Euromoney Liquid real estate March 2007
» at a glance:
» Deal: Anthracite CRE CDO
» Amount: €342 million
» Lead manager: Morgan Stanley
The European CMBS market itself only found its feet in the last two years (having grown 35% year-on-year in 2006 to more than €75 billion), so the fact that two European CRE CDOs were closed late in the year is remarkable.
CRE CDOs repackage pools of junior real estate collateral into floating rate debt securities, facilitating a cheaper weighted average cost of capital on this relatively expensive, subordinated debt. This type of collateral has traditionally been funded by short term recourse lending, which has to be marked to market, so CRE CDOs offer attractive match funding benefits for issuers as well.
Anthracite Euro CRE CDO is a €342 million managed cash arbitrage securitization of a pool of real estate assets overwhelmingly split between CMBS and B notes (39% each). The remainder of the initial pool is made up of mezzanine loans and C notes (11% each). The assets have a weighted average life of 5.5 years, weighted average rating factor of single-B plus and a weighted average spread of 340bp.
The asset pool, which will be managed by Blackrock Financial Management, backs €343 million notes tranched from triple-A to double-B. It retained a €67 million unrated first loss tranche.
The relatively straightforward structure is essentially a European version of Blackrock’s US CRE CDO programme, also called Anthracite.
The challenge to developing a vibrant CRE CDO market in Europe has never been structural complexity, rather it has been collateral availability. The CMBS market in the region is still so young that there is simply not that much collateral around. Indeed, the second CRE CDO to be launched in Europe (Taberna Capital’s euro CDO) was overwhelmingly backed by Reit debt – just 10% of the collateral was CMBS and B-notes.
This underscores the big problem that this nascent market faces: there is still a very limited and illiquid secondary market in European CMBS, which will constrain how fast CDOs backed by this collateral can be ramped up.
Given the lack of market depth in Europe, manager quality is particularly important. It was therefore always the case that the first CRE CDO in Europe would be issued by an experienced US name, and Blackrock certainly fits the bill. But the firm has traditionally had a very limited presence in Europe (although the merger with Merrill Lynch has changed that) and the Euro Anthracite deal will in fact be managed from New York at least initially. This is clearly not ideal.
Active management is important in Europe not only because of the unrated and illiquid secondary market but also because of high rates of prepayment and non-standardised inter-creditor agreements between the senior and subordinated lenders to CMBS deals. “The high rate of prepayment means that collateral needs to be replenished frequently,” notes Birgit Specht, managing director, securitized products strategy at Citigroup. “This leads to reinvestment risk and the chance that the day one collateral composition of a CRE CDO might be quite different five years down the line.” European collateral pools also tend to be lumpy compared with their US equivalents.
Given these concerns, it may appear surprising that the covenants in the euro-denominated Anthracite deal are relatively relaxed compared with US CRE CDOs. But this is unavoidable due to the shortage of collateral for such deals. For example, the single issuer limit for Anthracite is 10% whereas for a US deal it would be much lower. The initial collateral pool has 10% exposure to a senior mezzanine KarstadQuelle loan and an Auto Teile Unger C note. Even if carefully selected, large single exposures are generally considered to be a structural weakness in CDOs but on the positive side, this is junior debt and if either loan becomes distressed having a 10% stake will give Blackrock a greater say in any workout scenario.
Anthracite priced well inside the 30bp guidance for the Class A triple-As. This €142.5 million tranche came at 27bp over with the €29 million Class B double-A plus tranche pricing at 38bp, €48.5 million Class C single-A plus notes at 65bp and €31 million Class D triple-Bs at 140bp. The €25 million Class E double-Bs came at 275bp.
The difference in collateral between Anthracite and the subsequent Taberna Reit-backed deal was reflected in the respective pricing: the Taberna triple-As came at 38bp over and the triple-Bs at 250bp. The tight pricing resulted in a 70bp weighted average cost of capital on the rated Anthracite notes, which gives Blackrock a very attractive 275bp of gross excess spread on the portfolio.
