Several recent and pending commercial mortgage-backed securities transactions exemplify how effective this market has become. The latest is a $502 million transaction by Challenger International, a financial services company which specializes in managing retirement income. Challenger buys property to service its clients' annuity payments, and has a A$2.25 billion portfolio, spread between Australia and Britain (the company is about to enter the U.S. commercial real estate market). The deal, arranged and lead managed by Westpac Institutional Bank, is based on a portfolio of Australian properties independently valued at A$800 million and valued by Standard & Poor's at A$680 million.

One of the innovative features of the transaction is that the underlying collateral of 25 properties has been divided into four "silos." This reflects, firstly, the fact that life insurance companies in Australia are not allowed to borrow money to invest and must, therefore, invest in assets that are already geared. In Challenger's case, this means property trusts. Secondly, life companies are unable to invest more than 5% of their total assets in any single investment and still receive full regulatory treatment for their insolvency requirements (Challenger is a life insurance company in name only; it needs the status in order to be able to sell annuity products). The company has around A$1.6 billion in assets, and so is constrained from investing more than A$80 million in any one asset or property trust. The silo structure helps to overcome this limitation for the purposes of the securitization.

There is a slight downside to this for investors, however. As S&P points out in its rating rationale, the debentures and loans to each of the property-owning trusts are cross-collateralized only to the extent of the loans within each stock pool (silo). "A shortfall in interest or principal from any one stock pool therefore has limited capacity to be recovered from any other stock pool," says S&P. The rating agency compensates for this by requiring a higher degree of subordination than normal. It allows Challenger, for example, a loan-to-valuation ratio of just 32% at the AAA' level (based on S&P's conservative portfolio valuation), compared to 39% and 40% for comparable CMBS structures in the market.

The deal, which was still being roadshowed as ASR went to press, consists of A$220 million of Class A notes rated AAA'; A$115 million of Class B notes rated A'; A$55 million of Class C notes rated BBB+'; A$27 million of Class D notes rated BBB'; and five unrated tranches: E-1 (A$22.25 million), E-2 and E-3 (A$23.75 million each), E-4 (A$15.25 million), plus a credit-linked note issued against an asset where there is some possibility of default (A$8.64 million).

A shifting pendulum

Though the market has seen robust activity, it looks set to peak, just as the volume of deals so far this year reaches A$2 billion, ahead of the A$1.5 billion for all of 2001. The reason: banks want to start lending to property developers again.

One of the early drivers of the CMBS market's solid growth in Australia during the last three years was banks paring down their property exposures, which were approaching their limits. At the same time, property developers and owners saw the CMBS market as a way of diversifying their liabilities.

More recently, the market has gained additional momentum as asset sellers have discovered they can issue multiple tranches of tiered debt-secured, in some cases, against property portfolios over which they had already issued senior paper.

So successful has the market been, the banks are now looking at ways of filling the holes in their property books. At the moment, they are stepping up for CMBS lines at the lower end of the credit curve, and providing added liquidity to the sector. Securitization professionals believe, however, that it is only a matter of time before the banks start competing with CMBS to put property assets directly back on to their books. When that happens, say the professionals, the flow of CMBS will slow.

Other deals

Some weeks ago, South African-based investment bank Investec broke new ground with a deal which securitized A$250 million of property assets the first in Australia to pool together residential and commercial mortgages. The transaction, structured and arranged by SG Australia, is being warehoused in the latter's ACE program before being refinanced with public term debt.

In the residential MBS sector, Interstar Securities has made its first venture into the offshore market with a US$1 billion global deal backed up by a A$125 million tranche of subordinated debt. The deal is the fifth global RMBS by an Australian bank so far this year and takes the total of such issuance for the year to A$9.1 billion compared to A$13.6 billion for the whole of last year. Macquarie Securitisation, which manages the PUMA program, has filed a preliminary prospectus for its second, US$1 billion global issue.

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