European CMBS & CLO Update Amid Covid: The Need For Data Accuracy and Transparency
Europe, like the rest of the world, has been suffering at the hands of the pandemic. Starting with Italy, the virus soon spread to many other European nations. This unprecedented dislocation, along with upending our daily lives, has also created substantial volatility in the economy. In times like these, the need for high-quality datasets and models to make agile yet prudent decisions have become increasingly evident.
Like the broader financial markets, the European CMBS and CLO markets have also been significantly impacted. In this piece, we analyze issuance, spread, and general trends that we have witnessed in the past few months.
New Issuance – Recovery Yet?
The European CLO market saw a new issuance volume of more than €5.8 billion in the first quarter of 2020. In February alone, there were eight new deals priced with a total issuance volume of €3.3 billion, up from €2.5 billion the same month last year. However, the issuance quickly came to a standstill in early-March due to the outbreak. The following chart shows the issuance volume since February this year in comparison to the same months last year.
The market is starting to show recovery as the total issuance volume has trended up in the last three months. In June, the total volume summed up to roughly €2.1 billion, just shy of €2.3 billion in the same month last year.
Additionally, in the US market, the first refi deal since the pandemic was priced in early July. Considering that the European market typically follows the US market, this pricing of a refi deal is an interesting development to watch.
In the CMBS space, the market has also suffered a massive step back due to the pandemic. The year 2020 was poised to see a considerable uptick in new issuance in Europe and surpass 2019 issuance levels. However, there have been only three European deals for a total of €807 million and £257 million so far in 2020. To put this in perspective, the year 2019 saw the European market generate €2.3 billion of new issuance while the new issuance in the UK CMBS market amounted to about £1.6 billion.
All three new CMBS deals this year are single asset single borrower deals that were closed before the pandemic shook the markets. Two are backed by large portfolio loans comprising of office, industrial, and lodging properties in the Netherlands and the United Kingdom while the third one is backed by a large office in Paris, France.
Spreads Widening and Loan Price Changes Amid Uncertainty
The uncertainty in the last few months has also led to a noteworthy widening in the pricing of new CLO deals in the European Market. The median AAA spreads for the month have moved up from the 90s in February to above 170 in April and May. However, we are beginning to see some tightening as June recorded a new CLO AAA median spread less than 160. The most recent deal priced in the EU market was the €204.7 million Northwoods Capital 21 Euro managed by Angelo Gordon which priced at E+150.
The leveraged loan market has posted significant volatility over the last few months due to lockdowns and business closures. The following tables show the average percentage change in the marked prices of credits across various industries in the EU markets since the end of January. (We used Moody’s industry classifications and IHS Markit valuations based on data at the end of January and earlier this week.)
Companies, large and small, across the world have been struggling with the continuing impact of the outbreak. It has become difficult for a number of them to continue operations in these uncertain times, resulting in many businesses filing for bankruptcy protection while others have been preserving cash and/or borrowing to increase their liquidity. This has, of course, impacted the trading price of leveraged loans issued by these companies, many of which are in the BSL CLOs.
At Trepp, we provide daily insights in our newsletter TreppWire and in the Trepp CLO product to keep our clients informed on recent market news impacting various credits.
CLO: Not The Same As the CDO
Recently, CLOs have been highly discussed as the number of bankruptcy filings of the companies present in the universe has exploded. More often than not, they are compared to the infamous CDOs (collateralized debt obligations) from the last financial crisis. However, unlike CDOs that invested in subprime mortgage-backed securities, CLOs invest mainly in leveraged loans: bank loans to firms that are highly indebted, have high debt service costs relative to earnings, and are typically rated below investment grade. Simply put, CLOs are backed by simpler, more diversified pools of collateral. These deals also have limits in place on the share of each industry to prevent concentration to a sector. Furthermore, unlike CDOs, CLOs have witnessed very low levels of default. In essence, while the names of the securities may be similar, the structure, collateral, and the performance of the two are very different.
Moreover, new initiatives are being put in place to provide more transparency to the securitization market.
STS Framework – A CMBS & CLO Update from European DataWarehouse
With the Securitisation Regulation (EU) 2017/2402, the European Union aimed to establish a more risk-sensitive prudential framework for simple, transparent and standardized (‘STS’) securitizations. Ultimately, the goal of this European initiative was to create a level playing field in the securitization market and to avoid mistakes that have been made in the past, when opaque and complex structures ultimately contributed to the collapse of the global securitisation market in 2008/2009.
The new STS framework offers more favorable regulatory treatment for securitizations provided that the transaction and underlying assets comply with procedural and structural requirements. To obtain such an STS designation, a securitisation needs to comply with the general rules and criteria stipulated by the Securitisation Regulation, such as risk retention, transparency, and due diligence requirements. Based on these criteria Commercial Real Estate Backed Securities (CMBS) and Collateralized Loan Obligations (CLOs) are not eligible to receive the STS designation. The strong reliance of the repayment of securitization positions on the sale of assets securing the underlying assets creates vulnerabilities leading to the exclusion of CMBS from the STS designation. CLOs are not capable of attaining STS designation due to the active portfolio management nature of CLOs on a discretionary basis.
Despite the restriction regarding the STS designation of CMBS and CLOs both types of securitisations have to comply with the disclosure regime of the Securitisation Regulation. This regime requires to provide information on underlying exposures, investor reports, and further information to (potential) investors and regulators. Public CMBS and CLOs must use a securitisation repository for the disclosure while private securitisations are allowed to use a repository or chose a different channel to disclose the information to (potential) investors and regulators.
Navigating The Uncharted Waters
Founded in 1979, Trepp has a long-standing history of providing transparency to the market by collecting and analyzing data. We have operated in many different financial crises year-to-date including the early 1990s recession, the early 2000s recession through to the Global Financial Crisis to now – the COVID-19 recession (if we can call it that). In the current scenario, being able to rely on historical data for risk management has become more crucial than ever. Trepp’s data has been used to build models, conduct a thorough analysis on cashflows and to stress test portfolios to say the least.
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Disclaimer: The information provided is based on information generally available to the public from sources believed to be reliable.