Demand for debt is up but while there is some very focused interest the traditional CMBS market will remain subdued for the next couple of years, as Lynn Strongin Dodds reports

T he recent €350m Vesteda deal, which was Europe's first of the year, may have provided a few glimmers of hope for the moribund commercial mortgage backed securities (CMBS) market but no one is breaking out the champagne. The road to recovery will certainly not be smooth and the transactions that emerge are likely to be simpler structures that bear no resemblance to the multi-layered, complex transactions seen in the glory days of 2005, 2006 and 2007.

According to a recent report by Moody's, the market for new CMBS issues had almost evaporated in the wake of the credit crisis and deals were thin on the ground last year, albeit an improvement over 2008. Its figures show that volumes in the Europe, Middle East and Africa (EMEA) CMBS and multi-family market reached €16.2bn in 2009, well above the €6.3bn attained in 2008, but tiny compared with the €69.1bn raised at the peak of the market four years ago. The bulk of the issuance - €13.9bn in 11 transactions - occurred during the first half of 2009, with notable transactions including sale and leaseback deals from Tesco Property Finance and Land Securities.

Overall, the ratings agency found that investors had little appetite for traditional primary EMEA CMBS, instead preferring high-quality assets with long-dated notes, single-layered and at low loan-to-value rates. Property investment fund Vesteda, which owns 27,000 residential properties across the Netherlands, fits this bill. The notes were rated triple-A by Fitch, Standard & Poor's and Moody's and underwritten by ABN Amro, but the most significant feature was that they were sold to a single investor via a private placement, rather than in a public issue. In addition, the issue was classified as a hybrid deal because the pool, which consisted of a portfolio of rented multi-occupant apartment blocks and houses in the Netherlands, was a residential deal sold through a CMBS structure.

Simon Dunne, a director at Savills, notes: "If you compare and contrast where the market was in 2006 and early 2007, the players were investment banks originating loans on their balance sheets and securitising them. They were complex multiple tranche structures but I think those days are gone for the foreseeable future. The Vesteda deal demonstrates that there is demand out there for debt but only for single tranche, simple and low-leverage deals with quality sponsors."

Claus-Jürgen Cohausz, member of the managing board at Westdeutsche ImmobilienBank, also believes it will take time for the market to recover. "The CMBS market is still not yet alive. The deals that we are seeing today, such as Vesteda, are not typical of past transactions in that it was a low leveraged private placement sold to a single investor. Although I think that future deals will have junior and senior classes, they will be much more conservative, have low leverage and simpler structures than during 2006 and 2007."

Other deals expected to gain momentum are CMBS restructurings, such as the recent deal by Karstadt Kompakt, which was not only the largest but the first of its kind in Europe. The insolvent German retailer struck a deal with its consortium of 50 creditors to extend the maturity of its €3.5bn of debt, including €1.13bn of CMBS notes, by three years and to relax the loan-to value-covenants on the financing. In exchange, bondholders will receive an additional 52 basis points of margin of interest paid.

There is a view that the Karstadt CMBS could act as a precedent for other transactions exposed to refinance risk. Industry estimates show that €65bn out of a total €95bn of European CMBS is coming to maturity between 2010 and 2014. Restructuring has proved challenging, with one of the main sticking points being getting creditors to agree on the terms. They are on different pecking orders in terms of seniority debt and not surprisingly have different interests. While some investors are willing to extend bonds to avoid fire sales that would leave them with losses, more senior ranking investors who would not incur losses have been less willing to compromise.

Some participants such as Cohausz believe that the Karstadt deal did not amount to a true restructuring. "It was an extension of maturity and that will not solve the problems. Over the next couple of years we will see a huge amount of CMBS reaching their expiration and it will definitely be a challenge in how to refinance these deals."

Barry Osilaja, head of debt and structured finance at Jones Lang LaSalle Corporate Finance, also believes "the covered bonds market, similar to the German Pfandbriefe, could evolve alongside the CMBS market as a tool for refinancing. There are several regulatory issues concerning CMBS and conflicts of interest in the banks and one key advantage of covered bonds is that they are a plain vanilla product where the pool of loans the bonds support remains on the books."

Against this cautious environment, Moody's forecasts EMEA CMBS issuance of between €15bn and €20bn in 2010. It argues that while progress is being made certain prerequisites need to be met in order to truly jumpstart the CMBS market. These include the continuing stability of the debt capital markets once central banks and governments progressively withdraw their support and fiscal stimuli as well as a sustainable recovery of the commercial real estate market. There also needs to be a broad return of commercial real estate lending and a broader acceptance towards refinancing of outstanding loans.

Christian Aufsatz, senior vice-president of Moody's is "cautiously optimistic about the market's prospects because in a couple of years, many CMBS loans and bank loans will need to be refinanced. Banks cannot share the burden alone and a capital markets solution needs to be found. This year, though, we expect publicly placed issuance to be sporadic, with deals being either tap issuances of well-performing CMBS or deals similar to Tesco's sale and leaseback transactions."