By Iain Balkwill, partner in the structured finance team of law firm Reed Smith
Europe’s CMBS market is currently dominated by the securitisation of large, balance-sheet loans, but pricing achieved in three recent CMBS issues has been disappointing. Perhaps now would be an opportune time for lenders to embrace agency CMBS structures, with respect to the securitisation of such loans.
The challenging pricing achieved in relation to Logistics UK 2015 CMBS, Reitaly Finance CMBS and Taurus 2015-3 EU DAC shows the potential perils of CMBS as a distribution tool for CRE debt. These three deals bring into stark focus the pricing quandary that confronts many conduit lenders.
On the one hand, lenders are having to competitively price loans in a debt market that is awash with a plentiful supply of liquidity, leading to increasingly tighter margins. Meanwhile, when it comes to the distribution of these loans, the capital markets have proved to be anything but predictable.
As demonstrated by the impact of fears surrounding a potential Greek exit from the European Union and the Chinese financial crisis on the pricing of these deals, capital market instability can have a profound effect on lenders with a CMBS exit in mind. This is especially true when lenders are under pressure to free up balance sheets or meet investor demand for CMBS product.
With the continued fallout from the global financial crisis, uncertainty regarding the Eurozone, falling oil prices, instability in the Middle East and the unknown impact of rising interest rates, conduit lenders are likely to face continuing periods of extreme volatility in the capital markets.
These macroeconomic fears will no doubt be exacerbated with concerns about whether the commercial real estate markets are again in the midst of another pricing bubble, fuelled by cheap credit.
Agency issues aid big deals
These capital market vagaries are part and parcel of the business for lenders originating loans with a CMBS exit in mind. But when it comes to the origination of riskier, large loans with significant exposure to a sole sponsor and magnified pricing risk due to their size, then the structuring of an agency deal should be a desirable proposition for lenders wishing to negate such risks.
From a lender’s perspective, given that agency deals comprise direct issuance by a borrower of CMBS bonds into the capital markets, these structures have a huge advantage, as they allow banks to meet both borrowers’ and investors’ requirements without having to deploy any of their balance sheet.
The corollary of this is that although such lenders will not benefit from any profit received from the arbitrage between the weighted average coupon on the notes and the coupon on the loan, equally they will not suffer a loss caused by a mismatch in pricing of the underlying loan and widening spreads in the bond market, caused by capital markets volatility.
At a time when the markets have demonstrated that they are prone to periods of heightened instability and lenders are understandably reluctant to assume significant pricing arbitrage risk created by the origination of large loans, embracing agency structures would appear to be the perfect solution for satisfying borrowers’, investors’ and lenders’ requirements alike.
If there is indeed appetite to use agency structures and they are used on any notable scale, then the upshot will be lenders’ ability to deploy their balance sheets towards originating and securitising a greater number of smaller loans.
In effect, agency structures could be the catalyst for the re-emergence of CMBS conduit deals comprised of a greater number of smaller loans – and with it an increase in the universe of borrowers able to access this type of financing – while greatly improving the granularity of European CMBS product.