Managing Your Money 

Will CMBS always be property's four-letter word?

One of the financial instruments of mass destruction, commercial mortgage-backed securities (CMBS for short) were at the toxic heart of the credit crunch, providing a fast route to cheap debt. In the noughties, hundreds of billions of pounds of bonds were issued, secured on property assets which later turned out to be of dubious quality. Even in cases where the assets were sound, high levels of gearing and a collapse in property values triggered mass defaults. But now, there are hopes that the real estate securitisation markets could creak back into life.

"Securitisation got us into this mess, but there's a chance it could get us out of it," says Dominic Reilly, managing partner at King Sturge Finance. "Considering the over-borrowed commercial property market in the UK, the relaunch of a more regulated CMBS market might come to our rescue."

In the UK, the CMBS market went from nothing in 2000 to £50bn of UK real estate debt in 2009. The peak of the CMBS market occurred in 2006, when £18bn of debt was issued, more than 20 per cent of new lending activity in that year. Taking the whole of Europe into account, there are nearly €100bn of CMBS loans due for repayment in the next four years, with over €15bn to refinance in 2011.

Refinancing these loans is certainly a sizeable problem. But could issuing more CMBS debt really offer a solution, or simply store up problems for the future? Given the weight of refinancings in the pipeline, a comeback could be on the cards. In the words of Financial Times property correspondent Dan Thomas: "New debt needs to be found to replace the old debt".

"For this to happen, the key question is what have you got to change to make securitisation acceptable?" says Mr Reilly. "There is good evidence that investors are interested in bonds backed by good quality real estate."

He points to Tesco, which has pulled off four separate CMBS transactions totalling £2bn in the last two years, securitising the income stream from its portfolio of commercial property. In the summer of 2010, Tesco raised £950m from issuing bonds against 41 separate UK supermarkets, the single biggest single UK CMBS issue since the onset of credit crunch.

Another transaction to note is the £360m "Sceptre 1" CMBS struck by Britian's biggest property company Land Securities in 2009 on property leased to a government tenants. This deal succeeded because of its simplicity - one tranche of notes, fixed interest and freehold property assets - which resulted in a coveted AAA rating from Fitch.

These deals proved CMBS was possible, providing the financial covenant was credible. However, both were structured more like low-risk corporate bonds, bearing scant similarity to the slicing and dicing of debt at the top of the market.

However, investors have a growing interest in moving up the CMBS risk curve. Deutsche Bank is set to go to the market with a property-backed debt product aimed at institutional investors prepared to take a long-term view. The loans to be securitised could be drawn from those it has already underwitten, or even consist of new loans - leading to hopes of increased liquidity in the property lending sector next year.

Early reports suggest these products will have a five to seven year maturity, which is longer than many CMBS transactions of yesteryear. A further advantage for the banks that issue CMBS is the potential to minimise the impact of incoming Solvency II regulations. It is more capital efficient for institutions to hold property loan-backed bonds than physical property assets. Plus, it makes sense for pension funds and insurance companies to match their needs with long-term income from property.

In the meantime, the successful renegotiation of complex CMBS refinancing deals should be seen as a good sign. Bondholders are slowly realising that restructuring is preferable to the value destruction that would result from a fire sale of assets.

The problem with CMBS is its torturous complexity - typically there will be several classes of bonds, with different voting rights, held by different classes of investor often based in different countries, investing in different currencies.

Voting to extend the maturity of notes and underlying loans is a common solution (as seen on the successful extension of Fleet Street 2, a securitisation of German retail properties, last year). Last summer, similar restructuring deals were struck with bondholders of the Tahiti securitisation - a £1bn refinancing of debt secured on a hotels portfolio - and the property portfolio of care homes provider Four Seasons. In all cases, the payback for investors agreeing to extensions is increases in interest payments.

Another positive is that CMBS markets are functioning again in the US, with more than $3.2bn (£2bn) of issuances in 2010. This is tiny in comparison to what UBS estimates for European CMBS refinancings, with an estimated $700bn CMBS securities set to mature before 2017. But it's a start.

The situation in America is further advanced. In November, the second biggest shopping mall owner in the US, General Growth Properties, finally emerged from debt restructuring negotiations. Unmanageable debts had caused its shares to slump from a high of $70-a-share to less than fifty cents, but the recapitalised company now boasts a share price of nearly $18.

To attract investors, other changes must also be made. Greater disclosure would inject credibility into the CMBS model. Lower leverage of say, 65 per cent loan-to-value, would provide an equity cushion if markets fall further. But to remove the risks completely is impossible. Property banker and head of EuroHypo's UK division Max Sinclair cautions that CMBS is an illiquid investment, and there is very little secondary trading.

Nevertheless, the resurgence of CMBS has a strong read across for the UK listed property sector, as raising debt this way is likely to be cheaper than issuing corporate bonds. And investors may yet be tempted to buy property-backed notes from he UK government, which experts believe could extract value from its £370bn property portfolio in this way.

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