Fueled by easy money from the Federal Reserve and stronger economic activity, the commercial mortgage-backed securities market is back from the dead, though it remains far from frothy precrisis levels.
U.S. CMBS origination is believed to have soared 89 percent to around $84 billion in 2013, and forecasters see another bump to about $100 billion next year.
All of this is good news for borrowers, who have regained a crucial source of credit, especially for those in the market for the more leveraged loans that the CMBS market specializes in.
“We’re still seeing the market get its feet back under itself after the Great Recession and credit crunch,” said Jamie Woodwell, vice president of commercial/multifamily research at the Mortgage Bankers Association. “All signs are pointing to another year of growth for CMBS in 2014.”
CMBS origination remains a far cry from the heady pre-Lehman Brothers days. In fact, according to MBA data, 2013’s projected $84 billion in U.S. CMBS origination is 64 percent lower than the peak of $230.2 billion in 2007.
“We are still a country mile from where the market was in 2007,” said Paul Vanderslice, former chairman of the Commercial Real Estate Finance Council.
Still, U.S. CMBS origination had plummeted to near zero—just $5 billion in 2009—as the market collapsed in the wake of the worst financial crisis since the Great Depression. “The market seized up. It virtually disappeared,” Lawrence Longua, a professor at New York University, said of the plummet CMBS took during the period.
While uncertainty over Fed policy remains a risk for the CMBS market, analysts don’t sound overly concerned so long as interest rates don’t climb too high.
Mr. Longua said the Fed decision to begin dialing back quantitative easing this month may cause this year’s CMBS origination to be “heavily front-loaded.” Yet Mr. Woodwell believes if the markets continue to react calmly to the Fed moves, CMBS activity won’t be dramatically impacted.
So what has driven the bounce off the lows? The CMBS market has benefited from the overall improvement in economic activity that has lifted the real estate industry, as well as the Fed’s quantitative easing, which has helped keep interest rates at very attractive levels.
“Every single fixed income sector—high yield, asset backed, residential mortgages—everything is propped up somewhat because of the Fed,” said Mr. Vanderslice.
Uncertainty over Fed policy remains a risk for the CMBS market, but analysts don’t sound overly concerned so long as interest rates don’t climb too high.
Mr. Woodwell noted that the CMBS market has been able to “absorb” the rise in 10-year Treasury yields from around 1.6 percent earlier this year to above 2.8 percent “relatively easily.” He said the “challenge comes when there is greater volatility in rates, which can sometimes lead to a period of readjustment.”
CMBS activity is also being fueled by an estimated $300 billion in loans coming due over the next three years. “You have a wave of maturities, and the CMBS market is needed to absorb that,” added Mr. Vanderslice.
Leverage is also likely to ramp up as CMBS activity continues to climb. Average loan-to-value ratios rose to about 63 percent in 2013 from just below 62 percent the year before, Mr. Vanderslice said. He expects LTV ratios around the mid 60 percent range in 2014. “Leverage is definitely going up,” Mr. Vanderslice said.
Another potential risk to the CMBS market is declining underwriting standards.
In a recent report, Fitch Ratings noted a tendency for “poorer-quality properties and loan structures” to find their way into preliminary pools. “Often, they do not make the final pool cut, but the trend is another example of declining underwriting standards,” the credit firm wrote. Fitch also highlighted a concern that pools are being filled with small-balance, low-quality properties that “improve diversification but reduce property quality.”
Plus, there’s always the threat of overbuilding. Fitch said markets such as Charleston, Austin and Charlotte are expected to have supply growth that will impact vacancy levels in those markets, which are already slightly above the national average.
Mr. Vanderslice acknowledged the concerns among investors about credit quality but said “only time will tell” if they are credible. “They’ve gotten burned in this market once before, and they are diligent as it restarts,” he said.
Mr. Longua said for now it appears lending activities have been “much more disciplined and rational” than before the crisis, at least “until the next time we screw it up. Nobody remembers this stuff in good times.”