OREANDA-NEWS. Fitch Ratings says in a new report that European CMBS has made some progress on addressing the sector's more contentious structural weaknesses, although without delivering on calls for greater standardisation of documentation. With CMBS set to remain dominated by complex large financings of secondary property portfolios, vigilance is key to preventing deterioration in terms as competition in real estate debt market intensifies.

Issuer profit extraction mechanisms that were skewed in favour of the originator have been amended: the class X notes are subordinated upon loan default and tend to be more appropriately haircut for issuer costs. However, there is still scope for profit to be extracted from defaulted loans in the form of surplus interest recoveries.

Interest rate caps have so far been used instead of swaps. The more egregious examples of pre-crisis hedging - the long-dated swaps that were intended to allow for greater loan leverage by tapping cheaper sections of the yield curve - are unlikely to make a reappearance.

The lack of revaluations commissioned by servicers was a bone of contention in pre-crisis transactions once liquidity dried up, from 2007, as this in effect defeated the purpose of LTV covenants. In the first wave of post-crisis transactions, loan agreements provided for automatic revaluations at prescribed intervals.

Confusingly however, some recent transactions are using the servicing agreement to make up for laxer facility agreements when it comes to restoring automatic revaluations. Fitch does not take a positive view of this innovation as it may eventually give rise to servicer discretion over revaluations being reinstated.

The related issue of the controlling class, and its influence over special servicing, has also been tightened. Significantly, the interests of the controlling class in post-crisis transactions are now more aligned with other noteholders, although the bolder industry suggestion of enfranchising more senior investors in special servicer appointments has not materialised.

In addition much of the ambiguity around sequential principal triggers has been removed. This ambiguity may have contributed to the widespread sanctioning of maturity extensions for loans in special servicing during the crisis, where the alternative - formal loan default - would have deprived "valued-out" controlling class investors from further principal distributions. In post-crisis CMBS, a transfer to special servicing is explicitly recognised in sequential triggers.

The coveted standardisation of transaction documentation may only come about with a return of multi-loan issuance. With balance sheet limitations militating against portfolio aggregation among investment banks, EMEA CMBS issuance remains significantly down from its 2006 peak of EUR62bn. Underlying loan volumes are growing, but most loans are being syndicated - particularly those secured on higher- quality and, often high-profile, properties.

Without standardisation, CMBS is more susceptible to structural erosion as competition in the wider real estate debt markets intensifies. Absent a concerted effort to employ simpler structures capable of enjoying greater market liquidity, regulators are more likely to maintain a highly cautious approach to the asset class. Moreover, facing significant credit complexity an already thin investor base reliant on specialist talent risks being further depleted.