European Union: The Renaissance Of European Multi-Loan CMBS

The European CMBS 2.0 market was launched in June 2011 and in the years that have since followed, twenty four public rated deals have so far hit the market. Given that only seven of these deals have featured multiple loans and the smallest loan securitised prior to November 2015 had a balance of €55 million, the European market appears to be largely confined to the securitisation of large balance sheet loans. This is a stark contrast to the position immediately prior to the global financial crisis (GFC) when CMBS deals featuring eight or more loans were in plentiful supply. Indeed this "heyday" of European CMBS can be exemplified by one primary issuance that took place in March 2007 that was comprised of thirty two loans secured by commercial real estate (CRE) located in five different jurisdictions. Now that we are more than four years into this new era, many market observers are beginning to question whether the European market will once again reach the dizzy heights of CMBS 1.0 or whether deals featuring one or two large loans is in fact the new market norm.

In order to understand what direction the market is heading, it is essential to consider the evolution of deals prior to the GFC. CMBS 1.0 exploded into life in the middle of the last decade and with it multi-loan transactions were a common feature from the very outset. Fuelled by a favourable regulatory environment and an abundance of cheap debt, CMBS was able to flourish as an off-balance sheet tool for funding CRE. Against this backdrop, there was a huge amount of innovation in the market with deals featuring increasing levels of complexity and ingenuity culminating in some notable multi-loan deals, such as the thirty two loan transaction mentioned above.

Given the overwhelmingly favourable market conditions the CMBS 1.0 product evolved in a vacuum and was not subject to the tests, challenges and scrutiny that a product of this magnitude generally receives and requires. In effect CMBS 1.0 had managed "to run before it could walk", the corollary of which was that a number of unknown structural issues soon became endemic. With the onset of the GFC, the CMBS 1.0 product was subjected to a long awaited litmus test and with it many of the structural shortcomings were soon exposed. Indeed, a review of the new CMBS deals in the market reveal that the structural concerns raised by CMBS 1.0 have largely been addressed in the structuring of this new vintage of notes.

Since June 2011 we have now entered into a new era for the CMBS product. Given that so many market participants were adversely impacted by CMBS 1.0's structural flaws, the fragility of the global economic market as well as the high level of regulatory uncertainty, the new deals have so far evolved and developed at a much more measured rate than their predecessors. The trend for CMBS 2.0 has therefore been the utilisation of simplified structures which has largely been achieved by confining deals to the securitisation of single large loans. The use of these structures has proved invaluable in the rehabilitation of the product as these transactions have allowed confidence to once again return to the CMBS market as well as enabled an increasing number of arrangers to re-launch their CMBS platforms.

Although simplified CMBS structures are currently en vogue, this status quo is unlikely to subsist in the coming years. Given the limited availability of sizeable CRE loans that are suitable for a CMBS, the inevitable next step for the European market is the structuring of deals that are capable of accommodating the securitisation of a greater number of smaller loans. Assuming that this does happen (and there is every sign that it will), this would have a profound impact on the European CMBS market as it would not only hugely increase the universe of borrowers that could benefit from loans destined for CMBS but would also open up the floodgates for the level of primary issuance given the large number of loans that could be potentially originated with a CMBS exit in mind. Indeed as borrowers prepare themselves to face a sustained period of escalating interest rates, the opening up of CMBS to smaller CRE loans and with it the opportunity of obtaining cheaper debt will be a greatly welcome development.

It is not just borrowers that will herald in such a structural shift, but fixed income investors will also welcome such a development given their increasing appetite for investment in CMBS that has been spurred on by the continued low interest rate environment, the ECB's introduction of large scale quantitative easing as well as their own relentless search for yield. Accordingly on the basis that the securitisation of a greater volume of smaller loans will lead to an increased amount of primary issuance and a smoother flow of deals, this is likely to precipitate the deeper and stronger investor base required to absorb and competitively price such an increased volume of deals. Similarly investors that are already in this space would finally have the justification to put in place the internal resources and infrastructure required to invest in this asset class with any real volume.

Given that in the sixteen months that followed the launch of Europe's first CMBS 2.0 multi-loan deal in July 2014, seven of the fifteen public rated deals that have been brought to market were multi-loan deals, then the European market is already displaying a structural shift towards transactions featuring a larger number of smaller loans. This is a huge step forward for CMBS as a financing tool, as this development not only signifies that investors have appetite for the product but also that they are comfortable with the more complicated CMBS structures that are required to be put in place for such deals. Building on the success of these transactions and fuelled by the increasing levels of demand from borrowers seeking cheaper CRE debt, it is highly likely that the European market will witness a marked increase in the number of multi-loan deals along with a trend towards a larger number of loans being securitised in such structures.

Although at this juncture in the market it is hard to say whether the new vintage of deals will ever reach the dizzy heights of a thirty two loan transaction, what is apparent is that with the renaissance of multi-loan deals, the market has taken its first steps towards this CMBS 1.0 myth becoming a CMBS 2.0 reality and with it confining a market monopolised by the securitisation of large balance sheet loans to the evolutionary history books of CMBS 2.0.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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