While the European primary CMBS market continues to grow, secondary market trading still faces obstacles that keep the flow at a trickle, market sources said.
There has been limited liquidity for traditional cash CMBS issues, and trading volume remains at a relatively low level. Moreover, the market is still plagued by recurring issues that have yet to be resolved, said Jim Savitsky, director of global ABS sales at Markit Group. In speaking with buyside players, the main concerns hinge on the lack of information available, the lack of cooperation from borrowers and the lack of activity on the trading front, he said. "There are still a whole host of factors that need to be worked out. Things are improving, but information flow still remains a great hurdle."
European trades are still largely noteholder friendly in the sense that traders often have to rely on the information the holder chooses to disseminate, one trader said. "We are at a disadvantage as traders because the holder gets to know better," he said. "They know who the customers are and how good the underlying assets are."
Europe has developed quite differently from the U.S. For starters, there are no standard remittance reports and attempts to adapt an investor CMSA-IRP-styled template have been slow to develop. "It's not simply a case of Europe just taking what been done in the U.S. and applying it to the European market," Savitsky said. The sheer size of typical U.S conduit deals leads to a different approach with respect to data. While U.S. deals are often backed by 200 loans or more, European deals contain a much smaller pool consisting of only about 10 loans or less. "This makes the information required more granular because investors are exposed to a smaller loan pool and therefore really need to dig into the detail," he said. "In the U.S., the larger pool cushions investors from a single particular event."
Savitsky said that the history behind the emergence of the CMBS market in the U.S. also played in favor of investors. "The emergence of CMBS in the U.S. stemmed from a credit lending crisis which led to a lending environment driven by conduit lenders," he said. "As a result, one of the requirements for borrowers was that you had to provide information on loans." In Europe, the commercial mortgage market is highly competitive and issuers have more of a choice in terms of where to get funding. Many have rejected the strict, U.S.-style conduit lending requirements in favor of protecting their borrowers. Requirements differ according to jurisdiction, and traders are not so sure that banks want to adapt stricter requirements. "Investors may be working toward streamlining efforts in Europe to get more accurate information on deals, but it is not as easy to convince banks," another market trader said.
As is always the case, a lot of work is put into these deals when they debut on the primary. For a slate of multijurisdictional deals to hit the market it's the same story, but it's the ongoing reporting that traders are most interested in. "It is usually with the ongoing reporting where you start to see the fall-off in both the quality and depth of information," said Dave Colling, director in Markit's structured finance division.
At the moment, most European CMBS deals report on a quarterly basis, unlike the U.S. where deals have a monthly reporting schedule. Colling said that the European RMBS market is moving toward adopting monthly reporting and expects the CMBS market to follow suit, although he added that he was optimistic but skeptical of what the impact would be on CMBS secondary market liquidity going forward.
Without adequate transparency, traders said they are at risk for potential prepayment fallouts. European deals are more exposed because they have fewer loans and even one prepayment could have detrimental effects on a trader's books. "Because of the lack of transparency we have to make assumptions out of this air and not on tenant level information," one CMBS trader said. Markit's Colling said that according to market talk, some private equity and hedge funds are bidding for commercial risk, adding to the prepayment risks in CMBS deals. As part of their commercial strategy, some hedge funds are seeking to take commercial mortgage loans directly on to their own books, increasing both the prepayment risk in existing CMBS deals and intensifying competition at origination for traditional lenders.
As for the activity that the market has seen thus far, like the rest of the securitization market, CMBS continues to see a general tightening trend, particularly on the triple-A and triple-B notes. Investors do have an appetite for secondary trading, according to Nathan Kirk, a director of product development at Markit, based on what he has heard in the market. "How that percentage of appetite compares to overall trading market volume is hard to determine," he said. "But from where we are placed, we see spreads tightening from last year."
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