LandAid - The property industry charity - together we can do more

The CBRE Property Peak Challenge in aid of LandAid and The Chartered Surveyors’ Livery is nearly upon us and we are delighted to have two teams from the Association of Property Bankers taking part.

Alongside the APB teams we are expecting 300 participants from throughout the property industry to compete in the race to the top of the Heron Tower. Funds raised by the event will be split between LandAid, the property industry charity and The Charitable Trust of the Chartered Surveyors' Livery Company to fund projects that help disadvantaged young people achieve their potential.

Helping disadvantaged young people achieve their potential…
The work of LandAid’s could not be more current given as we rely on the private sector to create economic growth in our cities and with youth unemployment at 22% nationally. The continued growth of our Foundation Partner Scheme (51+ leading property organisations giving £10,000 a year over three years), and our association with a number of industry bodies, including the APB, through the Industry Patron Scheme has enabled us to invest more than £2million in over 30 building projects across the UK in the last three years.

We hope to raise in excess of £1million by the end of this year alone so that we can continue to establish a network of LandAid funded centres around the UK where young people can learn and progress in a safe and welcoming environment.

However, it’s not only about the money, increasingly LandAid is providing pro bono professional services to its charity partners as well. One such example is in Merseyside where a new Prince’s Trust youth centre will be opening its doors to 240 young people in April. LandAid has contributed a lead donation of £50,000 and added value by securing generous additional funding of £21,000 from Redevco as well as pro bono services from Knight Frank, Gardiner & Theobald and Grosvenor equivalent in value to a further £40,000.

In London LandAid has helped the youth homelessness charity, Centrepoint with the consolidation of its head office floor space from two floors to one. LandAid was able to introduce the charity to Telereal Trillium who have managed the process and saved Centrepoint an estimated £50,000 through smart procurement.

Chartered Surveyors' Livery Company
Chartered Surveyors' Livery Company will use their share of the funds raised by the CBRE Property Peak Challenge to support their bursary scheme which helps deserving young people from selected inner city London schools in deprived areas go to university. Their scheme has been a great success and it makes a real difference to the lives of young people. Last year their first graduate emerged from University with a law degree and they now support 12 students. ¬¬¬

As the new Chief Executive of LandAid I join at a very exciting time. There is huge potential for us to increase our impact as a Charity to help young and disadvantaged in an era of increasing need and the unique role the property industry can play is self-evident. We are therefore hugely grateful to the support of the APB and its members.

What are your ideas about how property investments and the industry can deliver wider social and community objectives? We would love to hear from you about how you would like to get involved corporately or individually.

Good luck to those of you taking part on the 23rd February, see you on the 36th floor.

Joanna Averley
Chief Executive of LandAid
Tel: 07748 966718
Email: joanna.averley@landaid.org
Twitter: @joannaaverley
Web: www.landaid.org

Strategic advice from your property advisor – useful or not?

The questions banks should be asking and the service they should be getting

The issue that has been exercising banking and property advisor’s minds is how to deal with the overhang of property related debts. There are broadly 4 options; firstly a restructure of the existing debt with the borrower in place; secondly, a consensual sale of the asset; thirdly enforcement action with the appointment of LPA Receiver or an Administrator or finally the sale of the debt. Clearly the starting point is a review of the property and this, frequently involves an external property adviser. Traditionally the question most frequently asked was about the value of the asset. However, lenders increasingly require a much more sophisticated product which encapsulates anticipated market movements, material cashflow events, sale strategy, asset management and crucially the time to complete these.

Where is the asset relative to the competition?

The heart of the matter is assessing and articulating what are the issues relevant to a property. For example if it is worth £10 today could that move to £15 – and if so how would that be achieved – or is it more likely to head towards £5 in which case what steps can be taken to mitigate or avoid the decrease. In order to address these issues the advisor needs to deal with both the strategic and tactical aspects.

Establishing the value of property in today’s terms is the first step. This provides an understanding of not only the current value and prospects of a property but also the future potential. To do this there needs to be an analysis of how a property sits in the local market but also how it relates to the wider market.

In simple terms this analysis at the ‘micro level’ will assess the quality of the property in terms of location, building and tenant quality (if occupied) relative to its peer group as well as the supply and demand side issues.

Red flag events

Having established the base point the interesting bit is to see where a property looks like moving on the value/pricing gradient. DTZ looks at each property to establish whether there are any ‘Red flag’ cashflow events such as lease expiries, tenant break options or likely tenant failures which would lead to vacancy. Crucially by involving leasing experts to advise on reletting timescales, likely lease terms including rent free and capital contributions. This enables a detailed cash flow analysis to be constructed which can be sensitised to enable scenario development. Clearly the length of time a space is vacant will determine the amount of income foregone but also results in operating income shortfalls as the owner is required to fund the empty rates and the unrecoverable service charge. The cost of refurbishing the space also needs to be considered not only from the aspect of cost vs rental return but also whether in fact it is a necessity in order to achieve a letting ie it is required as a defensive measure rather than as a value enhancing tactic. Decisions that flow from this includes those on timing, whether find a tenant and then do the works, do a show suite and then market or any other viable market strategy. Advice should include input where necessary from building specialists.

Getting the right advice on planning

When we are looking at sites or where alternative uses are being considered, getting advice from specialists is essential particularly against a changing planning environment. Understanding the possible vs the fanciful is important in order to arrive at a conclusion regarding the strategy for the site and it is at this point that the bank may be reaching initial conclusions regarding the borrower. In providing this advice, sensible attempts to quantify the likelihood of success should be articulated in order to enable an assessment of risk against reward. Timing and the cost of the planning process are also essential items – these drive requirements relating to extensions of existing debt facilities. In reviewing sites where we have been involved we have sought to provide a range of scenarios related to the potential alternative outcomes and the impact these have on potential exit prices but also the timing of these. Viability of the schemes needs to be assessed – planning being only part of the issue. There is no tactical or strategic sense in getting consent for an office building for which there is no demand either due to location, existing supply overhang.

Protecting the cash-flow

We recognise that the protection of the cashflow generated by a property is essential not only in terms of servicing the existing loan but also for protecting the longer term value of the property. The preparation of detailed cash flows with the ability to flex the inputs in order to demonstrate the potential impact of multiple scenarios provides banks with the opportunity to understand the impact on loan servicing over a range of scenarios. This also provides the opportunity to identify asset management opportunities or ‘must do’ initiatives. The latter relates to items that need to be executed due to the sensitivity of the cashflow to a particular event such as lease expiry or reletting following refurbishment. Key is determining future capex requirements how that will be funded whether it is a defensive spend or income enhancing. Experience suggests that there are some borrowers who clearly have the skills to act on these initiatives while others do not or have other priorities.

Identifying when to exit

Timing a sale to maximise proceeds is in the forefront of the minds of banks where the loan exceeds the value of the property. It is important to assess the decision in the context of the anticipated direction of travel of the market will move. The appetite of purchasers and their mindset is a very clear influencing factor and the inclusion of the investment agency team provides valuable insight in this respect. As indeed is their advice regarding the method and approach for sale.

In the short term hold scenario with a view to sell inside 12 months one of the options to consider are the preparation of a disposal pack to include:

• Report on title

• Detailed planning report

• Environmental report

• Site plans

The advantage is an accelerated due diligence process for bidders and reduced costs thereby encouraging a wide pool of potential purchasers to assess the property.

Where sites are being sold where there is potential higher values alternative uses, advice provided should address the merits of a straight sale vs retaining some overage position or whether a joint venture would provide a solution.

In the longer term hold scenario the key focus is on the initiatives that need to be executed in order to get the property ‘oven ready’ for sale. This might include some or all of the following:

• planning applications to be made and consent granted
• lease re-gears
• letting of vacant space

In order for these to represent a valid business plan each action point needs to have a timeline attached to it. This enables a consistent basis for monitoring progress and to act as an early warning if key dates are missed.

Conclusion

Secondary market properties dominate banks loan books and what is absolutely true is that each property has to be reviewed on its own merits. Generalisations can frequently be misleading. In order to make a difference to the final outcome you need a team with an understanding of the issues and who can provide commercial but well reasoned advice. The team needs to draw together all the relevant strands but also crucially have experience in providing this advice and understand the issues. It is important for the bank to assess the relative merits of the available options and the only way this is possible is for the advice to be provided to not only be comprehensive but also assumption explicit.

About the author

Charles Smith MRICS- Head of Valuation, London, DTZ
T: 020 3296 4411
M: 07768 065 419
E: charles.smith@dtz.com

A new approach to real estate due diligence

Can you answer yes to any of the following?

• Fed up with clients complaining about the amount of the bank’s legal fees?
• Ever been asked why you want to carry out your own due diligence instead of just accepting the borrower’s solicitor’s title report?
• Disappointed at the length of time lawyers take to get to close on a real estate lending deal?
• Believe that by paying your lawyers to carry out real estate due diligence, you are buying the benefit of their PI insurance?
• Have you ever thought there ought to be a quicker, cheaper, easier alternative way to get to close?

If so, then please read on.

Background

The traditional approach in the UK to the property transfer process and to secured lending often involves numerous firms of solicitors duplicating due diligence already carried out by others, as each stakeholder in the process (the site owner/developer/acquisition funder/development funder/ end purchaser/unit tenant/investment funder/ residential mortgagee etc.) seeks to protect its own personal interest. This is most likely to arise in any situation where the intention of the owner or developer is to split up and sub divide a single property into numerous separate leasehold or freehold interests (such as in the case of a new housing development, an apartment complex, a shopping centre, an industrial park etc.).

In the current economic climate business is being encouraged to consider new and better ways of doing things, rather than just sticking to doing what we have always done. In this brave new world where the interests of the consumer are paramount, and TCF (treating customers fairly) is the modern banking mantra, Intelligent Real Estate Due Diligence Limited (iREDD) has developed and is promoting, a modern approach to the use of insurance; (i) to expedite the real estate transfer process; (ii) to simplify the due diligence process; and (iii) to indemnify parties to a transaction without compromising security or value. By adopting this approach significant cost savings can be achieved over the lifetime of a project for the benefit of all parties.

Together with our commercial partner JLT Specialty Limited, iREDD will work with the parties to ensure the proper management of legal risks arising in connection with the acquisition, or taking of security over real estate, so that these real estate risks are effectively transferred to an investment grade, “A” rated European insurer. By properly managing the real estate legal risks, so that these are borne by an insurer better able to bear the same, the Lender secures greater protection.

Under a conventional approach to real estate due diligence, in the event of a loss a Lender may have recourse to its legal advisers backed by their PI insurance but only if it can first prove the legal advisers were negligent – never easy because the PI insurer will act to protect the lawyer and will use every means to oppose the claim.

Under the iREDD approach, we believe that a party wishing to have the benefit of insurance should pay an insurance premium for insurance protection and such party should pay legal fees for legal advice. When it comes to insurable real estate risks, a Lender will secure greater protection by relying on an insurer which has been paid to protect the Lender’s interest, than it will secure by seeking to rely upon a lawyer’s PI insurance, which was effected to to protect the lawyer.


2. How does the iREDD approach work?

A bank making a secured loan to fund a real estate transaction will conventionally require its own solicitors to carry out real estate due diligence on its behalf. Often, the same or substantially similar due diligence may previously have been carried out for the benefit of the Borrower, but the lender will generally require that this be refreshed and/or repeated. Reasons given often include; that the existing due diligence is out of date; or considered defective; or cannot be relied on by the lender because it was carried out by or for the benefit of another party.

Where brought in to assist on a real estate transaction iREDD will work with the parties and the identified insurer to properly assess the quality and value of any due diligence as may already exist, regardless of the identity of the party for whom it was carried out. Having regard to this available due diligence and in consultation with the Lender, the Owner and other relevant parties, iREDD will facilitate an acceptable due diligence strategy. iREDD will consider with the parties (having regard to the nature of the property being developed/charged) whether new/additional searches are absolutely necessary, or whether appropriate insurance is available and can be used for example, to replace or supplement old or missing searches, so as to meet and address any particular concerns or requirements of the Lender. By ensuring that real estate risks are effectively transferred to an investment grade, “A” rated European insurer the Lender will have greater protection and easier and quicker recourse in the event of a claim arising.

Where insurance is placed for the benefit of a lender (“Lender Protection Insurance”) the insurance arrangements will commence on drawdown of the loan and provide cover for the Lender in respect of the amount of the loan outstanding from time to time until the date of redemption. The insurance will protect the Lender, if the Property, as a consequence of an insured risk, suffers a reduction in market value or the Lender suffers a shortfall (loss) in expected recovery following the exercise of its security and the realisation of the charged property.

The precise details and extent of the cover can be tailored in each case to suit the particular needs and requirements of the parties. However, it would be usual for such Lender Protection Insurance to incorporate cover, for the benefit of the Lender against the risk of the charged property not having a “Good and Marketable” title and will incorporate protection for the Lender against any loss being sustained by the Lender should the charge be declared void or voidable as a consequence of any adverse matter insured against. Additional heads of risk, such as environmental risks and the existence of any latent defects in the property, are also available and can be incorporated, relatively easily and inexpensively.

3. Pricing is surprisingly cheap

The cost of effecting a standard Lender’s Protection Insurance, will be a single once-only premium paid by the borrower (but which can be financed as part of any development financing) so that premium installments can be geared to be consistent with an agreed drawdown schedule and the level of the insured indemnity geared to be consistent with ongoing project valuations and loan financial covenants. Typically the cost of such insurance, effected for the benefit of a Lender alone, will be cheaper than a similar policy effected for the benefit of the owner itself and its successors. In either case however, this type of cover is relatively inexpensive compared to the significant legal fees which can often arise for carrying out “defensive”, real estate due diligence.

4. Summary of Benefits of the iREDD approach

• The need for costly, repetitive title examination, searches and enquiries and other “usual” real estate due diligence can be avoided rendering subsequent transfers of the property /or of the bank’s debt easier and quicker.

• All parties (lender and borrower) benefit from a reduction in the time taken for transactions to complete and from associated cost savings.

• The lending and drawdown processes can be made smoother and simpler for the benefit of both lender and borrower as the need of the bank’s lawyer to certify / investigate real estate is supplanted by the independent insurance policy.

• Both the lender and borrower will achieve greater certainty and security.

• The existence and backing of the transaction by a well rated insurer will be particularly helpful should the Lender ever be desirous of securitising its loan book.

• In the event of an insured loss a simple claims procedure exists. There is no requirement on the bank to litigate against legal advisers to prove negligence, as would be the case if seeking to recover under a lawyer’s PI policy.


5. iREDD Core Values

• iREDD is committed to :

- minimising or removing unnecessary duplication of legal due diligence by the use of appropriate insurance indemnities, so as to save time and associated cost for all parties and

- working with relevant parties to identify and analyse relevant risks and to assess what is the most appropriate legal structure

• iREDD believes that legal advisers should be paid for providing legal advice and not for acting as insurers - insurance premiums for insurance protection and legal fees for legal advice.

• iREDD considers that insurable real estate risks are better placed with an insurer which is acting for the benefit of the lender.

• iREDD is convinced that the modern real estate industry deserves a new approach to simplify and expedite the real estate transfer process without compromising security or value.

Contact details

Should you be interested in finding out more about this approach, the benefits and how it might help you, please contact any member of the Intelligent Real Estate Due Diligence Limited team.

Intelligent Real Estate Due Diligence Limited
23 Austin Friars,
London,
EC2N 2QP
T +44 (0) 845 118 0049

Mr Moz Gamble
Director
M +44 (0) 7788 410648
mgamble@iredd.eu

Mr Robert McNally
General Counsel
M +44 (0) 7980 756218
rmcnally@iredd.eu

Light at the end of the recruitment tunnel

Whilst the challenges faced by the UK real estate market over the past couple of years are well-documented, from a recruitment point of view there does seem to be light at the end of the tunnel.

So who were the biggest hirers in UK real estate in 2010 and where is there going to be most demand in 2011? What types of vacancies did we see in 2010 and what vacancies are going to be vogue in 2011? And finally, how have the events of the past couple of years affected compensation levels?

Readers of this blog will be pleased to hear that banks were the biggest recruiters by volume, in UK real estate in 2010 with that trend set to continue in 2011. This makes sense given the huge volume of redundancies by banks in 2008 and 2009 and the need to bolster fairly lean teams as we move into more positive territory following the credit crunch. Whilst recruitment volumes are lower compared to the lofty heights of the peak in 2006 and 2007, it is not all doom and gloom as some readers may think and feel.

I’m sure it will be no great surprise that by volume, the majority of vacancies over the past twelve months have been in debt restructuring, risk management and portfolio management. That said, towards the latter parts of 2010 we started to see surprisingly high demand for bankers in relationship management and even debt origination roles, relative to the amount of lending actually being done in the real estate market. As it stands, we know of at least five banks actively recruiting in relationship management and origination here in the UK.

Recruitment in the debt restructuring world has followed an interesting three phase cycle beginning in the second half of 2008 when one or two banks anticipated early the challenges faced in the debt markets and started hiring externally in modest volumes.

This volume dramatically increased by the end of 2008 and by 2009, demand for workout bankers, was at an all-time high. The majority of restructuring vacancies in this second phase of the cycle were being filled internally through redeployment from origination, relationship management and credit risk teams with the odd sporadic external hire. It was difficult during this second phase in the cycle to gain employment in restructuring through a third party recruiter, the most effective way for candidates to secure employment was by approaching banks directly. The exception at this time were smaller representative or branch offices of international banks who did not have the luxury of redeploying hundreds of property bankers internally into restructuring roles. Being small by nature, such institutions did not hire in high volumes compared with their UK counterparts and appointed recruitment firms to hire on their behalf.

In the second half of 2010 we started to see banks looking externally to recruit restructuring bankers again, as market stability returned. This signified phase three of the restructuring recruitment cycle. Staff that had been loyal during the credit crunch doing restructuring were starting to resign, disappointed at poor bonuses, lack of strategic direction and limited internal communication. These people needed to be replaced and the larger banks started appointing recruitment firms again to search on their behalf. We are still in this third phase of the cycle and it is expected that banks will continue to need staff in restructuring for at least the next three years as they continue to work through challenging lending cases. It is unlikely that recruitment volumes in restructuring will reach the lofty demand of 2008 and 2009 as such roles have a finite shelf life. The question then is what job opportunities will be available to bankers after three to five years in restructuring?

If the recent increase in the volume of relationship management and origination vacancies is anything to go by, perhaps banks will redeploy everyone back into the front office and we will all wake up and think the last couple of years were a bad dream? With the major banks shrinking their real estate balance sheets and some international players pulling out of the market altogether, this seems unlikely. Who then, will employ restructuring bankers going forward? The most likely scenario seems to be a balance between jobs in relationship management, origination, portfolio management and credit risk management. For real estate finance high flyers, there have been and will continue to be opportunities in mezzanine finance on the buy side, although such firms are small and hence recruitment volumes are low. It will be interesting to see the impact that pension firms make on the market from a senior debt lending perspective as this will directly affect their ability to hire in the UK. Finally, question marks remain around the future of securitisation and whether opportunities will present themselves any time soon in this market. Whilst there were a few hires last year in securitisation by one or two investment banks, in reality these people have been hired to manage residual CMBS and RMBS books down. Until we see a successful CMBS transaction take place it is unlikely banks will invest in this market and when they do it is expected recruitment volumes will be low as small teams are already in place. Timing-wise it seems likely recruitment in securitisation will only happen in the second half of 2011 if the greatly anticipated first deal is done.

It is difficult to label in broad brush terms the change in remuneration levels over the past twelve months given that the circumstance of each individual and institution has been different. That said, on average basic salaries within investment banks have increased by up to 50% between vice president and managing director level to compensate reduced bonus levels. By comparison, basic salaries within corporate banks have increased by 20% - 30% at director and managing director level, again to compensate lower bonuses. At time of writing, banks are in the process of thinking about and announcing bonuses and with all the re-basing exercises that have happened recently, it is impossible to see what impact this will have on bonus levels until they have actually been announced and paid. On average, it is expected that total compensation will be 20% - 30% down from the lofty heights of 2006 and 2007 across both corporate and investment banking, related to both the institution and individual.

So what does 2011 have in store for the real estate market from an employment perspective? Whilst the tone of this blog is positive as we saw a lot of opportunity last year, the reality is that 2011 will be challenging. The obvious demand will continue to be in restructuring, risk management and portfolio management as banks replace staff that leave. There will also be opportunities in relationship management and origination in small volumes. If the securitisation market does come back this year hiring will only happen around September or October time as banks prepare their budgets for 2012. And finally, there will be demand from the insurers and mezzanine finance houses in small numbers.

John Lenz

Director

Caravel Search

john.lenz@caravelsearch.com

Will borrower hedging be ditched?

Interest rate hedging has been an essential element of most real estate finance transactions in recent years.

Typically the borrower enters into a swap with the lender which transforms all or part of a Libor linked loan into a fixed rate transaction. In some cases, the borrower may be permitted to hedge with a counterparty other than the lending bank.

All this may change as a result of a draft regulation on derivative transactions which was published by the European Commission in September and amended by the Council of Europe in a series of compromise proposals. The following is based on the latest compromise proposal.

Summary

• Borrowers which are “financial counterparties” will be required to clear swaps through a central counterparty (CCP).

• Borrowers which are “non financial counterparties” whose volume of trades exceeds a threshold will also be required to clear swaps through a CCP.

• Swaps with other borrowers will be subject to as yet unspecified risk management rules.

• Hedging through a borrower swap may be replaced by fixed rate loan agreements hedged by the lender with another financial institution.

• Borrowers risk losing the flexibility currently available.

Who does the draft regulation affect?

The regulation will apply where a financial counterparty or a non-financial counterparty whose volume of derivative trading has exceeded an as yet unspecified threshold enters into a derivative contract with a counterparty which comes within either category.

Financial counterparties are firms providing investment services, credit institutions, insurers, life insurers and reinsurers, collective investment firms, occupational pension firms and alternative investment funds managed by alternative investment fund managers (the last under the European directive of the same name).

Non-financial counterparties are any other undertakings which are established in the European Union.

The clearing obligation will also apply to financial counterparties and non-financial counterparties which have exceeded the threshold if they enter into derivative contracts with non-EU counterparties who would be subject to the clearing obligation if they were established in the EU.

Which derivative contracts are affected?

Derivative contracts affected by the regulation will include interest rate swaps, caps and collars used in real estate finance.

A class of derivative will be subject to compulsory clearing only if the European Securities and
Markets Authority (ESMA - one of the new European super regulators) has determined that
it is “eligible”. The current version of the draft regulation applies the clearing obligation only to derivatives entered into on or after the date when the regulation comes into force.

What do financial counterparties have to do?

A financial counterparty will be required to:

• clear “eligible” derivative contracts through a CCP where the other party is:

o another financial counterparty or
o a non-financial counterparty which has exceeded the threshold or
o a non EU counterparty which would be subject to the clearing obligation if established in the EU; and

• report all derivative transactions to a trade repository.

What do non- financial counterparties have to do?

A non-financial counterparty will be required to:

• clear eligible derivative transactions through a CCP where the other party is

o a financial counterparty or
o another non-financial counterparty which has exceeded the threshold or
o a non EU counterparty which would be subject to the clearing obligation if established in the EU;

but only when its overall positions excluding contracts “that are objectively measurable as reducing risks directly related to the commercial activity of that counterparty” exceed a “clearing threshold”;
• inform the appropriate authority when its overall positions in derivatives exceed an “information threshold”;

• when the information threshold has been exceeded, report all derivative transactions to a trade repository.

Clearing through a CCP can be done either by direct membership or as a client of a member. The rules of the CCP will amongst other things require its members to comply with collateralisation of each trade on a mark to market basis.

CCPs typically require collateral in the form of cash, government debt securities or performance bonds from acceptable banks.

Who determines the thresholds?

The key issues for real estate finance transactions will be the level of the threshold and the criteria for determining whether a derivative contract directly relates to the commercial activity of the counterparty.

The information and clearing thresholds will be determined by the Commission on the basis of
drafts to be submitted by ESMA by 30 June 2012. Under the Council's latest compromise proposal the Council will also determine the criteria for establishing which derivative contracts are objectively measurable as reducing risks directly related to commercial activity.

Derivatives which are not cleared through a CCP

Financial counterparties and non-financial counterparties must have in place procedures and arrangements to measure, monitor and mitigate operational and credit risk in relation to derivatives which are not cleared through a CCP (presumably because they have not been designated as eligible for clearing or the counterparty is not required to clear).

These include timely use of electronic confirmations, daily mark to market (or where market conditions do not permit this mark to model) of outstanding contracts, exchange of appropriately segregated collateral and proportionate holding of collateral. The Council's compromise proposal adds a requirement for both types of counterparty to segregate collateral "in accordance with their agreement" if requested by the other party.

The obligation to provide for exchange of collateral applies equally to a bank as to an unregulated borrower.

The Commission will have power to adopt regulatory standards specifying the maximum time lag for issue of a confirmation and risk management, collateralisation and capital requirements. ESMA and other competent authorities must submit drafts of these standards by 30 June 2012.

These standards will no doubt have a significant effect on the availability of swaps and other derivatives outside the scope of compulsory clearing.

Penalties

Member states are required to provide for penalties for infringement of the clearing and information rules in the Regulation including at least administrative fines by 30 June 2012.

Conclusions for real estate finance transactions

If the regulation is implemented in its present form fixed rate loans hedged by the lender with another financial institution may increasingly replace borrower hedged Libor loans. Factors which will influence this include:

• reluctance of borrowers who are required to clear through a CCP to collateralise swaps otherwise than through conventional security on real estate

• the more favourable regulatory capital treatment proposed under Basel III for exposures of banks to CCPs.

• the impact of the regulatory standards which the Commission will adopt in relation to derivatives which are not subject to compulsory clearing.

Any increased costs resulting from the need to put the swap through a clearing house will inevitably be passed on to the borrower.

The regulation is still in draft form so there may be scope for lobbying to set out a clear framework for transactions which are not subject to compulsory clearing. For example, it should be made clear, if possible, that a bank can take collateral in the form of real estate or other tangible assets and that a rigid relationship between mark to market values and collateral is not appropriate in real estate and other secured lending transactions.

Andrew Seager

Senior Associate

Taylor Wessing LLP

a.seager@taylorwessing.com

"City Rocks" 22 February 2011, Guildhall, City of London

"Advance Plasma Power, Canary Wharf, Eurohypo, Stephenson Harwood and WestdImmo, in association with Harvey Goldsmith, proudly present Rock at the Guildhall!"

Did we ever imagine that these fine institutions would be co-sponsoring the first ever rock concert at the Guildhall in its 600 year history in aid of the Lord Major's Appeal (Alderman Michael Bear, our Lord Mayor, himself a property man)?

But it is happening and it's coming soon!

Yours truly, SH Prop. Fin. partner (and occasional guitar widdler) has the great honour of chairing an august charity committee of no less than around 150 worthies, including many from the ranks of the APB.

All is revealed in www.cityrocks.org.uk but rest assured that an iconic evening is promised including champagne reception, rock concert (headlined by Bryan Adams, no less) and after-show party in the Crypt, with charity auction, featuring Angelina Jolie's necklace as worn in "Salt" amongst other items!.

Tickets are selling fast so bag yours by logging on and downloading an application form – or call me or anyone on the committee (see website for details).

Hey, if it's to be a rocky year, we, not values should git on down!

Neil Murray – Stephenson Harwood

(P.S. Don't worry, I won't be widdling!)

Neil Murray

Stephenson Harwood

neil.murray@shlegal.com

Debt for equity swaps

Converting debt into equity can be a key component of restructuring distressed real estate loans. In this economic downturn the general trend has been that lenders have not decided to bring to market the properties against which breached loans are secured. This strategic approach is juxtaposed against an estimated £120.7bn of commercial real estate loans that are due to mature by 2012 year end and large amounts of equity chasing prime UK real estate. The adage adopted by lenders to date of "extend and pretend" will come under increasing pressure if asset values do not bounce back and the debt for equity swap could be viewed as a real alternative.

What is a debt for equity swap?

A debt for equity swap involves the creditors of the company exchanging their debt for some form of equity. The form of equity provided in exchange for the debt can take different forms. The equity interest will frequently seek to achieve a priority of return in favour of the converting creditors and impose restrictions to preserve that priority.

Debt for equity swaps in real estate investment

Debt for equity structures are utilised in working out distressed real estate loans although they are more commonly associated with corporate restructuring. Eurohypo recently created a profit-sharing structure with Great Portland Estates and Istithmar World to complete the development of Marcol House in the West End and share the proceeds. More recently, it was reported that Europhypo had agreed a joint venture with Axa to build an office tower at the site of 6 Bevis Marks, EC3 from Monterverde, a Spanish developer, while Hammerson is helping Lloyds Banking Group on a series of developments.

The factual matrix for where a debt for equity swap would arise in a real estate transaction is usually where a borrower is underwater and perhaps looking to exit. An approach would be made to the lender, before enforcement, suggesting the avoidance of crystallising the lenders' losses with the opportunity to write back the loss provision. The debt for equity swap may incentivise the borrower to enter the swap with the potential benefit of a share of the future upward realisation of the asset. The creation of the equity interest in the borrower or property holding entity will attempt to mirror the terms of the facility agreement between the lender and borrower. An example of this would be the payment of interest can be linked to dividend payments with the repayment date replicating the redemption date.

The form of equity interest commonly created in a swap is preference shares. The creation of a new class of shares can be used to reflect the shareholders' agreed priorities for distributions of income and capital return. Preference shares can provide a lender with protection in respect of its shareholding in the borrower or property holding entity. This is achieved through specific rights attaching to the preference shares. For example, the inclusion of veto rights over designated corporate matters such as the variation of class rights or actions that may result in the dilution of the lender's shareholding.

Commercial challenges such as the right to appoint directors and resolving deadlock can be dealt with through the operation of a variation of class rights. Often a key concern for the majority of lenders, similar to the transfer provisions in a syndicated facility agreement, will be the ability of a lender to exit. In a debt for equity swap this may be achieved by a sale or redemption, or pre-emption of the shares by the borrower.

A debt for equity swap provides opportunities for third parties to enter into existing lending arrangements. Asset managers and investors may wish to assist in maximising the value of the underlying assets, whilst the equity in the borrower or property holding entity may be offered as consideration. The introduction of a third party can allow the borrower to exit the existing lending arrangements and salvage their reputation in the market.

Real alternative?

A lender's objectives when faced with a factual matrix such as the one described above are centrally focused on maximising returns and avoiding crystallising losses. Options available can narrowly be categorised as restructuring with the borrower, enforcement of security or entering an arrangement with a third party. The debt for equity swap option provides a lender with a hybrid solution and allows the benefit in any future uplift in the value of the asset and, potentially, super profits usually associated with "equity kickers". In addition, it may enable a third party to access prime distressed real estate with the ability to inject new equity and/or asset management skills.

Habib Ullah
Partner
Banking, Finance and Restructuring
Nabarro LLP
h.ullah@nabarro.com

Paul Donnelly
Associate
Banking, Finance and Restructuring
Nabarro LLP
p.donnelly@nabarro.com