When speaking to market participants and commentators about Europe’s first ever CRE CLO, more frequently than not there is an inference that the Starz Real Estate CRE CLO is the first since the global financial crises (GFC). This is certainly a view that has merit, thanks to the fact that on the eve of the GFC, we did witness the arrival of CRE CDO technology on European shores which has a strikingly similar appearance to a CRE CLO. On a superficial level, this view can largely be attributable to both structures featuring loans secured by commercial real estate (CRE), the existence of a collateral manager (or equivalent) and the resultant investment piece is a rated debt instrument. If however you delve into the vagaries of these two different structures, it soon becomes apparent that CRE CLO technology is new to the European market and that the Starz deal is a true first of its kind.
Indeed, their chief distinguishing feature is the nature of the underlying collateral. In the case of CRE CLO, these structures are designed to house whole loans secured by commercial real estate that is transitional in nature. In the case of CRE CDOs, heterogeneity is the name of the game, with the collateral pool comprising a whole myriad of debt interests secured by CRE including whole loans, B-Notes, pari-passu tranches, mezzanine loans, tranches in mezzanine loans and of course CMBS notes.
These products also serve different purposes. Rather like CMBS, CRE CDOs can be considered an arbitrage tool where investors in this collateral or indeed the originating bank set up structures in order to off-load collateral from their balance sheet and reap the rewards of the excess spread derived from there being a lower weighted average interest rate on the securitisation compared to the return on the collateral. In other words these structures were ideal in absorbing all the high yield CMBS by-products. Conversely, CRE CLO technology has a seemingly more noble existence in the form of a balance sheet financing tool for debt funds that originate CRE loans.
On a more macro level, both structures have very different prospects. CRE CDO technology can be considered outdated, thanks to its short-lived existence in Europe with less than a handful of transactions taking place. This is largely due to the fact that the public issuance window was extremely small with the first deal of its kind in December 2006 and the onset of the GFC seven months later which precipitated an immediate cessation in primary activity. Punitive regulatory capital treatment for re-securitisations, a lack of suitable underlying collateral and no investor appetite for this product has meant that CRE CDO has been confined to the doldrums and unlikely to re-emerge anytime soon (if at all). As for the CRE CLO, this is very much the new kid on the block, which currently benefits from huge demand, decent set of tailwinds and a really promising blueprint in the form of the United States market which is currently witnessing exponential growth of the product.
CRE CLO is therefore a very exciting prospect for the European market and there is no reason why we will not witness an explosion of activity in the coming months and years ahead. Ultimately, time will only tell whether it can truly live up to this hype, but one thing that is abundantly clear is that CRE CLO and CRE CDO is not the same product and to suggest otherwise risks tarnishing this new and exciting technology with an old and outdated brush.