Europe's innovative CMBS market is set to make further strides, with two landmark deals being marketed to European investors.

In the U.K., Morgan Stanley Dean Witter's highly successful property securitization team has structured a deal for supermarket group J. Sainsbury, which allows the originator much more flexibility than is possible under a traditional sale-and-lease back deal with a property company. It is thought to be the first time that a sale and lease back structure has been combined with a securitized bond issue.

The long-dated, fixed rate transaction - called Highbury Finance - is set to launch in mid-March and will be worth GBP335 million ($526 million). It is set to receive A1/A ratings from Moody's Investors Service and Standard & Poor's.

"Under a normal sale-and-lease-back structure [originators] are quite restricted in the way they can do things," a Morgan Stanley official said. "With this, Sainsbury has more operational flexibility: they can redevelop, refurbish and extend stores, as long as they don't do anything that is going to diminish the value of the stores or affect the ratings on the bond."

The structure also gives Sainsbury the option to re-lease or buy the 16 stores that back the deal at the end of the 23-year term. Again, in a normal sale and leaseback deal, the purchaser of the sites would be able to sell or lease them to Sainsbury's competitors at maturity. Even if Sainsbury decides to sell the sites, they would retain an interest in the likely profit.

Another advantage is that instead of the five-yearly, upward only rent reviews normal in traditional deals, the deal is structured with lease payments on the underlying stores fixed at 1% annual increases until maturity. Not only does that give Sainsbury certainty, it is also likely to mean rents rise well below rent rises in real terms.

This is possible because, with rating agencies assuming conservative forecasts for future rent, there is little benefit in incorporating upward only rent reviews, as long as the cashflows will meet bond payments.

"There is quite a complicated structure behind this, which has never been used before," the Morgan Stanley official said. "It has taken a while for us to put the structure together, but it has given Sainsbury a huge number of benefits, whilst offering investors significantenhancements versus straight unsecured debt."

The structure uses three Netherlands-incorporated special purpose vehicles. According to a Moody's presale report, the proceeds of the Highbury Finance bonds are used to subscribe for bonds issued by SPVs called Avenell Property and Avenell Leasing. With the proceeds, Avenell Leasing will purchase the head leases of the properties and sub-lease the properties to Sainsbury, while Avenell Property will purchase a beneficial interest in the properties.

The rents will be used by Avenell Leasing to subscribe for zero coupon bonds issued by Avenell Property as well as to make payments of interest and principal to Highbury Finance, which will use those payments to amortize its bonds down to GBP170 million, which is approximately 45% of current vacant possession value and 28% of estimated site value in 23 years.

The residual value of the properties at maturity will enable Avenell Property to redeem the zero coupon bonds and pay the principal due under the AP Bonds. With the redemption proceeds of the zero coupon bonds, Avenell Leasing will make final payments under the AL Bonds, and Highbury Finance will redeem the then outstanding principal of its bonds.

One-Nil to the Arsenal

Those with an interest in British soccer will notice that the three SPVs have names related to the home ground of one of England's most successful teams, Arsenal - one member of the Morgan Stanley team is an Arsenal fan.

The lease payments and the residual value of the stores are guaranteed by Sainsbury, so the whole transaction is linked to the company's A1/A credit rating.

Another advantage for the company is that the deal will allow it to access a different investor base from the one that normally buys its debt. Because it is a sterling-denominated long-dated, fixed rate transaction it will be aimed primarily at U.K. pension funds and insurance companies, such paper's natural home, the Morgan Stanley banker said.

Price talk for the deal, which has an average life of 19.5 years, was said to be around 225 basis points over Gilts.

If the deal is a hit with investors, the big question will be how many other potential issuers will come knocking on Morgan Stanley's door, hoping to take advantage of the structure.

The Morgan Stanley banker suggested that similar deals could appeal to any U.K. corporate with a large fixed-asset base. "There has been quite a high level of interest in the transaction already. When we close it, we will be looking at where else we can apply it," he said.

John Carrafiell, executive director of the bank's real estate group, is also hopeful that the structure will prove attractive to other retailers and sectors such as utilities and manufacturers that are facing shareholder pressure.

First Pan-European CMBS

The other landmark transaction - which was set for launch last week - is the first multi-jurisdictional European synthetic CMBS. The e1.381 billion ($1.33 billion) deal, called Europa One Ltd., is originated by Rheinische Hypothekenbank A.G. (Rheinhyp), a German mortgage bank, and arranged and underwritten by Barclays Capital.

The deal uses a credit default swap structure linked to a reference pool made up of loans originated and serviced by Rheinhyp and secured on commercial properties in Spain, Germany, the Netherlands, Austria and France.

Prospective ratings from S&P and Moody's vary from AAA/Aaa for three senior tranches (just over 80% of the deal), down to BB/Baa2 for the lowest rated tranche. Pricing will vary from around Libor plus 20 basis points for the 1.3 year A1 tranche down to about 150 over for the double-B chunk.

The senior triple-A and double-A notes are collateralized by pfandbriefe issued by Rheinhyp with the subordinated tranches collateralized by Rheinhyp's unsecured notes.

The synthetic structure avoids many of the problems associated with securitizing properties located in several countries, said Georges Ruchti, head of structured finance at Rheinhyp, but still allows the bank to free-up regulatory capital.

Rheinhyp is so pleased with the structure that it will use it as a major funding strategy in the future, securitizing up to e11 billion by 2002, Ruchti said.

There is little doubt that the structure will also prove attractive to other European banks, with Barclays already reporting interest from several potential originators.

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