European commercial property markets are on the cusp of a funding revolution that could make securitisation largely irrelevant, one of Europe’s most experienced real estate finance experts said on Monday.

Neil Lawson-May, co-head of asset manager Palatium Investment Management, said banks were no longer dependent on issuance of commercial mortgage backed securities (CMBS) to replenish capital, because an army of mezzanine lenders were poised to profit from the void left behind by frozen securitisation markets.

“Securitisation is essentially a good product, a good idea,” he said. “I’m not clear that it is a necessary idea going forward.

“We’re going to have much more diversity than in the past about where loans are booked … We’re going to see a whole menagerie of different funds and investors with different risk and return criteria that will look to buy parts of loans or originate loans and that will create a more interesting market.”

Palatium is the former asset management arm of Europe’s biggest commercial real estate lender, Commerzbank-owned Eurohypo, where Lawson-May co-headed investment banking from 2002 to 2007.Undermining the need for securitisation, Lawson-May cited rule changes under the Basel II banking regulations which slashed the amount of capital banks must set aside for triple-A-rated assets to 1 percent from 8 percent previously.“

If you’re hardly using any capital at all keeping a loan on your balance sheet, then what a bank needs is funding, not a true sale,” he said. “(Banks) could just as easily do a covered bond issue … you don’t actually need CMBS any more if you are a Basel II bank.”

CAPITAL CHARGE

In Europe, CMBS issuance grew from 15.2 billion euros ($23.6 billion) in 2004 to 60.1 billion in 2006. The amount fell to 47.5 billion euros in 2007, according to the European Securitisation Forum, in the wake of a credit crunch.The change to Basel II was also why Palatium was looking to raise at least 300 million euros for a fund specialising in preferred equity and mezzanine debt, Lawson-May said.

Banks will have a disproportionately high capital charge for assets rated sub-investment grade and “will be looking for partners to buy those sorts of assets”, he said.

Now that banks were more conservative in their lending, developers will find it difficult to get financing above 70 or 75 percent of the underlying value of a project, he said.

If the senior lender wants to refinance no more than 75 percent but the investor needs 90 percent, the new mezzanine fund would provide the financing to help fill that gap,  he said.

An end to the credit crunch was not imminent even though banks were rapidly cleaning up their balance sheets, Lawson-May said.

“Banks will not want to return to the provision of the kind of liquidity they have done,” he said. “The levels of gearing they are willing to provide have dropped, perhaps not permanently, but for a very long time.”

However, in spite of continued investor mistrust, the re-emergence of even commercial real estate collateralised debt obligations (CRE CDOs) could not be ruled out, Lawson-May said.

Eurohypo was one of only two money managers in Europe to venture into the sector for CRE CDOs during the boom years.

A CRE CDO is a pool of commercial real estate loans that has been divided into slices by degree of risk.

The Glastonbury vehicle Palatium inherited after splitting from Eurohypo continued to perform, Lawson-May said. “The mark-to-market of the underlying (asset pool) is par. It is all rated paper and all of that rated paper is performing.”

“Possibly if we do see them, we won’t brand them as CRE CDOs,” he said. “Having a diversified pool of risk and then leveraging it is a perfectly sensible thing to do”.

- By Jane Baird and Sinead Cruise (Reuters)

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