European CMBS has recorded some impressive figures so far this year, as Moody's Investors Service reported volumes are up 124% from the first half of 2004 to 16.6 billion ($19.9 billion). Issuance is expected to remain robust with several analysts recalculating year-end forecasts to closer to the $50 billion mark. Despite the widening seen over the past two weeks, market players say they expect pricing to revert to the narrower levels seen earlier this year, despite the continued deluge of supply.
"It's been fairly active in the market and we are looking at another record year," said Morgan Stanley research strategist Howard Esaki. "We estimate that full-year issuance will be around $50 billion - more than double the volume that we saw last year; $50 billion is what the U.S. saw in 2002. I don't think anyone expected Europe would grow so fast." Moody's puts year-end estimates for CMBS volume around the 35 billion to 40 billion mark.
Esaki attributes the accelerated growth to several factors converging at once, making it an ideal time for European CMBS issuance. Low interest rates have driven increased originations around the world and, in the meantime, property prices have risen, as some investors have directed funds to commercial property instead of equity, Esaki added. Another factor that has contributed to the rise in volume is the pullback of German banks, which should continue adding cushion as more players turn to the capital market for funding. "When we start to see more German-backed CMBS deals we'll see further increases in volumes, which could happen as early as next year now that the true sale legislation has been approved," said Esaki.
In a report published earlier this year, Dresdner Kleinwort Wasserstein analysts said that, while the European market still has a ways to go, the scale and harmonization of the several European legal systems could lead to 35 billion to 40 billion of supply this year, adding that CMBS volume has further converged with the U.S. market. "A higher level of understanding of the market and factors that affect risk and return can, in our opinion, only lead to greater liquidity and as such, greater long-term growth in this sector," DKW analysts said.
New originations have primarily been driven by new conduits, said Esaki. Moody's said that in the six months ending June 30, 28 CMBS and multifamily transactions closed in Europe, ranging in size from 46 million to 3 billion with an average size of 592 million. Esaki estimates that, at the moment, there are as many as 20 conduits in Europe competing for product, but added that it hasn't been an overnight development. Many of these conduits were set up last year and, as such, were expected to start issuing immediately but have spent the time gathering the adequate collateral to come to market.
In and out, where are spreads headed?
CMBS has historically offered a yield pick-up over consumer asset classes but oversubscribed rates seen in the course of 2004 led to spread tightening across the capital structure. Since mid-March, triple- and double-A spreads have softened back to early January levels - in line with RMBS and other asset classes on the back of strong concentrated supply and corporate spread uncertainty while mezzanine spreads remained firm - according to Dresdner. Subscription levels have also come down and tiering has increased.
As the market heads closer to the annual August slowdown, primary activity is defined by small sized euro and sterling deals. Last week Barclays Capital began marketing its GBP393.7 million Belatrix deal from its newly established Eclipse conduit. The deal includes 13 loans on 39 properties occupied by 238 tenants. The loan had a 75.7% weighted average LTV and a 1.38x DSCR. The last big transaction to come to market was the 1.3 billion Vesteda deal, which priced in June and analysts said benefited from being viewed as a mix between a RMBS and CMBS deal - pricing its triple-A rated tranches at 12 basis points, 15 basis points, 20 basis points and 28 basis points over Libor, respectively.
"It's the summer now so we are not seeing very transparent pricing on these deals," said BNP Paribas ABS trader Laila Kollmorgen. Bear Stearns' GBP149 million Ursus deal, at 29 basis points for the triple-A piece, is fairly illiquid, added Kollmorgen, which could reflect the fact that it was a small deal and it wasn't widely marketed. "It should have gotten better pricing but, then again, the DCSR is not that good and maybe it's reflected at the where the deal priced," she said. "There is not much currently on the market but secondary trading looks good - the levels for deals like La Defense transaction that are bullet tranches, single property backed deal are clearing at 20 basis points."
Once the market picks up again, Kollmorgen said she expected to see conduits out in force with a more continental European presence. "I think what we will see is these older loans continue to refinance themselves like DECO 2003-Cento, which was refinanced into Deco 2005-EU," said Kollmorgen. "We'll see these deals regurgitated both on the continent and the U.K."
After the summer break, Esaki forecasts that spreads will retract to a narrow range for the remainder of the year - barring some unforeseen corporate-spread shock. Esaki explained that as the CMBS market matures, it tends to be affected by what is going on in the corporate market - there is a spread correlation which has led to less volatility and European CMBS has reached that point of maturity.
"We are at the point where CMBS are still cheap to comparable corporates. But CMBS are pricing more closely to corporate spreads," he said. "I don't think Europe will ever go back to the low volumes of a few years ago. We may see some fluctuation as we have in the U.S. market but generally these big volumes are here to stay."
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