The commercial mortgage-backed securities (CMBS) market is beginning to defrost — faster than many had expected, but definitely slower than anyone had hoped. But, it's much too early to say that a robust CMBS market is reemerging, simply because new CMBS issuances have been unimpressive.
Since June 2008, there have been only a handful of new-issue CMBS deals, and all but one were single-borrower deals that closed during the fourth quarter 2009. Last month, The Royal Bank of Scotland Group (RBS) created some buzz by bringing the first multi-borrower deal to market, but it was relatively small at $309.7 million.
“These deals were welcomed because we hadn't seen anything for months,” says Lisa Pendergast, managing director of CMBS strategy and risk for New York City-based Jefferies & Co. Inc. “But they didn't make you think it was the beginning of something big…. Still, these are positive steps. Unlike first half of 2009 when you didn't have folks willing to lend, now they're willing to lend, if only for the very best properties.”
That's a marked change from when even marginal borrowers were able to finagle conduit financing because bond investors were so ravenous. At the same time, conduit lenders were able to attract institutional quality borrowers and assets because their pricing was more competitive than portfolio lenders.
“During the heyday, CMBS was cheaper and got the best assets,” says Gerry Mason, executive managing director of New York City-based Savills Granite. “Now CMBS is getting the stuff that portfolio lenders don't want.”
Mason isn't referring only to sponsorship or asset quality, but also to loan size. While portfolio lenders are active in the market, they have allocations and diversification requirements. Large loans might exceed those requirements.
Mason points to the recent CMBS deals done with Ramco-Gershenson Properties Trust as an example of a borrower with a class-B retail portfolio that would not appeal to a portfolio lender. The REIT recently closed on a $31.3 million CMBS loan with J.P. Morgan, securing a loan at 60 percent LTV for two retail properties at a ten-year term at a fixed rate of 6.5 percent.
Similarly, Glimcher Realty Trust closed a $55 million CMBS loan with Goldman Sachs Commercial Mortgage Capital, L.P. for The Mall at Johnson City in Johnson City, Tenn. The 10-year loan has a fixed interest rate of 6.76 percent. The REIT also obtained a $46 million CMBS loan through Bank of America, N.A. for Polaris Towne Center in Columbus, Ohio. The 10-year loan also has a fixed interest rate of 6.76 percent.
Interestingly, retail assets have emerged as one of the most attractive property types for both CMBS originators and investors, despite ongoing concerns about consumer confidence and retail spending.
There was a time when lenders ranked retail properties alongside hotel assets as something to stay away from because of uncertainty within the sector. Today, retail is seen as far more attractive than hotels and marginally more attractive than multifamily. It stands shoulder to shoulder with office and industrial, according to experts.
Like retail property investors, lenders consider grocery-anchored retail centers attractive given their recession-resilient qualities. Power centers are less attractive because of the number of closures in the big-box segment. However, power centers with market dominant boxes still look good to conduit lenders, particularly those in well-established markets.
In contrast, malls and lifestyle centers are pretty much out of favor, Mason notes. He explains that there are very few fortress malls to finance; instead, the majority of mall inventory is class-B assets that are located in secondary or tertiary markets.
Retail properties that were built around new housing developments are the least attractive of all retail assets. These properties are the most vulnerable to vacancy and re-leasing risk, experts note.
“I think that there is a very good case that well-located, anchored retail with a strong sponsor is a viable product,” says Mark Doris, national business development director for San Francisco-based Wells Fargo's commercial mortgage origination group. “When you get away from that, every deal has to stand on its own.”
Dipping a toe
Industry players have nicknamed this new world of conduit lending CMBS 2.0, but the moniker is more a clever turn of phrase rather than representing a new kind of lending. In fact, it seems more like a step backward rather than a step forward. The way lenders are acting today is to try and get back to the kinds of conduit loans originated between 2000 and 2004. During that period, banks embraced CMBS as a way to make money, but were judicious in the amount of leverage they provided.
Today, healthier banks and life companies are cautiously providing term sheets for conduit loans and pooling loans for securitization. But, many banks that were major CMBS players are still suffering with underwater assets across their lending business, not just in commercial real estate.
It's important to note that the banks that have originated and issued CMBS recently have closed the pools and priced the bonds in short order so they don't have to “warehouse” the loans on their balance sheets.
“There has been so much balance sheet damage that a lot of people are saying that there is no chance they can go to their boss and tell him they want to build a pool of loans to hold on balance sheet,” says Manus Clancy, a senior managing director at New York City-based Trepp LLC.
For 2010, Trepp predicts $25 billion to $30 billion of new CMBS, a big drop from 2007 when deal flow reached $207 billion, but certainly a big improvement over the $2.2 billion in 2009 and $8.9 billion in 2008.
“I think the industry will rev up because I have clients who were not in the market for making real estate loans for securitization last year, and now they are in the market,” says Michael Gambro, co-chairman of the capital markets department at global law firm Cadwalader. He says he has been involved with nearly every new issuance CMBS deal that has come to market in the past eight months.
This still developing market for new CMBS is awkwardly juxtaposed with growing defaults and delinquencies from vintage CMBS, particularly loans originated during 2006 and 2007. Even the most confident fixed-income investors have been shaken by increasing CMBS defaults.
For example, Jefferies & Co. anticipates the fixed CMBS delinquency rate will top out at 12 percent to 13 percent during this down cycle, with the 2010 year-end delinquency rate at 11.6 percent. By far, hotels are in the worst shape, followed by multifamily. Office, retail and industrial have delinquency rates ranging from 4.39 percent to 5.27 percent.
Simple structures
The thawing of the CMBS market began with very simple issuances — single-borrower deals, which are just a small subset of the CMBS world overall. Traditional multi-borrower conduit deals that made up the majority of the market prior to the credit crisis have been slower to emerge.
The Federal Reserve and U.S. Treasury introduced Term Asset-Backed Securities Loan Facility (TALF) in March 2009 to help the asset-backed securities (ABS) market including CMBS. By providing equity and debt capital, these programs supported lenders by making collateralized securities more valuable to investors. TALF for legacy CMBS expired in March, and TALF for new-issuance CMBS is scheduled to end in June.
TALF restarted the ABS market by offering liquidity. After the initiation of the TALF loan facility, ABS issuance averaged $14 billion per month compared to $1.6 billion in the six months prior.
But TALF has had less of an effect on CMBS. TALF provided loans to purchase $4.1 billion in legacy CMBS (issued before January 1, 2009), but there was only one new issuance CMBS deal expedited by TALF — a $400 million deal with Columbus, Ohio-based shopping center REIT Developers Diversified Realty Corp. However, even the DDR transaction saw minimal participation through TALF, with only $72.2 million or 22 percent of the DDR AAA tranches pledged to TALF, according to Jefferies & Co.
“By the time the DDR deal came to market, there was enough pent up demand for low-leverage high quality real estate paper that TALF wasn't necessary,” Gambro says.
Yet single-borrower deals like DDR's set the stage for CMBS to come back faster than many expected. Subsequent single-borrower deals with Flagler Development Group ($360 million) and Inland Western Retail Real Estate Trust Inc. ($500 million) were also well-subscribed.
The Inland deal, for example, saw AAA $58.4 million A-1 class priced at swaps plus 150 basis points and the $330.6 million A-2 class at swaps plus 205. The AA and A classes priced at swaps plus 360 and swaps plus 420 respectively, while the BBB- class priced to yield 9 percent.
Mason says he's been talking with conduit lenders for a couple of deals and has been “surprised” at how close CMBS rates were to what insurance companies are offering. CMBS originators are willing to go to 70 percent leverage on a 10-year fixed rate in the 6.50 to 6.75 percent range with 30-year amortization.
The RBS deal, initially planned as $500 million issuance, was sold as a multi-borrower securitization with many properties, but it actually only had six borrowers.
The smaller pool size was not caused by lack of investor interest, according to experts. In fact, the deal received strong demand and pushed pricing tighter than initial expectations to 4.5 percent yield or swaps plus 500 basis points.
Instead, banks are tentative about originating a large CMBS — both volume and the number of loans — that will have to sit on their books until they can sell it off to investors. The RBS deal closed, securitized, priced and sold to investors all on the same day, eliminating the need for warehousing.
Yet, the banks on the leading edge of CMBS 2.0 are demonstrating a rare creativity and courage, experts contend. “They're thinking this is an opportunity to make some money on the deals, but it's also an opportunity to make a splash and paint themselves as creative enough to revive the market,” says Tom Muller, a partner in the real estate and land use group at Manatt, Phelps & Phillips.
Wells Fargo, for example, has expanded its commercial lending platform to include CMBS. Last year, the bank wrote “a fair amount” of new commercial real estate loans in 2009 that it held on its books, Doris notes. He expects the bank's initial CMBS offerings will include 20 to 30 borrowers and that the bank will “take the warehouse risk” until they are able to pool them for securitization.
Strong investor appetite
As demonstrated with recent CMBS deals, investor demand has returned with surprising force, experts note.
Banks that have brought CMBS to market recently have reportedly had a series of meetings with large fixed-income investors to determine exactly what kind of deals investors want to see come to market and what they're willing to buy.
These recent meetings between originators and fixed-income investors have resulted in quasi “made-to-order” CMBS. Investors are not only determining what they're craving but also the menu options.
Investors want strong borrowers with high-quality, stabilized properties with strong in-place cash flow. Fixed-income investors find anything else — marginal borrowers or so-so properties — undesirable, and therefore, undeserving of loans.
Of equal importance is the strict underwriting and conservative terms. Fixed-income investors got their fill of CMBS collateralized with interest-only loans with 85 percent LTVs. Today, they're looking for fully amortized loans with conservative LTVs — 70 percent is pushing it, experts note.
The biggest obstacle for CMBS 2.0 may be timing. “There are a lot of people who want to borrow, and there are a lot of lenders who want to make loans, but it takes some time to warehouse the conduit loans,” says Malay Bansal, head of portfolio management & advisory services for commercial real estate and CMBS at NewOak Capital LLC in New York City. “Between the time it takes to make the loan and the time the bonds are priced, you could take a loss if the market moves in another direction.”
A longer version of this article appears at retailtrafficmag.com/features.