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This Refinancing Shines A Light On Private Equity’s Retail Dilemma

The Vancouver Centre in King's Lynn is one where a borrower chose not to put in equity to cure an LTV breach.

Last week Goldman Sachs launched a small securitisation that shines a bright light on the issues U.S. private equity firms that bought big in retail over the past five years will face in trying to profitably exit from those assets.

On the face of it Goldman Sachs’ £90M Elizabeth Finance 2018 commercial mortgage-backed securitisation is at the smaller end of the scale. But the assets it is refinancing provide a timeline of the last few years of the regional shopping centre investment market, and show where the financing market for such assets stands today.

One of the two loans in the CMBS is called the Maroon loan. It totals £70M and is secured by three regional shopping centres: the Kingsgate Shopping Centre in Dunfermline, the Vancouver Centre in King’s Lynn and The Rushes in Loughborough. There is also £16M of mezzanine debt secured against the portfolio.

The centres were all part of the Harrogate loan portfolio bought by Oaktree Capital Management from Lloyds Banking Group for around £260M in August 2012. At that point they were reported to have been valued at around £100M.

Six years later, the value has not moved much. According to a pre-sale report for the CMBS prepared by ratings agency Standard & Poor's, the portfolio today is valued at £105M.

The portfolio is 93% occupied, with 131 tenants and an average lease length of five years, paying a total of £9.5M of rent a year.

The strategy with the purchase of nonperforming loans is usually to buy a large portfolio and break it up by selling the assets as quickly as possible or getting the original borrower to refinance them.

Private equity firms typically sell the largest assets, which are the most liquid, first, and the three centres in question were the largest assets in the Harrogate loan portfolio. A typical hold period for private equity firms is around five years. The new loan on the portfolio runs to 2023.

Oaktree tried to sell the three centres as a portfolio in March 2017, appointing agents to market them for £120M, an 8% yield. Today that value has dropped by more than 10%, and according to S&P, the yield on the portfolio is 8.9%.

A positive for Oaktree is that the cost of its debt has been reduced. When it bought the loan portfolio from Lloyds, it used a debt facility from JP Morgan with an interest rate margin of 600 basis points.

Deutsche Bank refinanced the portfolio in 2013, providing debt against the assets at a valuation of £120M. The loan that Goldman provided to refinance the portfolio has an interest rate margin of 270 basis points, showing that the cost of debt on the portfolio has halved. The loan-to-value ratio of the senior loan is 66%.

That there was a bank willing to refinance the portfolio is a positive for the retail market, given warnings that many banks were pulling back from financing regional retail assets.

The fact that Oaktree is having to refinance the portfolio rather than sell it shows that private equity firms may end up holding regional shopping centres for longer than they expected. Given they bought about £3B from banks and distressed borrowers during this cycle, it could prove a tricky problem.