German multi-family values underpin new CMBS issuance


German resi deals may push reviving CMBS sector to more than €10bn in 2013, writes Lauren Parr


Prospects for new European CMBS issuance are starting to look up and Germany’s multi- family housing sector is where much of the activity is. Three big German CMBS issues with a €2.6bn aggregate value are in the pipeline and CMBS volumes there could hit €5bn-€7bn in 2013, Deutsche Bank calculates.

At least part of the €1.1bn loan Bank of America Merrill Lynch made to Gagfah in February to refinance its Woba multi-family housing portfolio in Dresden will be securitised. The structure is already in place and BoAML is looking for investors.

Paul Severs“Borrowers need CMBS because of restraints in the banking sector under Basel lll; banks are shrinking their balance sheets. This is pushing borrowers into the capital markets” Paul Severs, Berwin Leighton Paisner


Gagfah is also planning a second, €700m CMBS for parts of the €2.1bn securitised German Residential Funding portfolio, being brought to market by Goldman Sachs and Uni-Credit, while Deutsche Annington will repay some €1bn of its Grand CMBS via a new issue.

Another securitisation on the cards is a £400m refinancing of Blackstone’s Chiswick Park, details of which will emerge shortly.

Up to €15bn of new CMBS could be sold across Europe this year, said Deutsche Bank analysts Paul Heaton and Conor O’Toole in a note last month, although they are more bullish than others, who suggest €5bn- €7bn. The UK and Germany will make up the lion’s share, although multi-family housing deals could include collateral from the Netherlands, Sweden and France too.

This would be a steep rise on the €1bn-3bn issued each year from 2008 to 2012, by BoAML estimates, but a fraction of the amount issued when the market was in full swing between 2004 and 2006.

Berwin Leighton Paisner lawyer Paul Severs says this upturn is driven by the fact that “borrowers need it because of banking sector restraints and tight capital restrictions under Basel III; banks are shrinking their balance sheets. This is pushing borrowers, directly or indirectly, into the capital markets.”

CMBS financing has also become less expensive compared with bank loans, so now makes more economic sense for borrowers.

Rising bank margins make CMBS attractive

Spreads have tightened overall in the past 24 months, while UK senior loan margins are up from 220bps in 2009 to 335bps, BoAML credit analyst Mark Nichol said in The Year Ahead report on European struc-tured finance, published last year. This has opened the door for CMBS to return, he believes, particularly in large deals.

Although insurers may lend at lower rates than banks, prime property is their focus, which means that the bulk of borrowers face relatively more expensive options, including CMBS. Severs’ take is that around €13bn of European CMBS loans still need refinancing this year, so an alternative solution is clearly required. On the other side, banks and investors are looking to CMBS in their search for higher yields in a low interest rate environment.

Compared with other asset-backed securities, such as US CMBS and UK prime RMBS, German multi-family housing CMBS spreads look attractive (see top table). For example, a new five-year, AAA-rated German multi-family CMBS could be priced at around 120bps over Euribor, compared with 48bps for AAA-rated US CMBS notes, says Nichol.

The main reason for the differences in pricing between these competing products is the larger investor base for US CMBS and UK RMBS than for German CMBS.

“As European RMBS investors continue to be starved of new issuance and yield, some may consider German multi-family CMBS as a close substitute that is likely to offer greater new supply and yield this year,” Nichol says.

There is demand from US investors for European CMBS, but they need to familiarise themselves with European structures. For this reason, Patrick Janssen, ABS portfolio manager at M&G Investment, believes more investors will club together to do deals.

Nichol reckons having a large lead buyer, such as JPMorgan in the German multi- family Florentia agency CMBS by Vitus last September, could help such deals’ execution and may be a useful model for future issues.

CMBS investors need to recycle capital

As well as a relative value play, demand for new issuance is the result of debt investors in maturing CMBS deals needing to recycle capital when deals run off or are refinanced.

“When CMBS gets repaid, primary bond investors want to reinvest at current yield levels,” Janssen agrees. “It’s very difficult to find the right secondary market product. Holders of prime deals have been reshuffled and aren’t seeking a quick profit. The primary market is more interesting; its often collateral we’re already familiar with.”

M&G bought Florentia bonds last year and is examining Gagfah’s Woba securitisation as a potential investment. “We’re talking multi- family, which has performed well through- out the cycle,” Janssen says. “Effectively it is easier for those deals to be refinanced.”

So CMBS seems set to make a comeback as a viable refinancing tool in Germany. But with loan-to-value ratios below 65-70% and bond holders demanding greater transparency, it will take a new form, as it will for all asset types. “We’ll see new issuance in specific asset classes, with specific sponsors investors are comfortable with,” says K&L Gates partner Andrew Petersen. “We will see some single, big buildings in prime locations being financed though the capital markets.”

Apr 2013, p17, i1This goes for prime central London property or assets such as Dudley’s Merry Hill shopping centre, which was refinanced via a new securitisation last year (see table). “[These assets] are attractive to relatively risk-averse investors so they will invest in debt backing those deals,” Petersen says.

He believes secondary or tertiary property- backed structures will still be problematic, as will multi-borrower structures.

Deutsche Bank’s and Blackstone’s Chiswick Park securitisation, which is being refinanced via CMBS for a second time, is an example of the type of property that will characterise the market. “It’s a good asset with well-stabilised cash flows, and is relatively easy to underwrite from an investor perspective,” according to Severs.

Apr 2013, p17, i2Insurance companies such as AXA, as well as existing Chiswick Park investors M&G Investments, PIMCO, BlackRock and Legal & General Investment Management, are seen as natural buyers of the new bonds.

Other possibilities are more long-dated, credit-tenant lease deals such as Tesco’s programme, where the notes’ rating is linked to the issuer, and Toys R Us’s planned privately-placed CMBS to refinance its £405m UK debt.

More hybrid deals ahead

Petersen expects to see more hybrid deals, like Intu’s semi corporate-semi CMBS. “It’s about getting the right structure in front of clients. Everyone agrees that the collateral must be clean; the problems lie with the documentation and structure.”

The biggest barrier now to European CMBS issuance is the lack of a dedicated ‘real money’ investor base. Most banks still have big and often problematic legacy CMBS loan books, so have little interest in investing, while Solvency II rules give insurers an incentive to make direct loans, rather than buying secondary paper.

“For all the criticism of disintermediation in real estate credit markets before 2007, the investor base wasn’t as diversified as has been suggested,” says Jones Day finance partner Andrew Barker. “Banks held large amounts of CMBS as well as junior B notes.

“The CMBS market must generate interest from real money investors such as insurers and pension funds to be a sustainable credit distribution method. The key attraction is obviously yield, but the market must address structural issues as well as investors’ concerns about information dissemination.”

Annington brings home the benefits of high-yield refinancing for CMBS

Recent deals have shown Europe’s CMBS and high-yield markets coming together to provide alternative sources of finance for hard-pressed real estate owners, writes Conor Downey of law firm Paul Hastings.

Centre Parcs and Four Seasons completed big issues to high-yield and other investors to refinance CMBS issues. More importantly, Annington Homes has shown that high-yield finance can be issued by equity sponsors of CMBS issues, using excess cashflows to back payment-in-kind (PIK) notes.

Ways must be found to refinance secondary asset-backed European CMBS and to achieve the leverage reached for some assets before the credit crunch. These deals provide an interesting model for such situations and show fairly modest bank or CMBS market refinancings can co-exist with non-traditional types of finance such as high-yield notes.

Such notes may attract borrowers seeking greater covenant flexibility than mezzanine loans usually provide, although the Annington deal offered high-yield investors some of the protection commonly seen in real estate debt, but not high-yield issues. As capital markets investments, high-yield issues require fairly big deal sizes and detailed disclosure that may make them less attractive for some borrowers.

Likely future candidates for high-yield real estate issues include: owners of assets with operating risk, which may not be attractive to banks, such as hotels, pubs and healthcare property; owners seeking very large amounts that loan markets may not be able to provide (German multi-family housing is the obvious example); and owners of distressed or secondary assets for whom costly private equity money is now virtually the only option.