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It would be appropriate if a transaction named Taurus turns out to have triggered a sustained and bullish revival in the market for European commercial mortgage-backed securities. The €1 billion Taurus 2013 deal, led in May by Bank of America Merrill Lynch and HSBC, was certainly regarded as an important breakthrough, given that it was the first fully syndicated, publicly placed European CMBS since the financial crisis. Backed by a loan originated by BAML in February for a portfolio of 37,000 multi-family units in Dresden managed by real estate company Gagfah, each of the tranches on Taurus 2013 was oversubscribed, allowing for pricing to be tightened across the capital structure. A more testing examination of the strength of demand for European CMBS came the following month, with the launch of another Gagfah multi-family CMBS. The €2 billion German Residential Funding (GRF) deal was comfortably the largest European CMBS since the financial crisis. Although it was doubled from its planned minimum size, pricing on the most junior tranches was widened from the original guidance. Bankers who worked on the GRF CMBS say that this was principally a reflection of the timing of the deal, which was launched amid increasing misgivings about quantitative easing tapering in the US. They add, however, that the apparently inauspicious timing of GRF’s launch might – paradoxically – have made it a better barometer of demand for exposure to European CMBS than Taurus 2013 did.
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| Ramon Camina, manager of the EMEA real estate financing business at Goldman Sachs |
Ramon Camina, manager of the EMEA real estate financing business at Goldman Sachs, which led the GRF CMBS, says that the deal’s success in a more uncertain market made it an important staging post in the recent evolution of the broader European asset-backed securitization sector. “GRF tested the capacity of investor demand in a much more jittery credit market. To me, the fact that investors were prepared to compare GRF with other credits in the residential mortgage-backed securitization [RMBS] and corporate world was a further signal that the market is normalizing.” Clearly, transactions such as Taurus and GRF were an important step forward for a market that had previously been confined largely to privately distributed deals. The Florentia multi-family CMBS in 2012, for example, was placed largely with a single investor.
Nevertheless, even the bankers who led this year’s landmark CMBS in Europe stop short of declaring that they have opened the floodgates for issuance. “The Taurus transaction helped to re-educate investors about CMBS, gave confidence back to the market and introduced some price transparency,” says Lynn Maxwell, managing director of structured finance at HSBC in London. “But I wouldn’t be comfortable with saying that it reopened the market. It was issued against a portfolio with a long track record of performance and cashflows, and it had conservative LTVs across the capital structure. Even the BBB tranches had LTVs of about 60%.”
Perhaps the most striking weakness of the European CMBS market at the primary level has been the concentration of issuance by geography and asset class. To date, new issuance has been collateralized either by German multi-family units or by individual trophy properties, both of which will continue to be strongly supported by investors.
Some bankers say that in part, at least, one reason why these CMBS have been so well bid is that they are relatively straightforward to assess for RMBS investors on the lookout for relative value. “Multi-family CMBS are analysed much like RMBS, rather than on a property-by-property basis,” says David Wells, director of the CRE team at Barclays in London. “The risk on single-asset transactions such as Chiswick Park and Meadowhall is also easy to identify and analyse.”
Beyond the multi-family sector, supply – and therefore diversification – in the CMBS market is likely to remain patchy. “There is plenty of investor demand for CMBS,” says Clive Bull, director of the European commercial real estate group at Deutsche Bank in London. “The problem is that there is still very little demand for big loans. Back in 2005, 2006 and 2007 there were a number of very large property acquisitions that needed big chunks of debt. That source of demand for large loans from multiple lenders, which is where the CMBS market has a competitive edge, is no longer there.”
Although German multi-family issuance is likely to continue to dominate the primary market over the short term, Camina at Goldman Sachs believes that there will be increased scope for diversification. “We definitely think that CMBS will become an increasingly important part of the CRE financing market in Europe,” he says. “This is because with the commercial banks much less active than they were pre-crisis, there will be more opportunities for other lenders that don’t have big origination teams and would rather participate in the market by buying listed securities than by making private loans.”
Camina adds: “It may be too early for multi-country, multi-borrower CMBS, but can we move from multi-family properties to shopping centres and office buildings? Yes. Can we move from Germany to France? Yes. Frankly, we also believe we could see issuance from the European periphery at the right price.”
Bankers argue that the longer-term prospects for supply and diversification in the European CMBS market will depend to some degree on how it is used by the banks as they intensify their deleveraging drive. This, says Barclays’ Wells, will be a much more important determinant of supply than the so-called wall of refinancing facing the CMBS market over the next 18 to 24 months. “It is certainly true that a bunch of European CMBS are maturing this year and next,” he says. “There is about €15 billion due in 2013 and another €12 billion in 2014, but servicers will probably continue to extend and pretend on many of these deals. What is much more exciting is the €1.5 trillion of non-core and often non-performing CRE assets on the books of European banks that desperately need to reduce the associated capital consumption, P&L volatility and investor focus.”
Others echo the view that while they are hopeful about the long-term potential for more supply in the European CMBS market, there are still plenty of other elements holding back its development.
Ravi Stickney identifies at least three of these. He is co-head of real estate at Cheyne Capital Management in London, which set up its first real estate debt fund with an initial $25 million in 2009. Today, it has about $2 billion invested in the market in a number of funds, the largest of which now has $850 million in European real estate. Much of this is in CMBS, although Cheyne is also active in the RMBS market and focuses much of its research on identifying relative value at a primary and secondary level in both asset classes.
“Regulation, structuring difficulties and the underdevelopment of the investor base are the three main reasons why we’ve seen so few deals outside the single obligor sector,” says Stickney. “Regulation has made it increasingly difficult for investors to hold structured credit bonds, while structuring difficulties have meant that the market has remained heterogeneous without the one-size-fits-all structures that we see in the US.”
Stickney adds: “Unlike in the US, regulatory restrictions in Europe mean that we don’t have the same breadth of investors across the capital structure. One of the reasons why it has taken so much hard work to get some of the recent deals over the line has been the shortage of demand for junior tranches.”
The biggest change in the structure of the investor base since before the crisis has been the demise of the structured investment vehicles (SIVs). This has clearly blown a sizeable hole in overall European demand for CMBS, although bankers are hopeful that this will be at least partly offset by the emergence of other investors. At HSBC, director of securitization trading Eugene Gorelik says that US investors, for example, might take a closer look at relative-value opportunities in Europe, given the spread differential between CMBS on the two sides of the Atlantic. “It does feel as though we will need to rely on the US for growth of the investor base,” he says.
For the time being, however, demand appears to have been driven principally by London-based institutions – even for German assets. In the case of Taurus-2013, for example, UK investors accounted for 62% of distribution, followed by Dutch and Nordic buyers (11% and 10% respectively). “We were interested in understanding why German investors weren’t as involved in the Taurus deal as one would expect,” says Maxwell at HSBC. “The answer is that the German ABS investor base is made up mainly of banks, many of which don’t yet have sign-off for CMBS.”
Bank treasuries, says Maxwell, took up some of the slack in the Taurus transaction, accounting for just over 20% of the book, although they too remain focused mainly on plain-vanilla RMBS and auto-loan securitizations. That, she says, left asset managers prepared to do the credit work on the Taurus structure as the main buyers.
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| Shamez Alibhai, partner at Cheyne Capital Management and co-head of its London-based real estate division |
The yield pick-up that investors can generate by migrating from RMBS to CMBS certainly appears to make this extra credit work worthwhile. “European CMBS offers a large premium both to prime and non-prime RMBS,” says Shamez Alibhai, partner at Cheyne Capital Management and co-head of its London-based real estate division. He disputes the view that the analytical skills called for in the multi-family market are the same as in the RMBS market. “The barriers to entry in CMBS are higher in terms of the analysis required,” he says. “In the RMBS market investors take a more macro view, whereas in CMBS although the macro element is important, you can’t overlook the fundamentals of each asset within the portfolio or the role of the operator. We’ve developed robust and substantial underwriting and cashflow models for each of the CMBS transactions we’ve been involved in.” Another constraint on the growth of the CMBS market in Europe is the formidable competition it faces from other sources of funding for sponsors. “The senior loan market for CRE has been extremely competitive, with a number of very strong players having committed a large portion of their balance sheets to the market,” says Alibhai. “The amount of resources CRE sponsors need to do in terms of public disclosure, dialogue with the ratings agencies and putting the necessary swap packages in place is such that the pricing advantage they can derive from the CMBS market has to be very significant to compete with senior lending.”
None of this is to suggest that the prospects for CMBS in Europe are necessarily bleak. It does, however, imply that the market that takes shape as the broader ABS market continues to recover will almost certainly be smaller and probably much less diversified than it was at its pre-crisis peak. Even then, as Gorelik at HSBC says, the CMBS made a modest contribution to total real estate financing in Europe. “During the toppy times when CMBS was a very viable option for financing real estate it still accounted for only about 10% of the market in Europe,” he says. “And even in the UK, which was the most heavily securitized market, it was still never more than 20%.”
The European CMBS market will also remain very much smaller than its counterpart in the US, which by early June had seen total issuance for the year of close to $40 billion, compared with about $15 billion in the same period of 2012, according to numbers published by Standard & Poor’s. In Europe, by contrast, there was about €6 billion in the first half of this year, according to Peng Sun, securitization strategist at HSBC. That compares with annual issuance of more than €60 billion at the peak of the market in 2006.
While the European market is unlikely to repeat the volumes that were posted before the crisis, it is also probable that the market will be less aggressive in the way deals are structured than it was in 2005 and 2006. In many ways, it already is. “From an investor’s perspective the deals we’ve seen so far are more conservatively structured and offer a much better yield than they did before the crisis,” says Stickney at Cheyne.
Bankers say that the CMBS market in Europe, as well as being more conservatively structured, needs to become more transparent and standardized if it is to play a meaningful long-term role in financing commercial real estate. It will also need regulators and policymakers to give the asset class a more sympathetic hearing. Again, this already appears to be happening. “Before the credit crisis, banks accounted for about 85% of all CRE lending in Europe, compared with a little over 50% in the US,” says Alibhai. “I believe we will see more of a plurality of funding sources in Europe, and that CMBS will be one of those sources. Regulators are increasingly recognizing the importance of CMBS, and are slowly softening what was originally a very harsh stance on all structured credit products. ABS no longer carries the same stigma in Europe.”
Regulators might have a less jaundiced view of the CMBS market at least in part because of the efforts that have been made by the industry to move towards standardization and enhanced transparency. Notably, the 2012 publication by the Commercial Real Estate Council of its CMBS 2.0 guidelines on best practice is seen as a constructive step. Although the deal flow in Europe remains highly heterogeneous, market participants say they are already encouraged by the incorporation of several of the CMBS 2.0 principles into a number of recent transactions. “Taurus-2013 was a classic CMBS 2.0 deal,” says Maxwell at HSBC. “I think people recognize that the deals they’ll be working on in the future will need to be very clean, with structures that can be readily understood and accepted by senior and junior investors.”
Investors themselves will also need to contribute to the enhanced transparency of the market by intensifying their own scrutiny of individual deals. “It’s a bit of a caricature, but in 2007 the SIVs would buy CMBS on the basis of the prospectus and not much more,” says Deutsche’s Bull. “The most significant difference about the buyer base today is that investors are much more focused on their due diligence. Because they’re taking much longer to analyse the offering circular and will often want to visit the properties, the marketing period is longer than it was pre-crisis.”
That, says Bull, is a healthy development. But it is also one that potentially narrows the universe of CMBS. “From a new-issue perspective this means that each new deal needs to be assessed on how easy it will be for bondholders to do their due diligence,” he says. “A single asset in London is relatively straightforward. So too is a German multi-family portfolio, because all the properties within them tend to be the same, so investors need to spend no more than a day or two visiting them.”
As Bull says, a loan collateralized by a portfolio of 20 properties in five countries would be a very different proposition. “This would make the due diligence process much more time-consuming and expensive, and would need to be reflected in pricing,” he says.
