The Goldman Sachs team: Ben Green, Sarika Singh, Elena Paitra, Rob Ritchie (standing) Martin Wiwen-Nilsson
Since the Lehman collapse, selling commercial mortgage-backed securities has not been considered a worthwhile venture. It took some innovative thinking by Goldman Sachs, on behalf of UK supermarket chain Tesco, to prove otherwise. Writer Edward Russell-Walling
'Property' has been a bad word in the markets, and 'structured finance' or 'securitisation' are worse. So how on earth do you sell commercial mortgage-backed securities? By building them to look like corporate credits, in the way that Goldman Sachs has been doing for Tesco.
The UK's largest supermarket chain, Tesco has a property portfolio worth some £30bn ($49bn) at current market values. Unlike some of its rivals, it did not securitise most or all of that while market conditions allowed. But it did begin a sale and leaseback programme in 2004, when it securitised 33 supermarkets and two distribution centres to raise £632.5m in three credit tranches of 30-year bonds. The issuer was Delamare Finance, a 50:50 joint venture between Tesco and property developers Topland.
Sale and leaseback plan
In 2006, the store group announced its intention to release more cash from its property in similar fashion, internationally as well as in the UK. Though intending to maintain an overall asset mix of 70% freehold tenure, Tesco said it would raise up to £5bn through sale and leaseback over the next five years.
Before it could do much more, the credit crunch arrived and the CMBS market ceased to exist. Between then and June this year, the company has been able to place a number of smaller sale and leaseback transactions with single pension funds. "Pricing has held up well on those, but Tesco found it challenging to execute very large sale and leaseback transactions," says Ben Green, Goldman Sachs executive director for structured finance.
As he points out, these are very cost-sensitive deals, and only worth undertaking if acceptable yields can be achieved. "The key is to figure out the most efficient financing package to put into the acquisition vehicle," says Mr Green. Pre-crunch, cheap bank loans could be used to fund up to three-quarters of the purchase price, with the balance funded by equity - also cheap.
"That made for a very attractive transaction," says Mr Green. "But now you could only get a bank loan for, say, 60% and it would be much more expensive, leaving 40% equity, which is also much more expensive. So the pricing of sale and leaseback on that basis does not make sense."
But Tesco still wanted to get on with its programme of releasing capital from the mature stores on its balance sheet, and that meant increasing the volumes. It was back in the summer of 2008, even before the Lehman Brothers collapse, that Tesco and Goldman Sachs began to talk about finding ways around this situation. Those discussions included where those large pools of capital were most likely to be found.
"Historically, banks were big investors in structured asset-backed financings," says Martin Wiwen-Nilsson, co-head of investment grade debt capital markets (DCM) and the fixed income, currency and commodities derivatives team at Goldman Sachs. "But banks have much less appetite for real estate and structured assets today, so that market is no longer there."
Aggregating interest
Where was the market, and what was the best format with which to access it? There were clearly institutional pockets of interest in sale and leaseback deals, as evidenced by the small transactions Tesco was making. "The question was: could we aggregate that interest into a distributable security with price tension?" says Robert Ritchie, co-head of Goldman's corporate DCM business in Europe.
Given that institutional asset allocations - and hence liquidity - for fixed income are invariably much larger than those for property, it made sense to create a tradeable fixed income security that addressed investor concerns with traditional CMBSs. "CMBS are fundamentally predicated on what the underlying property value will be when the loan matures," says Mr Green.
Today, it is difficult to persuade investors to buy into a particular real estate value in five or seven years' time. "That's a problem, because you have to believe there will be enough liquidity in the system at that point to be able to refinance or sell that value," says Mr Green. "So we created a fundamentally different structure, based on the cashflow underlying the lease."
The result was an instrument that looked less like a property asset and more like a corporate credit - a proxy for Tesco risk. Simplicity was an important objective, and the team drew on the much earlier model of credit tenant lease securitisations which helped to get this market going in the UK. The result is a single-tranche, 30-year sterling bond in which the principal and interest payments come from rental income guaranteed by Tesco. In the first issue, from Tesco Property Finance 1 (TPF1), the bondholders have security over more than 12 supermarkets and two distribution centres. "But the purchase is fully amortised over 30 years," says Mr Green. "So as long as Tesco performs, investors don't have to take a view on property."
The bonds were credit-linked to Tesco's own A3/A- rating, and the company retains some exposure by owning 50% of the property vehicle. The structure is not entirely revolutionary. The BBC did a couple of similar deals earlier in the decade, one of them involving the sale of its iconic Television Centre in west London. But the BBC used monoline wrappers to enhance ratings, an absolutely no-go area today.
New structures
If enhancement is a big issue with investors, so, post-Lehman, is counterparty risk. A major departure from the BBC transactions is that TPF1's swap counterparty is Tesco itself, not a financial institution.
Early in June this year, the Goldman team sounded out investors on a no-names basis. "They told us that 'structure' was not necessarily a dirty word," says Mr Ritchie. "It just had to be the right structure." They did, however, want to see a liquid and tradeable security, and they wanted it posted on Bloomberg under the Tesco corporate ticker.
The structure in its final form was then road-showed in the UK for three days, with Tesco's chief financial officer on parade throughout. "We wanted to make sure that investors bought into the idea that the bond was Tesco-like, but structured," says Elaine Paitra, Goldman's head of corporate syndicate for Europe.
The technicals in the corporate bond market worked in Tesco's favour, with gilts and corporate spreads rallying, and sterling issuance shortening. Last year, new sterling corporate paper with maturities of more than 20 years made up 47% of the whole, but this year it is down to 30%, according to DCM Analytics.
Healthy returns
Having committed to make markets in the securities, Goldman Sachs was sole structurer and bookrunner. The £430.65m TPF1 deal was announced on 16 June and priced the following day. It attracted nearly 60 accounts - overwhelmingly institutional and considerably more than expected - and orders of £1.3bn. With a coupon of 7.6227%, it was priced at 330 basis points (bps) over gilts, off a guidance range of 330bps to 350bps. "That implied a structuring premium of 120bps over Tesco's plain vanilla paper," says Ms Paitra.
The deal performed well in the secondary market, and investor disappointment over allocations prompted a growing number of reverse enquiries. That led to Tesco Property Finance 2 (TPF2), announced on 15 September and priced the following day. With essentially the same structure as TPF1, TPF2 needed no roadshow. While the Tesco property team made itself available for calls, none came.
TPF2 raised £564.5m with a coupon of 6.0517%, representing a considerably tighter spread of 220bps. By now, TPF1 was trading at 210bps over gilts, so that was a new issue premium of virtually nothing. Again, £1.3bn of orders were booked, and both issues subsequently traded down to between 200bps and 205bps.
"It's not a wholesale reopening of the property refinancing market, but TPF1 was the first structured deal sold to the market since 2007," says Mr Green.
Mr Wiwen-Nilsson believes there will be similar transactions to come. "And the way they are structured is transportable to other asset classes," he says.
It is, Ms Paitra concludes, an issuer's market. "If an issuer brings a deal to the sale and leaseback market, we're confident that we can price it," she says. "That wasn't so six months ago."
