This article was published in the Spring issue of Historic House: The Historic Houses Association Magazine and is reproduced by kind permission.
Financing for landed estates has traditionally taken the form of loan facilities provided by a bank and secured against property in the form of a legal mortgage. The onset of the financial crisis triggered a significant reduction in the overall number and value of mortgages and many estates continue to find that banks are either less willing to lend or unable to lend in the larger sums and on the longer maturities desired by some estates. As a result, many estates are increasingly looking to alternative sources of capital to meet their long-term financing requirements. One alternative source of funding which has proved attractive in recent years is the private placement market.
Why alternative sources of long term finance?
There are several factors which have impaired the traditional use of the bank loan market as a means of raising long-term finance and encouraged borrowers to look for alternatives:
- New capital and regulatory restrictions on banks introduced in the wake of the financial crisis mean that they are typically less willing than before to lend substantial sums on the long-term basis which borrowers are seeking.
- Interest rates continue to remain at historically low levels such that, even where banks are prepared to lend, they are not prepared to do so on a fixed interest rate. Instead, they prefer to lend on shorter maturities (providing an opportunity for them to reset margins) and/or to offer floating interest rates (which can expose borrowers to interest rate rises, which can be mitigated by hedging arrangements but at a cost and on fairly bank-friendly terms).
- The ongoing obligations and financial covenants under bank loan facilities have become more onerous in recent years, whereas alternative funders are more willing to offer less stringent covenant packages.
- There has been an accelerated growth in the number of alternative non-bank debt capital investors in the market. These are typically insurers, pension providers, and debt funds, who have cash (but are receiving low interest rates on deposits), who may have long-term fixed liabilities for which they will require longer-term investments, and who have the internal infrastructure to enable them to provide the long-term debt funding required by borrowers.
- Depending on the financial strength and credit-worthiness of the estate, it may be possible to obtain unsecured debt. This clearly contrasts with the bank loan market where security over land and other assets will usually be a fundamental condition to the provision of any loan facilities.
What is a private placement?
A private placement is a private debt arrangement (often in the form of bonds or notes) between a borrower and a non-bank lender or a small group of non-bank lenders.
Historically a form of financing much used in the United States, private placements are increasingly being used in Europe as a means of raising alternative finance and diversifying borrower capital structures.
Whilst UK borrowers can look to US investors directly for this type of funding (particularly where large sums of liquidity are being sought), many UK pension funds and insurance companies are now offering this type of finance as a means of bridging the funding gap created by the recent reduction in available bank funding.
What are the key commercial terms of a private placement?
The commercial terms of the private placement will be crucial in ensuring both a positive uptake from the investment community and managing the estate’s risk over the life of the private placement.
It would be common for an estate to appoint an experienced financial adviser to provide guidance on the appropriate commercial terms for the private placement and to facilitate discussions between the estate and potential investors.
Key upfront matters for estate management teams to consider will include the following:
- Quantum: how much is the estate looking to raise? Generally the private placement market will only be open to those estates looking to raise a minimum of £10 million.
- Tenor: one of the key attractions of private placements is that their maturity tends to be longer than ordinary bank loan debt. A term of anywhere between 10 and 30 years would be normal (although it is possible for maturities to extend beyond even 30 years). For estates this can enable funding to be procured for large-scale, long-term capital projects (e.g. new developments, new estate activities, new visitor attractions etc.) and can also enable estates to align their funding needs with the maturity of trusts affecting their landowning families.
- Repayment: estates will need to consider the repayment terms for the debt both as to the ultimate repayment date and potential amortisations during the life of the debt, together with options for early redemption and prepayment.
Are the estate’s finances, both in terms of revenue streams (e.g. from rental properties, commercial estates activities, income-producing investments) and balance sheet, robust enough to sustain payments of interest over the life of the debt as well as repayment of capital at the end of the private placement’s life?
- Interest: the rate of interest that the estate might target and how often interest will be paid will be important elements to consider.
Interest rates in private placements will generally be fixed rather than floating, although interest rates tend to be higher than on traditional bank financing to reflect the longer tenor of the debt.
- Make-whole provisions: are estates willing to be locked in to the private placement for its entire term?
Private placements are attractive because of the length of maturity available. However, investors are also looking for that long-term investment; in order to protect their investment position they will very commonly include prepayment fees on an early repayment of the debt (sometimes termed ‘make-whole’ provisions) which ensure they receive their expected rate of return on the full term of the debt.
A ‘make-whole’ amount is typically calculated by reference to the discounted value of the interest which would otherwise have been payable on the prepaid amount.
The inclusion of make-whole provisions can make early repayment of a private placement costly and so estates should consider carefully whether they are content for the debt to remain outstanding to scheduled maturity.
Where an investor is from the US and has been prepared to make sterling available (usually by itself swapping US dollars for sterling over the period of the private placement), such an investor will also seek prepayment protection by requiring the borrower to indemnify it for any costs in breaking its original currency swap.
- Financial covenants: the appropriate level and types of financial covenants will need to be agreed. These will need to provide investors with comfort while protecting the estate’s flexibility to manage its day-to-day operations.
Investors may expect to see an interest cover financial covenant testing the estate’s ability to raise enough operating profit to cover its interest costs and a leverage covenant testing the ratio of the estate’s total debt to the value of its asset base. Other financial covenants might also be required depending on the particular estate and will be a matter of commercial negotiation. It is key to ensure that financial covenants are set at the right level at the outset of the transaction, as it can be difficult to procure amendments and waivers of covenant breaches later on.
- Information undertakings: another important matter will be the information regarding its financial performance and activities the estate will be required to provide to investors and the frequency with which such information will need to be provided.
Investors will expect audited annual financial statements for the estate and possibly also unaudited semi-annual financial statements. Any financials will need to be prepared using generally accepted accounting principles and consistently with the original financial statements provided at the outset of the transaction.
The key documentation required for a private placement will generally comprise the following:
- Investor presentation: the estate’s management or trustees (where applicable) will need to provide a thorough overview of the history and activities of the estate together with key financials. This usually takes the form of a set of slides presented to potential investors in roadshow meetings.
- Note Purchase Agreement: this is the equivalent of the facility agreement on a more traditional bank financing and will contain all the terms governing the placement. In general the terms of the note purchase agreement will be less restrictive than the terms of a facility agreement. For estates looking to diversify capital structures and have bank debt sitting alongside a private placement, it is usually possible to align the provisions of both to ensure consistency.
Planning and launching a private placement can be an intensive process and estates wishing to make use of the pool of financing available in the private placement market will need to seek out and engage legal counsel and financial advisers who are familiar with market practice and the documentation requirements for private placements.
Private placements: here to stay?
The use of private placements as a means of raising long-term finance has grown exponentially in the last few years and the UK market has developed momentum accordingly. Given the continued regulatory climate and imposition of capital controls facing banks, the use of private placements as a financing tool is likely to continue and grow further in the coming years. For those estates looking for sizeable longterm finance (whether for new capital projects or to match funding to long-term assets and investments they hold) private placements may prove an attractive alternative option to the usual route of bank financing.
If you require further information on anything covered in this briefing please contact Marc Glancy (Marc.Glancy@farrer.co.uk) or your usual contact at the firm on 020 3375 7000. Further information can be found on the Landed Estates page of our website.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, February 2017