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One of the desirable features of a CRE CLO is the ability of the collateral manager to buy and sell loans at will or, going one step further, originate loans directly out of the securitisation structure itself. Although the economic merits of such a feature are emphatic, this feature was purposefully omitted from the one and only CRE CLO to grace the European market, and instead the Starz transaction was comprised of a static portfolio of loans with principal proceeds applied towards repaying the notes. The absence of this important and compelling feature has not gone unnoticed and questions have been raised in some quarters about if and when we will witness the arrival of CRE CLO backed by a dynamic pool of loans. Although conventional thinking would infer that we are someway off given that there has only been the Starz CRE CLO deal to date, I would suggest that we may witness the arrival of this feature sooner rather than later thanks to the inevitable demand for bridge financing and the abundance of transitional CRE.
Indeed, at the present moment, bridge financing is receiving a heightened level of attention with a number of factors contributing to this. Chief amongst these is the fact that the loan origination market continues to be challenging and is clearly demonstrating that it is not immune to market turbulence. Compared to the position over the past few years, there has been a marked increase in the cost of credit which can be attributed to market volatility, a heightened level of uncertainty as well as some lenders closing their lending books until conditions improve. To add insult to injury, the exorbitant price of interest rate caps has added to these financing costs, and with it borrowers are once again embracing interest rate swaps as an interest rate hedging strategy. Furthermore, on the equity side a combination of rising cap rates and looming concerns over a significant economic downturn has had a negative impact on property valuations, which in turn has had a direct impact on the amount of debt that a lender is willing to lend but also the purchase price that a seller can command as part of any sales process.
The corollary of all of these woes is that there is little impetus for Borrowers to tie themselves into expensive term debt which is difficult to extricate themselves from, without being burdened by prepayment penalties and potential close-out payments under a swap. Bridge financing would appear to be the perfect solution for those borrowers that are in the unenviable position of being forced to raise fresh debt whilst at the same time looking to ride-out the current wave of volatility. Bridge financing also has the added advantage of affording borrowers the breathing room to reposition and stabilise transitional assets, and thus enable them to qualify for a cheaper form of long term debt. In this regard there is no shortage of transitional properties and volumes are likely to increase further as a consequence of landlords embracing best practices of ESG, re-positioning properties following the fallout of Covid, the eradication of voids as tenants succumb to the macro-economic stress as well as repurposing properties to meet ever changing consumer patterns and behaviours.
The inescapable fact is that bridge finance has an integral role to play in being able to provide borrowers with the space required to execute their business plans and somehow stave-off being burnt by market volatility. These stark facts will reverberate for proponents (like myself) of CRE CLO technology; after all, it is the financing of transitional assets and bridge loans that has fuelled the exponential growth of the US CRE CLO market. With the European market exhibiting a bountiful supply of transitional assets alongside what promises to be huge demand for bridge loans, then there is no reason why European CRE CLOs will not follow the same trajectory of growth experienced by its American cousin. The ramifications of this could be massive; not only will the flood gates be opened for a significant volume of CRE CLO issuance, but the market will also witness an unprecedented level of evolution of the product as it is finessed to cater for short-term loans, and with it a staple feature will be the ability of the collateral manager to re-invest loan principal proceeds in originating and buying new loans.
Although market conditions have clearly created a bedrock of challenge, the fact is that these are prime conditions for innovation to thrive and with it I would surmise that when the CRE CLO market does take-off (which it will!!), not only will bridge loans be a major part of this, but the presence of a dynamic pool of loans will become a mainstay of the European CRE CLO.