If regulation is the barometer, Europe’s CMBS market has yet to be rehabilitated, despite talk by governments and regulators aimed at encouraging its recovery as an alternative to bank loans for businesses and markets that need debt.
Notwithstanding lobbying for more judicious capital treatment for CMBS, regulation dictates that it is an expensive asset for both originators to issue and investors to hold. Market participants say regulators’ desire to promote the market as a way to diversify funding contradicts their actions, which treat CMBS as intrinsically more risky than other types of lending.
In the latest attempt to fight CMBS’s corner, the Commercial Real Estate Finance Council Europe (CREFC) and INREV say a key response to the proposed updating of Solvency II’s treatment for securitised bond investing would be an ‘artificial obstacle’ to a better CMBS market. The pair gave feedback in a letter to the European Insurance and Occupational Pensions Authority (EIOPA), which had itself responded to updated Solvency II proposals published in December.
This latest debate over CMBS investing involves institutional buyers – natural investors in commercial real estate debt, some of which already write private balance-sheet property loans. But there are others who either can’t invest this way or want to buy listed and rated, tradeable structured bonds, using other pots of money.
The EIPOA’s assessment of securitised bonds under Solvency II typified all CMBS as illiquid, ‘type B’ securitisations requiring greater capital reserves. Earlier, the EIOPA had proposed a 7.5% risk weighting for all securitisations; moving CMBS into ‘type B’ raised that to 12.5%, while ‘type A’ exposures have fallen to 4.3%. Prime RMBS is termed as ‘type A’, largely in line with European Banking Authority liquidity rules (see below).
Marco Rampin, BNP Paribas’s head of real estate capital markets, told a recent CREFC seminar on CMBS: “Insurers are unsure about Solvency II. They thought they would get a big price advantage over banks, but now they don’t know. Regulation is improving for some asset-backed security classes, but not CMBS. And there’s no sign that it will get better, unless we prove there’s a benefit to the real economy, which is hard to do.”
Part of the EIPOA’s analysis is drawn from problems that afflicted elements of the securitisation market in the financial crisis, particularly US sub-prime mortgages. But the CREFC and INREV said “the baby should not be thrown out with the bath water”.
Penal capital treatment for CMBS
They warned that indiscriminate regulatory capital treatment is penal for insurers – a core part of the CMBS investor base. It also limits diversification in institutional portfolios and puts CMBS at a big disadvantage to other comparable investments.
Certain CMBS should be allowed more lenient treatment, in their view, as it can provide stable, long-term returns with greater risk diversification and liquidity, and lower overheads, than direct property debt.
“It is odd that Solvency II ignores the fact that senior CMBS tranches (the most widely attractive to insurers) are invariably lower- risk than the loans underpinning that bond, imposing higher risk weights on the bond than on direct loans,” the letter pointed out.
The punitive approach to CMBS looks unlikely to improve in the near term, as the EIPOA is not obliged to act on the CREFC’s and INREV’s feedback.
But there is still hope for CMBS. The Basel securitisation framework released a proposal in December simplifying the way banks calculate capital charges for holding structured bonds (see below). It also proposed lower charges than December 2012 proposals, although they are still a lot higher than under the current approach.
The International Organisation of Securities Commissions also announced a review late last year to compare national requirements for securitised debt issuers to retain some financial risk – so called ‘skin in the game’ – in an effort to prevent divergent approaches from creating problems.
The hope is that banking, insurance and securities regulators will form an international working group to look at tackling possible hurdles to getting more money into the securitisation market.
Proposed rewrites for securitisation rule book
Basel securitisation framework for global banks: New proposal released in December simplified the methodology for banks to calculate the capital charge of holding structured bonds. Capital charges are lower than in the December 2012 proposals, but higher than current approach. For example, the ratings-based calculation for a AAA, five-year CMBS would lower the capital charge to 2%, from 4.6% under December 2012 proposals – but this is still nearly four times higher than 0.56% under current approach.
European bank liquidity rules: December report by the European Banking Authority to EC recommends prime RMBS be treated as liquid asset, but not CMBS.
Solvency II for European insurers: Updated approach in December recognises ‘high quality’ securitisations, including prime RMBS, but not CMBS. Capital charges remain very high: insurers face >60% capital charge for five-year, AAA CMBS, compared with <4% for five-year, A-rated direct loan.