Commentaries

Four Seasons debt odyssey – still one more year to go

Four Seasons Healthcare, the UK care home operator, has finally completed its 1.5 billion pound debt restructuring, after a year of creditor wrangling. The group has ended up in the lap of lenders including RBS, which owns about about 40 percent of the company.

Now it has to set about refinancing 600 million pounds of asset-backed debt due next September, which makes up the bulk of its remaining 780 million pound debt pile. If the company can pull it off it will be extra good news for RBS, which managed to negotiate a deal giving it an extra slug of equity (just over two percent) in exchange for advisory services, based on performance.

Four Seasons isn’t the private healthcare group to end up in RBS’ loving hands. The bank also indirectly owns the Priory Group – which it inherited from ABN Amro. The Dutch bank’s structured financiers bought the group in 2006 and refinanced later in the asset backed debt market.

Four Seasons original owner, Three Delta, run by former Natwest banker Paul Taylor, was less lucky. The company defaulted after failing to refinance a two-year loan taken out at the time of its acquisition at the top of the market in late 2006.

A dark hour for CMBS

The last week has been a bit of a shocker for Europe’s already crumbling commercial mortgage-backed securities market (CMBS). Investors have had to cope with steep declines in the value of their bonds and a wave of downgrades by rating agencies.

Now, to add insult to injury, there has been a jump in legal and structural issues. Bondholders are having their rights diluted over or taking on fresh liabilities they didn’t even realise they had.

In France a judge this week sided against bondholders who wanted to take control of a Paris-office skyscraper formerly owned by a Lehman Brothers unit. The loan defaulted earlier this year, but a Paris judge approved a safeguard plan proposed by its owners, which include Lehman’s receivers Pricewaterhouse Coopers. Creditors argue that the ruling risks damaging property investment in France.

And in the UK there is the never-ending saga of White Tower 2006-3. This portfolio of elegant city offices was once the property empire of billionaire Simon Halabi, who refinanced them with a CMBS arranged by Soc Gen.

Now the loan has defaulted and the properties are the playthings of a handful of frustrated bondholders and, all of a sudden, the UK tax authorities, which have slapped the companies that own the properties with a withholding tax charge. FT’s Alphaville tells the story here. 

This is all bad, but the worst is probably still to come for bondholders. The highly levered nature of many property loans refinanced during the boom years will likely lead to a truly ghastly default rate as loans mature and can’t be refinanced. The only thing that could save the market is a speedy recovery in commercial real estate and revival in bank lending, hardly a likely prospect.  The return of any kind of CMBS market in Europe looks further away than ever.

Debt default watch – 213 companies so far this year

It’s a big number, and it’s no suprise that corporate debt issurers defaulting are in the U.S. Standard & Poor’s Diane Vazza has the breakdown in a report emailed out today.

Two global corporate issuers defaulted this week, bringing the 2009 year-to-date tally to 213 issuers—nearly 4x the 55 defaults at this time in 2008. Both of this week’s defaults were based in the U.S., bringing the default tallies by region to 153 issuers in the U.S., 13 in Europe, 34 in the emerging markets, and 13 in the other developed region (Australia, Canada, Japan, and New Zealand).

The U.S. default rate as of Aug 31 sits at 10.2%, according to Vazza, who expects it reach its peak of 13.9% by mid-2010. Under a gloomier scenario, it could reach 18% and under a brighter one, 11.4%.

What’s also interesting is a large number of defaults that are due to distressed debt exchanges, which leave debt holder in a worse position but generally not as bad as would be the case if the company went into bankruptcy.

Distressed exchange offers are now the top reason for default this year at 74 issuers-over 5x the distressed exchange count in the full year of 2008 and nearly 19x the count in 2007.

Unending pain in CLO land

Rating firms and analysts have been lowering high yield default forecasts in recent months, but there’s still plenty of pain in store for the banks, insurers (and taxpayers) who own collateralised loan obligations, funds that package leveraged debt.

Here are some cheery stats from Fitch Ratings, which is busy setting about downgrading more European CLOs.

The average cumulative default rate for European CLOs is now 5.8 percent, double the rate in February this year. During that time there have been fifteen defaults, affecting 26 separate CLO funds, Fitch says. Some lucky CLO funds were exposed to as many as five of those fifteen defaults.

Some of the bonds Fitch may downgrade are already firmly in junk territory, though others are still rated as high as single A.

Commercial real estate loans grow more distressed

Realpoint, the ratings firm that specializes in bonds backed by commercial real estate properties, is out with its July delinquency report on loans in CMBS deals and it has lots of great data tidbits on the building pressure on distressed loans.

The amount of loans delinquent for three months or more – an indication of extreme distress – now stands at $11.23 billion, up from $9.57 billion in the previous month. What’s interesting about the 90-day plus delinquencies is that they’ve been rising at a much faster clip than say foreclosures and REO (when the property is turned over to the bank). Check out chart on page 9 of the full report here.

It could indicate that a wave of defaults is about to crash.

Part of the reason is special servicers, those charged with helping  borrowers work out a loan when they can no longer stay current on their payments, are still trying to figure out whether these loans are worth saving. Some, presumably will not.

Separately, Frank Innaurato of RealPoint notes that some loans, which are still current on their regular payments, have moved into special servicing anyway in anticipation of refinancing problems on the horizon. Typically, borrowers avoid special servicing unless they’re desperate since it signals a higher likelihood of default.

Here are some of the other key points in the report:

• Based upon an updated trend analysis, we project the delinquency percentage to grow in excess of 6% before year-end 2009 (potentially approaching and surpassing 8% under more heavily stressed scenarios).

• Nearly 54% of delinquent unpaid balance through July 2009 came from transactions issued in 2006 and 2007, with over 28% of all delinquencies found in 2006-issued transactions. When we extend our review to include the 2005 vintage, an additional 16% of total delinquency is found; thus over 70% of CMBS delinquency comes from 2005 to 2007 vintage transactions.

• Throughout 2009, we expect to see continued high delinquency by unpaid balance for these three vintages due to aggressive lending practices prevalent in such years. We also expect to see some loans from the 2008 vintage to show signs of distress and default in cases where pro-forma underwriting assumptions fail to be realized.

A bit of a mezz in the Carwash

It’s not all bad news for mezzanine investors after the recent UK court verdict on the debt restructuring of IMO Carwash, the Carlyle-backed management buyout which defaulted earlier this year. Senior lenders devised a plan transfer its assets to a new company, leaving junior-ranking mezzanine investors with nothing.  The mezzanine debtholders contested the plan, but a UK judge disagreed and approved it.

That is a blow for mezzanine investors everywhere, because it tips the balance in favour of senior lenders for future restructurings under so-called schemes of arrangement. But they shouldn’t feel too hard done by, and the judge’s arguments may even help them in future.

Schemes of arrangement are designed to keep businesses alive. Provided they are approved by the court, they can be implemented with only 75 percent of creditors in each class of debt agreeing. Junior creditors can be excluded, and may be wiped out.

The mezzanine investors challenged the Carwash scheme, arguing that senior lenders were getting the company on the cheap simply because valuations are currently so depressed.

To convince the court, the senior lenders backed their proposal with discounted cash flow valuations, as well as evidence of a recent attempt to sell the company. The judge rejected the mezzanine investors’ (higher) valuation, which used a computer simulation.

However, the ruling lifts the bar for squeezing out junior creditors in future schemes; it sets a precedent for companies to be valued as going concerns rather than on a liquidation or break-up basis. Other schemes have used liquidation valuations, something which promises to be difficult after the Carwash ruling. Senior lenders won this time, but in future the valuation debate will be more closely fought.