Agency deals could revive CMBS

Blackstone’s February closing of what could prove to be the first in a new series of agency CMBS transactions is a huge boost to the beleaguered European CMBS market.

Coming hot on the heels of two securitisations issued by Bank of America Merrill Lynch at the end of last year, the European market is enjoying its strongest footing since it abruptly ground to a halt in the summer of 2015 due to capital markets turmoil sparked by economic crises in Greece and China.

Although it is not certain that we are witnessing the revival of the European CMBS market, the success of Blackstone’s €404 million agency deal – secured by Italian retail – is a hugely welcome development for borrowers and banks alike.

From the borrower perspective, given that agency deals remove the role of the bank as an intermediate lender and therefore allow them to raise finance by directly tapping the capital markets, there is a clear pricing advantage to using this type of structure, compared with taking a bank loan that is subsequently securitised.

Broadly speaking, in the case of an agency deal, the cost of the debt is confined to servicing the coupon on the notes and the payment of ongoing transaction fees. In the alternative scenario, the sponsor is required to pay higher amounts of interest to cover the payment of excess spread and any regulatory costs of the lender incurred in holding and distributing a loan.

Given that we are in a lending environment where escalating interest rates are forecast to become the new market norm, it makes sense that we are witnessing the re-emergence of agency CMBS structures. However, the magnitude of their renaissance will depend on the appetite of sponsors to embrace this type of financing structure.

Despite the favourable pricing of these deals, the sponsor could be forgiven for being reticent. Firstly, sponsors must be capable of structuring these transactions which, when compared with a plain vanilla financing, is a time and resource intensive process that carries a high level of execution risk. Secondly, these issuances – particularly if the transaction is rated – will impose restrictive and burdensome covenants on a sponsor which could prove to be costly and challenging to the operation of their business. Although not insurmountable, taken together these factors could put sponsors off.

Although agency deals by their nature do not require a bank to deploy their balance sheet, banks can play an important role in the development of the market by assisting the sponsors with structuring and executing these transactions. This is particularly true in scenarios where a bank is prevented from being able to originate a loan due to unfavourable characteristics of the loan in question. For example, the size of the loan may be too large for a bank’s balance sheet to stomach or there could be an inherent issue with the underlying assets or security structure which could prevent a bank from originating a loan with favourable pricing.

In these circumstances, the facilitation of an agency CMBS by a bank would be a win-win for both themselves and the sponsor.

Although, for the time being, only a handful of sponsors are likely to spearhead a revival of agency CMBS activity, others are likely to follow suit to finance those more challenging assets. Looking to the future though, as interest rates rise, more sponsors will have little choice but to set aside their reticence and hop on board the agency CMBS bandwagon.