List of Abbreviations
1.1 Research Problem
The sale of receivables as such is relatively old. As far back as 1880, companies have sold receivables to each other. However, the transformation of receivables into tradable securities, which is described as ‘Securitisation’1 or
‘Asset-Securitisation’, is a fairly young financial markets innovation.2
In a classical Securitisation transaction a company sells a part of its – mainly homogenous assets – to a Special Purpose Vehicle (SPV) that is only created for the sake of the transaction. The SPV finances the purchase of the assets (usually receivables) by issuing securities on the capital market, which are backed by the SPV’s assets. The securities are amortized by the cash flows that are derived from the acquired assets.3
The concept of Securitisation has its origins in the USA, where Asset-Backed Securities (ABS) have evolved from Mortgage-Asset-Backed Securities (MBS).4 The roots of Mortgage-Backed Securities5 in the United States go back to the emergence of the secondary mortgage market and the foundation of the Federal National Mortgage Association (Fannie Mae) during the 1930’s.6 The first issuance of securities was not until the 1950’s and the MBS market did not
1 The spelling of Securiti s ation (Great Britain) and Securiti z ation (US) differs by continent. In this thesis the British English spelling is used.
2 Although Securitisation as a financing product falls into the wider category of structured finance products, Securitisation and Asset-Securitisation respectively are nowadays often used exchangeable with the term Structured Finance. This thesis will stick to Securitisation or Asset-Securitisation.
3 Cf. Seibert and Plohr (2001), p. B5.
4 Rosar (2000), p. 5.
5 In the USA the term Backed Securities usually refers to Residential Mortgage-Backed Securities. There is no generic term for the mortgage related Loan Securitisation, i.e.
Commercial Mortgage-Backed Securities (CMBS) are a total different asset class than Residential Mortgage-Backed Securities (RMBS). In Europe the term Mortgage-Backed Securities is the generic term for all mortgage related Loan Securitisations including residential and commercial mortgage loans. Confer Chapter 4.3.2.1, p. 214.
6 Cf. Brueggeman and Fisher (2001), p. 495.
really take off until the 1970’s.7 The Securitisation of Commercial Mortgage Loans into Commercial Mortgage-Backed Securities (CMBS) only evolved in the mid-1980’s during the Savings & Loans crisis in the US.8 Today the secondary market for mortgage loans in the USA is highly developed. Loan Securitisation and especially Mortgage-Backed Loan Securitisation9 play a decisive role. During the past five years, securitised loans have become the major financing instrument to companies.10
$0 bn
New Issuance Volume # of Issued Transactions
Figure 1: US Asset-Backed Security Issuance 1982-200311
Albeit the fact that Backed Securities as an asset class within Asset-Securitisation only exists since 1985,12 the new issuance volume in the US has risen exponentially from $0.07 bn (1982) to $260 bn (2003).13
7 Cf. Falcon (2003), p. 29; Kendall and Fishman (2000), p. 6.
8 Cf. Baum (2000), p. 45.
9 Mortgage-Backed Loan Securitisation essentially is the same as Mortgage-Backed Securitisation. The common terminology in the market is Mortgage-Backed Securities, which is semantically wrong, because the asset that is securitised is the interest and principle of a mortgage backed real estate loan and not the mortgage alone. In this thesis Mortgage-Backed Loan Securitisation will be referred to by Mortgage-Mortgage-Backed Securitisation or Mortgage-Backed Securities.
10 Cf. Friedemann (2003), p. 9.
11 Cf. Erturk, et al. (2004), p. 3.
12 Even though the terminology differs from region to region, today the term Asset-Backed Security stands for both the generic term for all kinds of Asset-Securitisations as well as for an asset class within this framework. Cf. Chapter 2.1.
The same trend can be observed in many other financial markets around the world. Today, Securitisation has become a global structured finance product being utilized in countries on all five continents around the world: ranging from Australia to Venezuela and beyond.14 The global new issuance volume of structured products rose from $47 bn in 1990 to over $530 bn year-end 2002.15 In Europe, as numbers from Deutsche Bank European Securitisation Research indicate, the market for Asset-Backed Securities has also proven to be a similar success story. In 1992 the new issuance for all asset classes was at close to $3 bn and augmented to about $210 bn in 2003; from 2002 to 2003 it came to an increase of 30%.16 The market expects yet another increase of total issuance volume in 2004, amounting to more than $220 bn.17
3.0 4.9 11.0 7.4
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Nov-Year 2004
European ABS - New Issuance Volume
Figure 2: European Asset-Backed Security Issuance (1992-11/2004)18
The enormous growth of the market during the last five years can be attributed to mainly three things: the amendment of the legal and regulatory framework, the growing acceptance in the corporate and the banking market, and the
13 Cf. Erturk, et al. (2004), p. 2; Rose, et al. (2000), p. 1. These figures do not include single-issue synthetic transactions, Collateralized Debt Obligations (CDOs), or home-equity loans.
14 Cf. Leamy (2003), p. V; Preston (2001), p. IV.
15 Excluding MBS; cf. Leamy (2003), p. VIII.
16 Cf. Weber (2004), p. 3.
17 Cf. Kullrich (2004), p. 2.
transparency of the market that has been brought forward by the rating agencies.19
Apart from that the evolution of the market in Europe was stamped by a constant innovation of transaction structures and by unique transactions that have constantly opened up the Securitisation market for new asset classes.
The most diverse asset classes have evolved over time. For example soccer clubs like Schalke 04 or Real Madrid have satisfied their financing needs by issuing Asset-Backed Securities (ABS).20 There have been a number of exotic Whole Business Securitisations (WBS):21 Pubs,22 Motorway Restaurants,23 Hospital Operators,24 Nursing Home Operators,25 Funeral Homes,26 Ferries,27 Railway companies,28 Utility Companies,29 Madame Tussauds,30 and Airports31 like the London City Airports.32
Characterized by the famous quote: “If it flows, securitize it.”33, today there is not one asset class (with predictable cash flows) that is not securitizable and that has not been considered for Asset-Securitisation.
18 Source: Deutsche Bank Securitisation Research Cf. Rajendra, et al. (2004a), p. 4; Rajendra, et al. (2003), p. 5; Rajendra, et al. (2002), p. 5.
19 Cf. Sampson (2001), p. 15.
20 Cf. Dorendorf (2004), p. 21; Miles (2002).
21 Depending on the rating agency, Whole Business Securitisations are also known as
‘Corporate Securitisations’ ‘Corporate-Entity Securitisations’, ‘Corporate-Hybrid Transactions’.
Cf. Bernous, et al. (2004), p. 1.
22 Cf. Cox, et al. (2004), p. 1.
23 Cf. Walker (2000), p. 55.
24 Cf. Anonymous (2002l), p. 48; Katz (2003), p. 55.
25 Cf. Anonymous (1999z), p. 1.
26 Cf. Collingridge, et al. (2003), p. 245.
27 Cf. Walker (2000), p. 55.
28 Cf. Anonymous (2003p), p. 14.
29 Cf. Unmack (2002).
30 Cf. Hay (2000), p. 168.
31 Cf. Anonymous (1999y), p. 13.
32 Cf. Hay (2002).
33 Cf. M. McCoy, Salomon Brothers, quoted from Paul (1994), p. 186.
Premier transactions like the Formula One Securitisation have proven the notion of the quote above and have demonstrated the various possibilities of Asset-Securitisation. The assets underlying the issued securities in the Formula One Asset-Backed Bond were future income from licence, advertising and merchandising rights originated by the Formula One Company. The only collateral was the going concern of the company.34 Another big Securitisation was the a ‘work in progress’ deal launched in 2001 by a European shipyard:
Chantiers de l'Atlantique. The Chantiers de l'Atlantique transaction securitised future instalment payments for the delivery of three cruise vessels under construction for Royal Caribbean Cruise lines.35 The airport of Rome (Aeroporti di Roma) also used Asset-Securitisation, when it refinanced existing bank debt by issuing Asset-Backed Securities. The Securities were backed by future proceeds of the Rome airport, i.e. take-off and landing fees as well as rental income from the airport.36
The last few years witnessed the growth of what are referred to as ‘Esoteric Asset Classes’37 within Asset-Securitisation. The observed expansion of new esoteric asset classes underlines the premise that if an asset can generate a predictable, steady stream of revenue, it may be a candidate for Asset-Securitisation.38
In Europe esoteric inventory Securitisations like the Champagne stock Securitisation have helped the structured finance market even up the way for the ongoing expansion of this financing instrument.39 Recent issuances of
34 Cf. Anonymous (1998e), p. 8; Anonymous (1998f), p. 12; Anonymous (1999t), p. 7.
35 Cf. Clifford Chance European Securitisation Group (2001), p. 37.
36 Cf. Weiffenbach and Ghali (2003), p. 248.
37 Esoteric Securitisations involve new complex asset classes that have traditionally been unused, as well as transactions and transaction structures that are very exotic or that will be one-time transactions. Cf. Seibert and Plohr (2001), p. B5.
38 Esoteric Securitisations belong to Asset-Backed Securities i.n.S. These assets include municipal tobacco litigation settlements, tobacco lawsuit attorney fees, healthcare receivables, aircraft leases, mutual fund fees, trademark licenses, patent-related royalties, insurance-related premiums, film receivables and music royalties, among others. Cf. Rosenberg and Weiss (2003), p. 111.
39 The Securitisation of the Champagne stock that was produced, stored and sold by the French Groupe Marne et Champagne a.r.l. (M&C) was characterised by one of the most innovative structures at that time. Cf. Clifford Chance European Securitisation Group (2001), p. 37.
securities collateralised by pools of limited partnership interests in private equity funds (Collateralized Fund Obligations – CFOs) have shown that the market has reached a very innovative level. This transaction has created growing interest among issuers, investors and other market participants in new asset classes in order to diversify their risks.40
The above described examples show that the current development can be described as: „What started as true sales of large pools of homogenous assets has spread to allow the technique to be used for more diverse, unique asset types.“41 This is also true with real estate assets. There could be a whole lot of real estate assets, i.e. real estate receivables, real estate sales proceeds, real estate development proceeds or the Securitisation of whole buildings that could qualify under this definition.42
And the reason, why this new innovative concept is important for the property industry in Europe and especially in Germany is that it seems to be the solution to the credit crunch experienced by the industry at the moment. It is aimed at providing companies and industry with urgently needed financing, which is provided directly from the capital markets.43
Asset-Securitisation is not entirely new to Germany. As far as the ‘German Pfandbrief’ is recognized as a relative form of Asset-Securitisation, the historic roots go back to the 18th century, the time as the first Pfandbrief concept was invented. The Pfandbrief has been the superior funding instrument for German Mortgage Banks ever since. It is similar to a Mortgage-Backed Bond that is backed by the issuing institutes balance sheet; it is collateralized by mortgage loans that do not go beyond 60% Loan-to-Value. In the case of the bankruptcy of the issuing institute the Pfandbrief-Investors take over the mortgage loans that are backing the bonds. The difference to Asset-Securitisation is that the
40 Cf. D'Souza (2003), p. 10; Flämig (2003a), p. 9.
41 Patrice Jordan, managing director of global asset-backed securities, Standard & Poor’s, New York. Cf. Rose, et al. (2000), p. 1.
42 Confer Chapter 3, p. 53.
43 Cf. Hagen (2003), p. 12.
assets backing the security are not transferred to a separate Special Purpose Vehicle (SPV).44
Asset-Securitisation as a general financing tool for corporates has, however, only gained momentum during the last three years. This is mainly due to the fact that those companies could always pick and choose among many financial institutions that were willing to provide financing with high loan-to-value ratios and very tight margins. Credit risk has until now been always underestimated.45 Only with the new Basel Capital Accord (commonly known as Basel II) that will be coming into effect in 2006,46 this trend is changing. Banks are pushed to raise their margins and to better manage their risks and their credit side.47 Non-performing loans and high loss provisions have urged the lending institutions to change their loan underwriting methods and criteria. 48
Until 2003, the German banking industry denied the non-performing loan problem.49 However, the magnitude of the problem became obvious, when expected losses – many resulting from real estate loans – in bank portfolios became so high and the built-up pressure on the earnings became so strong that banks had to admit to non-performing loans and had to sell large portfolios at liquidation values.50
Since 2003 there have been several portfolio sales of non-performing loans including:Sparkasse Görlitz,51 HVB Real Estate,52 Dresdener Bank,53 Delmora Bank.54 The German non-performing loan market is dominated by US private
44 Cf. Hagen (2003), p. 12; Schiereck and Rauch (2002), p. 174.
45 Kretschmar and Damaske (2003), p. 22.
46 Cf. Basel Committee on Banking Supervision (2003b), p. 1.
47 Cf. Hommel and Lehmann (2002), p. 231.
48 Cf. Anonymous (2003i), p. 1.
49 Cf. Anonymous (2003c), p. 22.
50 Cf. Schmid and Maier (2005), p. 19.
51 Cf. Anonymous (2004j), p. 18.
52 Cf. Anonymous (2004e), p. 26; Anonymous (2004h), p. 26.
53 Cf. Anonymous (2004g), p. 19.
54 Cf. Anonymous (2004g), p. 19.
equity firms.55 Lone Star, which acquired about half of the market to date, is the biggest player. In 2004, about €10 billion of non-performing loans were sold.
Lone Star’s expectation for the market in 2005 is to go up to €15 to €20 billion, with a total of outstanding non-performing loans that ranges around €250 to
€300 billion – approximately 5% of all outstanding loans in Germany.56
Part of the problem for banks was that the risk of the loans never got adequately priced into their lending rates. As loans became non-performing, banks had to take on large loss provisions that had not been taken into account when calculating the loan margins. The latest example is the Hypo Vereinsbank, which has admitted to €15 billion of non-performing real estate loans, which has led to loss provisions of €2.5 billion.57
As a result of this overall trend, the lending practice has changed dramatically in recent times to the disadvantage of property owners. Higher lending rates and lower loan commitments by lending institutions are the consequence. As a survey undertaken for this dissertation has shown:58
• 66% of the surveyed lenders expect a higher lending spread, due to an increase in the risk premium; only 32% believe that the lending spreads are going to keep steady.
• 40% of the respondents expect a lower loan commitment, 30% expect constant loan commitment and only 28% are willing to commit more loans than in the past.
This trend magnifies the problems of the property industry. While property companies are seeking new ways of financing their acquisitions, developments or existing holdings, banks – due to Basel II – are increasingly becoming restricted in their lending capacities. Hence, the main problem is that property
55 Cf. Anonymous (2003k), p. 1; Anonymous (2004f), p. 25.
56 Cf. Schmid and Maier (2005), p. 19.
57 Cf. Maier and Hegmann (2005), p. 1.
58 Confer Chapter 5.1, p. 483.
companies are increasingly facing the challenge of getting good and affordable financing. The companies are confronted with a credit crunch.59
Real Estate Securitisation might be the way out of the property companies’
financing dilemma and may help diversify their funding base; it could function as a means for the disintermediation of real estate lenders and therefore as an innovative financing alternative for the property industry.60 The concept of Real Estate or Property Securitisation,61 is positioning itself as an alternative-financing product to classical real estate alternative-financing. It could function as a substitute for traditional mortgage financing as well as a complementary product to enhance traditional financing. For example, if a borrower is facing restrictive financing policies from the banking side, he can directly access the capital markets.62
Summing up the research problem, the dissertation is concerned with property companies that are experiencing difficulties to finance their commercial real estate. Thus the focus of this dissertation will be on the viability of capital-markets oriented financing for commercial real estate assets as a substitute or a complement to traditional financing (i.e. Real Estate Securitisation). It will be derived from an international case study comparison that is subsequently applied to the case of Germany. Hence, two sets of subordinate research problems can be derived – Property and Asset-Securitisation related research problems.
The property related research problem is summarized in the following:
• There is a credit crunch observable in Germany.
• Sources for traditional real estate financing are becoming less.
• Real estate financing for certain properties will be tougher to achieve with the new Basel Capital Accord being implemented into the German banking system until 2006.
59 Cf. Lorz (2003), p. 7.
60 Cf. Pickersgill (2001), p. 125.
61 Real Estate Securitisation and Property Securitisation are exchangeable terms. In order to avoid confusion, this thesis will stick to Real Estate Securitisation.
• Alternative sources of financing are needed for the property industry.
The Asset-Securitisation related research problem is delineated below:
• The Asset-Securitisation universe is expanding, but Real Estate does not exist as a separate Securitisation Asset Class, yet.
• There is no consistent definition of Real Estate Securitisation neither in industry nor academic literature.
• There exists no adequate theoretical research framework for neither Real Estate Securitisation nor Asset-Securitisation markets.
• A Life-cycle model for the evolution of Real Estate Securitisation market is missing.
Concluding this part the main propositions are:
‘There is no adequate framework for the analysis of Asset-Securitisation or Real Estate Securitisation markets.’
and
‘There are no adequate capital market oriented commercial real estate financing instruments for property companies in Germany. Nevertheless, there is a need for such products, given the external circumstances’.
Consequently the two research questions that this doctoral thesis is aiming to answer are:
1. What is an adequate framework for Real Estate Securitisation markets and how do such markets evolve?
2. Why has the market for Real Estate Securitisation not evolved in Germany, yet, and how can the framework be adjusted to make Real Estate Securitisation viable in Germany?
62 Cf. Rügemer and Siemes (2002), p. 771.