Seven years later, CMBS market still feels the crash
A plan by a company that controls London’s Canary Wharf to repay bonds early highlights the ambiguities in contracts that have spurred disputes with investors and hurt the commercial mortgage-backed securities market.
Canary Wharf Group Plc said it will buy back £577.9m (€728m) of top-rated notes on July 22. A unit of the property company said it believes it’s not required to pay a £169m early payment premium and will ask a court for clarification, challenging a UK bond market convention since the 1980s.
The issue sets up a possible dispute with investors as Europe’s $138bn CMBS market struggles to rebound from the 2007 real estate crash. The plunge in prices exposed the lack of clarity in documents underlying the CMBS transactions, which has spurred court actions over everything from who manages loans to the disclosure of information.
“It’s concerning that it should come down to how you interpret the language in the prospectus,” said Ian Robinson, a fund manager at F&C Asset Management in London, which oversees about $140bn and owns the Canary Wharf bonds.
“We buy bonds to match long-dated liabilities and as such are used to ensuring that we have protection in the instance that a company wants to repay the bonds early.”
Robinson said investors should receive compensation for early repayment under the so-called Spens clause, named after an English Lord. The clause requires borrowers to pay a premium to investors to make up for the money they would have otherwise received if they held the bonds to maturity.
Canary Wharf Finance II, the unit created by the parent company to issue the bonds, said its opinion is that wording of the documents allows it to buy back bonds at par plus accrued interest, according to its June 20 statement. The subsidiary plans to ask a court for clarification of whether it has to pay the premium, according to the statement.
The unit has placed £168.7m into an escrow account managed by Deutsche Bank AG to cover the possible premium from early redemption of the class A1 securities, according to the statement.
“CWG is acting in good faith to resolve an ambiguity in the documentation,” John Garwood, Canary Wharf’s company secretary, said in an emailed response to questions. “In cooperation with the trustee, Deutsche Bank, CWG has made a full deposit of funds into escrow and will be seeking a court declaration on the relevant wording.”
According to the statement, Deutsche Bank indicated to the CWG unit that it is unclear at what price the debt should be repaid. A spokesman for the German bank in London declined to comment on the transaction.
The outstanding £954.3bn of October 2033 securities have dropped almost 10pc to 109.9 pence on the pound since the company announcement. The bonds are backed by prime properties in the financial district including the London offices of Citigroup and Morgan Stanley.
Many CMBS deals with investors were agreed to at or near the peak of the real estate market in 2007.
Commercial real estate prices in the UK, Europe’s largest CMBS market, plunged 44pc from June 2007 to July 2009, according to researcher Investment Property Databank.
The decline in real estate values during the crisis left thousands of properties worth less than outstanding debt. This encouraged managers of the securities to defer working out bad loans and fuelled legal skirmishes with investors, who now face losses and years of uncertainty over how much money they will get back.
The property crash was the first test of CMBS documents by severe market stress, said Conor Downey, a partner specialising in real estate finance at law firm Paul Hastings in London.
Plunging prices brought to light “glitches” in documents that define outcomes for the debt, he said.
About eight legal cases based on disputes over interpretations of contracts have come to the courts involving investors, loan managers and CMBS issuers, said Downey. About three times that number of conflicts were probably settled privately, he said.
“You can have a bond with really good underlying assets, but a lot depends on who owns them, what they want to do with them and what the documents say,” said Chandra Gopinathan, structured products analyst and consultant to Rogge Global Partners. “There is a lot of ambiguity about what you will be paid.”
A battle between different classes of bondholders over who had the right to replace the manager of a loan packaged into about $1bn of CMBS financing for about 270 nursing homes in the UK was settled by a London judge in April. Anchorage Capital Group LLC, which owns part of the riskiest portion of the bonds, argued the documents granted the right to the lowest class of notes, while senior bondholders including BlackRock said that was not the case. The judge ruled against Anchorage Capital.
A lack of clarity in CMBS documents was cited by CBRE Loan Servicing Ltd in April as the reason for seeking court guidance on the order it should pay investors in bonds financing shopping malls in cities including Birmingham and Leeds. CBRE is the loan manager of that £850.4m Gemini Eclipse 2006-3 Plc transaction, according to a statement to the London Stock Exchange in April.
“The crisis showed that legacy CMBS documentation was not only complex, heterogeneous and voluminous, but in many cases also unclear or even contradictory,” said Peter Cosmetatos, chief executive officer of the London-based Commercial Real Estate Finance Council Europe. “The industry recognises that must change if we are to rebuild confidence in CMBS and see a revival of new issuance.”
Annual CMBS sales have averaged about €3.7bn since 2009, down from €39.9bn in 2007.
Sales totalled just €752m in the first half of 2014, according to JPMorgan Chase.
Investors in the Canary Wharf bonds are counting on the Spens clause for protection against losses.
The clause was developed in the early part of the last century to ensure that holders of cumulative preference shares, a type of preferred stock, were not disadvantaged if the shares were trading at a premium when they were redeemed, according to Claude Brown, a partner at Reed Smith in London. The concept was applied to listed shares in the 1960s and translated to bonds in the late 1980s, Brown said.
Under the clause, if bonds are bought back before maturity, the investor receives sufficient compensation to allow it to obtain the same cash flows by re-investing in risk-free gilts, according to the UK Treasury. Pension funds and insurance companies that buy long-dated securities to match the maturity of their liabilities rely on it to avoid losses.
“The clause exists to help make bonds attractive to pension and insurance companies,” said Downey, the law partner.
“If they are repaid early, they are compensated for the fixed-income stream they will lose.”
Canary Wharf Group raised the funds for the early redemption by selling 10 Upper Bank Street, the 32-storey London headquarters of Clifford Chance LLP, to Chinese and Qatari investors last month, according to the June 20 statement.
Aviva, Legal & General Group Plc and Lloyds Banking Group are the biggest holders of the debt. Fund managers at these firms declined to comment. An initiative led by CREFC Europe, a trade association, to establish best practices in European CMBS, dubbed CMBS 2.0, was introduced in 2012. It includes a focus on simpler and clearer documentation for the deals.
The proposals are designed to remove barriers to investment and provide greater transparency on the way deals are structured and managed.
“The CMBS industry has through the CMBS 2.0 guidelines sought to learn the lessons of this and to establish standards for new deals,” said Downey. (Bloomberg)
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