The European CMBS market is positively booming!

Thus far CMBS has had a storming year and all current indicators point towards 2018 being a bumper year for the product.  After two years of relative malaise on the primary issuance front, the first half of 2018 has proven to be anything but sluggish.  Notable transactions that have so far taken place include Citibank and Morgan Stanley ‎closing an extremely well priced transaction secured by Finnish assets (a CMBS 2.0 first), Bank of America Merrill Lynch achieving some hugely impressive pricing on an Italian CMBS and most recently the spotlight has turned to Goldman Sachs who have recently obtained excellent pricing on a £427m CMBS secured by a portfolio of UK hotels.  The market though has not simply been confined to conduit deals as demonstrated by the fact that Blackstone successfully closed CMBS Pietra Nera Uno (which is apparently the first of a swathe of Agency CMBS deals that Blackstone are expected to bring to the market) and the recent market rumours that Natwest are currently in the midst of structuring a synthetic CMBS.  Taken together all these transactions provide the firmest indicator yet that that the beleaguered CMBS product is firmly back in vogue.

In our view, the inflection point for the latest surge in activity can be said to stem from BAML’s hugely successful Taurus 2017-2 UK and Taurus 2017-1 IT transactions which closed at the end of 2017.  Not only did these deals breathe fresh life into an otherwise sanguine market but the pricing achieved provided market participants with a very stark reminder that with the requisite macro-economic conditions and a healthy dose of investor demand, ‎then CMBS can really be the ticket.  The recent spate of deals not only re-affirm and endorse this message, but in fact positively demonstrate that CMBS not only has a role in financing European commercial real estate but the fact, that it can be extremely profitable for those market participants (borrowers, arrangers and fixed income investors alike) that wish to embrace this technology.

The great news about this recent surge in activity, is not only the fact that a number of different arrangers are sitting behind these issuances but also the fact that these transactions feature different underlying asset types from a range of different jurisdictions.  However from our standpoint what is most encouraging about this recent spate of activity, is the fact that European CMBS is making this resurgence notwithstanding the bout of European legislation that has penalised the product.  Although at times we have considered this penal legislation potentially fatal (CMBS – the little match girl of European ABS) fortunately market activity has proven that this is simply not the case.

For the erstwhile industry participant, this is not the first time that we have had the pleasure of riding a CMBS 2.0 wave, indeed 2015 was proving to be an extremely prosperous year until the summer when the threat of Grexit followed by the Chinese financial crisis brought primary issuance to an unexpected crashing halt.  Although a sobering thought that the market will only be too aware, nevertheless it is our hope that arrangers continue to “make hay while the sun is shining”.  Who knows, barring another macro-economic shock, then 2018 may not only be regarded as a truly momentous year for the product, but also go down as the year that CMBS rightfully re-established itself as an important financing tool for European commercial real estate.

CMBS – the little match girl of European ABS

Rather like the Hans Christian Anderson story about the little match girl, the news that BAML has successfully launched two CMBS deals in quick succession has flickered light into an otherwise cold and beleaguered primary issuance market.  Not only do these transactions provide a clear indicator that there is still life in the market, but this news is the most positive development for the industry since the summer of 2015, when adverse macro-economic factors precipitated by concerns over Grexit and the Chinese financial crisis shut down primary CMBS issuance.

In fact, the successful launch of these deals could not have come at a more opportune moment given that the future of European CMBS currently hangs in the balance following the European legislature’s decree that CMBS will not qualify as a simple, transparent and standardised securitisation under the Securitisation Regulation.  More simply put, the European regulators have legislated against the product by adopting a position whereby CMBS will not be afforded the same regulatory capital treatment that will benefit other equivalent securitisation products.

Although clearly not a welcome position, the European legislature can nonetheless probably be forgiven for being wary, given the myriad of issues that were prevalent in CMBS 1.0.  These issues have now been addressed and therefore should no longer be problematic for the new crop of deals.  Unfortunately though, by taking the stance that it has under the new Securitisation Regulation, the European legislature has purposefully chosen to ignore the hugely beneficial role that CMBS can play in the European markets by:

  • providing an important source of finance for commercial real estate;
  • providing an efficient mechanism to transfer loan risk from the banking sector to institutional investors;
  • providing institutional investors with a more liquid alternative to the loan syndication market; and
  • bringing about much needed openness and transparency to the commercial real estate lending market.

Against this backdrop, the news that BAML have successfully launched Taurus 2017-2 UK and Taurus 2017-1 IT is therefore likely to provide a much needed boost to the industry.  Not only do these issuances demonstrate that despite the regulatory headwinds, CMBS can still be done, but also that there is clear appetite for this type of fixed income product.  That said, one still cannot help but draw parallels with the Hans Christian Anderson story about the little match girl and more specifically whether these CMBS deals could be said to be the final flickers of light for the product before its untimely demise.  Whether this is ultimately true, rests in the hands of the European legislature given they hold the key to its fate however one thing that is certain is that the Securitisation Regulation in its current form does not create a glowing prospect for the future of European CMBS.

TIME IS UP- BOE’s deadline for banks to submit their Brexit plans passes …

On 7 April, the Bank of England gave financial firms a hard deadline of 14 July for submitting their contingency plans for Brexit, which passed last Friday.

These plans were required to contemplate a variety of scenarios including the prospect of a “hard Brexit”, which as the UK and EU governments continue along the path of tough Brexit negotiations, probably makes the Banks wish they possessed a crystal ball…

For more information please see our previous blog here.

NPL securitisation and the trail blazing funds

The recent news that Blackstone and Lone Star have just securitized a portfolio of re-performing loans secured by Spanish and Irish real estate respectively, could potentially mark the arrival of a new era for the European securitization market. Indeed, if these transactions prove themselves to be the green shoots for the emergence of a new fixed income product, then this has the potential to have widespread positive ramifications for not only yield hungry fixed income investors but also for those banks that have balance sheets saddled with large volumes of non-performing loans (NPL).

Indeed, we have long advocated the view that securitization has the potential to play an integral role in the removal of swathes of NPL’s that are currently stifling banks. In fact, the feasibility of such a product was the subject of an article that I had published in 2014 in the fall edition of CRE Finance World (Europe’s Future Power Couple – CMBS; A Financing Tool for NPL Portfolios). Simply put, these structures involve the transfer of non-performing (or rehabilitated) loans to a special purpose vehicle that funds such an acquisition through the issuance of notes into the capital markets thus providing lenders (be it debt funds or banks) with a tool for transferring the risk and reward of large volumes of loans.

The news of the successful execution of these transactions by two high profile NPL investors featuring loans secured by assets in different jurisdictions is significant for three main reasons. Firstly, these deals provide a clear rebuttal to the chief concern raised by the 2014 article that the myriad of structural complexities that needed to be overcome for the execution of a deal was too high a bar for the beleaguered securitisation market. Secondly, when these transactions are considered alongside the Italian GACs structure and the commendable efforts of other European jurisdictions to put in place the necessary infrastructure to support these types of transactions (such as servicing laws), then we could be witnessing the early stages of a paradigm shift towards securitisation as a solution for NPL’s (as it has been for so many other asset classes). Finally, the fact that these two transactions have been put together by two major distressed debt investors could be construed as the clearest sign yet that it may in fact be the debt funds (rather than the banks) that will be the key architects of this new fixed income product.

Ultimately though, only time will tell whether we are at the humble beginnings of the establishment of a new fixed income product or whether this is just another securitisation curve-ball. Certainly from a positive perspective, given the incessant pressure on banks to off-load significant volumes of NPLs and the demonstration by these debt funds that securitisation has a role to play in distributing NPL risk, then the news of these deals is a major positive development for the European market. Despite the question marks about the future, those banks that have sizeable volumes of NPLs to shift should follow the lead of these trail blazing debt funds and embrace (or at the very least consider) this technology which has the potential to solve some of their biggest headaches.

BREXIT- Hand-over your contingency plans…

Crossing out Plan A and writing Plan B on a blackboard.

Earlier this month the Bank of England’s Prudential Regulation Authority (the ‘PRA’) wrote to all UK companies undertaking cross-border activities between the UK and the EU under passporting arrangements, requesting a summary of their Brexit contingency plans.

The letter continues the regulator’s focus on ensuring firms have robust measures and business strategies in place to respond to market turbulence.  Addressed to the CEO/Branch Manager of each company, the letter states that firms are expected to create concrete contingency plans for a variety of potential scenarios (given the wide range of possible outcomes), in light of the UK Government’s decision to trigger Article 50.  This is to ensure the safety and soundness of each company’s UK operation, and to mitigate any risk of adverse financial consequences through effective structural planning e.g. setting up a subsidiary.

Interestingly, the PRA stated that although it was aware that many of its firms were well-advanced in their Brexit planning, the adequacy of these plans appeared uneven across companies, with many not being sufficiently tested against the most adverse outcomes.  It further stated that the responses submitted by firms would be used to shape the Bank’s own plans.

The letter highlights the need for UK companies to face the physical reality of Brexit and it will be interesting to see the types of contingency plans that emerge as a result.

The Prime Minister’s decision on Tuesday to call a snap General Election will not make this task any easier, at least in the short term, as the ‘hardness’ or ‘softness’ of Brexit is once again up for grabs.

For further information please see a copy of the letter here.

Indemnities – beware the consequences of “reasonableness”

Blog - reasonableThe provision of indemnities, particularly those provided to corporate trustees and agents, is an important feature of an effectively functioning structured finance market.  It enables the parties involved to allocate the risks of unforeseen expenditure to those parties with the ultimate economic interest in the transaction and allows trustees and agents to keep their fees at a reasonable level.

Whilst the need for indemnities is generally accepted, the terms on which they are provided can be an area of robust negotiation.

A recent case in the Commercial Court has highlighted the importance of carefully drafted indemnities, in a ruling which focused on the consequences of limiting attorney fees for which a party may recover under an indemnity to “reasonable attorney fees”.

In the case, the Claimant, Euro-Asian Oil SA, contended that, as it had a letter of indemnity in place with the Defendant, Credit Suisse AG, it should be entitled to recover its legal costs in connection with a dispute, on an indemnity basis.  The Commercial Court however held that the Claimant could only recover its costs on the standard basis, as the letter of indemnity included a limitation as to the recovery of “reasonable attorney fees”.

Specifically, the letter of indemnity provided that the Defendant would “protect, indemnify and to hold you [the Claimant] harmless from and against any and all damages, costs and expenses (including reasonable attorney fees) which you [the Claimant] may suffer by reason of the shipping documents…”.  Claimant’s counsel argued that the court should give effect to the parties’ contractual agreement regarding attorney’s fees and that the word ‘including’ was expansive and non-restrictive, meaning that, taking this into account with the provision for payment of ‘any and all cost and expenses’, the indemnity should be construed as a contractual basis for indemnity costs to be awarded.

Cranston J. disagreed, first distinguishing this case from the authority relied upon by the Claimant as the indemnity in that case did not include a limitation to “reasonable attorney fees”, and, secondly, concluding that the result of the inclusion of the phrase “reasonable attorney fees” resulted in the contract not providing for indemnity costs “because they would not be reasonable”. Consequently, the Claimant’s contractual right to costs was confined to costs on a standard basis.

To grasp the import of this, a brief refresher on costs may be helpful.

In general, there are three ways such costs can be recovered.  First, following a clear contractual agreement (e.g. indemnity) the indemnifying party shall simply pay fees pursuant to the contract. However, if there is no such agreement or if such an agreement is unclear or the amount is disputed, separate legal proceedings will be required to determine how the costs of the dispute are to be borne. Where costs proceedings are initiated, the court will make its costs order on either the standard basis or on the indemnity basis.

When dealing with costs awarded in litigation, there is a presumption that costs will be assessed on the standard basis (the most common approach used by the Courts) and under it a judge will only allow the recovery of costs where they are proportionate, and either reasonably incurred or reasonable in amount. If there is any doubt about either the reasonableness or proportionality, the judge will give the paying party the benefit of that doubt.

However, in circumstances where, for example, a party’s conduct during the proceedings is found to have been egregious, the other party may request that the court makes its order for costs using the “indemnity basis”.  If the court agrees to make a costs order on this basis, there is no requirement that the costs incurred are proportionate and costs will only not be recoverable if the paying party is able to show that they have been unreasonably incurred or are unreasonable in amount.

In deciding any dispute as to the amount of costs payable pursuant to a contractual indemnity, the starting point will usually be that the costs payable under those contractual terms will be presumed to be reasonably incurred and reasonable in amount.  This is akin to an award of costs on the indemnity basis and might well result in the indemnified party recovering in full.  However, as the decision in the Euro-Asian Oil case emphasises, this is not guaranteed and the precise wording of the indemnity will be important.  In the Euro-Asian Oil case, for example, as explained above, the judge found that it would not be appropriate to award indemnity costs pursuant to a contractual indemnity for “reasonable attorney’s fees” because indemnity costs are not “reasonable”.  Therefore, the judge decided that the award would be for costs on a standard basis.

So, the result of the indemnity including the phrase “(including reasonable attorney fees)” can have significant consequences on the recoverability of costs.  If there is a dispute over the amount payable pursuant to an indemnity for “reasonable fees”, the indemnified party might be put to the test of proving that the costs claimed are reasonable and proportionate.  This may result in a far smaller recovery than would have been the case if the word “reasonable” had not been in the indemnity.

This serves as a reminder of the importance of focussing on the terms of any transaction indemnity and explains indemnified parties’ resistance to the inclusion of reasonableness qualifiers in their indemnities.

ESMA clarifies timelines for publication of credit ratings and rating outlooks

ESMA for blogCredit rating agencies (‘CRAs’) that operate in the EU will be interested to hear that on 30 March 2017, ESMA published an update to its Questions & Answers (Q&A) on the ‘CRA’ Regulation (Regulation 1060/2009, as amended in 2011 and 2013).  The CRA Regulation requires CRAs within the EU to be registered and to comply with requirements relating to their independence and avoidance of conflicts of interest, their methodologies, their disclosures and their approach to sovereign debt.  It also contains requirements on parties involved in securitisations in respect of the rating of structured finance instruments.

Further guidance on Article 10 of the CRA Regulation (covering Disclosure and Presentation of Credit Ratings) has been provided by way of an additional section to the Q&As, which can be found here.

The guidance will ensure that CRAs and rated entities are clear as to their roles and responsibilities under this provision by specifically confirming how much time a CRA should provide to a rated entity prior to the publication of a credit rating or rating outlook: 24 hours, at a minimum.  It will also protect investors by ensuring the timely publication of credit ratings and rating outlooks “without delay”.

Fairhold Securitisation – can noteholders claim advisers’ fees through the trustee?

This week saw the High Court clash between the swap provider, UBS, and the recently appointed replacement note trustee (Glas Trust Corporation) on the embattled Fairhold Securitisation.  The dispute at hand centres on whether or not the ad hoc noteholders group’s fees and expenses (comprising the fees of its financial adviser and lawyers) can be recovered from the waterfall, effectively subordinating payments to the swap providers and noteholders.  The financial adviser’s fees were reported to be in excess of £3.75m.

Followers of the Fairhold Securitisation saga will be aware of the wider dispute between noteholders and the swap providers, in which noteholders directed the note issuer to rescind the transaction’s swaps, on the basis that the note issuer was induced to enter into the swaps as a result of an alleged fraudulent misrepresentation made by swap providers.

Whilst the two day hearing on the advisory fees dispute has now concluded, judgement has been reserved, so a further update will be posted on this blog once judgement has been handed down.  The outcome will be particularly relevant for corporate trustees, investors, financial advisers and lawyers advising in the context of capital markets restructurings and disputes.

Class X litigation: Not so appealing

Following their loss at first instance in Titan Europe 2006-1 P.L.C. and others [2016] EWHC 969 (Ch) (the background to the case and our commentary can be found here), the Class X Noteholder appealed the decision in respect of the central issue in the proceedings –  when calculating the Class X Interest Rate in accordance with the Conditions, is it necessary to take account of any additional interest due under the Loans following a default? A victory for the Class X Noteholder would likely mean a substantial pay out to them over the four CMBS transactions. However, once again, the English Courts have ruled against them on the issue. In a split decision, the Court of Appeal in Credit Suisse Asset Management LLC v Titan Europe 2006-1 PLC & Ors [2016] EWCA Civ 1293 dismissed the appeal, stating (per Arden LJ) that:

In summary, I conclude that the “per annum interest rate” in the definition in the Ts & Cs of “Net Mortgage Rate” is the ordinary rate of interest payable on the underlying loans exclusive of any element of default interest. So default interest payable on the underlying loans is not to be taken into account in calculating the Class X Interest Rate. There was also commercial logic in excluding default interest.”

That conclusion was supported by Underhill LJ, who stated “I agree with Arden LJ that the phrase “per annum interest rate”, in the context in which it appears, most naturally reads as a reference to the ordinary interest rate applicable to the Loans and specified in the Offering Circular”.

In contrast, Briggs LJ reached the opposite conclusion on the construction of the relevant drafting and stated “I regard the natural meaning, in its context, of the critical phrase “the related per annum interest rate due on such Loan” as meaning the per annum rate which includes all the interest contractually due as at the relevant Payment Date under the relevant loan agreement, so that it includes what may loosely be called default interest whenever that is, or is part of, the interest rate due as at that date.  Although that outcome produces a result in the context of a serious default which bears harshly on noteholders lower in the waterfall than the Class X noteholders, that factor is insufficient to require the critical phrase to be given some restricted meaning contrary to its contextual meaning.”

Reed Smith represented the successful Issuers in each transaction. The full judgment can be found here

It is of course open to the Class X Noteholder to make an application for permission to appeal to the Supreme Court. Watch out 2017…

CMBS noteholder litigation: where do they stand?

The recent spate of litigation in CMBS transactions by noteholders to obtain interpretations of their rights directly in the English courts rather than through the note trustee raises two distinct questions: do investors have standing as a matter of both the transaction documents and general contract law to launch such proceedings and secondly should they be able to?

A typical limited recourse CMBS transaction will contain a general restriction on noteholders proceedings directly against the issuer to enforce their rights under the transaction documents (that right being reserved for the note trustee). On its face that should prohibit noteholders launching proceedings where the issuer is named as a defendant. However, depending on the wording of the clause on question, it could be argued that proceedings launched under Part 8 of the Civil Procedure Rules (“Part 8 Proceedings”) which are aimed at resolving matters of interpretation are not caught by such restrictions even if the issuer in such proceedings is technically listed as a defendant.

At law the situation is slightly different, in a global note structure an investor will hold their entitlement through the clearing systems (and related intermediaries) and while we refer to such investors as ‘noteholders’ in the colloquial sense (as such persons will be beneficially entitled to a proportion of the interest and principal paid by an issuer) they do not have a direct contractual relationship with the issuer. The actual ‘noteholder’, as a matter of contract law, is the holder of the global note and without direct rights being granted to the ultimate investors in the issuance (e.g. through additional deeds of covenant or drafting in the transaction documents), such investors will not arguably have the locus standi required to launch proceedings against as issuer (as they are not a party to the relevant contracts). In order to get around this restriction, the English courts would have to look through the global note structure and grant direct rights to the ultimate investors. The courts have been reluctant to do so and have adopted a ‘no look through’ principle (as recently affirmed, although not in a CMBS transaction, in Secure Capital SA v Credit Suisse AG [2015] EWHC 388 (Comm)) in relation to notes held in the clearing systems.

The second question is whether the ultimate investors should be able to launch Part 8 Proceedings in order to interpret certain provisions of the transaction documents. There is, of course, an advantage in achieving certainty of interpretation when it comes to ambiguous provisions of the documents and should a genuine ambiguity in interpretation arise, it is open for the relevant transaction parties to agree that it would be sensible for a noteholder to lead and indeed launch Part 8 Proceedings (rather than having a note trustee front their position). However, the obvious danger in allowing any and all ultimate investors to launch such proceedings without the consent of the other transaction parties is that multiple proceedings could be launched either simultaneously or consecutively significantly increasing the costs of the transaction and ultimately impacting junior noteholder recoveries. In addition, without the ability of the note trustee to ‘filter’ investor concerns and allegations, the process is open to abuse as investors could launch Part 8 Proceedings which do not purely deal with matters of interpretation but seek to obtain access to additional information and/or involve disputes of fact. In such circumstances, the issuance of Part 8 Proceedings would likely be disputed by the transaction parties but that in itself will come at a cost to the transaction. As in most cases, the drafting of in the individual clauses will be key. Better start reading those terms and conditions closely…

Happy Holidays all!