Creditors’ decision yesterday to finally call time on the five-year saga over the Gherkin’s overly complex capital structure will lead to a lose-lose-lose situation for all equity and debt stakeholders as well as something of an unwelcome reminder of how mismanaged financial engineering can torpedo a perfectly performing asset.
Phil Bowers and Neville Kahn of Deloitte were appointed as fixed charge receivers over the Gherkin yesterday lunchtime, triggered by creditors losing patience with the skyscraper’s ballooning liabilities.
In the next three to six months, Bowers and Kahn are expected to get underway the process of marketing the 41-storey tower at 30 St Mary Axe, which opened 10 years ago this month, through the appointment of an investment agent.
Yesterday’s capital-structure led receivership has been described by those familiar with the financial complexities as among the most complex ever structured on a trophy European commercial property, which contrasts with the entirely stabilised property metrics of the asset itself.
Where did it all go wrong?
Evans Randall, the boutique investment bank, and Germany’s IVG Immobilien, through its Euroselect 14 fund, jointly acquired 30 St Mary Axe for £630m in February 2007 from Swiss Re, the re-insurance giant, which remains the property’s largest tenant.
The joint venture partners financed the acquisition with a 15-year £396m senior loan among a syndicate of senior lenders comprised of Bayerischen Landesbank (BayernLB), Helaba, Deka Bank, ING Real Estate Finance and LBBW.
CoStar News also understands that there is a sub £50m junior loan held by BayernLB.
As has been reported widely, including by CoStar News more than 18 months ago, the loan was sliced into multiple tranches with a significant portion of the original senior financing drawn as an unhedged Swiss Francs loan. IVG hedged interest payments on the loan but not the entirety of the principal loan itself.
Whether the failure to fully hedge the currency risk of the Swiss Francs loan drawn to pay Sterling-based liabilities was a simple oversight or not, the unhedged Swiss Franc-denominated senior loan effectively twinned the UK commercial property investment with a currency market play which went spectacularly wrong.
Shortly after the loan was extended in February 2007, the Swiss Franc sharply strengthened against Sterling culminating in a two-thirds currency appreciation to today – from £1 to CHF2.42 in February 2007 compared to £1 to CHF1.46 as at yesterday.
This currency liability first triggered a default in 2009, with IVG at the time unsuccessfully attempting to raise up to £75m in fresh equity to cure the default.
To further complicate the matters, the original multiple-tranched £396m was financed over a 15-year term with multiple co-terminous interest rate swaps with the 2022 senior loan maturity. The sale of the Gherkin in the next six months will trigger breakage costs on the interest swaps and the senior loan itself eight years early.
The gross liabilities of the Gherkin – now running to £644m – are therefore comprised of the currency liabilities and early breakage costs of the loans and the interest rate swaps.
Typically, interest rate swaps rank ahead of senior debt in the capital stack and it is likely that the currency liabilities would also, but the exact repayment waterfall is thought to still be somewhat unclear.
Estimates vary as to the Gherkin’s current value, at between £575m to £600m, meaning the sale of the iconic tower is almost certain now not only to wipe out the equity but also the junior loan with some pain shared by the syndicate of senior lenders – an issue no doubt uppermost in creditors’ decision to accelerate the loan.
However, the banks may have taken the view that the twin negative variables weighing down the capital structure – early break of the interest rate swaps and currency liabilities – are not going to move favourably anytime soon and creditors’ current highly leveraged senior positions, relative to the asset’s value, reflects inefficient use of capital.
CoStar News reported in September 2012 that the blended margin across the original £396m syndicated senior loan was priced at around 75 basis points over three-month LIBOR across the multiple tranches.
Unless the senior syndicate has successfully negotiated a behind-closed doors margin step-up in the intervening period, the margin is substantially out of synch with the risk in the deal.
In the circular nature of markets, through an eventual sale of the Gherkin, whether to a sovereign wealth fund or any of a host of core-type investors, the asset would be ironically an incredibly attractive financing mandate, possibly even including some of the very lenders which have agreed to call in the receivers yesterday.
Evans Randall confirmed yesterday in a statement that its efforts to acquire a larger stake in the Gherkin have been thwarted because of the inability to agree a consensual solution with IVG.
However, yesterday’s receivership instruction over the Gherkin has not diminished Evans Randall’s appetite to seek to retain – and even increase – its stake in the skyscraper.
“Evans Randall has equity ready to invest and has been unable to do so because of the inability to agree a consensual solution with IVG, given these uncertainties,” a spokesman for the boutique investment bank said in a prepared statement yesterday.
“We will be continuing the constructive discussions to date on a new financial structure. The Gherkin is a strong, well-let asset and one that we are firmly minded to continue our involvement in.”
This saga has a distance to run yet – and has all the hallmarks of being one of the most intriguing UK commercial property stories of the year.