CMBS defeasance hit a record high in 2015 with $21.2 billion and a total of 1,431 loans that were either defeased or replaced by government securities. That volume was up 11.5 percent over the $19 billion in defeasance that occurred in 2014, according to research firm Trepp.
The spike in defeasance activity over the past two years has helped to reduce the wall of looming loan maturities expected to hit the market in 2016 and 2017. The balance of CMBS loans scheduled to mature throughout 2017 continues to shrink, with $67.85 billion scheduled to mature in 2016, followed by $100.59 billion in 2017, for a two-year total of $168.44 billion, according to Morningstar. That volume is down from $222.48 billion at the beginning of 2015.
Key drivers behind the 2015 defeasance activity included the recovery in property values, still low interest rates and access to capital. However, volatility and wider spreads in the CMBS market have many borrowers putting defeasance plans on hold.
“If you had asked me before the end of last year, I would have said that this is not a high water mark and that it could remain high in 2016,” says Joe McBride, an associate at Trepp.
Recent volatility in new issuance spreads has changed the lending atmosphere and has, at least for now, taken away some of the incentive to resolve loans in advance of maturity dates.
Spreads started to widen at the end of last year and have expanded further in 2016. For example, AAA conduit spreads that were around 90 basis points last June are now in the 165 to 175 range. Spreads in the BBB- tranches have moved from 375 to 400 basis points six months ago to 750 to 900. Some of the challenges that persist in the global economy, along with the drop in oil prices, have impacted fixed income vehicles, which has trickled down to hit CMBS spreads, notes McBride.
The dramatic widening of spreads over the past six months has had an impact on new CMBS issuance. As of early March, U.S. issuance was at $13.6 billion, which is down more than 30 percent compared to the $20 billion in issuance that occurred during the same period of 2015, according to Commercial Mortgage Alert, an industry newsletter.
The wider spreads are being passed on to borrowers in terms of higher rates for new issuance. There is also greater pricing uncertainty as B-piece buyers in the CMBS market have become more selective about the loans that they allow into CMBS deals. As such, CMBS lenders are building more “wiggle room” into deals related to the rate in order to account for the diminished appetite and the volatility in the market, says McBride.
Last year was a booming year of defeasances, and activity has definitely slowed in 2016, agrees Paul Cairns, senior vice president and managing director, capital services, with debt and equity provider NorthMarq. Cairns also heads the defeasance services team for NorthMarq. “Because there is more volatility in the marketplace, people are taking more of a wait-and-see approach,” says Cairns.
Defeasance, or the early resolution to outstanding debt, is commonly done in the last two years of a loan.
On the commercial side, borrowers are likely to wait until closer to the end of their loan to defease with the hope that things stabilize in the bond market and spreads narrow, says Cairns. On the multifamily side, borrowers are still defeasing early as they can refinance at attractive rates through Fannie and Freddie with rates that are still below 4.5 percent, he adds.
Borrowers that defease loans often roll into a new CMBS loan, and the higher costs of new issuance has certainly been a deterrent. CMBS rates that were hovering at 4.0 to 4.25 percent last May were a powerful incentive. Rates have since jumped 100-plus basis points to about 5.25 percent.
“There is really no reason to do a defeasance, unless of course they think they market is going to be a lot worse when the loan becomes open for pre-pay,” says Ory Schwartz, a senior vice president and managing director at NorthMarq.
In addition, the majority of the new CMBS loans being done are not locking rates until the time of close. So, it is a little like a game of musical chairs, notes Schwartz.
“The best thing that we can do is to manage our client’s expectations and keep our finger on the pulse of the market to make sure that whatever the lender says they can do is in line with what is going on in the market,” he adds.
The defeasance activity that has occurred in the past two years has lightened the load of CMBS loan maturities that are set to expire in 2016 and 2017. “It has chipped away for sure, but there is still a ton that needs to be refinanced or purchased or whatever happens,” says McBride.
So far, the market has been digesting those maturing loans fairly well. In 2012, for example, there was a mini-wave of five-year loans that came due that had no adverse effect in terms of higher delinquencies. However, the wider spreads, coupled with new CMBS regulations and what appears to be a diminishing appetite among B-piece buyers, could create some added challenges ahead, notes McBride. Some of the marginal loans could have trouble, he adds.