Tim Knowles, the property investor and borrower behind Lea Valley, has proposed a revised offer to win back control of the 24-strong property portfolio through his real estate investment, asset management and receivership firm, First Investments Limited.
In a letter published on First Investments’ website, Knowles’ firm has offered to buy the mortgaged properties under the securitised Lea Valley loan, which has an unpaid balance of £210.7m, at a discounted payoff (DPO) comprised in three parts:
- The purchase of Lea Valley Limited, the company which owns the 24 predominantly industrial properties, for £90m;
- Less £2m in costs associated with executing the transaction (legal, valuation and advisory costs);
- In addition, Knowles has offered to waive entitlement to asset management fees, costs and expenses which First Investments claims is due in their management of the deteriorating property portfolio over the last three years. First Investments has calculated these total waived fees amount to £6.6m.
Based on the above calculations by First Investments, the total value of Knowles’ DPO amounts to £94.6m, after the £2m in fee deductions, and an effective payment of £88m, which CoStar News understands will be financed by a probable mix of senior and mezzanine debt.
The £88m DPO offer reflects a 1.5% discount on the latest valuation of portfolio of £89.4m, as reported by Situs in the January quarterly investor report. Arguably, the portfolio’s value has deteriorated since this valuation, after further tenants have exercised break clauses.
First Investments commissioned a valuation of the portfolio to Cushman & Wakefield, dated 29 August 2014, which valued the portfolio at £89.8m. The valuation summary report can be viewed here.
Knowles’ £88m DPO reflects a 58.2% discount on the £210.7m unpaid balance of the Lea Valley loan, which forms part of the DECO 8 ‐ UK Conduit 2 p.l.c CMBS.
This is Knowles’ second attempt to win back control of the property portfolio, comprised of predominantly secondary and tertiary industrial assets in Northern England and Wales, after an initial DPO proposal in December was rejected by Situs.
Situs rejected the December DPO for two central reasons: first, it was seen as overly complex and second, from a liability point of view, it was a difficult ask for Situs to agree to a DPO in primary servicing.
Situs agreed to a standstill agreement to provide Knowles with time to structure a revised and simplified offer but has instead declared an event of default under the loan agreement which triggered Situs to transfer the loan into special servicing one year ahead of the loan’s maturity.
In a statement to the Stock Exchange, Situs confirmed that the Lea Valley borrower notified it of further deterioration in the condition of the property portfolio as well as a further deterioration in the portfolio’s gross annual rental income – by £751,258 to £10.5m.
Effectively, Knowles has elected to make this revised DPO offer after triggering an event of default as a successful outcome in primary simply looked impractical. In one respect, this is entirely common practice for the workout of distressed securitised loans.
While the Lea Valley loan is performing and has not been in breach of any covenants up until now, the metrics of this loan reveal a clear picture: the loan’s LTV is 235.7%, the gross annual income has fallen to £10.5m, the vacancy rate is 18.45% and the weighted average lease term is 3.6 years.
In a research note analysing Knowles’ original DPO offer last December, Deutsche Bank’s CMBS analysts Paul Heaton and Conor O’Toole characterised the state of the property portfolio as follows: “The portfolio is locked in an unbreakable downward spiral, from both a) the high amount of leverage and b) the high amount of interest on that leverage that hinders the necessary investments to retain/attract tenants in buildings that otherwise have little competitive advantage.
“The maths of valuation dictate that as income is realised from the lease profile, value will adjust downwards.”
What makes the transfer of the Lea Valley loan into special servicing so atypical is that the appointed special servicer is Solutus Advisors, a firm Knowles founded, although he maintains day-to-day operations are entirely independent of his remit.
Indeed this perceived conflict of interest likely formed part of Knowles’ wish to secure a DPO in primary servicing – a resolution never before achieved in European CMBS.
“We also think there is a wish – assuming the economics add up – to strike a deal outside special servicing to avoid a perceived conflict of interest between the Lea Valley borrower and Solutus Advisors, the special servicer for the loan,” wrote Heaton and O’Toole in the 11 December 2014 research note.
Knowles’ £88m DPO currently has support of five noteholders representing above 50% of the class B and Cs, according to Solutus. There is also an undefined smaller proportion of senior noteholder support, Solutus has indicated.
This support is in the process of being formalised through a signed letter which outlines a view that there is no realistic possibility for value enhancement while the portfolio is financed by the Lea Valley Loan and moreover that the assets are likely to deteriorate considerably in the lead up to loan maturity.
In First Investments’ letter to Solutus’ James Bannister and Darren Davey, signed by director Carrie Sharp, it concluded: “We appreciate that, as the special servicer of the Lea Valley Loan, you have to consider the simplified proposal in light of your responsibilities before determining the merits.
“Accordingly, we are prepared to enter into an agreement with you to keep our offer outstanding for a prescribed period of time and to assist you in any way in relation to considering the simplified proposal.
“In consideration for your doing so, we would request that a standstill agreement be entered into so that no action is taken against the obligors or us while you are considering the simplified proposal and that the portfolio continues to be managed without disruption.”
Solutus’ Bannister said: “At this stage, we need to get advice from real estate professionals and form a view as to what is achievable in respect of sale price. From a transparency point of view, we will be driven by noteholders as to their wishes on the sale and as to whether or not we need to appoint any third party advisers to help manage the process.”