£417 Million Commercial Mortgage-Backed Floating-Rate Notes
This presale report is based on information as of March 31, 2006. The credit ratings shown are preliminary. This report does not constitute a recommendation to buy, hold, or sell securities. Subsequent information may result in the assignment of final credit ratings that differ from the preliminary credit ratings. For further ratings information, call Client Support Europe on (44) 20-7176-7176. Members of the media may contact the Press Office Hotline on (44) 20-7176-3605 or via media_europe@standardandpoors.com. Local media contact numbers are: Paris (33) 1-4420-6657; Frankfurt (49) 69-33-999-225; Stockholm (46) 8-440-5914; or Moscow (7) 495-783-4017. Investors are invited to call the SF Investor Hotline on (44) 20-7176-3223.
Class
Prelim. rating*
Prelim. amount (Mil. £)
Available credit support (%)
Bank LTV ratio (%)
Interest
Expected final maturity
Legal final maturity
A
AAA
270
35.25
50.0
Three-month LIBOR plus a margin
July 2014
July 2017
B
AA
40
25.66
57.4
Three-month LIBOR plus a margin
July 2014
July 2017
C
A
57
11.99
67.9
Three-month LIBOR plus a margin
July 2014
July 2017
D
A-
14
8.63
70.5
Three-month LIBOR plus a margin
July 2014
July 2017
E
BBB
31
1.20
76.3
Three-month LIBOR plus a margin
July 2014
July 2017
F
BBB-
5
N/A
77.2
Three-month LIBOR plus a margin
July 2014
July 2017
*The rating on each class of securities is preliminary as of March 31, 2006 and subject to change at any time. Final credit ratings are expected to be assigned on the closing date subject to a satisfactory review of the transaction documents and legal opinions. Standard & Poor's ratings address timely payment of interest and payment of principal not later than the legal final maturity.
Transaction Participants
Originator
The Royal Bank of Scotland PLC
Arranger
The Royal Bank of Scotland PLC
Servicer and special servicer
The Royal Bank of Scotland PLC
Liquidity provider
The Royal Bank of Scotland PLC
Transaction account provider
The Royal Bank of Scotland PLC
Borrower hedging provider
The Royal Bank of Scotland PLC
Supporting Ratings
Institution/role
Ratings
The Royal Bank of Scotland PLC as liquidity provider, transaction account provider, and borrower hedging provider
AA/Stable/A-1+
Transaction Key Features
Expected closing date
April 2006
Number of loans
1
Number of properties
4
Principal outstanding (Mil. £)
417
Country of origination
U.K.
Geographic concentration of assets
100% of the assets are located in one Central London location
Concentration of tenants by committed rent
Ernst & Young LLP (59.6%); Greater London Authority (17.8%); Hewitt Bacon & Woodrow Ltd. (9.4%)
Concentration of asset types by committed rent
97.8% is office income
Bank current weighted-average LTV ratio (%)
77.2
Bank weighted-average LTV ratio at loan expiry (%)
74.1
Weighted-average seasoning (months)
2.0
Redemption profile
Amortization sequential; after a prepayment the allocated loan amount is paid pro rata and the release premium sequentially
Day 1 liquidity facility size (Mil. £)
33.5
Bank weighted-average interest coverage ratio based on committed rents (x)
1.12
Bank weighted-average debt service coverage ratio based on committed rents (x)
1.09
Standard & Poor's property score*
2.1
Percentage of loans by pool balance fully hedged
100
*Where 1.0 is the highest and 5.0 is the lowest.
Transaction Summary
Preliminary credit ratings have been assigned to the £417 million commercial mortgage-backed floating-rate notes to be issued by Epic (More London) PLC, an SPE incorporated in England and Wales with independent directors.
At closing, the issuer will use the proceeds of the note issuance to acquire the senior tranche (tranche A) of a single investment loan advanced to London Bridge Holdings Ltd. The loan will be secured by four recently completed office buildings with ancillary retail, leisure, and restaurant accommodation. The buildings are situated at More London, a modern commercial scheme on the south bank of the River Thames, adjacent to Tower Bridge.
The borrower owns the freehold interest in the entire More London scheme. In addition to the subject collateral, the scheme includes development land and three soon-to-be-completed buildings: two offices and a hotel. Head leases have been granted to nominee companies in respect of each of the four completed buildings. This allows secured creditors to "overreach" the beneficial interests of the borrower in the collateral if the loan defaults.
The transaction is the sixth in the Epic series, originated and arranged by The Royal Bank of Scotland PLC. This transaction features additional debt (tranches B and C of the investment loan), which will be subordinated to the senior loan by way of an intercreditor deed and will not form part of the securitization.
Strengths, Concerns, And Mitigating Factors
Strengths
The loan collateral represents the first phase of a prominent office development fronting the Thames and comprises three high quality headquarters buildings and City Hall (the Mayor's office).
Ernst & Young and the Greater London Authority (through the First Secretary of State) together account for over 77% of Day 1 committed rent and occupy the property on leases with earliest break or expiry dates in 2028 and 2021, respectively.
The average unexpired lease term at loan maturity in July 2014 exceeds 10 years and less than 10% of income is subject to break options during the loan term.
The lease to the Greater London Authority has fixed rental increases every five years, with all other leases being upwards-only to market value and some having fixed increases at the first rent review.
Interest payments under the senior (securitized) tranche are fully hedged until loan maturity.
A liquidity facility of £33.5 million, equivalent to approximately 8% of issuance, will be available on Day 1.
Concerns and mitigating factors
This is a single asset-type transaction with 100% exposure to the Central London office market. More London provides quality accommodation at rents lower than those prevailing in the prime City sub-market, and generally on a par with those at Canary Wharf.
Two buildings include approximately 140,000 sq. ft (13,006 sq. m.) of vacant office space (representing approximately 19% of total office accommodation). This offers an opportunity to improve on existing DSCR levels. In the meantime, DSCR levels are met by committed rents and the originator has made available an £18 million (tranche C) facility to cover shortfalls should they arise before further lettings.
The senior loan includes only limited amortization (4% over the eight-year term), leaving a significant balloon repayment at maturity in July 2014. A relatively secure income stream with an average unexpired lease tail at loan maturity exceeding 10 years mitigates refinance risk. The size of the refinancing balloon has been reflected in the preliminary ratings assigned to the notes.
The borrower can draw additional debt under the loan facility. This is subordinated to the notes by an intercreditor deed and overall debt is limited to a maximum LTV ratio of 90% with Day 1 debt unlikely to exceed 86%.
The hedging arrangements are at the loan level and can be terminated upon borrower insolvency. The cash flow available to the borrower to pay the hedging counterparty relies on a range of tenants, with approximately 86% of Day 1 income derived from Ernst & Young, the Greater London Authority, and Hewitt Associates. The issuer can make hedging loans.
The borrower was incorporated in the Bahamas in 1999 and its activities have included property development. The borrower's activities have been limited to the More London scheme and legal title in each of the four buildings has been assigned to two nominee companies that hold the assets on trust. The ownership structure is intended to allow secured creditors to overreach the borrower's beneficial interests in the collateral if the loan defaults or the borrower becomes insolvent.
Transaction Characteristics
The structure of the transaction is shown in chart 1.
Issuer security
The loan is secured by a comprehensive security package and includes first-ranking mortgages over the property, charges over i) the borrowers' bank accounts, ii) the rental income derived from the secured property, iii) the shares in the borrower, and iv) all the assets of the nominees and the nominee holdco.
The security package will be assigned to the trustee under the deed of charge and assignment. In addition, the issuer will grant security to the trustee over its bank accounts and rights in the various transaction documents to the note trustee for the benefit of the noteholders and others secured creditors.
Liquidity facility arrangement
A liquidity facility will be available to enable the issuer to cover shortfalls in interest.
The Day 1 liquidity facility amount will be £33.5 million, which represents approximately 8% of the aggregate principal note balance, and approximately 16 months of interest payments under the notes.
Liquidity will reduce as the outstanding principal balances of the notes reduce. The reduction will not be proportionate to the reduction in the note balance, to take account of pool concentration.
The liquidity facility will also be subject to an appraisal reduction mechanism, which may reduce the amount of the facility available to the junior noteholders after a loan event of default.
Hedging arrangements
The borrower has entered into interest-rate swap agreements with the Royal Bank of Scotland. The borrower pays a fixed interest rate to the swap counterparty, which in turn pays a floating interest rate to the borrower to enable it to meet its interest payment obligations under the loan.
These swap agreements are not structured to survive borrower insolvency or enforcement and so would terminate upon enforcement of the security. Any associated break costs could reduce the level of recoveries available to noteholders.
The issuer may make a hedging loan by drawing on the liquidity facility if the borrower's failure to pay under its senior hedging arrangements would result in an event of default. Repayment of a hedging loan will rank senior to the notes.
At the issuer level, the notes will have floating-rate coupons based on three-month LIBOR. As the interest payments under the loans and the notes will occur on the same dates, there is no requirement for a basis swap agreement in the transaction.
Redemption profile
Scheduled amortization, together with the final balloon repayment received on the senior loan, will be applied to the notes sequentially. Upon a disposal of one or more of the four buildings, the allocated loan amount will be used to redeem the notes pro rata. The release premium of either 10% or 15%(as applicable) will be used to redeem the notes sequentially.
Prepayment risk
The borrower may prepay at least £5 million of the senior loan as long as prepayment will not reduce the loan amount outstanding to less than £200 million. Partial prepayments will be used to redeem the notes sequentially. Prepayment fees are payable to the originator in the first and second years of the loan term.
Additional debt
Additional debt that does not form part of the securitization is outstanding under the loan. This additional debt (tranches B and C) amounts to approximately £46 million on Day 1 but may increase if, for example, drawings under tranche C are necessary to cover debt-service shortfalls.
The relationship between the senior (tranche A) lender (and thus the noteholders) and the junior (tranche B and C) lenders is governed by an intercreditor agreement. The senior and junior debt is subject to separate hedging arrangements.
The junior lenders and the junior hedging counterparty have certain entrenched rights in respect of the administration of the whole loan. These rights principally relate to giving consent to amendments to the credit agreement but also include consent rights in respect of the release of security and the release of any obligor under the loan.
The junior lender can force the senior lender to take enforcement action if the loan is accelerated or if a loan event of default exists at the end of a 120-day standstill period, but only if the value of the real estate is at least 120% of the outstanding senior debt amount.
The junior lender can also cure payment defaults or a financial ratio breach in respect of the senior loan. It can only do this twice in any 12-month period and four times during the term of the senior loan. In some circumstances, the junior lender can also buy the senior loan. The purchase price includes all amounts due to the issuer by the borrower as well as all outstanding transaction costs owed by the issuer.
Controlling party
The controlling party will be the holders of the most junior class of notes that still has at least 25% of its Day 1 amount outstanding. The controlling party is entitled to appoint a representative to look after its interests if the loan becomes a specially serviced loan. This representative has the power to replace the special servicer.
Further advances
Two buildings (3 More London and 4 More London) are scheduled to be completed during 2006. Leases to Norton Rose and Lawrence Graham will then become effective for most of the new office accommodation. Subsequently, both buildings are likely to be refinanced and added to the existing securitization pool. Additional notes may be issued in order to fund the enlarged loan facility.
The loan agreement anticipates this refinancing and includes a number of pre-conditions that must be met. For example, the additional funding must be for not less than £50 million, is subject to Standard & Poor's affirmation that existing notes are not adversely affected, and must be supported by a revaluation of all the properties of at least £850 million and by a combined passing rent of at least £41 million.
Loan Characteristics
The loan pool comprises a single loan secured by four buildings at More London, a prominent office development located in London SE1, next to Tower Bridge on the south bank of the Thames.
The loan is summarized in table 1.
Table 1
Loan Characteristics
Loan name
Property type
Securitized loan balance at cutoff (Mil. £)
Loan expiry
Bank ICR Day 1* (x)
Bank DSCR
Day 1*
(x)
Bank LTV ratio Day 1 (%)
Bank exit LTV ratio (%)
Day 1 junior debt (Mil. £)
London Bridge Holdings Ltd. (Buildings 1,2, and 6 and City Hall)
Offices (with ancillary retail)
417
July 15, 2014
1.12
(senior loan)
1.09 (senior loan)
77.2
74.1
46
*Based on committed rents.
The loan has been advanced to London Bridge Holdings for a term of approximately 8.4 years to refinance an existing acquisition and development facility and has been arranged for this securitization. The loan is formed of three tranches (A, B, and C), of which only tranche A will be securitized.
The senior loan will amortize by £16.7 million during the term.
The borrower is required to meet a tranche A 12-month forward DSCR of 1.0x. After April 2007, it must also meet a backward DSCR of 1.0x. Both triggers rise to 1.1x once committed rents have reached £31.3 million and the tranche C facility has been cancelled. The tranche A portion of the loan is not subject to a LTV ratio covenant, but the permitted tranche B LTV ratio is 90.0%, dropping to 87.5% from April 2012.
Tranche C will be available to the borrower to cure a breach of any financial ratio. The tranche C facility is £18 million and the commitment fee payable by the borrower in respect of any undrawn tranche C balances ranks senior to noteholder payments.
Failure to comply with the financial ratios is an event of default, although the borrower has the opportunity to cure ICR or DSCR breaches twice during the loan term.
The loan contains typical property covenants covering the asset management of the properties, new leases, surrenders, and assignments. The consent of the loan facility agent is required for assignments or surrenders of any lease.
The Loan Collateral
The loan collateral comprises 999-year head lease interests in four office buildings located on the south bank of the River Thames, between Tower Bridge and London Bridge in Southwark. Together with two further office buildings (under construction), a hotel to be operated by Hilton Group and a parcel of development land, the entire site is known as More London and extends to 13 acres. The buildings under construction and the development land, while ultimately owned by the borrower, will not initially form part of the securitization.
Chart 2 illustrates the different uses within the collateral properties by floor area.
Tenancy information for the properties is summarized in table 2.
Table 2
Tenancy Information By Property
Property
Tenant
Property use
Area (sq. ft)
Lease expiry date (1st break option)
Passing rent (per sq. ft) (£)
External valuation market rental value (per sq. ft) (£)
% of passing rent
External valuation (Mil. £)
% of total value
1 More London
Ernst & Young LLP
Offices
384,672
Sept. 29, 2028 (N/A)
15,860,540 (41.23)
14,211,272 (36.97)
59.6
272.7
50.5
2 More London
CDC Group PLC
Offices
29,342
28 Sep, 2020 (25 Dec, 2008)
1,167,680 (39.80)
1,110,196 (37.84)
4.4
78.0
14.4
Visit London Ltd.
Offices
14,372
Dec. 24, 2020 (Dec. 25, 2010)
577,880 (40.21)
549,136 (38.21)
2.2
C.I. Investor Services Ltd.
Offices
14,627
June 3, 2021 (June 4, 2013)
584,580 (39.97)
555,846 (38.00)
2.2
Terra Firma Capital Partners
Offices
14,580
June 1, 2021 (March 25, 2015)
580,875 (39.84)
552,141 (37.87)
2.2
Signature & Strada Restaurants
Retail
4,628
Aug. 15, 2020 (N/A)
75,000 (16.21)
115,000 (24.85)
0.3
Tower Bridge Health Clubs Ltd.
Leisure
18,710
Sept. 1, 2030 (N/A)
187,100 (10.00)
187,100 (10.00)
0.7
Vacant
Offices
43,223
—
—
1,663,461 (38.49)
Vacant
Retail
3,283
—
—
90,000 (27.41)
Vacant (under offer)
Retail
9,579
TBC
Under offer
200,000(20.88)
6 More London
Bacon & Woodrow Properties
Offices
58,880
July 23, 2028 (July 24, 2023)
2,506,674 (42.79)
2,156,241 (36.37)
9.4
93.1
17.2
Vacant
Offices
96,932
—
—
3,652,174 (37.68)
Bagel Street
Retail
992
Oct. 8, 2023 (N/A)
35,000 (35.28)
32,240 (32.50)
0.1
Café Nero
Retail
1,611
Oct. 8, 2023 (N/A)
50,000 (31.04)
52,357 (32.50)
0.2
M&S Simply Food
Retail
5,132
Sept. 28, 2023 (N/A)
215,000 (41.89)
166,790 (32.50)
0.8
Café Amore
Retail
914
Oct. 22, 2023 (N/A)
30,000 (32.82)
29,705 (32.50)
0.1
National Westminster Bank PLC
Cash machine
36
March 30, 2009 (N/A)
8,000 (N/A)
8,000 (N/A)
0.1
Lloyds TSB Bank PLC
Cash machine
36
March 22, 2009 (N/A)
8,000 (N/A)
8,000(N/A)
0.1
City Hall
Greater London Authority
Office
130,045
Dec. 24, 2026 (Dec. 25, 2021)
4,746,658 (36.50)
4,761,643 (36.50)
17.8
96.5
17.9
Total
831,594
26,632,987
30,101,302
100.0
540.3
100.0
N/A — Not applicable. TBC — To be confirmed.
All four buildings were completed between 2001 and 2003 to a high (Grade A) specification and include ancillary retail and leisure space. City Hall provides office space arranged around an atrium housing the Assembly chamber but could be used by more-standard office occupiers with relatively little modification (see image 1).
More London is one of only a limited number of campus-style office developments in Central London, and so has benefited from master planning and a cohesive estate management strategy. The layout of the buildings has been carefully considered to allow the maximum amount of space to benefit from the river frontage and to encourage a pedestrian link through the scheme connecting the adjacent London Bridge Station with Tower Bridge.
Two of the buildings were pre-let to a single tenant each, while the other two are multi-let. 1 More London is Ernst & Young's U.K. headquarters and City Hall is home to the Greater London Authority. Buildings 2 and 6 are multi-let with office accommodation of approximately 140,000 sq. ft (13,006 sq. m.) still available to let.
Two additional office buildings and a Hilton branded hotel on the adjoining site (which do not form part of the securitization) are structurally complete and are being fitted out. The office buildings have been 83% and 81% pre-let to international law firms Norton Rose and Lawrence Graham, respectively. Both tenants have options on the remaining space.
The cleared development plot could accommodate a further building of approximately 480,000 sq. ft (44,593 sq. m.), although this is unlikely to be developed without a significant pre-let.
The lettings achieved to date indicate the scheme has proved popular with a range of large occupiers attracted by the quality of the scheme and occupational costs approximately 20% lower than prime City locations (see image 2). Importantly, public transport links from London Bridge Station make this a more accessible location than many other fringe City locations or Canary Wharf, for example.
A number of competing schemes are on the South Bank, including Bankside (808,000 sq. ft, of which approximately half has been pre-sold to IPC Magazines), Palestra (298,000 sq. ft), and 10 Blackfriars Road (382,000 sq. ft). However, much of this is either not available immediately or does not have all the advantages of More London. This should encourage further lettings, particularly in the context of a City office market where vacancy rates and rental levels are slowly improving, and which has record levels of employment.
Loan Origination
Origination
The Royal Bank of Scotland originated the senior investment loan in February 2006 with the intention of securitization. The originator has been providing development funding for the borrower in respect of the More London scheme for approximately five years.
Servicer and special servicer
The Royal Bank of Scotland will be appointed servicer and special servicer of the loan. Annual servicing fees are 0.03% of the principal balance of the loan.
An annual special servicing fee of up to 0.25% becomes payable after the transfer of the loan into special servicing. Servicing transfer events comprise all loan events of default, including potential loan events of default.
A liquidation fee of up to 1% is also payable to the special servicer from net realization proceeds following enforcement of loan security. A restructuring fee of 1% of all interest and principal is also payable to the special servicer for any loans that were, but are no longer, specially serviced. The restructuring and liquidation fees are paid junior to the rated notes.
Borrower
The borrower is a LPE incorporated in the Bahamas in March 1999. It owns the freehold of the entire More London estate and its activities have been limited since that time to the business of acquiring, developing, letting and holding the estate. The borrower has no employees.
Bank accounts and cash management
The borrower is obliged to open and maintain bank accounts with The Royal Bank of Scotland. The accounts include a rental income account, into which rental income is deposited, a general account, and a disposal proceeds account.
All accounts are charged to the issuer. The security trustee has sole signing rights in relation to all accounts except the general account.
Rent is typically paid to a managing agent who is required to transfer net rental proceeds to the rental account immediately.
Insurance coverage
The borrower is required to maintain building insurance for the usual perils, including terrorism cover and a minimum of four years loss-of-rent.
The minimum-rating requirement for insurance providers under the loan is 'A', however, two of the insurers are Royal Sun Alliance (rated 'A-') and AXA (rated 'BBB+'). These insurers may need to be replaced with an insurer with a rating of at least 'A' should their long-term ratings fall below 'BBB+'.
The tenant of City Hall is permitted to self-insure for as long as it remains a public body.
Environmental review
We have been informed that an environmental review was undertaken in 2004 in respect of the site and that its overall findings do not highlight any significant issues.
Credit Evaluation
Standard & Poor's primary focus is to establish a sustainable level of net income for the properties, having regard to the contractual provisions of the occupational leases, the nature and location of the buildings, and any nonrecoverable costs. Our analysis therefore evaluates the inherent strength of the real estate, including its ability to attract further tenants and generate additional cash flows.
While we expect the current vacancy rate to drop significantly over the short-to-medium term, we have nevertheless assumed a permanent void on a small proportion of the office accommodation.
Our analysis has assumed that current committed rents will rise from £26.63 million to approximately £31.6 million over the term of the loan. We have given credit to the fixed rental uplift at City Hall but where leases include a tenant option to break in the next three years, we have assumed the rent will revert to the current market rent, if lower. We have assumed vacant office floors will be let at 90% of the current market rent (the equivalent of approximately £34 per sq. ft). Where we have assumed a permanent void, a deduction has been made to net income to reflect associated nonrecoverable costs.
The sustainable rent was compared to the cash flow required to meet debt-service payments under the terms of the senior loan agreement. Analysis of the refinance prospects at loan maturity was also completed. This analysis principally focuses on the amount of exit debt and the corresponding exit yield on debt and gives consideration to the movement of capitalization rates over time. Both debt-service and refinance analysis were completed in a variety of stressed scenarios. We consider an appropriate investment-grade exit yield on debt for this transaction to be approximately 8%, based on a sustainable level of income of £31.6 million.
In assessing an appropriate exit yield Standard & Poor's made adjustments to the junior classes of notes to reflect the provisions of the intercreditor agreement.
In summary, while the assets are concentrated in one place, we nevertheless recognize the overall quality of the buildings, the relative merits of this location and the reasonably robust nature of the existing income profile.
Key Performance Indicators
Continual surveillance will be maintained on the transaction until the notes mature or are otherwise retired. Key performance indicators for this transaction include:
Changes to Central London office market benchmarks, including rental levels and vacancy rates;
Overall progress in the marketing and letting of the vacant office and retail accommodation;
The financial covenant tests;
Trends in property investment yields in particular as loan maturity approaches; and
The interest rate environment at loan maturity
Criteria Referenced
"European CMBS Loan Level Guidelines" (published on Sept. 2, 2004).
"European Legal Criteria for Structured Finance Transactions" (published on March 23, 2005).
Related Articles
"The Impact Of Repayments On European CMBS Subordination Levels" (published on Sept. 13, 2005).
"Record European CMBS Issuance Driven By Secured Loan And True Sale Transactions" (published on July 21, 2005).
"European CMBS Exhibits Strong Ratings Performance With Upgrades Outnumbering Downgrades" (published on July 21, 2005).
"A/B Structures Have An Effect On European CMBS Subordination Levels" (published on July 14, 2005).
All criteria and related articles are available on RatingsDirect, Standard & Poor's Web-based credit analysis system, at www.ratingsdirect.com. The criteria can also be found on Standard & Poor's Web site at www.standardandpoors.com.
