Nikko Salomon Smith Barney is close to completing a CMBS transaction, which will take the Japanese market to levels of sophistication not previously seen, securitization pros in Tokyo said.

The internationally offered private placement transaction, which is scheduled to close on May 25, totals 21 billion ($192 million) and is split into four tranches and three interest only strips. The four main tranches are rated triple-A, double-A, single-A and triple-B by Standard & Poor's, Fitch IBCA and Moody's Investors Service.

The deal arises from the bankruptcy of a property company called Nippon Landic Co. Ltd. A portfolio of 13 buildings - predominantly offices, but with some retail and residential spaces as well - was acquired from the bankrupt firm by a special purpose company ultimately owned by a consortium of Japanese and U.S. companies, including Mitsui Fudosan, Credit Suisse First Boston and DLJ Real Estate, with a non-recourse loan from Nikko Salomon and GMAC Commercial Mortgage Corp. The deal will take out that loan.

The floating rate notes are structured as soft bullets, on the assumption that they will be refinanced in 2004, but also feature a one-year extension and a two-year tail period. "The repayment on the notes is a bullet payment, but is to some extent reliant on refinancing, and if that proves impossible then we feel comfortable that the two-year tail period is sufficient for the servicers to liquidate the properties," said Vas Kosseris, a director in the structured finance team in Fitch's Tokyo office.

One of the innovative aspects of the deal - at least in the Japanese market - is that the servicing and the property management functions are handled by different entities, with Mitsui Fudosan, Japan's second biggest property management company, handling the management and the local branch of GMAC handling servicing. State Street Trust & Banking is the deal's trustee and has been retained as the back-up servicer.

"In most Japanese CMBS deals, the trust bank works as both the servicer and the property manager, but in this case both functions are handled by companies that specialize in their roles and are very professional," said Tokio Ueyama, an associate director at Fitch.

The bankruptcy of the original property company has forced the structurers to include further innovations unusual in the Japanese market. Because some tenants moved out of the buildings, all of which are based in central Tokyo, during the company's difficulties, average occupancy rates fell to 60%. Indeed, three properties, which account for 22% of the portfolio's value, have very low occupancy rates - one has no tenants at all.

This has led to inclusion of a "holdback reserve" which will retain 3 billion of the deal proceeds and will be used to redeem the relevant portion of the notes if occupancy levels at the struggling properties are not back to acceptable levels within six months. Ueyama is confident that the expertise of Mitsui Fudosan makes the use of the holdback unlikely, pointing out that since Mitsui has taken over management occupancy levels are already back at an average of 75%.

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