(Debtwire) Vivion rising coupon risk looms but unencumbered asset strength opens bond redemption prospect
26 September 2022 | 18:08 BST
Vivion has a relatively low loan-to-value ratio and is hoping for an upgrade to Investment Grade. The Germany-based real estate investment company’s transactions related to the Furst asset disposal continue to be scrutinized and bond prices suggest any refi could require a higher coupon according to three buysiders. But its improving liquidity and unencumbered asset ratio means it may no longer need access to high yield funding down the line according to one source familiar with the situation.
The company reported 1H22 earnings on 13 September and held an earnings call last Tuesday (20 September).
Investor concerns still persist on the name given acceptance of non-cash payments in related party transactions. Vivion previously sold its full 89.95% stake in its Furst Berlin asset to Luxembourg-headquartered real estate company Aggregate Holdings in June 2021, receiving a mix of cash and tradeable and non-tradeable financial instruments in return. Total financing for the Furst deal was announced at EUR 1.25bn including a circa EUR 250m capex reserve account that implied EUR 1bn of proceeds for Vivion. Tradeable financial instruments received as part of the Furst acquisition were initially stated to be investment grade securities. But it emerged from the Aggregate Holdings 3Q21 investor call that some of the instruments - namely EUR 220m tradeable securities - received by Vivion were Aggregate Holdings bonds, as reported.
The recent strife at Aggregate, as reported, has reduced its available liquidity and also sparked a plunge in its bond prices (including Aggregate EUR 220m 5.5% senior unsecured 2024 bonds held by Vivion relating to Furst) in recent months.
This has ultimately contributed to a solution earlier this month where Vivion would receive non-cash payments in return for settling the related party transactions between Vivion and Aggregate Holdings. It was announced that Vivion would acquire two segments of the Quartier Heidstrasse (QH) project in Berlin from Aggregate Holdings for a gross purchase price of EUR 456m, as reported. As part of the EUR 456m sale, around EUR 219m of the equity purchase price would be settled with the existing position of c.EUR 220m 5.5% senior unsecured 2024 Aggregate Holding bonds that Vivion holds. The Aggregate bonds had a nominal amount of c.EUR 220m but a market value of just EUR 77m (implying a 35 cents cash price) at 1H22, according to the Vivion financial report.
Following the transaction there will be no remaining commitments between Vivion and Aggregate Holdings including no outstanding pledges of subsidiaries relating to Furst. The non-tradeable financial instruments Vivion received as part of the Furst sale had a EUR 332m book value and were disposed to a EUR 4bn third-party Europe-based asset manager.
“The Furst asset was supposed to be so great they sold it but were now happy to receive non-cash considerations for it,” one buysider said. “They said there was a watertight security package for the bonds, but they swapped an asset that was not in cash and bondholders were taken for a ride.”
Aggregate Holdings are retiring bonds with the QH assets sale proceeds, the first buysider noted. He added that Aggregate Holdings didn’t have money to retire the c.EUR 220m bonds they provided to Vivion. This meant Vivion had to take the asset from them as they couldn’t get cash from Aggregate Holdings.
The source familiar with the situation countered that all of the positions with Aggregate Holdings (including both the traded and the non-traded bonds) were fully secured as part of the security package Vivion received.
“As a seller protection, and on top of any other rights the company received through the direct holdings of the traded and non-traded bonds, Vivion actually benefited from a waterproof security package over several companies that indirectly hold the Fürst project, additional German real estate assets and included an additional seller protections mechanism,” the source familiar said.
The source familiar noted that there was the thesis that Vivion was exposed to Aggregate Holdings and that Aggregate Holdings would not repay their debt, but the fact that Vivion exchanged the EUR 220m of the remaining position of traded bonds it held, with the best assets that are part of the QH complex, proved that Vivion was 100% secured along all the way.
The total proceeds received by Vivion group from the Furst Project disposal amounted to EUR 854m, split between c.EUR 634m of cash and c.EUR 220m net asset value of prime income producing real estate, the source familiar noted. He added that the total proceeds represent an approximately EUR 250m gain to Vivion’s acquisition price and that the QH assets Vivion obtained, at a discount to the actual value, are newly built, income producing and well occupied and do not require any material capital expenditures
Another investor governance concern was that Vivion in 1H22 benefited from a rise in value of derivative financial instruments. The company’s 1H22 Level Three financial instruments increased to EUR 124.2m versus EUR 71.5m at FY21. Vivion in a footnote noted that the derivative financial instruments were received by the group as part of the Furst Berlin asset disposal with the derivatives being provided as a protection for the asset seller Vivion.
The source familiar noted that as of today, and following the settlement and the exchange with Aggregate Holdings, Vivion no longer has any Level Three derivatives assets. As of June 2022, the Level Three derivatives assets were the value of the seller protection Vivion held before the exchange that occurred in September. This position together with the Aggregate Holding SA tradable Level One bonds is now settled and will be replaced in the next Vivion reporting with investment property, the source familiar added.
Vivionwards and upwards
There still remain some fundamental credit attractions. Vivion reported a relatively low 36.0% LTV at 1H22, which was marginally higher than 35.3% at FY21.
Additionally, the company argues that real estate has the benefit of being a good proxy against inflation with real rates deep in negative territory (see chart below). The CEO added on the earnings call that a decline in gross asset value of more than 33% would bring the Vivion loan-to-value only up to 50%.
Source: Vivion 1H22 investor presentation
One surprise however is that for UK hotel portfolio rent collection rates for the period 1Q22 to 3Q22 was around 88% with the remainder of collections to be deferred and paid in monthly installments in 1H23.
“Collection rates have still not gone back to 100%. Hotels are back up and running and they are taking in visitors. Why 88%?” the first buysider said. “They say in the hotel sector that occupancy rates are heading up towards 2019 levels but then some UK hotel rent was deferred and paid in installments.”
They have good liquidity and decent assets with rent linked to CPI, independent special situations firm Sarria noted. “Raising rent can of course lead to vacancies, but that’s where it pays to hold attractive assets,” Sarria told Debtwire. “On the UK hotel portfolio, after the Queen’s funeral has been televised across the world, I assume the next ten years of UK tourism are safe.”
“It seems that everyone forgets that there was a world pandemic in 2020 and another waive of Omicron in 2021 which impacted hotels operations and to aid tenants, part of rents were therefore agreed to be deferred in 2020 but 2021 rents have been almost fully collected,” the source familiar said.
The source familiar also noted that the company’s office tenants are mostly governmental tenants that pay below market rents, but are longer-term tenants which provide resilience towards recession and means the company is not materially sensitive to indexation. For the next five years, even if inflation climbs to 10% then average rent in Germany will climb to EUR 31 per square meter versus EUR 20 currently but tenants can still pay for it, the source added.
No prize for Furst place
Vivion bonds are outperforming high yield real estate sector peers. Its BB+ rated EUR 700m 3% senior unsecured 2024s are indicated flat since last Tuesday (20 September) and indicated today (26 September) at 91.5-mid yielding 8.1% to worst while its BB+ rated EUR 300m 3.5% senior unsecured 2025s are indicated around a half point down since 20 September at 89.25-mid yielding 7.2% to worst on Markit.
Vivion in June announced a EUR 150m a bond buyback program, as reported. Management noted on the earnings call that EUR 66m was the nominal amount purchased in 1H22, divided between around EUR 40m of the 2024 notes and around EUR 26m of the 2025s. However, the purchased notes have not been redeemed or cancelled.
With Vivion secondary bond yields around 8%, this implies that refinancing costs could rise in the coming quarters and erode free cashflow potential down the line due to higher interest costs.
“The problem is a little bit that Vivion is not set up to earn a maximum cashflow, but to buy, improve and sell assets at a profit,” Sarria said. “So, interest coverage would be the tight spot. In the high inflation environment investors prefer to see cash income but this is not Vivion's game.”
They could buy back bonds at discounts and, if needed, could use their large cash balance to refinance a smaller amount of debt, Sarria noted, adding that Vivion could also just choose to sell one to two hotels and cover coupons for years, so they don’t see this name in the “problem zone”.
An 8% yield in today’s world is still quite solid, Sarria noted. “The Bank of England will soon be in that range. It’s not exactly risk-free, but it beats holding cash,” Sarria said.
“If they refinance with 8% coupons while rental income yields are at 2%-4% then the business does not generate any cash,” the first buysider countered.
One positive scenario is that Vivion’s large unencumbered assets position means that it has the potential to fully redeem its EUR 651m 3% senior unsecured 2024 bonds and EUR 610m 3.5% senior unsecured 2025 bonds outstanding or access other funding markets.
The company’s cash balance of EUR 722m as of June 2022 is expected to be increased with operational cash flow, an additional EUR 212m following settlement of the deferred payment for the non-traded bond in December 2022 and through disposal of several assets which could mean cash balance of c.EUR 1.3bn by year-end, the source familiar noted.
The source familiar added that Vivion holds more than EUR 3.1bn of unencumbered assets that provides it with several financing or refinancing opportunities and allows the company to refinance the unsecured debt with secured debt, to redeem its unsecured debt with cash if needed or to continue the buyback of the bonds at a discount in the secondary.
Another additional positive for company refinancing prospects could come from an S&P upgrade of its current BB+ rating to investment grade. Management noted on the earnings call that they are in regular dialogue with S&P.
“The Vivion IG aim was dependent on growing the property portfolio. QH was largely residential. S&P will revisit the rating and it will be interesting,” the first buysider said. “It will be tricky for S&P, and they don’t want to be burnt like they were with [real estate peers] Adler and SBB.”
“We wanted to reduce our exposure to the real estate sector, and it made sense to sell out from a top-down perspective given we wanted less exposure to credits that could be impacted by rising rates,” a third buysider said. “But there were idiosyncratic issues as well on the name.”
Management disclosed in the 1H22 results that the company is working on refinancing options. Additionally, in June, a new investor made a 4.2% equity investment in Vivion and the company still targets an IPO within two to three years. Vivion Is owned by majority shareholder and founder Amir Dayan.
Vivion declined to comment.
by Adam Samoon with capital structure by Nikhil Godbole