CREFW-Fall2015

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CRE Finance World Autumn 2015
14
Europe
I ssuers in Europe are increasingly turning to unrated CMBS.
Since August 2012, 10 unrated deals totalling approximately
€ 2.2 billion ($2.45 billion) have been completed, making it a
new asset class.
Why the shift toward unrated bonds, especially since unrated
CMBS prices more expensively? Despite the disadvantages,
issuing CMBS on an unrated basis can save considerable costs for
arrangers particularly in relation to hedging and liquidity facilities.
Some regulated investors may, for the time being, receive more
favourable regulatory capital treatment for investments in certain
types of unrated CMBS.
It’s not entirely clear how the European CMBS market will shake
out on the question. The markets are continuing to explore the
potential of unrated CMBS. These transactions may, for example,
lead to the development of the first true private placement market
for CMBS in Europe. However the market develops, it seems that
this new type of CMBS will have a role and will continue
in some volumes in Europe.
Rationale for Issuing Unrated
There is no single reason why these unrated transactions were
issued. However, some general themes appear to be common to
many of the issuances which may provide guidance as to when
and where unrated CMBS will be issued in the future:
• Transactions, such as DECO 2013-CSPK, involved smaller
property portfolios than typical CMBS transactions;
• Smaller transactions which do not require wide marketing
(e.g. Mint Mezzanine1 and Midas2) and can be privately placed;
• Transactions that could have been syndicated as loans, but
investors preferred bonds (e.g., Mint Mezzanine, Midas, Zephyrus
and Reni). These are simple “pass-throughs” of the underlying
loans without any structural or credit enhancements and were
arranged for particular investors seeking exposure to the
underlying loans through fixed income instruments, such
as CMBS bonds. 3
• One transaction (Utrecht) was arranged to permit existing investors
to retain an interest in a refinancing. Investors did not appear to
require ratings. This was unusual but may be more common as
legacy CMBS winds down in the coming years with small but
troubled asset pools.
Advantages of Issuing Unrated
The overriding reason to issue unrated CMBS is cost. Rating agencies
will charge an upfront fee and an annual surveillance fee to rate a
transaction. Complying with rating criteria on an on-going basis will
also involve costs. Finally, new regulation imposes further costs on
rated securitisations.
1. Significantly fewer institutions now retain the high credit ratings
needed for liquidity facilities, hedging and bank accounts for AAA/
Aaa rated securitisations. Those institutions that do not have such
credit ratings face a significantly more onerous regulatory burden
when they provide such arrangements through measures such as
the European Market Infrastructure Regulations (“EMIR”)4 and
the imposition of significantly higher regulatory capital costs for
providing liquidity facilities under Basle III5. This has caused some
institutions to withdraw from the market entirely and the remainder
to pass on their increased costs to the securitisations.
uidity facilities for AAA/Aaa rated CMBS
Pre-Credit Crunch6 Post-Credit Crunch7
Commitment Fee 0.20%–0.25% 1.0%
Drawn Margin 0.35%–0.50% 2.0%–2.5%
As such, undrawn, post-credit crunch liquidity facilities are
between 4-5 times as expensive as undrawn, pre-credit crunch
facilities and more than twice as expensive when drawn.
Ratings criteria for AAA/Aaa CMBS require key transaction
parties to agree to specific provisions in relation to their credit
ratings. For example, hedge counterparties must provide collateral
on their downgrades below specified levels. Therefore, hedging
that is not rating compliant is generally less costly than hedging
for rated CMBS.
Similar issues exist for liquidity facilities. Some unrated transactions
have been issued without liquidity facilities, using expense reserves to
cover unpaid costs arising through non-payment on the underlying
CRE loans. The lack of liquidity facilities adds significant stress to
the rating for any CMBS other than for transactions secured by
very granular pools of properties. Significant costs can be saved
on a CMBS if no liquidity facility is required.
2. Unrated CMBS transactions may (depending on their structures)
be exempt from particular regulations and hence save compliance
costs. Other forms of unrated CMBS may offer regulatory
advantages to particular types of investors.
Conor Downey
Partner
Paul Hastings, LLP
Charles Roberts
Partner
Paul Hastings, LLP