Barclays Bank’s attempt to block itself from voting in the imminent restructuring vote for General Healthcare Group’s (GHG) vastly-complex £1.5bn debt stack has failed after a High Court written judgement rejected the bank’s “a hundred per cent u-turn”.
Justice Peter Smith, who presided over the convoluted case heard in the High Court of Justice’s Chancery Division on 14 August, ruled instead that the UK bank retains its voting entitlement, despite its own evidence to the contrary.
The legal dispute over voting entitlements has arisen out of a lack of clarity as to the voting powers of two sets of senior notes within the two securitisations – Theatre Hospitals No. 1 and No. 2 Plc (T1 and T2) CMBS transactions – which form part of the wider £1.5bn debt stack, which secures GHG’s 35 regionally-spread specialist care homes throughout the UK.
The significance of Friday’s judgement is material, as the legal judgement decrees that Barclays’ notes in T1 are not “disenfranchised” and retain their voting powers.
As a result, Ambac, a New York-based guarantor of structured finance obligations, with which Barclays entered into hedging contracts with, retains control over how Barclays votes under the terms of the credit protection contracts.
The reason for Barclays “somersault”, so described by Justice Peter Smith, in respect of its position on its own voting powers, was likely the result of opposing positions between Barclays and Ambac in respect of the upcoming £1.5bn GHG restructuring negotiations.
Superficially, it appeared that Barclays was arguing against its own economic interest in the High Court hearing, by declaring that its own notes no longer had voting rights, but, perhaps, this position was an attempt to invalidate its votes so that Ambac was not empowered to direct Barclays votes.
Barclays, which owns £231m of class A notes and £57m in class B notes in T1, could presume to benefit from restructuring talks ahead, in a simplified capital structure with a margin step-up and amortisation commitments, possibly linked to an orderly disposal of some of the 35-strong UK care home portfolio.
Ambac, by comparison, is unlikely to benefit from a loan extension and could conceivably be economically motivated to reject the restructuring proposal and seek to bring to a conclusion its liabilities on the senior notes.
Justice Peter Smith’s judgement ensures that any restructuring will have to placate the potentially competing interests of Barclays and Ambac.
Prior to Citicorp’s request for a High Court hearing, Capita Asset Services, the master servicer for the entire senior loan, was seeking a short extension on the 15 October loan maturity, which is expected to be approved.
Capita’s intention to pursue that loan extension, likely only for around three months, implies the servicer remains confident that an equitable restructuring remains possible, following the judgement.
The background to this High Court judgement, and indeed wider GHG £1.5bn debt restructuring negotiations, complete with all the hallmarks of confused documentation, conflicted economic interests and monstrous complexity which have plagued post-crisis real estate structured finance workouts.
Debt structure’s complexity “Byzantine in the extreme”
Friday’s judgement, which is subject to appeal, is expected to help determine the viability of a consensual restructuring of the outstanding debt and prevent a loan enforcement of the 35 separate loans, which would crystallise GHG’s £577m mark-to-market interest rate swap liability.
The legal wrangle was filed just under one month ago by trustee Citicorp Trustee Company, on 31 July, which was seeking clarification ahead of restructuring proposals between the securitised senior lenders – amounting to £617m within the Theatre Hospitals No. 1 and No. 2 Plc (T1 and T2) CMBS transactions – the £282m unsecuritised senior lenders, and the £656m group of junior lenders.
Barclays and Rabobank, which own £288m and £154m respectively across the most senior component of T1 and T2, entered into hedging contracts with Ambac, which provide guarantees against any losses incurred on the notes.
Barclays owns £231m of class A notes and £57m in class B notes in T1. Ambac provided credit default protection against £173.4m of Barclays’ T1 class A notes and a guarantee against the remaining £56.7m.
Separately, Rabobank’s £154m class A position in T2 is covered both by a total return swap (TRS) arrangement with Barclays, which Barclays, in turn, secured by credit default protection contract with Ambac.
These hedging contracts, also known as “negative basis trades”, created some uncertainty as to Barclays and Rabobank’s voting rights ahead of the anticipated restructuring of GHG’s £1.54bn debt, which prompted the trustee to seek legal ruling to clarify.
The junior noteholders represented at the High Court hearing by Citicorp argued that the “beneficial owners” in respect of these disputed notes in each case are “the persons in whom the benefit of those provisions is vested”. That is, Ambac.
On which basis, Ambac has control over how Barclays votes, in respect of the UK bank’s £288m T1 notes. Separately, Barclays can control Rabobank votes, in respect of its £154m notes in T2, although Barclays vote is also subject to control by Ambac, through the credit default swap.
In the words of Justice Peter Smith: “The set up and structure of the various transactions seems to a simple-minded property lawyer to be Byzantine in the extreme.”
A clause in the trust deed has further muddied the water here, effectively restricting those deemed to be “sellers” from voting.
Barclays Bank, along with Dresdner Bank, the Bank of Scotland and Mizuho Corporate Bank, as original loan underwriters are defined as “sellers”, which would “disenfranchise” Barclays votes on that definition interpretation.
Initially, Barclays rejected this interpretation, arguing that “sellers” are only disenfranchised when they are holding note to sell, and is not disenfranchised when a seller does not hold any notes for sale.
Barclays “somersault” was then to contest at the High Court hearing that it was disenfranchised simply because the bank currently held notes.
“I suspect this somersault caused some consternation and amusement,” wrote Justice Peter Smith. “Ambac, at the end of the line, the supposed controller of the way in which these notes were voted was not in favour of this concession of disenfranchisement.
“The junior noteholders no longer had an interest in appearing because as far as they were concerned Barclays’ concession was the best that they could hope to achieve. Had Barclays maintained its original stance doubtless the junior noteholders would appear to argue that which Barclays now argues.”
Instead it was left to Ambac’s solicitor – Mr R Knowles CBE QC – who “stepped into the breach at the last minute in effect to revive the Barclays argument”, who argued as Barclays did previously.
In his conclusion, Justice Peter Smith wrote: “I therefore conclude that Mr Knowles QC’s submissions are correct.
“It is clear that any disenfranchisement can only apply to a seller which is defined as being Barclays and the other banks in that capacity. As Barclays does not hold the notes in the capacity of seller they are not disenfranchised.
The Rabobank’s notes were, similarly, judged not to be disenfranchised.
This leaves both Barclays and Rabobank free to vote, with both bank’s voting decisions, ultimately, to be directed by Ambac, which in all probability, is seeking to extricate itself from its current liabilities in the two securitisations.
Underlying care home portfolio
GHG, owned by Netcare, the listed South African care home operator, APAX Partners and London & Regional, is a structured as an opco-propco, with the property company division owning 35 regionally-spread specialist care homes throughout the UK, which secures the £1.54bn of outstanding debt.
GHG commissioned the most recent “desktop valuation” of the portfolio last September, which came in at £1.45bn.
Against this value, the total outstanding debt stands at £1.56bn – in addition to which – is the enormous £577m mark-to-market interest rate swap liability which ranks above all senior lenders in the event of the sale of the portfolio.
GHG’s total liabilities, therefore, are £2.14bn, against an almost 12-month out-of-date “desktop valuation” of £1.45bn, which Deutsche Bank CMBS analyst Paul Heaton wrote yesterday in a research note “in a sale scenario, the valuation could be much lower”.
Heaton argued that “with little value attached to the contractual 2.5% annual rental uplifts by a buyer – conceivably falling even below the £1.3bn S&P thought the value was worth in 2007”.
Under Netcare’s valuation, after the £577m swap liability, the entire £656m junior lenders – which include KKR and FMS Wertmanagement, the bad bank of state-owned Hypo Real Estate Holding – would be out-of the-money, while value almost eroding the entire £282m stake held by the minority senior lenders.
By comparison, Deutsche Bank’s valuation estimate – at “conceivably falling even below £1.3bn” – would deepen losses into the junior securitised notes of T1 and T2.