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(Bloomberg) — Credit Suisse Group AG 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.

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The Swiss lender will furnish Aeon Investments Ltd with up to 900 million euros ($899 million) to help bundle up loans and issue bonds secured against them known as commercial real estate collateralized loan obligations, Aeon’s co-founders Oumar Diallo and Ben Churchill said in an interview. 

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The combined deals, funded by the three-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 fueled 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.

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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 says it’s 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 three 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, according to Diallo and Churchill.

Opportune Moment

“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.

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

With European real estate getting squeezed, the CRE CLO structure offers more flexibility than commercial mortgage-backed securities, a more traditional funding tool, said Iain Balkwill, partner at law firm Reed Smith LLP, 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.

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For example, “it’s unlikely a CRE CLO would have 100% 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 $45 billion worth of the securities were issued last year, according to Bloomberg data.

That’s more than five 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 pounds ($254 million), which was arranged by Credit Suisse. 

Economic Shock

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 Inc. in New York. Delinquencies for CRE CLOs peaked at 3.1% in 2020, compared with a level about three times higher for CMBS, according to Barclays Research.

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“They realized 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 Ltd. and specialist SME finance platform Assetz SME Capital Ltd 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.