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Capital Markets

Real estate: Prepayments require patience

Investors will have to wait for deals to burn out before prepayments in European CMBS transactions begin to ease.

The recent benign refinancing environment for European real estate borrowers has proved so attractive that the prepayment of loans in CMBS pools has become a real problem. Between 40% and 50% of loans backing CMBS prepaid last year, and there is little sign of a slowdown so far in 2006. NM Rothschild’s £366 million ($654 million) Real Estate Capital 2 deal paid down in full at the end of April (having had an expected maturity of 2011) and 35% of ABN Amro’s inaugural German deal, Talisman 1, prepaid during the first quarter of this year.

Last year, White Tower, SG CIB’s CMBS conduit saw three of the five loans prepay from its inaugural 2004 deal in July 2005, just 14 months after the deal closed.

Rating agencies are coming under increasing pressure to review the way prepayments’ impact on transactions is treated, taking more account of the high likelihood that some loans will prepay. “Rating agencies should give more credit for the probability of prepayments in CMBS,” says Howard Esaki, executive director of ABS research at Morgan Stanley. ”Deals are disappearing much faster than rating agencies and investors originally anticipated.”

When loans prepay, the junior classes of notes are usually upgraded but rating agencies differ in their approach.

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