Is now the time to value European CMBS assets?

CMBS specialists, speaking during an online industry conference last week, debated the merits of going ahead with annual valuations amid the disruption caused by covid-19.

Owners of properties that are financed by loans in European commercial mortgage-backed securities are requesting waivers of scheduled valuations because of covid-19’s impact on their assets’ performances, according to speakers at rating agency S&P Global’s European Structured Finance virtual conference on 3 September.

However, some panellists argued that annual valuations – a feature of so-called CMBS 2.0 transactions designed to provide ongoing transparency into the underlying collateral – should go ahead, despite recent property market turbulence.

“At the start of lockdown, we had an issue with physically calling the valuations,” said Serenity Morley, head of primary servicing for Europe at London-based loan servicer Mount Street, which is the designated servicer on several European CMBS transactions.

“But since lockdown has lifted, we are moving towards getting valuations on portfolios and individual assets in CMBS transactions because not only do we have an obligation to do so, but we believe that investors want us to call those valuations.”

She added that borrower requests for valuation waivers place servicers in a difficult situation: “We have a hard obligation in the agreement of the CMBS 2.0 transaction to call a valuation.”

Valuation challenges

Mathias Herzog, director at S&P, said some borrowers are concerned that new property valuations will result in breaches of loan-to-value covenants.

“Borrowers are also arguing that, in the current environment, particular assets such as retail are difficult to value because there is not a lot of market evidence to benchmark them against,” he said.

Herzog questioned the viability of valuing a property that is currently closed due to covid-19: “These last couple of months may not be representative of its long-term cashflow capabilities. How do we interpret these values and are they even reliable valuations?”

He added that new valuations could have an impact on investors, especially those that own notes from lower-rated tranches of CMBS deals, if they triggered an appraisal reduction: “If you’re at the bottom of the capital stack, a new valuation can still cut off an investor’s interest.”

Benefits of valuations

Morley acknowledged that it might be preferable from a borrower’s perspective to wait six months in order to gather a “more valuable data point”. However, she added that, ultimately, annual valuations are still necessary in today’s climate.

“Valuations can have a negative impact if we measure the value at the lowest point of the curve, which is not true to where it might bounce back,” said Morley. “But if we get a second wave or go into lockdown again, at least we know what potentially the bottom line might be.” Furthermore, if a borrower is requesting covenant waivers or a deferral of interest payments, it is “incredibly important” to have a recent valuation to hand.

“There are remedies available to use,” she said. “If you call a valuation, you might be able to put the loan in a cash trap. It brings the borrower to the table and informs a better decision.”

Providing a CMBS investor perspective, Matthew Kimberley, senior asset-backed securities portfolio manager at HSBC Global Asset Management, argued that regular valuations are something investors have fought hard to implement since the global financial crisis. He argued that they help protect investors against a potential deterioration in the performance of a loan as it approaches maturity.

“The GFC saw a lot of loans that were deteriorating yet still paying their interest,” said Kimberley. “There were no revaluations for years and, as a result, nothing could be done with the loan.” He added that noteholders are usually willing to come to agreements with borrowers when such requests are made, but that early discussion of potential problems is important.

“As an investor, we would definitely be keen to see those valuations still undertaken,” he said.