Lehman Brothers’ legacy throughout European real estate lives on almost three-and-a-half years after its stunning collapse.
Nothing better encapsulates the tangled web of its own making on this side of the Atlantic than the hastily-assembled collateralised debt obligation (CDO), Excalibur, which was structured to offload with the European Central Bank’s emergency “eurosystem” in late May 2008, to provide critical bank liquidity as global financial markets entered an unprecedented turmoil.
In a three-part series of articles over today and tomorrow, CoStar News examines the outstanding positons in Excalibur.
European real estate values began a dramatic descent in the second half of 2007, and while many banks smelt the panic, the Lehman real estate deal-making machine continued unabated well into the first quarter of 2008.
Around the turn of the following quarter, Lehman realised it was unable to exit its warehoused real estate debt positions through its usual open-market securitisations, via its CMBS conduit programme Windermere, or by selling down debt in the syndication market.
Less than six months before the ultimate demise of the once fourth-largest investment bank in the world by assets, Lehman packaged as much of its unsellable real state debt that the ECB permitted, and securitised the positions in the two-tranche €2.88bn Excalibur Funding No.1.
Excalibur was structured with a €2.16bn class A tranche and a €722.18m class B tranche, with a 46-year maturity, out to 2054.
The resulting Excalibur CDO was loaded with unsold bilateral senior and mezzanine loans, development loans, B-notes, CMBS bonds, corporate loans to real estate companies as well as syndicated positions, non-and sub-performing loans bought from other banks.
When first transferred to the ECB eurosystem, the projected initial aggregate financial liabilities on Excalibur, including the notes’ outstanding balance and due quarterly interest payments over a 46-year life cycle, were a staggering €9.91bn, according to a Companies House filing.
While this enormous liability is just an arbitrary number, reflecting an almost half-decade interest repayment schedule, it is an astonishing reminder of just how big Lehman’s European real estate bet became.
The original CDO was laden with 62 positions and was transferred from Lehman’s Germany subsidiary to the ECB’s eurosystem, which then passed under the purview of Deutsche Bundesbank, Germany’s central bank, to try and sell on.
But given the financial crisis that was engulfing global markets, the Bundesbank, under a mandate to recover as close to par as possible on the outlay for taxpayers, had no choice but to hold the giant CDO until markets calmed and investor appetite returned.
In the Bundesbank’s own words after CoStar News broke the story that the central bank had selected Lone Star, the global private equity firm, as its preferred bidder on all the outstanding securities: “[Excalibur is] highly complex which just a few large, financially strong and risk-taking investors worldwide would consider buying.”
“Given these constraints,” continued the statement, “it is in the general interest and ultimately in the [German] taxpayer’s interest, to dispose of collateral, such as Excalibur, as optimally as possible under the given circumstances.
“The realisation strategy must take due account of the complicated subject matter, the difficult market environment and a central bank’s duty to neutrality.”
Lone Star, so far, has only bought one of the remaining securities in Excalibur, the €430.4m Carlyle Loan, which was closed on January 11, with the private equity firm paying €279.28m, reflecting a 35.11% discount.
The loan, also known as Cerep III, reflected 20.3% of the outstanding Excalibur portfolio at the time of the trade.
The Carlyle Loan is the remaining balance of a €586.3m loan extended to The Carlyle Group, provided by Lehman Brothers on 30 May 2008, specifically to finance Carlyle’s acquisition of a portfolio of Lehman’s own Windermere XIV CMBS bonds for inclusion in Excalibur. The Carlyle loan matures on April 27, 2015.
Lone Star has already sold the Carlyle Loan’s par-valued €322.9m Class A Windermere XIV bonds to Credit Suisse.
The Bundesbank offset the discount accepted from Lone Star, by calculating the loss alongside the quarterly interest and principal payments which the central bank received over the last three and a half years, while the complete €8.5bn Lehman collateral has been on the Bundesbank’s books.
This calculation therefore is not just on the Carlyle Loan sale, or even the entire Excalibur, but across Bundesbank’s entire Lehman collateral. The Bundesbank argues, on this basis, across the whole €8.5bn Lehman legacy portfolio, a near par return will be achieved.
This, of course, depends on the extent of principal repayments and costs incurred in managing the portfolio, which include loan servicing, accountancy, trustee, legal, receivers as well as agency fees.
Regardless, Lone Star is now in the driving seat to choose the positions it wants to buy. Lone Star will spin the positions it acquires into a fresh special purpose vehicle, financed with around €300m from Citigroup and Royal Bank of Canada, on a maximum three-year workout.
Clearly, some of the positions in Excalibur represent value for Lone Star – and a good financing deal for the banks – while others do not. Quite what is bought by Lone Star, and financed by Citi and RBC, is still being determined.
One of the first myths which need de-bunking about Excalibur, is that while the CDO itself is convoluted, with many loans priced out-of-sync with the evaporating market liquidity at the time, the underlying properties should not be judged by the debt which obscures them.
There is a wide spectrum of quality, with some hidden gems in there. Secondly, there is equally a real range in the performance of the underlying loans, while at least a dozen are in special servicing, many more are not and are making interest payments.
Lone Star, along with its loan servicing subsidiary, Hudson Advisors, are pouring over the remaining positions, as part of a complex work-out and unwinding of the CDO. Strategies typically employed by loan portfolio buyers, include arranging refinancings of maturing loans, selling loans back to borrowers as well as loan enforcement to extract the properties.
Look out for Part II and Part III of CoStar News’ analysis tomorrow morning on the outstanding securities in Excalibur tomorrow morning , which will reveal who Lehman lent the debt positions to, and how each debt position ended up in Europe’s most convoluted ever structured real estate finance transaction.
Deutsche Bundesbank, Lone Star, Hudson Advisors and Hatfield Philips all declined to comment.
CoStar Finance 