Mortgage-backed securities make a comeback
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It’s a long way from the pre-crisis boom, but investors are showing interest once more in securities that package bundles of commercial real estate loans.
The market for such debt in Europe has been at a virtual standstill since 2008, but a recent rally has made pricing more attractive for issuers.
In the past few weeks two new European commercial mortgage-backed securities transactions deals have hit the market.
The first, the €754m Florentia CMBS arranged by Deutsche Bank is backed by “German multifamily” housing, a large portfolio of residential property that is rented out by commercial landlords. The second deal securitises a loan used to refinance Royal Bank of Scotland’s sale of non-
performing real estate to a vehicle, owned by RBS and Blackstone. The properties in the deal include UK retail and mixed-use commercial properties.
The transactions are significant not just because valuations on commercial real estate have dropped over the past few years, leaving a swath of loans behind the bonds arranged in the boom of 2004-2006 in default and many transactions facing restructuring, but because until last month there had been only two new CMBS issues in Europe since 2008.
Investors have been reluctant to return to the European CMBS market, although there has been a steady flow of residential mortgage-backed securities deals. CMBS in the US has also seen a significant pickup of issuance.
Mark Nichol, analyst at Bank of America Merrill Lynch, says that on Florentia the deal could have been done more cheaply in the bank market but the recent market rally means that pricing on CMBS deals has come in to such an extent that it looks attractive.
At the start of the year spreads on triple-A rated bonds in the secondary market were hovering at about 600 basis points, he says; now they are nearer 300bp. Florentia priced close to last year’s Deco/Chiswick Park deal.
“At least there is an argument that these deals make sense now,” Mr Nichol
says. But what is telling, is who bought the Florentia deal.
JPMorgan took 75 per cent of the CMBS, with investors such as M&G, Ignis, Cheyne and ING buying the remainder.
The US bank had been one of the most active players in the property-backed debt market during and after the boom, buying assets via its chief investment office, which suffered a more than $5.8bn loss this year.
However, the scale of the bank’s involvement has diminished in the past two years as other buyers have returned.
“I think what Florentia tells you, is that it helps to have a large core investor,” says Mr Nichol.
But he says that, at a time when government bonds are paying investors such low returns, securitisation is looking more attractive for some bank treasury teams.
What is likely to hinder a flurry of deals, however, is a shortage of buyers. Bankers say that a pool of 100 or so investors present in the boom years of European CMBS has shrunk to little more than 20.
Some hedge funds and asset managers that bought into CMBS in the boom years, which have now gone sour, face potential losses and lengthy restructuring talks.
Other investors still see opportunities. Bhavesh Patel, head of distribution and underwriting for commercial real estate at Deutsche Bank, says that a lot of the buyers for CMBS before 2007 were conduits of banks and structured investment vehicles. He says that while many of those investors have disappeared, the market is creating a new class of investor that is helping the market to revive.
There is demand for straightforward deals, perhaps backed by one high quality property or one loan, he says. German multifamily is proving particularly attractive.
Lee Galloway of Pimco views the European market in three categories: “At the top, a portion that is good quality and will repay all day long; at the bottom, a portion that is poorer quality, often ‘dogs’ that you don’t want, and a portion in the middle.
“This is the interesting element with future performance dependent on a variety of factors including investment appetite, availability of finance, and the ability to attract and retain tenants in the underlying properties.”
He says that there has been a noticeable increase in interest in CMBS in the wake of the recent deals and compression in CMBS spreads, but he is cautious. “We are more likely to see German multifamily deals and simpler transactions. But do I think there will be deals with 10 different loans and 40 properties in the immediate future? No I don’t.”
Mark Hale, chief investment officer of Prytania Investment Advisors, agrees, saying that falling valuations on many properties and the recent downgrades on existing transactions remind investors that significant problems still exist.
He said: “We are a long way from getting back to the conditions seen before the crisis or even the robustness of the market in the US,” which has performed better than the European CMBS market.
But he says that more investors are looking at European CMBS even if they are not bullish on the fundamentals overall.
“CMBS has piggybacked on the recent market rally and there have been some positive developments in property sales and refinancings . . . This does not mean a broadly-based revival for secondary properties or over-leveraged deals. This will remain a bifurcated market.”
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