a rate so low that if the loans were quoted, they would stand about 570 million pounds below par. This is equivalent to 61 pence a British Land share, about half of the mark to market gain of 119 pence that British Land recognises on its debt in its triple-net NAV figure.

The stock market may debate whether to recognise this gain, but a private equity firm like Blackstone would certainly value that cheap debt highly.

There is little current equity in Broadgate, and a half share might fetch only about 100 million pounds, but a leverage of about 10 times would produce a supercharged return if the buyer was prepared to wait for property prices to recover. The lack of any loan-to-value covenant in the debt reduces the risk of a breach if markets deteriorate further.

Banks face commercial real estate stress tests

One of the big uncertainties left at this stage of the credit crisis is the amount of losses banks will have to take from foreclosing on defaulted commercial real estate loans. The question is both how bad those losses will be and when they materialize, and how much money banks can make in the interim to absorb them.

Fitch Ratings is obviously sufficiently worried about the issue to launch a new review, looking at banks’  loans books and underwriting critieria,  and conducting its own stress tests.  

 So far banks haven’t had to take too much pain from forced sales, Fitch notes. But it expects losses to pick up as rentals decline and property companies breach covenants.

Banks’ “flexibility to absorb significant additional problems may be constrained by a weak earnings outlook and capital bases that have yet to recover from the current turmoil,’’ the agency said in a report today.

Of course the agency already has an idea of banks’ exposures and likely future losses and factors that into its ratings. But Fitch notes that “current indicators point to heightened potential for continued deterioration.’’  The agency doesn’t say anything about downgrades — yet.