European bank market still trumps CMBS as spreads stay high

Only one 2016 securitisation has been seen so far but the AAA pricing was more promising, writes Real Estate Capital consultant editor Jane Roberts in a special report on European debt capital markets. 

Bank of America Merrill Lynch’s pricing of the first, and so far only, rated European CMBS in 2016 was an encouraging sign for a market that has struggled recently to find any succour.

The €317 million securitisation of the ‘Kingfisher’ loan to Blackstone secured on German retail, called Taurus 2016-1 DEU, saw the €141.6 million of AAA bonds price at a margin of 130 basis points over 3-month Euribor.

While this spread was way higher than the 90 bps for the AAAs that the same bank achieved almost exactly a year ago for its Taurus 2015-1 DEU transaction, it was lower than the last CMBS to price in 2015. That was September’s Taurus 2015-3 EU where the AAAs priced at 165 bps.

The junior bonds didn’t do so well for the bank in the Kingfisher deal, with the class Es and Fs selling at a 5 percent and 6.8 percent discount respectively, but the market was more interested in a signal that CMBS AAA spreads had tightened in the long six-month gap since the last publicly-sold, rated deal.

“It is important because the AAA is always the largest tranche and the pricing sets the scene for the rest of the transaction as well. If you start a deal not being able to price the AAA then you will not be able to put it all together”, says one senior director in European structured finance.

‘You can have different challenges with different tranches, but the AAA is where it all starts.”

BAML had been cautious in its initial pricing guidance for the Kingfisher CMBS, indicating a 140-150 bps margin for the AAAs. Therefore getting 130 bps was a good result. Fund managers bought 92 percent of the deal with the total number of investors closing out at 16. Most were UK-based buyers, accounting for 63 percent, followed by German investors (19 percent) and then other European investors (14 percent) with 4 percent going to a US buyer.

Deutsche Bank’s Roman Kogan
Deutsche Bank’s Roman Kogan

“BAML issuing AAA’s at 130 bps is a good step forward for the market”, says Roman Kogan, Deutsche Bank’s head of European real estate finance of the new benchmark. “If that continues to the 120 area, and even to the low 100 area as we had last year, you get to the point where CMBS is once again very competitive against bank balance sheet pricing.”

Not there yet

“It’s a helpful step and it is important to establish a new benchmark at the top of the capital stack,” says another banker.

“Ultimately, however, what’s required is a situation where the whole capital stack can be competitive,” he continues. “And we are not there yet, that’s very clear, given where the total execution is and compared to the loan market.”

It is that disconnect between the low cost of debt in the bilateral lending/syndication market and the higher margins in the debt capital markets to which CMBS is benchmarked that have put up the roadblock for CMBS. Since macro economic jitters began last summer, with investors spooked by the slowdown in China’s economy, sluggish growth in much of the European Union and falling commodity prices, both equity and credit markets have been volatile. By September, asset-backed securities spreads had increased to two-year highs as investors demanded greater reward for perceived higher risk.

The poor macro economic environment effectively closed Europe’s real estate securitisation market in the second half of the year after what had been a reasonably promising start. There were seven publicly-sold, rated CMBS deals in the first six months of 2015. But things turned around when the three following transactions, Logistics UK 2015, REITALY Finance and Taurus 2015-3 EU got caught up in the summer volatility and were sold at partial discounts and estimated losses to the banks, Goldman Sachs and BAML.

A fourth, Deutsche Bank’s DECO 2015 Charlemagne, just squeezed through selling entirely at par and generating an excess spread of about 60 bps before the window closed.

All were well-structured deals to good sponsors say banks, advisers and investors. Their problems were chalked up entirely to market risk rather than to weaknesses in the individual deals or structured real estate credit per se.

While Deutsche Bank didn’t get caught out then, it has postponed deals since that it wanted to securitise. The bank had hoped to launch a second Irish transaction after 2015‘s ‘Harp’ and a first post-crisis Portuguese CMBS. The latter would have been backed by two loans secured mainly on retail assets, one of them to Baupost and Eurofund against Dolce Vita Tejo shopping centre in Lisbon and the other to Blackstone. All the loans are now likely to be distributed to the bank’s accounts through the CRE loan syndication market.

Similarly, Société Générale considered securitising a £400 million loan that the French bank made to Apollo for the US fund’s £630 million acquisition of 22 UK Holiday Inn hotels dubbed Project Ribbon. And JP Morgan, which did successfully price a securitisation of a hotel portfolio last year, the €474.4 million dual-currency Mint CMBS, was said to have looked at a securitisation in the second half of the year, as its exit from debt that the bank holds secured on a £200 million portfolio of performing loans. The loans are part of the Project Churchill portfolio bought for £2.3 billion from Aviva by Lone Star last year. But this has not seen the light of day either.

Investors want product

Investment banks would dearly like the securitisation market to reopen. It is about much more than feeding their structured finance bond trading desks which need product. Although the investor universe for CMBS these days is small, there are securities accounts that want to buy them and there are investors in real estate debt who prefer to invest in bond rather than loan format. This has been a key factor behind the issue in the last three years of a handful of unrated, privately-placed deals – often single tranche and bespoke – to suit particular investor requirements. It does also widen the pool of investors in CRE debt and the financing options for the asset class.

What might the next crop of CMBS look like? The challenges associated with pricing junior classes, because of the reward for risk expected by investors together with a reluctance by borrowers to take on expensive higher leverage debt, means selling a higher leverage deal looks unlikely at the moment. April 2015‘s Taurus 2015-1 DEU, for example, secured on IVG’s office complex The Squaire at Frankfurt airport, was a 73 percent LTV loan. Privately, banks say this is unlikely to be a leverage level that could be structured profitably.

But otherwise, there are no obvious no-go areas for deals as long as they are straight forward, backed by strong sponsors and good quality assets (see panel below). However, even if pricing normalises somewhat this year, challenges remain which mitigate against issuance returning in any volume. Deutsche Bank’s Kogan says: “Europe is still very much a bank-dominated market compared to the US where only about 50 percent of secured real estate lending is held by banks while CMBS plays a much bigger part. Since the financial crisis, there are inherent structural hurdles to building a large-scale, pan-European CMBS market. This is a function of a number of factors including sovereign rating cap differences, legal complexities with cross-border loans, and general investor appetite for more discrete CRE market exposure. This is why we have seen Irish-only CMBS or Italian-only CMBS and so on. It is very difficult to build scale”.

Sentiment improved

Broader financial markets generally had a terrible start to 2016, “About as lousy a start as you could get”, says one CRE finance banker. But six weeks or so in and things started to improve a little, followed by a fillip from ECB president Mario Draghi on 10 March when he announced additional monetary stimulation measures for the eurozone. As well as cutting interest rates again, the ECB announced €20 billion more quantitative easing a month, to €80 billion, and the programme’s extension to the end of Q1 2017.

It wasn’t just the equity markets which responded positively. Key iTraxx credit indices also improved. Shortly after the Blackstone Taurus deal priced, in the second week of March, one banker said: “I think if you had asked market participants three weeks ago, can we place AAAs at 130 basis points, the answer would have been ‘no’. And as such getting there is a very helpful step for the other deals to come in the future.”

“At a certain point in time, something’s got to give”, he continues, referring to the pricing differential between cheap loans and more expensive bonds. So far, there isn’t much evidence that real estate lending is getting more expensive or that it has been affected to anything like the same degree by the broader macro environment aspects that have knocked back the security market. Even in the UK lending market, where there continues to be anecdotal evidence that loan pricing has stabilised in the last six to nine months, bilateral debt remains plentiful and cheap compared to CMBS.

“It doesn’t make sense that there’s a big disconnect between the two”, he concludes. “Either one will move out, or the other one will move in — or, perhaps, one will go away.”

Despite headwinds, 2015 deals topped €6bn

Despite the strong headwinds buffeting CMBS from August onwards last year there were at least 18 deals structured, totaling €6.26 billion, a modest increase on 2014’s tally.

The majority, 11, were rated and relatively widely distributed. The others were unrated, in the main structured as bespoke deals for a particular investor or investors.

The jurisdictions included Spain, Italy and Ireland as well as Germany, the UK and the Netherlands and there were several issues covering more than one jurisdiction.

The sizes ranged from below €100 million in the case of some of the unrated, privately- placed notes issued, up to €1.5 billion for Silverback Finance (the clue to the size is
in the name) which securitised a loan to Uro Property Holdings of a portfolio of 754 Santander Spanish bank branches.

The deals also encompassed a range of asset types. “I don’t think there is any particular sector that does or doesn’t work. CMBS is too specialised for that”, says one banker.

“You need to have a strong sponsor, you need to have a good story. But you can have a good story around a shopping centre, around big box retail, you can have a good story around offices or hotels.”

The three banks that have led the CMBS market since it reopened, BAML, Deutsche Bank and Goldman Sachs, were once again the most active, but JP Morgan successfully launched and priced the first hotel CMBS since the crisis, Mint, which was structured in sterling and euro tranches and secured by two London and one Amsterdam Doubletree by Hilton hotels.

Citi looked at securitising loans it originated at least twice, one in the logistics sector and one in student housing, but, in the end, opted for the less risky syndication market.

There was also one failure: RBS’s attempted securitisation of the £171 million Antares 2015-1 backed by a single loan from the bank to Kennedy Wilson.

Next up this year after BAML’s Kingfisher German retail deal, Taurus 2016-1 DEU, might be the securitisation of BAML’s €575 million loan to Blackstone’s Logicor, made last month to refinance a portfolio of Finnish logisitics and industrial assets acquired from Certeum.

Click here to see European CMBS/CRE bond deals since January 2015