liquidity prospects improve
WHISTLER, B.C. - Participants at the opening session of Canada's Fifth Annual Asset Securitization Forum 2002 held here last week called CMBS the next big asset class in Canada. Also, during several of the panels devoted to the topic, it was noted that CMBS volume, as well as deal size, will increase going forward.
New entrants are expected to surface in the market - not only on the issuer side, but also from the emerging local B-piece investor base. As seen in Sun Life's Mansfield Trust transaction last year, some of the B-pieces in completed CMBS transactions have already been sold to Canadian investors, demonstrating the increased appetite for the product. Attendees said that there are currently two emerging Canadian B-piece buyers.
Before the IOs in the Mansfield transaction were placed, Nancy Yewen, a senior investment officer at Sun Life, said she was told that Canadian investors simply were not interested in the market. At the same time, she was receiving indications of interest in the product. Yewen noted, however, that her firm had looked for a passive investor because they had wanted to retain the servicing in the deal.
One challenge for Canadian B-note buyers is that they lack the necessary servicer expertise, according to speakers during the "CMBS 201" panel. An investment banker stated that a way around this is to select an approved special servicer and then sub-contract work to the B-buyer, who, in turn, must be approved by the special servicer. By doing this, the special servicer will be responsible for the actual servicing, while leveraging the Canadian investor's local knowledge and expertise.
Despite increased interest, the appetite for this product is still limited, as Canadian investors tend to be risk-averse, said Ken Toten, managing director in CMBS at Coventree Capital Group Inc. Furthermore, unlike the U.S., there is really no private-placement market in Canada that can provide a bid for these B pieces, hence there is some reliance on U.S. investors to fill in the gap. GMAC Institutional Advisors has been a buyer of B notes in Canadian CMBS transactions, for example.
"We understood that there was a lack of liquidity for the B-piece," said Michael O'Meara from GMACIA. However, O'Meara said that there were several factors that motivated them to go ahead and buy the B notes in Canadian CMBS deals.
The primary motivation was the fact that originators in Canada have very disciplined underwriting practices compared to their counterparts in the U.S. Also, the structures have less leverage and shorter amortization. Some loans actually have full recourse, O'Meara added, which means that they are secured by real property. Full recourse loans have a lower probability of default, as borrowers will go to great lengths not to put their non-pledged assets at risk.
O'Meara warns, however, that as more originators come into the market and increase competition, these qualities may diminish - something that is already happening in the U.S. This would lessen the attractiveness of Canadian B-piece collateral.
Canadian CMBS volume is predicted to grow by 30% to 50% going forward, with this year's volume pegged at about $2 billion, topping last year's showing of $1.6 billion. One of the proponents of this growth, Merrill Lynch, expects its next deals to be larger than its previous transactions. Having had its last three deals oversubscribed, the firm, which is planning to come to market twice more this year, wants to up it deal sizes to the $350 to $400 million range.
Liquidity in the marketplace is improving as new issuers have entered the Canadian CMBS arena. In February, GE Capital launched its new Canadian CMBS conduit program. On the horizon are new issuers, specifically from the insurance arena, following Sun Life's lead.
Some observers said that they are hoping Manulife Financial will eventually bring a term offering. The firm brought the first CMBS in Canada through Life Mortgage Trust, and has two existing commercial paper CMBS programs.
All told, liquidity in the Canadian CMBS marketplace is also being helped by the emergence of new structures, such as CDP Capital's A/B vehicle - the first such structure in the country.
In terms of CMBS secondary market activity, investors said that the market is not "terribly liquid." Though liquidity is adequate at the triple-A level, it becomes "very poor" for the lower-rated bonds. This is why investors would welcome larger deals. Panelists added that issuers need to be more aware of how much paper they have out in the market.