Europe’s commercial mortgage-backed securities market appears to be reopening with the first deal since May 2022, but its rejuvenation will be limited without reform of Solvency II and the capital charges it demands for real estate investments.
Insurers like real estate because it offers them returns over a long duration that matches their liabilities. The capital charges placed on insurers that hold CMBS paper, however, are so high that it does not make sense for them to participate, though they are otherwise natural buyers.
To avoid Solvency II's capital charges, insurers bypass the securitization market and gain real estate exposure directly by buying buildings.
If an insurer locks itself into owning a building, the capital charge is 25%.
In doing so, it also incurs the management costs of running a business in which it has no expertise and an asset that could take a long time to sell at a fair price.
But if it buys a five year triple-A rated CMBS secured by a loan on the same building, with all the protection and credit enhancement securitization affords and none of the hassle of maintenance and dealing with tenants, the capital charge is 62.5%.
As long as this continues, the European CMBS market will never achieve scale.
The capital charges are that high because CMBS does not qualify for the EU's ‘simple, transparent and standardised’ label. Though CMBS can be simple and transparent, by its very nature it is unlikely to be standardised.
Surely two out of three ain't bad. When securitization is done properly it makes risks easier to understand and more easily quantified.
Generally, European securitization regulators take a cautious but collaborative approach. They may proceed more slowly than some would like but regulation is moving in a favourable direction for most of the market. CMBS needs a tailor-made solution to allow all investors to benefit from that.