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Banking

CMBS debate: New jurisdictions offer hope as markets turn volatile

As volatility spreads across the debt markets, the CMBS market is taking stock. Property derivatives are likely to increase volatility in the market and contribute to spread widening just as refinancing activity – a significant driver of CMBS volumes – slows. But as competition between commercial lenders and conduit lenders expands across Europe, the market is looking to new jurisdictions to maintain growth.

CMBS debate: Participants



Executive summary

  1. Market reaction to the US will be contained – but spread widening, particularly at the bottom of the capital structure, will persist
  2. Levels of debt in the real estate market are not sustainable in the long term and some of the valuations that underlie CMBS transactions lack support
  3. Volume predictions for CRE CDOs in Europe were overplayed
  4. The ability to short the market will lead to volatility and contribute to spread widening. But property derivatives can be an imperfect portfolio hedging tool
  5. New jurisdictions will begin to bear fruit
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RF, Standard & Poor’s
Clearly the topic of the moment is sub-prime. We’ve seen US sub-prime take its toll on both US CMBS and US CRE CDOs, with very substantial spread-widening in the second quarter. We’re seeing triple-B spreads backing up above 100 basis points. What is the outlook for spreads for a European structured deal in CMBS?

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JD Spreads will widen. They came in too far from where they should be from a natural risk perspective. CMBS spreads should be wider than RMBS spreads because there’s less granularity in the portfolios. At the moment they are wide of where prime RMBS is generally in Europe but they’re now within sub-prime RMBS levels in the UK. Property derivatives and the CMBS index will also lead spreads wider. Spread widening in UK sub-prime has been led by synthetic products, primarily hedge funds shorting CDS against sub-prime, which has pulled out spreads in the cash market. The same will happen in CMBS.

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SG, LNR Partners There will be some spread widening due to repricing of risk in the market. It will differ somewhat in the triple-A and double-A segment, which has a different investor base from sub-investment-grade bonds, and it depends on your view. Are you looking at spreads relative to another asset class, such as MBS or other ABS products? Or are you looking at it from a pure, fundamental perspective – relative to equity returns for example? I expect to see spread widening in subordinate notes and below-investment-grade CMBS.

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JH, Fortress European CMBS spreads have to widen, and particularly at the triple-B level, for all of the reasons given, but not too far. There is a lot of real-money-funded capacity out there to buy and the arbitrage works, for instance, for CDOs pretty well at 150 to 175 basis points over on triple-B minuses and pretty well at 100bp to 125bp on triple-B flats. Most of those people are sitting on long cash at the moment. That helps support. However, you’ll see much more differentiation at the bottom of the capital structure from deal to deal.

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GP, European Credit Management I agree with John and James but I think the development of the derivatives market will increase spread volatility. That’s what we’re worried about.


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JD The ability to go short will be there, which means that there will be pressure on the other side of the equation. That will lead to increased volatility and it should lead to spread widening.


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RF, Standard & Poor’s Some people have commented that US sub-prime is an example of capital markets throwing money at originators who in turn made inappropriate loans at non-risk adjusted margins. Is there a danger that we’ll see the same in CMBS?


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JD The real issue is whether issuer tiering increases as you go along. If it does, there’s a prompt disincentive for banks to make bad loans. And while that disincentive persists, it should act to restrict the volume of inappropriate loans in the market. There has been very little tiering over the last couple of years, and there have been a lot of high loan to value (LTV) loans made as a result that were borderline credits. The recent dispersion of spreads on new issue triple B, triple B minus has been something like 85bp to 225bp across all of the issuance. We’ve not seen that level of tiering for a number of years.

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JH, Fortress Many CMBS investors have other options in deploying their money. CMBS as a proportion of the structured finance market in Europe is not as predominant as sub-prime. It is much easier for dedicated structured finance investors to express a dislike of underwriting standards in CMBS by stepping back. One of the problems in US sub-prime was that it’s hard to step back from 90% of the floating-rate market.

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RP, Morgan Stanley Most investors in CMBS have the chance to get comfortable with the underlying levels that the originators have used. If someone thinks that a loan is too aggressive from an LTV perspective or a low issuer credit rating (ICR) perspective, they can pass on it.


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DN, Natixis I don’t think Europe has got to the level of aggressive underwriting that was prevalent in the US CMBS market, which caused some push-back, both in terms of loans being rejected from CMBS issuances as well as spreads widening. We might see the reaction to what’s happened in the US catching us a bit earlier in Europe, and therefore we won’t see as much volatility and spread widening.

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JH, Fortress What has bothered investors is less underwriting standards and more a dirtying of CMBS pools from very transparent, visible, quite simple to underwrite loans, to loans backed by specialist asset classes or with very high leverage with a high degree of lease turnover risk, or to unknown sponsors. Those deals get pushed back more than others because they are harder work.

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JD There are few deals where every loan is great or where every loan is bad. It’s very much the case that every single deal has one or two loans within it that you don’t like, and you have to form a view. If one or two of those lower-quality loans do default, maybe it starts becoming too expensive to the cost of the deal as a whole to include them.

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SG, LNR Partners Below-investment-grade buyers in Europe do not as of yet have the power or ability to kick loans out of pools as they do in the US. I agree with John that a lot of deals have at least one or two loans that you just can’t get comfortable with. As it stands currently, though, first-loss investors have either to price in an expected loss or step back from the transaction. Either that or buy higher up in the capital structure, which can still leave you exposed to a potential downgrade if losses do occur.

Cap rate compression

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RF, Standard & Poor’s We’ve seen tremendous compression in European capitalization rates. Is this now coming to a natural close?



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SG, LNR Partners I think so. With interest rates going up and credit tightening it is becoming more difficult for property investors to achieve strong returns. While it is true that the wall of money in the property sector has driven down return expectations, eventually the market will correct. This will happen on a market-by-market basis just as it did with yield contraction. Yields in many markets have already stabilized and if the rental growth does not materialize they may widen. That said, there are probably some markets where yields still have room to tighten.

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JH, Fortress Yes, we’ll see further cap rate compression in Germany. There’s an element of catch-up there in that the prior yields were probably a little wide of where they should have been. I agree that they probably can’t go any tighter in the UK and be financeable within the CMBS market, so that creates a natural floor.

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RF, Standard & Poor’s Peter, have you a view of UK markets, prime versus secondary?



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PC, British Land Company We’ve felt for some time that prime yield won’t get much tighter, and that the yield compression between prime and secondary has probably gone too far. We expect a correction in that over the next six to 12 months by a movement out of some of the secondary yields. Although the prognosis is pretty healthy on the prime side, there may be some pain but certainly more in the secondary and even tertiary, particularly commercial property, in the UK.

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DN, Natixis In the French market, prime yields are continuing to come in, but so are secondary yields, to the point where it becomes difficult to justify them. But there does still seem to be an incredible wall of money searching for real estate. We’ve seen deals priced off something like 3.5% yields in Paris. It seems very difficult to justify that, even on properties where there may be some reversionary potential or you’ve got inflation indexation on the rents.

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PC, British Land Company But David, how much of that wall of money is real equity? I suspect the vast majority of it is debt. With considerable volatility in the debt markets at the moment, that wall of money may dry up quickly. With the debt gone, there isn’t sufficient equity out there to keep that momentum going and that’ll correct very swiftly.

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DN, Natixis I don’t disagree, not least because as we’ve seen yields come in and valuations correspondingly increase, the cashflows aren’t there to sustain the debt. Unless we lenders start underwriting on looser terms, with perhaps initial ICRs of less than one, it becomes very difficult to support the quantities of debt that the equity investors are looking for.

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JD That position can’t be sustainable in the long term. With the fallout in US sub-prime and other sectors, people are waking up to risk. Interest rates are trending higher, and the real estate market can’t be immune to that for an extended period. There could be pockets of particular value but a lot of the money coming into those markets is debt money, and if it’s not supportable, the equity returns currently don’t compare well with returns in other markets.

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RF, Standard & Poor’s In UK markets we saw reverse yield gaps back in the 1970s and 1980s. The 1990s became a story of positive yield gaps. How sustainable are cap rates of 4% and all-in borrowing rates of 6.5% in the UK?


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PC, British Land Company During the 1970s and 1980s with the inflation in the system you were effectively being bailed out by the rental growth. This time, if there is inflation, I don’t think it will feed through to higher rents. Where utility prices and wages are rising faster than inflation, and so there’s less money available to pay rent, less will seep through to being able to pay more rent. This means it will become a much more asset-specific market, driven by the fundamental characteristics of the underlying properties. And where you don’t have specific growth characteristics in the asset, the gap isn’t supportable. Generally, banks and property investors are starting to realize that you can’t get growth on everything. Certain assets will perform and certain assets not.

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GP, European Credit Management So if all these dire predictions come true, the first sign that an investor should look for is a substantial slowdown in prepayments?


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JD I’d look very closely at the exit yield that’s forecast on any new deal now. If you think the basic rental constituents are fairly stable and decent, the exit yield will determine the refinancing risk. How are people calculating that – based on assumptions about certain rental uplifts or unscheduled amortization? What does that exit yield tell you against where the current market is for cap rates and where you can see it going?

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JH, Fortress Unless they’re fixed uplifts on good-quality covenants, until you start getting rental growth kickers on your spread, a lender shouldn’t be underwriting rental growth anyway. It’s comfortable to have a decent amount of reversionary interest on a property but it’s not something you should be underwriting to.

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DN, Natixis But in the context of a continental European deal where you’ve got inflation-based leases, would you underwrite inflation?



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JH, Fortress If you run inflation at 1% or 1.5% it usually means that those indexation leases don’t get triggered. Most of them, particularly in Germany, are triggered on a CPI above 2.5% or 3%. Just run a much lower inflation assumption to wash that out of the system, because otherwise you are building in a rental growth that may or may not be there.

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SG, LNR Partners The problem is that many valuers are including rental uplifts in their valuations. Some lenders are accepting these valuations and lending on them. As a subordinate investor we look at valuations very carefully. We have seen in the last 12 months more and more aggressive assumptions being incorporated into the underlying property valuations. In many of these cases the assumptions lack meaningful support. When we see this we simply re-evaluate using more modest and defendable assumptions.

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RP, Morgan Stanley The rental cycle is also driven by how financial institutions react to recessions. In early 2000 a major investment bank started firing left and right and suddenly all this additional space became available. We probably need to monitor any indications of a perfect storm, ie, a situation where a lot of developments are coming live, but investment banks are reducing their space requirements at the same time.

CMBS growth

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RF, Standard & Poor’s The explosion of CMBS issuance in Europe is remarkable, and the growth rates are astonishing. Can growth rates continue at the levels we’ve seen over the past couple of years?


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JD The size of the market here is still significantly smaller than in the US. The European economy is similar in size to the US, so theoretically we can continue to have very strong growth rates for a number of years. Some of the fall-out we’re seeing in other debt markets will come to bite in the CMBS market, although probably not as heavily. But that is just a hiccup. Overall you will continue to see high growth rates in this market. It’s proved itself to be a good alternative to bank lending. There are continued benefits for banks that wish to avoid unfavourable treatments under Basle II, so there are continuing supports for this market.

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GP, European Credit Management Yes, there will be growth but not as high as we had in the past. Part of that explosive growth rate was to do with refinancing deals. If our cap rates are going down there will be less refinancing.


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SG, LNR Partners I agree with Giovanni that we should see fewer loans refinancing given where we currently are in the interest rate and property cycles. However, as John has rightly pointed out, this market is still in its early days and there is room for growth. More lenders are entering the market and increasingly they are looking to securitization as an exit for the loans they originate. The natural extension of this is that we will see a greater percentage of commercial real estate loans in Europe being securitized. Lately we have also seen new jurisdictions like Poland and Bulgaria become accepted, in a limited way, as securitizable markets. As lenders and investors become more comfortable we will see more growth in these emerging markets.

Loan volume prospects

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RF, Standard & Poor’s Turning to the guys who have got to originate the product, David, what’s the outlook for the volume of loans that you need to feed the CMBS machine?


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DN, Natixis I can’t see it continuing quite at the recent speed where we’ve seen almost a doubling of volumes each year. Something like 70% of the volume of issuance has come from UK property investors investing abroad. Continental European property investors, on the other hand, haven’t yet fully embraced securitization, and that will change. More of them will become willing to have securitized based loans, because more bankers will be offering that as a product with a 10bp to 20bp saving in margin. Conversely, UK investors may not be able to refinance as much and therefore there’ll be a slowing down in the amount of collateral that they are investing in and financing through securitized loans.

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RP, Morgan Stanley If you compare the share of conduit lending with straightforward bank lending, it’s still relatively low. It’s still not a major player in Europe. But we’ve seen a lot of paper coming out of France. Italy is becoming more active, as are Bulgaria and Poland. As long as investors push towards eastern Europe, the overall base will increase, but the competition between commercial lenders and conduit lenders needs to be fine-tuned and become more stable.

Also, more recent developments on the structural side, for instance pan-European deals, are helping to add volume to the issue size. Maybe you don’t have a lot of paper coming out of Italy or France or Switzerland individually, but combined they help conduit lenders put together loans and offer them in Dutch transactions. We’ve seen several unprecedented jumbo pan-European deals. Two or three years ago deals of that size would have been considered too difficult to be taken by the market.

Everyone agrees growth cannot continue indefinitely, but unless something significant happens on the capital market side, we should expect substantial growth over the next 12 to 18 months.

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RF, Standard & Poor’s How competitive are securitization lenders these days against the more traditional forms of property finance?



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DN, Natixis It depends. Lower LTV loans can be exceedingly competitive. With regulated borrowers who are capped at 50% or 60% loan to value borrowings, the price advantage achieved through issuing bonds rated mainly triple-A and double-A, means that we can offer very competitive pricing, which on-balance-sheet traditional lenders find difficult to compete with. The higher loan-to-value loans become more challenging because the lending market has moved its pricing as a result of the competition from the securitization based offer. The securitized lenders can probably still be 10bp or 20bp cheaper than a rationally priced bank loan, depending on how long they view that they’re holding the risk before they can securitize it.

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RP, Morgan Stanley I think it’s possible to securitize the higher leveraged loans, but only because we have B and C buyers that would buy those tranches either through the CDO or straight bank lending. But I agree with David, with low-levered transactions it is easy to compete with commercial banks. Certain borrowers are very focused on achieving flexibility. They still believe that the securitization lending market does not offer that flexibility, although things have changed and I believe that we can now even compete on flexibility terms. The third element is relationship banking. Commercial banks have been good at that, but now the conduit lenders, in Europe especially, have started doing deals on a relationship basis.

B- and C-note growth

LB, Euromoney The B- and C-note markets have grown significantly. Will this continue?

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DN, Natixis Well, I think we’ll see the investment-grade portions attaching at lower loan-to-values and that means we will have to distribute more to the non-investment-grade buyers if whole-loan LTVs are maintained. But there is significant demand for B- and C-notes, which has perhaps perpetuated the market longer than otherwise it would have done.

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PC, British Land Company But in what proportion of the market is the lending done at those very high levels?



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DN, Natixis The B- and C-note market has increased significantly in public transactions. Some people have brought deals, ourselves included, where 70% or 80% of the debt within the deal has B-notes attached. It will continue to grow, if the rating agencies maintain their stabilized cap rate position.

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RF, Standard & Poor’s There’s not much transparency in the pricing of the B-notes, and that pricing is key to leverage execution. The 150bp margin on the B-note that has an attachment point of 85% LTV – are those of you on the bottom of things ready buyers of that product?


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JH, Fortress We do buy B-notes within a spread range, typically 175bp to maybe 375bp if I was to wrap in mezz loans. Almost every B- or C-note investor in the market has a different way of doing it. We’d like the thickest tranches possible. We want to go from where the investment grade is cut off to the last dollar lent against the property so we have control, but we also have a nice thick tranche that absorbs loss severity. That means the pricings we get on the B-notes are perhaps lower than you might see from other guys, but that’s simply a matter of style. In the type of B-notes we buy, we have an agreement with originators who just sell every loan to us at a given spread and a given up-front fee, and that’s that. There’s very little point in risk pricing, to my mind, at between 65% and 90% LTV, because if you get the risk wrong, you’ll lose your money, and having 100bp more on the spread doesn’t make you look brighter. Sometimes we get things rated at the triple-B level with the same spread as we would at the B minus level. That’s just the way it is, but I do think that B-note pricing has been pretty stable for the last year.

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SG, LNR Partners LNR is a buyer of real estate risk – at the right price. The first thing LNR looks at is the credit risk of the underlying property. Can the property support the debt payments over the life of the loan? If it can’t, then the pricing question really becomes moot. With respect to subordinate debt market, B- and C-notes, we have seen modest growth in the past 12 months. One has to keep in mind, though, that this was from a rather low base. The increase in supply means that investors can afford to be more selective in what they buy. I expect that this will lead to tiering and spread widening.

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DN, Natixis We’re seeing quite a bifurcated market between the fund-based or CRE CDO houses and the banks. For example, the traditional German banks see that their space has been crowded out by conduit-style lenders, so they’re increasingly prepared to take the higher risk slice. They and UK building societies aren’t pricing in the same way as the likes of Fortress and LNR. They’re pricing at lower spreads.

CRE CDOs

LB, Euromoney Obviously S&P has had some views on CRE CDOs. Were expectations too high in Europe? Is the B-loan market large and deep enough to support the growth of a CRE CDO market in Europe?

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JH, Fortress The volume projections for CRE CDOs have no basis in fact or sense. There are a small number of people in Europe buying B-notes who are not banks. They’re the only people who would conceivably use a CRE CDO in its proper sense to fund that, so there is naturally a small number of deals. The market’s small because there’s a small number of B-notes that a small number of people want to own at the price at which they’re being offered. It is also difficult for new entrants to come into that market. While the people who manage these portfolios are a subset of the general CDO of ABS market, the big distinguishing characteristic is that you need a different type of platform to manage and buy loans, rather than bonds. It’s an expensive platform. It requires a certain level of expertise. It is quite a clubby market and is likely to remain so for some time. You can compare it to the CLO market in a certain sense. The Euro CLO market was slow to develop, but then a large number of US managers moved to Europe to manage in that space, because it was more attractive economically to be buying European loans than US loans at the time. However, I can’t see a large impetus for established US CRE CDO managers to come to Europe and establish platforms now.

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GP, European Credit Management CMBS CRE CDOs in Europe will have the same issue; lack of transparency.



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JH, Fortress That’s because the assets that we buy aren’t particularly transparent. We can’t invent a transparency that doesn’t exist in the underlying. That’s part of the risk associated with the CRE CDO, as with buying a B-note or buying a CMBS bond. We pay a compensatory spread pick-up on the debt that we issue as a partial compensation for the lack of transparency. Some investors don’t think that’s enough. Some do.

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SG, LNR Partners Despite the challenges, there has been no shortage of players who have looked to enter this space. How many are capable of overcoming these challenges remains to be seen. Staffing is a significant challenge not just for CRE CDO players, but for the market in general. The specialized platform required can also be prohibitive. Then there’s the availability of the collateral itself. Despite the growth there is not a lot of product available if one wants to build up a diversified portfolio. This, coupled with the prepayable nature of the collateral, means that CRE CDO managers face a significant amount of aggregation risk. The longer it takes to put a portfolio together the more exposed you are to the volatility of liability spreads.

LB, Euromoney Is there any concern about the kind of collateral backing these deals – that the asset class might come under stress of contagion from what’s going on in the leveraged loan market and in the sub-prime market?

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JH, Fortress There are risks associated with B-notes in a rising interest rates environment. There are risks associated with B-notes if you’re at a point in the cap rate cycle where you think cap rates have bottomed out and there’s risk for yield expansion. They’re the first loss in the loan. But I don’t think that means that that’s somehow connected to sub-prime or that’s connected to another industry. They are risky investments and that’s why they get typically the ratings that they get on a shadow basis. But the purpose of a CDO is to take that risk and then tranche up debt appropriately recognizing the level of that risk. The recovery rate assumptions used in modelling CRE CDOs and the default assumptions for those used for modelling CRE CDOs provide a lot of cushioning against the worst sort of events. These are conservatively structured transactions. When the first of these type of deals comes out there’s a lot of conservatism built in, until the market has proven itself. This is probably a good time to be investing in CRE CDOs compared with some other available CDO structures that have been through a few years and have been whittled down to the finest and most keenly structured points.

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JD I’m more concerned about the actual asset mix going into the deal. I’ve only looked at one of these CRE CDOs so far, but there was a very large concentration of exposure to B-notes originated by maybe three lead managers. What does that tell me? That particular house only has relationships with those particular lead managers, or those lead managers originate the best product in terms of risk/reward? Or it could be that that’s the only product available in the market that is either wide enough in spread to make the arb work for the trade, or it’s at the riskier end of the spectrum and not so many people were competing to buy it. So you can make a cynical or less cynical assumption, but that to me is more of an issue.

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JH, Fortress I think three originators is too small, but if you were to see many more than five or six accounting for 60%, 70% of B-notes, that would be quite surprising because a number of the 20 or so conduit lenders do one or two deals a year. There is a lot of getting to understand the origination process, knowing the originators personally at the relevant bank and so you do develop a stronger relationship with the bigger issuers in the market.

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SG, LNR Partners You also need to consider that not all originators are selling into the securitized market. Some are selling into the banking/syndicate market and therefore their collateral may never show up in a CRE CDO.


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JD To some extent that illustrates my point. The universe you can deal with is pretty much limited to guys who are selling off into this market for a particular reason. Maybe they can’t find anyone to buy in any other market. So the risk is concentrated in a particular type of product.


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JH, Fortress There’s more to it than that. There is a UK bank that will become a large issuer of CMBS and wants to sell B-notes. They’re used to selling the B-notes to building societies in particular, as a consequence of which the servicing is set up such as the servicer only services the A-note, and they expect that B-note holder to self-service. Now, that would not work for an investor like us, and so we’re automatically precluded from investing in the deals in that bank. Rather than not wanting to show it to us, it’s because of how their originating platform is driven and the way they structure their deals.

Derivatives

LB, Euromoney UK property derivatives suggest a relatively poor outlook for UK property over the next three years. Do you think the market is broad and deep enough for the UK IPD total-return contracts to give a reliable advance signal of future performance?

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JD It’s not broad or deep or liquid. It’s a very young, very small market. Other derivative markets have grown very rapidly from low bases, most particularly the ABX and US sub-prime CDS markets. You’ve seen relatively rapid growth and take-up in property derivatives because people, mistakenly or not, believe they can trade in and out of those products, whereas, with real estate, it’s harder at a practical level to trade in and out of the underlying asset itself. So do I believe it’s a good indicator here and now of where the market’s going? No, I don’t. Do I agree with the view it’s expressing? Possibly. I would argue that in some areas we have reached the top of the market on cap rates so it’s arguably right to take a somewhat negative trading view.

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PC, British Land Company Derivatives may not be a good indicator of where the market’s going but they are a good indicator of where people think the market is going. The property derivatives market has allowed a wider range of people to buy and sell property risk. The market makers are brokers and bankers rather than direct property investors, and one of the benefits of this diversity is the creation of liquidity. But I suspect that the universe of people who are contributing to that view are not as informed as the major property investors about the UK market drivers. Most commentators have been talking for the last two years about how important working the assets is going to be, selecting and driving property value through rental growth, rather than through yield shift or yield compression. The derivatives market tends to follow what market commentators are saying. What’s more, the major move in derivatives has been seen off the back of the movement in bond yields. It’s the same yield gap we talked about earlier. Over the very long term, having property as an asset class trading inside bonds is probably not sustainable. There’s a tension there and many people are betting that it’s the property market that’s going to correct, not the bond market.

LB, Euromoney The corporate CDS market is huge multiples in volume now of the corporate bond market. It may have only marginally impacted volumes in the corporate bond market, but it’s led to a huge overall increase in the volume of financial activity. Will this happen in real estate?

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JH, Fortress Well, the basis between a single corporate credit default swap name and the underlying cash instrument is vastly different to the basis between an IPD index and a single property within that index. That will be a constraint.


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PC, British Land Company A property derivative doesn’t realize value out of property assets. Sale and leaseback deals will continue because people want to realize real value out of their property rather than just taking a view on the value of the property that they own from time to time.

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DN, Natixis But you could take a view that the value of your particular portfolio of properties has got to the point where you could sell the index rather than the properties, because the index, arguably, should match roughly the same value. So you sell the index, because to trade in and out of property is more expensive than trading in and out of the index.

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PC, British Land Company Property derivatives do provide a hedge, but over a different period than selling the underlying property, and with different characteristics. You’re still carrying basis risk. Derivatives won’t prevent property transactions per se, but there may, at the margin, be some transactions which don’t happen because a derivatives transaction will happen instead. How do you explain to your shareholders what property you own if you’ve got £2 billion-worth of central London property and you’ve sold £1.5 billion derivative for five years and you’ve got 20-year leases. Identifying the actual exposure you’re reporting becomes more difficult the more you use derivatives.

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JD Some banks came to us a few years ago trying to persuade us that, as we buy CMBS, we should use property derivatives as a hedge for it. We struggled to calculate the hedge ratio in a way that made sense. There is clearly some level of correlation, but it’s very hard to measure or analyse it properly between those kinds of price shifts.

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PC, British Land Company That’s why, even in hedging underlying property portfolios, there’s a significant basis risk, even if you’re trading in sub-sectors of property, because the performance of whatever it is that you’re hedging will not necessarily be the same as the underlying sub-sector.

The future

LB, Euromoney What do you think future trends are going to be, both in terms of geographic expansion and the kind of assets you can see backing these deals? And what is your volume forecast for this year in terms of issuance?

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RF, Standard & Poor’s We’ve gone through about €30 billion in the first half, which is up over 80%. The second half is usually twice as strong as the first.


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DN, Natixis I think somewhere close to €100 billion, but I don’t think it will achieve more. Increasingly we’ll see more issuance backed by collateral from the main continental European jurisdictions. We’ll only see little bits and pieces from eastern European geographies, not least because the rating agencies and the investor base would be reluctant. The more of the esoteric countries you have in a transaction the more the impact on your pricing. But there’s a lot more to come in continental Europe.

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JH, Fortress I’d expect to see quite a lot of Swiss issuance, and the Netherlands is a recovering market. There will probably be slightly less in Germany and the UK, compared with earlier in the year, because it’s getting harder for those loan notes to work at where the yields and interest rates are. I do think, however, that we will continue to see the new jurisdictions represented in a small way in some of the larger conduits, perhaps even a Russian loan this year. But I think there will be a lot of push-back by investors.

The recent volatility is going to be very interesting, because it may result in a more disciplined investor community saying that we want pan-European CMBS to be pan-western European CMBS, and we want investment loans to be institutional grade. Some of the partial development loans in CMBS recently, particularly in the UK and the opco/propco structures, could be retrenched somewhat if investors get more concerned. We’re likely to see spreads soften the whole way down the capital structure, not a lot but a bit, for the remainder of the year.

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SG, LNR Partners There will be new jurisdictions, largely driven by where the property companies are going for yield. A lot of banks are obviously going to follow their larger clients into these markets. We’ll probably see more in Switzerland and the Netherlands, and we may see some jurisdictions further east, but there won’t be a large number of those types of transactions, because the market as a whole is not ready for large exposures to these new and emerging markets.

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RP, Morgan Stanley I would forecast €90 billion in issuance, more pan-European yields that will have more esoteric jurisdictions in them. Russia will be one of these new jurisdictions, but a small amount, maybe not even rated by S&P, and maybe just as part of a bigger transaction. That way the originator can test the waters, see how investors react to it and how it goes through the rating agency process.

Once there has been a Russian deal in a larger pan-European deal, if everything goes well, then I would expect the Russian campaign to increase, although not by a lot. Spreads will probably soften slightly, especially towards the bottom of the covered structure, rather than the top.

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PC, British Land Company We’ll see a significant repricing of risk, whether it’s in CMBS or the underlying property market itself. Spreads will be very different for different deals. There will be much wider spreads in CMBS and a correction in terms of the yield compression that we’ve seen in the underlying property.

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JD I think you’ll see spread tiering and spread widening at the lower levels in the structures, continued strong growth through the market, and more novel countries and odd loans thrown in to larger deals, such as loans from eastern Europe. There will probably be more restructuring and opco/propco deals as well. That trend has by no means run its course yet.

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JH, Fortress I think there are two secular trends that will overplay any short-term concerns of credit volatility. Real estate is continuing to change hands. Companies are increasingly not holding their own real estate, but selling it on, and that needs to be financed. Secondly, from a regulatory perspective it’s going to be capital efficient for banks to use securitization. That amounts to a substantial amount of growth. There might be a slight retrenchment in the type of loans that are securitized when we do go through a tougher cycle. Securitized loans are harder to work out than non-securitized loans for the banks. But broadly speaking growth rates will be similar to what we’ve seen.

LB, Euromoney Thank you all very much.

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