CREFW-Summer2015

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CRE Finance World Summer 2015
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ith approximately US $3.7 billion issued in 2014, the
European market is a whopping US $78 billion short
of its 2006 peak. With predictions of between US $5
billion and US $9 billion for Europe in 2015, now is an
opportune time to take stock of the European CMBS
market and consider what is inhibiting its growth and what is likely
to drive it forward.
Following the onset of the global financial crisis (GFC) in the
summer of 2007, true primary issuance of CMBS remained dormant
until Deutsche Bank brought to market Deco 2011-CSPK in June
2011 (Chiswick Park). Although the deal flow since has demonstrated
that CMBS 2.0 is a useful and valuable funding tool for European
commercial real estate (CRE), the volume of issuance over the
past few years remains disappointing. In one sense, given the
turbulent and fragile European economy that has presided over
this period, it is not a surprise that CMBS (a product that was
badly tarnished by the GFC) has failed to balloon. However given
that CMBS, like any other capital markets instrument, is a product
driven by market demand, a closer look at the drivers of originators,
investors and borrowers alike will inevitably shed some light on the
reasons behind the subdued level of issuance.
Originators
For originators whose business model was to originate to distribute
(primarily through CMBS), the decimation of the CMBS market
at the onset of the GFC proved catastrophic. Unfortunately these
players were left in the un-enviable position of having a significant
CRE exposure on their balance sheet which they were incapable of
off-loading due to tumultuous market conditions. Understandably,
having been burnt by the originate to distribute model, a large
number of once active players in the CMBS market either closed
their CRE lending businesses or simply confined lending activities
to core clients of the bank with the sole intention of holding such
loans on their balance sheet. Given the significant shortage of
originators with a CMBS exit in mind, it is therefore unsurprising that
this has manifested itself in subdued levels of primary issuance.
With improving market fundamentals, an increasing number of
market players that were formerly active in this area are announcing
their intention to return to this space, which would clearly add a
much welcomed boost to the level of primary issuance. Although the
return by such players has been slow, they can be forgiven for being
reticent, given that the following has made CMBS a lot more unwieldy:
• With Article 405 of the Capital Requirements Regulation requiring
originators to retain a 5 percent net economic interest in CMBS,
and given the regulatory capital requirements that apply with
respect to retaining such an interest, there is now a new and
significant cost to banks participating in the new vintage of
CMBS deals.
• Given the cost of providing a liquidity facility, fewer third party
banks are prepared to provide these. Therefore CMBS arrangers
are invariably having to make internal arrangements for such a
facility, creating another drag on the profitability of CMBS 2.0.
• There continues to be widespread regulatory uncertainty on both
the capital treatment for holding CRE loans prior to a CMBS exit
and for investing in CMBS notes.
• Given the increased breadth of CRE lenders in Europe, originators
are increasingly facing stiffer competition on the sourcing of
suitable CRE loans that are essential for an originator to execute
a successful CMBS deal.
As demonstrated by those originators that are currently active in
the CMBS 2.0 market, none of these factors can be considered
insurmountable, but nevertheless they certainly make it harder
and more of a challenge for banks to enter the market than was
the case prior to the GFC. Although originators will continue to
commit to this market, they are only likely to do so at a considered
pace, the corollary of which is that the market is unlikely to witness
a sudden surge of new entrants and therefore a surge in primary
CMBS issuance.
Investors
One of the major impacts of the GFC on CMBS is the profound
affect it has had on CMBS investors. Prior to the GFC, major
investors (on behalf of banks) were the so-called SIVs (structured
investment vehicles), however with a sudden rise of short term
interest rates, the vulnerabilities of these vehicles were quickly
exposed and with this came the vapourisation of an entire investor
class. Similarly, insurance companies, who were another major investor
in CMBS, have become stifled by the stringent requirements of
Solvency II, which has effectively prevented them from investing
in CMBS. However, despite these notable changes to the investor
base, no CMBS 2.0 has so far failed due to a lack of appetite for
the product and thus the diminutive volume of CMBS 2.0 cannot
be attributed to lack of investor demand.
W
Iain Balkwill
Partner
Reed Smith