KBRA Releases CREFC First Annual CRE CLO Conference – Recap
NEW YORK--(BUSINESS WIRE)--Oct 5, 2018--Kroll Bond Rating Agency (KBRA) releases conference recap. CREFC’s first Annual CRE CLO Conference in New York City attracted 475 attendees. It was a full day dedicated to the fast growing CRE CLO market. The five panel sessions covered perspectives from CRE CLO issuers, investors, bankers, lawyers and rating agencies. The overall sentiment was that CRE CLOs are a viable and widely accepted part of the commercial real estate bridge lending market and issuance volume should be sustainable, subject to the ebb and flow of the capital markets.
The day kicked off with welcome remarks from conference chairs Kunal Singh, Managing Director of JPMorgan’s CMBS Capital Markets Group, and Richard Jones, Partner at Dechert LLP. The chairs laid out how CRE CLOs have become a financing vehicle for bridge lenders and can be uniquely structured to their business needs. 11 of the 16 recent CRE CLOs issuers participated in the various panel sessions.
Eric Thompson of Kroll Bond Rating Agency, one of the sponsors of the event, provided a brief overview of issuance and the CRE CLO product. Year-to-date issuance is 29% over full-year 2017, and 2018 activity could more than double last year’s volume. In regard to the collateral composition of the transactions, Thompson indicated that today’s CRE CLOs are primarily comprised of short-term first lien whole loan product, making it different from the CRE CDO’s created prior to the financial crisis, many of which included exposure to subordinate debt and securities. The loans themselves are generally used to provide bridge financing for transitional assets. The CRE CLOs have different structures and features compared to CMBS with future funding requirements and active management of loan assets in the securitization. All this was discussed in greater detail in the sessions ahead.
CRE CLO 2.0
The conference began with an overview of CRE CLOs 2.0. What are they? How are they different from CMBS? How are they different from 1.0?
A CRE CLO is a securitization vehicle for commercial real estate bridge loans. CRE CLOs serve as an alternative to other forms of financing such as traditional bank warehouse lines. The vehicles are primarily collateralized by first lien loans on transitional assets. Issuers are usually qualified REIT subsidiaries that are required to retain the below investment grade securities (typically 20-25% of the deal).
In contrast to CMBS REMIC securitizations, CLOs are driven by the need for flexibility. Sponsors want the ability to manage the pools and to work out issues with the assets prior to the loans going to special servicing. Whether a deal is static (meaning that all principal proceeds are applied to the payment waterfall) or managed (meaning that principal proceeds may be used to acquire pari-passu loan participations), a ramp up period may also be present which allows the issuer to acquire additional assets post-closing. The issuer also has the ability to substitute or replace credit impaired or defaulted assets. Paydown of principal on the senior notes can also occur if overcollateralization and/or interest coverage note protection tests are not met. Another feature unique to CLOs is that certain notes may be PIKable, meaning that interest on those classes may be deferred. The deferred interest is added to the outstanding principal balance of such class, accruing interest at the note interest rate.
CRE CLOs in 2.0 are very different from the CRE CDOs issued pre-crisis, which may have offered the ability to more freely trade assets. Critically, the pre-crisis deals’ collateral composition varied widely from the first lien mortgage loans of 2.0 and included subordinate B notes, mezzanine loans, B pieces, CMBS, other CRE CDOs, and REIT debt. There was a portion of the market that utilized such vehicles for arbitrage, as opposed to today’s CRE CLOs, which are primarily used as a financing tool.
The CRE CLO market is robust, and the panel sees increased activity for the remainder of 2018 and into next year, including the entrance into the market of new issuers. Panelists also predicted an increase in the average size of deals, possibly as high as $600 million.
Bridge Loans: The Raw Materials Behind CRE CLOs
The panel covered many aspects of the underlying collateral of the CRE CLOs. It included four issuers, Eric Thompson from KBRA, and two attorneys. The issuers on the panel were diverse, representing programs that originate loans as small as $4 million and as large as $200 million. They also covered the gamut of the markets with some focused on primary and secondary markets and others who looked for value in tertiary markets. One commonality among the issuers is a propensity to focus on multifamily followed by office and less so on lodging and retail.
The panelists kicked off the session describing their definition of a bridge loan. As described by one panelist, it is a loan on a property that is not yet stabilized or will experience an event in the next two to three years that would make it not stabilized. Everyone agreed that bridge loans were not intended to finance ground up construction, but opinions regarding the extent of renovation/rehab that would preclude an origination varied. Issuers are looking for current debt yield but may consider fully vacant properties depending on the business plan.
In originating these loans and assessing their credit risk, issuers are looking at viability of business plans, financial strength of the borrowers and their experience in executing plans on similar assets.
Panelists highlighted the need for additional documentation and controls. These include loan provisions related to future funding, management of reserves, borrower guarantees, and business plan milestones. Also, ongoing asset management of these loans is critical. Issuers need frequent business plan updates. These loans may also need modifications along the way, so adhering to the servicing standard was emphasized.
Panelist acknowledged that competition for loans has resulted in spread compression. However, the spread compression seen at the beginning of the year seems to have hit a floor and has been flat over the past few months.
Before starting the afternoon sessions, Lisa Pendergast, Executive Director of CREFC, said a few words. Lisa emphasized how today’s market is very different from pre-crisis CRE CDOs and shouldn’t be characterized as 2.0. The CRE CLO market provides borrowers with a new source of bridge financing, non-bank lenders an additional option for financing their business, and investors relative value from a short-term floating rate investment. She also indicated that CREFC is continuing its involvement in the Alternate Reference Rate Committee under the auspices of the Fed in order to identify a sustainable alternative to LIBOR. Given the floating rate nature of CRE CLOs, the transition from LIBOR is a significant issue for this market segment. She also indicated that CREFC is examining recent results from a member survey soliciting feedback on the Investor Reporting Package and is considering adding new reporting fields germane to the asset class.
The afternoon included two sessions closed to the media that covered the issuer perspective in more detail and the state of the market & emerging trends.
CRE CLO – Investor Focus
The last open session of the day focused on the investor. The panel participants collectively represented over $3 billion in CRE CLO investments. The investors started off discussing the attractive features of the asset class, including the relative value and the floating rate short term nature of the securities, especially important in an uncertain rate environment. Since the product also tends to have higher levels of multifamily, its shorter duration and higher yield make it attractive compared to agency multifamily paper.
The investors generally accepting of managed deals despite the potential for negative credit drift and the additional work required to stay on top of the deal compared to a static deal. They felt the additional spread received on a managed deal was worth it if they were comfortable with the sponsor of the CRE CLO. The investors acknowledged that the market is not presently differentiating sponsor quality in pricing.
CRE CLO liquidity is not as deep as CMBS and in times of volatility could become much more limited, although presently not an issue. It is still a very nuanced market and has not evolved yet to include standard features and provisions across issuers. Given the transitional nature of the loans, which requires more due diligence by investors, coupled with short duration, the number of investors willing to spend the time to make an investment decision may be more limited.
The panel wrapped up with areas investors wanted changed or improved. These include better transparency on asset level business plans post-closing, more market depth to facilitate liquidity, additional time for due diligence prior to closing, standardization of documents, and additional rating agencies providing credit opinions through the capital stack.
CONNECT WITH KBRA
About KBRA and KBRA Europe
KBRA is a full service credit rating agency registered with the U.S. Securities and Exchange Commission as an NRSRO. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus, is recognized by the National Association of Insurance Commissioners as a Credit Rating Provider, and is a certified Credit Rating Agency (CRA) by the European Securities and Markets Authority (ESMA). Kroll Bond Rating Agency Europe Limited is registered with ESMA as a CRA.
View source version on businesswire.com:https://www.businesswire.com/news/home/20181005005418/en/
CONTACT: Roy Chun, Senior Director
Susannah Keagle, Senior Director
KEYWORD: UNITED STATES NORTH AMERICA NEW YORK
INDUSTRY KEYWORD: PROFESSIONAL SERVICES BANKING FINANCE
SOURCE: Kroll Bond Rating Agency
Copyright Business Wire 2018.
PUB: 10/05/2018 12:46 PM/DISC: 10/05/2018 12:46 PM