Credit Suisse finances collateralised loan obligations in wager on UK real estate

Credit Suisse Group is financing a foray into a niche corner of the debt markets used to fund real estate at a time when UK property is feeling the strain from rising interest rates.

The Swiss lender will furnish Aeon Investments with up to 900 million euros (S$1.3 billion) to help bundle up loans and issue bonds secured against them known as commercial real estate collateralised loan obligations (CRE CLOs), said Aeon's co-founders Oumar Diallo and Ben Churchill. 

The combined deals, funded by the 3-year revolving credit line from Credit Suisse, will be the biggest of their kind seen in Europe to date. A spokesperson for Credit Suisse declined to comment when contacted by Bloomberg.

UK real estate, like other property markets across the developed world, is in a moment of flux as a decade-long bull market fuelled by rock bottom interest rates shudders into reverse amid recession fears. Stocks and bonds of property firms have sold off sharply this year as investors weigh the impact of an economic slowdown sparked by rising borrowing costs and an energy supply crunch.

Some investors cherish the better returns and protection from rising interest rates offered by the floating-rate securities, while others warn of the higher risk of defaults as economic conditions turn sour.

For its part, Aeon said it is counting on strong demand for newer office space with top environmental credentials as UK firms appraise their workspace needs in the aftermath of the pandemic. 

The batch of 3 CRE CLOs the firm plans to issue from 2023 will fund mid-market projects across England and Wales, including offices, industrial units, warehouses and also some retail properties, as well as buildings in need of an upgrade, said Diallo and Churchill.

"For all of those pockets of value, we thought it was an opportune moment where we could capture a premium on the revenue side, while not increasing risk if both the loan selection and underwriting was prudent," said Diallo.

While credit market returns have fallen across the board this year, European high-grade bonds for asset-back securities are down about 1.6 per cent for the period, data compiled by Bloomberg showed. By contrast, investment grade corporate bonds have plunged more than 12 per cent, according to a Bank of America index. 

With European real estate getting squeezed, the CRE CLO structure offers more flexibility than commercial mortgage-backed securities (CMBS), a more traditional funding tool, said Iain Balkwill, partner at law firm Reed Smith, who worked on Europe's first CRE CLO last year. 

While a CRE CLO bundles up a bunch of loans, a CMBS can have as few as one large mortgage backing a deal. The structure of the securities also gives managers more control because they can make capital injections and trade in and out of the loans in response to market conditions.

For example, "it's unlikely a CRE CLO would have 100 per cent hotel exposure", said Pranava Boyidapu, a European real estate credit analyst at Barclays Plc.

While CRE CLOs are still a rarity in Europe, their use is growing in the US, where about US$45 billion worth of the securities were issued last year, Bloomberg data showed.

That is more than 5 times the total seen in pandemic-hit 2020. By contrast, Europe has so far seen just one such deal - a transaction by Starz Real Estate late last year worth the equivalent of £220 million (S$353.3 million), which was arranged by Credit Suisse. 

US investors were reassured by the way CRE CLOs weathered the economic shock of the pandemic with delinquency rates rising much less than for CMBS in 2020, said Anuj Jain, a strategist at Barclays Capital in New York. Delinquencies for CRE CLOs peaked at 3.1 per cent in 2020, compared with a level about 3 times higher for CMBS, noted Barclays Research.

"They realised these managers have experience in navigating this environment," he said.

A challenge facing the market in Europe is the relative scarcity of CRE loans that could underpin the new products and provide them with greater liquidity, said Boyidapu.

"More CRE CLOs would improve that and the two markets would grow together," she said.

Aeon will work with lending platform WayPark Capital, private bank Arbuthnot Latham & Co and specialist SME finance platform Assetz SME Capital to originate and manually underwrite new loans, while also looking at opportunities to buy up credits in the secondary market. 

"We are actively pursuing a number of opportunities where there are performing portfolios offered by banks and originators who are either looking to exit commercial real estate lending or de-risk their books," said Aeon's Churchill. Bloomberg

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