Lack of new investor base is biggest challenge for European CMBS

Brussels conference blog

Anyone looking for signs that the European CMBS market will re-open for new issuance will be disappointed by the year’s biggest annual securitisation conference, going on in Brussels this week.

One of the strongest fears being voiced in many of the IMN Global ABS sessions yesterday was that the incoming Solvency II insurance company regulations are another frustration to attempts to build a new investor base for CMBS and other structured bonds. Paul Heaton, Deutsche Bank vice president in securitisation research, said that insurance companies will have to hold 7% capital against AAA bonds, which over the term of a five-year note would be 35% -  much higher than the capital requirement for vanilla mortgages. The question being asked was: will this cause an exodus of insurance companies from the structured finance market in Europe?

This is serious, because, as several speakers re-iterated, the old investor base who bought the bonds before the credit crunch, SIVS (Structured Investment Vehicles) and banks, have fallen away, burned by losses, and so-called ‘real-money investors’, insurance companies and pension funds (which may also be drawn into Solvency II in future), are the great hope.

It is possible, said Heaton that big insurance companies able to agree their own internal models with local regulators will be able to continue to invest efficiently in structured bonds. But smaller insurance companies may not.

Caroline Philips, head of structured debt products at Eurohypo, asked delegates: “Isn’t a new investor base the biggest challenge? When we were selling AAA CMBS in the boom years, 90% was to the SIVs. If we had demand from investors, the CMBS market would come back because banks want to do it and they will have a go if they think there is a viable chance. But at the moment they don’t have confidence that there are real money investors out there”.

Philips said keeping new structures “simple” to try to attract investors was not a problem for banks or for borrowers. “It’s how the market started. It was only later when people got comfortable that it got more complex. You need to keep it simple”. She believed borrowers could look favourably again on CMBS, even though David Newby, head of European CMBS and UK finance at Natixis recalled that trying to persuade borrowers to use securitisation on a single deal basis was difficult in the past even when it was the cheapest option. “You were always told it was inflexible.. you had to approach the rating agencies about any changes to structures…”

Philips replied: “On the whole structuring and inflexibility point, our experience is that where a loan is performing, our borrowers have been very relaxed about it being securitised. We always made a CMBS look as much like a syndicated loan as possible and we always did the servicing so the sponsor always had us to deal with. Yes, the reporting was more onerous and more public…and obviously where a loan has defaulted it is more difficult, but even there you are dealing with investors who are now very happy to get involved in the restucturing and you only need 75% assent instead of the 100% needed in a syndicated loan”.

Newby questioned whether banks were in a position to warehouse loans on their balance sheets to test a capital markets sale, and observed that Deutsche Bank’s experience a year ago, when Chiswick Park was securitised, was tough: “I believe they road-showed it in both Europe and the US for a seemingly long time and maybe three investors bought the deal. It is difficult to call that a successful distribution”.

Chiswick Park was one of only two new European securitisations since the market closed, both by Deutsche Bank last year. The bank has been working on another, to refinance a German multi-family portfolio, but that would be an agency issue by the borrowers, Blackstone, Round Hill Capital, Aviva and Deutsche Bank itself.

Philips said that Eurohypo, which has been out of the new lending market since last November but is rumoured to be talking to borrowers again, was not going to underwrite on the basis solely of a securitisation exit, “but where one could syndicate in the whole loan market as a back stop.”

“We would love to find a loan that we felt was right and if we think we have a fighting chance to get it away in the securitisation market we will have a go”.

On a positive note, Philips predicted that the trend for banks to work more closely alongside insurance companies and other new entrants to property lending on balance sheet loans was “the first stepping stone back to a CMBS market”.  While Mark Nichol, research director at Bank of America Merrill Lynch said the emerging senior debt funds seemed like “good candidates” to buy CMBS as would mortgage REITs – if legislation is passed.

Commenting on the effects of Solvency II on debt investing, Colin Fleury, head of secured credit at Henderson Global Investors, was at pains to point out that Henderson “is not pitching debt as an asset class on the basis it works under Solvency II but because of the risk-adjusted returns and because it is a good opportunity given everything that is going on  with the banks”.

Equally, while sources say real money investors are increasingly interested in senior and whole loan investing, they are not all pulling out of ABS investing, at least in the secondary market. M&G Investments’ alternative credit fixed income team are rumoured to have two new pension fund investors lined up to come into its recently re-opened flagship £500m Lion Credit Opportunity Fund, which is 50% invested in secondary CMBS.

See June’s issue of Real Estate Capital, due to be published on June 25th, for a 10-page special on the structural changes in real estate lending.

Jane Roberts, editor