About three years ago, Guy Leech explored tapping funds from a commercial mortgage-backed securities (CMBS) lender to finance some properties. Problem was, he found the pricing not keen enough to overcome the legal and due-diligence hassles of a CMBS deal. So he went with a bank. [??] Hmm. Sounds more like 10 years ago--when CMBS was more rudimentary, had less competitive pricing and lacked uniform documentation. Why couldn't he find a decent CMBS loan? Because he was checking out CMBS money in Dublin, Ireland--not Dublin, Ohio. [??] Leech, the group finance director for Treasury Holdings Group, a commercial property fund manager in Dublin, points out, "Particular Irish laws like examinership--which is a Chapter 11-type of receivership--and a peculiar aspect of the tax law regarding capital gains, had to be resolved. And with the arbitrage in spreads between banks and CMBS at that time, it was not worth it to go the CMBS route." [??] In Ireland, tax liability ranks ahead of a lender's security position. An interesting arrangement also can emerge in an examinership after a default. [??] "It is possible for an examiner to give precedence to unsecured debtors over senior secured debt," Leech says. [??] "The credit underwriting standards of [New York-based] Standard & Poor's and Fitch [Ratings] are quite high. This presented complications, which have to be worked out legally in the securitization process," he adds. [??] As CMBS financing was getting off the ground in the early 1990s in the United States as a liquidity option amid a credit crunch, it was being discussed in Europe--but its evolution as a cost-effective way to finance a commercial mortgage would be a decade away.
"The only CMBS deals done in the early days were those [that] banks didn't want to do," says Neil Lawson-May, head of investment banking for German commercial real estate bank Eurohypo AG in London. "CMBS was a niche product, good for nursing homes and pubs. Europe didn't have a savings-and-loan crisis to speed its market development as in the states."
Lawson-May adds, "Anyway, borrowers preferred talking to banks, which had plenty of capital and were lending at low margins. CMBS was not a cheaper alternative."
Then the market in Europe changed dramatically in 2004. CMBS spreads halved, from 50 basis points to 19 to 25 basis points for triple-A bonds and pretty much across the board to triple-B bonds, where they remain today. (Spreads over London interbank offered rate [LIBOR] in sterling-denominated deals and over euro interbank offered rate [EURIBOR] in euro currency deals.)
"CMBS could compete with the commercial banks on price," Lawson-May says. "But banks responded. Now in Europe you cannot arbitrage balance-sheet lending and CMBS anymore, because big banks offer both."
Caroline Philips, managing director and head of securitization for Eurohypo in London, says, "The daylight in the spreads between normal syndicated loans and CMBS started producing lots of refinancings. We started looking at our syndicated loans at Eurohypo as the spread environment changed. If clients had loans that could be securitized, we wanted to do it."
And just like that, working out the earlier underwriting complications became a tad less unbearable to Treasury Holdings.
In 2005, depending on the transaction, many CMBS lenders held a pricing advantage over balance-sheet lenders. Treasury Holdings wanted to refinance a portfolio of 16 properties in Dublin, including office complexes, shopping centers and one office building under construction.
"We had a good mix of properties for securitization, all with diversified long leases," Leech says. "The covenants for CMBS loans had become slightly less onerous in the past two years, with better debt-service coverage and LTVs [loan-to-value ratios.]" Treasury Holdings was about to embark on the first European CMBS deal backed solely by Irish assets.
"We talked to the major CMBS issuers and conduits in London, and chose Eurohypo," he says, "and did an agency deal with Eurohypo as our lender and issuer, while Morgan Stanley underwrote the bonds. That was my preference, to have the bank entirely on our side and not acting as the underwriter sitting on the other side of the table."
The loan process, which began in May 2005, culminated in the February closing of the EUR375 million (U.S. $470 million) Opera Finance (CMH) deal. Opera Finance is the brand name for Eurohypo's conduit platform.
"We repaid just under EUR350 million [U.S. $440 million] in bank debt," Leech says, "and our net cash-out, including the EUR50 million [U.S. $63 million] B note, was about EUR70 million [U.S. $88 million.] I reckon we saved about EUR3 million [U.S. $3.8 million] in interest and financing costs a year, which runs to EUR21 million [U.S. $26.5 million] in savings over the seven-year term of the loan. And the loan is 10 [interest-only] at 75 percent LTV. Banks wouldn't do that. Most look for amortization at a 75 LTV."
B notes in European CMBS transactions typically are carved out of the loan and traded separately from the bond tranches, according to Clive Bull, director, European commercial real estate group, in the London office of Frankfurt, Germany-based Deutsche Bank AG. "The credit risk is sold out with the B notes, rather than through subinvestment-grade bonds as part of the CMBS structure as in the states," says Bull.
Philips points out, "Actually, the basis of the securitization in this transaction was very simple. We aggregated the Treasury Holdings' loans into one single loan at better margins and then placed that straight into securitization. The Opera Finance SPV [special-purpose vehicle] was the lender. Eurohypo acted as the agent on behalf of the lender. The servicing requirements were the same as in all our securitizations."
Eurohypo, as do most all securitizers in Europe, uses separate SPVs domiciled in tax-favored domains--such as the Channel Island of Jersey and the Isle of Man--to issue the CMBS paper.
"About the only difference in this transaction was getting the rating agencies comfortable with the legal and tax complexities in Ireland," Philips says. "CMBS in Ireland should not be beyond the wits of man."
"Origination to securitization is a new concept in Europe, which really took off in 2005," says Rob Leach, director and transaction manager for Capmark Finance Inc., Horsham, Pennsylvania (formerly GMAC Commercial Mortgage Corporation) in London. "A lot of the CMBS deals still tend to be one-borrower, one-off transactions, like Canary Wharf and Land Securities, but issuers keep coming back to market with others." There is no shortage of commercial properties available for such deals as more corporations--significant owners of real estate in Europe--re-deploy real estate assets in sale/lease-back transactions.
Fifty-four percent of the CMBS transactions in Europe last year were single-borrower, according to Barclays Capital research. But multi-borrower deals are gaining traction, up from 22 percent of deals in 2004 to 42 percent in 2005. Both Bull and Leach point out that more CMBS lenders are mixing in smaller balance mortgages into their multi-borrower securitizations. "We have developed a smaller loan program in the U.K. [United Kingdom]," Bull says.
Bull notes, "Americans have got to be very careful...