Despite the continued uncertainty across the real estate market due to the covid-19 pandemic, issuance in Europe of commercial mortgage-backed securities is gathering steam.
During the first quarter of this year, €2.1 billion of CMBS were issued across six transactions, compared to €2.8 billion of issuance in seven transactions during the whole of 2020, according to Bank of America Global Research’s data, published on 6 April.
The fact that Q1 2021 issuance was almost double that during the same period of 2020 is leading market participants to predict this year’s overall issuance will easily surpass last year’s volume. During the first quarter of 2020, three deals totalling almost €1.1 billion were priced, which is 90.9 percent below the volume of issuance recorded this year.
Sarwesh Paradkar, an analyst at Moody’s Investors Service, told Real Estate Capital: “We expect issuance volumes to recover compared to 2020, when there were seven deals. With the current pace of issuance, issuance might come close to the 2019 peak level of 17 deals.”
Conor Downey, a real estate partner at the London-based law firm gunnercooke and a veteran of the CMBS market, says the number of transactions issued this year to date shows there is significant investor demand for CMBS notes, despite continued uncertainty around real estate values.
“Broadly speaking, the rest of this year should be at least as good as the first quarter,” he said. “Looking ahead to the end of 2021, there are no particular reasons at this stage to think this upward trend is going to change.”
However, market sources agree overall issuance volume is likely to remain below the 2019 peak as the macroeconomic fallout from the pandemic persists. Ratings agency Fitch recorded €5.9 billion of 2019 issuance, though that included €1.8 billion across two single-tranche deals.
A potential challenge to CMBS issuers this year, sources argued, is volatility in note spreads, which are sensitive to conditions in the broader capital markets. Paradkar said: “For a CMBS to be profitable, the weighted average spread on the notes has to be lower than the margin on the loan, which is where the lender makes the profit,” he said.
“As soon as there is any uncertainty around the notes’ spreads, which are impacted by broader capital market conditions, that commercial aspect might not work for the lender, which in turn could be less incentivised to continue issuing CMBS.”
Securitisation activity so far this year suggests there is pent up demand for CMBS notes among investors. However, sources say investors are increasingly selective about the type of deals they want to invest in. In recent years, CMBS issuers have been gradually winning investors’ confidence by issuing deals backed by limited pools of assets from within single jurisdictions or sectors and with conservative leverage. CMBS deals issued before the global financial crisis often included large volumes of disparate loans.
According to Downey, post-credit crunch, investors have been clear they want relatively simple transactions. “With the benefit of hindsight, investors now consider multi-loan deals across multi-jurisdictions and different property types too complicated to be analysed properly in the time available.”
Logistics assets have featured prominently in the deals launched so far this year, having backed two transactions representing 35 percent of issuance. Offices have collateralised two deals.
Andrew Petersen, finance partner at law firm Alston & Bird said investors are considering more than ever the underlying collateral of deals and its tenants. “With regards to the chosen property types of Bank of America’s deals, they may have considered covid-19’s impact on the different property types, choosing those that were perceived to be operating well during the pandemic,” he said. “It was the right time for a logistics-backed asset class.”
Three transactions, representing just over half the year-to-date issuance, came from the UK while another third came from Germany across two transactions. In addition, there was one deal from Spain while the Netherlands represented just over half of the portfolio backing Last Mile Securities – PE 2021 DAC, a logistics-backed deal sponsored by global private equity giant Blackstone and issued by US investment bank Morgan Stanley.
Market sources predict there could be more logistics CMBS in the pipeline, as the property type continues benefitting from strong fundamentals, underpinned by covid.
Spreads tightened in Q1
Significant pent-up demand for CMBS is driving spreads tighter across the capital stack.
According to research by Bank of America, triple A notes priced at 85 basis points over SONIA in February, in the bank’s Taurus 2021-1 UK transaction, and at 90bps over Euribor in March with the Last Mile Securities – PE 2021 deal, issued by Morgan Stanley. This is roughly 70bps tighter than where triple A margins were understood to be at the start of 2021.
This tightening occurred across the capital stack with a return to pre-pandemic pricing across all tranches, with the possible exception of triple B, making CMBS finance roughly 100bps more affordable for borrowers compared to Q4 2020.
Petersen said that, although margins are tightening on the back of investor demand, there is still a premium when compared with other structured finance products. “Because of the spreads tightening, you can tell that everyone wants to have some yield, which they are not getting at all from government treasuries or by putting money into a bank account,” he said. “Having yields at 85bps is better than getting negative or zero yields.”
“For the Bank of America logistics deal, oversubscription was higher in the subordinated tranches, which indicates demand was higher than supply, with more people willing to buy those tranches than were able to be sold.
“The subordinated tranches, which have higher yield, were oversubscribed seven, eight times compared to the more senior notes, which got oversubscribed five times. This suggests there are investors looking for yield and leaning into risk. Price exploration is still evident but, undoubtedly, investors cannot get enough CMBS at the moment.”