CMBS: Keep Calm and Carry On
Carl Gaines Sept. 7, 2012, 8:30 a.m.
Anyone who follows the CMBS market, especially in relation to its contribution toward funding the massive amount of commercial real estate loans coming due the rest of 2012, knows that it can be a topsy-turvy ride. But experts tell The Mortgage Observer that despite the load of coming-due loans and a CMBS market that’s a fraction of where it was pre-crash, there’s no reason to panic. This, even as delinquency rates for CMBS climb higher and higher.
According to data from Trepp, initially there was roughly $70 billion in CMBS set to mature in 2012. As of the end of August, $38.6 billion of that was still outstanding, though this figure “is somewhat skewed by loans past their maturity dates but not modified,” one analyst said. These loans will likely meet differing ends, through extensions, modifications or liquidations. Just counting loans that are current, $13.5 billion is due to mature for the rest of the 2012.
Of note is the fact that several firms re-entered the CMBS market in 2011—among them Prudential, through a joint venture with Perella Weinberg, and KeyBank Real Estate Capital, which initially had a table funding arrangement with JPMorgan. Prudential Mortgage Capital Company said in a release at the time that the venture would “provide its borrowers with access to the commercial mortgage backed securities market without creating a new CMBS warehouse.”
Clay Sublett, a senior vice president at KeyBank who is in charge of CMBS as well as life insurance company placement and the FHA group, said his firm’s initial table funding arrangement allowed for a degree of protection too.
“That was to allow us to protect ourselves from warehousing risk,” Mr. Sublett explained. “In hindsight it was a good move because in July and August of 2011, for a combination of factors, the CMBS market went through a hiccup.”
He referenced three factors during this period—the debt ceiling debate, Standard & Poor’s downgrade of the U.S. credit rating and the agency’s withdrawal of its rating on a $1.5 billion Goldman Sachs and Citigroup pool of CMBS—as particularly pernicious. This all created a perfect storm, keeping the CMBS market tamped down at a time when it was crucially needed.
“What resulted from that,” Mr. Sublett continued, “was that CMBS spreads widened roughly 100 basis points.” He cited the lack of hedging products designed to protect warehoused loans as one reason the market isn’t more improved.
Christopher Bushart, a senior director at Fitch Ratings in the structured finance and commercial mortgage division, echoed this sentiment. “A big difference with the way that loans are originated now compared to how it was prior to the bubble bursting is that banks—in just the assessment of risk—they were much more comfortable warehousing, so you would always have a supply of loans,” Mr. Bushart said. “This was just a machine.”
Fitch Ratings, for its part, predicted in early August that the next 12 months would prove “challenging” as far as CMBS maturities were concerned. Fitch at the time saw $24 billion in deals it rated set to come due during that time frame, 41 percent of which, under the rating agency’s defined stressed refinance parameters, will not be refinanced. The problem child is that 2007 vintage of loan, underwritten to some pro forma income.
“What could be interesting is a loan on a property that was 70 percent occupied and they were saying that it was going to get to 90 within 12 months, and all of the numbers were based off of that and it didn’t happen,” said Jonathan Teichmann, a director at Fitch Ratings in the structured finance and commercial mortgage division. “That’s probably not going to get refinanced, certainly not without some new partner or infusion of cash to pay down the existing debt.”
Melissa Farrell, a managing director at Prudential Mortgage Capital Company, said that Prudential has looked at the issue of looming maturities in the CMBS market and loans coming up for refinancing. “It’s somewhere around $350 billion a year, give or take,” she said. “If you look at that $350 billion, where is the capital going to come from to refinance that?” Ms. Farrell estimated that about $50 billion would come from life companies, $50 billion from the agencies, $100 billion from banks and about $50 billion from CMBS.
“It leaves you about a $100 billion gap,” she said. Options left include deleveraging through recapitalizations, mezzanine financing and equity write-downs. In New York, a market unlike any other, this is not so dire. “You see that in New York—people coming in and putting fresh equity in to deals,” Ms. Farrell said. “And so we feel it’s manageable. There’s money to fill that gap, and it’s already being filled. I think overall it will be fine. It’s not so insurmountable.”
The variety among markets is one reason industry experts say that its best when considering the outcome of loans coming due to take it on a case-by-case basis.
“You need to be careful not to over simply,” said Mr. Sublett, when asked about a potential gap in capital available to refinance these loans. “It’s very property-by-property, loan-by-loan specific. Some borrowers are well-capitalized, other borrowers are not well-capitalized so it just depends on the individual circumstances of the loan in question.”
Ms. Farrell said that loans that aren’t secured by high-profile New York office buildings might face pressure in the future. “I think it’s more those tertiary, smaller conduit deals that either are going to have to just deleverage or write off the equity on,” she said. “Those are the tougher ones to refinance—when you start getting into those tertiary markets.”
In addition to the market, the asset type comes to bear as well, as evidenced in investment research firm Morningstar’s August 2012 Monthly CMBS Delinquency Report. Morningstar added 445 loans in 203 CMBS transactions to its Watchlist, a measure of loan and property level credit risk, during the month of July. Of these, about 36 percent—or $1.9 billion across 116 loans—represented additions by unpaid balance in the retail sector. Office accounted for roughly 28 percent—or $1.5 billion across 87 loans. These new additions to Morningstar’s Watchlist, however, didn’t necessarily reflect property types that experts told The Mortgage Observer are most troubled.
“Compared to historical numbers we’re still at pretty high delinquency rates across all the property sectors,” said Mr. Bushart. “But retail I guess you could argue that’s performing most strongly.”
As we close out the rest of 2012, predictions for CMBS issuance for the year vary. Following its table funding arrangement, KeyBank has contributed collateral to one securitization as an originator already, Mr. Sublett said. He predicted that over the next 60 days, two more securitizations would follow—with its UBS 2012-C3 scheduled to price in mid-September and a contribution toward a Deutsche securitization in the wings as well.
Mr. Sublett agreed with the generally accepted prediction of a $35 billion to $40 billion year-end result.
“Most of my colleagues in the industry would certainly like to see CMBS larger than—let’s just pick a number—$40 billion,” he said. “But my argument is that it is still significant.”
Mr. Teichmann, at Fitch Ratings, agreed, saying that the number he’s hearing is $35 billion as well. “In terms of the deal flow that we’re seeing, there hasn’t been any pause or slowdown,” he said. “And you’re seeing not only a steady volume of transactions, but the balances on the transactions are increasing as well. Those two elements should lead to surpassing where it was that we were last year.”
Asked about headwinds facing CMBS, Mr. Sublett again referenced the importance of protecting the value of loans held in the warehouse and compressing the time that they are held. Another headwind mentioned, though, proved to come from within.
“In the CMBS industry far too often the industry tends to have a herd mentality,” he said. “One of the things that we struggle with is, ‘Do we repeat the sins of the last cycle and do we damage the credibility that we are rebuilding with investors, including B-piece buyers and investment-grade buyers?’ What you want to do is make sure that you are rebuilding the credibility slowly and carefully.”