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Investors in UK commercial mortgage-backed securities (CMBS) are used to disappointments. Since the collapse in issuance following the financial crisis, there have been several false dawns where volumes appeared to be rebounding, albeit linked to specific deals and mostly in London.
Recent economic growth and rising commercial property prices, particularly in the regions, point to a broader revival in the UK CMBS market. “It has been subdued for many years, but a rebirth is coming through,” says Damian Thompson, head of asset-backed finance at RBS, the bank.
“Investor sentiment [towards CMBS] has turned. There’s huge unfulfilled demand.”
CMBSs package bundles of commercial mortgage revenues to sell to fixed-income investors.
The sharp decline in the value of CMBSs and residential mortgage-backed securities – which fared even worse during the crisis years – contributed to the 2008 collapse of Lehman Brothers, the US bank, that held billions of dollars of the assets on its books.
UK CMBS issuance slumped to virtually zero in 2009-10.
As the government has sought to encourage bank-led mortgage lending in order to stimulate wider economic growth, volumes have begun to creep up. In 2012, there were two deals, worth a total of $784m, according to data provider Dealogic, up from a single deal worth $492m the year before. Last year saw three CMBS deals, worth $1.4bn collectively.
Saul Greenberg, co-founder of SCIO Capital, a CMBS investor, says: “We have seen continuing improvements in lending and refinancing as a result of strong capital liquidity, increased tenant demand and sentiment improvement.
“As a result, the UK CMBS market is performing markedly better than its European peers.”
One catalyst has been the improved economy, which has led to increased demand for mortgage loans.
The news late last year that the Bank of England was ending its Funding for Lending Scheme, launched in 2012 to extend cheap finance to banks, has also played a role. The end of Funding for Lending will, analysts believe, lead banks to again use securitisation as a tool for funding – bundling CMBSs for sale in order to free money for more loans and diversify their risks.
“More banks will come back to securitisation as a funding tool this year,” says Andrew South, senior director at Standard & Poor's, the credit rating agency. “Some of the banks may become more active in terms of mortgage origination. There will be more loans.”
Another driver has been greater demand for the product itself. Record low interest rates in the UK have made higher-yielding CMBSs attractive to a range of investors – from insurance companies to hedge funds and asset managers – even if the stigma of securitisation has not been erased fully.
Euan Gatfield, head of European CMBS research at Fitch, the credit rating agency, says: “The restoration of liquidity is a game changer for the market. It gives investors the ability to exit risk and pass it on to other market participants.”
A sign of the turnround in CMBSs came last year with the £263m issue from Toys R Us, the privately owned retailer. The stores in suburban locations that backed the issue were exactly the types of properties that had fallen sharply in value since the pre-crisis heyday, an indication of how investors’ attitudes have changed. “Suddenly, there is renewed interest in what was previously off limits,” Mr Gatfield says.
While the improvement in sentiment towards UK CMBSs has not been matched in continental Europe, continental issuance still more than doubled last year to $6.4bn, primarily driven by Germany. But this is small compared with the US, the world’s largest CMBS market by far, which had over $102bn in issuance.
Despite recent improvements, worries remain. The loans supporting CMBS bonds that were arranged in the boom years are failing to repay at maturity. S&P says CMBS defaults more than doubled in the first half of last year – a trend that has continued.
Nearly 80 per cent of the 31 commercial mortgage-backed securities in the EU, representing a total €2.3bn in loans, due to mature in the final quarter of 2013 defaulted, partly because of high loan-to-value ratios, according to Moody’s, the rating agency.
One senior London-based securitisation banker admits there was “too much leverage” in the pre-crisis years. “We have moved to a world where values have stabilised,” he says.
Nevertheless, the 80 per cent figure represents the highest quarterly default rate for two years, with half the defaulted loans tied to UK commercial mortgage assets.
“Investor concern remains in some areas of the UK, and especially locations replete with weak secondary and tertiary collateral,” warns Mr Greenberg at SCIO Capital.
Recent growth in the UK should also be put in perspective: $32.9bn of CMBSs were issued at the top of the market in 2006. Many of the new CMBS deals are refinancings as borrowers seek to roll over loans and take advantage of ultra-low interest rates, rather than a reflection of robust loan origination.
As the sector’s long convalescence continues, that is bound to change, not least due to continued low interest rates, says Mr Gatfield at Fitch.
“The search for yield among investors is helping the market recover,” he says. “We are starting to see a re-emergence of primary issuance.”