Fitch sees divergent paths for US, EMEA conduit CMBS markets 

While the US conduit market continues to be the gold standard for predictability, the agency expects the growing EMEA CMBS market will follow a more bespoke path.

More US commercial mortgage-backed securities investors are looking at opportunities in EMEA CMBS transactions, a development that requires in-depth understanding of the stronger structures and transparency available in stateside transactions, according to a new report from Fitch Ratings.

While there are no hard-and-fast numbers on the number of US investors looking at EMEA CMBS, Euan Gatfield, a London-based managing director at Fitch, cites anecdotal evidence of more cross-border investment activity.

“There was a general trend that it was becoming a more crowded market for traditional EMEA investors, who saw themselves under more pressure because there was more money being allocated to the product,” Gatfield said. This interest is not just from US investors, but also from Asian accounts which are seeking to diversify their portfolios.

The report, How EMEA and US CMBS Differ, cites factors which include increased competition in the EMEA lending market that have led European banks to offer more borrowers more creative structures. Additionally, there is little ability to build in the call protection common in US conduit deals, a deep covered bond market, and higher regulatory capital requirements, Gatfield explained.

While US conduit structures are largely predictable and have been fined-tuned for more than 20 years, it is unlikely the EMEA market will gravitate in this direction. The agency expects to continue to see more bespoke structures which could include full or modified pro rata payments in the EMEA region, compared with fully sequential amortization for all CMBS in the US.

“Would we expect US CMBS to adopt some of these EMEA features? We don’t think so,” said Steven Marks, a New York-based group credit officer at Fitch. “Given the structures today are fairly frictionless and given the volume of issuance, we think the goal of arrangers and issuers is to have a standardized product that enables scalability. When you get into more complex or bespoke structures it just takes more time.”

It has been difficult for issuers in the EMEA region to create the same kinds of standards, Gatfield explained.

“I think once you’ve created a standard, there is a lot of value in keeping that standard,” Gatfield said. “In EMEA, it has been difficult to create that standard because of some of the underlying pressures in the wider funding that are a bit different than in the US. From the EMEA perspective, the borrower has been very traditionally reluctant to give away pre-payability and has become very used to having floating-rate pre-payment structures.”

Some of these structures are not, however, borrower-driven, Gatfield added.

“In the US, the CRE CLO product in a way is an area in which different things that don’t necessarily fall neatly into various iterations can be funded, securitized. What gives the US scale and standardization may be the fact that there is a 10-year, fixed-rate product that is very acceptable to borrowers despite maybe tying their hands a bit more than the floating-rate version that we see here,” Gatfield said. “In the EMEA region, I think it’s more of an arranger-driven feature in order to make things economically viable.”

The report, which details the structural differences between the regions, also notes another factor driving divergence: record-low yields for prime properties in Europe. This has partly been driven by record-low interest rates for the past decade in the region which have helped to drive up pricing. Additionally, the US banking market is more diversified between traditional and non-traditional lenders and borrowers have more options.

“The key thing we traced back is there are different ecosystems for the US versus EMEA. Sometimes this is not discussed as much as structures are discussed,” Gatfield said. “Some US structures have been imported into European CMBS because of the dominance of US private equity in the EMEA CMBS market. The European banks typically demand LTV and DSCR covenants at the loan-level and CMBS doesn’t tend to do that because the private equity firms have incorporated US standards.”

The report also found that there are more heterogenous assets in CMBS in the EMEA region, with common ground in larger deals completed for private equity firms. In the US, the collateral is typically more diversified. The differences between the regions means a more bespoke environment for rating transactions in the EMEA region, with Fitch expecting to see continued innovation in funding and property types.