CMBS Roundtable 2005: Participants

Like much of the suite of ABS offerings, the CMBS story takes in low absolute rates, upheaval in traditional bank funding markets, financial engineering themes imported from the US and the herd mentality of the hunt for yield. The first and most striking facet of this year's CMBS season has been the unprecedented growth of the sector, shattering consensus predictions. While still off the pace of US volumes, Europe has seen 75% more transactions this year, and looks on track to meet the magic US$100bn mark within a decade. The role of refinancings in this year's figures must be taken into account, however, as the pre-conditions that catalysed the 2005 flurry may not be repeated next year. Basel II regulatory capital rules will impact both sides of the CMBS market: lenders have begun to model loan pricing under the new regime. Meanwhile, the favourable capital treatment for B-tranches is a driver to growth of the sub-investment grade market. Information, or asymmetry of information, is one of the core issues in securitisation, in particular CMBS. Primary and secondary market investment decisions are heavily influenced by the quality and quantity of salient collateral reporting. The Prospectus and Market Abuse Directives offer the promise that disclosure without prejudice will become the norm for European CMBS transactions. Against a backdrop of hot real estate markets and tight spreads, more investment banks and balance sheet lenders have become CMBS issuers. This race has generated intense competition to originate loans, capacity issues for banks juggling client and principal business, and a general bottleneck in the new issue market. With increased pressure to source loans, has there been any significant change in lending standards? Borrowers have managed to extract increased leverage from the boom in CMBS lending and issuance. To compensate for this, covenants take on a new significance, and investors are scrutinising them very closely indeed. B-note buyers have been vital this year taking down high-leverage exposure outside of rated securitisation. Without this demand centre, which provides underwriters with a quick exit for high LTV risk, lenders would not have been able to exploit Continental European opportunities so aggressively versus the bank market. IFR gathered a group of the leading arrangers, traders, investors, lawyers and ratings analysts to discuss how it all came to this, and where we might go from here. Caroline Philips, attended from Eurohypo, alongside Shirish Godbole from Morgan Stanley and Deutsche Bank's Jonathan Pollack. Representing the investor base was Scott Goedken of LNR Partners while lawyers Charles Roberts and Peter Voisey attended from Cadwalader Wickersham & Taft and Clifford Chance respectively. RBS's Ronald Thomson spoke on behalf of research, while ratings input came from Rodney Pelletier of Fitch.

IFR: We are going to start by looking at growth levels and the sustainability of the tremendous market growth that we have seen in the past year. Let us start with Rodney, who has more of an overview of what is going on in terms of net volumes than most of us. Rodney Pelletier (Fitch Ratings): The volumes have been tremendous this year. They have confounded everybody's expectations. I think there was a CSFB conference at the beginning of the year that anticipated we would have about US$29bn equivalent this year. We blasted through that in June, and up to the end of July we were at US$36bn, or about €30bn. We should quite easily surpass US$50bn, meaning about €42bn–€43bn for the year, which is an amazing statistic compared to last year, so we are actually a little bit more than double where we were last year. In terms of the number of transactions we would probably be up about 75%, and there is no shortage in sight if the deal pipe continues to grow. It is amazing how many arrangers out there are doing not just two deals but three, four, five, or potentially even six deals in the next three to six months. IFR: How does that compare with the more mature US market in terms of volume? Pelletier: Well, we thought we would be catching up with the US market, but talking to US counterparts, it seems there are some months where they see US$10bn worth of product now. That just dumbfounds me. IFR: Charles, do you think growth will continue over the next 12 months at the same rate? Charles Roberts: (Cadwalader): I think what we are seeing is a market that has evolved in a different way from the US market. There the investor market was established and it basically helped originators to come up with more competitive pricing. Now the market has been established and the originators are competing with the balance sheet lenders, regardless of where rates go. What is going on in Europe is that there is really a large untapped market as far as CMBS origination is concerned. The US has already been through this, and I think they are coasting on what rates are right now, and they know it. Caroline Philips (Eurohypo): Do you think European growth can be sustained? That would imply €18bn–€19bn of extra growth in 2006, and I cannot see that happening. It would be a great target to keep the levels as they are, but I cannot see growth increasing that much. Roberts: Maybe not exactly sustained, but I think growth will still be there. Morgan Stanley was predicting some US$100bn by the decade end. Shirish Godbole (Morgan Stanley): Yes, but that is doubling in four or five years, as opposed to doubling in a year, which would be pretty amazing. Pelletier: There are two sides to this – supply and demand. Let's think about it from the perspective of the arrangers. How do you feel? Do you think there is capacity to get to US$100bn in the next four or five years? Philips: Over that period of time, frankly who knows? It is perfectly feasible. Next year will be very interesting because our experience this year has been that there has been an awful lot of refinancings. You flip loans from the bank market to the bond market because there has been that big difference in pricing. Now the bank market and the bond markets are pretty aligned pricing wise, and a lot of the refinancings have already happened. Spreads are not going to tighten that much further, because they physically cannot. So we have lost that driver. Roberts: We should not expect refinancings to continue that way. Philips: No, exactly. I don't know if Ron has done the sums, but it would be interesting to know what proportion of the collateral underlying this year's issuance is refinancings. Godbole: You talked about people having six deals in the market in the next three to six months, and I look forward to 2006. It is very hard for me to look beyond that, but it looks like the pace is going to continue. There is a tremendous amount of principal volume; there is still a lot of agency dema