Broadening the scope of CMBS loan issuance

The predominant deployment of CMBS deals will be the distribution of loans secured by challenging secondary assets – either due to property type or location.

Borrower demand for the origination of such loans is unlikely to abate, as those purchasers of the recent swathe of non-performing loans pick through these portfolios and seek out leverage on the underlying commercial real estate (CRE) to maximise returns.

For CMBS issuance, this means that in the next year or so we are likely to witness the continued widening of the CMBS geographical net to more peripheral jurisdictions, including the first forays into eastern Europe.

Consistent with the CMBS 2.0 era to date, deals this year are likely to feature continued structural innovation. As market observers will testify, the first transactions featured the utilisation of simplified structures, which were achieved by confining deals to the securitisation of single large loans.

Although these structures are still used, they have since been refined and finessed, culminating in the advent of multi-loan structures in 2014 and the first pan-European, multi-loan deals reaching the market in 2015.

Given the limited supply of sizeable CRE loans that are suitable for a CMBS distribution, it is inevitable that we will see the utilisation of the more complex and involved structures required to accommodate a greater number of loans, a larger range of the size of such loans and the deployment of those structures that are necessary to efficiently securitise loans originated in new jurisdictions.

Although both structural reform and the widening of the geographical net of assets financed by CMBS will be welcome developments, whether this is a fiction or a reality will largely depend on how market participants can address those challenges that continue to stifle the market. Judging by the lack of issuance in the latter half of 2015, the most pertinent of those challenges is the impact of macroeconomic conditions.

The vulnerability of CMBS to adverse economic factors was clearly demonstrated by fears surrounding a potential Grexit and the Chinese financial crisis on the pricing of three deals last summer and the consequential premature cessation of issuance.

Given the fragility of the CMBS market and the fact that a number of these economic uncertainties still subsist, it is understandable that participants continue to be wary.

It is therefore critical that these macroeconomic fears are alleviated and that there is the recommencement of primary issuance, hopefully paving the way for a steady flow of properly priced deals.

A further challenge to instilling confidence in CMBS is that the new vintage of deals continues to be overshadowed and tarnished by the incessant reporting of CMBS 1.0 issues, including the plethora of litigation that has so far hit the courts.

Furthermore, there is little sign that the steady flow of regulation impacting negatively on the deals will cease. Such regulation has proven to be yet another uncertainty impacting issuance of CMBS given its potential to impact the structure, demand and economics of the product.

Assuming that neither of these challenges derails the market completely, it is inevitable that we will continue to witness the evolution of CMBS structures to address them.

As for 2016, if arrangers can build on the structural achievements of the past few years and not succumb to those challenges that have demonstrated the potential to paralyse the market, then there is the real possibility that CMBS 2.0 can finally be unlocked as a distribution tool for a greater number of loans.

Iain Balkwill is a partner in the structured finance team at Reed Smith