CMBS: Five talking points

There will be more securitisation, although the market faces challenges, heard the audience at CREFC Europe’s CMBS seminar.

European CMBS issuance could hit €5 billion in 2018, although a rise in bond yields due to the winding-down of the European Central Bank’s asset-purchasing programme may hit investor demand in the long-run.

These were among points raised by CMBS market players during a panel discussion on the revival of the European market, hosted in London by the Commercial Real Estate Finance Council Europe and moderated by Paul Hastings partner Miles Flynn.

Overall, sentiment towards a sustained return of European CMBS – following an 18-month hiatus – was strong, although panellists discussed the factors that will determine the ongoing strength of the securitisation market. Here are five things to consider:

1. A steady flow, rather than a burst of activity, is expected.

On the back of data provider Trepp’s CMBS roadshow earlier this year, up to €5 billion of European issuance across 10-12 deals was predicted for this year, panellist Vivek-Anand Dattani, sales director with the firm, said. “The year to date puts us on track for that,” he added.

“There will be at least a few more deals, judging by the pipeline,” agreed Emile Boustani, director – asset backed products at Société Générale. “The optimistic view is that the current rhythm of the market continues.”

Providing an investor perspective, Jake Caldwell, head of CMBS bond trading at Goldman Sachs, argued demand for paper is strong. “A lot of capital is committed to the product and the market is not close to meeting that demand. The real question is whether underwriters have the appetite to take a six- to nine-month forecasted view, to provide a flow of deals.”

The current rate of issuance can continue, Clive Bull, director at Deutsche Bank, added. The performance of the market will depend on there being enough large portfolio transactions or cash-out refinancing deals to securitise, plus the investment banks’ willingness to do multi-sponsor securitisations. “A lot of deals come out of jurisdictions such as Italy, where macro-events could put deals on hold,” Bull warned.

2. CMBS will be limited to a certain type of deal.

While multi-loan, multi-sponsor CMBS transactions were commonplace pre-2008, today’s deals are far more homogenous. Single-borrower deals are likely to dominate, Bull argued.

“The problem with multi-sponsor deals is inventory risk,” he said. “Are you prepared to risk your balance sheet for nine months while you build up inventory? Spreads in some countries – such as we have seen recently in Italy – can move out quickly.”

There is a limit to how many loans ‘core’ CMBS investors will accept in deals, Bull added. Those investors that want to do due diligence of the underlying loans and property – as opposed to those simply looking for paper with a sufficient rating – do not have the resource to fully scrutinise deals once there are more than four loans, he suggested.

3. The end of the ECB’s bond-buying could have a knock-on effect.

The ECB calling time on its asset-buying programme could pose the biggest challenge to the market, Caldwell argued. Compression in bond yields due to the ECB’s activities has led investors into structured products in their hunt for yield.

“What happens now the ECB has put an end-date to its programme? Potentially, we have a steepening rate curve next year, so we need to consider what that means for the money raised and those paying asset managers to find additional yield they haven’t been able to get in traditional avenues,” Caldwell said.

Panellists agreed there is a core of investors for the current crop of deals. Reports of 20 separate account investors for new deals, which were at least twice oversubscribed, were noted. Diversification is driving investors into CMBS, including some from Asia, as well as US investors getting interested in what’s happening in Europe, Trepp’s Dattani said.

However, the sustainability of the investor base was questioned by moderator Flynn.

“It depends on what goes on in other sectors; we’re the tail on the dog,” responded Bull. “If spreads widen in other sectors, volumes go up and a lot of the new investors into CMBS disappear. So, it all depends on what happens in markets such as CLOs and RMBS. Our non-core investor base might migrate.”

4. Debt funds won’t issue CMBS – yet.

Asked by Flynn whether private debt funds would attempt to securitise multi-borrower, multi-loan portfolios any time soon, Bull questioned the likelihood: “Are debt funds set up to do that, given the specifications and agreements they have with investors?” he asked.

However, Boustani, suggested there is scope, in the longer-term: “There’s demand from debt funds to ramp-up portfolios over the next couple of years, so there is the potential for them to refinance through CMBS,” he said, adding: “However, no-one knows where the CMBS market will be in two years.”

5. Covenant packages are changing (and X-notes remain a talking point).

Panellists discussed the lack of financial covenants and loose change of control requirements seen in some of the recent wave of CMBS deals. It was noted that such structures are limited to the CMBS market, with such deal structures unlikely to be accepted in the syndicated loan market.

“The bank market won’t accept a lack of covenants. The only place it can be accepted is the CMBS market,” Bull said.

“It’s spilling over into the wider market to an extent,” added SocGen’s Boustani, “with some of the wordings seen in CMBS documentation becoming more standard.”

Although some investors have voiced concerns about the lack of default financial covenants in some deals, it has not prevented them from placing orders, Bull noted.

The ever-controversial subject of Class X notes in CMBS deals – in which excess spread is paid to the issuer – was raised. The new crop of deals features Class X interest diversion mechanisms, in which payments are diverted to a ledger in the case of a default.

Such innovations, Boustani argued, can mitigate for the lack of day-one financial covenants in some deals: “It shows deals can be arranged without default covenants, but still with measures by which cash is trapped when necessary.”