Termsheet: A tangled tale

When Texas-headquartered distressed debt specialist Lone Star Funds acquired Coeur Défense in March, it brought the curtain down on a troubled period for the trophy asset that has seen its valuation, not to mention its occupancy rates, collapse.

The property, which shares with the notorious Palace of Parliament in Bucharest the distinction of having more floor space than any other building in Europe, is appropriately situated in the heart of Paris’ business district, La Défense.

Its troubles began with its acquisition by Lehman Brothers seven years ago at the height of the buyout boom, and escalated following the collapse of Lehman. Since then the building’s owners have been fighting a lengthy campaign against creditors in the French courts. That four year legal battle – featuring no less than 16 judicial decisions and three separate courts of escalating seniority – has had far-reaching consequences for investors in real estate in France, and the creditors who supply finance to such deals.

How the Texan manager managed to acquire the asset amid that feud is worth exploring as it demonstrates how a canny manager with knowledge not only of real estate, but more pertinently of financial engineering and structuring, can acquire a trophy asset and leave creditors broadly satisfied.

To understand the Lone Star deal however, it’s worth revisiting the property’s acquisition by Lehman.

TOPPING OUT

In March 2007, Lehman Brothers paid a top-of-the-market price to owners Rodamco and Goldman Sachs Whitehall Funds for the asset: €2.1 billion. It is understood to have outbid other investors by around €150 million. As one ex-Lehman banker told Private Debt Investor, “When you’re distributing risk and skimming fees at each stage, you can afford to pay €2.1 billion for a building.”

At the time, it was the largest single asset property deal in Europe.

Equity of around €500 million came from the bank’s balance sheet and French group Atemi. Lehman had originally planned to transfer ownership of the asset to one of its real estate funds, but ended up keeping it on balance sheet. Lehman used an acquisition vehicle called Heart of La Défense (HOLD). Shares in HOLD were held by a Luxembourg-domiciled SPV called Dame Luxembourg. That in turn was held by another holdco called LB Dame, whose equity was held by two Lehman units and GE’s pension fund.

Lehman financed the deal with two bullet loans: a B1 loan of €1.297 billion and a B2 loan of €342 million (giving a total term loan debt package of €1.639 billion). The term loan package initially matured in July 2012.

These were issued by Lehman’s German unit, and subsequently acquired by Windermere XII, a CMBS structured as a fond commun de creances (FCC). The CMBS was managed by EuroTitrisation, a vehicle owned by several French lenders understood to include Crédit Agricole, AXA, Natixis, Banque Populaires-Caisses d’Epargnes (BCPE) and BNP Paribas, who financed the deal by issuing notes listed in Dublin. These notes were secured against rental income on the property, and interest rate fluctuations hedged via Lehman Brothers International Europe (LBIE).

LEHMAN AND A LEGAL LEGACY

When Lehman collapsed in late 2008, LBIE lost its credit rating and therefore became unable to act as counterparty to the hedges, triggering a default. The loan documentation required that hedges be replaced in such a scenario, at current market rates. At that time, with the financial markets in meltdown, that proved impossible to achieve.

Windermere’s only recourse in that scenario was to invite noteholders to vote on a proposal to accelerate the term loan and enforce redemption. That would have led to the insolvency of HOLD and Dame Luxembourg and a distressed sale of Coeur Défense itself. With property values plummeting, that was an unedifying prospect.

In late 2008, Jean-Philippe Robé, a Paris-based partner at law firm Gibson Dunn, successfully argued in the Paris Tribunal of Commerce that Dame Luxembourg and HOLD should be placed into the French sauvegarde (safeguard) system, a French creditor protection regime similar to the US Chapter 11 debtor-in-possession procedure. It effectively stayed any proceedings against the two parties by creditors.

In September 2009, the same tribunal adopted the safeguard plan, enabling a restructuring of the term loan. Five months later, however, the Court of Appeal in Paris overturned the decision on the basis that HOLD And Dame had failed to prove they were in sufficient operational difficulties.

That ruling was itself overturned in March 2011 by France’s highest court (the Cour de cassation), which ruled the procedure was open to any debtor confronted with insurmountable difficulties regardless of their nature and regardless of the nature of the debtor (be it an operational owner, holdco or special purpose vehicle). Despite it being a Luxembourg-domiciled vehicle, HOLD’s primary business activity (or ‘centre of main interest’) was in France so it came within the court’s jurisdiction, the ruling added.

As Gibson Dunn pointed out at the time, the decision had far-reaching consequences in France, extending the range of debtors entitled to call on the safeguard process.

“The safeguard procedures are all about preserving the possibility to recoup equity over time,” comments Francesca Galante, co-founder of continental European real estate specialist First Growth.

“Safeguard is effectively similar to a Chapter 11, but a debt write down cannot be imposed on creditors, even if junior debt tranches are wiped out. An extension of term of up to 10 years can be imposed on creditors. It’s a more European way of delaying taking the pain and hoping things sort themselves out,” she adds.

ENTER LONE STAR

The Texan investment group began work on the deal in late 2013, according to sources close to the transaction. The firm itself declined to comment further on the deal beyond a statement released in March confirming it.

Its acquisition of Coeur Défense progressed very quickly, with the firm’s deal team working through the Christmas break to get the transaction finalised.

Time was of the essence – the safeguard procedure would have expired in July this year, meaning the asset would have had to be put up for sale, or further court proceedings instigated. Lone Star, which had previously successfully dealt with the executors of the Lehman estate, began buying up the Windermere-issued notes, which had traded in some volume on the secondary market.

It had earlier acquired Excalibur, a legacy Lehman CDO, in two tranches in early 2012. The CDO had aggregated some of Coeur Défense’s junior debt, sources said.

Perella Weinberg, meanwhile, had also been buying up notes, including Goldman’s exposure to the deal. It had amassed a sizeable position as a result. Reports have suggested that Perella had been eyeing its own bid for Coeur Défense, having held a large portion of its debt for several years.

THE DEAL

Lone Star’s approach to acquiring Coeur Défense in the end was straightforward. It bought the equity in the holdco and then hoovered up all the junior notes in the secondary market.

Lone Star paid €1.35 billion to acquire LB Dame (the parent company of Dame Luxembourg, which owns HOLD).

As part of the deal, HOLD was removed from the safeguard system with a view to its debt being repaid at a negotiated discount.

Lone Star funded the acquisition with a five year term loan package provided by BankofAmerica Merrill Lynch, and with equity from Lone Star Real Estate Fund III, its latest distressed real estate debt vehicle.

BoAML provided €805 million of senior debt (equating to 62 percent LTV) priced at approximately Euribor + 180-200 bps and €130 million of mezzanine (72 percent LTV) priced at Euribor + 650-700 bps, according to Debtwire ABS. 

AXA Real Estate Investment Managers is understood to have picked up 34 percent of the debt package in line with its strategy of teaming with banking partners in syndicated financings.

The sale price represented a 40 percent discount to its 2007 valuation, a remarkable reflection of how much the asset has depreciated in just seven years, essentially returning to its 2004 price after 10 years.

This reflected perhaps the uncertainty over ownership of the property, with an insolvent SPV and heavily-traded debt, and also declining occupancy – its current vacancy rate hovers around 24 percent and the lease profile is just 3.2 years to final break clause and 5.3 years on a full lease expiry basis, according to reports.

Without the deal, Coeur Défense would have been obliged to leave creditor protection in July this year, triggering a likely liquidation or sale of the property. This would have been complex, given the different positions of the various classes of note holders, and a sale of the asset would likely have triggered transfer tax that would have hurt the most junior noteholders. So for all parties, the outcome is a largely positive one.

Lone Star, having acquired the asset, will be keen to improve those numbers and create value. It’s well-positioned to do so, having demonstrated its financial acumen in acquiring the asset.

Cyril de Romance, a partner at and co-founder of First Growth alongside Galante, said Lone Star had a major advantage when it approached the asset.

“Real estate investors who understand financial engineering and structuring have a tremendous advantage over those who take the narrower, property-only approach. Both approaches are key in this market.

“Real estate advisors were preparing for the asset sale and institutional investors were expecting a neat info memo. Lone Star had a shrewd approach by approaching the various creditors in the capital stack to gain control of Coeur Défense through its debt.”

COEUR DÉFENSE TIMELINE

1997 – Unibail begins work on a project based in La Défense.

1998 – Unibail acquires the site of the old Esso tower.

2001 – Construction concludes, and Coeur Défense (CD) is 99 percent let. Project cost €665m.

2004 – Unibail sells 51% stake to Goldman Sachs Whitehall Funds, valuing CD at €1.345bn.

March 2007 – Lehman Brothers and Atemi acquire CD for €2.1bn.

September 2008 – Lehman Brothers collapses.

November 2008 – Paris Tribunal of Commerce grants safeguard proceedings to HOLD and Dame Luxembourg.

October 2009 – Perella Weinberg acquires around €600m of notes from Goldman at a steep discount.

February 2010 – French Court of Appeal rules that CD should be removed from safeguard.

March 2011 – Paris’ Cour de cassation overturns Court of appeal ruling; CD remains in safeguard.

Q4 2013 – Lone Star begins work on a deal to acquire CD.

March 2014 – Lone Star completes the acquisition of CD having bought LB Dame and notes.