Commercial Mortgage-Backed Securitisation (CMBS) - Clive Bull, CMSA

Clive Bull, former chairman of the board of governors, CMSA Europe (Commercial Mortgage Securities Association) and director, European commercial real estate, Deutsche Bank AG explains why Commercial Mortgage-Backed Securitization has taken corporate Europe by storm.

Companies that own the properties they occupy and wish to finance these on a secured basis can do so without using up valuable capacity in the bank market by issuing Commercial Mortgage-Backed Securities (CMBS), or borrowing from a lender who will refinance through the CMBS market. Provided the properties are 'liquid' in terms of the ease both of finding replacement tenants and selling the properties then unrated or lower rated companies can do this as easily as investment grade companies.

THE CMBS MARKET COMES OF AGE

The major development in the European asset-backed securities market in 2005 has been the explosive growth of CMBS. For several years securitization of commercial mortgage loans has been the dominant way in which US commercial mortgage lenders have funded loans secured by commercial properties. Although CMBS have been used by lenders in Europe, the volume of issuance has been low. In 2005 that has changed and issuance rose dramatically to approximately €40 billion with every expectation that it will continue to grow rapidly in 2006.

FINANCING CORPORATE REAL ESTATE

The implications of this growth in the CMBS market for European companies depend critically on their property holdings and how they are financed. While the growth of the CMBS market makes commercial mortgage terms more attractive in general, for some companies its impact is much more direct. European companies own a significant fraction of the properties that they occupy. There is a growing sense among companies that owning so much real estate may not be a good use of capital and that even where it does make sense, for instance because the properties are strategic, funding these properties through the corporate balance sheet may not be the optimal financing strategy.

BANK MARKET CAPACITY: THE CMBS ALTERNATIVE

If a company decides to own the properties that it occupies, then what is the best way to fund them? Basically the choices are unsecured corporate debt from the bank or capital markets or secured, commercial mortgage debt. There is no one right or wrong choice and each company must decide based on the specifics of its case. One consideration that comes into play is capacity in the bank market. The fear is that commercial mortgage debt raised in the bank market will simply compete with the company’s unsecured bank debt and use up valuable capacity in the bank market. In this context, commercial mortgage loans that will be refinanced in the capital markets through the issuance of CMBS are attractive because they tap a very different investor base.

YOU DON’T NEED TO BE INVESTMENT GRADE TO USE CMBS

Many companies that have considered raising debt against their real estate by using CMBS have been put off by the belief that only an investment grade company can borrow at investment grade spreads. If this were true it would be a particular problem because it is precisely companies that are not investment grade and so have higher unsecured funding costs that benefit most from raising mortgage debt. Fortunately, this belief is wrong. If the properties can be readily relet or sold if the company were to go bankrupt then significant amounts of commercial mortgage debt can be raised and refinanced at investment grade pricing through the CMBS market.

EXAMPLES

An example of this is an upcoming UK CMBS transaction in which the recent buyers of Toys 'R' Us, a global toys and baby goods retailer, are directly financing the real estate owned by the UK subsidiary through a £350 million investment grade CMBS. On a smaller scale the buyers of Karstadt Kompakt, a German retailer, have done the same thing indirectly by borrowing from Deutsche Bank on a mortgage basis. Deutsche Bank in turn is refinancing itself through a CMBS issuance backed by a pool of loans including the Karstadt Kompakt loan.