CMBS Stages a Comeback

CMBS activity came back strongly during February with more than $6.5 billion in new securitization reported. Additionally, Freddie Mac brought two multifamily-backed offerings totaling $1.86 billion to market.  February’s level of activity is almost two-thirds of all CMBS deals offered in 2010.  The level resembles 2007, when commercial mortgage-backed securities offerings were at their peak.  Because of CMBS’ resurgence, the commercial real estate market is both bullish and fretful.  The rising volume in CMBS loan origination is a welcome sign that liquidity is returning to the markets.  The fact that a relatively large amount was created during the year’s shortest month is raising worries that the still delicate condition of commercial real estate is being sustained by too-eager lenders.

“I think it is clear that CMBS is coming back — something that is probably positive in the short-term as far as jump-starting the investment marketplace and helping to establish a new baseline for pricing while, hopefully, alleviating some of the distress issues out there. But is it a good thing in the long run?” asks Garrick Brown, Northern California research director of Cassidy Turley BT Commercial asked.

“As the number of participants in CMBS lending continues to increase, the competition to originate loans eligible for new CMBS deals will be fierce,” said John O’Callahan, capital markets strategist for CoStar Group.  “Insurance companies, GSEs (government-sponsored enterprises), and even the healthier large banks will lend on the best properties in desirable markets, while CMBS originators will compete among themselves for the leftovers. They will have to cast a wider net across all markets to garner the volumes anticipated in 2011.”

Just 15 months after the initial CMBS issuance, structural, leverage and issuance amount trends have quickly changed, according to Standard & Poor’s. The ‘CMBS 2.0’ market started with the pricing of three single-borrower transactions with relatively simple structures in late 2009; more recent deals have been more complex, more highly leveraged and with significantly higher opening balances.  “Most recently, three $1.2 billion plus conduit/fusion deals were issued this month, each of which included an average of 10 principal and interest bonds and two interest-only classes.  Compared with late-2009 issuances, the newer multi-borrower deals have higher leverage, less debt service coverage and somewhat looser underwriting,” says Standard & Poor’s analyst James Manzi.

Despite the good news from February, Trepp LLC, a provider of commercial mortgage-backed securities (CMBS) and commercial mortgage information, analytics and technology to the global securities and investment management industry, found that the CMBS delinquency rate rose 9.34 percent in January. The value of delinquent loans exceeds $61.4 billion.  “While the rate continues to head higher, optimists can point to the fact that the rate of increase is significantly smaller than it was in the prior two months,” said Manus Clancy, managing director of Trepp LLC.  “Pessimists can counter that the jump comes despite the fact that new issues continue to make their way into the calculation and servicers continue to resolve troubled loans.”

The re-emergence of CMBS does not mean a return to the go-go years of 2004-2007. If $35 billion is issued in 2011, it will total just 15 percent of the peak.  Additionally, the revised underwriting criteria are far more conservative and issuances are smaller and geared toward low-risk assets.  Significantly, originators are more frequently required to retain stakes in the offering.  The CMBS market is expected to steadily climb this year and could see additional issuance in 2012, perhaps rising to $100 billion by 2013.  This would still be less than half the peak level of 2007, but a substantial amount, bringing desirable liquidity to the commercial real estate market.