Investors seek safety in Europe’s secondary market

Prime CMBS recovery expected as AAA bonds offer investors ‘safe haven’

Worsening global economic news has caused secondary European CMBS spreads to widen, presenting a buying opportunity at the prime end  of the market. This means returns are much more attractive now than they were before the summer. “We have seen hardly any weakness in the prime segment,  at the senior and mezzanine end,” said Patrick Janssen, M&G Investments’ portfolio manager of structured credit products.

“These types of deals are regarded as the safe haven in ABS and credit as a whole.” Compared to early July levels, spreads are now wider by roughly 110bps for AAA notes, by 160bps for AAs, by 225bps for As and 275bps for BBBs, according to Bank of America Merrill Lynch research.  A moderate recovery is expected to take place during September, with demand coming from existing European CMBS investors.

The bank believes US investors are out of the market, owing to the weakness of US CMBS (see below), while property players or fixed-income investors outside structured finance are not likely to enter the market. However, Janssen believes that although those levels might reflect the most prime bonds in the sector, the overall CMBS market widened much more.

He saw conduit CMBS AAA spreads in May at 350bps; they are now closer to 600-750bps. Prime bonds have held up but average-to-weaker deals – particularly mezzanine – are back to the levels seen at the beginning of the year. “The relative value argument for prime CMBS and senior conduit CMBS is so compelling that we would not be surprised to see a rally if several new investors enter the market or if/when macro-risk reduces,” said Janssen.

“Even including loan extensions and asset liquidation scenarios, mid to high single digit returns are feasible for a granular, well selected portfolio. That is very compelling versus property yields.” New private equity real estate firm Crosstree Real Estate Partners, which has £300m of cash to invest from the Ernesto Bertarelli family office, plans to invest in CMBS debt and non-performing loans. Deals will be sourced by Sean Arnold, former head of Euro-pean acquisitions for Starwood Capital. Nick Lyle, former head of Blackstone’s UK business, set up the business with Arnold.