Promissory loan notes as an alternative to real estate bank lending

REFIRE sat down just before Christmas with the Frankfurt-based finance advisory K-Bonds AG to learn more about a number of its recent transactions. K-Bonds, founded and headed by the erudite lawyer Hans-Günther Nordhues, provides mortgage-backed loan notes (Schuldscheindarlehen) which are then placed with institutional investors, frequently insurance companies and pension funds.

With traditional lending banks withdrawing from financing anything but the most rock-solid core properties to investors with blue-chip credentials, and CMBS markets in Europe still largely moribund, the marketplace has seen the emergence of a new class of alternative finance providers for real estate investment focusing on different tranches of the capital stack, from mezzanine specialists to debt funds, and those providing junior or investment grade debt.

What K-Bonds does is arrange and structure the real estate financing of projects on its CMFF platform, for example bringing insurers with certain investment profiles together with borrowers whose asset matches lenders' criteria.

It uses external service providers such as rating agencies and valuation specialists for asset-specific information. K-Bonds places promissory notes with the institutional investors, and then handles all the reporting and information obligations towards the trustees, the paying agent and the investors.

Nordhues says that mortgage-backed promissory loan notes can play an important role in filling the gap between traditional bank lending and investors' borrowing needs. While below borrowing needs of about €25m the local Sparkassen or co-operative banks can step in, from €35m upwards it can get trickier. Banks and bigger insurance companies can cherry-pick among the best of such projects on a 60% mortgage lending value basis. But many deals in this category won't easily find lenders.

At the same time, occupational pension funds and smaller insurance companies are also desperately looking for quality investments that meet their quality, yield and time horizon requirements. This is where loan notes can come in, says Nordhues.

Promissory loan notes are secured on the asset's value, which is subject to continuous valuation and a rating using the same criteria to assess Pfandbrief suitability. In fact, the first tranche is constrained to the same 60% against which a Pfandbrief offers security – the second and third tranches can be issued to raise up to 80% of the asset's market value. The interest rate is similar to that of Pfandbriefe, at between 150 and 200 basis points, while the duration is for between seven and twelve years. This gives the promissory note as an instrument the edge over traditionally available bank lending.

Nordhues described a recent transaction in which K-Bonds partnered with the independent Stuttgart-based BF.direkt AG, a provider of finance for residential and commercial real estate projects. The two companies arranged a loan note for the justice centre (Justizzentrum) in the city of Halle an der Saale in Saxony-Anhalt, and placed it with institutional investors. The loan note was for €33m, maturity is 2025, and the initial interest payable is 3.55% per annum.

The modern building houses several courts as well as public authorities of the state of Saxony-Anhalt, with E&P Holding from Cologne acting as asset manager.

The loan note, divided up into two tranches (senior and junior), is collateralised by mortgage bonds on the property financed. The senior tranche was awarded investment grade rating BBB by the rating agency Euler Hermes. Nordhues said that the decisive factors for the good rating were the first-class collateral, the high free cash flow and the tenants’ (State of Saxony-Anhalt) robust credit standing.

Francesco Fedele, whom REFIRE talked to recently on the fringes of the recent Frankfurt Real Estate Finance Day, commented: "In addition to conventional bank funding, alternative forms of financing meanwhile play an increasingly important role. In the process, we do not only confine ourselves to subordinated forms of funding like mezzanine capital but also use loan notes to provide attractive solutions in the senior-ranking field. Together with K-Bonds AG, we succeeded in structuring the refinancing deal for the justice centre in Halle in a spirit of mutual trust and partnership."

And Dirk Iserlohe, the head of the property's asset manager E&P Holding GmbH also commented, "In addition to conventional bank funding, the financing alternatives available on the market today, that we as investors had already analysed at an early stage, will play an increasingly important role in future."