Buying your own debt

Owning the debt in your own transaction sounds interesting if you can buy it at a discount. But do the banks want to play ball? By Robin Marriott

For a time, it seemed as though firms buying their own debt in real estate investments would become commonplace, but the “opportunity” has not panned out that way in Europe.

While there have been more examples from the LBO world in the US, in Europe the trend has been less certain, and almost non-existent in real estate.

The possibility in Europe was first highlighted by Danish telecoms company TDC in April this year when it purchased €200 million ($297 million) of its own debt at markets rates of about 90 to 95 cents in the euro. The move by TDC's owners – private equity firms Apax Partners, The Blackstone Group, Kohlberg Kravis Roberts, Permira and Providence Equity Partners – was as notable not just for its opportunism but for upsetting the lenders. In a high profile way, it raised the question of when does such a thing breach the loan agreement, which traditionally places strict limits on who is allowed to buy debt and on how excess cash in a company can be used. On an ethical level, lawyers at Kirkland & Ellis told the Financial Times newspaper that it was “just not cricket.”

“There seems to be an opportunity out there with certain banks who would love liquidity. I am sure we will see more of it.”

Such a high profile example though also had another effect: it encouraged private equity real estate firms to analyze whether they could do the same thing. It seemed like the obvious move. Yet in the following five months there have been no reported instances of it happening. Why?

According to a number of market practitioners PERE has spoken to, there are a few good reasons why. One is that many of the loans that were once syndicated or securitized have prohibitions on selling parts of the capital structure to the borrower. Secondly, banks are understandably reluctant to sell to borrowers because they hate the idea of issuing a loan and immediately seeing the borrower benefit at the bank's expense. Thirdly, the banks haven't really written down loans to where the paper will trade on the market, and fourthly, banks have provided non-recourse lending to borrowers buying back private equity loans but have not done this in real estate, yet.

There is also, perhaps, a fifth reason, which is more to do with the perception of real estate funds. As Matt Probert at Ernst & Young's London real estate funds team says: “At the moment there is a desire to be seen as good, old-fashioned asset managers rather than financial engineers. Added to that is their own, and the bank's desire, not to draw attention to such transactions if they do happen.”

PERE has spoken to three firms considering buying back their debt. One partner approached a lender, but got zero response. “Buying our own debt is certainly something we have been thinking about,” he said. “If we could buy our own debt back at a discount we would be keen to do so in certain situations. But there haven't been that many debt sales generally and it is completely up to the lenders,” he added.

However, to an extent, we have seen it happening – in the public arena at least. Last month, major UK shopping center owner, Liberty International, bought £110 million ($206 million; €139 million) of commercial mortgage backed securities relating to some of its shopping centers. Anecdotal evidence also suggests some banks are talking with borrowers. A principal told PERE when his firm pursues possible debt investments the banks sometimes says they are in negotiations with the borrowers.

Another well placed source said that it wasn't an area his firm was focused on, it had nevertheless been offered a piece of its own debt at a discount and found the opportunity very interesting. “There seems to be an opportunity out there with certain banks who would love liquidity,” he said, adding: “I am sure we will see more of it.”

Of course, these are not representative of an avalanche of opportunities. Instead the loans seem to be stuck up a mountain. In general, banks with balance sheet issues are finding ways to improve liquidity via rights issues and other capital raising functions, so their need to sell real estate loans at a discount does not seem all that urgent. Whether we will see any real volume depends more on the banks than anything else.

Blackstone raises $3bn for Europe fund
The Blackstone Group is in the “final stages” of closing its latest European real estate fund on $3 billion (€1.95 billion), the firm's president and chief operating officer Tony James said last month. Unveiling the New York-based private equity real estate firm's second quarter earnings, James said Blackstone had enjoyed a “very successful” fundraise for Blackstone Real Estate Partners Europe III, revealing that to date it had closed on about $3 billion. James said Blackstone was focusing on distressed real estate assets and distressed sellers of real estate, but warned during the conference call that the firm would wait to buy in the US, arguing it “will be cheaper later.”

ING launches €1bn FoFs
ING Real Estate has launched a global fund of funds, Global Osiris, with plans to attract €1 billion ($1.5 billion) of capital within 12 to 18 months. ING Real Estate Select, ING Group's property fund of funds business, said Global Osiris would be structured as an open-ended vehicle targeting returns of up to eight percent by investing in unlisted real estate funds in markets around the world. The firm also revealed that Global Osiris had attracted £150 million seed capital from the London Pension Fund Authority. Vanessa James, investment director at the London Pension Fund Authority, the largest local government pension scheme in London, said the fund had held a beauty parade of real estate fund managers offering global property exposure.

Ex-Lehman bankers set up UK fund
Real Estate Venture Capital Management (Revcap) and Kilmartin Property Group have launched a central London opportunity fund. Kilmartin London Partners, a 50/50 joint venture, has raised initial equity of £10 million (€12 million; $19 million), which, when geared, will provide it with around £40 million of firepower. The joint venture partners said in a statement there was considerable potential for value creation in central London despite challenging market conditions. The strategy is to identify commercial real estate assets, in lot sizes of between £5 million to £30 million, in areas of London where a combination of low supply and good growth potential exists. Revcap was established in 2004 by former Lehman bankers Andrew Pettit and William Killick, with offices in London and Paris.

Fortress to build €5bn Italian fund business
The US alternative asset manager, Fortress Investment Group, has announced a joint venture with a subsidiary of Italian banking giant, UniCredit, to grow a real estate fund management business in the country. Fortress is making the move via its Italian affiliate, Torre, according to a statement. Under the terms of the deal, UniCredit's subsidiary, Pioneer Investment Management, has agreed to transfer its real estate fund management business to Torre and will retain a 37.5 percent stake in the venture. The remaining 62.5 percent will be owned by Fortezza, a subsidiary of Fortress. The partners are hoping to amass €5 billion ($7.7 billion) of assets under management.