14 July 2003
ALThough slow to start, the market for securitisations in Germany is building up steam. In 2002, Germany became the third-largest market in Europe for asset-backed securitisations (ABSs), ranking just behind the UK and Italy. Over the past two years, more than 20 mortgage-backed securities (MBS) transactions have been originated by German banks, involving mortgages in Germany, Europe and the US, with volumes ranging between E500m (£345.6m) and E3bn (£2.07bn). For 2003, Europe is expecting MBSs totalling approximately E100bn (£69.11bn), half of which are to take place in Germany. The German Federal Ministry has also recently expressed its intention to insulate special purpose vehicles (SPVs) from trade tax liability, which might have a positive impact on the German ABS market.
In essence, ABS transactions involve the sale of assets of a seller (the originator) to an SPV, which finances this purchase through the issuance of securities in the international capital markets. In the real estate area, ABS is used in two different ways. First, commercial and mortgage banks use this instrument either for their own refinancing in the form of MBSs, or to control risk and equity within the framework of synthetic securitisations. The latter are marked by the fact that only the connected credit risks and not the loan itself are transferred.
The second type of transaction, which may be called a real estate (or property) securitisation (RES), does not originate from the bank providing the loan but from the real estate owner. Thus, the typical receivables on which an RES is based are lease rentals, real estate residual values and real estate proceeds of sale.
One example of such an RES is the 2002 transaction in which ABN Amro and JPMorgan helped the Prologis Group, a global provider of integrated distribution facilities and services, use capital markets to finance scores of warehouses and logistics properties located throughout Europe. Other securitisations will arise through the financing of acquisitions of large residential housing portfolios, which in the past have been structured as share deals. This upswing in RES will also be bolstered by many large German companies with real estate assets of more than E1bn (£691.1m) such as Allianz, Deutsche Bank, Deutsche
Telekom, Deutsche Post, Metro and RWE, which are now considering selling parts of their portfolios in order to concentrate on their key businesses.
The benefits of securitisation
RESs offer real estate owners and investors new opportunities to raise financing and make investments. For potential originators such as real estate funds, real estate companies, building societies and companies with large real estate ownership, RESs can offer:
independent bank financing;
better access to capital markets;
improved real estate asset liquidity; and
more active real estate management, and a higher return on equity.
In addition, potential investors such as banks, insurance companies or funds have the opportunity to invest in real estate markets without acquiring the real estate directly. In this way, risks for particular investors can be tailored individually.
Variants for structuring
RESs can, as with classical ABS structures, be created by the sale of receivables relating to the real estate that generates cash-flow. Examples include rental payments as well as real estate residual values and proceeds of sale, all of which may be sold to the SPV. In this case, a relevant sale agreement, as well as an agreement of assignment to transfer the said receivables as security, would be concluded. Following a transfer, the originator would collect the receivables for the SPV pursuant to a servicing agreement. Alternatively, there is the possibility of concluding a loan agreement between the originator and the SPV. Claims by the SPV against the originator for interest and capital payments are limited to the cash-flows arising out of the relevant real estate portfolio. To secure these rights, far-reaching security interests in the form of assignments of rental receivables, warranties, the granting of land charges and the pledging of accounts and of company shares would be needed.
An RES in the UK would usually be structured in the form of a secured financing securitisation as the position of a secured lender upon the insolvency of the originator vis-à-vis the assignee is highly advantageous under administrative receivership. For this reason, multinational real estate portfolios, as in the case of the Prologis transaction, are often structured by way of secured loan financings. With regard to structuring, it must also be considered whether the relevant real estate property should continue to be included in, or should be removed from, the balance sheet of the originator.
Problems in German law
Germany, unlike some other European countries, does not provide a legal framework for ABS transactions. Thus, general rules and regulations apply. A basic condition for every RES is to isolate the company that owns the real estate, as far as possible, from all risks.
One crucial issue is the invalidity of the assignment of rent claims to the SPV beyond the month of commencement of the insolvency proceedings. Such a result would destroy the basic condition for each securitisation based on the cash-flow of the assets. But this problem can be avoided by an adequate structure.
In granting the securities, the German issue of an initial or subsequent oversecuring of the secured party must be taken into account, as disproportionate oversecuring might lead to invalidity of the securitisation agreements or to an entitlement to exemption of the securing party. In case of international transactions, there is a danger that not only the German securities, but also the foreign securities, flow into the assessment of the oversecuring.
Another issue is posed by the provisions under corporate law on the protection of equity. If a company offers security to support financing provided to its parent or affiliate, and that security exceeds the company's net worth, the security may be void. This problem must be taken into account when granting securities for a shareholder's or an affiliate's liabilities.
Finally, if the originator prefers an off-balance sheet structure, the real estate would have to be sold to the SPV, which would lead to substantial transaction costs. These costs could be reduced if the originator remains the owner of the property and the parties agree on the transfer of solely economic ownership, a synthetic structure by which the purchaser achieves a position similar to an owner.
Balance sheet and tax law issues will determine whether German ABS deals are structured as assignments of the rental receivables or through secured loans. As shown by Prologis and other transactions, bankers, lawyers and property owners have now found a way to make RES fundamentally possible in Germany. With the regulatory logjam largely cleared, dealmakers are looking for 2003 to be a breakthrough year for the securitisation of some of Europe's most valuable real estate holdings.
Jörg Michael Lang is a real estate partner and Jörg Wulfken a banking and finance partner, both at the Frankfurt office of Mayer Brown Rowe & Maw