The outlook for the German securitisation market has never been better, with volumes forecast to rise further after a bumper 2006. But last year's growth driver, multi-family CMBS, is likely to take more of a back seat, and although it has survived a recent tax reform, the TSI platform has its limitations. William Thornhill reports.
In its German securitisation outlook for 2007, S&P said that the German structured finance market would be unable to maintain what it called the "dizzying growth it showed in 2006". The agency said that volumes would be approximately the same as last year, when the number of deals it rated rose to 52 with a value of €66bn, up from €30bn in 2005 – a 120% annual growth rate.
That growth was driven by the CMBS sector, where there were 27 deals worth €27bn, representing one third of the total European CMBS issuance. CMBS accounted for 41% of total 2006 German securitisation, and achieved a whopping 567% annual increase from the paltry €4.5bn issued in 2005.
No one expects that rate of growth to be repeated, but there is confidence that volumes of CMBS will continue to rise. Morgan Stanley analyst Howard Esaki has suggested that Germany could even exceed the UK to take the number one spot this year. Morgan Stanley expects a rise in European CMBS issuance in 2007 to €80bn
In 2006, there were six pure multi-family CMBS deals. While declining to forecast an absolute number for this type of deal this year, Moody's said that with the bigger ones like GRAND now priced, a contraction in pure multi-family issuance was likely. But the agency also said that it would be increasingly common to find smaller multi-family components, around €100m to €200m, within bank conduit deals.
Moody's believes there could be significant challenges for the multi-family sub-sector ahead. At its London conference in January, delegates were asked which property sector was likely to be most overvalued, and the majority response was German multi-family.
In an illustration of the bid for German property, the Blackstone group was recently reported to have sold a property portfolio worth €1.6bn to a consortium of institutional investors including Round Hill Capital, Morley Fund Management and Aviva. But Terra Firma's Deutsche Annington and Fortress's Gagfah were apparently not prepared to pay this price.
"Values rose significantly in 2005 and 2006, suggesting a greater probability that risk prices could decline going forward," Moody's analyst Christian Aufsatz said. He added that multi-family cash flows are, however, generally stable, suggesting that problems are more likely to surface at the refinancing date, typically five to seven years ahead.
The net incomes on the various multi-family portfolios are very different, Aufsatz noted. On the revenue side, some deals have underlying restrictions on sales and rent increases, while on the cost side, many sponsors expect to spend less than was the case in the past to maintain and operate those assets. Moody's analyst Oliver Schmitt also noted that professional landlords were likely to gain economies of scale, but warned that such economies were becoming increasingly less easy to extract.
"Going forward, property portfolios are increasingly being exchanged between professional landlords (rather than non real estate focused corporations and municipalities), so it is more likely that the more significant economies of scale will have already been accounted for," he said.
In terms of overall strategy, Schmitt suggested that multi-family investment was now increasingly more likely to rely on a "buy and hold" strategy as opposed to the more risky strategy of asset sales to tenants.
"The focus on selling to tenants is still within business plans, but it seems to have become less of an obvious focus," he said.
Increasing diversification
In an illustration of the German market's growing maturity, the securitisation asset class mix is showing increasing breadth and diversity, with MBS, ABS and CLO products in both cash and synthetic format.
In the RMBS arena, the onset of Basel II will lead to many synthetic deals being called. Postbank, which already operated under the new regime, called its Provide Domicile 2003-1, and Moody's reckons that a lot more synthetic deals will also be called.
"We expect to see a lot more calls of this type early next year, as many [German] banks are expected to introduce Basel II at the end of 2007," Moody's analyst Martin Lenhard said, though he added that each decision would depend on the institution in question.
Elsewhere within RMBS, many banks are thought to be working on setting up their own near-prime platforms. RFC-GMAC is already well established with its bank independent E-MAC series. In terms of the loans it originates, Jennifer Anderson, managing director at GMAC RFC, said the brand focuses on: "quality borrowers with expanded criteria like higher LTVs. We are also focused on investment properties and taking a more regionalised approach, as opposed to simply going East" – meaning the former East Germany.
This March, Deutsche Bank priced the first deal off its Eurohome non-conforming programme. Though this was backed by UK assets, future deals are likely to be originated out of Germany. The Eurohome brand is segregated from the rest of Deutsche Bank, and in comparison with the relatively static loan underwriting standards of the prime German business, it will be able to offer a more differentiated, price-flexible product suite. The business aims to originate near-prime deals corresponding to the US Alt A market, such as high LTV loans to high net worth individuals or creditworthy migrants.
Turning to the German CLO sector, this is likely to go from strength to strength, both for the mezzanine profit participation product and synthetic balance sheet deals. In the case of the latter, capital relief will continue to play an important role as banks seek to mitigate the punitive risk weighting of corporate loans.
SG's director of securitisation in Germany Axel Graeff said: "It makes sense to continue doing synthetic transactions like Promise over the transition period as the risk weighting for pools of German SME loans under Basel I will stay in average comparable to the situation under Basel II."
Though deals in the mezzanine CLO space have come in for a degree of bad press, they are structured to withstand a few defaults with zero recovery. And there are sound fundamental drivers that will ensure this market grows. The loss of the Landesbanks' guarantees has effectively reduced the amount of lending that these institutions can undertake.
In addition, Basel II means it will be hugely expensive for banks to lend on a sub-investment grade basis, and the consolidation of the German savings bank sector (Sparkasse) has revealed a large degree of loan overlap, which further constrains loan provision.
Draft German law threatened SPVs
A draft trade tax law recently proposed by the German government earlier this year had led to concerns that the TSI-platform, which as it stands has limited applicability, might have become completely redundant.
The first draft of the corporate tax reform was published in February. Initially Germany lawyers warned that German SPVs could in certain cases no longer be allowed to fully deduct their interest expenses for corporation tax purposes. Were that to be the case, SPVs would always be left with their profits subject to 100% tax. Had this version of the draft law gone ahead, there would have been little incentive to locate SPVs in Germany, effectively bringing an end to the TSI platform.
However, wearing its hat as a lobbyist for the securitisation market, the TSI successfully carved out exclusions for SPVs. According to its CEO, Hartmut Bechtold, a new draft was approved by the cabinet on March 14 whereby German SPVs are excluded from the draft law. The new law allows for continued preferential trade tax treatment for SPVs located in Germany under the TSI-platform.
But bankers bemoan the fact that, even in its existing form, TSI's applicability is limited and cannot be applied to assets other than bank loans.
SG's director of securitization in Germany, Axel Graeff, noted that only 10 out of a total 54 deals had used the TSI-platform. While most transactions securitising loans granted by banks during last year were done via the TSI-platform, it is unfavourable from a tax perspective to securitise other assets via this platform.
"Under the current German tax law you must add a part of the long term interest to the taxable income for trade tax purposes, therefore it is economically inefficient to use a German SPV for the securitisation of assets."
Ulf Kreppel, a partner at White & Case LLP in Frankfurt elucidated on that point, "if you have long-term debt, that is beyond one year, you are only allowed to deduct 50% of the interest as cost".
He added that the German trade tax exemption is very limited in terms of the assets that can benefit. He also pointed out that German SPVs are subject to the somewhat onerous "minimum taxation requirement".
"This is not predictable as entities can only take losses forward to a limited amount and any profit exceeding that is subject to full taxation," he said. As such, if there are unforeseen realisation proceeds following a write-off, the SPV could be left with a tax exposure.
"The rating agencies prefer predictability, so in practice it is currently less work intense to use an Irish or Luxembourg-based SPV," Kreppel added.