There was a concerted effort in Brussels last week to be positive.
The Belgian city was the location for this year’s Global ABS conference, hosted by Information Network Management, so chosen, not for its aesthetic splendour, but to draw in Europe’s regulators and – possibly – aid banks’ lobbying efforts.
There were, among the commercial real estate contingent present at the Square Brussels Meeting Centre, good reasons for that moderate energy. Within the context of a much-reduced investor market, reasonable expectations for what could be achieved in future were palpable.
The first CMBS in almost four years had just closed days earlier, the largest representation of debt investors had turned out since 2008 in Cannes and in closed-door meetings the talk was about the possibility of more securitisations.
But the market will be slow to come back; pricing in the bank and covered bond markets still leaves CMBS uncompetitive in the UK. The contrast with the US CMBS market is stark – across the Atlantic deals have raced out of the traps with CMBS pricing likely to enable around $50bn of issuance this year.
The mood in Brussels could be characterised as reflecting the wider European commercial real estate market’s two-tier investor base. In the pre-lunch and mid-afternoon sessions on Wednesday, common themes surfaced.
CMBS pricing not yet competitive
“If you look at the UK and Germany, the two main drivers of the European CMBS market, bank pricing in Germany has been falling like a stone,” said Caroline Philips, head of structured debt at Eurohypo. “You can now get 70% LTV on good quality assets at sub 200 bps over Euribor, so CMBS can’t compete.
“In the UK, bank pricing is more competitive, but for prime deals, which is really all that is happening at the moment, there are more banks playing there than three months ago, so we are seeing margins starting to fall. So at the moment, I don’t think CMBS is competitive enough on pricing.”
Earlier, RBS’ Damian Thompson, who works in the bank’s ABS and portfolio credit structuring business, set out the context. “The European real estate market is, by any measure, a very large credit market. People often focus on the outstanding CMBS debt but that is a reasonably small proportion of the total outstanding debt market – at an estimate, the total market is €1.9trn at the end of 2010 and there is around €5bn maturing in the next couple of years.”
European CMBS represents only around 10% of the total outstanding debt secured against the asset class, estimated Michael Cox, an ABS trading strategist at UBS, but that’s not to say the problems within that spectrum are not significant – there remains a huge quantum of debt to be refinanced and restructured, and time is against borrowers.
“Loans will continue to be restructured until the final maturity of the CMBS bonds – but there will not be a huge wave of bond extensions, I struggle to see where the initiative will come for that,” said Christian Aufsatz, EU CMBS strategist at Barclays Capital.
How to re-finance secondary stock?
Tom Jackivicz, managing director and head of real estate finance at Morgan Stanley, said: “The market has made strides in terms of lending capacity – through the German banks and the re-emergence, a bit, of the French banks, and then there is the CMBS market, although I don’t think there is going to be massive amounts of capacity there.”
“Where will the cash be found to finance the acquisition of property in defaulted loans?” asked Cox. “It is quite tight. German banks only lend on prime and against modest LTVs, and while there is mezzanine finance out there it is expensive – so there is a real shortage.”
Jackivicz crystalised the problem with: “The senior part of the capital stack for secondary assets is by far the most challenging part of the refinancing wall.”
Indeed, who will want to lend, whether balance sheet or syndication, and if through securitisation, what investors will want to buy CMBS bonds backed by poor secondary assets – will the pricing make the risk worthwhile? This cuts to the heart of so many of the CMBS workout problems: the unsuitability of secondary assets, specifically at the poor end, to securitisation.
“Part of the problem of the past was that many investors in pre 2007 CMBS transactions ended up being property investors by accident,” explained Cox. “For a large part the people who bought CMBS were property guys and too little attention was paid to how deals work when they are stressed.”
“Investors’ accept that a lot of the problems have been market-led,” said CBRE’s Paul Lewis, a director in the property services company’s special servicing team, “but many are still asking, ‘how come the market is down by 25%, and this CMBS portfolio is down 50%?’”
There is no doubt “prime, good quality assets with long income streams are suited to securitisation” but the focus should be less on valuations when judging deals, argued Lewis. “A valuation is only ever a spot price at one time, it doesn’t say anything about the direction of the asset value or properties’ potential volatility. That is something that needs to be understood more.”
Underwriters need to move away from “traditional credit metrics and look more at the underlying volatility of the assets,” Lewis argued.
Special servicers need to take the lead
The overriding concern for special servicers, when loans fall into their management, is to get the best recovery possible within a reasonable amount of time, with an eye to junior lenders, who suffer first loss position, even if they technically are “out of the money”, said Stewart Hotston, a director at Hatfield Philips.
“The complexity of CMBS structures have been very apparent in the deals we have invested in,” said Palatium’s James Tarry who manages the £353m CRE CDO, Glastonbury Finance.
He went on to highlight some of the weaknesses in the CMBS market, and those who represent the interest of noteholders, which the scale of the crisis has exposed.
“We need to have a decent constituency of noteholders across the capital structure and people need to be prepared to ‘come inside’ (were sensitive information disclosure prohibits secondary trading) for short periods.
“The key thing is that this has to be led by the primary or special servicer, and actions have to have an objective and cannot be taken to simply cover their own liability.”
Tarry pointed to the example of first round negotiations between noteholders and the servicer, Rothschild, for the Plantation Place CMBS workout in autumn 2008.
“Looking back with the benefit of subsequent restructurings, it was a bit of a shambles. The servicer was pretty much absent from that whole process allowing themselves to be bullied by a few dissenting voices at the top of the capital structure, who bought in at a discount and were trying to enforce against the breach of the LTV covenant.
“If the servicer actually had had some conviction would they have said, ‘we are not listening to this, this is utter nonsense,’ instead they spent god knows how much on legal fees, advisory fees dealing with something which should not have been an issue.”
New deals will bring gradual structural improvements
But we are where we are with legacy deals and loan documentation, panelists agreed. “The only time investors can insist upon better standards in how deals are structured is when a new deal comes to the market,” argued Christian Holder, director EMEA fixed income at Blackrock.
And that has already happened in Deutsche Bank’s Chiswick Park securitisation, the £302m DECO-CSPK. “My understanding is, at the last minute, there was a fairly major structural change at the insistence of the investors – and good for them for getting the change.”
Deutsche agreed to restructure the class X note, the tranche that the originating bank receives its profit from. Under the revision, the class X senior note is fully subordinated in the event of loan default, to appease investor concerns that the bank could still drawdown a profit in the event of an underperforming loan. The final offering circular will be published in two weeks.
“That’s an incredible positive,” countered Philips. “Having that dialogue between the investor community, the structures and sponsors in a live deal is incredibly important and healthy. The next deal will be slightly different and it will evolve; any evolutions that are more aligned with what investors want, as long as it is not to the detriment of the borrowers, has to be a good thing. That way, you do get a proper functioning market.”
So a flood of new CMBS deals is unlikely, but there will definitely be a few more this year – Deutsche is planning another one, and others are in the pipeline if the whispers in Brussels are to be believed.
CoStar Finance 