Have regulators spurned CMBS?

Regulators are proposing more lenient capital treatment for ‘safe, transparent and comparable’ types of securitisation. CMBS does not appear to have made the cut.

Last week, the Basel Committee on Banking Supervision published updated proposals intended to define ‘safe, transparent and comparable’ (STC) forms of securitisation. CMBS was not explicitly excluded, but it seems apparent that such deals are unlikely to meet the criteria which merit that status.

Securitisation has a toxic reputation following its role in the Global Financial Crisis and the regulators want to rehabilitate it. As part of its wider agenda to reform the global banking industry, the Basel Committee is putting forward proposals for more lenient capital requirements for less risky types of asset-backed securities.

The committee suggests that the minimum risk weighting for bonds which meet the STC criteria ought to be cut from 15 percent to 10 percent, bringing it in line with proposals from the European Commission (EC) on what it calls ‘simple, transparent and standardised’ (STS) securitisations.

So, why will the criteria not apply to CMBS?

The key issue is granularity. The Basel and EC proposals require that no single exposure can account for more than 1 percent of the underlying assets. CMBS deals typically comprise only a handful of loans, meaning a single borrower can account for a significant exposure, even though each individual loan might be secured by a large number of properties in cases.

In late June, Conor Downey, a real estate lawyer with Paul Hastings, attended what he described as a “dispiriting” consultation meeting in Brussels chaired by the left-wing Dutch politician Paul Tang. Tang is steering two legislative proposals relating to the EC’s STS criteria through the European Parliament.

“Granularity is the problem for CMBS. Final discussion drafts had watered that element down, so we hoped it would open the door to CMBS. However, arguments in favour of CMBS do not appear to have been heard in the EC process and this latest document from Basel on STC seems to have closed the door,” said Downey.

For the Basel Committee, ‘safety’ means the homogeneity of assets underlying a securitisation and structures that are not overly complex. ‘Transparency’ means sufficient information is available on the underlying assets, the deal structure and all parties involved. ‘Comparability’ is championed in order to enable bond buyers to better understand their investments.

But due to the unique nature of commercial properties, CMBS deals can be backed by heterogeneous assets. Underwriting standards can vary by the circumstances of each loan (does it fund an acquisition or a refinancing for example?). And redemption cash flows are not always straightforward, as they can depend on properties being refinanced or sold at loan maturity.

Peter Cosmetatos, chief executive of the Commercial Real Estate Finance Council (CREFC) Europe, sees CMBS’s effective omission as disappointing, but not surprising. The nuances of commercial real estate are often missed when it comes to banking regulation, he complains.

“This is making things marginally worse for CMBS on a relative basis,” Cosmetatos said. But, he added, “the real issues remain the ones we already knew about; criteria that exclude CMBS pretty categorically, undiscriminatingly and, ultimately, inappropriately.”

Many believe the CMBS market will not be significantly impacted by omission from STC and STS definitions. One analyst said that the difference in capital treatment for certain types of ABS will not make much of a difference when the spreads between varying ABS classes are taken into account.

In Europe, the overall profitability of CMBS is a more immediate issue than its regulatory treatment. Spreads widened last summer, scuppering banks’ attempts to profitably distribute their real estate loans through the capital markets. Only circa €5 billion of CMBS was issued in Europe last year – down from more than €8 billion in 2013. Bank of America Merrill Lynch has been the only bank keeping the CMBS flame alive in Europe this year with a couple of deals.

However, CMBS’s effective exclusion from the regulators’ vision of what makes a ‘high quality’ securitisation is clearly viewed by many as unfair and unhelpful.

CREFC has not given up making the real estate finance industry’s case in the EC’s STS process, Cosmetatos told me. Further representations are to be made to Tang.

“Realistically, achieving significant changes to benefit CMBS at this stage in the process is going to be extremely difficult, but it is important to raise the CRE finance industry’s profile with the regulators and keep articulating our points,” he said.